Sign interest rates are set to fall dramatically

Three forces are bearing down fast on the Aussie economy. If they converge, interest rates look set to drop to an extreme degree.

ANALYSIS

The hawks are dead.

It looks as though Reserve Bank of Australia will cut interest rates soon.

The trigger will be rising unemployment:

The debate now turns to how far rates will fall.

Australia has been mired in per capita recession since the Albanese Government came to power.

This is profoundly deflationary so it’s likely that we will see substantial easing over the next 18 months, in the order of six to eight cash rate cuts.

The long-term outlook is terrifying

However, the longer term presents a more significant challenge to monetary policy.

Three forces are bearing down fast on the Aussie economy. If they converge, today’s rising unemployment will become a structural spike.

1. The first is Peak China. We know that the Chinese economy is undergoing immense structural change away from those areas that have supported Australian bulk commodities.

Australia’s income shock will be huge, with an iron ore and coking crash compared to pre-China boom prices.

Nobody got a pay rise for the better part of a decade the last time we saw that happen.

2. The second is Peak Human. Artificial intelligence is evolving at a stunning speed and is already hollowing out jobs in media and IT.

Soon, many white-collar jobs in Australia will become little more than modules bolted onto an AI spine in Palo Alto. It cannot be stopped.

Unemployment is already rising and AI will accelerate that. Picture: Damian Shaw

3. The third is Peak Fat. New obesity drugs are about to roll out worldwide. The health benefits for society will be enormous. One such outcome will be a much fitter labour force with fewer days off and rising participation.

The Aussie economy is especially vulnerable

While only some of the challenges are bad, one must understand the Australian economy’s peculiar nature to assess the impact on interest rates.

All other developed economies have investment-growth-led economic models. This makes sense because investment drives productivity and improves income and living standards.

On the other hand, Australia has a labour-growth-led economic model via mass immigration. This does not make much sense because it chokes productivity and income growth and causes living standards to fall.

But pollies and their corporate mates love it because they don’t have to do anything to get richer. More warm bodies from overseas to do that for them, if not you.

However, suppose we add the three converging forces of Peak China, Peak Human, and Peak Fat to the labour-growth-led economy.

In that case, we get an ever-larger mass of idle humanity with enormous mortgages sharing shrinking national income.

To say the least, this is a recipe for weak domestic demand. More likely, it will add endless high unemployment. Bugger all wage growth. A gutted budget that needs help rather than offers it. And next-to-no inflation.

This leaves monetary policy and the currency as the primary tools to ease the adjustment and both will need to fall a very long way indeed.

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geopolitics and economics portal. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.