Australia’s Hidden and Lopsided Inflation

— So the Eurozone as we know it is destined to die a slow, instead of immediate, death. Overnight the German Constitutional Court ruled existing EU bailout programs are okay, but future ones need to be approved by the Bundestag… not Angela Merkel acting in concert with European banking interests.

— The markets loved it of course. For the past few weeks, the lumbering Eurozone vehicle had been inching toward the can in the middle of the road. Investors were increasingly concerned that someone was going to have to stop the vehicle, get out, bend down and pick it up.

— But markets aren’t interested in hard work anymore. Speculation is the name of the game. Profiting from the moves of politicians and central banks is what Western capital markets have become. And so when the German judges kicked the can down the road once again, markets rejoiced. The day of reckoning averted once more.

— So how long will the market rally last this time? How long will it take for investors to remember that the US economy is creating zero jobs (regardless of what Obama says tonight) and that Greece will soon default?

— At some point, would be our imprecise answer. For something a little more tangible, check out the latest free YouTube update from our trader and technical analyst Murray Dawes. Murray has been eerily prescient with his market calls lately, so you won’t want to miss this instalment.

— Getting back to the can kicking… Was such an outcome ever really in doubt? This was a grave decision to put in the hands of men. Had they voted against the bailouts and killed the euro, they would have put an unwanted spotlight on themselves. As Ambrose Evans Pritchard wrote in The Telegraph ‘The judges did not want a global depression on their conscience.’

— And that’s the point. No one does. But it doesn’t stop it from being inevitable. Hayek knew this all too well. In the Constitution of Liberty, he wrote:

‘From what we know, it still seems probable that we should be able to prevent serious depressions by preventing the inflations which regularly precede them, but that there is little we can do to cure them, once they have set in.’

— We’d say this depression is setting in nicely. After a major inflation comes deflation. The deflation (in this case in asset prices) uncovers the bad investments made during the boom. The debts backing these investments are written down. The banks that made too many dumb decisions lose value or go bankrupt. The slate is eventually wiped clean, setting the stage for the next sustainable expansion.

— But in Europe and the US, the meddlers keep scribbling on the slate. Trying to protect the value of bad debts by imposing ‘austerity’ on the middle class will condemn the Western world to years of depression-like conditions.

— What about Australia? Are we West or East? Yesterday’s better-than-expected economic growth figures suggest we are heading in an easterly direction. Growth for the three months to 30 June came in at 1.2 per cent. That got Wayne Swan, err…crowing.

— But ‘inventories’ were the largest contributor to growth in the quarter, adding 0.8 per cent. Inventories are sort of like unconsumed production. The production adds to economic growth, but if it just sits on the shelves, it’s not quality growth.

— The hero of the quarter, once again, was the Terms of Trade, or the ToT. In seasonally adjusted terms, the ToT rose 5.4 per cent in the quarter, following a 4.1 per cent rise in the March quarter. This is why the RBA is still threatening to raise interest rates despite weak annual economic growth of just 1.4 per cent.

— The ToT has all sorts of behind-the-scenes impacts on the Australian economy. It impacts Australia’s nominal economic growth, which is growth measured in current prices. The increase in the ToT feeds into the nominal economic growth figure but not the headline number you see in the media. That’s because the headline number is measured in constant prices.

— So while the economy grew just 1.4 per cent in real terms in the year to 30 June, in nominal terms growth was 6.3 per cent. You can thank the ToT for much of that difference.

— If you look at the two figures it will also give you an idea of the inflationary pressures in the economy. The difference between the two numbers is called the ‘implicit GDP deflator’. Another word for it might be ‘inflation’. At 4.9 per cent, it’s rather hefty.

— But it’s also misleading if you’re someone who thinks the RBA can control inflation. Australia is experiencing inflation brought about not by our central bank, but by China’s. Raising interest rates here to combat inflation in the resource sector would be futile.

— That’s why Glenn Stevens wants to maintain the threat that interest rates will rise, but he’s praying that the ToT will soon take a breather – so he can too.

Greg Canavan
for Markets and Money

Publisher’s note: “I have loved your videos and have watched in awe as the market unfolds as you have predicted! Great stuff, you are well on the money.” This was how one YouTube viewer described Murray Dawes’ market update video from the 17th August. And our Slipstream Trader keeps on nailing the big calls. After last week’s free video (31st August) the market followed the script exactly and sold off hard from the “sell zone” Murray predicted. Earlier today, Murray posted his newest video on YouTube. If you’re wondering whether the latest rally has real legs, you might be interested to hear Murray’s verdict… He also reveals where he thinks the short-term momentum is taking the index… To watch Murray’s just-recorded video update – for free – go here.

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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Increase in GDP may simply be a case of money spent rebuilding after the floods. Note which states had highest GDP growth…headlined by QLD.

The rest of the states were flat or negative.


More coal going to port is the QLD “growth”, but it is only growth on the last 1/4 not on the previous (non-flood affected) average.

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