Australians are suffering from a rigged economic system.
For more than 28 years, the Australian Government and key economic institutions such as the Reserve Bank of Australia (RBA) have systematically misled Australians as to the true nature of their economic plight.
Since the 1991 recession, Australians have been consistently told by the political, economic and financial establishments that the Australian economy has experienced low levels of inflation.
This is simply not true.
Rather, Australians have experienced high rates of inflation which have been masked through:
a flawed and broken monetary policy framework;
definitional and statistical manipulation;
mass economic ignorance;
ideologically trained Keynesian economists;
a compliant financial industry; and
complicit misreporting by the state-corporate mass media.
Evidence of the high rates of inflation is abundant including:
the tremendous cost of living pressures experienced by Australians;
asset bubbles, particularly in real estate;
unprecedented levels of non‑government debt, particularly record levels of household debt; and
rising economic inequality.
Difference between Price and Value
Significant confusion abounds in the Australian public debate over economic concepts such as ‘price’ and ‘value’ as well as the factors that determine these concepts. The current debate regarding housing affordability is a classic case.
The price of any good or service is determined by two components:
its real component (or factors); and
its monetary component.
The real component consists of real-world demand and supply forces. In the case of housing, this would include:
the demand for housing - including the demand for various types of housing;
the supply for housing - including the supply of land, the cost and availability of materials and labour, and the impost of specific housing transactional taxes such as stamp duty.
The monetary component consists of the demand and supply of the money (typically a government‑issued official currency) in which the good or service is valued in. With respect to Australia, this would include the quantum of Australian dollars (physical and digital) which constitutes the money supply originated by the RBA and the banking system.
The price of a good or service (e.g. a house) may increase or decrease as a result in changes of its real or monetary components.
Throughout the 19th and early 20th centuries, European and American economists, such as Ludwig von Mises (circa 1912 via his book ‘The Theory of Money and Credit’), defined inflation as the growth in the quantity of money that results in a fall in the ‘objective exchange value of money’.
Under this definition, the consequence of growth in the money supply is an increase in prices. Prices increase not because a good or service is worth more, but because the exchange value of money used to purchase the good or service is worth less, meaning that more dollars are required to purchase the same good or service.
However, many Australians have been led by the RBA to believe that ‘inflation’ is defined as an increase in prices, irrespective of the source of the increase.
This error in economic understanding is central to many of the policy challenges facing Australia today.
Australia’s current monetary policy framework, which was established by the RBA in 1993, seeks to keep the growth in the general level of consumer prices or what the RBA has defined as ‘inflation’ between 2% ‑ 3% over the economic cycle.
The RBA formally mandated in the September Quarter 1998 that its key statistical measure which it will use to achieve its inflation targeting regime would be the Consumer Price Index (CPI) regularly published by the Australian Bureau of Statistics (ABS).
This monetary framework regime has been endorsed by successive Treasurers from Paul Keating to now Josh Frydenberg.
Comparing the growth in the quantity of money in Australia defined by ‘broad money’ (the RBA’s widest official definition of money) relative to the growth in the CPI over the past 28 years, illustrates that the quantity of money has grown more than four times the official growth in the CPI.
Assuming the classical definition of inflation, Australians, over the past 28 years, have suffered under an average inflation rate of 7.24%, with inflation reaching an annual high of 16.78% (in 2007‑08) and an annual low of -0.8% (1991-92).
Thus, according to ‘classical economists’, Australians have not been the beneficiary of low inflation, but the victim of high rates of inflation and a substantial reduction in the purchasing power of the Australian dollar.
Official Manipulation of the Consumer Price Index
The significant divergence between the growth of broad money and the CPI, indicates that a significant amount of the inflation generated in Australia has been officially concealed from Australians.
This ‘missing inflation’ can be explained by several methodological considerations underpinning the CPI, including:
Firstly, the CPI as a measure of the changes of prices experienced by consumers, does not include all prices within the Australian economy. The costs of existing housing, land, mortgage interest payments and capital assets are not included in the CPI basket. A portion of these CPI basket exclusions were driven by changes to the CPI methodology in 1998 where it was changed from a cost-of-living index measuring outlays to a price index measuring acquisitions. Under this new model, the cost of land for owner-occupied housing was removed and the cost of including a new building (excluding land) was included.
Secondly, the CPI, over the past 28 years, has been subject to methodological changes including the inclusion of geometric price indices in the December Quarter of 1998 and hedonic regression modelling for personal computers which analysis by several American economists has shown, coupled with similar methodological changes to their CPI, suppresses the index’s rate of increase.
Where has Australia’s missing inflation gone?
The ‘missing inflation’ has manifested itself throughout the Australian economy.
Created Australian dollars, whether base money (created by the RBA) or credit (created by the banks) have been lent to Australian businesses and consumers and has become concentrated in the Australian housing sector through mass originations of mortgages.
This is evidenced by the fact that credit pumped into the Australian housing sector was 21.07% of Gross Domestic Product in June 1991 and by the end of June 2018 this figure had sky rocketed to 96.01%.
Role of the RBA
This outcome is partly due to a series of submissions made to the ABS by the RBA in 1998 in which it advocated for a series of methodological changes to the CPI including the alterations noted above.
Thus, the RBA has been at the forefront of manipulating Australia’s official inflation statistics which has resulted in official interest rates being lower than otherwise would be the case given the 2% - 3% inflation target as part of the RBA’s monetary policy framework.
The RBA, through its efforts in manipulating the CPI, has been instrumental in creating and blowing up of the biggest property and household debt bubble in Australian economic history.
So, while Australians believe that their property is worth more in a rising market, the concentration of credit in the housing sector actually means that the value of the Australian dollar in being able to purchase real estate is increasingly less as more dollars are required.
In conclusion, Australia’s monetary policy and inflation measurement frameworks are seriously flawed.
These flawed frameworks and grossly irresponsible policy settings have therefore led to the Australian middle class and Australia’s most vulnerable citizens suffering chronic cost-of-living pressures, major asset bubbles and record household debt which now stands at 189.6% (as of December 2018) of a proportion of disposable income.
Public policy problems such as cost of living and housing affordability cannot be resolved until Australia’s monetary and inflation scandal is resolved.
John Adams is the Chief Economist for As Good As Gold Australia