Westpac: RBA Statement on Monetary Policy

It appears that the objective of this Statement is to emphasise that without a significant deterioration in global financial conditions policy should remain unchanged. When you assess the various pieces of the Bank’s description of the domestic economy – weak employment; rising unemployment rate; subdued retail spending; soft housing market; below trend growth outside mining; scaling back of public investment; building construction subdued; inflation to remain around the mid-point of the target range; policy at neutral, not stimulatory – we see a fairly clear case for policy to move into the stimulatory zone immediately. Of course our forecasts as contrasted with the Bank’s forecasts clearly suggest that the qualitative descriptions provided in this statement are understating the need for a policy response.

It has been and remains our view that a further 50bps in policy easing can be justified immediately although our forecast is that this adjustment is likely to occur over a three to four month period. We find the use of the requirement that demand conditions need to weaken materially before a rate cut can be delivered overly conservative and expect that the Bank’s policy will change more rapidly than we assess is their current intention.

Consequently at this stage we maintain our view that the next rate cut in this cycle can be expected in March to be followed by a move in May but recognise that we are currently dealing with a central bank that while acknowledging all the reasons policy needs to be stimulatory appears to have no immediate intention to move.

Bill Evans
Chief Economist

New Economic Perspectives: Banks Weren’t Meant to Be Like This. What Will their Future Be – and What is the Government’s Proper Financial Role?

So we are brought back to the question of what the proper role of banks should be. This issue was discussed exhaustively prior to World War I………

It was above all in Germany that long-term financing found its expression in the Reichsbank and other large industrial banks as part of the “holy trinity” of banking, industry and government planning under Bismarck’s “state socialism.” German banks made a virtue of necessity. British banks “derived the greater part of their funds from the depositors,” and steered these savings and business deposits into mercantile trade financing. This forced domestic firms to finance most new investment out of their own earnings. By contrast, Germany’s “lack of capital … forced industry to turn to the banks for assistance,” noted the financial historian George Edwards. “A considerable proportion of the funds of the German banks came not from the deposits of customers but from the capital subscribed by the proprietors themselves.[3] As a result, German banks “stressed investment operations and were formed not so much for receiving deposits and granting loans but rather for supplying the investment requirements of industry.”

via New Economic Perspectives: Banks Weren’t Meant to Be Like This. What Will their Future Be – and What is the Government’s Proper Financial Role?.

Comment:~ The author contrasts the short-term focus of modern banks with the long-term outlook of the early German banking system which was largely equity-funded, rather than deposit-based. The question is: could we ever successfully return to such a system?

Living In A QE World | Jim Bianco

Central banks are ruling markets to a degree this generation has not seen. Collectively they are printing money to a degree never seen in human history.

So how does this process get reversed? How do central banks pull back trillions of dollars of money printing without throwing markets into a tailspin? Frankly, no one knows, least of all central banks as they continue to make new money printing records.

…..When/If these central banks go too far, as was eventually the case with home prices, expanding balance sheets will no longer be looked upon in a positive light. Instead they will be viewed in the same light as CDOs backed by sub-prime mortgages were when home prices were falling. The heads of these central banks will no longer be put on a pedestal but looked upon as eight Alan Greenspans that caused a financial crisis.

via Living In A QE World | The Big Picture.

The winners and losers of QE3 – macrobusiness.com.au

The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.

That’s a clear declaration of intended QE3 if conditions are met. The two conditions are price stability and inadequate employment growth. Price stability now has a number with the Fed also announcing a new inflation target of 2%. Anything under that number potentially triggers QE3.

via The winners and losers of QE3 – macrobusiness.com.au | macrobusiness.com.au.

King Says BOE Ready to Act – WSJ.com

[BOE Governor Mervyn King] kept the door open for more stimulus in his speech Tuesday. “With inflation falling back and wage growth subdued, there is scope for interest rates to remain low and, if necessary, for further asset purchases, to prevent inflation falling below the 2% target,” he said. The annual rate of inflation in the U.K. dipped to 4.2% in December from 4.8% a month earlier, and is expected to slow sharply this year.

via King Says BOE Ready to Act – WSJ.com.

