Andrew Pegler – 12 November 2010

James Wolfensohn – not the 1950s Chicago blues legend – reckons Australia is missing the Asian boat and that the US will be stuffed for years.

James Wolfensohn is an Australian-born investment banker who became president of the World Bank in 1995. He reckons Australia hasn’t really woken up to the global shift east yet. The “Wolf” reads a lot. He gets out heaps. And he’s just written his autobiography called A Global Life. According to the Wolf our failing is to do with education. “The interest of young Australians to study in Asia is less than it should be given the huge economic dependence of Australia on Asia as a buyer of natural resources. We should be putting a tremendous effort into making sure that our young people understand those cultures better.” He has a point. So go east young men and women!

He’s also pretty downbeat on the US economy. “For the next two or three years growth will be two or three per cent, which won’t get them out of this problem”. That problem, according to the Wolf, is 10% unemployment and a further 7% have either fallen off the radar or can only get a few hours’ work a week. That makes near 17% unemployment. The Wolf also estimates that by 2050 over 60% of global GDP will be in Asia and points out this last happened in 1815. FYI in 2000 80% of the world’s GDP came from the US, Europe and Japan.

For what it’s worth here’s an idea for Barack. In an effort to kick start your ailing economy, shift that stubborn 10% unemployment, offset your crippling national debt and postpone the looming national identity crisis that will come as global power moves inexorably from west to east, the US should consider obtaining an Avon distributorship. I’m sure Hilary will be busting to hit the road and sell high-quality cosmetics and perfumes, particularly the bath and body care ranges. Vice President Joe Biden could run the online shop and Ben Bernanke could manage the customer relationships with China and India.

I will be in my caravan.

And in other news… the aforementioned US economy grew 2% over the last quarter up from 1.7% in the quarter before that. The biggest driver of demand there, consumer spending, i.e. people buying stuff, rose a tad but continues its sluggish form compared to past deep recessions.

Should Glen Stevens and the RBA board be stamping our interest rates “Made in China”? Me thinks so.

China just overtook Japan as the world’s second-largest economy and this export-driven inexorable rise of the dragon continues to laden this lucky country with a largesse of fortune cookies. Dirt? We got heaps of the stuff! Coking coal, iron ore. Natural gas? More than you poke a Bunsen burner at! And then there’s our meat, wheat and the odd treat. China’s demand-driven growth will continue to underpin demand for all this stuff and barring a global catastrophe (rogue asteroid, volcanic explosion bringing on a new ice age or Lady Ga Ga coming out as an alien) the outlook for the little economy that could is pretty damn good. And then there’s India coming online – no need to curry that favour. But if there’s a dark side to this moon it’s that rates could stay up for ages.

Why? Economists are a nervous bunch, especially when the economy grows too fast. When this happens demand for goods and services grows faster than supply. FYI goods are those results of economic activity you can drop on your foot, services are things you can’t. When goods and services grows faster than supply there is a scarcity – the laws of supply and demand kick in and prices go up, which is what inflation is.

So how do you control inflation? That’s right folks, good old interest rates. Higher rates mean less people want to borrow and that means less economic activity and therefore less inflation. Capice?

In this post-GFC resources boom mark II the world is throwing money at us for our dirt and other goodies. This in turn is boosting our incomes, and also encouraging the big mining companies to make massive, long term infrastructure investments. And all this action means spending is likely to grow faster than production, which could very easily unleash the inflation genie.

Just how high rates will need to go to put a cork on all this fun remains to be seen. At least one ex RBA bigwig reckons there’ll be four increases between now and the end of next year.

Mmm � perhaps we should get our trade figures made in China too. I hear 8 is highly sought after.

In other news … sex sells! SEX.COM could be worth up to $13m when it goes under the hammer. It last sold in 2006 for a steamy $14m, but resurfaced in July after its owner went belly up. FYI Insure.com went for $16m in 2009.The question “what’s in a name?” never seemed so relevant eh?

Andrew Pegler – 15 October 2010

With so much talk about interest rates I thought it apt to take a look at some of the basics of the whole shebang.

