Eureka's Week: US and Japan, productivity, monetary policy, growth, Trump, liquidity, debt, banks

US and Japan | Hayman | Productivity | Monetary policy | Growth | Trump | Liquidity | Debt | Banks | Robots and artificial intelligence | Australian GDP | Readings & viewings | Last week | Next week

Last night 

Dow Jones, up 0.25%
S&P 500, up 0.43%
Nasdaq, up 0.65%
Aust. dollar, US71.87c

A letter from Paul Clitheroe, our Chairman

Eureka's Week

with Alan Kohler

US and Japan

More evidence emerged this morning of the bipolar world we're in: American GDP growth for the first quarter was revised up and Japan sank further into deflation. To drive the point home, Fed chair Janet Yellen gave a speech in which she pointed again to another rate rise in “coming months” and the US dollar promptly surged against the Yen, and all this happened as President Obama was visiting Hiroshima, not that there's any connection.

The Japanese headline CPI fell 0.3 per cent year on year in April, after falling 0.1 per cent in March. It was mainly caused by lower commodity prices and the higher yen (it's up 12 per cent against the US dollar since early December, which is definitely not what is supposed to be happening). But domestic inflation is also weakening: underlying inflation fell from 1.1 to 0.9 per cent in April.

The deepening Japanese deflation is a bit of surprise, considering that GDP growth for the first quarter surprised on the upside recently – 1.7 per cent annualised instead of the 0.3 per cent expected. Mind you, 1.7 per cent growth is hardly spectacular.

US growth had been 0.3 per cent in the first growth but this morning was revised up to 0.8 per cent – also not spectacular by any means, but as one economist said: “First-quarter growth still looks disappointing, but the most recent data indicate that activity is bouncing back solidly”.

The key quote from Janet Yellen's speech at Harvard University was: “It's appropriate — and I've said this in the past — for the Fed to gradually and cautiously increase our overnight interest rate over time,” she said. “And probably in the coming months such a move would be appropriate.”

Yes, she's said it in the past, but as always the market acted surprised and the US dollar bounced from 109.5 to 110.4 yen. The Australian dollar fell from US72.2c when I was on the ABC News last night to 71.8c this morning.

There has been a succession of Fed speeches and statements pointing to a June US rate hike, so it seems pretty much locked in. Will that confirm US dollar's May strength and end the inconvenient weakness that has been causing such problems around the world since last December? Let's hope so. The last thing we need right now is another interest rate cut, as the RBA tries to get Aussie dollar into the 60s.

What we need, along with the Japanese, is for the 3.5 per cent rise in the US dollar trade weighted index since the start of May to be consolidated and turned into a proper dollar bull market. The signs look good for that: apart from the revision to Q1 announced this morning, the labour market there has stayed strong and there have been signs of inflation rising back to the Fed's two per cent target.

Hayman

I attended the Australian Davos Connection's Hayman Island leadership retreat last weekend (I was there when last Saturday's review was sent to you). I've been going to these retreats for the past few years and they're always like a three-day dinner party discussing the big economic (and other) issues of our time and this year was no exception.

The deal is that it's Chatham House Rule, so I'm not allowed to quote anyone, but I can discuss the ideas I heard. What follows is from my notes.

Productivity

American productivity growth has halved, from an average of 1.5 to 2.5 per cent between 1995 and 2005, to one per cent on average since 2005. In fact productivity in all major countries, including Australia has collapsed.

That's despite one of the most intense periods of technological disruption ever seen – something we're all familiar with. What's going on?

One of the world's top economists and thinkers offered a few possible explanations:

1. There's a measurement problem, a “radical increase in incompetence” at measuring economic data.

2. Investment is very weak. Companies have lots of money but aren't investing it (this is true).

3. Demand is weak and firms are employing people but not getting much out of them (I'm not sure what that means).

4. Technology is not as transforming as we think, that it simply isn't having that much effect. This is the explanation that the speaker preferred – that technology is not affecting huge swathes of the economy, specifically government, education, health and tourism are 70 per cent of the economy and it hasn't yet transformed those industries. Are we really happy to be looked after by robots, he asks? In manufacturing humans are being replaced by robots, but that's now a small part of the economy.

