Capital Circuits and the Aussie Construction Boom

The Reserve Bank of Australia noted in the August meeting minutes that they believe the dark days are over for wage deflation.

Of course, they didn’t say when but, judging by the minutes, the RBA is confident wages will turn a corner soon.

While the wage price index (WPI) measures wage growth across the board, there is a discrepancy between private and public sector wage growth.

Public wages grew 0.6% for the June quarter, rising at a rate of 2.4% for the year.

The private sector experienced much slower growth, increasing by only 0.4%, for a year-on-year figure of 1.8%. Meaning private employees are seeing their wages increase by less than the current 1.9% inflation rate. Not only is inflation eating away at what your dollars are worth, but wages in the private sector aren’t even growing at the pace of the cost of goods.

This most recent June quarter for the WPI means Aussies have now had 18 months of persistent wage deflation. Have a look at the chart below.

growth in wages


Source: The Age
[Click to enlarge]

Based on the data available, wage growth is now the weakest it has been in almost 30 years.

Still, the RBA believes that’s about to change. Why? Because it believes skills shortage in certain industries will slowly contribute to employers being forced to pay more for labour.

It’s an optimistic view.

However, the RBA did briefly touch on the construction sector within Australia, stating:

The number of new residential building approvals had stepped down since 2016 and members noted that, if approvals remained at current levels, construction activity could also begin to decline.

I pay close attention to activity in the construction sector.

Construction is big business in the country. Because of its sheer size and importance, any weak spots are going to show up in construction first. As they did when the mining boom was critical to economic growth.

The construction industry should be something you pay very close attention to.

The three circuits of capital

In The Urbanization of Capital, demographer David Harvey analyses how capital flows through an economy.

Harvey’s analysis is simple. There are three circuits in a capitalist society: the primary circuit, secondary circuit, and tertiary circuit.

The primary circuit refers to an economy in the production phase — the ability of a country to produce goods. In Australia’s case, that was the mining boom. Our spare capacity in the both the labour market and available minerals were exploited to grow the economy.

Or, in simple terms, we had the rocks to sell, a skilled workforce, and demand from buyers. For half a decade, it worked. The mining boom provided incredible amounts of growth for the Aussie economy.

The problem, according to Harvey, is that too much ‘success’ in the primary circuit results in over-accumulation. Again, in the case of Australia’s mining boom, we were supplying far more commodities than the global market demanded.

With the excess supply in the market — like excess iron ore for example — prices fall, which means profits shrink. In turn, companies reduce staff numbers and scale back production. Leading to higher rates of unemployment and investors looking elsewhere for returns.

Once this production phase (the primary circuit) has ended, Harvey says the capital flows into the secondary circuit.

It is here where an economy shifts from producer to consumer.

The secondary circuit is very much about capital flowing into fixed investments that relate to building and consumption. For example, housing and consumer durables that aid consumption — such as appliances and office furniture.

This phase is called the ‘built environment for consumption’. Essentially, when the economy switches to this, the economy becomes focused on what it can build, rather than what it can produce.

Just like the primary circuit, there can be excess supply in the secondary circuit. That point comes when we build much of anything — much more than people want to buy.

Harvey’s argument was that, once an economy becomes focused on building for growth, the whole system starts to look shaky.

In his view, when you build for profit — just like mining commodities — eventually the construction will stop or move elsewhere if prices start to fall.

Throughout Australia, we are smack-bang in the middle of the secondary circuit.

Check out the Performance of Construction Index below. The chart breaks down activity in the four sectors of construction: engineering, commercial, apartments and houses.

Performance of Construction Index — Activity by Sector

construction index


Source: Australian Industry Group
[Click to enlarge]

This particular chart shows new constructions started from 2012 to 2017.

And based on the most recent monthly data for July, everything looks rosy.

For the month of July 2017, commercial construction jumped an incredible 9.8 points higher to a reading of 64.3 on the index. Not only is this three months of growth, it’s also the fastest expansion in this sector recorded in 12 years.

The engineering sector also got a lift, rising 6.9 points, to 57.5. However, the increase for engineering largely comes from government spending on infrastructure on the east coast of Australia, and not private investment.

While new apartments did increase 4.3 points in July, new starts in residential building are a long way off 2015 highs.

A quick glance at this chart could lead you to believe everything is fine within the construction sector. But the data represents projects that have been approved for some time now — with funding now coming through, and construction commencing.

As I mentioned earlier, the RBA noted that new approvals in the construction sector have fallen from their peak. Which means the activity you’re seeing above was approved some time ago. Generally, from approval to construction, you should allow about 18 months to two years.

Falling new construction approval rates in Australia could pose a serious long-term problem. Simply because we have used the housing sector to prop up the economy when the mining boom ended. To borrow from Harvey’s analysis, the Aussie economy has relied on construction to drive the economy. In order for construction to remain a driver of economic growth in Australia, profits must remain to attract capital. If these developers decide to move on and chase higher profits elsewhere, it could leave Australia in a very vulnerable position. A position no one appears to be talking about.

Let’s be clear: The only thing that keeps construction levels high in Australia is that there are profits to be made. Once those profits start to diminish, investor money moves elsewhere.

What it could leave us with might be a big, giant mess. You see, this one sector of the market directly employs 1.1 million Australians. Construction represents a massive 9% of the Australian workforce. This figure doesn’t include all the indirect jobs to the construction industry, like real estate agents or architects.

The end of the mining boom rattled Aussie markets. At its peak, the mining sector employed about 200,000 Aussies.

Imagine the impact high rates of unemployment in the construction sector would have.

Australia has an economy that relies on red rocks and red bricks. The construction sector is our Achilles heel. Building approvals, new constructions and employment data need to be carefully watched. Because that will tell you where the problems are first.

Kind regards,

Shae Russell,
Editor, Markets & Money

PS: I didn’t touch on the third phase of circuits of capital. The tertiary circuit happens to have enormous potential benefits for investors. It’s this phase that shifts how we invest. Rather than just looking at products for consumption, the tertiary phase is about investing in science, technology and products benefiting the health of society. Like the rise of marijuana as a new pillar of medicine.

It’s early days yet but, thanks to legislation changes, Australia is now reaping the benefits from the boom in medicinal marijuana. For details on this developing story, click here.


Shae Russell started out in financial markets more than a decade ago. Working with a derivative brokering firm, she helped clients understand derivative markets, as well as teaching them the basics of technical analysis. Since joining Port Phillip Publishing eight years ago, Shae has worked across a number of publications. She holds the record for the highest-returning stock recommendation, in which a microcap stock returned over 1,200% in six months. Ask her about it, and she won’t stop yapping on. For the past two years, Shae has worked alongside Jim Rickards as his Australian analyst, translating global macro trends for Aussie investors, and how they can take advantage of these trends. Drawing on her extensive experience, Shae is the lead editor of Markets & Money. Each day, Shae looks at broad macro trends developing around the world, combining them with her distaste for central banks and irrational love of all things bullion.


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