What’s a central bank?

This is a country’s primary monetary authority. Ours is called the Reserve Bank of Australia, known as the RBA. Other examples include the European Central Bank, the Bank of England and the Federal Reserve in the US. Central banks are busy bees. They issue currency, hold banks’ compulsory deposits and, most importantly for our purposes, set interest rates. Like most rich countries ours is independent of politics so it can’t be dictated to by the PM or anyone else. That way we usually get what is best for the economy, not short-term political objectives like lowering rates during an election campaign.

Who are these people?!

The nine members of the RBA board come from business and academia the board’s only women is Jillian Broadbent AO. They meet on the first Tuesday of every month to work though a few cups of tea and decide to cut, raise or leave rates as is. They do this after taking a good look at the latest inflation figures, economic growth, employment, home loans, building activity and how much people are spending on consumer goods. They also look at what’s going on overseas and how that will affect us. The board members are very smart, they get out a lot.

This is in your interest

As I said, the RBA is our central bank and it – not the government – sets interest rates. There are a few different kinds of interest rates but the one we’re dealing with is called the cash-rate, which is the one that influences mortgage, loan and deposit rates. The RBA uses interest rates to control economic activity. It raises them to keep the inflation genie square in its bottle and drops them to stimulate demand and investment. The principle is that if rates are higher then less people will want to borrow money and therefore economic activity will slow and that means prices slow and that means inflation slows. And vice versa. When they’ve done deciding our fate the RBA sends out a press release outlining the new rate, and why. A few weeks later they release the minutes of the meeting, which are often very revealing about what individual members of the RBA board thought and why.

Hopefully that clears that up.

Andrew Pegler – 24 September 2010

It seems like just a few weeks ago that the dollar was sub USD 90c…hang on that WAS just a few weeks ago!!

Yes folks, the little-dollar-that-could recently surged past .96c in a 26-month high. But, as we have discussed, this comes with benefits and pitfalls. Ahh, such is life.

The AUD has risen more than 17% since May against the US dollar, thanks to a strong domestic economy, a weaker US economy and relatively higher local interest rates in comparison to those in the rest of the world. This creates demand for the AUD, further pushing up its value. The laws of supply and demand again, eh?

The good bits

Get on a plane. Overseas travel is cheaper because a higher dollar means you literally get more bang for your buck. So right now your massage on that idyllic Bali beach just went from not much to hardly anything and it’s time to book in that Easter Island lunar eclipse festival (but avoid the brown mushrooms). Meanwhile imports from iPods to Belgian chocolates and from nuclear submarines to BBQ’s big enough to see from space are also cheaper as the dollar climbs in value compared to other currencies. And, while the RBA doesn’t target a particular exchange rate, cheaper imports tend to keep inflation lower. So that’s a nice win� or is it? According to Glen it ain’t and he’s gone and spoilt the party again with a warning that interest rates are heading up. That cheaper Plasma means nought if you have no home to watch it in because you defaulted on the mortgage.

Piggy in the middle

In the middle are the farmers and the diggers and drillers who get a mixed bag. On the one hand, what farmers produce is less competitive against overseas buyers but on the other hand that American-made tractor has never been cheaper. Meanwhile, BHP and Rio Tinto are more insulated because they sell our dirt in US dollars. But they take a hit when they repatriate their earnings.

The badder bits

The regular currency whipping boys of manufacturing and tourism cop another hammering with the rise of the AUD. Manufacturers who export or compete locally with cheaper imports are squeezed as their product becomes more and more expensive. And the same goes for tourism.

The future?

The other week Bloomberg claimed the Aussie Dollar was the most overvalued currency in the world and with China taking new steps to reign in its property bubble and the bond market starting to waver there is fear in the air, folks, and the herd is getting skittish. That means a potential flight to the USD which will see the Aussie go down and rates to go up – a spiral that could get very ugly, very quickly.

Andrew Pegler – 17 September 2010

For the years leading up to the financial crisis banks across the world had been progressively thinning out how much money they had up their sleeves for the day things turned ugly. As we know that ended predictably but last week the regulators finally struck back.

