Here's A Brilliant Analogy From JP Morgan About Australia's Economic Hangover

J.P. Morgan chief economist Stephen Walters has a timely warning for the Christmas party season: “The worst hangovers follow the wildest parties.”

But while many party-goers can expect ugly morning afters, J.P. Morgan says the Australia’s won’t be so bad despite the latest commodity price bonanza.

That’s all thanks to the RBA’s efforts to prevent an inflation break-out, and a “flexible exchange rate that acts as a pressure valve for domestic excesses”.

Like Goldman Sachs’ advice in June, Walters said Australia would avoid a recession although there would be another year of sub-trend growth.

Here’s what he said:

Australia has handled previous terms of trade booms very badly; recession has followed the five previous commodity price bonanzas dating back to the gold rush of the 1890s. The forecast this time, however, anticipates a far more benign outcome.

Indeed, unlike during previous such episodes, Australia now boasts an independent, nimble central bank which, crucially, has prevented an inflation break-out, and a flexible exchange rate that acts as a pressure valve for domestic excesses.

Although AUD has not fallen as much as RBA officials hoped, it has dropped materially since the terms of trade peaked, cushioning the adjustment for the economy.

Still, booms in commodity prices and investment absorb spare capacity in labor and product markets, driving up costs, and inevitably require adjustment to more sustainable conditions.

Modest post-boom adjustments are apparent in the historical data for a handful of commodity exporting countries like Chile, New Zealand and Norway, but not Australia, nor the batch of South American economies that suffered deep recessions in the 1970s once their terms of trade fell.

The worst hangovers usually follow the wildest parties, but not this time; the forecast anticipates merely another year of sub-trend growth, not recession.

Australians should accept an extended period of sub-optimal growth as the modest price to be paid for the earlier euphoria.

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