Economy Archives - Page 60 of 134 - the patient investor

February 4, 2015

Goldman describes Australia’s lost decade | Macrobusiness

Posted by Houses and Holes. Reproduced with kind permission from Macrobusiness.

Goldman’s Tim Toohey has quantified the unwinding commodity super-cycle for ‘Straya’:

Lower commodity prices risk $0.5trn in forgone earnings
The outlook for revenues from Australian LNG and bulk commodities shipments – which account for almost half of total export earnings – has deteriorated significantly. To be clear, overall revenues are still forecast to increase substantially over the coming years – underpinned by a broadly unchanged strong outlook for physical shipments (particularly for LNG). However, in a nominal sense, the outlook is far less positive than before. This owes to a structurally weaker price environment, with GS downgrades of 18% to 25% to key long term price forecasts for LNG and bulk commodities suggesting that cumulative earnings over the years to 2025 are on track to be ~$0.5trn lower than previously forecast.

… and will erode Australia’s trade/fiscal positions
The deterioration in the earnings environment naturally has direct implications for Australia’s international trade and fiscal positions. On the former, a return to surplus by CY18 no longer looks feasible, and we now expect a deficit of ~$15bn. On the latter, relative to the 2014 Commonwealth Budget, we estimate that weaker commodity prices will cause a ~$40bn shortfall in tax revenues over the next four years. Given our expectation that Australia’s LNG sector will deliver no additional PRRT revenues over the coming decade, and the ~$18bn downgrade to commodity-related tax in the December MYEFO, we therefore see a risk of further material revenue downgrades at May’s 2015 Budget.

Resulting in changed GDP, RBA cash rate and FX forecasts
Although the commodity export changes mainly manifest through the nominal economy, there are significant impacts back through to the real economy. Lower export earnings result in lower profits, lower tax receipts, lower investment and lower employment. We continue to expect just 2.0% GDP growth in 2015 but have lowered our 2016 to 2018 real GDP forecasts by an average of 50ppts in each calendar year. As a consequence, we have moved forward the timing of the next RBA rate cut to May 2015, where we see the cash rate remaining at 2.0% until Q416, where we expect a 25bp hike. We now expect just 75bps of hikes in 2017 to 3.0% and rates on hold in 2018. Despite the recent move in the A$ towards our 75c 12 month target, the reassessment of the medium term forecast outlook argues for a new lower target 12 month target of 72c.

OK, that’s quite a piece of work and congratulations to Tim Toohey for getting so far ahead of pack. I have just two points to add.

The LNG forecasts look good but as gloomy as his iron ore outlook is, it is not gloomy enough. $40 is a more reasonable price projection for 2016-18 and we’ll only climb out of that very slowly. That makes the dollar and interest rate forecasts far too bullish and hawkish.

Second, even after these downgrades, Mr Toohey still has growth of 3.25% GDP penned in for 2016 and 3.5% for 2017. We’ll have strong net exports and is about it. With the capex unwind running right through both years, housing construction to stop adding to growth by next year, the car industry wind-down at the same time, political strife destroying the public infrastructure pipeline, the terms of trade crashing throughout and households battered half to death by all of it, those targets are of the stretch variety, to say the least.

The analysis is exceptional, The conclusions, sadly, overly optimistic.

February 1, 2015

An Unconventional Truth by Nouriel Roubini – Project Syndicate

Nouriel Roubini argues for increased infrastructure investment to accompany monetary easing, else the benefits of the latter will not last:

Simply put, we live in a world in which there is too much supply and too little demand. The result is persistent disinflationary, if not deflationary, pressure, despite aggressive monetary easing.

The inability of unconventional monetary policies to prevent outright deflation partly reflects the fact that such policies seek to weaken the currency, thereby improving net exports and increasing inflation. This, however, is a zero-sum game that merely exports deflation and recession to other economies.

Perhaps more important has been a profound mismatch with fiscal policy. To be effective, monetary stimulus needs to be accompanied by temporary fiscal stimulus, which is now lacking in all major economies. Indeed, the eurozone, the UK, the US, and Japan are all pursuing varying degrees of fiscal austerity and consolidation.

Even the International Monetary Fund has correctly pointed out that part of the solution for a world with too much supply and too little demand needs to be public investment in infrastructure, which is lacking – or crumbling – in most advanced economies and emerging markets (with the exception of China). With long-term interest rates close to zero in most advanced economies (and in some cases even negative), the case for infrastructure spending is indeed compelling. But a variety of political constraints – particularly the fact that fiscally strapped economies slash capital spending before cutting public-sector wages, subsidies, and other current spending – are holding back the needed infrastructure boom.

