Factoring in the China slump

Election season in Australia kicked off with announcements that the mining boom was over - perhaps a good opportunity to align voter's expectations prior to starting on the campaign trail.  But there does seem genuine concern of the risks to Australia from a China meltdown, not only from the RBA but also from ratings agency Standard and Poor's:

Australian banks' credit ratings would be cut by up to two notches and house prices would fall by as much as a quarter if China's economy were to slow sharply, Standard & Poor's says.

In a report assessing how Australia's financial system would respond to a ''hard landing'' in China, the credit rating agency says a dramatic slowing in Asia's growth engine would have severe ripple effects on the domestic economy.

S&P sees a hard landing in China - where growth slows from about 7.5 per cent now to 5 per cent - as unlikely, attaching only slight probability to this scenario.

But if growth did slow this sharply, it says Australian banks would face credit rating cutsbecause of their heavy exposure to the domestic economy and the $1.2 trillion mortgage market. (here)

An optimist reassessed

It has been very interesting to read the changes in tone from respected Ross Gittins in his publications in the Sydney Morning Herald.  Gittins is a respected economist and long term contributor to the Herald and often takes an alternative viewpoint on issues.

So it was not surprising that as recently as June Gittins was still in the boom times camp (or boom times are coming again camp):

In other words, it's wrong to imagine the boom's about to leave us high and dry. Mining production and exports have a lot further to grow in coming years. Even the fall in imports (which constitutes a reduction in their negative contribution to growth) is linked to the boom: reduced investment in new mines means reduced imports of capital equipment (here)

An observer looking globally would conclude that in fact the boom is about to leave and right now is leaving all emerging economies high and dry as has been seen by the plunging currencies and poor statistics of high growth favourites like South Africa, India, Mongolia and Brazil being reported recently.

What a change then a couple of months makes:

Stevens warned that, in our efforts to get economic growth back to its trend rate of about 3 per cent a year - which is necessary to stop unemployment continuing to worsen - ''the challenges ahead are substantial''. What's more, those challenges will continue for ''the next few years''.

His speech explained those challenges. You know the basic problem: ensuring the rest of the economy takes up the slack as the stimulus from the mining investment boom tails off...

It turns out that, in our present circumstances, low interest rates don't pack the punch they used to, so we're not going to get as much increase in activity as usual.
Why not? Because, Stevens reminds us, we're not just coping with the aftermath of one boom, but two. The other is the end of the ''credit boom''.
… we should not expect a return to the sorts of growth seen in the 1995 to 2007 period' (here).

Now that's a turnaround!  If the Australian economy could rebound to such a degree (in the opposite direction), it would...oh no it won't!

"Horrendous"

Quite a strong adjective!  Used to describe Australia's latest PMI figures which some commentators are figuring are worse than crisis hit Spain.

The headline number fell to 42.0 from 49.6 a month ago.
Any number below 50 signals contraction.
“Manufacturers are telling us that, while the fall in the Australian dollar and the May interest rate cut have been extremely welcom, they have not yet been enough to turn around a very challenging business environment, locally and internationally,” said the Austrailia Industry Group.
The production sub-index tanked to 37.7, down 12.5 point from July.(here)

Times changing for big Aussie banks...

Some details about CBA and ANZ shifting their strategies to meet new challenges - CBA stripping back its balance sheet to meet stricter capital requirements (although question if a recent private wealth scandal had anything to do with it) and ANZ looking to expand beyond Asia.

But changing is hard to do and to what extent will problems in the core outweigh any escape attempts at the periphery? Mutterings of increasing mortgage insurance costs don't bode well.

Interestingly though there seems to be a divergence between those with a domestic focus at the moment (CBA and Westpac) and those focussing overseas (ANZ and NAB).  It was noted previously that CBA and Westpac have larger domestic lending books and as this article indicates they are busier than ANZ and NAB due to integration of their Australian subsidiary groups (BankWest, Bank of Melbourne, St George, Bank of SA).

In the event of Ozzie contagion could it be that ANZ and NAB survive better due to less local exposure? Could be worth a study of long/short strategies!

Learning how to make stuff again...

Australia's manufacturing industry has been decimated by a high currency, weak consumer demand, distorted tax and incentive systems and crowding out by the resources sector.  With a weakening currency, falling commodity prices, and talk of further interest rate cuts that is shifting however the game has changed and this time Australia is going to have to work for its growth.

