View From The Couch - 13/Aug/2015

Double Dose of Chinese Reality

For two days in a row, the Chinese government devalued the Renminbi in what is seen as a currency war. Xi Jiping denied it was a currency war, but sometimes when you get punched in the face, you have to accept it's a fight even though the other guy denies it was a punch thrown in anger. The devaluation hit the AUD as one would expect seeing that we are a handful of economies that are seen to be largely commodity-driven. Indeed, Brazil might be the only other nation that is just as deeply dependent on commodity exports and specifically exporting them to China.

As it stands we saw the bourse drop in Australia, as well as seeing the AUD drop 1.3% before it regained some ground. The good news is that China's share market crash doesn't reflect the entire Chinese economy; much in the same way that the All-Ords does not reflect the entire Australian economy. The bad news is that taken as a whole, the collapse in the Chinese markets as well as the devaluation and the resultant drop in the AUD and the ASX are all part of the one big picture where by China is struggling to adjust to slowing growth.

China of course even denies it is doing the devaluations because of the slowing economy. If a government lies this much about what it is doing, do we ever trust it with any announcement? It's hard to say. There's a certainly level where if it talks like a duck and walks like a duck but denies it's a duck, you call it a duck at your own peril because it's a duck that's in charge of 1billion people of the planet, and you never know what might do with those numbers.

A quick look at Brazil suggests that this downturn in demand for its commodity exports as wells the devaluation of the Yuan indicates this is a terrible thing to have happened to Brazil, one year out from their staging of the Olympics. Iron ore, copper, oil are all falling. Even agricultural commodities are falling to 6 year lows and 7 year lows. Those figures have not been this bad since 2009 when the markets turned around thanks to Quantitative Easing by the US Fed. Naturally, Australia is not too far behind in being hit by investors because the income we thought we had coming from China doesn't seem to look like it's going to materialise. It's not a catastrophe yet - but as Rob Gordon asks, does "yet" mean we will eventually end up doing/witnessing/living the catastrophe?

On The Radio They Said...

I caught a snippet on the radio in Pleiades' car today. They were saying that as unemployment has gone up, so has personal loan defaults. The bank spokesperson also said so far loan defaults have not broken out amongst mortgage holders, but they are "keeping an eye on it". An interesting thing is happening with the banks: they are posting record profits on then hand, but they're also raising capital from their shareholders. That bring up the question - why?

Obviously Basel II means they have to have a certain amount of cash handy to withstand any shocks to the financial system, but it's also curious that ANZ, NAB and the CBA have all chosen to undertake the raising of capital this year. If nothing else, it telegraphs they are expecting trouble. If China really falters, then there will be deeper impacts to Australia's economy. Investors will run to the door. If that brings about a collapse in the property market in Australia...

After The Parity Party

Who Benefits More From The Devalued Dollar?

Late last week, RBA boss talked the AUD down, and then quite spectacularly, the Aussie dollar fell through the 90cents barrier.

A new round of jawboning on the need for a lower exchange rate by the Reserve Bank governor Glenn Stevens pushed the currency below US90¢ on Friday, and the dollar could face further headwinds when the central bank releases its December meeting minutes on Tuesday.

The RBA’s assistant governor Guy Debelle is set to speak at a banking and finance conference in Sydney on the same day, while Mr Stevens fronts the House of Representatives’ Standing Committee on Economics in Canberra on Wednesday.

Both central bank officials have talked down the local currency in recent weeks, stressing that a lower dollar is needed to support growth in export-facing sectors of the economy as mining investment peaks.

“It’s a market that seems to be responsive to jawboning,” Westpac senior currency strategist Sean Callow said about the recent declines in the Australian dollar.“If it was a couple of years ago, I think the market would have brushed off such talk, but it seems there are still investors who will sell it on jawboning, even though the domestic story really isn’t presenting a very compelling case to sell the [Australian dollar].”

The currency could face further headwinds in the form of the federal government’s Mid Year Economic and Fiscal Outlook. It will be released on Tuesday and is expected to reveal increased budget deficits.

Which goes to show the markets are jittery ahead of the possible taper from the QE3. The valuation of the Aussie dollar has been one of those interesting concerns for the past few months because we keep hearing that Australian manufacturing can't continue withe the Australian Dollar so high. Well, it's lost close to 15% since the days it was trading at US$1.08, so you have to figure that 90cents was a reasonable level for the AUD to sit. It's not like the RBA is willing to cut interest rates further from historic lows, so it figures that there would still be enough in the carry trade to make it worth while holding Australian Dollars - not that I'm any expert.

Anyway, in that context, this interesting article floated into view.

“I don’t see why the RBA wants to see the global purchasing power of Australians reduced by 20 per cent in exchange for one percentage point of extra growth,” Mr White told The Australian Financial Review.

Mr White says “targeted deprecation policy” amounts to “a transfer from households through imported inflation to firms through higher profitability,” pointing to rising food and fuel costs as a result of the weaker currency.

“The bottom 50 per cent of income earners have the highest proportion of imported products in their spend,” says White.

“The data would suggest at least 80 per cent of that 50 per cent work in domestic services so they won’t benefit from the increased competitiveness but they will suffer from [things like] higher petrol prices.

“I think moving away from mining investment is a good thing but the weak $A isn’t going to get us there, it will just make Australian mining more competitive,” he says.

Mr White believes there have been fundamental changes in the composition of the economy that should force a rethink in conventional application of policy.

“The structure of the economy has changed. If we were a manufacturing economy, a weak currency would help us but we are not we are a service economy. We don’t have the substitution industries to take advantage of the falling dollar,” he says.

Now, that's interesting because it has been something of an axiom that the Australian Dollar had to come down, and that it would be good for everybody. I've always wondered what the fuel costs would be like under an AUD that fell 20% in value would mean a 25% increase in the same thing.

As in, if the AUD went from 1.00 to 0.80, then  you would need 1.25 times the currency to get the same purchasing power as before. That's a 25% inflation on imported goods being slapped on right there. Any drop in percentage will have to be reflected in a larger number in inflation. So if the RBA really was looking for say,a maximum 3% inflation, it couldn't be asking for more than a 2.9% drop.

Now, of course there are things that would and should go down as a result of the Australian Dollar dropping in value, but if you're already trading in Australian Dollars, it's not going to help. So from the consumer's point of view, this James White is correct, the fall in AUD is in fact robbing us of our purchasing power, while the benefits of the fall are likely to go right by us. Like this James White fellow I'm yet to figure out how the 20% drop for the sake of 1% growth is really all that a great trade off, especially if it's courting a 20% inflation of imported products.