Over the past year, oil prices have doubled, pushing up business costs and the price of a range of goods and services. At the same time, higher interest rates seem to be seriously dampening demand. In recent weeks, financial commentators have begun to mutter the ugly "S" word: stagflation.
Stagflation, described as a central banker’s biggest nightmare, occurs when prices continue to inflate even though consumer confidence is low. This sends the economy into stagnation as businesses try to cut costs, usually by cutting wages and retrenching staff.
For several years the Reserve Bank of Australia has fought a serious inflation problem which has more than once broken the sacrosanct 4 per cent barrier. However, the RBA now believes it has turned a corner, with consumer confidence falling in successive months, and the latest figures at a 16 year low. It is predicting that the effects of its credit tightening will filter through to the inflation rate by the end of the year putting it back in the safety zone at around 2.75 per cent. As a result, rates are currently on hold.
However, much more powerful forces in the world economy are conspiring to undermine the anticipated fall in price growth. While Wall Street floundered earlier this year in the wake of the sub-prime meltdown, speculators flocked to basic commodities like food and oil, coinciding with the sharply rising and insatiable appetite of China and India for these selfsame commodities.
With hedge funds and investment groups anxious for their new investment targets to produce rising profits – and global demand showing no sign of abating – the vital commodities of food and oil continue to surge towards new record highs.
The effects of these rises have not even filtered through to our economy yet, and unless prices miraculously fall soon, the Australian economy and many others could be headed for price shocks. Oil in particular will affect the pricing of all goods and services: transportation, construction, agriculture and manufacture are all dependent on petrol and diesel.
So it would seem that within months the RBA could face the unwinnable dilemma of high inflation and low growth: stagflation.
Well, not quite, say many of the experts, who in the face of this growing clash of economic wrecking balls say this isn’t quite "stagflation".
Veteran Sydney Morning Herald economics commentator Ross Gittins wrote that those using the word are either too young to have lived through the stagflation of the 1970s, or ignorant of economics. He argued that "a rise in a particular price" – namely of oil and associated goods and services – "doesn’t add to the ongoing rate of interest unless wage-earners get pay rises to compensate […] thus building it into the wage spiral."
This implies that Gittins – and many who use the same argument – accept that there will be a major shock to prices while consumer confidence continues to decline. It may allay the fears of economic analysts to hear we won’t be entering a wage-spiral, but it is doubtful that the everyman at the gas pump with a mortgage at home will be relieved to hear the cost of living is about to soar and that he’s not going to be compensated.
Perhaps even more seriously, small business owners, especially new ones who are fretting over the high business lending rate, are unlikely to be able to absorb the growing cost of business as consumer confidence continues to fall so dramatically.
From recent commonwealth and state statistics, it is clear Australia is entering a homelessness crisis, and the coming rise in the cost of living could see a sharp rise in evictions, home loan foreclosures and repossessions. This growing societal problem is going to put pressure on a Government (and Federal Treasury) dedicated to cutting spending programs.
The certainty offered by economic analysts that the rise in the cost of living will not enter the wage-spiral is highly surprising. They are basing their forecast on the tough stand taken by Kevin Rudd and Wayne Swan in dealing with the ACTU and in urging wage restraint.
Having won middle Australia on the promise to rebalance the playing field after John Howard’s ideologically reckless WorkChoices legislation, Labor is set to sacrifice their famous "working families" to stay true to their commitment to economic conservatism.
The backlash is already on the horizon, and union leaders who thought they had won their battle in November are becoming apprehensive of the corporate language adopted by Rudd, his ministers and the fiscally conservative statements emanating from Treasury.
The contours of the impending collision are already visible in the current Qantas dispute, as unions see demands which they believe would have been accepted in years past, flatly rejected. If the Federal Government doesn’t show flexibility and make some concessions in the next six months to take account of the soaring increases in the cost of living, unions will be drawn to using industrial action in both the public and private sectors.
Elected six months ago on the back of massive union activism in electorates across the country and middle Australia’s opposition to Howard’s anti-union laws, Rudd inherited a boom-time economy, a resources bonanza and a massive $22 billion surplus.
But suddenly there’s been a seismic shift in the economic landscape and Rudd has unwittingly wandered onto a minefield.
The global economy is pushing Australia towards stagflation, and the economists are telling him that the way to avoid it is to quietly turn the knife on his own constituency. That’s a recipe for a one-term government.
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