TLDR

I don’t mind sharing that today’s chart from the recent RBA chart pack makes me go hmmm. It’s been doing this to me for a while. And it’s not getting much better.

What it shows is that non-tradable inflation is still running at about 4 times the rate of tradable inflation.

And what that means is that the domestic inflation pressures on non-tradable goods and services that are not easily traded across borders (e.g., housing, healthcare, energy, and education) are about 4 times more powerful/stickier than the inflation pressures that come from goods and services which can be traded internationally, e.g., electronics, materials, oil, clothing, etc.

Most of our inflation still comes from us (our own economy and society) and not from overseas or from macro factors.

It means that if we continue down the path of deglobalisation, and if we over-regulate, under-resource and overpay our non-tradable industries – higher prices will surely remain stickier for longer and Australian living standards will take a dive.

The answer? Recalibrate Australia.

We should widen and deepen our economic base, access more skills via immigration, incentivise the use of robots, automation, AI and advanced manufacturing, transition to planetary friendly affordable nuclear power, and get in step with the future.

More ranting from yours truly, below.

What are tradable and non-tradables?

First, and as a refresher, non-tradable inflation is the part of the CPI basket that is predominantly shaped by a mix of wage, capital and energy costs and driven by politics, i.e., regulatory environment/policy. It is not easily traded across borders (hence its name), and it includes things like domestic housing, education, healthcare, personal care, and those hellish insurance premiums.

Tradable inflation refers to price inflation that’s predominantly influenced by international supply issues, USD strength/weakness, and other macro factors as well as geopolitics. Components include things like electronics, clothing, oil, and many of the things we import.

If you look at the chart above, you can easily see how the bulk of inflation has been coming from non-tradable inflation, which is driven by the domestic factors mentioned above.

And there is a higher weighting of non-tradable in the CPI basket, meaning there is a compounding effect of higher prices within the larger slice of the pie.

As I mentioned above, non-tradable inflation is about 4 times stickier than tradables, even despite a strong USD (making imports expensive), supply chain issues that still remain in certain areas as well as geopolitical trade skirmishes and standoffs!

Intuitively, you might have thought these factors would have had a much higher impact on tradables like imported electronics, clothing, vehicles, right?

Wrong. In fact, inflation from these tradable goods is running at <1.5% which is well below the RBA’s CPI target.

In totality, monthly indicated CPI (for January) was 3.4% because while tradables printed <1.5%, non-tradables were still a very uncomfortable 5.4%, predominantly due to still high prices for dwellings, rents, insurance, electricity, wages and other costs.

At roughly 50/50 for each component, you get the January monthly print of ~3.4%.

What are the historical causes of this?

I found Graph 1 below in an old RBA paper. While date limited, it’s still quite useful because it clearly records the higher inflationary contribution flip from tradables to non-tradables, which occurred at the end of 2001.

Why then? That’s when China joined the WTO (World Trade Organisation) which allowed China’s handbrake to be released and the world to be flooded with China originated goods. And those goods were cheap! Remember complaints about the use of lead in paint, and the way our kids’ toys from China used to fall apart?

Nevertheless, China effectively began to export deflation to the rest of the world in the form of low-price goods, steel and intermediate items. It was one of the many benefits of globalisation, before COVID and Ukraine.

By 2004 tradable goods inflation had gone negative, i.e., deflationary thanks to accelerated globalisation via China.

The AUD/USD edged up above 70c (from a low of 51c in 2001) and eventually went to parity over the next 10 years, creating a double advantage for Aussie importers and consumers.

We witnessed the birth of Kogan and a raft of other consumer-facing and industrial businesses that were enabled because of an ability to access cheap product from China with very few limitations.

Also, a natural resources development/commodities super cycle started (circa 2003) with China hoovering up every tonne and kilo of minerals available to make steel, build cities and become the ‘world’s factory’.

With these raw materials and intermediates plus a massive workforce, China could export cheaper and cheaper goods to the world.

Generally, goods became cheaper worldwide and this was one of the many benefits (along with the geopolitical risks) of living amongst comparatively advantaged/globalised supply chains, pre-COVID and Ukraine.

But, back to Graph 1 - and the point that it highlights well is that tradable goods dis-inflated significantly over the period. China goods increased everyone else’s standard of living.

Thus far, the contributions to our CPI from tradable inflation has remained below the contribution from non-tradables, China has largely reopened (although its economy is still suffering from leverage and geopolitical realignment) and the gap between the blue and orange lines has continued to oscillate in a downwards wedge.

So, the goldilocks story for Australia over the 20 years leading up to COVID was one of disinflationary goods imported from China, and bought (mainly in USD) with a strong AUD.

Post-COVID, Russia/Ukraine, deglobalisation, friendshoring and nearshoring, the story has become more complicated. Prices for tradables have come down faster than non-tradables, and our CPI is stickier and more stubborn than any politician and economic forecaster has been prepared to admit.