All of this adds up to a recipe for continued slow growth, secular stagnation, disinflation, and even deflation. That is why, in the absence of appropriate fiscal policies to address insufficient aggregate demand, unconventional monetary policies will remain a central feature of the macroeconomic landscape.

Again, I add the warning that infrastructure investment must be in productive assets, that generate market related returns. Otherwise we are merely swapping one set of problems (a shortfall in aggregate demand) for another: high public debt without the revenue to service or repay it.

February 1, 2015

Will the global economy follow Japan?| Michael Pettis’ CHINA FINANCIAL MARKETS

More from Michael Pettis on “Japanification” of the global economy. How abundant capital and investment in unproductive works may lead to long-term stagnation:

“Panics do not destroy capital,” John Mill proposed in his 1868 paper to the Manchester Statistical Society. “They merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.” Our ability to postpone the recognition of the full extent of these unproductive works depends in part on our ability to expand the supply of credible money. If we are constrained in our ability to expand the money supply, one impact of the crisis is a contraction in money (velocity collapses) that forces lenders to write down debt. If money can expand without constraints, however, debt does not have to be written down nearly as quickly.

With the main central banks of the world having banded together to issue unprecedented amounts of credible currency, in other words, we may have changed the dynamics of great global rebalancing crises. We may no longer have to forcibly write down “hopelessly unproductive works”, during which process the seemingly endless capital of the globalization phase is wiped out, and we enter into a phase in which capital is scarcer and must be allocated much more carefully and productively.

Instead, the historically unprecedented fact of our unlimited ability to issue a credible fiat currency allows us to postpone a quick and painful resolution of the debt burdens we have built up. It is too early to say whether this is a good thing or a bad thing. On the one hand, it may be that postponing a rapid resolution protects us from the most damaging consequences of a crisis, when slower growth and a rising debt burden reinforce each other, while giving us time to rebalance less painfully — the Great depression in the US showed us how damaging the process can be. On the other hand the failure to write down the debt quickly and forcefully may lock the world into decades of excess debt and “Japanification”. We may have traded, in other words, short, brutal adjustments for long periods of economic stagnation.

Investment in infrastructure is essential to rescue an economy from a contraction of aggregate demand following a financial crisis. The unpalatable alternative is a deflationary spiral and significant contraction in GDP. But we need to ensure that investment is made in productive assets — that generate market-related returns — rather than investments in social infrastructure that cannot generate sufficient revenue to service, nor be be sold to repay, debt funding.

February 1, 2015

Infrastructure opportunity | Michael Pettis’ CHINA FINANCIAL MARKETS

Interesting view from Michael Pettis:

Excess liquidity and risk appetite makes it easy to lock in cheap, long-term funding for investment projects. Countries that have weak infrastructure, or whose infrastructure is in serious need of improvement, have today an historical opportunity to build or replenish the value of their infrastructure with very cheap capital. This is truly the time for governments to identify their optimal infrastructure needs and to lock in the financing.

January 28, 2015

Crude still has further to fall

West Texas Crude has been falling since breaking support at $75/barrel, following through below $50/barrel. A test of 2009 lows at $30/barrel is likely unless there is major disruption to supply.

WTI Crude Monthly

When we adjust crude prices for inflation, they remain high by historical standards. Prior to the China boom of the early 2000s, the ratio of WTI Crude to CPI had seldom ventured above $20/barrel when measured in 1982-1984 dollars (shown as 0.2 on the chart below). After the dramatic fall of the last 3 months, the adjusted price at the end of December 2014 (in 1982-1984 dollars) is still $25.20/barrel (0.252 on the chart) — well above the former high.

WTI Crude adjusted for inflation

December 23, 2014

Gold and Inflation

The Dollar Index is testing long-term highs at 90. Breakout is likely and would suggest a strong bull trend.

Dollar Index

One reason is falling inflation expectations, with the Breakeven Rate (5-year Treasury yield minus equivalent TIPS yield) testing its 5-year low. Further falls would increase pressure on the Fed to raise interest rates.

Breakeven Rate

A strong Dollar and low inflation both weaken gold prices. Declining 13-week Twiggs Momentum, below zero, suggests a strong down-trend. Follow-through below $1180/ounce would confirm this.

ASX 200 daily

December 8, 2014

Murray has endorsed macroprudential | Macrobusiness.com.au

Posted by Houses and Holes
At 12:52pm on December 8, 2014
Published with permission from Macrobusiness.com.au.

From Callam Pickering:

The one glaring problem with the Financial System Inquiry is that it didn’t push hard for the introduction of macroprudential policies. That takes the heat off both the RBA and APRA.

