Australia has become a house of cards

Retail sales figures released last week add weight to my warnings as far back as 2014 that the Australian economy is a house of cards. The 2014 federal budget assumed consumers would dramatically increase their spending while real wages stagnated or fell. It predicted that home owners would spend up big on the back of their increased wealth from rising house prices. That hasn't happened and now, with house prices easing, consumers have become downright gloomy. Pull the house-price card out and the whole economy can collapse. Such is the folly of orchestrating a housing boom as a substitute for an economic strategy.

Other indicators attest to the fragility of the Australian economy. Wages growth remains insipid. While employment is growing, underemployment has been rising, as many workers are unable to obtain the hours of work they are seeking. Energy prices, too, are rising, as are the prices of other non-discretionary items such as childcare and healthcare. Is it any wonder that consumers have pulled back from going out to restaurants and cafes?

Australian households are borrowed to the hilt, a worrying proportion of mortgagees having taken out interest-only loans and an even more worrying proportion of those not understanding what they have done. They will get a shock when the banks call upon them to begin repaying the principal they have borrowed. To make matters worse, despite the Reserve Bank's cash rate remaining unchanged, mortgage interest rates have begun edging up as international wholesale funding costs begin to rise.

When retail sales enjoyed a couple of good months among many bad ones, consumers were dipping into their savings to maintain their spending. No more. It could never be sustained. If, out of their flat wages, consumers spend less while they rebuild their savings, then growth in consumption – accounting for almost 60 per cent of the Australian economy – will be negative.

A race is on. Employment is rising, including full-time employment, but retail spending is falling. Will employment rise fast enough to counter the effects of weakening spending? The Turnbull government will be hoping so. If not, the house of cards will collapse.

And if the US Federal Reserve starts raising interest rates again, Australia's mortgage interest rates will rise regardless of whether the Reserve Bank keeps the cash rate on hold – which it will for the foreseeable future. Those economists predicting the Reserve Bank will soon begin raising interest rates are living in Rainbow Land.

We continue to be assured that wage rises are just around the corner. The governor of the Reserve Bank wants them. The Prime Minister says he wants them, while supporting a cut in Sunday penalty rates for retail and hospitality workers. Now that the Fair Work Commission has ruled that Sunday is no more important than Saturday, reductions in Sunday penalty rates might well flow on to other workers, such as hairdressers, as employer groups bring further cases.

Instead of being encouraged into productivity-raising pursuits, the federal government has encouraged investment in a house of cards by refusing to pull back on tax concessions for investments in rental properties.

Like wage rises, the government continues to assure us that a lift in private non-mining investment is just around the corner. Just as we are assured a budget surplus is on the way in the final year of the budget period, as it has been for the past six years.

The forthcoming mid-year fiscal and economic outlook is an opportunity to level with the Australian people. To its credit, the incoming Turnbull government revised down the budget's estimate of trend growth in the 2015 mid-year fiscal review. It's time for another reality check, instead of jollying along the Australian people in the hope that they will believe the economy is under control, wages are on the up and the budget will magically flip into surplus in a couple of years' time.

The Australian people can handle the truth. The question is whether the Turnbull government can too.

Source: http://www.afr.com/opinion/columnists/aust...