• Paul Atherton

Will Australia hit a recession?

Updated: Apr 1

(POST FROM 2018)

Recession or boom? Best or Worst?

I am often asked. Is Australia heading into a recession? And if so when?

My response is a little unorthodox, but I think pretty accurate.

We’ve been in a recession for some time. We’ve just not recognized it yet.

It kind of reminds me of the line from the movie ‘The Sixth Sense’ – “I see dead people, some don’t even know they are dead…”

How do we measure wealth?

The wealth of a country is usually represented through a statistical measure known as the Gross Domestic Product or GDP.

You might hear this on the evening news, where there are reports of a positive GDP. This means the Australian economy is expanding. If GDP is negative, this means the economy is contracting. A recession is defined as two consecutive quarters (or 6 months) of contraction (negative GDP) in the economy.

A contracting economy is characterized by high unemployment, layoffs and bankruptcies.

It’s not nice and it’s politically terminal and it’s why politicians will do whatever they can to avoid one.

Unfortunately, GDP does not always reflect the wealth creation in society and what I am suggesting is that for Australia, although we have seen GDP continuously expand for close to 25 years I believe we have not seen this reflected in the wealth creation of the average Australian citizen.

GDP is dead, but politicians and economists just don’t know it’s dead.

Let’s dig a little deeper

In Australia gross domestic product (GDP) numbers that are printed each quarter are an arithmetic number and are not synonymous with an increase in wealth for the citizens of the country.

We print GDP by pulling down (very strongly) on two main levers. Both of which do very little or nothing to create wealth for the average citizen. But print GDP. An arithmetic GDP.

These levers are the following:

1. Massive Immigration

2. Debt Induced Asset Bubbles

Immigration generates GDP because every person that comes into Australia MUST by definition participate in the economy. They don’t even have to do very much, but at a minimum, a new immigrant will consume, eat food, house themselves etc.

But does it raise the GDP per capita? In other words, does mass immigration raise the living standards and the general wealth and well-being of the current incumbent residents.


Asset Bubble

But let’s talk about the second lever – an asset bubble. How does this ‘print GDP’?

When we have an asset bubble such as we are seeing in housing prices, we have an up-tick in consumption. Partly because of the wealth effect (as house prices rise, people feel wealthier and tend to consume more) and partly because we have more money (via debt) released into the economy.

That’s it. Two levers

1. An asset bubble or 2. High immigration

Who’s in control?

Australia and in fact any country interacts with other countries via trade. This is captured in the balance of payments. We trade goods and services with our international trading partners. Agreed? Yes, perfect.

This is shown in the current account side of our balance of payments (BOP). The balance of payments equation is an accounting identity. It CANNOT be violated. It must always hold true. And it does. Here it is:

BOP = Current Account + Capital Account = 0

Still with me? Good.

I think most economists and I are still on the same page at this point. But it starts going south rather quickly from here.

What you will be told is that the Current Account captures our goods and services that we buy or sell. And the Capital Account is the balance of money that is transferred or owed due to this trading.

In other words, so the narrative goes, the economy is more or less like an individual or family. That is, a large current account deficit means you have been buying too much. Or more than you can ‘afford’. Similar to your parents telling you off for spending more than you earn. And you have a bedroom full of junk and a huge credit card bill.

Same goes for Australia Right? Buying too much stuff and now we have a huge credit card bill? Well not so fast mate. When it comes to nations, things are not the same. Not the same at all.

I want you to focus on the balance of payments equation again:

BOP = Current Account + Capital Account = 0

Now tell me, which one causes the other to move?

Doesn’t say, does it.

For most of the early part of the 20thcentury when we were dealing with more tangible goods and a less flexible banking system. The current account was the driver and the capital account adjusted.

But today and probably for the past 40 years the chain of causality has been the other way around – the capital account (money) moves first, and the current account (goods and services) adjusts.

What this means of course, is that if a country exports capital into your country. It will appear in the capital account and be called a capital account surplus. This will force, and this is the important point, forces a current account deficit.

How does it work?

Let’s walk through a scenario. Say a Chinese multi-millionaire buys a property in Bondi for $2m cash. The current account deficit has just increased by, how much?

That’s correct $2m.

Say if the Chinese government buys $1billion of Australian Government Bonds. You guessed it, the current account deficit has just increased by the same amount. By $1billion.

Is this happening in Australia? Absolutely. For China, Australia is a great place to send money. And it has been flowing down under at pace.

So, we have a deficit, now what?

Very few people would argue that a deficit in the current account is a good thing. Some economist say it doesn’t matter but I disagree. It very much matters and as a country, there are limited responses to a current account deficit.

Let’s explore them by a look at this next equation.

Current Account = Savings - Investment

If we MUST have current account deficits in other words, savings must be lower than investments. If Chinese money is being shoved into our country, we must either increase our investments or decrease our savings.

This again is just an accounting identity and cannot be violated.

Unfortunately, Australia has been woeful at its investment spend. Terrible. So that leaves savings to go down.

How do you make savings go down? Well, you have two choices:

1. You spend more.

2. Increase Unemployment.

Spending more due to a housing boom

Consumption is just the opposite of savings. Consumption up means savings down. This is what we saw in the United States before the GFC and what Australia has seen before and after the GFC.

Well, quite clearly, we have chosen an asset/housing boom in Australia. House price to income ratio are roughly (at the time of this writing) about 12.9 to 1 in Sydney, 9.9 to 1 in Melbourne.

Why does unemployment increase consumption?

Sounds strange I know. But it’s simple. An unemployed person is earning zero $$. However, the unemployed must still consume - eat and other various minimal activities.

This means consumption goes up under higher unemployment.

Which path next?

It’s clear which path Australia has been heading down. An asset boom with the subsequent rise in debt. However, at some stage, a country will reach debt capacity constraints and will have no choice but to move down path 2 – high unemployment.

With the royal banking commission forcing a tightening of credit standards. We might see a slowdown in debt creation and asset bubbles slowing or bursting.

Are we seeing signs of increased quality controls of credit? Yes, we are, check this out here.

What does this latest unemployment report suggest? Well, unemployment is edging up apparently.

So, perhaps the switch is already underway?


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