The truth is that higher capital requirements — combined with higher risk weighting on mortgages and tax reform — would have a similar (potentially larger) effect as macroprudential policies. In the long term financial system and tax reform is clearly the better approach to creating an efficient and sustainable housing and financial sector, but these reforms will take longer to implement.

That’s right. Murray’s principle recommendations are macroprudential. APRA is now free (and is being urged) to implement higher capital requirements. They do not require anything from government to go ahead. This is basically the model of MP envisaged by Prof Ross Garnaut.

A more interesting question is whether or not APRA will still act on specific areas of risk such as interest-only loans. These are a menace, as the US bust showed, and are surging. Murray did not mention them, being too granular, but said the following on MP more particularly:

The global financial crisis (GFC) prompted policy makers and regulators around the world to reconsider their approach to maintaining financial stability. Some countries at the epicentre of the crisis have since expanded their prudential perimeters and adopted more formal and centralised institutional arrangements. This includes establishing single entities with responsibility for macro-prudential regulation. Australia has long adopted what could be called a ‘macro-prudential’ approach to supervision under the rubric of financial stability. Yet, Australia’s institutional structure is relatively informal and decentralised. The Reserve Bank of Australia (RBA) and APRA each have responsibility for financial stability. However, most macro-prudential tools can only be deployed by APRA. This places a strong premium on cooperation between the two agencies.

Against the background of developments overseas, the Inquiry has considered whether Australia should change its institutional arrangements for making and implementing financial stability policy.

However, the Inquiry does not see a strong case for change in this area. Although approach has advantages and disadvantages, alternative institutional approaches are yet to be tested — as indeed is the effectiveness of many macro-prudential tools. For this reason, the Inquiry recommends no fundamental change to the current institutional arrangements for financial stability policy and no change to the prudential perimeter at this time.

That is neither here nor there and APRA will still be free to raise capital requirements for specific loans if it sees fit.

December 8, 2014

Economics is just politics masquerading as science | Pragmatic Capitalism

From Cullen Roche:

….much of economics is just politics masquerading as science

In an earlier blog, Roche discusses the reasons for this (emphasis added):

Most of economics involves conforming a political bias with a world view. For instance, most Keynesians start with government spending and taxing, how those government policies can influence the economy and then interpret a “model” in such a way that confirms their political bias. Monetarists start with the central bank and interpret a more laissez-faire view of a “model” to interpret how policy can impact the economy. Austrians start with the private sector and build a “model” that seeks to eliminate government. So on and so forth. Every “school” of economics has a very specific ideology and the political lines are very clearly drawn. This doesn’t even approach “science”. It’s more like religion.

If economics were more of a science it would start with stylized fact. It would start purely with how the system works and how it functions at the operational level instead of looking at how a certain political entity can use certain policies to conform to a particular world view.

Why did most economists fail to predict the crisis or prescribe the right cures? Because they’re not working from the foundation of stylized fact. They’re working from a policy bias position that renders their world view inapplicable much of the time.

So, what is economics good for? Unfortunately, not very much given that so much of it is really just a policy debate masquerading as a scientific debate. And until we start getting more scientific, like say, trying to figure out how key institutions (like banks) in our monetary system operate, then we’re just chasing our own tails thinking that economics is useful.

Read more at Economists are Politically Biased and That’s a Good Thing | Pragmatic Capitalism.

December 8, 2014

Australian banks rally on Murray Report

The ASX 200 Financial sector (ex-REITs) responded well to release of David Murray’s report into the financial services industry. As the largest constituent of the ASX 200 index, comprising more than one-third of market capitalization, sector performance is critical in determining future direction of the broader index. Breach of resistance at 7220 suggests that the correction is over. Follow-through above 7400 would confirm a fresh primary advance.

ASX 200 Financial ex Property

David Murray’s Financial System Inquiry

The Final Report of the Financial System Inquiry, led by ex-Commonwealth Bank CEO David Murray, calls on Australian banks to become “unquestionably strong” to prevent another financial crisis. The FSI calls for increased bank capital in the form of common equity, with capital ratios increasing from an average of 9.1% to the 12.2% threshold for the top quartile of international banks. The FSI also proposes that banks increase their average risk-weighting for home mortgages to 25-30% compared to current weightings as low as 15%.

Chris Joye from the AFR estimates that the first proposal would require about $21 billion in new capital, while increased risk-weighting would require an additional $15 billion. There may be some overlap between the two, but the combined requirement is likely to be more that $30 billion.

Impact on consumers is likely to be negligible. The FSI projects that a 1% increase in bank capital ratios would increase the weighted cost of capital by 6 basis points (0.06%) because of the higher cost of equity capital.

