An update, and a more somber look at the earning side of pandemic economics.
Well, when last we met, Melbourne had been free since November, NSW was not yet infected with the Delta plague, and we were as yet unaware that half the population would be back under lockdown in July.
Nor did we expect that even after QLD (and VIC, mournfully briefly) escaped the terrible jaws of isolation, that our two most populous states would publicly give up on COVID elimination. Currently, NSW and VIC are both fighting to contain the virus for long enough to adequately vaccinate the population, but will not attempt to eliminate it.
The government was once again called on to support Australia’s largest state economies, well after it had expected those economies to be recovered and happily churning along on their own. The return to “normal” is no longer assured – the best we are hoping for is COVID-normal. This raises a number of question marks over the assuredness of our predictions earlier in the year. What happened to inflation? Can we still borrow more money? Where’s employment at, and what does that mean for us?
So let’s reassess the Australian situation, and dig in a bit further on the jobs side of things.
Debt
Debt is still continuing to be Australia’s saving grace and a source of continual hilarity to me, personally. We continue to borrow large amounts, in both Treasury Notes (short term, under a year to two years) and Treasury Bonds (3-30 years). Economic disruption does not seem to be shaking confidence in the government’s future income flows, and is coinciding with stock market anxiety to interesting effect: creditors are fleeing the uncertainty into the government’s welcoming arms. As a result, Australian securities are still widely-coveted, leading to very, very low interest rates.
However, note that 2.5% is the highest interest rate we’ve had in a year and a half. These are for bonds that will last a minimum of ten years, and the possibility of fairly high inflation in the meantime (such as a 3.8% inflation rate since June last year). These are really, historically low interest rates.
A caveat: The longer the bond, the higher the interest rate – so if you’re selling long bonds after short ones, you’ll get higher interest rates even as the market stays the same. To cut out the side-effects of super-long or super-short bonds, we had to get creative:
This graph represents how pricey it is to buy an extra year to pay off government debt. (Divide bonds by their length, and you get a frankensteined measure that captures how much the interest rate increases for every extra year of the bond.)
Controlling for bond length, then, we can see that debt was extremely cheap during 2020, then jumped in February-March 2021 as Australia seemed to leave lockdowns behind. With the resurgence of private-sector business activity, creditors found other places to invest. Bond yields had to increase to become competitive. Since June, the return to lockdown has led to some backsliding in the interest rate, but it is somewhat more stubborn this time around. This could be due to overseas businesses continuing with normal life, financing and investing; it could be due to greater familiarity with pandemic conditions, fewer unknowns, and less of an impulse to panic. Interest rates through the current lockdowns are thus higher relative to last year.
Despite this, actual interest rates are still incredibly low, since June averaging just 1%, well below current inflation (3.8%) and target inflation (2-3%). The value of Treasury bonds continues to erode, eroding our real debt burden with it.
If you want real entertainment, though, look at Treasury Notes (short-term bonds, from less than a year up to three year government debts). Even during 2020 Treasury Note interest rates were very small but positive; since August they’ve taken a skydive. The last sixteen issuances of Treasury Notes since August, totalling $16 billion worth of debt, have been at negative yield rates. Creditors are effectively paying (very small margins) for the government to take their money. 
So fear not: COVID developments are not posing any difficulty to our current debt and borrowing. The Treasury is having a grand old time, I’m sure, committing legal, consensual daylight robbery.
Inflation
Inflation is at 3.8%.
This inflation measure, however, is somewhat deceptive. It measures June 2020 to June 2021, the difference between the same quarter a year apart. Yet in June 2020 the CPI first measured the enormous hit we took due to the pandemic starting in March. In June 2020, we had deflation. The rate of inflation didn’t just slow – inflation itself went negative. Things became cheaper, rather than more expensive. Demand plummeted but a lot of supply was still around. Farmers reported plowing fresh vegetables back into the ground because they couldn’t be sold, and this occured the world over. In June 2020, inflation was -1.9% compared to the March quarter before it. So any annual inflation measure for June was going to be overemphasised. Allowing for that, let’s look at the composition of inflation.
