September 2010

Andrew Pegler – 16 July 2010

No it’s got nothing to do with hanging money out to dry or even laundering it. Please let me explain.

All this babble about China unpegging its currency from the USD may sound like something for the pointy-headed economists to mull over but it’s actually not that hard to grasp.

Exchange rates fluctuate just like the share market, i.e. they’re up and down like Lindsay Lohan. To stop this a country can fix its currency at a specific rate. This is known as pegging. So Wayne could peg the AUD permanently at 75c to the USD if he wanted (he wouldn’t, more on that later). BTW Australia’s dollar was pegged until 1983 when it was “floated”. Apparently that was Bob Hawke’s idea. Just ask Paul Keating.

Pegging works thusly. To lower the value of the AUD the Reserve Bank will sell heaps of it into the market but to increase its value it buys up heaps of it. That’s the timeless law of supply and demand for ya.

Gee sounds like a great idea, so why don’t we all do it?

To keep a rate pegged/fixed the government has to play with interest rates. A lot. And that’s always trouble. If the AUD is in danger of falling, it will raise interest rates to increase demand, which pushes the price back up. And vice versa. The RBA also needs to have mountains of foreign reserves and AUD stashed away to manipulate the rate using the laws of supply and demand.

Now, what’s all this babble about China unpegging the Yuan?

In mid 2008, as the GFC was tonking us all for six, China moved to peg its currency, the Yuan, at around 6.83 to the USD. Many regarded this as too low because it made Chinese exports far cheaper and gave them an unfair trade advantage. Needless to say this ticked off a lot of people so the Chinese are unpegging it. This is good news for us because if the Yuan does increase in value, China can buy more of our dirt. On the flip side, a stronger Yuan will make Chinese exports more expensive and hence lessen demand, which could dampen growth there and clip its need for stuff we produce (as opposed to dig out) like meat, furniture, cars and budgie smugglers. Swings and roundabouts.

And that’s pegging unpegged.

And in other news… The International Monetary Fund has just raised its global economic growth forecast for this year from 4.2% to 4.6%. However, it warns of a possible slowdown thanks to sovereign debt dramas and budget imbalances across the developed world. An all too familiar warning folks.

As always I welcome your feedback and any ideas for subjects I can tackle. So go on, let us know what’s on your mind – log in and post your comments below.

Andrew Pegler – 3 September 2010

The political kafuffle and those pesky global jitters have seen the AUD come off the boil a tad. But for an export-dependent country like ours this isn’t a bad thing.

A nation’s currency rises and falls depending on the performance of its economy and the sentiment of its investors. If everyone wants a piece of the action then it heads north. If everyone wants out it could fall lower than Whitney Houston piggy-backing a carpet snake. The laws of supply and demand. Right now the AUD is down from the heady days of possible parity and while this may seem like bad news, it’s not.

Increased exports

The weaker our currency the more competitive our goods. So if the AUD falls 10% in value against the USD Aussie exports are 10% cheaper to importers and therefore it’s more likely they’ll buy them. This is why China is pegging its currency below the USD.

This 10% depreciation also means we pay 10% more for our imports, which makes locally made products relatively cheaper, which is good for local producers and manufacturers who get a medium-term advantage, leading to more jobs and more spending. Plus having more money flowing into the economy from the boost in exports reduces the trade deficit (i.e. the excess of imports over exports or money in and money out).

More foreign investment in local companies and shares

If a currency continues to fall it also makes foreign investment in local companies and shares more attractive particularly if the currency is stable. This is because it costs foreign investors less to invest here. Generally they look for local companies with sound fundamentals and typically swoop when it looks like the dollar weakness is nearing an end.

Companies’ profits go up

Multinational Aussie companies like Pacific Brands, Cochlear, BHP etc., which earn a lot of money from overseas sales, earn more from overseas revenue they bring back into Australia because of the improved conversion rates.

More tourism dollars

A weaker currency helps to boost tourism because it’s cheaper to travel here. The lower Aussie dollar will be a great relief to this really important sector that has been smashed by the high AUD of late.

And finally…

Aussie firms have less competitive pressure to keep prices low and Australian bonds and shares become more attractive to overseas investors allowing governments and companies to raise longer-term capital more easily.

So see, it’s not all bad news.

And in other news… the latest data from the US government shows official Chinese holdings of US Treasury bonds fell from $938.1 billion last year to $843.7 billion this year. It looks like the Chinese are quietly reducing their exposure to the weakening USD. The rise of the RMB anyone?

Andrew Pegler – 27 August 2010

Interest rates will stay steadyish until the end of the year when the economy picks up again and people start buying plasmas, doing those overdue renovations and generally consuming stuff.

As you may know the RBA uses interest rates to keep the lid on inflation; raising them increases borrowing costs, which dampens economic activity and that puts a lid on inflation. And vice versa with lowering them. The latest Reserve Bank board minutes reveal the boys and girls don’t think inflation will be much of a drama over the next six or so months and so giving the RBA time to consider its medium-term strategy.

There are three reasons why the RBA will pause for thought. Firstly, there�s the fear of what�s called contagion that may come out of the European debt crisis featuring P.I.G.S. (Portugal, Ireland, Greece and Spain) struggling to pay their debts. Contagion is the panic-driven spread of a financial crisis that rises out of a series of vicious cycles that form when confidence in a country�s ability to repay its debts goes south. Secondly, the sluggish US economy is struggling to stay awake at work and taking us all with it. (See recent blog US and us). And thirdly, there’s been a definite softening here in Oz over the last couple of months with banks reporting a reduction in the demand for mortgages and the aforementioned international issues hitting business confidence. Interesting to note that while consumer confidence is strong it’s not really translating into people buying stuff and firing up the economy in the process. This is because we have two things going on at once – firstly, households and businesses are deleveraging i.e. paying off the debts and secondly, the economy is softening.

