Contributed by Adam Carlton and Joe Montero
As Australia heads towards the October budget, the global economy is showing sharper signs of deterioration. This is going to have an impact on the Australian economy and should be and should be seriously considered in domestic economic policy.
The worst part is that global manufacturing and demand for manufactured products contracted in September. According to JPMorgan’s findings, this was the fourth consecutive month, and it hit the lowest point since 2020. This is blamed on a fall away in demand. It is this in part. But it is mostly caused by falling investment, due to a declining rate of return. This is indicated in the graph below.
Source: Penn World Tables 10.0 IRR series
The Internal Rate of Return on Capital, which provides an approximation of the rate of profit for the world’s major economies grouped in the G20, has been falling. It has fallen further for the top 7 (G7) economies. Down from over 10 percent to a little over 6 percent concerns all returns on capital invested.
We can see here that there has been a long-term decline. The difference now is that it is at a lower level and compounded by other factors. The seriousness of the situation is revealed by a rapid shrinking of global currency reserves. They have gone down 7.8 percent this year, Down from $13 trillion in US dollars to $12 trillion. This might seem like a small amount. But it isn’t. It is enough to cause destabilisation of currency exchange rates.
“This is all part of the catalogue of symptoms of the canary in the coal mine,” said Axel Merk, chief investment officer at Merk Investments, of the declining reserves. “Cracks are showing up. And those red flags will come at an increasing pace.”
It has happened because nations are having difficulty covering debts and governments have released their reserves to stabilise the currency exchange rate and soften the impact of investment flight. The rising rate of inflation, which initially worked as a factor causing the problem, rebounds to it.
Although the global economy may not collapse tomorrow, the situation is serious enough and one step closer to a precipice.
Much of the capital flight is moving in the direction of the United States. This is why the exchange rate of the American dollar is on the rise for now. This is causing global dislocation and is a sign of disinvestment.
The graph below shows an ongoing decline in international Investment Position and in US assets and liabilities in the global economy.
This is a withdrawal from the global economy, only partly mitigated in early 2022 by the end on the pandemic lockdown. The figures from JPMorgan show that this has ended, and the downward trend has resumed.
The next graph shows that there was short rise of manufacturing at the start of the year. Although this is not shown, the last quarter has seen a reverse in direction. It doesn’t show the new reversal downward over the last two years. What it does make clear is that there has been a slow since the financial crisis of 2008-2009, then a quick rebound from the initial impact of the first part of the Covid Pandemic. This year’s figures show that it is falling again.
Inflation is another global problem on the rise. For a declined to a record low, along with interest rates. This year has seen a reversal in both. It means new factors have come into play. There is not enough room here to deal with this properly. Only to just say that inflation is a symptom of the forces at play. It is officially at 8.7 percent now and rising. This is growing faster than wages and the consequent rise in the cost of living is dampening effective demand for what the global economy produces.
There’s no doubt. Australia can’t escape this. Our manufacturing has gone in the same direction, although foreign currency reserves have remained relatively stable a grown slightly for now, thanks to mineral export earnings. Inflation is having a major effect. Care should be taken to cushion against both internal and external shocks that are coming.
Only by turning away from past policies, which have relied heavily on giving power to the market and the withdrawal of government responsibility, can Australia have a chance of rising this out and being better placed to build the future.
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