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The resources boom signals good times, but is manufacturing telling another story?
Gerard Jackson
Happy days are here again, or so Michael Stutchbury, economics editor of The Australian, seems to think. Not only that, Australia even managed to avoid a recession. (See The recession: once again our rightwing get it wrong for an explanation of what really happened). No wonder I treat most economic commentary with utter contempt. He happily tells us that the Reserve now calculates that the rate the economy can grow without sparking inflation now exceeds "the standard estimates of recent years".
This is total nonsense. There is absolutely no way that genuine economic growth can create inflation. First and foremost, growth is another term for capital accumulation. The only way capital can be accumulated is through forgone consumption otherwise known as saving. This done by directing resources from consumer goods to the production of capital goods, sometimes called producer goods. In the terminology of the Austrian school of economics it is the process by which present goods are transformed into future goods. That any economists could even entertain the thought that economic growth can be inflationary is a bloody disgrace.
In fact, if a country enjoys sound money then economic growth will produce a gently falling price level as increased productivity lowers costs and prices. (It's equally disgraceful that the vast majority of economists cannot distinguish between a money-induced fall in prices and a productivity-induced fall.) Growth has become associated with inflation because the great majority of economists fail to see that when investment exceeds savings this is because credit expansion is creating unsustainable investments. In plain English, excess investment is inflation.
Stutchbury reports that the Reserve believes the growth rate has been lifted by an increase in labour and capital in response to an increase in demand by China for our mineral and energy resources. It is also estimated that the capital stock is growing by more than 5 per cent a year. The problem here is that because capital is heterogeneous we cannot measure it. All we can basically do is add up how much is spent on plant and equipment. Now the Reserve states that even a small increase in productivity will raise the economy's potential for growth. This is wrong through and through. It is increased investment that raises productivity, not the reverse, meaning that only a sustained increase in real savings — from which investment comes — can accelerate the rate of capital accumulation.
We are then warned that it might not be long before the economy runs into capacity constraints. That this would be an indication of accelerating inflation never occurred to Stutchbury any more than it occurred to RBA economists. When constraints and bottlenecks emerge it is a surefire sign of inflation-induced distortions in the capital structure.
It's pretty clear that all of this new investment is being directed to the resources sector. And of course we all know that this sector is largely being driven by demand from China. But what happens if much of this demand is the result of an inflation-driven boom? The result is that once the boom is terminated a great deal of these investments will have to be abandoned.
Moreover, the aggregate approach to investment gives the impression that the pattern of investment is irrelevant. This is a dangerous line of thought. When it comes to the boom bust cycle Austrian economic analysis warns that manufacturing is where the downturn first appears. (This is because of the role time plays in production.) The chart below shows the PMI (performance manufacturing index) peaking in December 2007 57.6 and then rapidly dropping, reaching 30.1 in April 2009 after which is rapidly rose again flattening out at in August at 51.7*.
BrookesNews.Com
Monday 23 November 2009
After remaining comparatively flat for a time M1 quickly rose from 239.1 April 2009 to 256.2 in the following June, a rise of 7 per cent in 3 months. Then in July it dropped to 246.8, a 3.5 per cent contraction in one month. M1 stood at 252.7 for September. PriceWaterhouseCoopers' October report for the Australian Industry Group shows a downturn in every manufacturing indicator bar one for that month. The correlation from last April between changes in the money supply and the PMI strongly suggest that monetary policy is responsible for the rise in manufacturing indicators* and also October's drop. (It should be noted that China's demand for resources did not prevent the prolonged contraction in manufacturing.)
If manufacturing is this sensitive to monetary changes then it is very likely that any further monetary tightening will cause a continued contraction irrespective of the demand for resources. So it seems that the country's capital structure is being dangerously distorted by domestic monetary policy and China's policy of creating masses of credit to fuel growth, with the latter policy integrating Australia's higher stages of production into China's capital structure.
Right now it looks like the country is being given another ride on the RBA's monetary roll-coaster with the People's Bank of China of busily greasing the wheels.
*There is no one-to-one relationship between the money supply and manufacturing, as shown by the chart. Austrian analysis explains why manufacturing can still slow and then contract even when the money supply is still expanding.
Gerard Jackson is Brookesnews' economics editor