Mixed Economic Blessings

In yesterday’s Markets and Money, we wrote about Europe, which is coming apart at the seams. Down under, our economy is chugging along nicely. We’ve got

  1. A commodity boom
  2. Low unemployment
  3. Great terms of trade
  4. A strong currency

Oops, did you just count your blessings?

Don’t worry, as you’ve guessed, they’re mixed economic blessings. Each one of them has an upside and a downside. We’ll go into why they’re mixed blessings and how you can prepare for the downsides in a minute. Before we do that, earlier this morning we spoke with Slipstream Trader Murray Dawes about two questions that have been bothering us. He was kind enough to leave his endless charts for a moment.

Which way do you think the AUD will go?  Is it really a safe currency?

Australia is one of the few stable currencies in the world that isn’t printing money.  We have high interest rates compared to the rest of the world and are reaping the benefits of strong commodity prices.  We also have a central bank that doesn’t seem concerned by the rise in the AUD.

Of course the key risk at the moment is that China’s property market is looking fragile and Europe is in a recession that will get worse before it gets better.  Commodity demand could suffer and the AUD will suffer if that occurs.

The US Fed indicated that there is little desire within the FOMC to start QE3 any time soon, so on that basis I would say that the AUD is vulnerable in the short term because it has rallied strongly over the past three months and has come up against some key resistance levels.  Therefore I would expect to see a move back towards $1.02 over the coming weeks.

My longer term view is that I wouldn’t be surprised to see the AUD hit levels of $1.20-$1.30 if the governments of the world continue to print.

Why do you think the Aussie market has lagged behind the U.S.?  Will that continue or will the Aussie market play catch-up?

Most of the US rally is based on money printing in my view.  We are seeing a nominal rise in values as the value of their currency falls.  Our non-resource shares are getting hurt by our strong currency and our resource shares are possibly near the top of the current cycle if the European recession starts to bite and China growth softens.

This is not a recipe for a huge rally in my view.  I still think this rally is a bear market rally.  US growth will start to soften before long, bringing back in line with the European weakness so I don’t see a huge breakout to the upside happening unless the central banks really start working their printing presses at full tilt.

As you can tell, Murray isn’t just a chartist. He factors in his views about economics and even individual companies when evaluating a trade. And his technical analysis is often longer term. That makes it useful for investors and traders. Click this stock market update video link, to view Murray’s latest take on the markets. One of his predictions has already come true.

Now, back to the mixed blessings. Why is economics such a pain in the neck? Why must everything have a good and a bad side? Why, as economists put it, are there no solutions, only trade-offs?

This is probably the most useful lesson you might pick up at an academic institution trying to teach you economics. We’ll try and spare you the pain of going through that. The story goes that President Harry Truman once exclaimed he would like a one-handed economist. He was sick of them saying, ‘on the one hand…but on the other hand…

It’s a clever pun. And one that you might agree with. But a one-armed economist would be as useful as a one-armed trapeze artist. Or a one-legged man in butt-kicking contest. He would only tell you half the story. That’s what politicians want, but it doesn’t make for good policy.

An obvious example of this is the exchange rate. As it rises, we get richer. That is, one Aussie dollar will buy you more overseas. But it becomes more difficult to sell our products overseas. No matter which way the dollar moves, some benefit, some lose.

Here’s a specific example. Remember Japan’s foreign-exchange intervention after the tsunami? The Bank of Japan pumped hundreds of billions of dollars worth of yen into the Japanese economy in an attempt to stop the yen from skyrocketing. This downward pressure on the yen encouraged exports, but also made it more expensive for the Japanese to buy the imports they needed to rebuild their country. For some reason, the Bank of Japan favoured the exporters over those buying foreign goods to rebuild their country.

Interest rates face the same conundrum. Lower rates spur on borrowing, but reduce the income of savers. In Europe and the US, where interest rates are low, savers and pensioners are having their budgets squeezed by inflation and lower incomes, while the banks are borrowing money at near-zero interest. No solutions, just trade-offs.

The list goes on. But why does it have to be this way? Well, the economy is a self-correcting mechanism. Prices and profit are its signposts. The reason the dollar has risen in the first place is because of demand for Australian goods and assets.

The increase in the exchange rate is the adjustment of this flow – it is a reaction, not just a change that forces itself on people. The higher the dollar goes, the less demand there should be for Aussie goods and services overseas.

