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The pitfalls in talking up the economy

By Arthur Thomas - posted Friday, 12 December 2008


Prime Minister Kevin Rudd and Treasurer Wayne Swan have been happily espousing the need to forget the doom and gloom mongers and go out and spend, spend, spend.

$10.4 billion will be distributed to Australia's aged pensioners, carers and families to be put back into the economy by spending to keep our local businesses operating and people in jobs. What businesses are we talking about?

The most obvious are retail, hospitality, tourism, entertainment, car dealers, real estate, and so on.

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Spending, it appears, is the solution to recession and the short cut to the survival of our local industries and businesses, returning money to Treasury via GST, PAYE, taxes on profits etc.

The recent “glad tidings” from Mr Swan, confirmed that Australia is not in recession, and although we are very close to it, should not talk of gloom and doom.  Unfortunately the figures he quoted were for the September quarter before the real impact of the global crisis on the Australian economy was emerging.

Australia’s iron ore, coal and agricultural exports provided a timely buffer with a record trade surplus during a period of high iron ore prices and the approaching northern winter for coal demand. It was also before miners were being asked to delay shipments, cancel sales negotiations and then, to cancel orders. The spot market died.

At that time Mr Rudd was espousing that our strong and well regulated banking systems gave Australia a major advantage over other countries and he was confident that China’s demand for our iron ore and coal would continue, although at a slightly lower level.

What was needed was quick, innovative and positive action combined with strong leadership. Despite clear evidence that this crisis was already seriously impacting on China’s economy and declining demand for Australia’s resources, Rudd committed $10.4 billion to a consumer stimulus package to revitalise our economy. The intention was to produce a slower decline in the December quarter and suggest a softer rather than a hard landing for Australia's economy. The 2009 March quarter however will reveal the real state of the economy.

Is the strategy realistic in changing times?

Since the depression, spending has been a successful strategy to drive demand for local industries and keep the money in a country to revitalise the economy.

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That was true however, before globalisation, rampant outsourcing and decimation of our skills base and local manufacturing industries. Our domestic industries would have been major beneficiaries from a spending spree except that this looming recession cannot be compared with earlier downturns.

A nation with thriving industrial and manufacturing facilities and a diversified skills base has been decimated. The skilled and unskilled job market declined as high labour content manufacturing industries migrated to China and Asia for cheaper labour and other cost savings.

Gone, the locally produced clothing, shoes, sporting goods, equipment, toys, hats, shoes, appliances, textiles, furniture …

How much will go back to Treasury?

The spending strategy in 2009 will follow totally different lines from that of earlier financial crises.

It has been suggested that the local industries to benefit most from this expected spending splurge will include retail, hospitality, tourism and car sales.

Let us follow the money trail.

Imports now dominate the retail trade with miniscule local content. True, it will provide jobs for the sales staff to sell us the fully imported cars, appliances and gadgets as well as high imported content in many other items. Imports are increasingly dominant in our supermarkets, displacing local food, beverages and other household items. Check out the fish, meats, fruit and juices to name but a few.

Hospitality is increasingly reliant on imported content ranging from kitchen equipment, foods, beverages, food product additives, furniture, table cloths, cutlery, glassware, crockery, lighting, visual and audio, etc.

Local tourism will be facing cut throat discounting from Asian centres also suffering from the crisis and, as we have seen before, at prices that Australia tourism cannot match. A strong Australian dollar offers cheaper overseas travel and the money leaves Australia. It also deters incoming foreign tourism. A falling dollar works in reverse.

Where does the money go?

What it all comes down to is spend, spend, and spend and a simple matter of mathematics. Money flows out to pay for imported content and profits to credit providers. The residual local content stays here.

Not to be forgotten is the downturn in resource exports that will increase unemployment, reduce state and federal revenues and increase the looming deficit. Add to that the decline in our car industry exports.

What appears to have been overlooked is the fact that China's steel and metals industries have been in decline since the beginning of 2008 and rapidly worsening ever since. Unemployment in China was on the rise early 2008 but escalated rapidly throughout the year, triggering increasing civil unrest.

What else can we spend the money on in Australia? New cars, boats, houses, beach homes, improvements?

Consumers considering those options will face more stringent credit conditions and deposits in a falling asset market. Not all of that spending will stay in Australia either. New car purchases range from the fully imported to high imported content in locally assembled vehicles, as well as accessories and parts for improvement and maintenance.

The flight of salesmen is sending a clear message on the near and possible medium term future for these sectors.

Lessons learned

The crisis has taught the financial sectors a very painful and belated lesson in reckless lending practices and poor credit assessment.

And housing? What impact will lower interest have when it is the cost of housing and capital repayments that are beyond reach?

For this to change, house prices will need to reflect a realistic relationship between earnings, affordability and a deposit that go hand in hand with affordable interest and repayments. Credit providers will be demanding adequate equity in case the payments stop should the homeowner suffer financial difficulties.

The big infrastructure spend

This has been touted as crucial to Australia's future and a major employment creator.

