Tuesday, February 12, 2008

The Price Of Prosperity

After an unprecedented period of uninterrupted economic growth it should be no surprise that there now appears to be a speed bump ahead. The Reserve Bank Of Australia has warned that the outlook is for inflation to remain uncomfortably high for the next two or three years. This in turn points toward further increases in interest rates. The prospect of home mortgage interest rates reaching 10% and more is now being more widely considered. All this as housing affordability reaches an all time low. That’s right, the price of a home as never been further out of reach.

Throughout the long stretch of economic growth we have been told repeatedly how things have never been so good. We’ve been reminded about low unemployment, and high wages growth. We’ve seen people who already own houses benefit from their capital growth. Now, it is becoming clear that the party is starting to fizzle. While most observers are forecasting that Australia will survive the global economic slowdown thanks to the resources boom, there is a risk that things could become more gloomy, at least for some of us.

The Reserve Bank warning caught some by surprise in that it is more severe than expected. But the problem is that international conditions are causing credit problems and market instability at the same time as our local Reserve Bank is trying to tackle inflation. So, where is this inflation coming from?

The biggest price increases contributing to the C.P.I. growth are in the cost of housing and the cost of financial services. Adding a twist to that is the view of the Reserve Bank that there is the risk of increased labour costs feeding into a price increase spiral. And here’s the crunch. Wages growth, while healthy, has not significantly outpaced inflation. In fact at 3.8% it’s about right. Contrast that with the increase in executive remuneration for the past year, which is a monumental 28%. Clearly it’s not a wages breakout that is driving inflation, but a drive by companies to pursue maximum profits.

So, just who exactly has been benefiting from all this economic prosperity? And more to the point, who is going to carry the can as the economic sunshine turns to dark clouds this year? As you can see, the people who have gained least from the period of prosperity are very likely to also be the ones who suffer most as the economy slows down.

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