The economy often has plenty of contradictions and confusing conditions for us to decipher. In the most recent set of strange occurrences, we have seen a slowing Australian economy apparently flush with cash with people piling their money into assets, creating a new era of asset price inflation across the economy. Moreover, as the price of iron ore continues to plummet and Chinese tariffs continue to impact our economy, the recovery expected by the government may not occur by December, contrary to previous expectations.
1. Financial Markets expect COVID vaccine rollout to greatly boost economy
While both Victoria and NSW struggle to break out of lockdown, Australia’s main stock price indicator, the ASX 200 index is soaring off the back of growing share prices. The question many are asking is why this is happening in such a precarious period, and what it means for the economy as a whole.
Firstly, it should be noted that the stock market is often disconnected from the realities of the economy, due to its nature as a speculative environment where investors purchase shares as a reflection of how well they expect the economy to perform rather than a close reflection of actual current economic conditions. In this case, the market is rising due to expectations of the economic recovery that investors expect to happen soon.
For the economy as a whole, the rise of asset prices may allow for the growth of the wealth effect, where Australians who see the value of their net assets rise may choose to consume at greater amounts, or increase investment of their earnings into the economy.
An example of this occurred across 2015 and 2016, when Sydney house prices grew 22%, then a further 10%, leading to homeowners having significantly more wealth than previously. Many of them spent this new wealth buying new cars, proving the existence of the wealth effect, as you can see for yourself in the articles below.
The increased consumption from the wealth effect will drive up aggregate demand and therefore the total level of economic growth. However, it may also be the case that individuals choose to purchase financial assets rather than consume in the economy, reducing aggregate demand and leading to a closed system of growth within the stock market.
Moreover, in terms of our distribution of income and wealth, we can recognise that the growth of stock prices is going to disproportionately benefit the wealthiest Australians who can afford to take thousands of dollars to invest in shares and other financial assets.
Therefore, the positive increase in total consumption in the economy will likely be minimised by high income-earners’ high Marginal Propensity to Save (MPS), thus lowering the positive impact of the investment multiplier on economic growth.
2. China-Australia Trade War continues
As this article series has mentioned before, Australia’s relationship with China is largely predicated on the strength of our commodities trade, and especially the price of iron ore. However, it is still often a surprise to many that the price of our commodities, and the volume that we sell to China is almost entirely out of our control, as the price of raw materials remains set at a global level.
Recently, China has scaled back its iron ore production as a means to achieve both self-sufficiency and to blight Australia for its various political disagreements.
As the New Daily reports “Iron ore prices have now fallen from a July peak of AUD300 a tonne to just AUD228 on Thursday night as China continues to decrease its steel production.” Therefore we can expect that in the coming weeks our terms of trade will decline, decreasing injections of export income, further reducing our economic growth and impacting Australia’s COVID recovery.
For more resources and notes on the Global Economy and Free Trade HSC topics, visit https://www.projectacademy.com.au/year-12/hsc-economics
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This series of weekly articles aims to compile the important economic news of the week into bite-sized summaries with HSC-specific takeaways.
You can expect a new article every Monday!
