Tuesday, October 27, 2009

Smart Drugs

Seeing as it's exam time, I'm keen to know whether these smart drugs have made it to Australia, or at least Brisbane.

See the Freaknonomics Blog
Adderall Speculation

By Daniel Hamermesh

Students apparently consume mass quantities of the performance-enhancing drug Adderall during exam time. Normally the price is $3 for 10 mg, but it rises during exam week to at least $5.
One student reports that in his suburban Dallas hometown, drug dealers, realizing this price variation, speculated by buying up large supplies of the drug at $3 and dumping them on the market during exam time, hoping to sell at $5.
They didn’t realize that this large increase in supply would cause the price to drop below $5. Indeed, so many dealers engaged in speculation that there was a surplus at the usual equilibrium price of $3. Students were able to buy the drug for only $2 as dealers sold off their excess supply. One imagines that the dealers were less enthusiastic about speculation the next year and that the exam-week price stayed above $3. (HT: AM)

Paul Krugman on the Yuan/Renminbi Dilemma

Krugman's blog is one of the best in the business.
How does he find the time?
What’s in a name?

Since I wrote about China’s currency in today’s column, I had to confront the issue of what to call the darn thing. In fact, I sometimes think that the whole renminbi/yuan issue is a sinister plot by the Chinese designed specifically to deter people from discussing Chinese currency policy. (Note to literalist readers: that’s a joke).
So: renminbi is the name of China’s currency; but yuan is the denomination of bills, the unit in which prices are measured, etc.. The closest parallel I can think of is Britain’s currency, which is sterling, but whose unit is the pound.
In the case of Britain, however, everyone is easy on talking about the pound’s value, the pound’s exchange rate, and so on; if you talk about sterling’s value, most non-Britons will have no idea what you’re talking about. But for whatever reason, using yuan in the same way draws disapproval.
But here’s the thing: talking about the number of renminbi per dollar is also, as I understand it, wrong — as wrong as talking about the number of sterling per dollar. Renminbi is the currency, but not a unit of the currency.
The Times stylebook recommends … evasion — try to avoid using either term, and just talk about “Chinese currency”. I get the motivation, but you end up going through a lot of circumlocutions and eating up crucial page space.
So I did what I could …

Monday, October 26, 2009

China and America

A new report from The Economist on US-China relations.

A special report on China and America
A wary respect
Oct 22nd 2009
From The Economist print edition

Miles argues:
The financial crisis has sharpened fears of what Americans often see as another potential threat. China has become the world’s biggest lender to America through its purchase of American Treasury securities, which in theory would allow it to wreck the American economy. These fears ignore the value-destroying (and, for China’s leaders, politically hugely embarrassing) effect that a sell-off of American debt would have on China’s dollar reserves. This special report will explain why China will continue to lend to America, and why the yuan is unlikely to become a reserve currency soon.
Who has the power in this situation, the country that borrows or the country that lends. Most would argue that it is the lender, but when the lender has to keep on lending becaus eof US structural power, then it is not so clear cut. We will also find out over the next few years just how much the lender (China) is dependent on the borrower's (the United States) markets.
The economic crisis briefly slowed the rapid growth, from a small base, of China’s outbound direct investment. Stephen Green of Standard Chartered predicts that this year it could reach about the same level as in 2008 (nearly $56 billion, which was more than twice as much as the year before). Some Americans worry about China’s FDI, just as they once mistakenly did about Japan’s buying sprees, but many will welcome the stability and employment that it provides.
The rest of the world is going to have to get used to Chinese investment, just like they had to get used to Japanese investment in the 1980s. But this doesn't mean that countries like Australia shouldn't continue to review strategic investment by the Chinese state. Anything less would be against Australia's national interest!!

China may have growing financial muscle, but it still lags far behind as a technological innovator and creator of global brands. This special report will argue that the United States may have to get used to a bigger Chinese presence on its own soil, including some of its most hallowed turf, such as the car industry. A Chinese man may even get to the moon before another American. But talk of a G2 is highly misleading. By any measure, China’s power is still dwarfed by America’s.
Authoritarian though China remains, the two countries’ economic philosophies are much closer than they used to be. As Yan Xuetong of Tsinghua University puts it, socialism with Chinese characteristics (as the Chinese call their brand of communism) is looking increasingly like capitalism with American characteristics. In Mr Yan’s view, China’s and America’s common interest in dealing with the financial crisis will draw them closer together strategically too. Global economic integration, he argues with a hint of resentment, has made China “more willing than before to accept America’s dominance”.
The China that many American business and political leaders see is one that appears to support the status quo and is keen to engage peacefully with the outside world. But there is another side to the country. Nationalism is a powerful, growing and potentially disruptive force. Many Chinese—even among those who were educated in America—are suspicious of American intentions and resentful of American power. They are easily persuaded that the West, led by the United States, wants to block China’s rise.
All good points and there is no doubt that it is this relationship that will largely shape the next 20 years.

For a good short review of recent books on US foreign policy see Amy Chua "Where Is U.S. Foreign Policy Headed?"

