A couple of ‘D’ words have been bandied about in the popular press recently. They are the type of words that are easy to write and get an immediate reaction. The first is the grand daddy of them all - Depression.
Images of living like The Walton’s flash before your eyes. “Oh no” you say, “the kids are never going to move out, and soon the old folks will want to move in with us!” And not to mention the eldest son who wants to laze around writing diaries when he should be out earning a quid.
The other ‘D’ word is probably the most overused and yet least understood - Deflation. All of a sudden, barely three months after data from the Australian Bureau of Statistics (ABS) told us inflation was running hot at 5%, the market has done a 180 degree turn.
In fact, now we think about it, no-one seemed to care about inflation and its harmful effects anyway. It’s too abstract a concept, even for the pros. For the last four years we have been told to ignore the headline rate of CPI because that includes volatile items like food and fuel.
Much better focus on the core CPI that excludes those pesky items we all use every day. And so it was that the establishment succeeded in making the public believe that inflation was not a problem.
But take a look at the numbers in dollar terms and see the difference it makes. The RBA’s own inflation calculator paints the picture for you. Plug in the numbers and it will show you that a basket of goods bought in early 2003 for $100 will now cost you $117.83.
That’s a 17.8% increase. In annual terms it is a mere 3%. That is supposed to be the top end of the RBA’s inflation band.
Throughout this period we were told that it isn’t a problem because of the tight job market and rising wages. Yet over the last year while inflation has increased by 5%, the rate of wages growth has only been 4%. So in real terms, the average employer is worse off today than they were one year ago.
Now, supposedly we can all forget about the fear of inflation because something much more dangerous is on the horizon. That’s right, it’s that ‘deflation’ word. For the uninitiated, deflation is the opposite of inflation. It means a sustained fall in prices.
Why is that bad? Surely it just makes things cheaper. It does, but it can have a damaging effect on an economy because it encourages people to delay purchases in the belief they will get it cheaper at a later date.
The reality is that Australia will not see deflation, even if the economy moves into a recession. In fact it is more likely that the real menace will continue to be inflation which will have an even more damaging effect on the economy.
The facts are that the central banks are making the same mistakes as they did after the dot-com bust. Instead of letting the market work its way through an economic downturn, they are forming an interest rate cartel to drive rates down as low as possible to encourage borrowing and spending. Which is - we don’t need to remind you - one of the major reasons markets are going through this current slump.
Unfortunately, while central banks take their eye off inflation, the basket of goods that today costs you $117.83, next year will probably cost you more than $121.
Spend For Australia
But because of the fear of deflation and the want to engineer a ’soft landing’ for the economy, the odds are stacked towards the RBA dropping interest rates by another 0.75% today.
In fact, if we rely on the SFE Target Rate Tracker, the market is even factoring in a full 1% cut. That would take the cash rate down to 4.25%. Good news for mortgage owners, but not so good news for savers.
The savers must be ruing the day they ever decided to responsibly tuck away savings for a rainy day while all around them were spending like crazy. This is the thanks they get. Save and you shall not be rewarded seems to be the new motto.
China Express Just Stopping to Refuel
Meanwhile, the wheels appear to be falling off the China Express. Or are they? Well, it certainly looks like it. As Reuters reports “China’s manufacturing industry slumped in November as new orders, especially from abroad, tumbled in the face of deepening economic gloom and financial uncertainty.”
The problem causing all the angst is the fall in the Purchasing Managers’ Index (PMI) to 38.8 from 44.6. Any number below 50 on the scale indicates a contracting economy.
One important point to remember is that whether we like it or not, the Chinese authorities have much greater control over industry than western governments. The other important point is to compare what is happening with the various government stimulus packages worldwide.
In the US, Europe and Australia, the stimuli is aimed mainly at one target - the financial services industry. The aim is pure and simple, get people and businesses spending again. The hope is that if spending increases it will increase company revenues, increase asset prices and therefore increase the government tax take.
This must be music to the ears of the Chinese. Rather than propping up their millions of manufacturing companies, their government can instead focus on stimulating domestic infrastructure programmes - roads, bridges, very tall buildings, etc. The sort of thing that will be useful when the West have finished bailing out the Chinese manufacturing sector - Oops, we mean, stimulating their domestic economies.
The message here is, don’t write the Chinese economy off yet.
