A vote, a rally and the RBA

The Reserve Bank got a quick endorsement from Mr D Jones this morning, with the US share index rallying strongly and supporting Governor Glenn Stevens and his board's decision to leave rates on hold yesterday.

The problem for monetary policy, though, is what might be called the Chinese Puzzle, with a twist – which is: when investment declines, will domestic consumption take its place?

As the RBA statement yesterday noted: "the peak in resource investment is likely to occur next year, at a lower level than expected six months ago. As this peak approaches, the board will be monitoring the strength of other components of demand.”

Chances are they'll be monitoring it falling short and scrambling to cut rates. That, presumably, is why some ammunition was left in the magazine yesterday.

China faces a similar issue, with the twist that the Australian government can't just keep spending on infrastructure to prolong the investment cycle if consumption falls short, as Beijing is doing.

The housing market here is showing signs of picking up and there are also signs of an improvement in consumer sentiment and spending, but there is no way this will be enough to replace the resource investment from next year, especially with unemployment rising as a result of plant closures, retail difficulties and government spending cutbacks.

As for the US, there are some suggestions the market this morning is up in anticipation of a Mitt Romney win in the election, but that seems unlikely: nobody had clue before the market close who would win, with the polls totally inconclusive, and there's no sign that anything can or will change afterwards on economic policy.

Some pundits are suggesting that Romney will appoint a more "hawkish” Federal Reserve board chairman than Ben Bernanke when his term expires in 2014 – someone less likely to print money and more likely to raise interest rates before 2015, which is the current deadline for the Fed's zero rate policy.

But that's grasping at talking points. It's a long way off and Bernanke is just one of 12 members of the Federal Open Market Committee, albeit the most influential, along with the seven members of the Federal Reserve board and five of the 12 Federal Reserve Bank presidents.

It is far more likely that the US market rallied overnight because investors agree with the Reserve Bank of Australia board that: "America is recording moderate growth” which is likely to continue.

That involves a judgment on the fiscal cliff, which looms on December 31, when the Bush tax cuts are due to expire and automatic spending cuts are due to begin, as a result of the Congressional deadlock over raising the debt ceiling.

The Dow Jones fell 3.1 per cent in October – having rallied 12 per cent in three months – because of concern about the fiscal cliff, and unless there is the sort of decisive single party mandate achieved in the White House and Congress in 1933 (Democrat) and 1896 (Republican) it's unlikely to repeat the usual post-election rally in election years.

By far the most likely winner of the 2012 US presidential election is gridlock and its running mate dysfunction. The Republicans are very unlikely to win the Senate and the Democrats won't win the House, so whoever is in the White House won't be able to do anything to stop the economy doing whatever it was going to do.

If nothing is done about the fiscal cliff, of course, that means recession next year; if the spending cuts are repealed and the tax cuts reinstated before December 31, or the whole thing is put off for a while, then the US economy is likely to keep growing at around 2 per cent per annum until the bond market forces Washington to reduce the deficit. But that looks a long way off.



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