Never mind the volumes, feel the prices! Australia as a microcosm of the world economy
Plus, the rebound in cross-border M&A; the 12 economists’ letter on the review of the RBA; and #NFPguesses
Australia’s Q1 national accounts were in many respects a microcosm of the global economy. The terms of trade rose to record levels, exceeding even the wool boom of 1950-51, while net exports were the biggest drag on real growth, subtracting 1.7 percentage points from the headline growth outcome of 0.8% q/q and 3.3% y/y. The net exports subtraction over the year was 2.4 percentage points. Real GDP growth was slower than the 4.4% y/y in Q4 last year. The economy is now 4.5% bigger than it was in Q4 2019 before the onset of the pandemic.
Hours worked, export volumes and dwelling and non-dwelling construction all took hits from COVID or weather-related disruptions, while domestic and global supply-side constraints are also showing up on the price side of the economy. As a net commodity producer and exporter, what we lost on volumes we more than made up on prices, with nominal GDP increasing 3.7% q/q and 10.2% y/y. Of course, if Treasury is to be believed, nominal GDP growth falls to 0.5% for FY 2022-23. Overall, the data seem more consistent with an economy being buffeted by supply shocks rather than a positive aggregate demand shock.
Benchmarking wages growth
We previously suggested nominal gross labour income as a benchmark for demand pressures that abstracts from the volatility in the terms of trade that mainly falls on the capital rather than the labour share of income. Compensation of employees rose 1.8% q/q and 5.5% y/y, which just so happens to be in line with the 5.5% nominal income growth rate I have previously suggested as the basis for a nominal income level targeting regime. Private COE rose 2.3% q/q, which is more consistent with an excess demand story.
The RBA has recently referenced non-farm average earnings per hour as a wages benchmark, presumably because it was coming up short on the fixed weight WPI. This is calculated by the Bank at 5.2% for the year-ended March compared to 3% y/y previously and an average rate since 1990 of 3.9%. I suppose the acceleration in the annual rate will help them rationalise a further increase in the official cash rate next week, but I’m not sure how we are otherwise meant to interpret that series. For the year-ended June 2020, annual growth was 12%!
Australia as net exporter of direct investment capital
Australia’s current account surplus narrowed to 1.3% of GDP in the March quarter, the smallest surplus since the December quarter 2019 just before the onset of the pandemic. This still left Australia as a net exporter of capital to the tune $55.4 billion for the year-ended in March.
Once again, the net capital flows obscure some staggering gross flows. We previously noted the massive gross outflows of the portfolio equity capital, mostly from conscripted saving in the pension system. Australia was also a net exporter of direct investment capital for the year-ended in March. Australian direct investment abroad was a record $134.6 billion over the year, with most of that in the first quarter of this year. This is quite a bit larger than the $116.3 billion for inward FDI, with $82 billion of that in the March quarter. Cross-border acquisitions in both directions have clearly sprung back to life. That’s a good thing, although as we noted in our review of Australia-US bilateral investment for 2021, still leaves Australia in the odd position of being a bigger investor in the US in absolute dollar terms than the US is in Australia.
There was a net outflow of $16.4 billion on portfolio investment over the year to March, with Australian investors buying $178.5 billion in foreign stocks and bonds compared to $162 billion coming back the other way. There was a net inflow in the March quarter, which suggests a return to a more normal pattern as the current account surplus narrows.
While Treasury is forecasting a return to a current account deficit next financial year, this is most likely a reflection of iron ore price and exchange rate assumptions long since overtaken by events. The forecast current account deficit is about as likely as 0.5% nominal GDP growth. A nominal GDP futures market would be helpful at this point.
The narrowing in the current account in the March quarter partly reflects the knock to export volumes due to weather-related disruptions, an offset to the 9.6% q/q gain in export prices. But the underlying story remains the persistent weakness in domestic investment relative to saving, which is likely to see current account surpluses persist. Business investment as a share of GDP remains just above 29-year lows. The growing stock of foreign assets has seen Australia’s net international liability position shrink dramatically, from a peak of 61% of GDP in 2016 to 37% of GDP in Q1 2022, reducing the net income deficit on average. As I noted in my The ‘reserve currency’ myth, Australia’s international liability position looks increasingly like that of the United States. We usually think of capital flight in terms of foreigners pulling investment out of the host country, but in Australia’s case, it is surplus domestic capital going abroad for want of sufficient opportunities at home. If you thought persistent current account deficits were a problem you might think this a good outcome, but you would be wrong.
An open letter to the Treasurer
A group of 12 economists has written an open letter to incoming Treasurer Jim Chalmers calling for any review of the RBA to be led by an international expert. This reflects a widely held view that Australia is too small a place for a frank and fearless review to come from a local. Australia’s elites are simply too interconnected. An international expert is also better placed to benchmark Australia against international best practice rather than simply accepting existing arrangements because that is how things have always been done here.
A few people have argued against a review on the basis that it might serve as a vehicle to load-up the RBA’s mandate with issues like housing affordability or climate change that monetary policy cannot address. By the same token, a review could also affirm why we don’t want monetary policy serving broader objectives. If there really is a significant constituency for broadening the RBA’s mandate, a review is the right place to process and deal with those arguments. My guess is that changes to the RBA Act will be put out of scope because the government won’t want to have to broker any changes with the minor parties in the Senate, but that’s not a major constraint given that the existing legislation is pretty open-ended. If the Act is in scope, the government should be able to secure support from the Coalition for any recommended changes, assuming both sides agree with them.
The letter writers suggest what they think should be in scope for any review. Monetary-fiscal interactions are explicitly nominated. In my view, any review should uphold the existing functional and institutional separation of monetary and fiscal policy. Monetary policy should be assigned the role of stabilising aggregate demand. Fiscal policy should focus on supply-side issues, managing the efficiency and equity issues arising from the operation of the tax and transfer system and responding to severe shocks. Making this division of labour more explicit would improve the quality of both monetary and fiscal policy decision-making. If it were up to me, I would write this division of labour into the terms of reference. But I suspect most of the 12 economists have a view different to mine and see a greater role for activist fiscal policy in demand management. This difference largely turns on assumptions made about the extent to which the RBA’s operating instruments are bounded.
#NFPguesses
Our model has May non-farm payrolls at 330k, not substantially different from the median expectation of 325k after a 428k increase in April, which the same model had called at a better-than-expected 429k. Our model is still calling the unemployment rate at the pre-pandemic cycle low of 3.5%, down from 3.6% the previous two months. The median expectation is also 3.5% this month. On an unrounded basis, we actually have the unemployment rate ticking up a little compared to April, which should sound a cautious note. Option-adjusted high yield spreads rose 88 basis points on average between April and May, while our lagged labour market indicator variables weakened overall between March and April, so I view the risks on this release as being skewed to the downside, notwithstanding the models landing on an outcome consistent with market expectations.
ICYMI
How Does the American Economic Association Invest? Vanguard of course!
Deglobalisation is boosting foreign exchange volatility. My read is a bit different. Foreign exchange rate movements are smoothing the implications of deglobalisation shocks.
Who knew?