China's trade war

This week in Talking Finance, it's all about politics, the economy, the markets, and global trade.

• Katharine Murphy, Political Editor for The Guardian, takes me through the week in politics and the impact Barnaby Joyce is still having on the National Party; 
• Michael Blythe, Chief Economist for the Commonwealth Bank, runs me through the national  accounts;
• Julia Lee, Equities Analyst at Bell Direct tells me through how the markets have been performing; and
• Peter Drysdale, Emeritus Professor of Economics and the Head of the East Asian Bureau of Economic Research and East Asia Forum at the Crawford School of Public Policy at the Australian National University talks us through the China trade war issues with the U.S. and what it might mean for Australia.

Hello and welcome to Talking Finance, I’m Alan Kohler.  This week on the show, Katherine Murphy is my favourite political journalist, she’s the Political Editor for The Guardian and she’s going to take me through the week in politics and in particular, what’s going on with Barnaby Joyce and what impact he’s having on the National Party.  As for the national accounts this week and the news that GDP went up by 1% in the first quarter, 3.1% for the year, we’re going to check in with Michael Blythe, Chief Economist for The Commonwealth Bank, to take us through what he found. 

Julie Lee, Equities Analyst at Bell Direct, tells me about what’s going on in the markets.  And Peter Drysdale, Emeritus Professor of Economics at Australian National University and an expert on Asia, talks us through the China trade war problems with US and what it might mean for Australia.

[Parliament audio clip]

As usual lately, it’s a big week in politics and to talk about it we’ve got Katherine Murphy, Political Editor of The Guardian.  Katherine, perhaps you can advise me, I can’t figure out whether the Barnaby Joyce saga is completely trivial or significant, which is it?

KM:  [Laughs] Well, like a lot of things in politics, it’s both.  The minutiae is – you sort of get repelled by the sort of playing of someone’s personal history over and over and over, but it is important in the sense that obviously this sequence of events has cost Barnaby Joyce the leadership of the National Party, the Deputy Prime Ministership.  It’s isolated him within the National Party and he’s like an unguided missile from the point of view of the government. 

He mentioned in his much hyped Sunday night interview on the Seven Network that part of the reason he had sort of batted on and tried to hold his position even though he himself knew it was untenable, was out of spite, which was a fairly extraordinary admission for a politician to make and so basically since this scandal of his private life exposed in the public domain there’s been a move on internally within the Nationals to get him to move along, to move out of politics because his position at least from the vantage point of many colleagues is now viewed as untenable. 

But the more obvious that sort of hip and shoulder charge becomes, the more he digs in and defends his position and that creates day after day of these negative news cycles for the government.  It’s significant for another reason also, not only the end of a particular individual’s career in leadership of his political party, it is also I think impacting the political fortunes of the government. 

If you have a look at the Guardian Essential Poll that we published at the start of this week, it shows that the Coalition’s primary vote dropped by 4 points which is outside the poll’s margin of error, therefore something actually happened there and that coincided with another round of controversy about Joyce’s private life being in the public domain.  So, as long as this saga continues it’s going to deadweight the government.  It is quite tricky and it’s a longwinded way of saying it is both trivial and significant.

Do you think if he retains preselection for New England the government might lose it?

KM:  It’s possible.  I am from that part of the world and also went up during the by-election last year and there’s a lot of emotional attachment to Barnaby Joyce in that part of the world, but a lot of that emotional attachment is sort of tied up with two things.  It was tied up with his status in the government that he was the Deputy Prime Minister and also about his style as a politician, that he speaks the language of his constituents and that a lot of constituents in that part of the world related to it. 

The talk about his private life was audible in the electorate during the by-election period, no one new precisely what was going on but they knew that there had been a great eruption in his private life, so it was kind of known at the time of the by-election and yet he was re-elected with a swing to him.  I imagine though that the iterations since have been damaging, even though he has a strong bedrock of support up there.  He has a lot of supporters but I think there would be a lot of people in the New England area who would be concerned by his behaviour and how he’s conducted himself. 

Possibly depends on who stood against him, I guess.  I mean, Tony Windsor won that seat as an Independent and I wonder whether he’d stand again?

KM:  Well, it’s possible.  We’ve spoken to him this week, he’s certainly not ruling it out.  I think the difficulty for Windsor is that there’s sort of been a blood feud between himself and Joyce in that electorate over a couple of election cycles now and I think a lot of people around Tamworth are kind of weary with that blood feud.  The other disadvantage Tony Windsor has, despite delivering an enormous amount for that electorate particularly during the 43^rd parliament is that he did a deal with Labor.  There’s a lot of country people who won’t forgive him because he gave his support to a minority Labor government. 

