China's Gift to Oz

Inflation? Why, it's just what we always wanted...! WITH THE U.S. markets shut
down for Thanksgiving and a game of football, there was no Wall Street 'lead'
for the local bourse to follow yesterday, writes Greg Canavan of Australia's
Sound Money, Sound Investments . Just as well then that Reserve Bank governor
Glenn Stevens gave investors something to focus on. In his 'Opening Statement'
to the House of Representatives' Standing Committee on Economics, Mr Stevens
told the assembled bureaucrats that the price of money in Australia is just
about right. The vibe of the speech was that rates would stay where they are for
the time being, but further increases down the track were still on the cards.
Stevens is concerned about the cost of labor, which has a major bearing in the
cost of money: "Growth in labor costs, however, is no longer declining, but
rising. The overall pace could not be described as alarming at this stage, but
the turning point is behind us." Wages are a big deal in the inflation equation.
Price rises without compensating wage increases are actually deflationary. If
the price of your electricity bill goes up (and it certainly has in New South
Wales lately) for a given disposable income you have less to spend elsewhere.
That's not inflationary. But if you bargain for a wage increase and do not
increase your output, THAT is inflationary. Wages are the biggest expense for
businesses so wage pressures are generally followed by price rises. Hence
Stevens' legitimate concerns. So if the unions, the great protector of the
worker, continue to have success in fighting for higher wage claims without
offsetting productivity gains, you can expect to see inflationary pressures
strengthen, and interest rates to rise again next year. Speaking of
productivity, or lack of it, we should point out that the government is
contributing heavily to the upward pressure on wages. The latest figures from
the ABS show that full time adult total earnings for the public sector rose a
hefty 6% for the 12 months to August 2010 on a trend basis. This compares to
private sector growth of 4.3%. The problem is, government workers do not produce
anything of value. The productive part of the economy, the private sector,
sustains the public sector via the taxes they pay. So the fact that wages are
rising faster in the non-productive part of the economy is troubling. What's
also troubling for Stevens and his mission of guessing the right level for the
price of money in Australia is China. What happens there is the wildcard for
interest rates. Credit conditions in Australia are very weak and do not call for
interest rate tightening at all. Credit growth is down to an annual rate of 3.3%
(all due to housing, by the way) while growth in M3 money supply is 5.8%. The
inflationary impetus is coming from China. While Stevens didn't mention China
directly, he mentioned its proxy, the 'terms of trade' on a few occasions.
"Measured in nominal terms, the rise in GDP is running at about 10% per annum
just now, because of the rise in the terms of trade." China's credit boom (where
growth in bank lending reached 33% in late 2009 and is still buzzing along at
around 18%) is clearly spilling over into Australia via record high iron ore and
coal prices. As Stevens' points out, this is due to very strong demand for
steel. We all know the emerging economies are growing strongly/industrializing,
hence the demand for steel. But what is really causing it? If the developed
economies of the west are struggling to recover from the credit crisis and
experiencing below average levels of demand, why are the developing nations
growing so fast? After all, isn't the west meant to be the buyer of the emerging
markets' goods? In China at least, the answer comes down to the lending binge
that kicked off in late 2008. This was an unprecedented attempt to reflate the
Chinese economy during the deflationary shock of the credit crisis. It certainly
worked. Get a load of this. In 2009, China's banks lent out a whopping 9.6
trillion Yuan, equivalent to around US$1.44 trillion. The lending target for
this year is 7.5 trillion Yuan (US$1.13 trillion) but that looks like being
exceeded easily. As the Chinese bureaucrats are now finding out, once a credit
boom takes hold it is very hard to stop. The majority of these loans are going
into 'fixed asset investment'. According to an article in Fortune: 'Fixed-asset
investment accounts for more than 60% of China's overall GDP. No other major
economy even comes close. And of that fixed investment, slightly less than a
quarter is attributable to new real estate investment. Fixed-asset investment
means buildings, road, property. Tangible, 'fixed', objects. There's your steel
demand right there. That's certainly good for Australia now and it is giving
Stevens plenty of food for thought when it comes to setting interest rates. But
surely he must be wondering what happens when the Chinese lending and fixed
asset boom ends, as it surely will. (Or is it different, this time, in China?)
One thing is for certain. The bureaucrats in Canberra wont be asking Stevens
about Australia's very heavy reliance on China's ongoing boom. More than likely
they'll be playing politics (it's what they do) and asking why banks can't make
the price of money for housing cheaper than it should be. After all, no one
wants to see the end of a boom, especially politicians. Buying Gold or physical
Silver Bullion today...?