My view for the next 12 months, and let me preface this by reminding you that economic forecasting was invented to make astrology look credible, is that inflation will move towards the top of the RBA 2-3% inflation target range towards the end of the year as people start to feel confident about flat interest rates and start spending and borrowing. Then in the absence of a global shock (a possibility) or the invasion by alien life forms with no respect for monetary policy (not so probable) the only way is up.

And in other news… according to the fourth Australian Work and Life Index study, Australians aren’t that happy with their job conditions, and we work too much. More than a fifth of us work over 50 hours a week and 60% don’t take regular holidays. Not surprisingly working mums cop it worst with 70% always feeling rushed and pressured. No wonder those paid parental leave schemes have gone down such a treat.

Andrew Pegler – 20 August 2010

With the US consumer crippled by debt and Europe going pear shaped, the Chinese have been looking for new markets. And they’re finding them in their own backyard.

It’s part of the arc of economic maturity that eventually a nation goes from being a cheap destination for making stuff for richer countries, to having enough internal wealth to support an aspirational middle class that can afford overseas imports. Think Tawain, Singapore etc. Anyway, McKinsey & Co predicts China will add 400 million to its urban population by 2025 and quadruple “middle class” households to 280 million. That’s a lot of wallets that will want emptying and will take China from being the world’s widget factory to its next big consumer market.

China is also starting to buy overseas assets to keep up with internal demand. Legendary Harvard economist Niall Ferguson wrote in his book Empire that empires really begin when a nation has enough internal demand to find it cheaper and safer to own factories and food production facilities overseas than to continue buying from them. The commodity spike of 2007-08 scared China into buying mineral resources across Africa in earnest and it’s now turning its steely gaze onto the lucky country. But it’s not just mines, it’s also our food production assets i.e. farms and prime land. Liberal Senator Bill Heffernan is now worried Australian farmers could become tenants in their own country. Probably a slight exaggeration, but you get the picture.

All this movement will bring foreign ownership laws and regulations into sharp focus. Somehow we need to strike a balance between being a liberal economy and maintaining our national interest. Not surprisingly Bill Heffernan has plenty to say on that too.

Speeding up this shift in China is the decline of the US. At present the US is being crushed by national debt and its interest payments will exceed its defence budget by 2020. As Niall Ferguson also points out, when an empire starts paying more to service its debts that to maintain its borders it’s on the way out the door. My advice is get your kids to learn Mandarin.

And in other news…. Japan’s latest GDP figures are less than China’s and suggests that this year China will pass Japan once and for all to hook the mantle of the world’s second biggest economy. The rise of the dragon continues. Roar!

Andrew Pegler – 13 Aug 2010

The Libs say the stimulus package only played a small role in getting us over the line and it was a dog’s breakfast anyway. Labor points out that ours was the shortest and shallowest downturn in the industrialised world – end of argument. Whoever you support here’s your script for this weekend’s BBQ. (Sorry for not including the Greens.)

The Liberal voter’s script

Scene: BBQ with friends. Beer/wine in hand. Intelligent, authoritative look on face.

You: Yeah, I hear what you’re sayin’ but you can’t assume the stimulus spending spree kept us out of recession. I mean just look at the US. They spent heaps more and the place is still a basket case (see last week’s blog). So the way I see it, it wasn’t just the stimulus that saved our bacon, there are two other major factors. Firstly, by reducing rates to emergency lows the Reserve Bank made it cheaper and therefore easier for people to borrow money to invest in things and this created jobs and strengthened the economy against the GFC onslaught. Ultimately this bolstered our GDP (Gross Domestic Product) and that kept us out of recession because a recession is when you have two quarters in a row of negative GDP. The second thing was the depreciation of the Aussie dollar. At one stage AUD was hurtling towards parity i.e. one $AUD equals one $USD. Then suddenly it dropped to the low 0.80s making our exports cheaper, which meant a lot more money flowing into the economy. So as you can see the stimulus only played a co-starring role … and the rollout was a dog’s breakfast anyway. Oh and while I’m at it did anyone see that the Australian National Audit Office has cast serious doubt on Labor claims that the stimulus added 2.75 per cent to GDP in 2009-10?

Pause for applause at your brilliance.

You: I’m off to the fridge. Beer anyone?

The Labor voter’s script

Scene: BBQ with friends. Beer/wine in hand. Intelligent, authoritative look on face.

You: The crisis struck hard and fast and no one knew how deep it would go or how long it would last. So with the whole financial system on the verge of collapse we needed decisive action or it was curtains.

Pause for general mutterings of agreement.

You: In that context the fastest and most effective way to combat the GFC was a big money injection like the stimulus package. Plus the pink bats rollout helped to reduce our national carbon footprint and building the education revolution benefited the Aussies of tomorrow. With that in mind I tend to agree with former World Bank chief economist and Nobel Prize winner Joseph Stiglitz, who recently said the Australian stimulus package was one of the best designed in the world.

Then there’s the issue of waste, which if you’re going to spend that much money that quickly, is inevitable. The question is what would have happed if we hadn’t spent it? Just try to estimate what waste it would represent to the economy and to the nation if 200,000 people had lost their jobs. Then there’s a gap between what the economy could have lost in terms of taxes with high unemployment and with big machines and factories sitting around collecting dust. In other words, as Joseph Stiglitz also pointed out, our choice was one form of waste versus another. And I reckon the government choice of waste was the right one.

Pause for applause at your brilliance.

You: I’m off to the fridge. Beer anyone?