One book I want to read is by Andrew Bacevic.
Andrew Bacevich’s searing manifesto, “The Limits of Power: The End of American Exceptionalism.” Excoriating American profligacy and delusions of military invincibility, Bacevich calls for a foreign policy rooted in humility and realism. One of Bacevich’s most interesting arguments is that the astronomical costs of the Iraq war — not just unregulated hedge funds and subprime mortgages — contributed directly to the 2008 financial collapse. By 2007, he writes, “the U.S. command in Baghdad was burning through $3 billion per week. That same year, the overall costs of the Iraq war topped the $500 billion mark.” Nor does Bacevich go easy on the Obama administration. He describes Barack Obama’s national security team as “establishment figures, utterly conventional in their outlook.” He sees Obama’s stimulus package and commitment of more troops to Afghanistan as ominous signs of continuing “self-destructive behavior.”

Bacevich, a harsh critic of neoconservatives like Kagan, also favors a return to cold war policies, but in his case to a strategy of “containment.” Bacevich urges the United States to “let Islam be Islam. In the end, Muslims will have to discover for themselves the shortcomings of political Islam, much as Russians discovered the defects of Marxist-Leninism.”

Friday, October 23, 2009

China and India at the End of the Rainbow

Two contributions to the long-tern economic policy debate in the last week are must reads for those interested in Australia’s political economy. The first contribution came from Treasury Secretary Ken Henry and the second from BHP Billiton Chairman Don Argus.

The first from Henry, The Shape of Things to Come: Long Run Forces Affecting the Australian Economy in Coming Decades provides a wide-ranging contribution on Australia’s future. Henry discusses (1) population ageing; (2) climate change adaptation and the prospect of climate change mitigation; (3) the information and communications technology revolution; and (4) the impact on Australia's terms-of-trade of the re-emergence, as global economic powers, of China and India.

No one could accuse our key economic policy figures Henry, Stevens, Rudd and Swan of not being big thinkers (and with the exception of Swan all have a fairly high opinion of their own brilliance).

Henry’s mid-week comment to a Senate estimates hearing received many headlines.

It now appears the impact of the global financial crisis on the Chinese economy and the Indian economy hasn't been nearly as large as many feared … It seems that's likely to support relatively high commodity prices, that is prices for Australian export commodities, for a considerable period of time, quite possibly for some decades.
The second from Argus mulled over China’s foreign investment in Australia. Like many people Argus is worried about the Chinese state’s ownership of what he calls our “endowment assets”. I’ve tried to find a transcript but there’s not one available yet although audio is available. Barry Fitzgerald and Mathew Murphy report on the speech in The Age

“Mr Argus suggested at the Melbourne Mining Club luncheon that one response from the Federal Government could be to allow foreigners to acquire ''green fields'' or early stage resource projects, but only on the basis that half of the project is floated off to Australian investors, say, 15 years later.
Mr Argus has long raised concerns about the lack of policy on the ability of state-owned enterprises and sovereign wealth funds to buy up the resource endowment of a host nation without there being reciprocal investment rights. His 50 per cent, 15-year suggestion is his ''lateral'' response.
''We can't get complacent from a competitive point of view because we have had a good run with China,'' Mr Argus said. ''China is now going out and branching out to try and lock in resources themselves.'' He emphasised that he was not anti-Chinese investment or anti-foreign investment ''because Australia does need foreign investment''.
But he does not want Australia to end up like Canada, where foreigners have replaced local owners of the resources industry. ''Canadian investors certainly don't have the same holdings in their endowment assets that they might have had 10 years ago,'' he said.
As far as I know the Australian mining industry is already majority foreign owned, but it’s likely, as Argus suggests, to get even more so in the future without a strategic approach from Australia’s policy-makers.

Ultimately, what matters is that the benefits of Australia’s resources go to their owners – the Australian people, with obviously suitable compensation for those risking their capital and using their endeavour. Australians should be wary about the need to always act quickly to ensure continuing investment. I for one think the Foreign Investment Review Board provides for necessary review of important investment issues for Australia’s future. Let’s not forget that China does not believe in open slather in its own industries, particularly in its mining sector. The argument that Chian will be offended by a strategic approach is laughable. Indeed, anything but a strategic, discriminating approach is likely to invoke derision amongst Chinese authorities.

The thing that interests me most in both posts, however, is the unflinching assumption that China’s growth will necessarily continue onwards and upwards, seemingly without any faltering at all. Over the medium term, there is indeed much to be confident about. China and India have huge growth potential and both, while having grown significantly in recent years are still poor countries (their GDP per capitas are very low).

The major issue is whether commodity prices will stay high or whether they will revert to the long-term trend decline that has been going on for the last 150 years. (For weights see The Economist and here)

It’s possible that China and India’s rise will reverse this trend for the foreseeable future. But even if Asia continues to expand without major reversals or periods of stagnation, it’s likely that resource prices will decline as their supply increases. And it’s possible that technological change will undermine demand as happened to Australian’s pre-eminent export until the 1950s – wool. One only has to think about the impact of the Internet and mobile phones to realise how technology came change the game very quickly indeed. Mobiles in particular have changed communication in countries without the old telephone infrastructure in ways that was impossible to imagine even a few years ago.

