Despite the steps taken in the last couple of weeks, it remains the case that the European project is only half-finished. We admire Europe’s ambition in seeking to bind itself together so that it may never again tear itself apart through pan-European military conflict and political upheaval.
We don’t doubt the emotional commitment at the heart of the euro. But Europe’s leaders must accept that the economic structure they sought to build lies incomplete. A monetary union standing alone remains structurally unstable. It must be reinforced by the strong foundations of a fiscal union, and the supporting pillars of a banking union and political union.
The answer – the only answer – lies in more Europe, not less. Of course, this is a reform story that will span decades, not months. It requires more political courage among Europe’s leaders than they’ve shown to date – to take difficult decisions in the long-term interest of their people. That’s what leadership is about – forsaking the politically easy, populist road, in favour of the more challenging but more sustainable path towards prosperity for the future. There’s been too little of this in Europe up to now.
Here in Australia, we have rich and proud history of leaders who have set aside their political interests to take decisions in the long-term national interest. Whether it was floating the dollar, bringing down the tariff wall, abolishing centralised wage fixing, or introducing compulsory super. Or in our case the carbon price, MRRT and more. We’ve stumped up and pushed forward when the times called for it. Europe has much of this nation building task still ahead of it. As they bind their countries closer together, European policymakers must continue their efforts to support economic growth and job creation, and recapitalise their banking system. They must do this while they implement a credible medium-term framework to reduce excessive sovereign debt levels and boost competitiveness through structural reform. There is little doubt this will be a very long and painful adjustment with bouts of volatility in global financial markets along the way.
So Europe’s obviously the first key risk to the global outlook, but there’s another on the other side of the Atlantic. In the United States, we are reminded again of the price paid by the community when hard decisions are delayed. It’s been just over twelve months since the venomous partisan debate over the United States’ legislated borrowing limit and fiscal trajectory led to S&P stripping the US of its prized AAA-rating after 70 years. Despite President Obama’s goodwill and strong efforts, the national interest was held hostage by the rise of the extreme right Tea-Party wing of the Republican Party. The consequences were grave.
S&P said at the time that the downgrade reflected its view that: "The effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.” S&P cited "the difficulties in bridging the gulf between the political parties over fiscal policy”.
These are words of warning to politicians the world over. There can be few things more alarming in public policy than a political movement which was genuinely prepared to see the US government default on its obligations in order to score a political point.
Fast-forward to today, against the backdrop of a very close presidential campaign, and global investors are once again keenly focussed on political gridlock in the US. As is well known, a ‘fiscal cliff’ looms early in the new year threatening to derail the still moderate recovery in the US. The Congressional Budget Office estimates that currently legislated spending cuts and tax increases amount to a fiscal consolidation worth around 5.1 per cent of GDP in the 2013 calendar year. This would tip the US economy back into recession – the CBO estimates the US would contract at an annual rate of 2.9 per cent in the first half of 2013.
To give you an idea of the counterfactual, the CBO estimates that if US lawmakers removed the scheduled contraction in full, the US economy would likely grow somewhere in the order of 4.4 per cent in 2013. With the world watching, it is imperative that the US Congress resolve an agreement to support growth in the short term. In a throw back to a year ago, global markets are nervously watching the positioning of hardline elements of the Republican Party for signs that they will dangerously block reasonable attempts at compromise.
Let’s be blunt and acknowledge the biggest threat to the world’s biggest economy are the cranks and crazies that have taken over a part of the Republican Party. Of course, Congress must outline a credible medium-term plan to assure markets that the US can put its budget back on a sustainable footing over time, building its fiscal strength to respond to future challenges. Last week, Moody’s confirmed it would likely join S&P in downgrading the US from AAA if the US Congress does not outline a credible plan for reducing its debt levels over time. But Moody’s observed that unless this was achieved without a "large, immediate fiscal shock – such as would occur if the so-called fiscal cliff actually materialised” its ratings outlook would likely remain negative.
So in the US as in Europe, we’ve seen political gridlock, excessive public debt, and no room to move on interest rates – leading the US central bank to respond with unconventional monetary policy. The Fed last week delivered on market expectations for another round of quantitative easing – in fact surprising on the upside with an open-ended program and the promise of very low rates even longer into the recovery.
The numbers involved are staggering. Consider this. Even before QE3 – as it’s known – the total nominal value of unconventional monetary policy undertaken by the Fed so far – at over $US2.5 trillion – is around 75 per cent greater than the size of the Australian economy in 2011-12. Of course Ben Bernanke doesn’t think he can bridge the ‘fiscal cliff’ or that QE3 will be a panacea – but like Draghi he’s willing to do what it takes within his mandate because the politicians aren’t stepping up. Just like Draghi, Bernanke has mounted a strong defence of his actions to defuse the ideologically-driven criticisms of the political class – in his case, ultra-hawkish.