So, what if underlying domestic price factors are 4x stickier?

The chart and Graph 1 show how inflationary pressures at home are way stickier than offshore/imported pressures.

It means we have some significant issues associated with our narrow economic base, energy cost, productivity, industrial relations, and efficiency issues (as well as immigration, home affordability, healthcare, NDIS, and other serious social issues) that we need to solve.

It means that domestic labour market conditions and policies are sub-optimal; and that our housing, energy, water, and social infrastructure are far too exposed to inefficient supply, costs and therefore, unstable prices.

But the chart and graph also serve as a lesson to protectionist woke governments that globalisation was good for standards of living. It allowed more efficient price discovery for multilaterally traded goods and services and allowed each country to excel at what it was good at for the net benefit of most countries.

Globalisation accelerated comparative advantage and shaped entire domestic industries as each country chose its own response to price competition in an almost borderless trade world (before the Trump tariffs were introduced).

However, following the redirection of trade flows that was accelerated by the Trump sponsored US/China trade war, and since COVID and Ukraine, we have moved into a geopolitically torn world where globalisation is in reverse.

This could mean higher rates of domestic inflation for many countries that are unable to access the past benefits of cheaper goods and/or without access to geopolitically aligned supply chains, and/or with a lack of means/capital - and/or with the wrong political policies (and parties in power) to recalibrate/optimise their economic base.

We are one of those economies.

Now the question becomes whether we will see stickier inflation for longer emanating from onshore pressures; or whether we have the wherewithal for some socio-economic redesign.

Nuclear robots for dinner?

One of the ways to try and solve for the above is to reweight the basket by replacing more inefficient goods and services in Australia with imports from new trading partners, i.e., find friendly and politically aligned partners. This is possible in some areas but not a fix for the problem because it won’t sort the domestic issues and all it can really do is optimise tradables, not non-tradables.

Change Government. Well, yes, although that doesn’t mean a new government will make anything better.

Another solution might be to broaden our economic base by downstream processing our materials into intermediate and end products, and to bring manufacturing to our shores.

Are you laughing yet? Won’t manufacturing just add to more problems given the wage and energy costs required to re-onshore it as well as the industrial relations, safety and other regulation that would drown it?

Well, manufacturing went out of style because we never had a comparative advantage in manufactured goods. We gave up our skills to China and countries in Asia where labour costs were orders of magnitude lower - and these countries took the comparative advantage.

At the same time, we have relied too much on onsite manual building trades instead of developing offsite building capacity. This is probably the way to alleviate the 100,000 plus housing shortage across the country. Home affordability would improve, and more skills through immigration could be accessed.

Another limiting factor here in Australia (and a key source of price pressure on non-tradables) has been and is our cost of energy. It’s insane. So too are our domestic energy policies. These are often blockers to developing downstream industries, and a massive source of inflation for households.

But what can solve this and other related choke points and pain points?

Technology. AI, robots, automation software, incentivising government policy, nuclear energy and an optimised supply chain assisted by efficiencies through disintermediation and programmatic trust enabled by web3 and blockchain, is the answer for countries like ours.

It’s not about coal-fired EVs with long life batteries containing conflict minerals and subject to ever-changing chemistries – it’s about nuclear-powered robots and automation platforms that can deflate prices, enable housing supply and create cheap energy as well as higher growth rates and standards of living for all.

These nuclear robots could start to eat away the stagflationary pressures that are at the heart of our non-tradable inflation, while tradable inflation pressures subside on their own. Nuclear robots can help us to increase GDP without the same level of incremental cost or social taxes that it currently takes to generate it.

Workers can contribute to new forms of GDP enabled by new future facing policies (another choke point, thus far), and we might just find that the typical central bank dual mandate of stable prices and full employment would be a lot easier to achieve.

In Australia, I would like to see Government withdraw the nuclear energy ban, put more incentives into advanced manufacturing, robotics and industry building technology, and back-off over-regulation. There’s also a seemingly blind focus on renewable energy that’s, well, inflationary. Time to get smarter. Too much to ask? Maybe.

Still, I contend that Governments could incentivise nuclear robots that would happily eat our non-tradable inflation and supercharge our GDP, if they wanted to – and with AI alone representing double figure trillions in additional GDP to be had, let’s not be the ‘once was lucky country because of our wheat, sheep and rocks’ that simply gets left behind in a she’ll be right state of mind.

The writing is on the wall just like it was for Nickel. Let’s not ignore it this time.

Let’s not be the economically narrow stagflationary-prone outlier anymore.

It’s time to feed the robots, preferably with yellowcake.

As always, feel free to reach out with comments, and/or shower me with offers for coffee - they are gratefully received.

See you in the market.

Mike