Ausbuy

The Growing Threat of Inflation

January 3rd, 2008

Australians have forgotten what inflation means. The last 10 years have seen rising real wages and relatively stable prices. Each rise in petrol prices or .25% rise in interest rates was greeted by a public outcry. Unemployment was at a 40 year low and spurred on by dropping prices for consumer goods from China. We rushed in to buy the latest trinkets and built ever larger houses for smaller families. The world economy increased to take up spare productive capacity and in many cases prices actually dropped. The effect of this favourable pricing movement was, in the case of Australia, increased by an overvalued exchange rate which made imports cheaper. The subprime lending fiasco has brought this to an end. Credit to finance Australia’s Balance of Payments is no longer easily available and is more expensive.

One of the early effects of this worldwide credit crisis is to draw attention to the method by which Australia funded its trade deficit. Instead of the Reserve Bank borrowing, it was left to the commercial banks. This allowed the then treasurer to proudly state that the federal government did not owe any money. If the commercial banks can no longer do so than the Reserve Bank will have to borrow offshore. This would be matched by a lower exchange rate which is required to correct the Balance of Trade Deficit. The resultant inflationary pressures will not be easily controlled.

The problem is that once inflation gets to a higher level it feeds on itself. Savings are eroded, confidence is destroyed and those that have power push for excessive wage increases that they believe are necessary to protect them from rising prices. Long term investment decisions are shelved as investors worry about the short term problems of paying the interest on the borrowings needed to finance their investments.

Those days of easy credit are now over and like any household that has overspent we will be forced by our creditors to get our house in order. Our currency will drop which will make our exports more competitive and our imports more expensive. Unemployment will rise as the economy slows. This will increase welfare payments and reduce the tax base. The likely rises in interest rates will fight inflation in the long term but will initially flow into further price increases from domestic suppliers. This, combined with the increased cost of imports referred to earlier will have an impact on the public. It will tip the economy into recession, which is likely to end the inflationary spiral, as did “the recession we had to have”.

Perhaps this sounds like a gloomy scenario but if it forces us to re-examine our economic policies it will be for the best. We need to have a strong Australian owned manufacturing sector which partially insulates us from the vagaries of the global market. Much of what happens over the next few years will be influenced by what happens in the USA and its knock on effect in China. Anyone who says that this mining boom is different has never read history or doesn’t realise that mineral prices depend on supply and demand.

Australia is generating savings but much of these are being invested overseas while we look to foreign money to develop Australia. As our currency drops we will see a renewed interest by foreign investors buying Australian companies cheaply. This must be resisted or we will emerge from this period as a foreign owned quarry with no control over our economy. Handling these difficult times will require strong leadership and understanding citizens. On a personal level, people must control their spending and keep debt to a level that they can service.

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