The “old normal” is back. But the new normal is coming. And in the meantime, gold is on the move. What does it all mean?
The “old normal” is the way things were before they fall apart. Nearly everyone would like to believe that nothing has changed all that much since September of 2007. Sure, there was a massive stock market crash and a serious blow to confidence in the global financial system. But all of that is ancient history!
In the “old normal” view – preached by politicians left and right and amplified by a compliant media and a smarting financial industry – you should go back to doing what you were doing before. Have a short memory. Buy stocks automatically because they always go up. Get a mortgage and buy a house, perhaps even a second one. Spend money. The government will make more.
There are some key problems with the old normal. These problems were exposed in the last two years. But they are being swept under the proverbial rug of rising stock prices. Those problems include too much household debt, unaffordable house prices, and an entire economy geared to consumption over production.
But all that is changing, says Bill Gross of PIMCO. In his latest note to clients, Gross says we have entered a world of slower growth. This makes sense to us, given what we said earlier this week. The growth in the world’s GDP over the last twenty years has been boosted by cheap credit and cheap energy.
Those two forces accelerated the depletion of natural resources. And with cheap credit anyway, you saw the birth of securitisation and dervitisation, in which bundles of debts became tradeable assets, sold to investors by Wall Street firms (which then loaded up on these assets relative to equity with leverage, sowing the seeds of their own share price demise).
Gross says we are entering the era of DDR – deleveraging, deglobalisation, and re-regulation. He writes that, “All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognize that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years.”
“We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.”
If Gross is right, what does this mean for Australians? For starters, there is the danger that growing government deficits could push up interest rates. If Gross is right, larger government deficits could become a staple feature of the economy. If the Australian government insists on maintaining its stimulus measures, we’re pretty sure it will push interest rates up.
Treasury Secretary Ken Henry disagrees, probably. In a recent speech, Henry said that even though global capital flows between developing and industrialised countries were rebalancing in favour of the developing world, Australia might see a net increase in capital flows because it’s such a nice place to invest in. If that were the case, interest rates would remain low as global capital poured into Aussie assets, including the dollar and all that debt being sold by the Australian Office of Financial Management.
Maybe the Secretary is right. But yesterday’s trade figures would give us a bit of fright. Australia reported a$1.55 billion goods and services deficit in July. It was the highest deficit in the last 14 months and nearly three times the size of the June figure. But what does it really mean?
Well, it means the government stimulus kept people spending, whether it was good for them or not. This led to a 4% increase in imports and a decline in exports (in both volumes and dollar figures). There were two interesting nuggets in the data one big takeaway.
The first nugget is that capital goods imports were up by 5%. This isn’t a bad thing. If you can turn new capital goods into new production and profits and employment, it’s actually pretty good, although it does contribute to the deficit. The second nugget is that petroleum products imports were up by 21%.
Australia is well on its way to becoming a chronic net importer of refined fuels. When you couple this with declining domestic oil production, you get a country that is highly dependent on oil imports, which is not a good place to be. Here’s a thought: why not convert Aussie cars to LPG and use some of that massive new gas from Gorgon to power Aussie cars for the next 50 years?
The big takeaway is that the economy is achieving growth in the same “old normal” way, with consumer spending on imports exceeding the volume and value of Australia’s mineral and metal exports. It’s astounding. The “old normal” way of thinking is still firmly in place.
Gross says that, “Our world, and the world’s world, is changing significantly, leading to slower growth accompanied by a redefined public/private partnership.” But he points out that the slower growth might be better for some countries than others. Gross reached five “strategic conclusions” which you’ll find below.
- Global policy rates will remain low for extended periods of time.
- The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally.
- Investors should continue to anticipate and, if necessary, shake hands with government policies, utilizing leverage and/or guarantees to their benefit.
- Asia and Asian-connected economies (Australia, Brazil) will dominate future global growth.
- The [U.S.] dollar is vulnerable on a long-term basis.
There is some good news and some bad news in those conclusions for Australia. The good news? Gross reckons Asia-connected commodity producers are going to benefit from “future growth.” And the bad news?
We reckon there will be an interval between the old normal and the new normal. Call it the “new bad,” after the first bad of the last eighteen months. This “new bad” will see a second round of falling asset prices and lower growth as government stimulus plans falter and companies and households are forced to engage in more re-balancing of the balance sheet. And frankly, it looks like it’s starting this month.
Gold moved back up near US$1,000 overnight. This is one indication that risk-averse assets might start getting a bid again in the “new bad.” And we might even see another strange period of U.S. dollar strength on deep pessimism about global growth. But that is far too complicated to explain in the little space that’s left this Friday. So we’ll leave it to Monday! Until then…
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