3.8% is higher than the RBA target of 2-3%, but they’re not putting on the brakes just yet. The RBA is after sustainable inflation of 2-3%, and inflation is currently being driven by a few outside factors.
- The price of childcare rocketed from “free” back to usual-levels-of-pricey after the government unwound its childcare provision policy, driving a 15.9% inflation figure in its consumption group (the Furniture, household equipment and services area).
- The price of fuel, up 27.3%. In some sense, this over-represents the price increase. During the pandemic, the average price of fuel crashed by 30 cents. A 27% inflation rate has restored it to just 4 cents above March 2020 levels.
- The price of new cars increased 7.4% in the same period, for unrelated reasons. Semiconductor chips go into phones, household devices, and cars. The demand for them is ever-rising and production pre-pandemic was only just keeping pace. Then then shutdowns proved the final straw in the already-strained industry. We’re currently constantly on the verge of running out, and aren’t actually making enough. The largest manufacturers in Taiwan have also undergone a severe drought this year, also limiting production. A global semiconductor shortage is well underway, and expected to last at least two to three years. So car production is being strangled by the semi-conductor shortage across the world, and prices are rising. Additionally, the cost of shipping form Asia to Europe has apparently increased ten-fold, making the chips more expensive.
- Private health insurance premiums rose, driving Medical and hospital services to 6.7% inflation.
Over 1% of current inflation is being driven by child care costs, and the unwinding of the free childcare policy. This means over 1% of inflation is a one-off. While fuel inflation is not a one-off, we can expect much lower fuel inflation in the long-term now that this surge has returned fuel prices to pre-pandemic levels. Essentially, we can ascribe a significant chunk of fuel inflation to recovering their sudden dip. Accounting for both of those, inflation seems likely to drop by about 2%, leaving us with 1.8% of ongoing inflation. The RBA’s official underlying inflation (they have three different measures) similarly remains under 2%; this adds to my certainty that I’m calling this right. This is not a high level of inflation. That is below the RBA target, which perhaps explains why they’re not reining in their horses just yet. The problem is not spiralling inflation – it’s sluggish inflation.
So why all the inflation panic?
In the 1970s, an old economic strategy started to warp. We had known for a while that you could trade high inflation for high employment, and under the social-democratic regime, that had been a trade that the governments of the time were willing to take. That pattern – the Philips curve – began to fail, as people adjusted to expecting steadily-higher inflation every year. Inflation went spiralling. Add to this that the price of oil quadrupled, the Soviet Union’s harvest failed and they pushed up food prices worldwide by buying out the US’s entire wheat reserve, and then that the population had recently boomed with the highest growth rate in history just a decade before (hence nicknaming an entire generation “boomers”). Add to that terrible mismanagement by central banks, especially in the USA, and those were very, very rough years. And the 1970s haunt us. It doesn’t help that most of our top journalists (ages 50+) grew up in the aftershocks of that period. It’s all so easily recalled, especially when the pandemic era carries glitzy echoes of those high-debt, high-interest, high-inflation days.
These glitzy echoes, however, are only that. Sharp, eye-catching mirages of similarity. The 1970s came about after decades of mismanagement, and were exacerbated by the top officials involved. While the US was in enormous debt after the Vietnam War, and suffered commensurate interest rates with the inflation spiral, debt is probably not as responsible for the Great Inflation as everyone thinks – spiralling inflation occured everywhere, not just countries in debt. It should also be noted that this period of unprecedented debt is being carried by unprecedentedly low interest rates. The Australian government, at least, has become a monetary safe haven, with corresponding low debt costs, and still maintains a much lower debt position than the majority of OECD countries. We’re in a medium-debt, low-interest, record-levels-of-employment situation in Australia, at least, and while the outlook is not precisely as sunny for everyone else with debt and employment, it’s nothing like the 70s.
