THE DISTILLERY: Dollar dilemma

Jotters examine the possibility of Dutch disease induced by the Australian dollar, while some delve into China's long-term prospects.

Australia’s business writers have looked beyond the overdue acknowledgement by the Reserve Bank that the Australian dollar has decoupled somewhat from commodity prices. Instead, questions are being asked about what point the dollar really becomes a Dutch disease inducer, why intervention is on the central bank’s agenda and why deeper questions need to be asked about China’s economy rather than ‘soft or hand landing’. Also in this morning’s edition of The Distillery, two separate pieces on Billabong International illustrate the fruits and pitfalls of taking a chance.

Firstly, Fairfax’s Malcolm Maiden says the Reserve Bank has acknowledged the Australian dollar is no longer tracking commodity prices and that Dutch disease is a concern.

"The question, not attempted by the Reserve yesterday, is what value for the $A produces Dutch disease, or sufficient threat of it to warrant intervention. I suspect the Reserve will do one of the things it does best: wait, to see if the $A succumbs to gravity, perhaps if European tensions ease and the ''safe haven'' buying of the $A slows. If it is comfortable about inflation it can also cut rates to weigh the $A down, and it does not have an interventionist culture. It spent $3.8 billion buying the dollar to shore it up at the height of the global financial crisis in October and November 2008, but that was an extraordinary time, and it hasn't intervened to sell the currency since March and April 1992, when it mounted a $220 million operation. It knows, too, that intervention could raise problems of its own.”

Indeed, as pointed out by The Australian Financial Review’s David Bassanese, who reminds his readers that the Reserve Bank expects inflation to rise from 2 per cent to 2.5 per cent by mid-2013. What would happen if the RBA intervened in currency markets?

"If the dollar were start to fall in earnest – other things being equal – the RBA would be forced to revise its inflation forecasts upwards, making further interest rate cuts even less likely. What’s more, while the carbon tax is expected to only modestly and temporarily push up inflation – as its effect is hard to precisely quantify, it will further complicate the assessment of inflation trends in the coming year, and force the RBA to be especially cautious. All that said, with large downside risks still hovering over Europe – and weak hiring intentions suggesting the unemployment rate will drift a bit higher in the next few months – the bias on local interest rates remains to the downside.”

As The Australian’s economic editor David Uren explains, the Reserve Bank’s greatest immediate concern is Europe. But the longer-term problem for Australia is China and, as pointed out by The Australian Financial Review’s economics editor Alan Mitchell, this is being viewed through a prism that’s too short-term.

"The other issue that is exercising economists is the apparent lack of progress in rebalancing the Chinese economy from investment-driven to consumption-driven growth. Despite the structural reform designed to boost household consumption, the period since the global financial crisis has seen a continuing reliance on investment-driven growth. Investment is running at almost 50 per cent of gross domestic product. The prominent American economist, Barry Eichengreen, recently sounded this warning: ‘The restructuring agenda is now on hold. The new measures will succeed in keeping high-single-digit growth going for a time, as they did in 2009-10. But they will do so by aggravating the economy’s imbalances and storing up problems for the future. This is not good news for those of us concerned with China’s longer-run prospects.’ And of course, in Australia, companies making large, long-term investment decisions, and federal and state governments agonising over slow-acting structural reforms to boost productivity, must be concerned with China’s longer-run growth prospects.”

Mitchell’s colleague Robert Guy hits similar notes in his piece entitled, rather worryingly, ‘In China, every province is a Greece’.

"While Beijing has talked down another mega stimulus, it seems many provincial leaders aren’t prepared to chance any slowdown, even if it risks exacerbating the problems caused by China’s reliance in recent years on fixed asset investment (equal to nearly half of gross domestic product). Thirty of the country’s provinces, municipalities (like Shanghai) and autonomous regions posted reviews of their first-half fixed asset investments by August 2, with 26 reporting a rise in spending above the national average, according to reports in China Enterprise News. The temptation among provincial governments to fall back on the tried and tested policy of fixed asset investment rather than push ahead with the hard work of structural adjustment is a worrying sign for an economy beset by over-building and excess capacity.”

The other major topic in this edition of The Distillery is the hero and villain that emerged from the collapse in Billabong International’s value. We start first with Fairfax’s Eric Johnston, who brings us the hero – JP Morgan retail analyst Shaun Cousins, who bucked the trend in mid-2009 and dropped Billabong.

"He held on to the underweight call as the stock seemed to be catching a better wave. Billabong moved from $8.07 at the time of the underweight recommendation to touch as high as $9.54 just a few months later. But the JPMorgan analyst held tight. He pointed to the cyclical headwinds facing Billabong as well as some more company specific problems such as high levels of debt and a decision to open retail stores. Then from the start of 2010, things started looking shaky for Billabong – as well as the broader retail sector. They began to fall on broader concerns of a pullback in spending, and cool summers in its key markets of Australia and North America while the debt levels also weighed on sentiments. Yesterday Billabong shares were trading at $1.39. The savings to fund managers from the time of the call was more than 80 per cent.”

Fairfax’s Ian Verrender brings us the villain – legendary Billabong founder Gordon Merchant, who is becoming friendless since refusing a proposal from TPG Capital at $3.30 a share.

"Back then, he said, he wouldn't even consider $4 a share for Billabong. Now, after shareholders were asked to stump up $255 million in new capital, the Billabong board is considering a reduced $695 million offer from the very same private equity firm. Merchant, once hailed as the richest man in surfing with a personal wealth somewhere north of $870 million, is now worth a fraction of that. Even the normally fawning world of surfing has turned against him. His much despised childhood nickname is now freely bandied about on the glossy pages of surf magazines. An uncompromising individual with a sometimes volcanic temper and a demand for perfection, he put a great many people offside in his obsession to build the company that Billabong eventually became. Now, with the glory days well in the past, the knives are out.”

Verrender goes on to explain that on two occasions in the company’s history, Billabong has been on the brink of collapse. But Merchant stood firm and the company endured and rediscovered its value. Third time unlucky, it seems.

In other company news, The Australian’s John Durie has a great yarn about a battle between the investment banks and the ASX.

Fairfax’s Ross Gittins says it’s simply less credible to claim that Fair Work Australia is a conspiracy against employers after the industrial umpire ruled against the Transport Workers Union in its dispute with Qantas Airways.

In mining, The Australian Financial Review’s Jamie Freed, a fantastic resources reporter, says some of Rio Tinto’s shareholders are arguing that the miner should cut its losses truly and divest the its entire aluminium business. The Australian’s Robin Bromby says the people at Excelsior Gold really turned it on at the Diggers & Dealers conference.

Fairfax’s banking writer Eric Johnston reports that the Australian Prudential Regulation Authority, the top regulator of the financial industry, is warning the big four banks to be wary of lending risks when considering hardship concessions for borrowers.

Fairfax’s Adele Ferguson gives her take on how technology is changing the face of the financial industry landscape.

The AFR’s Chanticleer columnist Tony Boyd said that between Telstra’s share price drop, NBN Co’s budget blowout and Stephen Conroy’s poor PR performance, it was a bad seek for the telecommunications sector all up.

And finally, Fairfax’s Peter Cai reports that Beijing is being urged by Chinese business leaders to review its government-led overseas investment strategy after finding resistance not just in Australia, but the US as well.

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