There is also the problem of climate change that may make even more urgent the need to find replacement technolgies for resource intensive development.

For some more coverage on Henry's optimism in comparison to the pessimism of Ross Garnaut see Tim Colebatch "Balance of Power".

Wednesday, October 21, 2009

China, Japan and the United States

Though recent wild currency swings could delay the reckoning, many economists expect Japan to cede its rank as the world’s second-largest economy sometime next year, as much as five years earlier than previously forecast.
At stake are more than regional bragging rights: the reversal of fortune will bring an end to a global economic order that has prevailed for 40 years, with ramifications across arenas from trade and diplomacy to, potentially, military power.
China’s rise could accelerate Japan’s economic decline as it captures Japanese export markets, and as Japan’s crushing national debt increases and its aging population grows less and less productive — producing a downward spiral.
“It’s beyond my imagination how far Japan will fall in the world economy in 10, 20 years,” said Hideo Kumano, economist at the Dai-Ichi Life Research Institute in Tokyo.
Not long ago, Japan was “the economic miracle,” an ascendant juggernaut on its way to rivaling the United States, which has the biggest economy.
While China has caught up quickly to Japan in recent years in terms of its total economy (due to China's rapid growth and Japan's stagnation) it still has a way to go on a per capita basis.

But the Japanese growth miracle and its subsequent slowdown, crisis and stagnation show that things change. We often think about China growing forever on a linear path, without recession and without a generalised slowdown.

No doubt if it does Australia will benefit, but contrariwise if problems emerge this will badly affect Australia.

For everything to stay the same, everything must change ...

Not even. Things have just stayed the same really. The crisis is over and everyone can continue on. Just as it ever was. Indeed.

But really what has changed also rings true when we consider whether the fundamental problems have gone away. While I've focused on financial vulnerabilities, it's also important to point out social vulnerabilities.
This is more true for the US than for Australia, with its continuing belief that if you treat money well, it will spread itself all over town. Yeh right.

Bob Herbert has been writing about these things for a long time, scandalised by the inequalities in the US political economy. And never more than now.

See Safety Nets for the Rich

We’ve spent the last few decades shoveling money at the rich like there was no tomorrow. We abandoned the poor, put an economic stranglehold on the middle class and all but bankrupted the federal government — while giving the banks and megacorporations and the rest of the swells at the top of the economic pyramid just about everything they’ve wanted.
And we still don’t seem to have learned the proper lessons. We’ve allowed so many people to fall into the terrible abyss of unemployment that no one — not the Obama administration, not the labor unions and most certainly no one in the Republican Party — has a clue about how to put them back to work.
Meanwhile, Wall Street is living it up. I’m amazed at how passive the population has remained in the face of this sustained outrage.
We need to make some fundamental changes in the way we do things in this country. The gamblers and con artists of the financial sector, the very same clowns who did so much to bring the economy down in the first place, are howling self-righteously over the prospect of regulations aimed at curbing the worst aspects of their excessively risky behavior and preventing them from causing yet another economic meltdown.
We should be going even further. We’ve institutionalized the idea that there are firms that are too big to fail and, therefore, “we, the people” are obliged to see that they don’t — even if that means bankrupting the national treasury and undermining the living standards of ordinary people. What sense does that make?
If some company is too big to fail, then it’s too big to exist. Break it up.
Another NYT report "Study Says Reporting on Economy Was Narrow" reveals how reporting on the economy fails to focus on the plight of the poor. Instead it focuses on Wall ST, government and a few big stories. The Pew Research Centre does excellent surveys on a variety of issues (it does an excellent one on global attitudes towards  the US).

Reviewing almost 10,000 reports from Feb. 1 to Aug. 31 in newspapers, on news Web sites, on the radio and on network broadcast and cable television, Pew found that almost 40 percent of economic news reports dealt with the trials of the banking and auto industries, and the federal stimulus bill passed in February.
Unemployment and the housing crisis accounted for 12 percent. And, the study said, “stories that tried to explicitly examine the broader impact of the economic downturn on the lives of ordinary Americans filled 5 percent of the economic coverage.”
Three-quarters of the reports originated from Washington or New York, and a similar number were based on the actions of government and business leaders.
In February and March, the economy was the subject of nearly half of all news coverage, driven mostly by the stimulus bill and the uses of bank bailout money. After those fights died down, financial news coverage fell by more than half.

Friday, October 16, 2009

Financial Vulnerabilities

The IMF has just released a Working Paper on Australian financial sector vulnerabilities.
Australian Bank and Corporate Sector Vulnerabilities—An International Perspective by Előd Takáts and Patrizia Tumbarello WP/09/223.
In a generally benign report, the authors point out some of the problems that could face Australia's banking sector dominated by the Big Four.