Bank Funding Costs with Increased Capital

But this does not take account of lower risk premiums required, for debt and equity, when capital is increased. A reduction of debt funding costs to 3.65% and equity to 14.75% would offset the increase in equity capital; so the actual cost increase may be considerably smaller.

A resilient banking system would not only avoid significant losses of GDP (as high as 158 percent) in the event of a financial crisis, but would save up to 900,000 jobs according to the FSI. In addition, reduced risk of a government bailout would minimize the threat to government debt levels and Australia’s AAA credit rating. Banks would also benefit through improved profitability and stronger growth prospects.

My concerns with FSI are mainly long-term. Raising capital ratios to the top quartile of international banks would certainly improve the resilience of Australian banks, but this is a moving target. We can expect average capital held by international banks to increase as other countries conduct their own reviews into the adequacy of bank funding. Also, leverage ratios (ignoring risk-weighting) remain low and should be progressively lifted towards a long-term goal of 6 to 8 percent. Reliance solely on risk-weighted capital ratios can encourage industry-wide concentration in low-risk-weighted assets which in turn will elevate risk. Lastly, bail-in bonds are dangerous — any attempt at conversion would destroy creditor confidence in the banking system with far-reaching repercussions — and should be discouraged.

I believe that stronger capital ratios are a win for both Australian taxpayers and bank shareholders. Implementation of the FSI recommendations would be a major advance towards building a resilient and sustainable banking sector.

December 7, 2014

A long-term view

Better than expected US jobs data and strong German factory orders helped to rally markets Friday. Also, ECB chief Mario Draghi’s Thursday announcement is seen as supporting broad-based asset purchases (QE) early in 2015. A long-term view of major markets may help to place current activity in perspective.

The S&P 500 continues a strong advance, with rising 13-week Twiggs Money Flow indicating medium-term buying pressure. Long-term and medium targets coincide at 2250* and we should expect further resistance at this level.

S&P 500 Index

* Target calculation: 1500 + ( 1500 – 750 ) = 2250; 2050 + ( 2050 – 1850 ) = 2250

CBOE Volatility Index (VIX) continues to indicate low risk typical of a bull market.

S&P 500 VIX

Germany’s DAX broke resistance at its earlier high of 10000, suggesting a further advance. Recovery of 13-week Twiggs Momentum above zero indicates continuation of the up-trend. The long-term target is 12500*, though I cannot see this being reached until tensions in Eastern Europe are resolved.

DAX

* Target calculation: 7500 + ( 7500 – 2500 ) = 12500

The Footsie is testing long-term resistance at 6900/7000. Respect of the zero line by 13-Week Twiggs Money Flow indicates long-term buying pressure. Breakout above 7000 would signal a fresh primary advance, with a long-term target of 10500*.

FTSE 100

* Target calculation: 7000 + ( 7000 – 3500 ) = 10500

China’s Shanghai Composite Index broke resistance at 2500 and is likely to test the 2009 high at 3500. Rising 13-week Twiggs Money Flow indicates strong (medium-term) buying pressure.

Shanghai Composite Index

Japan’s Nikkei 225 Index is testing resistance at its 2007 high of 18000. 13-Week Twiggs Money Flow respecting the zero line indicates long-term buying pressure. Breakout would signal another primary advance. A long-term target of 28000* seems unachievable unless one factors in rising inflation and continued devaluation of the yen.

Nikkei 225 Index

* Target calculation: 18000 + ( 18000 – 8000 ) = 28000

Weak ASX 200 performance is highlighted by the distance below its 2007 high of 6850. Falling commodity prices have retarded the recovery and are likely to continue for some time ahead.

The 2005-2008 Australian commodities boom was squandered, damaging local industry and hampering the current recovery. Norway successfully weathered a similar commodities boom in the 1990s, protecting local industry while establishing a sovereign wealth fund that is the envy of its peers. Their fiscal discipline set a precedent which should be followed by any resource-rich country looking to navigate a sustainable path through a commodities boom and avoid the dreaded “Dutch Disease”.

Respect of support at 5000 would indicate the primary up-trend is intact — but declining 13-week Twiggs Money Flow indicates selling pressure. Reversal of TMF below zero or breach of support at 5000/5150 would warn of a down-trend.

ASX 200

* Target calculation: 5000 + ( 5000 – 4000 ) = 6000

The daily chart shows a slightly improved perspective. 21-Day Twiggs Money Flow oscillating around zero signals indecision. Recovery above 5400 would suggest the correction is over. But reversal below 5200 is as likely and would warn of a test of primary support at 5120/5150.

ASX 200 daily