This stash, known as reserves, is supposed to be pretty heavily policed but pre GFC things were good so no one was really watching. Then the punch ran out, the cops turned off the music, the party stopped and the hangover started and banks everywhere went into meltdown with little in reserve to absorb mounting losses. A response was needed and a room full of bankers in Switzerland called the Basel Committee have delivered it in the form of tough new reserve regulations for banks.

Known as Basel III, the recommendations include doubling the amount of equity capital (the best kind) a bank must hold in reserve from 2% to 4.5% and an extra reserve of 2.5% of their assets called a “conservation buffer”. This buffer can be reduced or increased depending on the economy i.e. rise up to 2.5% if credit is too loose and drop if the economy is tightening. All this means that banks will now have to keep 7% of their equity in reserve in case the wheels come off again. And that’s about double what they had to hold before.

But wait, there’s more! The Basel Committee also added an optional third reserve figure of 2.5% of assets called “countercyclical buffer”. So if credit is expanding faster than GDP, bank regulators can up the reserve requirements to slow credit bubbles and strengthen the banks. Vice versa in a credit crisis – regulators can abolish the buffers immediately and set capitalism free. Nice.

My view? In the glacial-paced world of banking regulations the Basel Committee has done good/played hard. The banking system will be more resilient to larger shocks, less reliant on government support and better able to absorb losses. But let’s not forget this crisis was not about banks missing 1% or 2% of capital. It was about uncontrolled lending that went viral and undetected until it was too late. And then there’s the TBTF (“too big to fail”) problem that none of this addresses. Oh and not having all this coming into effect until 2019 is too long in this fast-paced financial age.

And in other news… Legendary US investor Warren Buffett has ruled out a double-dip recession in America. Da man with the golden touch, the oracle, the seer, the doer. “I am a huge bull on this country,” says Warren. “We will not have a double dip recession at all. I see our businesses coming back almost across the board.” Da Buff has spoken in da buff.

Andrew Pegler – 10 September 2010

Hello readers and Selamat pagi. I’ve just returned from Indonesia where interest rates aren’t the only way they keep inflation under wraps.

As we have discussed before, central banks control inflation by raising or lowering interest rates. Lowering them encourages spending and growth and vice versa. But this hits growth pretty hard and Bank Indonesia (BI), Indonesia’s central bank, has a pro-growth policy so raising interest rates goes against this. So instead BI controls the supply of money to the economy using something called the “primary reserve requirement”. What happens is BI forces Indonesian banks to park a certain fraction of their deposits with it in reserve i.e. a primary reserve requirement. And it can increase and decrease this reserve requirement as it sees fit. The thinking is that this is a neater way to alter the amount of money available for people to borrow without raising interest rates and hence control inflation. This method is not a commonly used monetary policy tool in western industrialised nations but Asian countries like it because it doesn’t hit growth as badly as raising interest rates. And in Asia growth is always the new black. But aside from academic interest, the reason I bring all this up is because right now the BI is worried that Indonesian banks have too much money available to lend to people and it fears this will feed Indonesia’s growing inflation, which just hit a 16-month high. So it has increased the banks’ primary reserve requirement from 5% to 8% of their deposits, sucking out Rp 50 trillion ($5.6 billion) from the economy in one hit. This will slow spending and cap inflation while giving BI the room to delay a rate increase if global growth picks up because, as I said, in Asia growth is always the new black.

One obvious problem I can see in all this, however, is that raising the reserve requirement reduces the amount of money around. And with less money available for people to borrow, it will be more expensive to borrow i.e. rates will go up in line with the laws of supply and demand.

FYI at the moment the Indonesian interest rate is at a record low of 6.5% – ours is 4.5%, the US’s is close to 0% and the UK’s is 0.5%. Also the BI targets an inflation rate of 4-6% while the RBA is a more sober 2-3%. The difference reflects the fact ours is a more developed economy.

Terima kasih banyak readers!

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 – 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?