Beyond the noise

Given the news and events of the past week, it is easy to think that Australia’s economy is suddenly being dragged down the gurgler by a deteriorating world economy and one-off events such as the war in Ukraine.

So, let’s just step back and turn down the dial on the noise that often passes as economic commentary. While there is the potential for Australia to fall into recession, it will be a recession with no teeth, and it will be short lived.

Why? Recessions are usually characterised by high unemployment, and it is that loss of income that bites so hard and causes pain in any economic downturn. That’s not happening now. Australia is facing a prolonged labour shortage and so high unemployment is not expected to be an issue.

Secondly, Australia is enjoying record high levels of export earnings. This means the economy is awash with cash and as much as the Federal Government doesn’t want to talk about it, this will take a lot of pressure off both Government revenues and household budgets.

Also, this bout of inflation is very different. Certainly, inflation appears to be reaching record levels and to bring this under control the Reserve Bank is lifting interest rates to slow the economy, curb demand and with that take some of the pressure off prices.

However, unlike previous bouts of inflation that have been largely driven by demand factors, such as higher wages leading to higher prices, particularly for housing, this bout of inflation is driven by supply side factors. Real wages are actually falling.

The long ‘economic’ tail of Covid is proving difficult to shake and it is creating significant pressure on all businesses. It is still hard to ship goods around the world. It is still hard for manufacturers to source key items particularly out of China which is still enduring lockdowns.

It is still hard to run a business, wherever that business is or what it does. Whether you run a local café, or a tourism business in North Queensland or a manufacturing business in outer Melbourne that is waiting on motherboards from China to eventually arrive to start your machines.

These factors will slowly resolve themselves. Until then, the only real lever the Reserve Bank has to slow price hikes, which are now tipped to increase by as much as 7.75 per cent by year end, is to lift interest rates.

This strategy will eventually work, and it is possible that in pursuing this strategy, the Reserve Bank will tip the economy technically into recession but with unemployment still expected to be a relatively low 4 per cent, it will recession with no teeth.

So there will be some short term pain along the way. There will be endless headlines about petrol prices increasing, the price of lettuces reaching record levels and stories of couples who bought a home in Sydney for $1.5 million with almost no deposit this year who can’t afford their loan repayments.

It will also be a tough time in the property markets, with higher interest rates making buyers reluctant to pay top dollar and in the building industry, where it will be difficult for builders to confidently think they can build a house and sell it for more than it cost of construction.

However, with unemployment expected to remain low, it is unlikely that there will be widespread business closures or bad debts which is usually the hard price of any recession.

As well, Australia is well placed to continue to achieve record export earnings, which hit a record $16 billion for the month of May alone. The trade surplus was up 20 per cent on the previous month with exports up 10 per cent.

For good or for bad, we sold more coal in the month than iron ore for the first time in more than a decade and across almost every category, export earnings were near record highs.

So again, looking past the noise of today’s news reports that are focused on inflation and interest rates, if the economy does fall into recession, it will be a recession without much bite given unemployment will stay low and the economy will be awash with record high export earnings.