Our hothouse isolation is an economic trap
Here we sit, in splendid isolation, with ample water, light and fiscal fertiliser. The trouble with hothouses, though, is they breed a false sense of security, even superiority, which wilts in the wild world.
Hothouse Australia sure has its travails, with citizens marooned offshore, stay-at-homes piling up savings, and those earning in the private economy exposed to the helter-skelter of lockdowns.
This is no way to live.
“As the vaccine rolls out, our ability to open up increases,” Josh Frydenberg tells Inquirer. “It’s inevitable we will be living with the virus because we can’t eliminate it. That is why moving our strategy from suppression of the virus to prevention of serious illness, hospitalisation and fatalities, consistent with national cabinet’s road map, is so important.
“It will be key to our sustained long-term economic recovery and economic engagement with the world.”
Beyond our fortress walls is a world of financial distress and human misery. Deaths from Covid-19 are rising in our region, including in Indonesia, Malaysia and, of course, India. The Delta variant is on the march.
The OECD reported this week that 114 million jobs were lost last year, 22 million in the rich nations’ area the Paris-based group represents. The pre-pandemic share of working-age people employed has returned in Australia and Japan, but it will be several years before employment recovers in the US, Britain and other OECD nations.
There’s an increased risk of a rapid build-up in long-term unemployment, with young workers and the low-paid vulnerable to scarring effects. “Many who lost their job in the first phases of the pandemic have been jobless since then and may find it increasingly difficult to compete with those whose jobs have been previously sheltered,” the OECD said in its annual Employment Outlook.
Yet closed off from the world, for the rest of this year and most likely well into next, Little Australia is in expansion mode, in almost every sphere except population and business investment. Our labour market is recovering at a world-beating pace, pumped up by the Reserve Bank’s cheap money and a $300bn fiscal jab from Canberra.
Home prices are rising at a ridiculous clip, not that the RBA will step in to cool the property sector. The labour market waved goodbye to JobKeeper in late March with a shrug and 115,000 jobs were added in May. Bank data on credit and debit card spending show households are finding new uses for their income and savings; short, sharp shutdowns are having minimal effect on goods purchases.
With near-zero population growth, and all this free money, average living standards are rising, while the world keeps buying our grains, cereals, wool and rocks. Even the ugly spat with Beijing is having minimal effect on total exports. In May, our trade surplus was $9.7bn, just short of the record performance of $9.9bn posted in January. Iron ore exports rose by 63 per cent over the year.
“Exports to China reached a record high in May,” Commonwealth Bank senior economist Kristina Clifton noted. “Looking forward, we expect large trade surpluses to continue given commodity prices, particularly iron ore, are forecast to remain elevated. That said, we expect the iron ore price will begin to retrace some of the gains later this year as stimulus from the Chinese government is wound back, which reduces the demand for iron ore.”
Australians can’t travel overseas. Because in aggregate we spend more on tour than visitors spend here, “service imports” as they are termed won’t be a negative on our external accounts. Regional tourism is booming, with operators short of workers and hotels obliged to turn on the “No Vacancy” LEDs.
Many of us are getting used to this homegrown buy-now-pay-later prosperity, not least Labor premiers in the frontier states fresh from pandemic election victories. Parochialism wins, and they have the approval numbers to gloss over collective failures in quarantine. Emboldened, the premiers forced Scott Morrison, looking politically weaker by the week, to halve the number of international arrivals.
Gladys Berejiklian is an outlier, taking responsibility for the state’s bungle on an infectious limousine driver. Yet opting for gold-coin donation-style restrictions on the residents of Greater Sydney during school holidays was crazy-brave. The NSW Premier looked to Canberra to provide income support as her “honour system” of lockdown was ditched on Friday and more explicit “stay-at-home” orders were put in place.
On Thursday, the Prime Minister eased conditions for household assistance, which provides up to $500 a week to those eligible, the same rate as JobKeeper when it ceased in late March. Again, deeply indebted Canberra will pay part of the freight of the states, some of which are in the black or will be sooner rather than later.
But the hothouse may be getting too hot in pockets of the economy, where wage pressures are likely to emerge because of a lack of skilled workers. RBA chief Philip Lowe believes the tropical heat is getting to people in the markets, as economists trim their forecasts for unemployment, raise the spectre of strong wage growth and inflation, and bring forward the day of the next move on interest rates, perhaps as early as next year or in early 2023.
On Tuesday, the RBA announced a winding back of crisis-era monetary settings, surprising financial markets with its “taper” of weekly bond purchases, from $5bn to $4bn in September, with a review in November. The language around when the cash rate would be lifted was tweaked, enough for Martin Place watchers to see a change in “forward guidance”.
Lowe maintains the bank will continue to provide extraordinary support – cumulative purchases of commonwealth and state government bonds will be $237bn by mid-November – until actual inflation is sustainably within the 2-3 per cent target band. This requires wages growth to exceed 3 per cent.
“The bank’s central scenario for the economy is that this condition will not be met before 2024,” Lowe said in his policy statement. The governor then gave a rare post-board meeting briefing to reporters and financial market operatives, where he ranged from wonky technical details about “yield curve control” at the short end, to morale management, as he urged Australians to be patient about vaccinations over the coming six months.
