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

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.

Greg Canavan

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2 Comments on "Pinning the Tail on the Donkey in the Australian Economy"

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You know the old saying Greg, lies, damned lies, and statistics, interspersed with rubbery figures and behold, government facts. As for Mr Stevens and the decline in the economy, look to Europe where interest rates are at 0.5% and bank accounts are raided, now it seems a 70% raid is in the offing, beware the political animal, as they love precedents.
Everything here in blighty is going like an express train., backwards. We are in (semi official) a third recession, nee depression, and I can see what is happening in Aus is a mirror image.

The panda-huggers in Treasury would never be able to convince Beijing’s poodles in Canberra that China’s growth is coming to an end. The big thing they miss regarding China is the demographic effects. Recently in numerous publications it has been confirmed that China’s “working age population” has begun to decline, exactly at the same rate and time that the Brookings Institute forewarned in a demographic report on Chine in 2010. But then, the problem in Australia is that we are led by dashounds and cocker spaniels who are more inclined to lick boots in Beijing than examine reality. Treasury just… Read more »
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