He thought the last of those was the most plausible.

Monetary policy

Almost everywhere it is the most aggressive it has been in the history of the world. Everyone has become Japan – low growth, low inflation/deflation, low interest rates, weak demand. We are in uncharted territory.

Central banks are powerless, so far, but there is actually no limit to what they can do. There is no limit to amount of money they can print and interest rates can go a lot more negative than they are (five central banks currently have negative rates, somewhere between zero and minus one).

But there is another reason rates are low, apart from central banks trying to get inflation back up to two per cent: “savings aren't worth anything”.

That is, there is vast glut of savings in the world and little demand from companies to invest it. Simple rules of supply and demand are driving down the price of those savings, so if you are a saver, or someone living in savings, you have something that's in oversupply.

Growth

Someone from the IMF described the outlook as “low for long”.

The world permanently lost 12 per cent of GDP in 2008-09 that will never be got back. In fact it's worse than that because the GDP growth line has flattened since the GFC, so the gap between what would have happened without the GFC and what has actually been happening is getting wider.

Why? Because it isn't just savings in oversupply – there's overcapacity everywhere, or everything.

Partly as a result of that trade has collapsed (countries don't need to buy as much stuff from elsewhere). Between 1986 and 2007 annual growth global trade was 1.5 times GDP; now it's less than GDP growth (two per cent versus three per cent).

Foreign direct investment used to 4.8 per cent global GDP; now it's 2.4 per cent.

Trump

The push for Brexit and Trump winning the Republican nomination, as he did yesterday, and possibly becoming President, are two manifestations of the same thing: a backlash against globalisation.

The good news is that Brexit won't happen, but the bad news is that Trump could happen. This is perhaps the greatest threat that the global economy faces, because if Trump carried through all his promises and ideas he would have to withdraw the United States from the World Trade Organisation.

It's clear that the economic and financial elites failed. People suffered costs and saw their futures blighted, and they have also seen those responsible for that not properly punished.

That has led to a fundamental crisis of confidence in policy making elites. Why? Because it's true. They did well in the immediate aftermath of the crisis, but since then they have been at sixes and sevens.

Liquidity

Liquidity is a dangerous illusion because it's never available when you really need it.

Debt

Governments should all borrow incredibly long at the moment to lock in low interest rates to fund infrastructure, so that if/when rates go up it won't affect the existing stock of debt.

Interest rates will only go up if there is an investment boom, and if that happens economic growth will return and the debt will “melt away”.

Banks

What's really unnatural about the present situation is that bank assets are exchangeable at par with the central bank. The assets are risky and are not worth what they're in the books at.

This is a peculiar and unstable situation.

Robots and artificial intelligence

Looking at it in terms of machines replacing jobs is unhelpful – what they are actually doing is replacing tasks.

In every job some tasks are routine and some require judgement and creativity. It's clear that the number of tasks that can only be performed by human beings will be smaller than we think.

Australian GDP

The National Accounts come out on Wednesday, but a few components were released this week so we can have a pretty good guess at it. GDP growth is likely to be less than three per cent for the year, probably around 0.8 per cent for the quarter.

In other words, growth is slowing, and more importantly perhaps, without the contribution net exports Australia would be in, or close to, a recession. In other words, the domestic economy is quite weak – almost shrinking.

We learnt on Thursday that business capital expenditure fell by 5.2 per cent in the quarter. On Wednesday it was construction – down 2.6 per cent. Residential construction remained firm (up 1.5 per cent) but non-residential fell seven per cent.

Domestic final demand is expected to be flat in the quarter. Household consumption is slowing.

