‘Hey! Hey! RBA! How many notes did you print today?’
We tried out the above chant in the shower this morning. It has a nice ring to it. And besides, people will need something to shout in the streets when they discover the defined contribution pension scheme that locks you into a falling share market will not pay for your retirement.
‘Hey hey, ho ho, paper money has got to go!’ That’s better, isn’t it?
Speaking of the price of money in Australia, the Reserve Bank of Australia will meet today to fix it. It’s an interesting dilemma. Plenty of macroeconomic data from Australia and China might argue for a rate cut. For example, retail sales fell by about 1% in July to $21 billion, according to the Australian Bureau of Statistics. It was the biggest monthly drop in consumer spending in about two years, and department store spending was down even more, by over 10%.
People don’t spend money when they’re not confident about the future. Lately, the hits to Australia’s economic confidence keep coming. By far the biggest worry is that iron ore and coal prices will fall further and faster than ‘official forecasts’. The chart below shows that’s exactly what’s happening.
The index fell 3% in SDR terms since last month. It’s down over 18% in Aussie dollar terms in the last twelve months. A decline of that magnitude isn’t that surprising, given the weighting iron ore and coal have in the index. It’s more accurate to call that RBA’s index a steel index than a commodity index.
The steel story just gets more interesting, by the way. Remember China’s $630 billion stimulus package in 2009? How could anyone forget, really? It’s what caused that big ‘V’ shaped formation in the chart above. Well it turns that Chinese banks were in such a hurry to do the government’s bidding and loan money that they extended over $400 billion in loans to the steel industry.
Any time central planners are that free and easy with money — and let’s be honest, they’re always free and easy with other people’s money — you’re bound to get some funny business. Some of the steel company executives in China took the free money and made bets in the stock market, on real estate, or pet property projects.
Imagine that. The government gives away money to people who didn’t ask for it and those people blow it on things that can make them more money or give them more pleasure. What a shock. That could never happen here!
It did happen in China, though. Of course, it happens anywhere morons in government think they can promote growth by growing the money supply. ‘After the financial crisis,’ said Shanghai steel trader Li Huanhan, ‘when the government released its stimulus, banks begged us to borrow money we didn’t need… We had nothing to do with the money, so we turned to other investments, like real estate.’
That’s about as clear an example as you’ll ever get of how free money and low interest rates turn otherwise prudent investors into crazy speculators. One trader borrowed 23 million Yuan, and then fled to Australia, according to Reuters. The banks now have the steel companies in court, trying to claw back some of the money that may not be repaid.
This whole scenario of running companies at a loss at the direction of the government is exactly why Greg Canavan published his timely China Bust report earlier this year. When a company loses money (by design, in some cases) somebody has to take the loss. In China, that somebody is the banks, which serve as the vehicles for the fiscal and monetary policy of the Chinese Communist Party.
You’d expect more Australian iron ore projects to get the sack the more we find out about what’s really going on in the Chinese steel sector. The ABS reported that exploration spending by miners fell by $53 million in the June quarter after hitting an all time high of over $1 billion in March. You tend not to look for minerals and metals when they’re falling in price over the long term.
Of course that’s begging the question. Are minerals and metals falling in price over the long-term? Or are they, to use the favoured term of the Pollyannas, merely ‘moderating’? It is the job of the RBA to act like it knows the answer to this question and then confidently proclaim the correct interest rate for the future.
Lower commodity prices, weak retail sales, and slowing growth in China would all argue for a cut to the cash rate, currently at 3.5%. But there’s a danger. Relatively higher official interest rates make Australian dollar-denominated assets (stocks and bonds) attractive to foreign investors. The interest rate advantage is one of the factors that brings foreign capital into Australia.
It’s a good thing that money flows in, as well. The inflow of foreign capital offsets the deficit Australia runs in its current account. The current account is made of Australia’s trade balance and net income. In basic terms, the current account reflects the difference between imports and income paid to foreigners on the one hand and exports and income received from foreigners (through stocks and bonds).
For the better part of the last 30 years, Australia has run a current account deficit. It’s paying more for imports and to foreign investors than its receiving for exports and earning on foreign investments. The housing boom and the mining boom came along just in time to make sure Australia had enough capital to balance its payments.
That’s another reason why cutting interest rates is a risk for the RBA. If foreign money decides Australia is no longer a safe, high-yield place to park capital, the money flowing in through the capital account will no longer balance the money flowing out in the current account. Australia will have a balance of payments crisis without having a government debt crisis. This is exactly the subject we wrote about in our last issue of Australian Wealth Gameplan.
But is it as serious as all that? Well, the current account deficit was down 9% in the June quarter, although it still came in at around $12 billion. The net foreign debt liability, however was nearly $15 billion for the quarter. Australia now has net foreign debt of $756.2 billion.
Borrowing money isn’t a bad thing if you can put it to productive use. But if you borrow money from foreigners to fund, say, a housing boom, well then you have a problem. You have an even bigger problem when the foreigners no longer want to loan you money. Australia may soon have that problem.
‘Ho ho, hey hey, the RBA is scared today!’
for The Daily Reckoning Australia