I know that sounds a bit sort of black and white, but a lot of people do feel that way, so I don’t know whether Windsor would try and mount a comeback.  That seat’s certainly ripe for a high profile Independent.  There’s also quite a lot of talk about some of the guys that are in the adjacent state seats possibly making a transfer over to the federal scene.  Joyce may make way of course in amicable fashion for a successor but there’s no sign of that at the moment.  

You did a piece recently, just today or yesterday, looking at the interesting Australia Institute research where they’ve looked at the distribution of the tax cuts over seats, and surprise-surprise, the big winner is Wentworth, the Prime Minister’s seat!  There you go!

KM:  Yes, whoa, imagine that! [Laughs]

[Laughs] I suppose the question is whether this question of wealth distribution both for the personal tax cuts and obviously the company tax cuts is going to bite at some point?

KM:  Well, I think there is now quite an interesting discussion about the geographical distribution of the full tax cut package and also the gender implications of it curtesy of some more granular data that’s been put in the public domain over the last week or so.  I think if we sort of step back from the nitty gritty of the tax package for one second and look at what’s going on in the political discussion here, what Labor and others or opponents of the government has attempted to do every budget cycle over the life of this government, both Tony Abbott and Malcolm Turnbull, is to fight the main initiatives in the budget and portray the budget initiatives in this case, the tax package, as intrinsically unfair.  I think Labor and the government’s opponents have won every cycle of that battle since Tony Abbott was elected, they’ve won the fairness fight every single budget season.  The government has failed to convince the voters that its budget is fair.  We’re seeing another iteration of this now over the tax package.

Will it bite?  I think certainly the tax cuts are for higher income earners which is where the distributional effect bites in terms of where Malcolm Turnbull’s constituents get a big chunk of the pie, because obviously reflecting a number of high income earners obviously reside in his seat.  I think it is, from Labor’s perspective, campaignable that certainly the latter stage of the tax cut plan which is the abolition of the 37% tax bracket.  Because on every piece of data from everyone, the parliamentary budget office, Treasury, interest groups like the Australia Institute, NATSEM – all of the major modelling exercises that we’ve seen in the wake of the budget do indicate beyond any shadow of a doubt that wealthy people benefit disproportionately from that tax cut plan.

We shouldn’t forget of course that the first phase of what the government has put on the table is for low and middle-income earners and it’s interesting to see if we go back to gender for a second and that distributional debate that the opening phase of the tax cut plan which is for low and middle-income earners, benefits the genders more or less equally, reflecting income patterns and work patterns in that level of income.  Look, everyone wants a tax cut, Alan, it’s sort of one of those funny things.  As a political journalist, I don’t know how many opinion polls I’ve seen where people say, ‘Oh, we want to fund services, never mind the tax cuts.’  However, the lived experience of governments giving tax cuts indicate that more often than not those government’s get re-elected. 

The question is whether the higher income tax cuts survive, I suspect, is going to be very difficult.  And one of the most difficult arguments Scott Morrison’s got in order to land the higher end stuff, on the one hand he’s saying to players in the parliament, cross-benchers, Labor and others, ‘Look, we can’t accurately forecast figures 10 years out in relation to these tax measures because estimates about economic growth, wages growth and all those other things, they’re unreliable over a 10 year cycle.’  Now, that’s true, what he says is absolutely true, but yet in the same breath he is asking the parliament to lock in behind tax cuts that basically rollout for a decade, they’re baked in, they’re legislated, they rollout for an entire decade regardless of the prevailing economic conditions. 

From Labor’s perspective you can fight this on two fronts, you can fight against the lock-in mechanism and you can also fight on the fairness and distribution mechanism.  But anyway, Scott Morrison’s digging in for a fight, he’s hoping the Senate will blink and pass the lot.  

[Music]

I’m joined now by Michael Blythe, Chief Economist for The Commonwealth Bank, to talk about this week’s national accounts.  Michael, did you learn anything in yesterday’s national accounts that you didn’t already know or that we didn’t already know?

MB:  Well, I think we all suspected the Australian economy was travelling pretty well at the start of 2018, but I think it’s fair to say the bottom line outcome was a bit better than expected.  Clearly there’s been kind of a negative tone to news from offshore and somewhat domestically as well that was kind of colouring perceptions.  It was nice to get some confirmation that there is solid economic momentum there at the moment.

And it’s all about net exports and public investment, isn’t it?