Let me turn now to the outlook for China. There’s been a lot of talk recently about the pace of Chinese growth – with markets forensically examining each monthly data point for evidence that China is slowing too fast or not speeding up fast enough. So I say this very clearly – I am an optimist about China. Setting aside the limitations of monthly data, I can tell you I was just up there recently meeting with the leadership and I think there are very good reasons to be optimistic about China's prospects. Yes, China’s growth has moderated, but this partly reflects a very deliberate move to more sustainable growth, together with the impact of ongoing weakness in Europe on Chinese exports. Chinese policymakers have got substantial policy flexibility to respond and they’ve said this repeatedly in recent weeks. And when it comes to China’s growth rate, we really just need to keep things in perspective; China is now 40 per cent larger than in 2008 so its growth rate can be 20 per cent lower – 8 per cent versus 10 per cent back then – for it to make the same contribution to global GDP growth.
It’s like Usain Bolt easing off a bit at the end of the 100 meters because he’s 10 meters in front and has already smashed the world record. Yes, the recent moderation in China’s steel demand has contributed to the decline in commodity prices, and as we forecast in this year’s budget, our terms of trade peaked in September quarter last year. We also know there are other pressures, not assisted by such decisions as the Newman government’s decision to jack up royalties which the industry loathes because they hit smaller players hardest. But we also expect our terms of trade to remain at high levels over the medium term, underpinned by the long term growth story in our region.
And as RBA Assistant Governor Christopher Kent reminded us this week, we’re only part of the way through the current mining boom, which can be characterised as three overlapping phases. A boom in prices, then investment, and then in exports. And while we’ve passed the peak in prices, the second and third phases still have a way to run. In the June quarter, business investment as a per cent of GDP reached its highest point in 40 years at 17.1 per cent, and we expect it to rise further over the next year or so. That’s why I have to laugh when I read ideologues in our print media try and write about sovereign risk. It’s absurd. We’ve got a half a trillion dollar pipeline in the mining sector alone, with more than $260 billion at advanced stage. These are projects which are largely locked in already.
So we’re sitting in the right part of the world at the right time, at the dawn of the Asian Century. We’re witnessing a structural change in the global economy, with a massive shift of economic weight to our region. Of course it’s much broader than just China – it’s countries like India, Indonesia, Vietnam, Thailand and Malaysia. But the industrialisation and urbanisation of China is a long-term trend as powerful as any the global economy has ever seen.
And there is still a very long way to run. Although it has already lifted many millions out of poverty, China’s GDP per capita today is still only one-fifth of the average of advanced economies. By 2025, it is projected to still only reach around 50 per cent. China still has enormous capacity for deepening its capital stock through investments in productive infrastructure. Consider this: China and the US are roughly equal in land mass. But China’s rail lines are still only just over one third the length of those in the US. According to the Reserve Bank, there is also a long way left to run on China’s path towards urbanisation. Over the next two decades, China’s urban population is expected to increase by 42 per cent, so that by 2030 around 7 in 10 Chinese will live in urban areas. But by 2030, China still won’t have caught up to Australia with our urbanisation rate of nearly 90 per cent. The peak steel requirement for Chinese residential construction is not expected to be reached until around 2023 – a decade from now.
All of this means, in the Reserve Bank’s view that: "Australia is well placed to retain its position as the largest supplier of iron ore to China in the coming years, particularly given the relatively low cost of extraction of iron ore.”
I’m really optimistic about the role that Australia can play in the global transformation I’ve been talking about, not just as passenger but as a driver of the Asian Century. It’s not only about digging things up and shipping them off. Across the Asia-Pacific, the ranks of the middle class are swelling at something like 110 million people a year.
That’s a figure that should have ambitious Australian entrepreneurs champing at the bit. By the end of the decade, there are will be more middle class consumers in Asia than in the rest of the world combined. It won’t just be the biggest production zone in the world, it will be the biggest consumption zone too. Just think of the enormous opportunities this will mean for Australian industry to get up the value chain and deliver the complex consumer durables and sophisticated services Asia’s middle class will demand.
This article is an edited extract of Treasurer Wayne Swan’s speech to the Financial Services Council on September 21.
China's boon is only beginning
As Europe displays a dangerous lack of courage and US growth stands hostage to the extreme right, China will continue to defy its naysayers. Australian entrepreneurs should be champing at the bit.
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