Why so?  Well the Oz economy can no longer rely on the internet or rapid increases in the terms of trade to lift Australian's incomes.  As set out in macrobusiness it happened before, but now it's back to basics:

 the surge in incomes over the 2000s was extraordinary – driven primarily by the once-in-a-century lift in commodity prices – and that income growth will be much slower going forward. Indeed, to the event that the terms-of-trade continues to retrace back towards its longer-term average level, it will detract from household income growth, unwinding much of the gains enjoyed over the 2000s. 

In the years ahead, Australians will have to get used to much slower income growth than they have become accustomed to and will instead have to earn pay rises the old fashioned way: via improved productivity.(here)  

What is productivity? Making or doing things better and more efficiently.  This is why Kevin Rudd has been sounding out on the issue.  So Australia may not necesserily be making more stuff, but needs to be doing it smarter.  And when New Zealanders start to gloat about this - something needs to change! 

Learning to live with a deficit...

Optimistic Australians are taking some getting used to the idea that the good times are over.  At least those in government.  While it has been pointed out that being in a small deficit is no huge deal for a country like Australia, the huge disappointment due to misaligned expectations is indicative of a ruling class which is out of touch with the economic mood - needing to tighten instead of dreaming up grand spending plans:

Collapsing revenue from lower company profits has blown a $12 billion hole in the federal budget this financial year, Prime Minister Julia Gillard will reveal on Monday...What she will categorise as a ''significant fiscal gap'' has forced a Hobson's choice on the government as it crafts the budget to be delivered on May 14: either trim or delay expensive recurrent programs, including the $14 billion disability insurance scheme and the $6 billion school education reforms or, hand down an even larger deficit in place of what only months ago was confidently forecast to be a small surplus (here)

And it is only down from here:

Australia's economy is the envy of the developed world but there is a question lurking at the back of economists' heads: when will the good times end?One prominent economist warns we could be in recession within two years once investment in the resources sector - the great driver of the economy for much of the past decade - drops off.....Meanwhile Dr Robert Gay, a former senior economist with the US Federal Reserve now working in the private sector with Fenwick Advisors, says Australia faces the prospect of a "perfect storm" of economic dangers in the not-too-distant future.....He warns a fall in commodity prices could be the catalyst for a particularly unpleasant economic downturn. (here)

Will Australia rebalance? Has any economy rebalanced?

No and no.  Not in the short term anyway.  Whenever you read about politicians and/or bureaucrats having to engineer a rebalancing or engineer a soft landing, you know they will not succeed.  An excellent FT article paints the picture: 


...many forecasters are still worried. They do not believe business investment will be a major driver of growth and argue the Australian economy will have to rely even more heavily on housing construction to meet the RBA’s 2013 GDP growth forecast of 2.5 per cent....As such, they reckon the central bank, which has lowered its benchmark cash rate by 175 basis points since November 2011, will be forced to cut again to stimulate demand....

....“I think we are more of a quarry than what we were 50 years ago and that worries me. The strong mining cycle can’t last forever, that’s inevitable,” Bob Every, the chairman of retail and resources conglomerate Wesfarmers, told a gathering of business leaders in Sydney earlier this month. (here)

Where it all went wrong...

Nice piece in the Sydney Morning Herald which hits all the major factors.  No one cause and no simple solution.  In particular with he banking system - as elsewhere private sector risk is now sovereign risk.

...On one half of the pincer, government does not have any choice but to aim for surpluses. This is because the federal budget guarantees Australian banks’ offshore debts, which funds much of the service sector’s growth.....The other half of the pincer inhibits monetary policy.  The lower interest rates get, the greater the likelihood that the banks will need to resume borrowing offshore to fund renewed credit expansion as deposit growth falters and credit demand climbs (here)

...In short, whatever mix of monetary and fiscal policies Australia chooses, growth will be squeezed by the legacy of yesteryear’s offshore bank borrowing binge....The only way to grow out of this in the long run is via productivity gains and/or external demand. So far that has been gifted to us by China. But to keep growing as the mining boom ends we will need to be competitive at both the fundamental and currency levels....

....Basically, Australia’s entire macroeconomic structure is geared towards a dated growth model of borrowing offshore to fund excessive and unearned income inflation. The astute might also observe that this set-up is entrenched also in both political parties....