Update on the Iran War

Context

Each month I have taken the opportunity to reflect on the war in Iran and consider what might happen next. This is the fourth piece in that series.

Eighty-nine days after Operation Epic Fury began, the war is closer to its end than it has been at any prior point. The Mexican standoff I described on 1st May appears to be resolving in substance, with Trump taking a Bath, which the May piece called as the most likely outcome. Trump has not yet signed and surrendered. But the question is less whether he will and increasingly: when he will.

On 23 May US time, Trump posted on Truth Social that a deal had been "largely negotiated, subject to finalization." The deal as described in regional press includes an official declaration of the war's end, a 30 to 60 day window for nuclear talks, gradual reopening of the Strait of Hormuz with Iran continuing to manage access on a fee basis, and US ending its blockade of Iranian ports. Iran's foreign ministry, through spokesperson Esmail Baghaei, publicly described the emerging text as a "framework agreement." Iranian Parliament Speaker Mohammad Bagher Qalibaf travelled to Qatar to take part. Fars News, the IRGC-affiliated outlet that had spent two months denying that negotiations were occurring, confirmed implementation details and corrected Trump's characterisation by stating publicly that Iran would continue to manage the waterway.

This is largely the same deal Iran put on the table on 28 April. The terms have not moved in Trump's favour. The position has been publicly acknowledged by Iran for the first time. The signature has not yet arrived.

Inflation Targeting vs nGDP Targeting

What Are We Talking About

Today's blog post is very technical. We are talking about which variable should be the focus of a central bank when it sets interest rate policy. Most of the world's central banks use an inflation target, typically around 2 per cent, although Australia has a 2 to 3 per cent target band and within that it targets the 2.5 per cent mid point. An alternative which is often promoted is nominal gross domestic product (nGDP) targeting, where the bank aims to maintain a steady growth rate or path for nGDP.

Weekly Energy Update

 Wholesale prices

Wholesale prices were up a touch at the end of this week.

Australia's Productivity Slump

In my last post I argued the Aussie dollar is being held up by the carry rather than by the fundamentals. The biggest of those rotten fundamentals is productivity growth. Australian labour productivity sits below where it was in 2019. Capital deepening has collapsed to zero. Multifactor productivity peaked in 2004 and has gone nowhere since. The slump is deep and it has been persistent.

Why is the Aussie dollar so strong?

Australian productivity has gone backwards since 2019. Unit labour costs are running ten points above the United States from a common base. The goods trade balance in trend-terms has fallen from above 13 billion dollars a month at the 2022 peak to barely 3 billion, with the latest print briefly negative. Inflation has reaccelerated above the target band on every measure. By any fundamental read, the Australian dollar should be weakening. It isn't. It has rallied from briefly below 0.60 last year to above 0.72 now and the trend is looking up.

The answer is the carry. Everything else is detail.

Housing Shortages and the Elasticity of Demand

Almost no one lives in the house of their dreams. We rent the flat we can afford, not the one we'd choose. We buy further out than we wanted, or smaller than we planned, or later than we meant to. The spare room becomes a bedroom. The study becomes a nursery and the nursery stays a nursery. The adult child who would have moved out is still down the hall. We tell ourselves the commute is fine. We build a granny flat to accommodate ageing parents. Whether we rent or buy, almost all of us are living in a compromise, and we made it because of what housing costs - be it the purchase price, the mortgage repayment cost, planned renovation costs, maintenance costs or rental costs.

That ordinary, universal experience is the reason a claim now circulating cannot bear the weight being put on it. The claim, in its various forms, is that we are building enough houses, or that at some lower rate of population growth the current rate of construction would be sufficient. The evidence offered is usually a ratio: dwellings against households, or population growth against completions, or population per dwelling with the conclusion that if the two roughly match, or match some historical figure, then demand has been met and there is no real housing shortage.

I am not going to argue the opposite. I am not going to tell you there is a shortage of a particular size, because I do not think anyone can honestly tell you that. I am going to argue something narrower, and I think harder to dismiss. You cannot cleanly conclude adequacy from a ratio like that, in either direction, because the quantities in it are not independent of the thing you are trying to judge. And what we most need to know, how much housing demand has been compromised away, and at what price it would reappear, is not in the data at all.

Weekly Energy Update

Australian Wholesale Prices (Cents per litre)