The report outlines:

1. The Australian banking sector entered the financial turmoil in a sound position and has been resilient to the global crisis. Banks’ capital ratios are well above the regulatory requirements. The major banks’ AA credit ratings have remained unchanged since the crisis unfolded, and they were able to raise private equity capital in the midst of the global crisis. Impaired assets are still low by international standards, although they have increased in the past year.
Most people have been surprised by the resilience of the Australian banking sector, although there has been a fair bit of luck involved with Australia managing to stay ahead of the economic cycle. The fact that Australian growth has been so strong for so long matters a lot. This has enabled unemployment to stay low and the corporate sector to stay profitable. It is clear that having a very severe financial sector shakeout made the banks more cautious and madfe the regulatory authorities nore vigilant.
2. The international downturn points to several vulnerabilities. On the liabilities side, banks remain exposed to rollover risks on short-term wholesale funding. On the assets side, banks are vulnerable to the household sector as well as to possible corporate sector distress.
This is exactly the point, remembe rthe hosuehold sector in Australia is more indebted than ever before and a period of slow growth and rising unemployment will no doubt make things more difficult for the banks. While the rest of the world has been severely tested and Australia has done very very well, there are more tests to come. Despite the high levels of confidence around, just as in 2007, supposed strenth brings its own problems. Rising interest rates (and expectations of further rate rises) will cause households to tighten their belts putting a dampener on spending. A higher currency helped along by rising interest rates will lessen the profitability of those earning income overseas and make our exports less affordable.

3. Nonetheless, the risks from the corporate and household sectors appear to be manageable. ...
No doubt this is true as long as we don't get another external shock or a long period pof low growth. .

6. However, a deterioration in banks’ asset quality has been evident since early 2008.

7. A key remaining vulnerability is the roll-over risk associated with sizable short-term external debt. Banks’ wholesale funding (domestic and offshore) accounts for about 50 percent of total funding, of which about 60 percent is offshore (Table 3). Financial institutions short-term external debt (on a residual maturity basis) is estimated by staff at about $A 400 billion (35 percent of GDP) in March 2009.
The ability to roll over funds could be a problem in 2010. There are alsoa considerbale number of corporates that need to roll over debt in 2010. See "‘Twin Towers of Debt’ Loom Over Australian Companies, NAB Says".

8. The establishment of deposit and wholesale funding guarantees in October 2008 helped maintain confidence in the financial sector. As a result, banks were able to raise about $A 140 billion between December 2008 and early July 2009 (Figure 2) and have rolled over short-term debt. Recognizing the increased importance of liquidity and rollover risks associated with short-term liabilities, banks have started to increase medium-term funding.
The danger lies in a confluence of negative events (I don't want to use the cliche of the past couple of years - "perfect storm") that could undermine the current rosy picture. Fiancially-based recessions traditionally take longer to clear and one has to wonder about the underlying health of the US and European financial sectors.

Credit markets are still impaired and competition for debt is likely to remain high given the extensive amout of money needed to fund bailouts and stimulus measures throughout the world.

This crisis is not over yet, despite the cheery views of RBA Governor Glen Stevens. He might be right and thus far it appears that Australia has done well under his monetary managenent, but its the performance of the Australian economy and our ability to deal with long-term vulnerabilities that matters most.

Thursday, October 15, 2009

The Impact of the Aussie Dollar on Trade and Profits: For 1003IBA Students

Re our discussion on this yesterday in the lecture:

China, the dollar and feds' stimulus the shape of things to come

Glenn Dyer writes:
The shaping factors for the Australian economy and business over the next year were seen yesterday: China, the strength of the Aussie dollar and the federal government's stimulus spending produced good and bad news for some leading companies and the economy generally.
China's trade account had its best performance this year, but the strength of the Australian dollar and its impact on sales and profits is starting to have an alarming impact. It is shaping up to be the biggest influence for a lot of companies in the next 6-12 months.
The dollar has already started cutting the country's export income, it's going to slash sales and profits if the current level is maintained into next year and some of the gains from the stimulus spending could drain away in rising imports of cheaper consumer items such as cars and electronic goods.
Take CSL, Australia's biggest pharmaceutical company and mulinational: it's facing the prospect of its 2008-10 profit being flattened by the stronger dollar, with shareholders being told on Tuesday that despite the higher earnings offshore, profit could be cut sharply. At the company's AGM yesterday CSL said trading had been in line with expectations at the end of the first quarter of the current financial year
But chairman Elizabeth Alexander told the meeting: "For the 2009-10 fiscal year, we expect net profit after tax to be between $1.16 billion and $1.26 billion at 2008-09 exchange rates. However, if currency rates on October 9, 2009 were to apply for the balance of the fiscal year, the net profit after-tax range referred to earlier would be in the order of $970 million to $1.07 billion." That lower range would put it under the 2009 figure of $1.15 billion
Then the world's biggest zircon (a beach sands mineral) producer, Iluka, revealed the damage the stronger dollar had done to revenues. It said its mineral sands sales revenue (before currency hedging) for the nine months to September 30 was $348.7 million, down sharply on the same period last year, reflecting the significant adverse effect on demand for mineral sands products, particularly in the first half of 2009, associated with the global economic crisis. That figure was almost half the revenues for the first nine months of 2008.
But after the costs of currency hedging, sales revenue for the January-February period of 2009 was cut by a further 13.4% to $300.4 million. The company's average AUD/USD exchange rate moved from 71.2 cents in the June half year to 83.2 cents in the September quarter. The dollar has since moved over 91 US cents this month and there's every chance it could remain there into 2010.
But China's economy continues to grow. Next week that will be confirmed with third quarter growth numbers, but yesterday we saw a sharp improvement in exports and imports in September (which was the best month this year), thanks especially to record iron ore imports of more than 64 million tonnes and copper imports up 23%.
Chinese exports fell 15.2% in the year to September (which were 6.3% higher than August when they were down more than 23% from August 2008), while imports were down 3.5%. Those record imports of iron ore, plus higher shipments of other commodities boosted imports and helped offset the continuing impact of lower prices for iron ore, coal and oil products. Imports were in fact up 8.3% from August. On a monthly basis, China's imports have rebounded 55% from lows earlier this year, while exports are up 19%.
Chinese car sales jumped 84% in September, after a 90% surge in normally slow August. That's using up a lot more steel, which means more iron ore and coking coal sales (of varying types). Chinese car sales totalled more than 1.01 million units last month, the seventh month in a row they have averaged more than 1 million vehicles a month. China passed America in January and General Motors says it sold more cars in China through its joint ventures last month than it did in the US for the first time.
No wonder Rio Tinto, the struggling giant miner that almost sold a big stake to the Chinese government-controlled Chinalco earlier in the year, upgraded its 2009 iron ore export targets by 5-7.5%, or an extra 10 million-15 million tonnes ( to a figure of 210 million to 215 million tonnes).
Rio said in its quarterly production report late yesterday that production and sales from its WA mines are running at record levels and above rated capacity. In other words a boom bigger than the boom years of 2007 and 2008. So much for all that media and political twaddle that the Stern Hu and Chinalco cases would damage Rio's and Australia's relations with China.
And two clever retailers, JB Hi-Fi and The Reject Shop, revealed at AGMs yesterday that their current trading conditions were improving, despite the fading impact of the cash splash. JB Hi-FI said it had boosted the number of new outlets it is planning to open in the current financial year, while The Reject Shop told shareholders that comparable store sales growth has been increasingly positive since mid August with recent weeks particularly strong.
Both retailers are saying that despite the fading impact of the stimulus on consumers, demand remains strong enough to boost sales by more than expected.
A rising dollar creates winners and losers. If you're going overseas you'll be a big winner.

Property/Rental Market

Article from Adam Schwab from Crikey about rents Experts Get it Very Wrong on Rentals.
Schwab is pretty good on this sector of the market and points out the way to get through the bullsh-t on rents.
[R]ental prices are almost solely determined by the number of vacant rental properties -- although business journalists are commonly thinking of other excuses or reasons as to why rents go up or down.
One of the ways state govts, especially the South Australian govt, used to achieve this was through public housing. The Housing Trust in SA provided low cost housing (and commercial property), which kept a lid on rents.
The problem with the first-home-owner argument is that those first-home buyers who are leaving the rental market are reasonably likely to be buying a property that is currently being rented anyway (unless they are purchasing a newly constructed property). What that often means is that they will often buy from an investor a property that is currently tenanted to a first-home buyer (alternatively, they are buying from another owner-occupier who has to then find another property themselves). When the investor evicts their current tenants so the first-home buyer can move in, those tenants are put back in the rental pool, so the supply-and-demand equation remains unaltered. (If anything, the movement is actually likely to lead to an increase in rentals as landlords often take the opportunity to increase rentals to current market rates when tenants depart).
While the first-home-owner's boost wouldn’t have a real effect on rental prices, there is a government policy that is having an effect -- that is, the recent changes to foreign investment rules.

Until March this year, property developers were only able to sell half off a new development off-the-plan to overseas (often South-East Asian) buyers. Selling to overseas buyers was perfected by large developments, with those buyers appearing less cynical than locals. The new changes allow developers to sell 100% of a new project off-the-plan to overseas-based investors so long as the project is marketed in Australia as well. The rule change will make it easier for developers to start new projects and increase margins. It is also a good thing for the rental market because overseas investors will almost always rent the property rather than move in themselves.
The effect of the law change is already occurring. Melbourne’s largest apartment builder, Central Equity, recently successfully applied to expand its proposed apartment development on current Age site on Spencer Street to more than 800 apartments.
The law change may not have been intended as a means of keeping rents down (it more likely came about following lobbying by politically savvy and high-donating developers) but it will most likely have that (positive) effect. Well, until overseas buyers finally realise they are over-paying for properties.
It's always interesting to note the unintended consequences of policy decisions.

While people get excited about rising house prices, they are a negative for the economy as a whole. Buying and selling houses has been a generally unproductive development for the Australian economy and has left us heavily exposed to debt. While it's good that people feel richer when house prices go up the benefits are largely illusory.

And of course rising house prices and rents have very negative distributional consequences.