Having set off on the road to tightening because “of an economy that has bounced back earlier and stronger than expected”, Lowe then emphasised the negatives. He outlined the factors holding us back and why rates would not necessarily be going up any time soon, mainly because wages growth had not exceeded 3 per cent for a decade.
Structural change means the anti-inflation fix was in: globalisation, technology, low inflationary expectations and low unionisation are likely to remain a drag on wages. “The governor’s Q-and-A was a tour de force in dovishness,” Westpac’s market doyen, Bill Evans, observed immediately after the Lowe show.
What to make of it all? Evans told his clients the decisions to taper and to retain the April 2024 bond as the yield target were influenced by the need to avoid disruptions in the bond market by “spreading out” the purchases.
Westpac expects that after the November review there will be a reduced purchase target extending into next year, followed by a considerable break of 9-12 months before the first rate hike in the March quarter 2023.
“But this business is always about forecasts,” Evans said. “The RBA’s current forecasts are probably consistent with 2024 tightening; our forecasts are in line with an earlier tightening. If our forecasts prove to be correct, then (the) RBA will be obliged to act.”
CBA’s Gareth Aird forecasts a rate hike as early as November next year because wage and inflation growth will be in the target zone, following post-Covid “euphoria” among businesses and consumers as the shackles come off.
On Thursday, Lowe told the Economic Society of Queensland the private sector was betting “the closure of borders will lead to a hothouse environment and wages will pick up more quickly”. He said this was “possible”, but that “a more plausible scenario is that over time the borders open again and some of the hothouse pressure points in the labour market dissipate”.
But Aird asks: What if wages growth accelerates? Will the RBA say this is only transitory? Will it be game enough to plug in forecasts for wages that are lower than real-world outcomes?
Lowe insists “the condition for an increase in the cash rate depends upon the data, not the date”. “It is based on inflation outcomes, not the calendar,” he told his fellow economists.
Well, the data are running pretty hard, while Lowe is taking an each-way bet. He wants to have maximum flexibility and just because the market is charging towards higher interest rates, maybe the heat will come off the expansion.
What could set us back, of course, is the psychology of living in the hothouse. Frydenberg knocked back the request of a JobKeeper-style intervention to help NSW. There will be no second act for the $89bn wage subsidy lauded by the OECD for its effectiveness.
In truth, the four-point national plan for reopening is an embryonic communique, missing the “magic numbers” for vaccination targets but with good-vibe horizons. It reflects Morrison’s desperation and the fragility of a federated mission.
As in Melbourne, the Sydney outbreak will encourage vaccinations. Extra supplies will be put to good use, especially if NSW can get more throughput via its state-run hubs, which have utilised virtually all allocated doses. The stockpile of unused vaccine supply in fridges is 2 million doses nationwide (once a 10 per cent wastage rate is deducted), with the bulk of it in the commonwealth-run GP stream, most likely due to the brand damage caused to AstraZeneca.
As of Thursday, 2.2 million, or 10.6 per cent of Australians aged over 16, had been fully vaccinated. Just under one-third, or 6.6 million, have had at least one dose. The bring-forward of Pfizer obviously helps to speed the rollout, as will moves to shorten the gap between AstraZeneca jabs.
The relatively low vaccination rate in southwest Sydney has forced Berejiklian’s hand on tougher restrictions. But, while the virus was at large in Bondi and Sydney’s east, and inner areas were targeted, good sense was abandoned further afield. It’s a collective failure, but one Berejiklian owns for a lack of explicit guidance and an abundance of trust.
According to Deutsche Bank economist Phil Odonaghoe, the “very best-case scenario” is it will take 15 weeks “to break the zero-tolerance policy approach that has the Australian economy shackled to lockdown orders”. He cites the UK’s 50 per cent rate for full vaccination.
“The contrast with England’s Freedom Day on July 19, when virtually all social mobility restrictions are set to be scrapped, could not be starker,” he said on Friday after Berejiklian announced 44 cases of community transmission in NSW.
“But the UK experience could also offer hope Down Under. British policymakers accept, and expect, a further spike in Covid cases once restrictions are scrapped. The test will be whether hospitalisations and deaths follow suit.
“For Australia then, we would argue that the UK’s experience offers an extraordinarily valuable real-time experiment for how best to juggle lockdown orders and economic consequences.”
Odonaghoe noted one important caveat for Australia’s tolerance threshold compared to the UK. Some 4.3 million Britons have recovered from Covid, so the Doherty Institute is likely to arrive at a higher threshold of vaccination than Europe, the UK and the US for “opening up”. Low case numbers in Australia have reduced the spread of community immunity.
Lowe urged Australians to be patient. A sense of normalcy will come by year’s end when a high proportion of us are inoculated. Normal interest rates, a neutral setting of perhaps 1.25 per cent, says Aird, are years away. But what will a normal economy look like?
Pre-Covid, Australia was in the middle of an investment strike, the farm sector was ailing, productivity growth was actually falling and wages were stagnant. High population growth was keeping the economy ticking over. We were slipping down the global rankings, flabby in our policy performance, not nearly as dynamic as we should aim to be.
So here we sit, in splendid isolation, with ample water, light and fiscal fertiliser. Trouble with hothouses is they breed a false sense of security, even superiority, which wilt in the wild world.