THE DISTILLERY: Euro honed

Jotters dissect what 'unlimited' bond buying means, while several highlight growing concerns for China's economy.

Australia’s business commentators collectively address the immediate outlook for our economy by looking at events in Europe, China and at home. Europe’s long-term demand for Chinese products is in the hands of its central bankers, while China’s demand for Australian resources is in the hands of its policymakers. All of this will greatly influence our own Reserve Bank.

Fairfax’s Malcolm Maiden explains how Italy and Spain are the main targets for the "outright monetary transaction” scheme, available to nations that bow to austerity measures in exchange for bailout funds. European Central Bank president Mario Draghi said "precautionary” fiscal programs might be rolled out to nations that struggle to hit their targets, which is a crucial sign that Greece’s turnaround might be slowed to reduce the pain.

"The ECB says it will ‘sterilise’ any bond purchases, by withdrawing the same amount that it spends buying bonds somewhere else in the European financial system. Theoretically, this is a different tack to the ‘quantitative easing’ taken by America's Federal Reserve and the United Kingdom's Bank of England, which have both conducted unsterilised bond-buying operations to deliberately inject cash into the economies they are overseeing. Sterilisation is, however, mainly aimed at placating inflation fetishists, notably Germany's central bank, the Bundesbank, which voted against Draghi's plan at yesterday's ECB governing council meeting, in the belief that it breached the central bank's ban on directly funding governments. The reality is the ECB is also a quantitative easer: it has twice offered European banks unlimited three-year funding to keep them afloat, and has injected 1 trillion ‘unsterilised’ euros into the economy through that window so far.”

Karen Maley, formerly of Business Spectator fame, unleashes her European expertise in the pages of The Australian Financial Review. Maley explains how the fresh optimism in Europe could come under threat this week with a preliminary verdict from the German Constitutional Court on the legality of Europe’s permanent bailout fund and the fiscal pact.

"Although Germany’s Parliament ratified both measures at the end of June, German President Joachim Gauck has delayed signing them into law until the Karlsruhe-based court comes to a decision on the two contentious issues, which were subject to legal challenges from a huge range of disparate groups. These included the ‘More Democracy’ movement which collected 37,000 signatures and which enjoys the backing of Germany’s Pirate Party as well as the country’s powerful Taxpayers Association; eurosceptic politicians and academics, as well as the radical leftist Die Linke party. Opponents argue that German politicians lack the constitutional right to approve the euro zone’s new €700 billion ($864 billion) bailout fund, because it is allowed to borrow from ‘other institutions’ and that these borrowings will saddle German taxpayers with massive financial liabilities, in violation of their democratic rights.”

Fairfax’s Asian affairs reporter Peter Cai takes readers into China’s internal debate about economic stimulus, which is so crucial to Australia’s prospects.

"A leading financial publication in China has called the local governments' stimulus plans ‘delusional’. He Fan, a senior researcher at the Chinese Academy of Social Sciences – an influential government think tank – and a special adviser to China's Minister of Finance, said it was unlikely the government would unleash another round of a large stimulus package and any future spending would be carefully targeted. He said the government was concerned about the after-effects of the 2009 ¥4 trillion stimulus package, which resulted in widespread waste and corruption. The previous round of stimulus spending was largely financed by banks and many of them were concerned about the ability of the local government to repay their debts. Dr He said ‘banks would not make the same mistake again’.”

The Australian Financial Review’s economics editor Alan Mitchell makes direct reference to the price of iron ore and coal in his analysis of China’s possible policy directions.

"The slowdown is partly cyclical, and the weakness of China’s European and North American export markets is causing unsold inventories to pile up along the length of its production chain. But China’s problems are also structural. Symptomatic of these structural problems is the failure of state-owned producers to adjust their production more quickly to the emerging market reality. They were responding, not to market signals, but to politically determined incentives including a history of bottomless government-directed credit. The change of government in Beijing undoubtedly made this problem worse. These underlying structural problems – and the need now to deal with them – will affect what the new leadership can do to speed up the growth of demand.

And bringing things back home, The Australian Financial Review’s David Bassanese revisits his suggestion from two weeks ago that the Reserve Bank would have to cut rates by 100 basis points in the coming year.

His commentary specifically deals with the fact that the cash rate is 170 basis points below its 5.2 per cent average since 1996, while the average rate that borrowers are paying is just 60 basis points below the average.

"That’s consistent with the view that higher post-GFC bank funding costs have reduced the ‘neutral’ level of the official cash rate by around 100 basis points. All up, we might consider that the neutral cash rate is now around 4.25 per cent, implying the cash rate is presently 75 basis points below neutral. Is this enough to stoke demand? So far the evidence is pretty poor: home lending has barely lifted, consumer confidence is down and business investment intentions in the non-mining sectors of the economy quite weak.”

The Australian’s economics editor David Uren delves into last week’s employment numbers to make some sense of the falling jobless rate, which is contrary to the expectations of both Treasury and the Reserve Bank of Australia.

Uren notes the observation from economists that if the participation rate had been as high as a year ago, the unemployment rate would be 6 per cent. True, but if the participation rate had been where it was in January 2007, before the global financial crisis hit when employment wasn’t exactly hard to find, the jobless rate would be even lower than it is now.

Meanwhile, The Australian’s Barry Fitzgerald grapples with the outlook for Australia’s uncommitted resources projects.

Fairfax’s Michael Pascoe again rallies against the China bears with some analysis from none other than the research department of the Reserve Bank

Pascoe’s colleague Michael West carries an interesting yarn about Australian financial chat room HotCopper potentially moving to the US because there’s no guaranteed freedom of speech in Australia.

Fairfax’s Adele Ferguson also has a good story this morning about the increasing tendency of our big regulator to settle out of court rather than push for a final decision. Ferguson doesn’t miss the opportunity to explain how the strategy improves the financial return as the federal government tries to balance to budget. Coincidentally, The Australian’s John Durie looks at the consumer watchdog’s victory in the High Court for the right to take action against Indonesian carrier Garuda Airlines. And in a story with revenue raising implications, The Australian Financial Review’s Chanticleer columnist Tony Boyd investigates the potential consequences of a federal government crackdown on superannuation tax concessions afforded to higher income earners.

In banking, Fairfax’s financial writer Eric Johnston writes about the possibility that ANZ Bank could be forced to sell some of its minority stakes in Asian banks because of capital requirements under the pending Basel III.

Elsewhere, Fairfax’s Clancy Yeates tries to highlight the double standards in Australia foreign investment mindset.

And finally, The Australian’s Robin Bromby looks at the lingering sense of optimism in metals prices that Federal Reserve chairman Ben Bernanke will hit the pull the stimulus lever again.

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