Australia | Dec 17 2007
By Greg Peel
The obvious rear-view conclusion on 2007 is that no one saw it coming. It has been a year dominated by the subprime crisis and the global credit crunch. But aside from the obvious, there have been other factors of influence in the year gone by.
CommSec’s chief economist Craig James has been brave enough to recount what he predicted as the big issues of 2007 at this time in 2006. There’s no point in CommSec offering up predictions for 2008 without some sort of score card. So this is what James said in 2006:
Australian interest rates had peaked. It was a reasonable assumption to make given the economies of NSW and Tasmania were close to recession, drought had gripped the country, and just about everyone was expecting the Chinese economy to ease off from its soaring highs. As it was, rates remained on hold from November 2006 to August 2007 but by then the booming Australian economy (spurred on by no let up in China) had forced the RBA’s hand.
The oil price would come down. We entered 2007 with an oil price of less than US$60/bbl, would you believe. But apart from ongoing Chinese strength, and strength in other emerging market economies, 2007 saw continuous supply disruption problems as old and tired infrastructure was pushed to the limit, ongoing geopolitical tension particularly surrounding Iran and its mythical nuclear weapons program, and no impact of any note from alternative fuel sources despite the great ethanol boom.
The Australian rental market would remain tight as would the jobs market. Two ticks here. The jobs market has remained tight as the Australian economy has continued to surge, and has done so despite record skilled migration and initiatives such as Welfare-to-Work. Migration helped to keep rentals very tight, along with the cyclical downturn in residential property development.
Climate change/water security would be the big issues. They were at the beginning of the year, and were revived late in the year thanks to the Bali conference, but in between, subprime overshadowed all.
Consolidation would continue in the media sector and private equity would continue to be dominant. Another two ticks, but the media sector has just about sorted itself out now and private equity came to a screaming halt once credit dried up.
So what will be the issues of 2008? James has another go at the crystal ball:
The US subprime crisis obviously, which is then tied into whether the US economy will go into recession. “Clearly much work lies ahead”, James says of the subprime situation, noting at least government initiatives have offered some breathing space. As for the US economy, James believes Americans will continue to spend sufficiently and exports will continue to respond to a weaker US dollar and emerging market demand.
Climate change/water security, which never actually went away.
Unemployment versus inflation. Across the globe, economies have been in the enviable position – one which hasn’t occurred since the 1970s – of achieving very low unemployment without any great leap in inflation. Can this continue? From Australia’s point of view, James suggests it will be up to the federal government to streamline the skilled migrant approval process if we are to stay ahead of the rest of the world in attracting this increasingly scarce resource. As far as inflation is concerned, one of the big issues for 2008 will be “agflation”.
Inflation driven by the cost of food has become a real problem in 2007 as China and other emerging markets have shifted from grain-based diets to more meat-based diets given the expansion of wealth. While clearly this pushes up the price of meat, animals are still fed grain so there is not a lot of let up there, and given US farmers are now more interested in growing grains for ethanol instead of food there’s a bit of a double-whammy.
James notes the last time the world experienced major agflation was during the industrialisation of Japan in the 1970s. From 1971 to 1974 the foodstuffs index soared 170%, and despite recent strong price movements we haven’t yet reached that sort of level this time around. It is unlikely the boom in food prices will rival that which we have experienced in metal and mineral prices, given farming is a much less infrastructure-intense industry. However, there is always a lag as land is converted over to farming and there is still no let up in ethanol production.
Industry consolidation will be important in Australia and across the globe in 2008, given there is little point in continuing to fight over labour, equipment and land that just isn’t available. James expects mining industry consolidation to continue, and other industries will also join in on the act. But look for construction, engineering and mining services to be key candidates. The longer shot is the Australian banking industry. The credit crunch has rattled the four pillars and the government will be under pressure to review this policy.
The oil price should ease into 2008 but only modestly. With prices safely now at such high levels, there is nothing to hold back alternative fuel source investment which picked up in 2007 and will continue to be a focus in 2008. The nuclear debate will come back to the fore as well. By the end of 2008 there will be a new US president. The current tip is for a female Democrat but any Democrat would make a big difference in the energy debate – although that’s really a 2009 story.
The drought is something which will always be an issue. It is apparent we are currently reversing from an El Nino period to a La Nina period which is bringing rain to Australia. If such weather patterns remain, Australia will be well placed in the agricultural boom.
The big question is as to whether Australia might enter a recession. This seems an unlikely prospect, says James, but 16 straight years of record expansion must come to an end one day. Apart from the US, which James is not too worried about, it will come down to the Chinese authorities and whether (given inflation in particular) they are forced to really tighten the screws on their economy much more aggressively.
Despite all the shenanigans going on in the world in 2007, the Australian share market still posted above average returns. CommSec doesn’t see quite as spectacular a result for 2008, although forecast 15% growth would still be slightly above average.