But when looking closer, one may ask just how many from the unemployed finance, retail, hospitality, entertainment and car industries will find jobs here? Even if these projects are as big as proposed, will there be enough skilled and unskilled workers laid off from the mining sector downturn to fill the jobs. Will Australia once again look overseas for labour on 457 visas?

Just how big is the consumer spending base?

While the task of spending Australia out of recession lies squarely on the shoulders of Australia's 20.8 million total population Rudd appears to see the white knights as Australia's pensioners, carers and families splurging their $10.4 billion windfall.

The days of unlimited and easy credit and zero equity are gone and we now face the consequences. These years of "splurging" have produced increasing numbers of Australians being added to the credit risk lists resulting from defaults on credit card debt and purchase agreements for appliances, furniture, gadgetry, cars and personal possessions. With their creditworthiness destroyed, it is unlikely that these Australians will be joining the pensioners, carers and families in Rudd's Christmas splurge.

Home buyers, caught out first by rocketing mortgage interest payments and then plummeting house values, find their equity below asset value and face mounting debt. Similarly those who borrowed against the family home on rocketing valuations to invest in real estate, home improvements, family leisure items and the stock market, face the same harsh reality.

It is unlikely that a sizeable percentage of these two groups will readily participate in the Rudd urge to splurge.

For them it is a Catch 22. Continue paying for a falling market asset in times of uncertainty and the prospect of looming unemployment, or surrender to repossession and become another credit risk list name.

The overall result appears to be a substantial decline in the consumers that Rudd has relied on to join in his "spending splurge".

There are clear signs of rising unemployment for the post Christmas retail trade as well as those already being laid off in the resource related industries. Rudd's spending pep talk is an insult to these Australians at a time when they have to unload and reduce debt in a market short on buyers and credit.

Those wanting to spend Australia out of possible recession or worse will face a new harsher credit market for the bigger items with mandatory deposits to ensure equity for the credit provider in the event of future default. A good savings record may also be needed.

It will be interesting to see just how much of the $10.4 billion stimulus package will be "splurged", saved or repatriated to pay for the imports.

Many consumers will be under pressure to reduce credit card debt, mortgage payments and purchase agreement repayments just to save their credit ratings. Debt reduction represents money already spent and not new consumer spending.

Pensioners, experienced from earlier downturns and suffering massive reductions in income due to superannuation asset decimation will recognise the need to save for the tougher times ahead. Those facing imminent retirement are even worse off.

As for the families, Rudd also needs to give due consideration to those parents whose offspring cannot afford to move out and may face unemployment.

Rudd also has to make provision for declining commodity prices and share yields and somewhere along the way the cost of Kyoto, energy, water and other related cost increases. The economic effect of plummeting oil prices will also represent a major challenge.

True, if consumers do not spend, recessionary pressures will increase, but then again, what of those whose homes and/or survival depends upon savings.

Unlike the depression, it will not be a matter of allocating surplus manpower to major infrastructure construction projects.

Rudd's intention is to motivate massive spending to blunt the economic figures for the 2008 December quarter. He also needs time to delay the release of the 2009 March quarter that will reveal the real impact of the global crisis on Australia's economy.

2009 will herald a new economic climate for Australia with declines in both volume and prices for our resources exports as China is followed by cut backs by Japan and South Korea. Now the coal industry will join the steel industry in cut backs, further increasing unemployment. State and federal treasuries will be hit hard by declining revenues at a time when the $10.4 billion consumed by the spending splurge package may have been better used in new and more urgent demands.

Swan's scenario of "possible deficit" with short term implications now appears more like a "certain deficit" with longer term implications. It is the price that inexperienced government pays for poor preparation and self promotion by rushing in with rhetoric and grand visions before determining the full extent of the crisis.

Mr Rudd should have checked his facts before arrogantly lecturing the leaders at the APEC conference to talk up the global economy and not talk of doom and gloom. The change in body language and ensuing talks of a possible deficit on his return to Australia were clear signs that the students were in fact the headmaster.

Australia is not a mushroom economy.

If we are to trust a new and novice government that appears to be floundering, then Australians need facts, realistic responses and strategies to face the challenge, not policy on the run, visionary rhetoric, and politically inspired expediency or panic spending splurges.

The Rudd Government is calling on Australians to give up saving and just spend. Just check our current levels of savings to find the margin for that. The overall effect is a demand and increasing reliance for "easy credit" and zero deposit for items ranging from electronic games, to cars and homes. We've just been there.

Rudd is relying on spending by pensioners, carers and families who receive the "windfall spending bonus".

What happens if that doesn't work? Will he blame the pensioners, carers and families for failing to do their duty in saving Australia's economic problems?

The real extent of this looming recession will become clear in the 2009 March quarter figures, an agonising wait of almost six months.

A healthy economy is one in which savings allow consumers to spend on items they can afford and is usually reflected as a percentage of savings and GDP.

Rudd is saying empty your pockets now and somehow you will make it up in the future. He knows what he is doing and the consumer's don't.

Who to trust?

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About the Author

Arthur Thomas is retired. He has extensive experience in the old Soviet, the new Russia, China, Central Asia and South East Asia.

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