MB:  Yes.  I think the good news there is these are sort of long-running features of the growth story.  That infrastructure story will be playing out over the next couple of years and it’s in a sense guaranteed contribution of growth.  Typically you start digging one of these tunnels, you don’t stop until you get to the other end and likewise, what we’re finally seeing in the net export numbers, the resource export story really firing up as all those new LNG plants come online.

Given that fact as you’ve just pointed out, public investment is more or less locked in for years and the net exports number to a large extent is about the LNG plants that have been built, there they are and they’re going to start producing, would you say that it’s pretty much impossible therefore for there to be a recession over the next few years?

MB:  I think while parts of the growth story are kind of locked in or guaranteed by the nature of what is going on, there are some big issues playing out on the downside as well.  We’re coming off what’s been the biggest residential construction boom we’ve ever had.  That’s a potential drag on the economy that builds from here and the biggest issue really though I think is that combination of high levels of household debt at a time of very weak income growth and that’s a fairly toxic mix when you’re thinking about the consumer part of the story.  That’s what we did see as well in those numbers for the first quarter GDP.  

In fact, we saw that consumption is largely being held up despite low wages, low income, by the reduction in the savings rate and I suppose you wonder how long that can go for.

MB:  Yes, well certainly the savings rate is starting to get to pretty low levels.  A lot of that boost we saw after the GFC has now been unwound and so there’s a limit I think to how much further we can go there.  Certainly, from here our consumer spending is going to depend a lot more on income growth and what sort of numbers we get there arrive on this being funded, if you like, by cutting our savings because we’ve got to use that one up.

What’s the next thing to look for, Michael, and what do you expect to see in it?

MB:  Well, I think the things we really need to see confirmed is this lift in non-mining capex that appears to be underway now.  The turn that we’ve all been waiting for a number of years now is that a sustainable increase coming through and we need to, I think, continue seeing the benefits from the growth in incomes in the Asian region flowing through.  That has been thriving booms in the tourism and education in the Australian economy, we kind of need to see that part of the story continue as well. 

But ultimately though, what we’re really looking for is a turn in the wages story.  If wages growth picks up then you can be more confident about the consumer side and some of the risks in that consumer story start to recede at that stage, it also makes you a bit more confident that inflation probably will move a little bit higher and clearly that’s something the Reserve Bank has been looking for for quite a while now.

And just finally, when do you think the first change to interest rates will be – and I presume you think it will be up?

MB:  Yes, well the Reserve Bank itself is saying the next move is almost certainly up, so we’ll agree with the direction, and then our forecast – we have that first rate rise pencilled in for February 2019, so the rest of this year nothing happening.  Slowly the Reserve Bank continues to emphasise words like ‘patient’ when they’re talking about the policy outlook.  I think you need confirmation really that that wage and price story has turned in a sustainable fashion.  The rest of the economy is looking increasingly normal.  GDP growth running above trend, the unemployment rate slowly moving towards the 5% full employment figure, for example.  If you’ve got a kind of normal economic backdrop then the case for more normal looking interest rates is there as well in that point. 

February next year makes you one of the earliest in the market, doesn’t it? 

MB:  Yes, certainly the market itself is not pricing much until you get in the second half of 2019.  The consensus amongst economists is a little bit earlier than that, Q2.  So we’re sitting in Q1, are a little bit ahead of that, but if we keep generating the sort of GDP type numbers that we saw in the first quarter then I think it makes you pretty confident that unemployment will keep moving lower and you’ll see some of that start to flow through to the wage and price story as well.  

[Music]

I’m joined now by Julia Lee, Equities Analyst at Bell Direct, to talk about this week on the markets.  Julia, there’s so much negativity around, there’s all this stuff with the banks, ANZ getting charged criminal things, CBA getting fined $700 million dollars, the trade wars, all the stuff in Europe… But the market seems to be powering along, three rises out of four days this week, what’s behind it?

JL:  I think a lot of what we hear around Italy and trade wars is noise for the market and the key for the market is that earnings growth still looks relatively strong and global growth, while there is the threat of a trade war which might de-rail growth is still looking relatively strong at the moment.  If we have a look at the market this week, despite all the noise we’ve been marching forward.  In fact, the Australian share market, less than 100 points away from a post global financial crisis high and over in the US tech stocks have been absolutely booming.

This week we saw an all-time record high for Facebook, Amazon, Apple, Netflix and indeed for the Nasdaq which is a technology based index.  Here in Australia, things not looking too bad and given that the market has been marching high it’s unsurprising that we have seen some of the Australian stocks that we love reaching all-time record highs as well.  This week, stocks like ResMed, CSL in the healthcare sector have hit all-time record highs.  As you’d expect, the internet technology sector has been highlighted and stocks like Xero, Altium and Afterpay have seen a record high.  We’ve also seen stocks like Lovisa in the retail sector as well as Sandfire in the resources space hitting an all-time record high.

