Cheer up: after the mining boom, Australia is still doing OK

Sell everything. That's the advice global financial giant the Royal Bank of Scotland gave its customers just two months ago. It warned of a "cataclysmic year" ahead as the world economy grappled with a deflationary spiral and recommended offloading all investments except "high quality bonds." Around the same time there were forecasts the Australian dollar would dip into the US50¢ range amid fears the Australian economy would falter in 2016.

Global markets have fluctuated wildly since those dark New Year prophesies. But lately the headlines have been more positive. The latest official economic figures showed a "spending spree" had helped growth accelerate to stronger-than-expected 3 per cent. And rather than plunging towards US50¢ our dollar has climbed back over US75¢ for the first time since the middle of last year. The fortunes of Australia's most important export commodity, iron ore, are also looking up. Its price surged by 19 per cent on Monday night and, despite an inevitable correction the following day, a tonne of Australian iron ore is now worth considerably more than in December.

Despite a rollercoaster ride on the stockmarket, Australia's economy is adjusting well to the end of the mining boom.
Despite a rollercoaster ride on the stockmarket, Australia's economy is adjusting well to the end of the mining boom.  Photo: Photo: Travmedia

So what are we make of the mixed economic messages so far this year?

ANZ's head of Australian economics, Felicity Emmett, says the gloomy start to the year was driven by unfounded fears about the economic outlook.

"A fresh look at the data suggests the world is not going to hell in a hand basket," she said.

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That sentiment was backed by two of Australia's top economic officials who gave thoughtful speeches about the state of the economy this week.

Philip Lowe, the deputy governor of the Reserve Bank, was upbeat about Australia's economic performance since the end of the mining boom. Dr Lowe said the economy has proved far more resilient than many expected.

"A few years back when we were looking down from the peak in the mining boom, there was considerable trepidation in some quarters about how Australia would manage over coming years," he said in a speech.

"As things have turned out…we have managed pretty well so far, despite what has been a fairly difficult environment. Over the past two years, the prices of our commodity exports have declined by 40 per cent. Mining investment has also declined by almost 40 per cent, which is the equivalent of nearly 3 per cent of GDP. Yet over these two years, our economy has continued to expand at a reasonable pace, with growth over 2015 having been a bit stronger than was earlier expected and not too different from the long-term average."

How did we pull it off? Dr Lowe said Australia's relatively successful post-boom transition owes much to reforms made in the 1980s and 1990s such as the floating exchange rate and a more flexible labour market.

He expects the post-boom headwinds will now gradually wane.

"As things have turned out…we have managed pretty well so far."

Philip Lowe, deputy governor of the Reserve Bank

"Then the underlying strength of the economy will be more clearly evident," he said.

In a separate speech this week the Deputy Secretary of the Federal Treasury, Nigel Ray, said the department's "central case" is for the economy to continue to perform well.

Even so, the financial market turmoil over the past few months shows some serious threats linger.

Mr Ray warned that "global risks are tilted to the downside" and have intensified in recent months.

"Slower global growth has been accompanied by a number of trends that are observable across the global economy: slower growth in trade; weak business investment; slower productivity growth; slower population growth in advanced economies; low inflation; and lower inflation expectations," he said.

Shane Oliver, a veteran market analyst and chief economist at AMP Capital, says the financial markets are unsettled because three important "turning points" are taking place simultaneously: US interest rates have started to rise for the first time in a decade, the global commodity price boom is unwinding and the Chinese economy has embarked on a difficult transition to being more reliant on local consumption and less reliant on exports.

"All these things have come together at the same time causing ructions in financial markets and that leads to negative headlines," he said. "We are going through a messy phase at the moment."

Of course, Australia will be especially exposed should China's economy falter. Mr Ray pointed out that around 32 per cent of our total merchandise exports went to China last financial year and Australia has the highest proportion of its exports going to China of any advanced nation.

The world economy is yet to make a sustained recovery following the global financial crisis. Mr Ray pointed out that the international monetary fund recently issued the 17th downgrade to its global growth forecasts in five years.

"Markets seem to be questioning whether global growth will be strong enough to drive corporate earnings and maintain low default rates in order to sustain current valuations," he said. "In a lower growth, lower inflation world, there may well be continued heightened volatility on financial markets."

One thing that really has economists puzzled is why wages growth and inflation have remained very low in advanced economies even though employment growth has been reasonably strong. Normally healthy jobs growth results in higher wages and, eventually, higher inflation.

Dr Oliver said anyone schooled in economic policy would expect inflation to have started rising by now given years of massive economic stimulus in the wake of the global financial crisis.

"It is very strange," he said. "The world is a radically different place." Oliver says these shifts have also made analysing the global economy more complicated than in the past.

Philip Lowe said the inflation dynamics in advanced economies are now different from those in the past.

"In earlier decades, it was very rare for central banks to worry that inflation and inflation expectations were too low. Yet today, we hear this concern quite often, and the 'unconventional' has almost become conventional," he said.

Some see the stagnant inflation as major problem. The influential American economist, Larry Summers, warned in the Financial Times this week that entrenched low inflation – and low expectations of inflation – is as significant as the "Stagflation" crisis the 1970s.

During that damaging episode economies were plagued by soaring inflation even though economic growth was stagnant and unemployment high. It took years for policy makers to understand the problem and respond.

"Today's risks of embedded low inflation tilting towards deflation and of secular stagnation in output growth are at least as serious as the inflation problem of the 1970s," wrote Mr Summers, who is a former secretary of the US Treasury. "They too will require shifts in policy paradigms if they are to be resolved."

Australia is among the advanced nations where inflation and wages growth is unusually low.

Dr Lowe said the Reserve Bank was keeping a close eye on this and other worrying global "cross currents."

While offshore hazards have intensified, Mr Ray said it was domestic factors that would be the key to Australia's economic performance over the next two years, especially household spending.

"We need consumption growth to continue to grow strongly – we need the savings ratio to come down to achieve that – and we need…Australian businesses to invest," he said.

ANZ's Felicity Emmet said some recent economic indictors have been mixed. She expects the Reserve Bank will need to cut interest rates later this year to sustain growth as the economy continues its post-mining boom transition.

"The economy clearly finished 2015 on a strong note, but we are not out of the woods yet," she said.

Dr Lowe and Mr Ray also drew attention to the lingering decline in Australia's national income. In past decades economic growth and national income have been very closely correlated but since the mining boom the two have diverged.

As a result the key measure of the economy – gross domestic product – has continued to grow but net national disposable income per capita – a key measure of living standards – has stalled. Average real income is no higher today than it was in 2008.

"It means that as a nation, we're working hard but not getting paid as much as we used to for what we produce," Dr Oliver said.

Mr Ray warned that national income growth might lag for sometime yet.

"There are at least some factors that suggest Australia could continue to find itself in a challenging income growth environment," he said.

"That would have implications for growth in living standards and government revenue."

That's bad news for the Treasurer, Scott Morrison, as he prepares the May budget.

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