“Inflation, no longer considered a concern with growth prospects under such a threat, increased by 0.7% in February…” – Chris Zappone, The Age.
Economic growth, economic growth, economic growth. It’s the financial equivalent of the jungle drums. A constant repetitive beat. It’s sent everyone into a trance. Economic growth must be maintained – at all costs.
Or does it…
Money Morning reader Marilyn asks, “Can you publish a simple explanation of why we need economic growth?”
It’s a good question. Everyone tells us the economy must grow. But they never explain why. Maybe they think if the economy stops growing it would be like if the earth stopped spinning – we’d all start floating in the air. And that wouldn’t be at all convenient.
So we’ll throw our two-cents into the economic growth argument shortly. But the comment in the The Age had two parts: the bit about economic growth, and the bit about inflation “no longer considered a concern.”
Let’s take inflation first. We’ve argued for some time inflation is a concern… when the RBA was cutting interest rates… when the RBA was increasing interest rates… and again as the central bank takes the cash rate ever closer to zero.
During that time the conventional wisdom has been the RBA are excellent managers of monetary policy and they know what they’re doing. If they are cutting rates it must mean we don’t need to worry about inflation. No one, under any circumstances should disagree with the RBA.
Even when inflation was high due to higher costs of food and fuel we were told that these are volatile items. We should discount them from the CPI. So they did. And inflation kept going up.
Even recently when inflation was still rising, only a bit slower than before, it was decreed inflation had been licked. Of course, it hadn’t. Prices were still rising. And now the inflation gauge published yesterday by TD Securities shows inflation rising by an annualized 3.1%.
So why does the myth of “inflation is beat” continue to persist?
Well, one reason is most commentators don’t understand what inflation is. They look at the CPI number every quarter and stop there. But taking the official inflation data and price gauge data at face value is asking for trouble.
You need to look for further evidence of inflation. For that we turn to data published by the Reserve Bank of Australia. Last Friday the data shows exactly why inflation is still a major cause for concern. You may have read in the press over the weekend about the increase in credit recently and how this is good for the economy.
For a start, it isn’t. Too much credit is to blame for the current recession. We need a period of less credit, not more…
But anyway, not surprisingly, the press didn’t make a single mention of the other information supplied by the RBA – the increase in money supply during the last twelve months.
Whichever monetary measure you look at, they all indicate the same thing – the money supply is rising which means more inflation. Take a look at the table below…
This is information lifted directly from the RBA. You can get the full spreadsheet here. It’s in plain sight, and it wasn’t hard to find.
Depending on which measure you use, the increase in the money supply over the last 18 months ranges between 10% (M1) and 46% (Money Base). During the same period, prices – according to the ABS – have risen by 4.7%. And that’s just the beginning.
What does this all mean? It means more and more money is being tipped into the economy. This will naturally devalue the money already in circulation, and therefore the greater the amount of money, the higher prices will rise to compensate.
So, what does this have to do with economic growth and whether or not we need it?
Well, that’s exactly the point. The reality is we don’t always need growth. There, we said it. The downside of no economic growth is a period of time when consumers buy fewer things, so companies produce fewer things, and therefore employers need less staff.
After fifteen years of economic growth in Australia, the market is trying to ‘not grow.’ Unfortunately, the united efforts of the boffins in government, industry and pressure groups are trying to prevent this natural contraction in the market from happening.
You see, if the market was allowed to get on with what it’s trying to do – namely, convince everyone that we’ve all spent too much – then over time, and after a period of consolidation, consumers would save and viable businesses would have cut back on production, then growth would begin again.
The problem isn’t that the economy is moving into recession. That’s just the consequence of what happened before. The move into recession is the next necessary step to purge the bad elements of the economy, and the strong elements of the economy – and importantly – new elements will emerge.
But governments are treating the economy like a heroin addict who’s trying to go ‘cold turkey.’ The addict is saying it doesn’t want any more heroin, but the doctor is sticking the needle in anyway.
But the worst part is they are trying to sustain the economy at an artificially high level. A level achieved thanks in large part to excess credit, over-production and over-consumption. In time, the attempts to prop an economy that wants to contract will be seen for what they are – futile.
What this economy needs – dare we say it – is a recession to cure it of the ills it became infected with during the bubble.
In a nutshell, this long answer to Marilyn’s short question is that in actual fact, we don’t need economic growth all the time, only some of the time. The other times we need to let it shrink so it can grow again.
Other Stuff on the Markets
The RBA Cash Rate decision is today. We heard a wonderful comment on the radio last night from the chief economist at NAB Capital Markets, we’ll paraphrase it here:
“We think the RBA will cut by 50 basis points, but we think there’s a chance they could cut by 25 basis points. And depending on whether they think the banks will pass any of the cut through to customers, there’s a chance they won’t cut at all.”
The Aussie market hit a five-year low yesterday. Macquarie Bank took another hammering. There must now be serious questions about whether Macquarie can survive in one piece.
The Dow Jones Industrial Average closed at 6763.29 this morning. Anyone prepared to bet against a fall to 5,000 points?