NAB's economists put out a paper this week estimating that Australia's potential growth had fallen from 3.25 per cent to 2.5 per cent – a little below actual growth.

Productivity growth has slowed noticeably since the 1990s (see item above), but the effect of that on GDP was postponed by the mining boom.

Given the likely weakness in population growth, the only way potential GDP growth is going to get to where it was is through a surge in productivity (GDP growth is basically the addition of population growth and productivity).

The low hanging fruit for productivity gains has all been picked, so future gains will be hard. However progress can still made and IMF analysis shows there are still a few industries that could benefit a lot from efficiency gains.

But as I told an audience of western suburbs business people at a breakfast at Flemington Racecourse yesterday morning, it means the easy wins for business, and therefore investors, are probably over. 

Readings & viewings 

Here's a piece I wrote for the ABC's The Drum in 2012, called “Australia's super system is a national disgrace”. I actually think it still is.

An hour-long video of Jim Grant explaining about the forgotten depression of 1920 – “the crash that cured itself”. Worth every minute, if you can spare the time.

Daniel Blake of Morgan Stanley explaining on video why he thinks the RBA cash rate is going to 1%.

How could American society have regressed to the point where a bridge that could be built in less than a year one century ago takes five times as long to repair today?

Big business doesn't want to talk about it, but SMEs lose from a company tax cut (says Janine Dixon of Victoria University). 

Europe's latest deal on Greek debt is hardly a breakthrough.

Greece is being destroyed by the EU that it so foolishly joined and trusted.

At its core, the financial crisis was a systemic run.

An octillion. A billion billion billion. That's a fairly conservative estimate of the number of times a cellphone or other device somewhere in the world has generated a bit using a maximum-length linear-feedback shift register sequence.

The superbug that doctors have been dreading has arrived in the US.

Stephen Koukoulas: the art lover's guide to the election.

Smart tampons? Maybe not every single thing should be connected to the internet.

The problem with Wikipedia is not the reliability, but the fact that it has become a monopoly.

The US military uses 8-inch floppy disks to co-ordinate nuclear force operations.

A new political thriller on climate change.

Fascinating interview on media economics.

Barrie Cassidy: So taking all factors into account - the strength of the sitting members where it matters most; the patchy nature of Labor gains; and the state by state break down - the Government's losses would have it winning the election but bumping right up against minority government.

Review of a new book about the race to crack the human genetic code.

Amazing: bees swarm on a car in Wales.

On of the 20^th century's most important figures, Bob Dylan, turned 75 on Wednesday. His importance was all about his qualities as a poet.

His body of work is incredible, unmatched. I think his masterpiece is Blood on the Tracks, but others might say Blonde on Blonde, or perhaps Planet Waves. But this piece in Rolling Stone says I'm in good company.

As for particular songs, for a long time I loved Simple Twist of Fate best of all, and didn't really like Lily, Rosemary and the Jack of Hearts. But lately I've really come round to that longest song on the album. 

And today is the 71^st birthday of John Fogerty, leader of Creedence Clearwater Revival. Great band. Here they are doing Proud Mary. 

Last week

Shane Oliver, AMP

Investment markets and key developments over the past week

Share markets had a good week helped by a combination of improved confidence regarding US growth, increasing signs that the global oil market is rebalancing helping the oil price and energy shares and Greece and its creditors agreeing a new debt deal. Combined this saw most share markets rally for the week and gains in oil and metal prices. However, bond yields fell and the $A was little changed as was the $US generally.

Message from Fed remains that a rate hike is getting closer, but July still looks more likely than June. Fed regional presidents continue to wax lyrical on rate hikes (which makes me wonder whether Fed transparency is really a cacophony) but it's worth reiterating that many of them don't vote and they tend to be more hawkish that key Fed decision makers. In terms of the latter comments by Fed Governor Jerome Powell (who always gets to vote) suggest a lack of urgency given the Brexit vote and the low risk of waiting, suggesting that July is more likely for a hike than June.