Inflation is the true boogeyman here, but I’m not seeing compelling reason for fear. The cash rate, the interest rate at which central banks lend money to other banks, influences all the other interest rates passed on throughout the economy and thus the amount of money in circulation and its speed, both key drivers of inflation. In the 70s, the cash rate was at 7.25% and struggling to rein in raging inflation. In 1990 in Australia (“the recession Australia had to have”), it hit 17.5%. Today, it is at 0.1%. We are flooding the economy with easy money, which in normal circumstances should send inflation through the roof. We currently have maximum possible capacity (second only to Japan’s negative cash rate) to cut off inflation by raising economy-wide interest rates. We are not doing so. The central bank is explicitly attempting to turbo-charge inflation. They’re worried that we do not have enough of it. Prices deflated during the pandemic for the first time since 1998, and none of our current major inflation drivers are sustainable. We can cut off money to the economy any time we like. But we’re not going to yet. The trimmed CPI, which is the RBA’s calculation of a”real” CPI, less affected by volatile externalities like fuel price swings, still only sits at 1.6%, which is a much less exciting figure for the media than the headline 3.8%. The 1970s were a rodeo hanging onto wild inflation by the horns. We, on the other hand, are attempting to chivvy along a turtle.
The general exit from lockdown on the American side of the Atlantic has been accompanied by a surge in spending, as consumers luxuriate in previously unavailable goods. American inflation has been at 5.3-5.4% for the last two quarters. The US administration insists that what we’re seeing is transitory inflation, and to their credit, their previous predictions upon releasing Biden’s new stimulus package were pretty close to the mark. However, Americans also have full ability to jack up the cash rate and choke inflation, and they’re subject to many of the same forces as Australians in the current moment. Their core inflation is much lower than headline inflation as well.
Most of the inflation we’re seeing is temporary or exogenous. It’s not part of the gentle self-reinforcing cycle of inflation that central banks aim for.
That gentle self-reinforcing cycle is driven by wage bargaining.
Wage Bargaining – Jobs and Vacancies
Unless inflation occurs in sync with wage growth, it erodes purchasing power. Ideally, workers expect inflation, bargain for a proportionally higher wage to maintain their real wages; that will then drive inflation, fulfilling everyone’s expectations and propagating the expected level of inflation into the future. This works really badly when inflation goes haywire and spreads too-high expectations, driving too-high inflation. But the 2-3% inflation expectation is what the central bank deems healthy for the economy.
Unfortunately wage growth has been falling for quite some time. ABS tracks the Wage Price Index (WPI), which captures the price of labour (rather than the increase in number of hours worked or the move from underemployment to full employment). It shows that pay increases have been getting smaller and smaller since 2009.
In the last quarter, private sector wage growth increased by 1.9%, nearly back to pre-pandemic levels of growth, while the public sector hit an all-time-low of 1.3% after a wages freeze. These are both well below inflation of 3.8% – though for those who don’t drive, don’t have children, and don’t pay for medical health insurance, their wage growth will be keep even with inflation in their consumer profile.
The government is under some pressure to raise public sector wages as a solution to wage growth. Raising public sector pay independently of the rest of the labour market, however, is difficult for the government to justify in a period of record-breaking deficits. Especially a government previously preaching fiscal responsibility. Pay increases would be directly funded by taking on more debt. The government is essentially waiting on the private sector to pick up the slack and begin raising salaries in line with actual inflation, bringing the WPI in sync with the CPI.
