Big Trouble in the Australian Economy… Everybody Relax

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In the movie Big Trouble in Little China there’s a classic line by the ‘hero’ of the show, Jack Burton. The group he’s leading is in a panic as they’re getting away from the bad guys. But Jack reassures them in a swaggering drawl… ‘Everybody relax, I’m here.

Yesterday, Atlanta Fed president Dennis Lockhart did his best impression of Jack Burton. In a Bloomberg television interview he said, 

‘There certainly seems to be an acute fixation on the timing of any adjustment to the asset purchase program and I guess I would just encourage everyone to not lose sight of the bigger picture.

‘Any adjustment is not a major policy shift. The high level of accommodation will stay in place.’

There you go…everybody relax, the Fed’s here.

Or maybe just the Atlanta Fed. Because before that, San Francisco Fed President John Williams said an improving US economy would allow the Fed to pare back its purchases of bonds in the coming months.

This has all got beyond ridiculous. These Fed muppets have absolutely no idea what they are doing. They are desperately trying to placate markets while pretending to be committed to price stability and withdrawing record stimulus. 

Our friend Jim Rickards summed it up best in a recent tweet. ‘After two years of “risk on, risk off”, we now have “taper on, taper off”. Madness. There are no markets left, just puppet shows by the Fed.

It wasn’t long before poor economic data turned the market from taper on to taper off. Because soon after the various Fed verbal acrobatics, we got news that US manufacturing contracted in May. The widely watched Institute of Supply Management’s gauge of manufacturing in the US fell to a four year low of 49, down from 50.7 in April. Any reading below 50 signals contraction.

But who needs manufacturing and the production of real stuff when you have the Fed?

Well, China could do with a bit more of it. After the ‘official’ reading came out over the weekend showing modest expansion, the HSBC reading out yesterday showed a manufacturing contraction. There’s a dilemma for you…do you believe the Chinese government or a bank? Either way, it shows China is struggling.

And you’d think Australia’s economy could do with a little more manufacturing activity too. Our index came in at 43.8 in May, marking the 23rd consecutive month of contraction. While it was a better reading than the depression-like conditions of April (where the index had a reading of 36.7) our makers of ‘things’ are still clearly hurting.

That hasn’t been an issue for the past 20 months or so because we’ve had the mining boom to cushion the impact. But now that is going, going, gone.

So what does the Australian economy rely on to drive growth now? The RBA hopes that lower interest rates will lead to another boom in housing and consumption. Phil Anderson argues it doesn’t really matter…the stars are aligned to give housing another 14-year bull run.

Phil makes a convincing argument, but we’re sceptical. Then again our scepticism comes from taking note of the ‘fundamentals’, those quaint little bits and pieces of data that are meant to provide the foundation (or otherwise) for asset price movements. And they don’t seem to matter anymore.

Although RP data did report a 1.2% fall in Aussie house prices during May. Just a blip, we’re sure…

Anyway, we’ll see just how concerned the RBA is about the Australian economy at 2.30 today when it announces its interest rate decision. The consensus is that it will remain on hold. We have no idea what they’ll do. We can only tell you that rates will probably be a lot lower in six months’ time.

Because we doubt a new consumer or home construction boom will take up the slack of the slowing mining boom. So the RBA will have no choice but to resort to the same playbook that every other central bank in the developed world is resorting to. That is, cut interest rates and pray.

But Australia has one disadvantage in this game. We’re a peripheral economy and a large debtor nation. That is, we don’t have the same ability as the US, Japan, or even the UK to cut interest rates to the bone and still be able to attract foreign capital to fund our $800 billion-odd debt pile.

Yes we can cut interest rates, but that will send the dollar lower, which will eventually feed through to higher inflation, which will force interest rates back up. Keep in mind that although the higher dollar has hurt manufacturing and many other parts of the Aussie economy in recent years, it has enabled interest rates to remain very low and provided an added benefit for our foreign creditors to keep providing credit (that is, a currency windfall).

The strong Australian dollar has kept a lid on imported inflation…so even though domestic prices seemingly rise every other day, import prices have ‘deflated’ keeping the overall price level stable (that’s if you buy a mass-produced electronic item with your shopping every week). 

A weakening dollar will slowly (it takes a while to flow through into the economy) seep into higher imported inflation…and combined with higher domestic inflation, you’ll eventually see rising prices play havoc with the RBA’s ability to blow another bubble…somewhere, anywhere.

But that’s probably a story for 2014. Exchange rate effects take time to flow through to consumer prices and you have to take into account the fact that companies might absorb or pass on higher costs emanating from a weaker dollar.

For now, it’s fair to say that Australia is between a rock and a hard place. Slowly but surely, the vice is tightening.

But don’t worry. Channel your inner Micawber. Something will come up.

Everybody relax…

Regards,
Greg Canavan
for The Daily Reckoning Australia

Join me on Google+

From the Archives…

Why You Should Keep Your Portfolio Grounded in Cash
31-05-13 Vern Gowdie

China’s City in the Sky
30-05-13 Dan Denning

House Prices First, Stocks Second.
29-05-13 Dan Denning

Why Natural Gas Could be the Next Crucial Industry for Australia
28-05-13 Dan Denning

The Japan’s Nikkei is Starting to Crack
27-05-13 Dan Denning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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8 Comments on "Big Trouble in the Australian Economy… Everybody Relax"

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Don
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I don’t think you are right on this one. I think their strategy is to keep the unemployment rate down by devaluing the Aussie dollar.

Lachlan
Guest
“These Fed muppets have absolutely no idea what they are doing” I wonder if you really believe that Greg. I think the Fed is doing well. They are giving people the idea that they operate internally in a democratic way and giving false signals to traders at the same time so that every man and his dog cannot successfully front run the process they are determined to carry out and which was designed so long ago. Well done Fed, great job. Power centralises over time. This is a derivative of human nature, a constant around which history revolves. Look how… Read more »
truth and integrity
Guest
Well the Fed thinks that Debt is the answer! The bank will not allow you to run too much debt while you have the asset. However once the equity in the asset is destroyed by the too high level in debt what do you think you are going to trade. There is nothing left but capitulation and bankruptcy. Keeping the unemployment level down is only by false stats to appease the populace into false security; not reality; unemployment is far higher than you may imagine. Devaluing the dollar is a capitulation that your currency isn’t worth that much; you lose… Read more »
shortchanged
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Do I detect a bit of tongue in cheek there, Lachlan, the fed has done good?. If you know,and I presume you do, the way the fed was set up by congress and rammed through when most members were not even there, speaks volumes for the evil way it was set in motion, and the fraud on the American people who will pay for the rest of their lives. To managle a saying, for evil to prosper, good men stand by and do nothing,,,where are all the good men?.

Smithy
Guest

“Channel your inner Micawber,” haha, Love it.

Ross
Guest
Perhaps the Japanese QE failure informs us that the Americans were only bating the Europeans when trying to convince them to swap austerity for QE. There will only be one source of liquidity and it is the USD. Go for QE and you will get shaken down by Wall Street and little mate London flogging your bonds. Big shirt sleeve meeting among the G2 (China and the US) coming up. Both are heavily invested in that USD fiat bubble. At a point China will pull the plug on the USD but biding their time until the balance of forces disparity… Read more »
Jeff
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Interest rates will not go up anytime soon, Australia is now where UK was in early 2008…a recession is on its way then once the aussie dollar weakens enough the next boom cycle will start

Lachlan
Guest

Nope. No tongue in cheek at all SC. Darth Bernanke dropped by in a dream last night. Told me he was my father and it was then I realised my calling ;)

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