When will the music stop?

The world economy is well into its fourth year of above trend growth. The various global agencies, such as the International Monetary Fund (IMF), are busy raising their forecasts for global growth with strong growth now predicted to continue into 2007.

The prices of oil and of many commodities are setting new records in nominal terms and in some cases also in “real”, i.e. inflation adjusted, terms. Interest rates are rising in most countries, and globally on average.

Global inflation is a major question addressed by the IMF, with extensive analysis that encompasses the late 19th century, arguably an era of relatively free trade and globalisation not unlike present experience. Their analysis is not for the faint-hearted, but is highly recommended for real economists. As Henry reads it, the IMF believes that low global goods and services inflation can persist despite “accommodating” monetary policy and several years of above trend growth.

I must disagree. Global monetary policy has been more than accommodating, positively loose in the case of the US economy where cash rates at 1 per cent were by any standard inflationary. Global goods and services inflation was, however, held down by the extraordinary surge of US productivity - its sources far from fully understood - and the productivity-enhancing entry of China and to a lesser extent India into the global economic mainstream.

With easy money and goods and services inflation constrained by unusually high productivity growth, asset prices have been where the excess money has had its influence. The prices of many commodities, most equities and prime global real estate have boomed.

Australia has shared more than proportionately in the benefits of this process. Both federal and state governments have seen their incomes soar, and so can be generous to voters, especially families in the great suburban heartlands. The Reserve Bank has built a reputation for omnipotence, with US, Chinese and Indian productivity flattering its record as a doughty inflation fighter.

Owners of prime real estate in Australia’s major cities and seasides have grown rich, and competent property developers are revered as Australia’s best and brightest businessmen. Well run corporations have prospered, and their bosses have grown rich with the benefits from generous share schemes. Superannuation funds have prospered as share prices regularly hit new records. Smart investors who went “long” resource stocks are especially happy and if they also own a lot of real estate they light candles (or they should) in the cathedrals to Messrs Howard, Costello and Macfarlane.

The losers include the Federal Labor Party opposition, unskilled workers - who feel the competition from China and India most directly, the union bosses - whose constituency has evaporated before their eyes, incompetent businessmen and those who are squeezed out of the great prosperity-building game by lack of education, lack of initiative or lack of opportunity. This is a brutal Darwinian process, but it helps ensure that domestic productivity continues to grow, keeping a prosperous Australia well up in the global economic contest.

Can this great game go on? When will the music stop?

The great burst of globalisation in the late 19th and early 20th centuries was ended by brutal conflict. The first war on a global sale was followed by global depression and then by a second global war - scholars have convincingly traced the many links from the first Great War to the great depression and to the second Great War. The restrictions and controls applied during and after this half century of war and depression took many years to unwind.

The wars then were a manifestation of competition between two great empires. Now we see a number of worrying developments, collectively likely to slow, and possibly to reverse, the growth of global prosperity. There is global conflict between the prosperous west and the fanatical parts of the Islamic nations. There is the battle to save the environment, and to overcome growing disparities between rich and poor.

We cannot ignore the more narrowly economically-based battles either - with their symptoms the “imbalances” so emphasised by agencies such as the IMF. China has a vast and still growing current account surplus, while the United States has a vast and still growing current account deficit.