With the release of yesterday’s economic growth data, you’re finally starting to see a clearer picture for the Aussie economy. It explains why growth is strong but the economy ‘feels’ weak.
The headline GDP number showed Australia grew a very healthy 1.1% in the three months to 31 March, and 3.1% over the past year. Given what else is happening in the world’s developed economies, that is exceptional.
And yet the RBA saw fit to cut interest rates in May, not long after this powerful economic performance. So what is going on with the Aussie economy? If it’s strong, why the interest rate cut and concerns about growth? Or is the economy really weaker than the numbers suggest?
Here’s my take…
The Aussie economy is indeed growing at a decent clip. But it’s quite a fragile form of growth. Let’s have a look at the numbers to show you what I mean…
First of all, understand that GDP is a measure of gross domestic product. It measures the amount of production in an economy. Right now, the economy’s production numbers are very healthy.
That’s mostly due to a big pick up in exports of iron ore, coal and natural gas. Combined with a slight fall in imports (which adds to economic growth) ‘net exports’ contributed 1.2% to the overall quarterly growth figure of 1.1%.
The only other decent contributor to growth was household consumption. It accounted for 0.4%, while the winding down of the mining boom continued to detract from growth.
That’s the good news. But the problem for the Aussie economy is that the prices we receive for this increased production keep falling. The terms of trade, which measure this, fell 1.9% in the quarter, and a whopping 11.5% over the year.
Taking this into account, along with a few other things, produces a more accurate measure of growth called ‘real net national disposable income’. For the March quarter, growth in this measure was just 0.2%; over the past year, it actually contracted 1.3%.
This is why the RBA cut interest rates in May. Despite the strong headline economic growth numbers, they know there is considerable underlying weakness in the economy.
To see this more clearly, just have a look at the current account data for the March quarter, which came out on Monday.
The current account measures the trade balance as well as the balance of Australia’s income payments to the rest of the world. Because Australia has a large net foreign debt (over $1 trillion), we must pay interest on it. The current account measures this, netting it off against the interest payments coming into Australia. It’s called the ‘net income deficit’.
Right then. Given the big contribution that exports made to economic growth, you’d probably think Australia runs a trade surplus, right? That is, we export more than we import.
Not at all. In the March quarter, Australia still managed to produce a trade deficit of $8.1 billion. It was an improvement on the December quarter’s $10 billion trade deficit shocker, but it’s still ugly given our apparent ‘export boom’.
This tells you that, despite the big increase in export production, thanks to falling prices for that production, it’s not improving our trade situation at all.
And because our trade deficits don’t improve, we need to keep borrowing to make up the difference. That’s why our net foreign debt is now at $1.028 trillion. In the March quarter, the net interest bill on this debt was a whopping $12.1 billion.
Add the net interest bill and the trade deficit together and you get the current account deficit. For the 12 months to 31 March, Australia’s current account deficit was $84.7 billion.
That’s $84.7 billion dollars flowing out of this country to maintain a standard of living we can’t actually afford.
This is not a new development. It’s been going on for decades. And for years it’s never really bothered financial markets.
But I don’t think this happy state of affairs will continue. Here’s why:
For a long time, the build-up of debt in Australia was all about households. Because incomes were on the rise too, this debt build up was manageable. In addition, government debt was low for a long time too. That gave financial markets confidence in Australia.
But ever since the crisis of 2008, government debt has increased. It’s coming off a low base, but the growth trajectory is worrying, and there is no credible plan to get the budget deficit down anytime soon. That means government debt will continue to grow as a percentage of economic growth.
And since 2011, when the prices for our main commodities like iron ore and coal peaked, income growth has been in decline. Yet we have continued to borrow at a rapid clip.
At 31 March 2011, Australia’s net foreign debt was $636 billion. It’s now $1.028 trillion. That’s a 62% increase in five years. Over the same timeframe, national incomes have barely grown.
This big increase in debt hasn’t posed a problem so far because the RBA keeps lowering interest rates, which makes it easier to manage.
But that also encourages more debt accumulation. In the short term, everything looks OK as it translates into strong household consumption.
But make no mistake; it’s a ticking bomb for Australia. Both household and government debt is growing rapidly, while income growth is stagnant. That means the economy is more and more leveraged, and ever more susceptible to an external shock.
When that day comes — and it always does — the real shock will be felt inside Australia. Most Australians, including our leaders (but not you, dear reader), have no idea just how fragile our economy is.
For Markets and Money