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Six suspects in the murder of inflation

What happened to Harold Holt? How did we allow mullets to become fashionable? Who murdered inflation? These are some of Australia’s greatest mysteries, and economists have felled many a tree in recent years expressing their bewilderment that inflation has vanished without a trace.

The whereabouts of inflation in Australia and other major economies has been a monetary mystery for more than a decade now. According to economic theory, low interest rates should increase consumption and borrowing, increasing demand and resulting in higher prices. According to economic theory, low unemployment should force employers to offer higher wages as a way of competing for scarce talent. So, who could be responsible for the murder of inflation?

We’ve enlisted the assistance of Hercule Poirot, Sherlock Holmes and Jacques Clouseau to narrow down a list of suspects:

Suspect 1 - Amazon Armageddon: Increased globalisation has resulted in many Australian businesses having to keep prices low to remain competitive. This is particularly relevant for Australian retailers, who are struggling to keep up with the likes of Amazon.

Suspect 2 – The Grocery Wars: The price war between Coles, Woolworths and Aldi has helped keep a lid on inflation. A PwC report found that Aldi’s presence in the Australian market has resulted in Australian shoppers saving more than $2.5 billion per year.

Suspect 3 - Follow the Money: The RBA has been lowering interest rates since November 2011. Total credit in the economy has increased by $890 billion since then, with housing loans accounting for 70% of that new debt. Australians didn’t respond to lower rates by taking out more personal and business loans and stimulating economic activity as the RBA may have hoped, choosing instead to borrow up to their eyeballs in housing loans. At least there was inflation in property prices!

Suspect 4 - Underemployment: The ABS considers someone employed if they work more than one hour a week, meaning that low unemployment figures may be misleading. Underemployment, which measures workers who are employed but want to work more hours, is historically high. It should be no wonder that wage growth is non-existent when there are more than a million Australians looking for more work.

Suspect 5 - Not just call centres: Cheap foreign labour is typically associated with the decline of Australian manufacturing jobs, however thousands of white-collar jobs in Australia have been lost to ‘outsourcing’ (corporate Australia loves a euphemism!). As profit margins get squeezed, Australian companies can save up to 70% on wages by shipping low-skill jobs overseas. This trend will only accelerate as the quality of foreign labour increases, with high-skill white-collar jobs increasingly at risk.

Suspect 6 - Running out of luck: The Australian economy remains anaemic, as reflected by its woeful productivity growth figures and per-capita recession. China is building 20 million square metres of new floor space each month – for reference, the total floor space of Sydney’s CBD is 17 million square metres. If China decides to stop building a new Sydney CBD each month, the demand for our major commodities will plummet and our much-treasured streak of 27 years without a recession will almost certainly end.

Who do you think pulled the trigger? Did the suspects work in cahoots? Were there other accomplices? Despite having a rock-solid alibi, the RBA appears to have pinned the murder of inflation on interest rates being too high. Sherlock Holmes once warned that we should twist our theories to suit facts and not the other way around. Rather than relying on conventional economic wisdom to solve this mystery, we should ask ourselves a simple question – why would prices and wages be rising in the first place?

Lowering interest rates further does nothing to improve the Australian economy, which needs major reforms to improve the quality of its labour force and business conditions. Although it is undoubtedly a foreign concept to them, our dear leaders in Canberra may actually need to stop sharpening their knifes and do some work. At this stage, we may as well save on the labour costs and outsource our politicians to the Philippines!

 

Nicholas Stotz is Investment Research Analyst at advisory firm, Stanford Brown. This article is general information and does not consider the circumstances of any individual investor.

 

5 Comments
Stuart
September 05, 2019

Great article. Did you miss demography? Extending lifetimes and health, Too many retirees or early retirees causing the money cycle to bog-up as they assume living healthy life to 99 and sit on savings accordingly.
Although the counterpoint is reducing % of population of working age would push inflation higher (but that has been counterbalanced by net immigration).

Gary Judd QC
September 01, 2019

Aren’t the economic laws concerning supply and demand the relatively simple and obvious answer to the question?
Increase the quantity of goods and services whilst keeping the money supply the same and prices should go down. Lowering interest rates, and QE more so, increases the money supply. If equilibrium occurs prices should remain the same.
If the increase in the money supply exceeds the increase in the quantity of goods and services, prices should go up.
Prices as measured by the CPI haven’t gone up much because the quantity of those goods and services has increased, but prices of many other goods and services which are not measured by the CPI, have increased. Mainly those where there are constraints on supply such as land and buildings. And other assets such as bonds and shares which have been in high demand because interventions by the government and its agencies have disincentivised reliance on traditional savings vehicles.
If the market were allowed to operate without interventions, these distortions would not exist.
Prices of CPI goods and services would have decreased. Asset prices would not have skyrocketed. This would have been good, not bad.

Nicholas Stotz
September 02, 2019

Hi Gary,

Completely agree with your comment, as up until recently I was a card-carrying libertarian (I can still watch Thomas Sowell videos for days). All of my points above boil down to supply and demand issues (e.g. higher supply of providers selling consumer goods capping prices, higher supply of global labour putting pressure on wages, etc).

Couple of comments to add:
- Increasing the money supply should increase the price of goods, assuming that the velocity of money stays the same. It's all well and good for Josh Frydenberg to say that we consumers should spend their tax cuts and that companies should increase their investment in Australia, but if the economy was healthy consumers and companies wouldn't need any encouragement. To me that's evidence of a weak velocity of money.
- I'd argue that we have low inflation because we've allowed the market to operate without interventions. Yes we have a major distortion in terms of interest rates, but for the most part we've allowed consumers and companies to freely choose lower cost alternatives (Amazon, low-cost foreign labour, etc). The taming of inflation in recent decades probably has more to do with the liberalisation of the Australian economy than any interest rate decisions made by the RBA.

Cheers,
Nic

Dave
August 29, 2019

I love the last sentence in your article. If only

Nicholas Stotz
August 30, 2019

We can dream Dave!

Hope you enjoyed the read.

Cheers,
Nic


 

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