To what extent do you think the driver of the market around the world, the global market at the moment, is the FAANG stocks in the US, those ones you mentioned?

JL:  Well, at this point in the economic cycle – and I guess this is a point in the cycle which tends to be good for equities and bad for bonds.  That’s the point in the cycle where you’re seeing rising growth and rising inflation.  We’re calling this late cycle because the next inflexion point is not so good for equities and that’s where you’re seeing slowing growth but still rising inflation.  But we’re still in the box where things are pretty good for equities and when you come to the late point in the cycle, what tends to perform well are growth type of stocks and growth companies. 

In fact, we’ve been at this point in the cycle many times before in history and if we go back in time we can have a look at the different sectors that have performed best at this point in the cycle, and that’s areas like energy, the material sector which includes the resource companies, as well as healthcare.  If I just have a look at how some of those sectors have performed year to date, if we have a look at the energy sector that’s been driven by higher oil prices and if we have a look at oil prices they’re up 8% in the year to date.  The healthcare sector here in Australia is up 23% just in 2018 so far, so certainly some of those late cycle growth stories are doing quite well.

Can you be a bit precise for us about where we are in the cycle?  I mean, you talk about it being late, but how late do you think it is?

JL:  That’s the fascinating thing about markets, Alan, you can be 100% correct and still lose money and that’s because of timing of these things are difficult.  There’s, I guess, a big argument going on in financial markets at the moment on how late we are in the cycle and how much longer we have to go.  My personal opinion is that we’re still 18 months away from a possible inflexion point from rising growth into the slowing growth part, but that part is what’s causing the volatility in markets this year.  The nervousness around things like trade wars, Italy perhaps leaving the Eurozone.

I think in 2018 we are going to see a lot more volatility from markets, that’s because of nervousness and the market trying to predict when the next stage of the cycle might occur.  But the truth is, nobody knows.  One of the things I’m watching very closely is the US.  It’s unprecedented that at a time of rising growth you also see this massive investment by the US government and that’s exactly what we’re seeing.  The US government is borrowing about $955 billion this year and that’s around about double what it borrowed last year. 

Not only do you have this strong growth coming through, but then you have the US government, one of the biggest spenders in the global economy also putting money back into the economy as well.  I think the worry might be that growth starts to run away, that we get runaway inflation, and then the Central Bank in the US clamps down on that growth quite aggressively and we see a strong policy response and I think that’s a major risk for the markets. 

There’s no sign of it yet though is there?

JL:  No sign of it yet!  Things are still looking pretty good as you can see from some of the market indices around the globe reaching all-time record highs.  And despite some of the doom and gloom out there and the talk of trade wars, if you have a look at the market’s performance, the Australian market has been doing quite well.  May and June tend to be very weak months for the market, in fact they tend to be some of the worst months for the market.  If you go back to 2000 and crunch some numbers, May is the worst month.  But we saw a positive performance in May, we’re seeing a positive performance in June and April was a positive month as well, so we’re looking down the face of three consecutive months of positive growth for the Aussie share market.

[Music]

I’m joined now by Peter Drysdale to talk about China trade wars and what’s going on there.  He’s with the Crawford School of Public Policy at The Australian National University and an expert on Asian economies.  Peter, apparently Wilbur Ross, the Commerce Security of The United States came back from talks in Beijing last weekend empty handed.  Nothing happened and now the trade war appears to be back on.  What impact do you think this is likely to have on Australia? 

PD:  Yeah, well I don’t think it ever was quite sorted out, Alan, so I think there’s still basically a process of negotiation going on.  I guess there were some exchanges in Beijing but they didn’t seem to satisfy either side.  The more it goes on, the more it’s difficult to see a happy resolution to this.  There aren’t many happy resolutions anyway because these are the two biggest trading nations in the world having really quite – whatever you think about the motivations of Trump’s initiative on the Super 301 and the 232 tariff initiatives, this is going to lead to a settlement that either sparks a larger trade war – best case outcome, some kind of agreement between China and the United States which means more managed trade and damage to the world trading system.  I suppose the optimism is trading now for a benign outcome in which the push from Washington is used to initiate a wider range of trade and other reforms in China, which move ahead quickly enough to satisfy the politics in Washington.  

