–O’ Reserve Bank of Australia Governor Glenn Stevens, must you tempt the fates so? The most interesting thing about his speech yesterday is that he threw in his lot with the “structural changes” crew. This means Stevens believes the high terms of trade Australia is enjoying are going to last, and that the economy and the currency are not likely to be affected by, say, a sovereign-debt default in Greece.
–Has Stevens just set himself in the Aussie dollar bullish camp, only to be utterly gored by the “risk off” trade in which emerging markets and commodities are sold and the U.S. dollar bought? Discuss….
–Granted, Stevens didn’t say a word about Greece yesterday. We’ll get to Athens in a moment. The clock is ticking on the next Greek bailout. And the credit markets are already punishing French and German banks with “exposure” to Greece. We’ll show you how Greece’s problems could be transmitted to Australia.
–But first, back to Mr. Stevens. In his Brisbane speech yesterday, Stevens said,
A good part of the change in our terms of trade is a manifestation of a large and persistent change in global relative prices. Let me be clear here: there is a cyclical dimension to the China story, and it is important that we remember that. But there is also a structural dimension. And the associated change in relative prices constitutes a force for significant structural change in the economy. I think we have all only begun to grasp its implications relatively recently.
–This is a pretty important point regarding the RBA’s attitude to, among other things, interest rates. He concedes that commodity prices go in cycles of boom and bust. But by siding with the “structural change” crowd, he’s telling us the boom is a lot bigger and will last a lot longer than a normal cycle. Kind of like a “super cycle”.
–This tells you what Stevens thinks about the terms of trade. But it could also be showing you that the RBA thinks the economy and the dollar are not vulnerable to Greece because they have so much China going for them. Stevens makes a really important argument, though. So let’s have a look at more of it. Emphasis added is ours:
For a long time, the world price of foodstuffs and raw materials tended to decline relative to the prices of manufactures, services and assets. But for some years now the prices of things that are grown, dug up or otherwise extracted have been rising relative to those other prices. This is mainly due to trends in global demand. At any point in time for a particular product we can appeal to supply-side issues – a drought, a flood or a mine or well closure, or some geo political event that is seen as pushing up prices. But stepping back, the main supply problem is really that there has simply been more demand than suppliers were prepared or able to meet at the old prices.
We do not have to look far for the cause: hundreds of millions of people in the emerging world have seen growth in their incomes and associated changes in their living standards, and they want to live much more like we have been living for decades. This means they are moving towards a more energy- and steel-intensive way of life and a more protein-rich diet. That fact is fundamentally changing the shape of the world economy. Even if China’s growth rate moderates this year, as it seems to be doing, these structural forces almost certainly will continue.
It is worth noting in this connection that many commentators have for years been calling on policymakers in the emerging world to adopt growth strategies that rely more on domestic demand and less on exports to major countries. This is happening. It carries the implication though that, first, more of the marginal global spending dollar is going to products that are steel-, energy- and protein-intensive for the emerging world’s consumers and less on other things like, say, luxury property in western countries.
–This is all pretty much straight from the gospel of China Boom Forever. It’s also a fair point. In real-world terms, globalisation has been deflationary for most Westerners. Prices for imported consumer goods fell for 20 years. True, the jobs for making those things left too, and this was wage deflationary. But no one really felt that, until now.
–Why now? Globalisation led to lower prices for consumer goods. That offset the sting of lower wage growth; the result of losing all those high-wage, highly skilled manufacturing jobs. In simpler terms, the average salary may not have gone up much in real terms over the last 30 years, but cheap imports from Asia made up part of the difference.
–The other part of the difference was made up with credit growth. You might think this is just an American or Greek phenomenon. But don’t forget that the household-debt-to-GDP ratio in Australia is over 100%. And don’t forget that credit growth fuelled asset-price gains in stocks and houses-all of which makes debt loads seem more manageable (until asset prices fall when credit growth falters).
–Stevens says that the general trend of falling prices for things is now reversing. This is the big cyclical change-the period in which demand exceeds supply for a long time. He reckons that despite the many billions of dollars in capacity expansion planned in Australia and elsewhere, demand growth will still exceed supply growth. This will keep resource prices, the terms of trade, and the Aussie dollar all high for a while.
–Stevens says that, “Ultimately there will be enough steel, energy, food and so on to meet demand – supply is responding. But considerable adjustment is needed to get there (and Australia is a very prominent part of that adjustment).”