Why are markets so far more relaxed about a Fed rate hike? Several reasons: 1/ more confidence in US/Chinese and global growth; 2/ Fed caution and delays have provided confidence it is not going to be reckless; 3/ the global oil market is rebalancing helping stabilise the oil price and reducing the risks for oil producers; and 4/ less concern about a collapse in the Renminbi. Of course this could all change if the $US takes off big time again, but so far so good.

While the oil market may be rebalancing (with supply cutbacks in the US & outages in Canada, Nigeria and Libya) this is not the case for iron ore where the price is on its way back down as the global steel glut remains. After spiking to $US70/tonne early this year it's now back below $US50. 

Brexit risk receding? Polls appear to be edging in favour of a Remain outcome from the June 23 referendum as opposed to Leave. In my view the case to Leave is dubious because it would be a big negative for the UK financial sector and would either harm UK free trade with the EU (if no trade deal is agreed after a Leave vote) or lead to reduced national sovereignty if a trade deal is cut (because the UK would have to agree to EU rules but have no say in setting them). Perhaps this logic is starting to set in. The end of the migration crisis in Europe (sea arrivals have collapsed to 12,000 in April from 220,000 last October) may also help the Remain case.

No Grexit scare this summer. I know it didn't get much coverage (why bother to report good news, it doesn't sell), but Greece, the EU and the IMF agreed a new debt which will see €10bn disbursed. This is good news because it means there won't be another Grexit scare this summer. Bond yields in Spain and Italy also fell in response.

Major global economic events and implications

US data again provided mixed messages over the last week. On the one hand business conditions PMIs slipped in May and core durable goods orders were weak in April. But against this home prices continue to rise, new and pending home sales surged, the advance goods trade balance for April was better than expected and jobless claims fell again. The overall impression remains that US growth has bounced back in the current quarter with the Atlanta Fed's GDPNow GDP tracker now running at 2.9 per cent, but growth is averaging out around 2 per cent or slightly less so the trend is still not overly strong. But a long way from the recession obsession of earlier this year.

The news out of Europe was okay. Sure manufacturing and services PMIs fell in May but only fractionally and they continue to point to moderate economic growth. Meanwhile, consumer confidence and the German IFO index picked up.

Japanese data was soft with a further fall in the May manufacturing conditions PMI to a weak 47.6 and a higher trade surplus due to weaker imports. GDP may be falling again. Meanwhile, national core inflation remained low at just 0.7 per cent yoy in April, with Tokyo data pointing to a further fall in May. Expect more fiscal and monetary stimulus in the next month or so.

Australian economic events and implications

In Australia, the business investment slump continues with March quarter construction and capital expenditure data (or capex) falling more than expected. Mining investment remains the main driver. What more business plans point to is ongoing mainly mining driven weakness over the year ahead. The ABS' capex intentions surveys are continuing to fall compared to estimates made a year ago and point to a roughly 20% decline in capex in the next financial year driven by a further 35 per cent slump in mining investment. So capex remains an ongoing detractor from growth.

However, there are some positives: dwelling construction rose again in the March quarter; the slump in mining investment over the year ahead will take it back to around its long term norm as a share of GDP so it's growth detraction will fade (see the next chart); and the outlook for non-mining investment is starting to look a bit less bleak with non-mining capex plans edging up from year ago levels. That said the economy will still need help from lower interest rates and a lower $A to help offset the growth gap over the year ahead from falling mining investment.

RBA Governor Stevens didn't really add anything new on the interest rate outlook but provided a solid defence of its inflation targeting approach describing it as "easily the best monetary policy framework we have ever had", and indicating he "does not agree" with proposals to adjust the target. I agree.

Next week

Craig James, CommSec

Big week of economic data

To claim that the upcoming week is a big week for economic events borders on under-statement. Around a dozen key events are scheduled and at least a dozen events are in focus overseas. In Australia, the week kicks off  on Monday with the release of the Business Indicators publication from the Bureau of Statistics (ABS). The publication includes data on profits, sales, wages and inventories.

