Australia: This Time It’s Different?

by Nigel Bolton-Shaw on September 11, 2012

We learn from Reuters that Australia stands to break its “boom-bust” cycle.

But is this really so? We’ll examine the reality in a moment. First let’s take a look at the Reuters’ report we’re referring to.

It is entitled, “Analysis: Australia stands to break its “boom-bust” cycle.” And the article’s thesis is that while Australia often turns resource booms into bust, “this time could be different.”

The article gives us examples of booms that eventually soured. There was the gold rush of the 1850s, we learn, and the wool booms in World War I and the Korean War. “Almost all the good times ended in recession.”

Why was this? According to the article, “terms of trade” were to blame. That’s a fancy way of saying Australia received much more than was offered out.

Commodities, in other words – Australia’s main export – turn immensely profitable during a boom. This in turn showers Australia with cash and causes “inflation.”

Interesting Reuters calls it “inflation.” In neo-classical economics, it is commonly understood that inflation is an upsurge in monetary product. Too much money constitutes inflation.

What happens then is called PRICE INFLATION. But by confusing the terms, Reuters is making it difficult to see the connection between the money supply and the result.

Here’s the telling phrase: “This red-hot demand sparked an outbreak of inflation which could only be contained by a severe tightening in policy.”

Again, what was sparked was price inflation. The “inflation” had already happened.

The article is correct to point out that price inflation is generally accompanied by a rise in interest rates. Central bankers usually panic when they see the results of their own monetary industriousness. Having printed too much money and caused a false boom, now they scale back their money producing programs and tighten interest rates.

This inevitably causes a bust. However, it is a manmade occurrence, not some sort of supernatural process.

The Reuters article points out that, “In the previous boom in the late 1970s, for instance, annual inflation topped 12 percent while interest rates hit 17 percent. It was this inflationary spiral that ruined the party.”

Notice, this process is asserted as if it were some sort of natural evolution, but it’s not. It is the result of a banking process. But for those making the assertions, it is inconvenient to point out the monetary aspect of what they are accomplishing.

Those who take to the airwaves to explain that “this time it’s different” are usually those with a vested interest in planning for the economic future. These individuals inevitably turn up during the most palmy time of an economic boom to claim credit.

This is what’s going on here, we’d guess. The Reuters’ article has all the signs. Here’s some more from the article:

There are crucial differences this time that offer hope that a slump can be avoided, the most important of which is the absence of malign inflation.

Seven years into the current boom, the economy has expanded by 60 percent, yet inflation is under 2 percent, the very floor of the Reserve Bank of Australia’s (RBA) target range. Australia has not had a recession in 21 years, it was the only developed nation to avoid one during the global financial crisis, and this year it will overtake Spain as the world’s 12th largest economy, despite being 52nd in terms of population.

Instead of needing to tighten the screws, the central bank had room to cut interest rates in May and June taking them to 3.5 percent, and it might well ease again next month.

Some of this good fortune comes from having a freely floating currency, as its strength has pushed down prices for imported goods while keeping a clamp on the non-mining economy.

A more flexible labor market has helped stop wages taking off, and even the global financial crisis played a part by scaring consumers into spending less and saving more.

So, while much of the media has rushed to declare the boom dead and buried, policymakers are not arranging a wake just yet.

“Previous terms of trade booms were periods where we blew ourselves up,” Glenn Stevens, the governor of the Reserve Bank of Australia (RBA) told lawmakers last month. “The boom crashed and everything went backwards.”

“What is interesting about this boom, is that the overall economy has come through this without a big breakout in inflation, and I think we will come through it without a slump at the end,” was his cautiously optimistic assessment.

It is human instinct to want to think that booms last forever … that this time it is different. But when in the history of the human race has a commodities boom continued unimpeded?

Will the boom perhaps subside without a slump? This is extremely difficult to believe. These booms are NOT production-driven in a central bank economy.

It is very hard for people to understand that however. They see the upsurge in production and believe it is due to economic factors. Certainly economic factors have something to do with it but essentially, in the modern day, it is monetary policy that drives economic performance, not the other way round.

And monetary policy has predictable results. First there is an artificial boom created by monetary overprinting and then there is a monetary bust when the overprinting inevitably sparks a reduction in the worth of the currency.

The overproduction of currency ensures that eventually the currency will be worth less. And that is seen by the average person as a rise in prices.

Inflation is what happens when the money supply itself is expanded. And eventually central bankers will have to tighten. We know they’ll have to tighten because too much currency inevitably debases the price of the currency.

The only way to raise the price of the currency is either to remove it or slow its velocity. You can slow its velocity by raising interest rates.

If money doesn’t move, then prices will subside. Less demand will naturally cause prices to fall.

This is surely what will occur in Australia. The boom is no doubt partially a monetary one, as all booms are in this modern central banking era. The bust will be man made as well, and it will occur when central bankers, panicked by price inflation, begin to raise interest rates.

In between, however, there can be unpredictable slumps as volatility increases. From an investment standpoint this can happen any time. Russia, for instance, has undergone a reversal of market sentiment just since May. You can read about that here.

Commodities booms eventually subside. In Australia, they will too. There will be less and less talk about how “this time its different.” Eventually those proposing that “this time” the central planners and central bankers have got it “just right” will fall silent.

And then, gradually, the central bankers will start revving the printing presses, and the cycle will begin all over again.

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