–Australia’s prominence in that adjustment protects it, Stevens says. But from what? Well, as demand grows in the developing world for the same goods and services enjoyed in the developed world, it leads to lower purchasing power for the developed nations. Countries with high household and government debts see weaker currencies.
The average consumer in an advanced economy is effectively experiencing a decline in purchasing power over food, energy, and raw material-intensive manufactures. Australian consumers face this to some extent as well. Were Australia not a producer of raw materials, we would be experiencing a good deal more of it. In such a world, there would be no resources sector build up. Our currency would be much lower. We would be paying much more for petrol at the pump, for our daily coffee and for a wide range of other consumer products. We would not be holidaying overseas in our current numbers.
–The China boom has delivered a huge boost to national income and made the Aussie currency a kind of island of strength in the Western world. Glenn Stevens argued yesterday that this is a “structural change”. He’s making monetary policy based on this argument. But what if the boom in China and the strength in the Aussie are products of a global credit boom? And what if that credit bust which began in 2007 in the private sector, is about to enter a new destructive phase in the public sector?
–This brings us back to Greece. Greece is just one economy and not a particularly big one, although what happens there certainly matters to the Greeks. But Greek problems become global problems because of the connectivity of the global banking sector, which is yet another product of globalisation (the globalisation of finance).
–A lot of European banks own Greek debt. And a lot of global banks own European bank debt. The toe bone is connected to the, nose bone. This is why the suits at the European Central Bank are determined to prevent a restructuring of Greek debt. It’s not because the ratings agency considers a restructuring a defacto default.
–It’s because if the Greek’s restructure their debt and force creditors to take losses on bonds (force in the least compulsory way, of course) a precedent will have been set for every other troubled bank and sovereign bond issuer in Europe. It’s not that everyone will default. It’s that everyone will restructure, and in so doing, the capital of a lot of European Banks, including the ECB itself, would go up in smoke.
–“Greece could have a contagion effect,” ECB Vice President Vitor Constancio said in Frankfurt today. “That’s the reason why we are against any sort of default with haircuts and any form of private-sector event that could lead to a credit event or a rating event.”
–The “credit event” would be even worse for markets. The rating event is a sideshow. The real story is whether Europe will hurtle towards taking all these losses now…or kicking the proverbial can down the road and tolerating a much weaker Euro in the process. Kicking the can down the road would mean more loans to Greece et al. by the ECB and perhaps outright bond purchases with new cash (debt monetisation).
–The Europeans have to get their act together soon. The fifth part of the International Monetary Fund’s loan to Greece is due at the end of this month. But the IMF is prohibited by its own rules from releasing that money if Greece doesn’t already have a year’s worth of financing lined up at the time the IMF is ready to release the money. Without the money, the Greek government has about six days of cash left before it goes broke.
–The meta-story here is that everything central bankers have done since 2007 has been designed to prevent a real reckoning. That reckoning isn’t moral or philosophical. It’s financial. Too much unproductive debt has saddled the global economy. That debt is hard to service (globalisation has eaten into tax revenues as average incomes declined) and will likely never be paid back.
–Everyone at the ECB must know that. So why are they pretending otherwise? Well, the obvious answer is to prevent a systemic meltdown and the collapse of the Euro. The sick children of Europe-in debt and economic terms-may be forced into some kind of second-class currency. In order to save the Euro it may be necessary to destroy it.
–Or, it could be that deep down in their trans-national progressive centralising hearts, the heads of the ECB and the European Union believe the only way to achieve a more integrated political and economic union is to destroy national sovereignty altogether. If that’s their goal, then they are certainly making progress in Greece, where the government has been forced to call a confidence vote and is further forced by the IMF and the ECB to implement fiscal austerity measures that are not pleasing to the Greek’s throwing yogurt in the streets.
–What will happen next? Will the yogurt throwers topple the government and prevent their political masters from selling Greece into European servitude? Or do they have a choice at this point? Hmm.
–A single debtor in thrall to his banker/lender/overlord probably doesn’t have much choice. The law is against him. His resources are exhausted. And after all, he incurred the debt.
–But a whole nation of debtors? Or, more specifically, a whole nation asked to pay off debts run up over generations? It seems to us they DO have a choice. They can tell the bankers to stick it where the sun don’t shine…and then see what happens. And if that’s what happens in Greece, you can bet it’s a dress rehearsal for what will happen elsewhere.
Markets and Money Australia