Alarming global economy trends

Sun, 23 Nov 2014  |  

Below is the article I wrote for the Adelaide Review. The link is here: https://www.adelaidereview.com.au/commentary/article/alarming-global-economy-trends 

Alarming global economy trends

There are some disconcerting trends unfolding in the global economy, as lurking behind every bit of positive economy news is a significant threat.

The good news centres on the US economy maintaining momentum with the unemployment rate falling sharply, and policy makers giving consideration to a tightening in policy in the New Year. Buoyant share markets and rising asset prices suggest favourable times for consumers and the economy. At the same time India, the world's fourth largest economy, is also forecast to experience a moderate acceleration in growth into 2015, as the recently elected Modi government steadily implements a broad-based agenda aimed at economic reform.

This is about as far as the good news extends in terms of the major economies. The Eurozone economies, which the World Bank estimates to be larger than the United States in terms of its share of global GDP, is floundering with growth bobbing in and out of recession. The Eurozone is also at risk of sliding into a period of deflation, which, if realised, would be poison for government finances and the prospects for reducing the unemployment rate from current levels of around 11.5 per cent.

Japan remains problematic. Despite what is now two years of aggressive monetary stimulus, the hints of more favourable economic news have recently stalled. So worried is the Abe government, it recently announced a further radical economic stimulus program, which appears to be fraught with risks given the parlous state of government finances in Japan. There may be some short-term gain but the medium-term outlook remains challenging.

The Chinese economy is somewhere in-between. Economic growth is widely forecast to remain solid at around seven percent, but the housing market is showing signs of stress, to the point where the banking sector and the economy, more generally, have unambiguous downside risks. Inflation is falling, which indicates a growing spare capacity and sub-trend growth.

This mixed news from different parts of the global economy is being reflected in commodity prices. In the past few months, the prices of some key commodities such as oil, iron ore, coal, gold and copper have fallen sharply. Prices are down by 20 to 30 per cent in just a few months.

This commodity price collapse suggests that demand is falling well short of supply or, in very simple terms, the global economy is faltering.

For Australia, a softer global economy and falling commodity prices are new challenges. Already, there has been a collapse in mining investment and, generally, pessimistic consumer sentiment is seeing consumer demand growth curtailed. Even before this most recent decline in commodity prices starts to impact on the economy, employment was flat and the unemployment rate was rising to the point where it is at its highest level in over a decade. Clearly, this is not good news.

Linked to this weakness in the labour market comes a potentially dangerous self-fulfilling cycle to a persistently weak economy. Wage growth has fallen to levels never seen in Australian modern economic history. Low wage growth crimps household incomes and the purchasing power of consumers, which indicates that consumer demand will weaken further into the New Year.

Even before this economic negativity from offshore hits the economy, the key indicators for the economy were below par. It will be very hard for real GDP to reach three percent.

There are a number of issues needed to address these obvious weaknesses in the economy. The easiest option, but one largely outside the control of the government, is to have the Reserve Bank of Australia reduce interest rates. This would free up cash flows, discourage savings and lower the hurdle for new investment, but the RBA seems unwilling to consider easier monetary policy while house prices in Sydney are rising rapidly. The RBA's independence from the government means that the pressure may soon come on the government to relax fiscal policy as a means of supporting economic growth and to stem the rise in the unemployment rate.

Policy choices are complex, especially on the budget. The government has increased the petrol excise and it is looking to tighten, rather than ease, fiscal policy as it strives for a budget surplus.

The biggest problem for the Australian economy in 2015 would be if the government stuck to this fiscal tightening agenda at a time when the negative influences from the global economy were dominating the positives and if the RBA was stubbornly refusing to cut interest rates for fear of adding fuel to overheated house prices.

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Or irrelevant. 

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