On Tuesday the weekly consumer confidence data from ANZ and Roy Morgan is released. The ABS issues building approvals, government finance and balance of payments data. The Reserve Bank releases data on private sector credit (broadly, outstanding loans).

On Wednesday, the March quarter economic growth figures are released – that is, growth in gross domestic product. The data is somewhat dated, covering the quarter. But currently the economy is growing at a world leading annual pace of 3 per cent.

Also  on Wednesday, CoreLogic RP Data releases May data on home prices. Of some concern for the Reserve Bank, latest data suggests Sydney prices have accelerated, up 3.3 per cent over May to stand 13.3 per cent higher than a year ago. Nationally, prices are up 1.6 per cent in May and up 10.2 per cent over the year.

On Thursday, the ABS will release April data on retail spending as well as international trade (exports and imports). Retail trade is growing at a 3.5-4.0 per cent annual pace, well above the 1.3 per cent rate of inflation. And on Friday, the ABS releases the “Overseas arrivals & departures” publication. The main interest is in the data on tourist arrivals and departures. But the publication also includes longer-term immigration flows.

Also on Friday the Federal Chamber of Automotive Industries releases the May data on new car sales. Annual sales figures have been consistently setting new highs in recent months.

Chinese purchasing managers surveys & US jobs data in focus

In the US, the highlight in the coming week is the release of employment data on Friday. And in China, gauges on manufacturing and services sector activity are released. The US celebrates the Memorial Day holiday on Monday. But on Tuesday economic data arrives in spades with readings on home prices, consumer confidence and personal income and spending all slated for release.

Home prices are up by a healthy 5.4 per cent over the year. And spending is tipped to have lifted 0.6 per cent in

April, ahead of the 0.4 per cent expected lift in incomes. The usual weekly data on chain store sales is also released on Tuesday.

On Wednesday the Federal Reserve Beige Book is released with the ISM purchasing managers index for manufacturing,the ADP employment index, construction spending, auto sales and weekly data on home purchase and refinancing. The ISM gauge may have been little changed near 50.8 in May suggesting modest expansion in the manufacturing sector. The ADP survey is expected to show an 180,000 lift in private jobs in the month.

Also on Wednesday, in China the National Bureau of Statistics will release results of purchasing manager surveys for both manufacturing and services sectors. The equivalent Caixin survey for manufacturing (final reading) is also issued on Wednesday with the result for the services sector on Friday.

On Thursday, the Challenger job layoffs series is released in the US together with the ISM New York index and the usual weekly data on new claims for unemployment insurance (jobless claims).

And on Friday in the US, the pivotal non-farm payrolls (employment) data is issued. Analysts expect that jobs grew by 170,000 in May while at the same time earnings grew by 0.2 per cent and unemployment was unchanged at 5.0 per cent. The jobs market is at or near “full employment”. But with wages only growing modestly, the Federal Reserve has been reluctant to lift interest rates.

Also on Friday, the US ISM services sector survey results for May will be released. Analysts expect a reading near 55.7, confirming that the sector is expanding at a moderate pace.

As usual speeches by US Federal Reserve officials will be watched closely over the week.

Sharemarket, interest rates, currencies & commodities

Over the year the ASX 200 index has fallen by around 6 per cent. While disappointing, the UK market is down 13 per cent and Japanese market has fallen by 18 per cent, although the US market is down only 4 per cent.

And while the Australian market is down over the year, it's not the same for all companies. The MidCap 50 index has lifted by around 5 per cent over the year while the Small Ordinaries index has lifted by 1 per cent. At the other end of the scale the ASX 100 index has fallen by almost 8 per cent, while the ASX 20 – representing the sharemarket's heavyweights – has fallen by almost 13 per cent.