Wednesday, October 14, 2009

More debt than you can shake a stick at

Despite the supposed good times we're all experiencing at the moment and the idea that the recession has well and truly gone away, the one thing that hasn't gone away is the high level of debt in the Australian economy.

The financial crisis provided a slight set back to the increase in credit (debt) but growth resumed in the June quarter.

An article in the RBA's September Bulletin on Measuring Credit. See also RBA Statistical tables B21 shows just how much debt exists in Australia. A total of $1.914 trillion (about 175 per cent of GDP)   (156.1 per cent of disposable income).

The article also shows just how dominant the Big Four banks have become as a result of the financial crisis, with securitisation of home loans going into free fall. The Residential Mortgage-backed Securities (RMBS) market has hitherto provided decent competition to the banks and despite the general quality of the securities in Australia, the market suffered because of the crisis.

The Rudd govt has attempted to bolster the RMBS market by buying $8 billion of them. This is a good move. These are high quality home loans and so the risk is not great.

Less competition in the banking sector, will be a negative for Australians.  It also makes the economy more vulnerable to poor decisions amongst the big four.

For a summary of the RBA article and an analysis of the state of play see Michael Janda Banks dominate Australia's housing debt overhang.

My recent book The Vulnerable Country also contains a chapter on the financial vulnerabilities of the Australian economy.

For some suggestions on what could be done to bolster securitisation (RMBS) even further see Christopher Joye.

For 2016 Students: Currency Politics in Asia

See the article by Philip Bowring in the NYT "China and the Sickly Dollar"
The notion that Beijing has real responsibilities to the international trading system by letting its currency adjust and freeing up its capital account like all the other major players in global finance may be accepted by many academics and senior officials. But it remains a difficult concept to accept for a political leadership flushed by economic success and 60 years of Communist Party rule.
It is only natural for the dollar to be weak. Currency valuation is part of the solution to global trade imbalances. For the United States, the approximate halving of its deficit since its peak two years ago has been due in part to a 15 percent fall in the trade-weighted value of the dollar and partly to the drop in consumption as American households have started to save again. The United States doesn’t need to worry now about a weak dollar anymore than President Nixon did in 1971. It is someone else’s problem.

Tuesday, October 13, 2009

Industrial Overcapacity in China

One of the other potential problems for the Chinese economy is industrial overcapacity. There are a lot of resources beign stockpiled in China at the moment and while this has led to the maintenance of demand for Austrlain resources, eventually the have to be used up through either domestic or international demand.

Adjusting to this overcapacity is now apparently an important goal of the Chinese govt.
According to a Reuters' report in the NYT:
China's cabinet has laid out detailed plans to curb overcapacity in industries such as steel, aluminium, cement and wind power, warning that the country's economic recovery could otherwise be hampered.
In a reiteration of existing policy targets, the State Council said meeting the government's long-standing goal of reducing overcapacity was urgent because the result of inaction would be factory closures, job losses and rising bad bank loans.
"What especially requires our attention is that it is not only traditional industries such as steel and cement that suffer from productive overcapacity and are still blindly expanding," it said in a notice posted late on Tuesday on www.gov.cn.
Part of the reason for the continuing expansion is of course another state directive for the banking sector to increase lending to stimulate the economy.

All of this will have significant implications for the Australian coal sector.
"There is 58 million tonnes of crude steel capacity under construction, most of which is illegitimate. Crude steel capacity could exceed 700 million tonnes and overcapacity will intensify if curbs are not implemented in time," it said.The cabinet said it would no longer approve or support any new steel projects or any expansion in existing projects.Analysts said the immediate casualty of the clamp-down could be Australia's coking coal sector, whereby exports to China have surged more than 10-fold from a year ago to reach 14 million tonnes in the first eight months of this year."
The policy would support our view that the surge in China's coal imports over the past few months will be short-lived. From an Australian perspective, we could be seeing some degree of a pullback over the coming months," said Clyde Henderson, a coal analyst at Wood Mackenzie consultancy in Sydney.
Overall analysts argue that demand elsewhere will pick up compensating for declining Chinese demand.
"But still, many other steelmakers elsewhere are now looking to restart their capacity, so that will compensate for softer demand in China."
Despite the climate change problems of coal, it's likely to be important for a long time yet.

Another major economic figure bearish about the short-term prospects for China and Asia is Stephen Roach. (But like me optimistic about the medium to longer-term).

His most recent book is reviewed in the Financial Times by David Pilling:
In The Next Asia, a collection of essays on the region’s place in the world, Roach could not fairly be described as bearish. “Don’t get me wrong,” he says at one point in a typically down-to-earth interjection. “I am a long-standing optimist on Asia.”

But he does challenge, and in forthright terms, any notion that the world can go back to business as usual. If Asia, particularly China, thinks that it can simply wait for the west to recover before merrily recommencing its export-dependent growth strategy, it is kidding itself, he argues. Only if it can rebalance its economy towards greater domestic consumption will it fulfil its enormous promise. “It may be premature to crack open the champagne. The Asian century is hardly as preordained as most seem to believe.”

