Looking ahead to Australia's economic future, we're faced with a provocative question - does Australia need a recession now?
This episode promises to stir your thoughts and provide some food for consideration as we delve into the impact of interest rates on inflation and how this tool could be used to induce a deliberate recession. Brace yourself for an in-depth discussion of the implications of rising costs of living, including wages, energy costs, and insurance premiums, on Australians from various income brackets and debt levels. We'll also dissect how businesses may need to increase their charges to sustain their profit margins, potentially triggering a wage-price inflation spiral and an unsustainable economy.
Switching gears, we engage with the potential approach of the Reserve Bank of Australia to manipulate interest rates in an attempt to counter inflation and possibly induce a recession. We promise an enlightening exploration of its possible impact on productivity and inflation, and how this strategy could stabilize the economy for the long haul. However, this episode isn't all doom and gloom; we'll also highlight the potential opportunities in such a scenario to restructure certain industries. But we won't shy away from the possible downside either, emphasizing that a deep recession isn't necessary to gain the desired outcome. Need some insights into Australia's economic future? Prepare for a roller-coaster ride of ideas and perspectives in this episode.
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Speaker 0:
Hi, this is Stuart Weems and welcome to the Investopoly Podcast. My goal is to give you simple, easy to understand strategies, insights and tips to help you master the game of building wealth, and in this episode, I'd like to talk about or pose the question does Australia need a recession Now? Of course, some people were surprised at the RBA-hiked interest rates last week, and some would argue that interest rates have already been hiked well enough and, coupled with rising cost of living, this will eventually reduce inflation, but it's also important to recognise that persistent threat of high inflation poses a significant threat to the economy. We don't want to live in an environment where inflation becomes entrenched. In addition, central banks want to avoid repeating past mistakes that is, being too slow to adjust interest rates, and they don't want to be blamed for taking inadequate action to curtail inflation, because that's going to erode their credibility further. Though they were too slow to hike rates to begin with, they want to make sure that they get the job done well this time around.
Speaker 0:
However, interest rates as a tool to curtail inflation is a blunt instrument, and the risk is that it starts to feel like death by a thousand cuts. That is where this incremental increase in interest rates causes more and more pain but doesn't actually achieve, which is curtail inflation. Now what do I mean? That it's a blunt tool. Well, if you think about it, not all Australians have a home loan. So approximately 30% of Australians own the home outright, 37% have a mortgage, so home and a mortgage, and 26% rent from private landlords. So therefore, interest rates are only directly affecting 37%, a little over a third of the population, I guess, indirectly impacting 26%, given 26% rent. Although there is a bit of a delay, it isn't direct in, as a landlord can't pass on the higher interest costs straight away to tenants, of course. And the other drawback is that higher interest rates disproportionately impact lower income earners compared to higher income earners. So whilst you might be raising interest rates to curtail spending of a particular cohort in the economy that are in a very strong financial position, both from an income and debt perspective, you do that at the cost of really hurting those borrowers with lower income amounts and don't have that financial strength. Additionally, raising interest rates just makes housing affordability worse, so it locks people out of the property market and it means that those that are renting are almost doomed to continue renting until interest rates normalise. So it is a blunt instrument in terms of pooling consumer demand and trying to get that inflation under control.
Speaker 0:
I wrote a blog a few months ago, in June, and of course did a podcast topic on it, where I referenced some historical research by a firm in the US called Research Affiliates that suggests that historically, inflation can be a lot more persistent than we might imagine and that typically it takes an extended time for inflation to drop below 3% per annum and the median time was around about 11 years. So based on that research, it's entirely possible that inflation might be persistent unless we take some evasive action. So why is inflation being so persistent? Because the RBA's height interest rates by 4.25% over the past 19 months. Surely you would think that's enough to curtail inflation by now.
Speaker 0:
Well, I came across a post on Twitter or X, whatever you want to call it Over the last week or so someone complaining about the price of takeaway coffee and they sort of posted their receipt $7.50 for a takeaway coffee and they pointed out that actually over the last two years the cost of coffee beans has fallen by 18% and milk's fallen by somewhere between 10 and 20% over that period of time. But of course over the last two years some costs have increased for that person that selling that business that's selling that takeaway coffee. Wages, energy costs, insurance premiums in particular have all risen by a substantial amount and it really made me sort of think. $7.60 for a coffee, that's huge and it really made me think about is it profiteering or really where is the cost? Why does it cost $7.50 if you sell a coffee? And I think a lot of it is really in the labor cost. So when you look at the ABS figures for the wage price index, in the private sector wages have increased 6.6% over the past two years. That's not an annualised figure, that's the over that two year period. So in the numbers it's high, it's on the high side but not crazy. But I know, speaking to other business owners, in some sectors wages over the last couple of years have increased by a hell of a lot more than that 20 or 30% in some situations and some sectors are really suffering a very tight labor market. For example, I know in our business to find an experienced accountant really really challenging and it's the tightest. I think it's been for more than 20 years and as such, a lot of accounting firms are often kind of over the odds in terms of remuneration to attract those people to the business.
