Expect the unexpected

In looking at the economy, the most likely thing to happen in the year ahead is something unexpected. All forecasting of this sort is based on things more or less continuing as they are.

And while there are problems in large numbers already visible, implicit in all forecasts is a rough expectation that we will be able to muddle through, as we usually do.

That said, on present trends, and knowing what we know, Australia should experience a solid if unspectacular year. The economy will continue to grow, new jobs will be created, inflation will stay within the Reserve Bank’s target range, and interest rates, even if they do rise, are unlikely to rise by much.

The market meanwhile should continue to post reasonable gains in keeping with the tighter world economy that surrounds us.

The one major positive looking forward is the almost certain prospect of personal tax reductions in the Budget in May. How such tax cuts will be sculpted is still an open question, but tax cuts there will be.

Politics would again make across-the-board reductions, targeted at the lower paid, the most likely outcome. This is almost always the case, but it is particularly likely this year since new workplace laws will already have diminished the likelihood of higher real incomes for lower paid employees.

Removing the safety net adjustment while at the same time lowering taxes for only those on higher income levels would be inviting electoral disaster. This, the Government, will not do.

At the same time, there are many looking at shifting tax rates at the higher end so the top marginal tax rate is closer to the company tax rate.

But irrespective of how they are structured, the reductions in taxation will provide extra momentum to an economy that is at any rate continuing to expand.

Not that we lack problems. Probably at the forefront of the issues claiming attention is the Australian balance of payments. The current account deficit is moving upwards at alarming rates for reasons not all that clear.

Domestic spending has been growing rapidly, not just pulling in exports from overseas, but also diverting domestic production into the Australian market and away from foreign buyers.

The banking system has developed a taste for overseas borrowing, which it is now increasingly able to do using Australian-denominated securities. It is therefore less risky for banks to borrow, since foreign exchange losses on such debts can be ignored.

So the money has continued to pour in, financing our international debt, but for how long? Confidence is a tricky business, and for the present the dollar remains stable and interest rates are not expected to climb.

Yet there are many who wonder whether this can go on forever, and if not, when the crunch will finally come.

The distortions here are similar in many respects to the problems flowing from the American budget and current account deficits.

To a very large extent, the stability of the world economy is dependant on the ongoing willingness of the Chinese to exchange clothing and electrical goods for US dollars they are never allowed to spend.

Should the Chinese actually attempt to redeem those dollars for actual products produced in the USA, the resulting imbalances would cause the American dollar to plunge and the Chinese yuan to soar.

Moving further, the world has to some extent adjusted to the very high price of crude oil. The more subdued nature of economic activity over the past year can be largely traced to the higher cost of crude. Some slowing in its cost has partly alleviated these pressures, but hardly all.

Nor has it ensured anything like an enduring stability for the coming year. The EU and the US have both been talking about invoking sanctions against Iran for trying to develop nuclear energy. It is hard to play out any serious attempt to constrain Iranian ambitions without seeing a massive rise in the price of oil.

It’s not for nothing, therefore, that markets have started the year a bit more slowly than 2005. There are genuine problems bubbling in the background troubling analysts.

In the meantime, resource stocks should do well, and construction seems to be continuing in spite of continuing forecasts of a slowdown. The All Ordinaries will pass through 5,000 during the year but is unlikely to get to 5,500, which it might have done in a very good year.

Dr Kates is a senior lecturer at RMIT.