Pinning the Tail on the Donkey in the Australian Economy

The bean counters at Australia’s Treasury Department are stumbling around blindfolded after being spun around half-a-dozen times trying to pin the tail on the donkey that is Australia’s economy.

Confirming what the ‘man in the street’ already knows, the Treasury downgraded its economic growth forecast for this year and next from 3% to 2.75%. On the surface it’s not a massive change but the Financial Review tells us it’s enough to cut $1.75 billion from government revenue expectations next year. Ouch.

That should make next week’s budget very interesting. Does Labor just go all out in an attempt to win the election by bribing everyone with handouts and ‘entitlements’, or does it cut back on middle class welfare in order to show some semblance of fiscal rectitude?

The question is a rhetorical one…we know nothing.

But we do know it should also make tomorrow’s Reserve Bank meeting an interesting one as well. Will Glenn Steven’s take the momentous decision to cut the official interest rate to historic lows?

There’s evidence that he should. April manufacturing and service sector surveys show that both are in recession. The unemployment rate is ticking up, the dollar’s real trade-weighted index is at the highest level since 1974 and the mining sector remains in the doldrums. Oh, and today the Australian Bureau of Statistics reported that March retail sales contracted by 0.4%.

Thankfully, the property Ponzi scheme remains in full swing as already low interest rates unleash another round of national speculation and those already in the market buy and sell to one another. So property, and mortgages, are the one economic bright spot at the moment.

Last week we suggested to Dan Denning that Australia should try to figure out a way of exporting mortgages to improve its trade balance. Mortgage origination seems to be the one thing we are truly good at.

Except we realised you need capital in the mortgage business. And we import that too. So that idea is out the window.

Getting back to the question of interest rates. With the caveat that we know nothing, we reckon Mr Steven’s will keep rates on hold, but then soften the market up for a June cut if conditions continue to weaken.

And of course a lot depends on China, our largest trading partner. The economy is clearly slowing as it attempts a precarious rebalancing act. Consensus opinion suggests China will handle the transition but we think something will go wrong.

Consider the currency, the yuan. It recently reached a record high against the US dollar, leading to speculation that China might move to let the yuan float freely. (The yuan currently trades in a loose peg to the dollar, managed by the People’s Bank of China).

Allowing the currency to strengthen would assist rebalancing by increasing domestic purchasing power relative to foreign goods. But it would also be a major blow for the manufacturing sector as Chinese exports become less competitive with a stronger currency.

A recent gauge of manufacturing in China showed slowing growth in the sector, reflecting weak demand in the developed world —  the traditional consumer of Chinese manufactured goods.

So weak demand combined with higher costs (should the yuan rise) would be a double blow for the Chinese economy. Could domestic demand make up for the manufacturing slowdown? Possibly.

But the real growth engine in China is credit fuelled infrastructure spending. It accounts for around half of all economic activity. Any slowdown in this area would need domestic demand to grow incredibly (and unrealistically) strongly just to keep the economy from slowing.

With the caveat (again) that we know nothing, we would still make a bet that China won’t be able to pull off this rebalancing without suffering a major growth slowdown. You’ll probably see evidence of this later in 2013.

Greg Canavan
for Markets and Money

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From the Archives…

The US Federal Reserve: What a Humiliating Failure!
3-05-13 – Bill Bonner

The End of the Road
2-05-13 – Bill Bonner

Why Apple’s Advantage is Gone
1-05-13 ­– Dan Denning

The Kamikaze Rally That Could Drive Stocks Higher
30-04-13 – Dan Denning

Australian Deficit: Where Did the Money Go?
29-04-13 – Dan Denning

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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