Where is the Australian economy heading? The new MW Index rates the Government according to the things which it says are important.
What does the RBA say is going on? Governor of the RBA Philip Lowe said on September 24: “After having been through a soft patch, a gentle turning point has been reached. While we are not expecting a return to strong economic growth in the near term, we are expecting growth to pick up … At our board meeting next week, we will again take stock of the evidence”.
Here’s the MW view:
How the MWI works
There are a number of elements in the MWI. It’s a momentum metric. And momentum has been slowing for some time.
We’ve looked to PM Scott Morrison, treasurer Josh Frydenberg and the Reserve Bank to design the core elements of the index for us. We’ve listened to what they say is important and we’ve given those elements the most weight.
We are emphasising what the government emphasises: changes in growth, inflation and interest rates. Therefore these account for over half of the movement in the MWI.
Highest weighting goes to the changes in GDP (growth). This is the standard the government set itself politically with its “growth means jobs” mantra. The Treasurer’s April budget speech was clear: “Australia is stronger than it was when we came to government six years ago. Growth is higher”.
And this one: “Under a coalition there will always be more jobs”.
Growth has declined throughout the year but remains positive. Two negative quarterly numbers in a row means recession. We’re not there yet, even after 30 years without a recession.
Less weight in the Index goes to bond yields (interest rates). There have been some big moves here. Yields have tanked. The MWI uses shorter term government bond yields.
Less weight again goes to the inflation numbers (CPI). The RBA uses its inflation target to decide when to intervene. The MWI treats high and low inflation in the same way. The RBA says that because the demand for goods and services is falling, the CPI and growth are both down. The government is now asking the RBA to drop its inflation target.
Around one third of the index is forward looking. It uses longer term interest rates to give a view of business future earnings. The Australian banks’ monthly consumer and business sentiment surveys also influence this aspect of the metric.
We do not include unemployment data or the jobs participation rate. This is because the MWI is focussed on the demand and supply for goods, services and money. The demand for labour lags these other indicators. It’s a consequence of the other numbers, as the recent uptick in unemployment suggests.
The economy has been decelerating and losing momentum for at least nine months.
There are two pronounced dips in the index (in March-April and again in August- September). These show the impact of a rare and, some say ominous, “negative yield curve”, where long term interest rates are less than short term rates.
The second dip was deeper and considerably more sustained than the first. It is shallower now and it is lingering.
The MWI is now around 75. It would approach 50 if annualised CPI and GDP growth, along with 10 year bonds, all went to zero.
The MWI would approach 80 if the ongoing decline in these numbers bottomed out and consumer sentiment as well as business confidence lifted from their current lows.
The MWI fluctuates slightly daily. Monthly and quarterly data is smoothed. Its next significant adjustments are a couple of months away, when the Australian Bureau of Statistics updates its quarterly inflation and growth numbers.
Where could this go?
What does conventional wisdom suggest would happen if the MWI fell under 50? And stayed there. Or decline further.
One: a continuing declined in the big numbers can see investment move from income-producing and job-creating assets to places of perceived relative safety; particularly towards tax-preferred, government-subsidised cash flows. Or retained profits can be paid out to shareholders, if a business cannot find a profitable use for the funds, and shareholders then put them out of harm’s way.
Josh Frydenberg’s speech to the Business Council on 26 August 19 shows that he is already concerned that business is vacating the field. He asks: “share buybacks and capital returns are becoming increasingly prominent and the default option for corporates but is a buyback always the best option for the future growth of the company and therefore the economy?”
Two: early on, declining interest rates tend to increase asset values. Land, business valuations and equities go up. There’s a tentative optimism. But this optimism lasts only until declining business revenues become apparent.
Consumer sentiment and business confidence falls. The RBA drops the cash rate. The mood shifts to tentative pessimism. Now values go the other way: consumers are no longer responding to monetary stimulus (lower interest rates) and delayed fiscal stimulus comes too late (income tax cuts, welfare payments, drought relief, infrastructure investment).
Once business revenue projections collapse, asset values decline (deflation). The onset of negative interest rates would confound and distress savers and investors. By then unemployment may have risen noticeably.
Three: Conventional wisdom also says, if deflation takes hold and low or negative interest rates are not enough to rescue poorly managed businesses, then it’s up to the bankruptcy laws to reorganise the economy by placing insolvent businesses with good products, good systems and good people into the hands of those with the wherewithal to wait till the economy picks up.
The insolvency laws act as a type of economic re-restructuring device which sorts the good businesses from the bad. Opportunities for some, but unemployment for others.
Where is the risk?
The risk of insolvency in a deflationary economy is with those businesses whose financiers default loans not just for delayed payment but also for loan-to-valuation ratio (LVR) breaches. Businesses with collapsing balance sheets and no orderly means to pay down debt, fall to their financiers. The banks want out.
This was the dominant complaint against banks which saw Coalition backbenchers demand the Royal Commission into Misconduct in the Banking Superannuation and Financial Services Industry.
Distressed debtors tend to be those where management learned their basic skills at the school of hard knocks: get cash in, restrict cash out, be nice to the employees you want to keep, try some marketing, and keep the laws which are enforced.
These are work-a-day small business habits for the good times, not for challenging times. Around 90 per cent of employment is in the private sector. And 45 percent of that is in businesses with less than 20 people. These small enterprises are the least likely to be restructured on an insolvency. Instead they shut their doors. And the number of Newstart recipients grows.
But we’re nowhere near a 50 score on the MWI, yet.
John Howard, treasurer for five years in the Fraser Government, saw the economy suffer five consecutive quarters of negative growth in 1982-83.
Unemployment rose to almost ten percent, its highest level since the Great Depression. John Howard had a drought and bushfires to contend with, but so do Josh Frydenberg, Mathias Cormann and Scott Morrison. And they have a way to go to challenge treasurer Howard’s record negative 2.9 percent contraction in GDP.
Josh Frydenberg told Parliament on 2 April 19: “It is a testament to the strength of the Australian economy that it is its 28th year of consecutive economic growth.” There’s a doggedness to Mr Frydenberg which earned him praise as he diligently and calmly fought off the right wing of his party on the National Energy Guarantee until his leader was toppled and he took the deputy leadership.
The only question is whether his dogged determination to move from his balanced budget to a surplus gives him enough time to avoid ending Australia’s world record for growth.
Parliament of Australia website.
Josh Frydenberg: “Making Our Own Luck – Australia’s Productivity Challenge” address to the Business Council of Australia 26 August 19.
Josh Frydenberg: “Powering Forward – the National Energy Guarantee” address to the National Press Club 11 April 18.
RBA website. RBA Statement on the Conduct of Monetary Policy.
Phillip Lowe: Address to the Armidale Business Chamber 24 September 19.
MWI sources: Australian Bureau of Statistics website. ASX website. CBA, NAB and WBC websites. Bloomberg LP website.