So far, Roach has been disappointed by the Asian, particularly the Chinese, response. In the section on Chinese rebalancing, he concludes: “There are worrisome signs that China just doesn’t get it, that it is clinging to antiquated policy and economic growth strategies that presuppose a classic snapback in global demand.” He cites as evidence the make-up of the $585bn two-year stimulus package that, he says, is biased towards old-fashioned infrastructure projects and too light on pro-consumption measures such as bolstering national health insurance, the absence of which encourages people to make precautionary savings.

He welcomes China’s willingness to engage more actively in debate about the global financial system. But for Roach, Beijing’s emphasis on the US deficit and on seeking alternatives, such as special drawing rights, to the dollar as a reserve currency betrays a complacency towards its own problems. China’s massive holdings of US Treasuries, he contends, are the flip side of America’s: they reveal a dependence on exports and the need to recycle foreign currency reserves abroad for fear of putting upward pressure on the renminbi.
For those students in 1003IBA this latter point relates to those global imbalances I'm so keen for you to understand!!

Monday, October 12, 2009


It's as though we're living in a dream world at the moment where debt can be wished away by continuous growth and where virtuous circles can't turn into vicious ones. How high can foreign debt go before it sparks a reassessment by international financial markets.

Australians are right to feel lucky, we are very lucky but that doesn't mean we're not vulnerable.

There’s no doubt that talking about economic vulnerabilities at the moment appears akin to turning on the lights and turning off the music just when the party is starting to rock, but a little less hubris might actually help to avoid some later calamities.

Ironic as it might seem given the major banks’ role in the debt binge, the NAB warns of potential vulnerabilities for corporate debt rollover.
See the story by Sarah McDonald on Bloomberg http://www.bloomberg.com/apps/news?pid=20601081&sid=a1NeEFavHCjc

“The thing that scares me about what’s coming up are the twin towers of debt, 2010 and 2011,” James Waddell, National Australia Bank’s director of capital markets origination, said at a conference in Sydney today. “That really seems to me to be people positioning themselves poorly.”

Australian companies will need to repay or refinance $223 billion of debt by 2012, including loans owed by Qantas Airways Ltd. and $2 billion of bonds sold by Westfield Group, Fitch Ratings said in a report published today. “At face value, the refinancing task faced by corporates appears onerous in the context of the current state of the market,” the risk assessment company said.

Companies will need to consider selling bonds in Europe and the U.S. as well as Australia to extend the maturity of their debt beyond relatively short-dated bank loans, Waddell said.
It's possible that this debt will be comfortably rolled over through international bond markets, but the real question is whether the productivity of investment will allow debt to be rolled over through profit and not just more debt; debt that will still need to be serviced and, of course, eventaully paid back.

Sunday, October 11, 2009

China Bubble

It's long surprised me that economic liberals in Australia place such faith in continuous Chinese growth based as it is on a state-based capitalism that they generally find abhorrent.
For many liberals as long as the direction of change is liberalisation then the economy can be considered as fitting the liberal model.
I'm not against liberalisation - far from it- just against dogmatism, ideological purity and mistaken assumptions.
China could do with considerably more liberalisation but it needs to be gradual and mindful of distributional consequences.
For many writers who now believe that Australia is invulnerable, long-term growth in China is a given; but is not only long-term growth that is assumed but continuous growth, without downturns or other problems. This position places considerable faith in China's communist leadership to effectively manage the Chinese economy.
I believe that the long-term picture is probably very good for Australia but there will be lots of bumps along the way.
One of the things that worries me is the banking sector and the directives of the state for banks to lend and the failure of the state to deal with non-performing loans.

AndyXie is fairly negative about the Chinese stockmarket (from http://www.nytimes.com/2009/10/11/business/mutfund/11china.html?emc=tnt&tntemail0=y)
In August, he called the Chinese stock market a “Ponzi scheme” supported by “appreciation expectation” and surging liquidity, and predicted a fourth-quarter slowdown. The recovery was built on “a pure liquidity bubble,” Mr. Xie wrote in Caijing, a financial magazine.
I think the China bubble could be due for some problems over the next year or two but the following article from Arthur Kroeber takes a longer-term but still pessimistic view about non-commercial lending.
See http://blogs.ft.com/dragonbeat/2009/10/06/chinas-npls-another-financial-time-bomb/