It’s kind of like that Wall Street saying: ‘What’s the cure for higher prices? Higher prices!’ That might sound stupid, but the idea behind it is that the higher prices will spur more production, which brings prices back down.

That’s why economists see profits as a signal, not a reward. If, as politicians do, you try to keep prices low, there will be even less production, which leads to even higher prices.

Forget for a moment that you are either an exporter or an importer (demander of foreign goods) and take an objective stance. This process of self-correction begins to make sense. If exporters are having a lovely time selling vast amounts of goods overseas, this gets corrected as the currency rises.

If it becomes incredibly cheap to buy American jeans online, this will bid up the American currency against ours, until a balance is restored. To importers and exporters, this is a trade off. Some gain, some lose, each way the currency goes. But to an impartial bystander (not all economists are impartial) this is the process of correction taking place.

Of course, this assumes that the free market is allowed to correct and that the signposts of price and profit fluctuate freely. Sadly, this self-correction isn’t allowed to happen in the interest rate market.

Central banks around the world feel the need to intervene. They try to keep interest rates at the level they think is appropriate. But this ‘stability’ comes at a price. It means the normal corrections of a free market can’t take place. There is a misallocation of capital somewhere. For example, more people borrow than should if the rate is kept too low.

The difference between the (more or less) free market of currencies and the not-so-free market of interest rates is intervention. All of a sudden, the self-correcting aspect of the free market takes the back seat in favour of actual trade-offs. Policy makers must decide who their policy will favour, rather than allowing the market to return to the correct balance.

As long as you can blame others for the misallocations that happen, like the sub-prime debt, this trade off doesn’t matter so much. Federal Reserve Chairman Greenspan got plenty of credit for ‘The Great Moderation’ boom of 2003-7, but only some blame for its spectacular collapse. That episode demonstrated nicely that misallocations of capital come back to bite eventually.

So do we have any misallocations in Australia?

Greg Canavan has been telling his subscribers at Sound Money. Sound Investments he reckons so. And not just because Australia is part of a dysfunctional global economy.

‘The ‘Great Correction is coming… and you have less than 12 months to prepare’ he warns.

Greg won’t let us give away what he is telling his subscribers to do with their money, but some of his warnings are crystal clear. He has laid out three mistakes you might be making right now in your investment decisions. What unites them is Greg’s view of what’s in store for your wealth:

I think we’re now approaching the final act of the four year old Global Financial Crisis. Why is this important to you? Because how this plays out in 2012 – and where you have your money invested – could have a MASSIVE impact on the amount of capital you have in five years time.

That’s not much of a revelation after the last five years. What’s different this time around is how exposed Australia is. Last time around, in 2008, our currency plunged and so did our stock market. But that was about it, really. Not to belittle that experience.

But another lesson from economics 101 is that everything is measured in relatives. And Australia came through 2008 relatively unscathed. Perhaps we’re wrong, but there’s something altogether different in the air in 2012.

We’ll go into what’s making our nose wrinkle tomorrow. For now, think of it like this: the more you have, the more you have to lose.

Even if you don’t think Australia is in for a tough time, it’s a good idea to find out whether you are making one or more of Greg’s 3 mistakes. They apply in boom times just as much as they do in what we see is in store for Australia.


Nick Hubble

for Markets and Money

Nick Hubble
Nick Hubble is a feature editor of Markets and Money and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about Markets and Money, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails.

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3 Comments on "Mixed Economic Blessings"

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I’m not impressed by this article. It reeks of the facetious dressed as irony… A commodity boom (what % of the economy, hence significance, and past 4 decades of growth?) Low unemployment (where is employment, hence significance, and past 4 decades of growth) Great terms of trade (what are the terms of trade in services and the record over the past 4 decades?) A strong currency & Is it really a safe currency? & “My longer term view” (live by your word, lay out the AUD against the AUD boom bust cycle even before considering the great inflation of AU… Read more »

and yes that carry trade inducement is generated by spurious liquidity that looks askance at the prospects in the local market and seeks to flee to the ‘new world’ or ‘promised lands’ with narrative written at both originating and receiving ends to facilitate it. The same in manner that is was after London’s “financialisation and profligacy” leading up to the 1840’s and again up to the 1890’s.


Nice pitch, but no sale. Your pay-walled approach to analysis prevents you from becoming part of the conversation. I know your selling of advice is your business model, but this leads to a curious question : If your so smart (ie. your advice is valuable), why ain’t you rich already ? Why do you need subscriptions ?

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