Yet sustaining wage growth in Australia appears to be a tricky problem. On the bright side, closed borders are giving Australians some extra traction by cutting out international competition, the job market seems relatively tight, the unemployment rate is below 5%, and private WPI growth has almost reached pre-pandemic levels. On the other hand, pre-pandemic WPI was pretty poor in the first place and borders will not remain closed forever. Despite the radical labour shortage in the absence of backpackers and working holiday visas, fruit and veg inflation is being driven by weather events, not increased wages. Other areas are suffering even less from the the shrinking of the employee pool, and it’s not clear that significant progress for wages is being made in the economy at large. While the recovery in employment and private WPI, alongside the wide availability of job vacancies, is cheering, this does not strike me as a permanent up-turn, merely a relief from the COVID storm. Our normal problems are still with us, and wage growth is going to continue to be an issue
Some more on the unemployment numbers: they have their detractors, but overall they’re pretty positive. You may have heard that the participation rate (employed+looking for work=participating percentage of the population) dropped, and therefore that the drop in unemployment was not due to people finding jobs, but people giving up on finding jobs and thus leaving the workforce and improving the statistic. The participation rate has fallen, but only slightly. It has fallen 0.1% from the previous quarter; it’s still 0.4% better than Feb 2020, pre-pandemic.
We have a marginally higher participation rate relative to pre-pandemic, and a lower unemployment rate. We actually haven’t gotten below 5% unemployment since 2011. (If we get below 4%, which some people are advocating that we try, it’ll be the first time since the 1970s.)
Our underemployment rate – people who have work, but not as much as they want – also increased in the last quarter, but is still 0.5% better than Feb 2020.
We are working 3 million fewer hours, but again, that’s compared to last quarter, which was an unusual peak of 1.81 billion hours per month. Pre-pandemic, the (Dec-19) peak was 1.78 billion hours, just above this quarter’s 1.77 billion. We’re very much par for the course. Of course, this will be felt differently in different areas. New South Wales has been hard hit and is shedding jobs, with other states making up the difference.
One large caveat: we’re drawing quite a bit of reassurance from only a few quarters worth of data. We need more time to see the full extent of the Sydney lockdown, and whether hours-worked will begin increasing again. The one I’ve been referencing was last released in July for May. Perhaps the next quarter’s reports will show an unexpected and unfortunate sea change, in which case the dooms-daying and hand-wringing over employment and inflation will seem prescient instead of just excessive.
I don’t think we’ll keep up with target inflation. If we do, it’ll be as a knock-on effect from America. Regardless of the last quarter’s volatility, we just haven’t got a good engine of inflation chugging us forward. Wage growth may have recovered to pre-pandemic levels, but that’s a return to a falling trajectory. I prefer hang-gliding to free falling, but they’re both going down.
I don’t see much reason to expect wage growth to begin driving inflation, unless borders stay closed for a good deal longer. Australia is stuck in a wage growth rut, and has been for almost a decade; whatever cultural or external factor is driving it, it seems remarkably stubborn. Transport-driven inflation, on the other hand, I expect to continue to be an issue, as well as technological inflation for the next few years. The rise in shipping costs and supply chain issues will probably continue. I think that we’re likely to have around 1.5% inflation at a consistent rate, with a temporary surge as Melbournians and Sydneysiders come out of lockdown over the next few months. Transport, electronics and ferrying costs could help us push a little higher. Possibly a resurgence in rent in the major cities on the Eastern seaboard.
From this perspective, Treasury Bonds resolve into a more sensible picture. Our creditors don’t expect inflation to live up to the RBA’s target; they’re actively betting that it won’t. They may still shooting lower than their expected inflation, so we can’t group-source expected inflation from bond interest rates . Remember that $16 billion has been lent at negative interest rates, which no inflation rate will save them from, no matter how low. Lenders are still being motivated by security (or complicated financial deals) more than profit. But they’re not going to lose as much as target inflation might lead us to believe. Debt is working out great for us; but it’s a lot more worrying as a glimpse at the educated banker’s prediction of future inflation rates. Our worries should not be an overheated economy. Our worries are much the same as pre-pandemic: a parachute-fall into steadily less ambitious growth.