China’s NPLs: Another financial time-bomb?
October 6, 2009

By Arthur Kroeber
Is China’s credit binge a financial time-bomb waiting to blow the country’s much-vaunted economic miracle to smithereens?
Beijing has long bet that the problem of bad loans can be solved by pushing off the day of reckoning into the future, with rapid economic growth reducing the size of the problem.
So far that calculated bet has proved a sound one.
But the unprecedented expansion in bank credit this year, coupled with last month’s decision to roll over for another decade the bonds used to finance the first non-performing loan (NPL) workout of 1999, make it a good time to submit this policy to a stress-test.
Chinese NPLs can be divided into four tranches. Tranche 1 is Rmb1,400bn removed from the “Big Four” commercial banks – Bank of China (BoC), China Construction Bank (CCB), Industrial and Commercial Bank of China (ICBC) and Agricultural Bank of China (ABC) – and China Development Bank in 1999.
Tranche 2 is Rmb1,300bn removed from the first three of the Big Four in 2004-05 as they were being prepared for international stock market listings, plus some other bits and pieces from other banks in 2007.
Tranche 3 is Rmb816bn removed from ABC in 2008, presumably preparing the ground for it to list.
And Tranche 4 consists of whatever NPLs still sit on the banks’ balance sheets, especially as a result of this year’s lending binge.
The treatment of Tranche 1 is illustrative of Beijing’s calculated bet. If the government had simply financed a write-down in 1999, the cost would have been an unbearable 18 per cent of GDP. Government revenue was only about 12 per cent of GDP at the time – so explicit recognition of these liabilities would have blown a very damaging hole in Beijing’s books.
Instead, Beijing devised an accounting dodge: the NPLs would be purchased by special asset management companies (AMCs) set up by the Ministry of Finance, paid for via a combination of cash and 10-year bonds.
The AMCs would then spend the next decade trying to recover what they could, with the final loss being absorbed by the Ministry of Finance – by which time that loss would be vastly reduced because the economy and MoF’s resources would have grown enormously.
And yea, verily, so it came to pass: the net liability to the government of that original NPL tranche at the end of 2009 will be less than 4 per cent of GDP, and less than 20 per cent of expected government revenue for the year.
Indeed, the bet has paid off so handsomely that CCB’s decision to roll over an Rmb247bn bond from Cinda Asset Management Co for another decade looks set to be followed by the other big banks.
Will the bet pay off again – or have officials simply set the timer on a financial time-bomb and decided that someone else will be in the room when it explodes?
To begin estimating the full cost of writing down China’s NPLs in 2019, we assume that recoveries on NPL Tranche 1 are 15 per cent, which the distressed assets specialists tell us is reasonable.
For Tranche 2, 72 per cent has already been written off. We assume no further recoveries on the outstanding balance of Rmb348bn, all of which seems to have been financed by the central bank.
For Tranche 3, we assume a recovery rate of 15 per cent – but this may be too optimistic. To balance that out, we make a very aggressive estimate for Tranche 4, assuming that one-sixth of the Rmb20,000bn in bank loans likely to be issued in the three years 2008-2010 will go sour.
This is bold: it means that China will have to deal with an as-yet unrecognised NPL liability of Rmb3,300bn, almost equal to the face value of all NPLs hitherto recognised (Rmb3,500bn).
So just how big is China’s NPL time-bomb? That is largely a function of economic growth rates.
Average annual nominal GDP growth of 11 per cent, 9 per cent and 7 per cent over the next decade would generate net fiscal NPL costs of 6 per cent, 7.2 per cent and 8.7 per cent of GDP respectively in 2019 – substantial, but not catastrophic.
There is no necessary reason why existing NPLs, even including bad loans arising from the 2009-2010 monetary stimulus, should threaten the viability of the system. In short, the calculated bet of letting NPLs shrivel through time and growth can safely be placed one more time
But this bet absolutely cannot be placed a third time.
The above scenarios only work if the financial system generates no net new NPLs in 2011-2019 beyond the banks’ own ability to provision and write down.
After 2020, demographic and other factors will turn unfavourable, and the structural real GDP growth rate will fall from 10 per cent in 1980-2008, and an expected 8 per cent or so in 2010-2020, to around 5 per cent. When that happens, growth can no longer erase past NPLs – only inflation can.
The solution is that banks must start lending on a commercial basis; they must be permitted to deny credit to state entities that are obviously un-creditworthy; and enterprises that cannot sustain themselves in a market-based financial system where capital is properly priced must be allowed to go bankrupt.
If China wants to avoid a hard choice between financial crisis and rampant inflation in the 2020s, it must start fixing its financial system, right now.

Interest Rates

Just got back from Vietnam and Cambodia.
Things keep on moving while you're away.

The current consensus is that interest rates will keep on rising because growth will return to trend very soon (at least according to RBA Gov Stephens). I think this is a big call and it's possible that the RBA will have to do a big u turn in 2010 like they did in 2008 if they continue rises over 2009.

The problem is now that the RBA believes its own hype that it got the economic cycle completely right. No doubt decisions to reverse monetary policy rapidly and to stimulate fiscally played a big role in Australia avoiding a technical recession but there's abeen a fair bit of help from China as well.

Luck has played a big role too.

I think the RBA is taking a big risk if it keeps going with rises over the next 12 months.

The RBA wants to avoid a renewed bubble in housing but there are other ways to do this. Not making what are effectively direct payments to venders through home loan grants would have been one way. Or at least limiting grants completely to new home builds.

On the personal front some good advice from Chris Vitale of Mortgage Choice

"If you were going to take a fixed rate now, you would have to believe that interest rates were going to increase by significantly more than two per cent in the next 18 months," he said.
"That's at least another eight interest rate increases, before you even break even."