I suppose the point partly is that China does have issues to answer in the way that it does require technology transfer, it hasn’t really opened up its markets.  I mean, there are a bunch of things that we can reasonably ask of China but they seem to be reluctant. 

PD:  Well, I think the reasonable ask is there, there’s no question about that and that’s open to negotiation.  But what we’re involved in here is something well beyond that, which is an initiative which works outside the established rules-based trading system which will have the effect of bringing that system down rather rapidly and that’s a pretty high price to pay for negotiating a different arrangement for technology transfer.  That is clearly what the issue is on the entry of foreign investment and other technology players into the Chinese market.

That’s what’s at stake here, it’s not a trivial thing.  As I said, almost any outcome from this negotiation you like to think about is going to do serious damage to the trading system.  We’ve got a circumstance in the world trading system now where it’s everybody else against United States no matter what problems still remain in China’s approach to trade and commercial policy.  That’s why everybody is so worried about this, there’ll be a direct corrosion of international rules-based trading regime if either of the most likely outcomes from this negotiation occur.

Well I guess it can’t be regarded as a surprise in that this is basically the main thing Trump talked about before he was elected and arguably has a full mandate to go ahead with what he’s going.

PD:  Yeah, it’s a complicated issue, the politics of that.  Of course, the optimists always believe that like other presidents in the past, he’d back away and see reason from the viewpoint of what the impact of this will be not only on the global trading system but also on the US economy.  I mean, there aren’t many optimistic estimates in whatever scenario you build of what the impact of this will be on the global economy.  You know here in Australia we did some scenario building on this earlier on through the Productivity Commission looking at costs of trade war on Australia, but also on other countries including United States. 

If you go down this path anyway very far, none of it’s very pretty.  There’s no question that it costs income and jobs in the United States.  If Donald Trump did what he promised in the election campaign it would bear a percentage point of precious GDP growth in the States, it’d cost 100,000 jobs on one scenario, 400,000 on an American scenario I read recently, a year.  This is a destabilising element in the global economy and despite the other elements of Trump policy, the budgetary expansion and the bullishness associated with that, you’ll have noticed that there’s a great deal of uncertainty in the market about what the outcome of this might be and every time it hits a bump, of course the market takes a hit and that’s for good reason because the effects will be longer to come in, but they will be serious and real in their impact on US growth prospects in the medium term.

What about Australia though?  I mean, this week we saw GDP numbers which were largely all about net exports, or at least that was a big factor in the growth numbers we’re seeing, and obviously net exports to China which are going really well at the moment, so what impact do you think it’s likely to have on Australia?

PD:  That’s always the immediate interest, of course.  The bigger interest, as I’ve said, is what happens to the whole system, but the immediate effects of say, a settlement with the US which saw a significant expansion of energy and agricultural exports from the US into China would damage our export prospects in that market.  Of course, as some of the more cases, American negotiators have noticed there to be a lot of a shift away from US markets to other places and into China if that was to have any immediate effect.  Of course, that comes out in the wash in global markets. 

In the longer term, as supply began to respond more special access for US exports to the Chinese market, then that would certainly damage Australia’s export prospects in the longer term.  Those effects in the medium to longer term are overwhelmed of course by the effects of whatever the trade war does or the trade settlement does out of the scuffle.  Whatever that does to the global trading system in terms of the retreat from the rules-based system and basically roughly equal access for everybody into other people’s markets, which is what that system guarantees.

It sounds like a lose-lose for Australia.  If the trade war happens, we lose and if they come to a deal that increases exports from the US to China, we also lose.

PD:  The second of the sort of best case of the worst case outcomes, as it were, but there’s no question it’d have an impact on some of our markets.  Of course, there are a range of markets in which we don’t compete with the United States in China, but there are a range in which we do.  Quite prominently, of course, beef will be directly affected as soon as a significant uptake of US beef into the Chinese market – that was to be expected anyway as soon as that distortion in the trade was eliminated, and wine and a range of things like that including some grain products.  But by far and away, some of the major markets of the US in China are on the agricultural side like soya beans and so on, we’re not a competitive supplier in. 

But there are important and very rapidly growing markets in which we are and there’s no question that even the best case outcome, some kind of agreement which gives special access to US suppliers of agriculture and energy commodities to the Chinese market will damage Australian interests.  What do we do in response to that?  That’s the question I suppose.

Happy birthday to Boz Scaggs who turns 74 today and his big hit was Georgia and it paid for his Napa Valley vineyard where he now lives in retirement – good on you, Boz.  Georgia’s a great song.

[Music]

That’s it for Talking Finance, I’m Alan Kohler, have a great week!