Can Wayne Swan make it?

His plans (and that of the Gillard government) to produce a surplus in 2012-13 risks pushing Australia into recession.

No Australian government — not even the “heroic” Howard government in 2006-08 — has ever proposed slashing federal government spending by so much. Swan plans to take us from a deficit of $37 billion this financial year, perhaps more, to a $1.5 billion surplus in 2012-13. On Treasury’s estimates, that would take at least 2.6% of GDP out of the economy in 2012-13.

To avoid recession, Australia will have to have growth of 3% to 4% over the next 18 months, which is possible, but no certainty. It will mean more pressures on employment, industries such as retailing and real estate, and an even greater dependence on the mining boom, which will make for an even more unbalanced economy. Sounds tough, and it will be, but it is not insurmountable.

But as Stephen Koukoulas pointed out in Crikey yesterday, such sharp cut in spending will open the way for a series of interest rate cuts from the Reserve Bank (that’s what opposition treasury spokesman Joe Hockey calls “heavy lifting”). He wrote:

“Of huge significance, Swan’s very clear message to the RBA is that it can easily cut interest rates knowing that government demand will be dampening demand and inflation pressures over the forecast horizon … It’s a near-perfect application of economic policy: tighter fiscal policy which builds savings, giving even great fiscal flexibility for the future, allows for a lower interest rate structure and therefore a lower Australian dollar. Recall the alternative is an easy budget with on-going deficits, higher interest rates and an even higher Australian dollar. Lovely.”

Built into the underpinnings of the spending cuts is an assumption that China won’t be crunched by the current slowdown, although two days of sharp falls on the Shanghai stockmarket are starting to worry investors about the real state of China’s economic health and whether it can avoid a “hard landing”, led by property.

For that reason the weekend ahead could be fraught with concerns about China with the two monthly surveys of manufacturing activity (one official, one private, from HSBC) due out tomorrow. The early HSBC survey last week showed a larger than expected fall deeper into the contraction (under a reading of 50). Any reading close to 48 will spark more concerns that the slowdown in China is getting bumpier.

But there could be a saviour from left field: not dramatic enough to make Swan’s job easier, but enough to mitigate the intensity of the cuts as we move into 2013. That is the US economy, which is developing a moderate, but not startling growth surge.

We had confirmation overnight of that with an upbeat update from the Organisation for Economic Co-operation and Development while the final estimate of fourth quarter US economic growth was  an unchanged annual rate of 3%. That growth estimate was unchanged from the second one issued a month ago, but despite that consistency, US economists are not as confident as the OECD, which sees first-quarter growth of 2.9% (annual) for the US, slowing to 2.8% for the second and above 2% for all of the year, against the 1.7% for all of 2011.

US economics see growth at 2.1% in the first quarter of this year and won’t pick up significantly from there. Growth over the course of 2012 is expected to be about 2.5%, and only 2.9% in 2013. The economists expect job growth to slow slightly, ending with a full-year gain of 2.2 million, or an average of 170,000 a month for the rest of the year, down from the average gain of 255,000 during January and February. The unemployment rate, which fell to 8.3% in February from 9.1% last August, is expected to only modestly improve to 7.9% by the end of this year.

Now there have been solid starts to the year before in 2010 and 2011, but both were derailed by the eurozone crisis, which now seems to be easing, although Spain is firming as the crisis point for 2012. Fed chairman Ben Bernanke isn’t as convinced as some economists in the private sector (nor the OECD) that the jobs surge in the US and growth are sustainable. He made that clear in a speech in the US on Monday night of this week, our time. Bernanke and the Fed have been bitten in the past by the early signs of recovery turning to dust. Remember his “green shoots” comments in early 2010 that were overtaken by Greece’s woes in Europe.

The OECD has a far more rosy view of the current state of the US economy, as it said in its interim updat overnight.

In an update, the Paris-based OECD said the “forecasts for the first half of 2012 point to a decoupling of GDP growth between Canada and the United States on the one hand, and Europe on the other. Robust growth is projected for the former, whereas in Europe the outlook remains weak. In the United States growth prospects continue to firm. The rebound in equity prices, stronger consumer confidence, and growth in non-farm payroll employment have lifted projected activity”.“Our forecast for the first half of 2012 points to robust growth in the United States and Canada, but much weaker activity in Europe, where the outlook remains fragile,” said OECD chief economist Carlo Padoan. “We may have stepped back from the edge of the cliff, but there’s still no room for complacency,” he said. The OECD projected said that after the 2.9% rate (annual) in the first quarter, growth will ease to a 2.8% rate in the second quarter.

The OECD said recent economic data suggest the US economy will power ahead of Europe in the first half of 2012, with consumers growing increasingly confident and boosting activity in the former while more reforms are needed in the latter to boost growth, the OECD said.

“Deleveraging by the household sector is under way in the United States,” the OECD said. “However, the housing market is still fragile and negative equity continues to weigh on households. Unlike the Fed and its chairman, Ben Bernanke, the OCD seems more certain of the US rebound.

“The firmer labour market outcomes and the rebound in equity prices are underpinning the recovery. The improved outlook is also reflected in better consumer confidence. Other indicators such as motor vehicle sales, industrial production and credit growth also point to a pickup in activity,” the OECD added.

And why is this important to Australia when we are exposed by close links to slowing China?

Well a faster-growing US economy will pull in more imports, from countries such as China. It has already shown up in the February trade figures for Japan. In something of a surprise Japanese exports to the US rose 12% against a 14% fall to China. It was the most significant rise in Japanese exports to the US for months and helped the country produce a surprise surplus for February instead of the expected deficit.

The stronger growth expected in the Japanese economy will have some impact in Australia on our commodity exports, especially of thermal coal and LNG as growth expands. But Japan does face months without its 54 nuclear reactors (30% of electricity production in 2010), offline from May with the final reactor (in Hokkaido) shut for inspection and maintenance.

The US is not without problems, deficits, political gridlock and high debts, but a stronger for longer American economy might just ease the pain for Australia as the year goes on and into 2013.