Speaker 0:
The other interesting observation in Australia is productivity, and so productivity is measured by the output per hour and over the past decade is declined 30% and in fact productivity is at the lowest level it's been since World War Two, which is a real problem for Australian business. Not only are they paying more for staff, but staff are doing less, so they're producing less output, and this is a problem that's relatively unique to Australia. And the whole factor that employees have a greater expectation of flexibility in terms of their working than what they might have done maybe, for example, a decade ago. So things like working from home and flexible hours and so forth. And while these sorts of arrangements can be beneficial for both the employee and employers, it does come with added responsibility. So if the employees fail to maintain their level of productivity, that flexibility just isn't sustainable in the long run.
Speaker 0:
So really we've got higher wages, lower productivity, which then means that businesses need to charge more to sort of cover that profit. But then that can produce a wage price inflation spiral, which is an economic situation where increasing wages trigger increasing higher prices, which then result in even higher wages yet again, and it's a bit of a spiral and I'm not suggesting this is the case at a macroeconomic level, but certainly in some sectors I think this has been a contribution towards inflation. It's not just an increase in demand. It's a sort of combination of wage rises, tight labor market, poor productivity, and really to address this there's a few things that you can do. You can reduce the demand for labor, so that is to shrink the economy. You can increase supply of labor, which the government's been trying to do with immigration, but that's not across the board. And probably the easiest thing is enhance productivity, so generate more productivity. I think that's something that Australian businesses really need to reinvest in and producing better productivity from their labor. But there's no doubt that in particular sectors this is contributing to stubborn inflation.
Speaker 0:
There's another couple of observations that I would share in respect to the question why is inflation being so sticky after such a dramatic hike in interest rates? The first one is that Australians have been able to amass unusual levels of savings it's equated to about 20% of household income in terms of the amount of savings they accumulate during that COVID period. And so accumulated savings do act as a bit of a cushion against higher interest rates and they can kind of postpone the need to decrease consumer spending. So there's that element there. Secondly, the Australian economy does have several industries where there's a lack of competition. No-transcript big four banks they dominate the banking sector. You've got two supermarket chains that control over about 60% of the market. You've got a single airline that's received a lot of attention lately. That has around a 60% market share, and so it could be argued that in particularly in some sectors, australia lacks the price competition and maybe gives too much pricing power to these businesses that have oligopolies or monopolies on particular industries and markets and products and services.
Speaker 0:
So how do you solve all this? Well, one of the problems is Australia has had 30 years of growth, and when I say that's a problem, most people wouldn't look at that as a problem. But there are some drawbacks. With a prolonged period of economic growth, typically an economy will go through sort of boom and bust sort of cycles and there's some advantages to those bust cycles. So such as there's three advantages I'd like to talk about.
Speaker 0:
The first one is there's a cleansing effect and improved productivity. A recession allows inefficient or poorly managed businesses to fail to make way for more innovation and competition and, in addition, highly competitive or crowded industries with minimal profitability benefit from a bit of thinning out as well. So just have a walk down your neighborhood shopping strip and notice how many cafes have sprung up over the last 10 years. If we have too many cafes and too much competition, no one's actually making any money. Sometimes a recession will sort of clean out industries like that and then result in more competitive, more sustainable businesses that replace them. The additional benefit is more realistic allocation of capital.
Speaker 0:
So during recessions, many businesses, individuals, sort of rethink their investment returns and risk and therefore the resultant value of properties or shares and so forth. You know we've just been through a period of very low interest rates and I've discussed previously in this podcast one of the consequences of very low interest rates is that people don't really think deeply about their decision making, because money is cheap, so you don't need a lot of return as a reward for the risk that you're taking, and it results in inefficient allocation of capital. So in a recession, people start to really value money and put a value on the return they get on their money and start to make better quality decisions. So in a boom, things get away from us a little bit in a bus situation. We sort of come back to reality in a way, and of course, the last benefit is you end up sort of cooling inflation and dealing with the inflation issue, and that's obviously one of the key things that we need to solve at the moment.
Speaker 0:
So I want to be really clear I'm not advocating for a recession. I'm not suggesting the RBA should intentionally cause recession. I don't think I've reached that conclusion yet. Really, the aim of this podcast topic is just to highlight some of the structural weaknesses in the Australian economies, maybe some of the potential things that are contributing to the persistence of inflation, and really question whether interest rates are a good tool for ultimately achieving the aim that we want to achieve, which is maintain our economy and the health of our economy, but cool the inflation element.
Speaker 0:
And I guess what I'm throwing out there is perhaps, rather than solely relying on interest rates to address inflation, which is kind of a bit of a gradual and a very painful process for some cohorts in the population, maybe the RBA should be considered using interest rates to deliberately induce a recession and the idea behind that approach might lead to increased productivity and competition while also help stabilizing inflation and, to use a common saying.
Speaker 0:
Maybe the RBA should just rip the bandaid off. Let's deal with all the pain, let's get inflation under control and then we can sort of rebuild the economy. You don't need to have a really deep recession to achieve that potential outcome, but maybe a few industries do need a bit of shaking up, sort of rebuilding the economy and enjoying a prosperous lifestyle that we've become very used to here in Australia. Again, I'm not saying that should be the outcome, just throwing out there of what might be contributing to this persistent inflation. And we don't want to have this inflation to hang around for many, many years, because that's a more painful outcome. Okay, that's it for me for this week, until next week. Bye for now.