Banks Point to a Pickup in Lending – WSJ.com

At Citi, retail-banking loans rose 15% from a year ago to $133 billion, as the New York bank lent more to individuals and local businesses. At San Francisco-based Wells, commercial and industrial loans rose 11% from a year earlier to $167 billion at Dec. 31, amid what Chief Financial Officer Tim Sloan called broad-based growth.

All told, loans outstanding at the companies and J.P. Morgan rose by $41 billion from a year ago in the fourth quarter, to $2.14 trillion. That’s the first increase for the three giant lenders since 2008…

via Banks Point to a Pickup in Lending – WSJ.com.

Comment: ~ Private sector deleveraging is slowing and new capital investment improving, but this may prove a temporary respite as purchases were brought forward to take advantage of accelerated tax depreciation in 2011. The 100% write-off of new capital investment (in the year of purchase) will expire in 2012 if not extended by Congress.

Nouriel Roubini’s Global EconoMonitor » The Straits of America

Given the bearish outlook for US economic growth, the Fed can be expected to engage in another round of quantitative easing. But the Fed also faces political constraints, and will do too little, and move too late, to help the economy significantly. Moreover, a vocal minority on the Fed’s rate-setting Federal Open Market Committee is against further easing. In any case, monetary policy cannot address only liquidity problems – and banks are flush with excess reserves.

Most importantly, the US – and many other advanced economies – remains in the early stages of a deleveraging cycle. A recession caused by too much debt and leverage (first in the private sector, and then on public balance sheets) will require a long period of spending less and saving more. This year will be no different, as public-sector deleveraging has barely started.

via EconoMonitor : Nouriel Roubini’s Global EconoMonitor » The Straits of America.

Mega-trends and their impact in 2012

To arrive at an outlook for the year ahead we first need to analyze the big trends that endure for decades and in some cases even longer.

Population growth and food resources

The number one dynamic over the last century has been the exponential rise in global population. It took 123 years for the world population to grow from 1 to 2 billion (by 1927) and only 12 years to grow from 5 to 6 billion (by 1999). Growth, however, is now slowing and we are predicted to rise from the current 7 billion to a peak of 9 billion in the 2050s.

At the same time we are faced with increasing scarcity of food and water. Advances in technology have improved crop yields, but increased meat consumption in China and other Asian economies will reduce overall output. The area of land required to produce an equivalent amount of edible protein from livestock is 4 to 5 times higher compared to traditional grains and legumes, and up to 10 times higher for beef. Diversion of land use for ethanol production will also restrict food output.

Global warming, whether man-made or a natural cycle, may also contribute to declining food production — through droughts, floods and depleting fish stocks.

Depleting natural resources

We are also depleting global deposits of ferrous- and non-ferrous ores — as well as energy reserves of crude oil and coal — as global industrialization accelerates. Commodity costs can be expected to rise as readily available resources are depleted and we are forced to dig deeper and endure harsher conditions in order to access fresh deposits. Deep water ocean-drilling and exploration within the Arctic and Antarctic circles are likely to increase.

As energy resources are depleted, nuclear energy production is likely to expand despite current safety concerns. Development of technologies such as thorium fluoride reactors hold out some hope of safer nuclear options, but these may be some way off. Wind and solar energy are likely to remain on the fringe until technology develops to the point where they are cost effective compared to alternative sources.

Global competition

Competition for scarce resources will increase tensions between major economic players, with each attempting to expand their sphere of influence — and secure their sources of supply. The Middle East, Africa, South America, Australia, Mongolia and the former USSR are all potential targets because of their rich resource base.

Trade wars

In addition to competition for scarce resources, we are also likely to see increased competition for international trade. Resistance to further currency manipulation — initiated by Japan in the 1980s and perpetuated by China in the last decade — is likely to rise. US Treasury holdings by China and Japan currently sit at more than $2.3 Trillion, the inflows on capital account being used to offset outflows on current account and maintain a competitive trade advantage by suppressing their exchange rate.

Rise of democracy

Another factor contributing to instability is the rise of democracy in some parts of the world. The Arab Spring is still in its infancy, but the development has no doubt caused concern amongst autocratic governments around the globe. Food shortages and rising global prices will act as a catalyst. The likely result is increased suppression in some autocracies and a rapid transition to democracy in others, like Myanmar. But the transition to democracy is never smooth — especially in countries with clear fault lines, such as language, religious, racial or cultural differences — and can lead to decades of conflict before some degree of stability is achieved.

Decay of Democracy

On the other hand we are witnessing the decay of long-standing, mature Western democracies. Undue influence exerted by special interest groups with large cash resources — such as banks, big oil, and armaments manufacturers — force politicians to serve not only their electorate but their financial sponsors. Aging populations pose a new threat: large voting blocs who are not participants in the economic workforce will wield increasing influence over distribution of social welfare payments such as Medicare and Pensions. And politicians are increasingly guilty of over-spending, running up public debt and debasing currencies, in their attempt to keep voters happy and secure re-election.

The long term hope is that we evolve a more consensus-based form of democracy, along the lines of the Swiss model, and away from the excesses of the current winner-takes-all system.

Global debt binge

The decay in Western democracy resulted in a massive debt binge over the last 3 decades, with private debt often growing at double-figure rates, accompanied by burgeoning public debt levels. The massive debt bubble far outstripped GDP growth, effectively debasing currencies and causing soaring inflation of consumer and asset (housing and stock) prices. The GFC marked the peak of the debt expansion and was followed rapid contraction as the private sector diverted income to repay debt. Debt contraction is catastrophic, however, and can cause GDP to fall by up to 25 percent as in the Great Depression of the 1930s.

The response has been a massive expansion of public debt as governments run deficits in order to offset the private debt contraction. Overall debt levels hardly faltered as government spending programs filled the hole left by private debt contraction. While this succeeded in plugging the gap, many Western governments are left with huge public debt and increasingly nervous bond markets.

Central banks such as the Fed and BOE stepped into the breach, purchasing government bonds with newly-created money. Apart from putting gold performance on steroids, central bank asset purchases had little impact on inflation because the effect was offset by the deflationary debt contraction. But cessation of the debt contraction would let the genie out of the bottle.

Outlook for 2012

Here is how I believe these big trends will impact on 2012. I do not claim to have a crystal ball and it may be amusing to review these predictions at the end of the year:

  • Further debt contraction
    Contraction of private debt and constraints on government borrowing will strengthen deflationary forces.
  • Further QE
    The Fed and BOE are likely to expand their balance sheets to support public borrowing. The ECB may make a limited response because of constraints imposed by member states such as Germany.
  • Low inflation
    Deflationary forces will outweigh the inflationary effect of QE by central banks.
  • Low global growth
    Debt contraction and a euro-zone banking crisis will ensure low growth.
  • Euro-zone banking crisis will require further bank rescues
    Placing further stress on public debt levels, and pressure on the ECB to act.
  • China “soft” landing
    A second massive stimulus focused on low-cost housing and quelling social unrest will restore economic activity, but export markets will remain flat and the banking sector inundated with non-performing loans.
  • Easing of commodity prices slows
    Massive stimulus from China will support commodity prices.
  • Further social unrest amongst autocratic regimes
    The Arab Spring will continue sporadically across a far wider area.
  • Crude oil prices remain high, aided by further conflict
    High crude prices will also contribute to low growth.
  • US current account deficit shrinks as yuan rises
    Increased pressure from the US will prevent China from expanding its Treasury investments causing the yuan to strengthen against the dollar.
  • Dollar strengthens against euro
    A euro-zone banking crisis will ensure that the dollar preserves its safe-haven status.
  • Gold bull-trend when QE resumes
    Resumption of QE by the Fed would ensure that gold resumes its bull-trend against the dollar.

I wish you peace and prosperity in the year ahead but, most of all, the good health to enjoy it.

Regards,
Colin Twiggs