THE DISTILLERY: Triple whammy
Commentary today creates a premonition of the Rudd government going to the polls with frayed budget projections, a tax that appears ill-timed and outmoded, and crumbling house prices. Good luck.
It is with no joy that this column today claims vindication for its discussion several weeks ago of a bearish convergence between diminishing European, US and Chinese growth.
Today, commentators begin to catch up, though most see only parts of the whole. John Garnaut of The Sydney Morning Herald offers what detail there is on China's slowdown: "Chinese banks lifted minimum mortgage deposits from 20 to 30 per cent for first home buyers, and from 40 to 50 per cent for second home buyers. Beijing and some other cities went an extra step by suspending all third mortgages, banning mortgage lending to non-city residents and floating threats of a new property tax. Chinese media were required to report 'the success of government policy tightening' and otherwise guide 'healthy market expectations'."
Garnaut goes on to describe large falls in house prices in Shenzhen, Shanghai and Beijing, though he qualifies this by pointing out that these markets "...only account for 8 per cent of Chinese residential construction, according to UBS.”
He also goes on to warn against excessive pessimism because "...household debt is rising fast but remains minuscule when compared with Australia. Chinese incomes continue to outpace the rise in house prices. Slowing real-estate investment will assist with China's economic rebalancing project, so that Beijing will not become Dubai. Most importantly, when policymakers find they have over-applied the brake – as they probably will – they can simply repeat the global financial crisis recovery program ... The Beijing property price data ... doesn't look quite so frightening to investors who also read a blog on May 12 by the chairman of a real-estate company called Huayuan ... Much of the slump in average sale prices was a statistical distortion, it seems, because high-priced housing stock had been banned from the sample. 'Prices will fall … and we'll have a difficult six months,' says Stephen Green at Standard Chartered. 'But this isn't Armageddon – it's a directional change.'”
So what does this mean for Australia? Garnaut's conclusion is chilling: "Last month China produced a record 55.4 million tonnes of steel – an annualised 676 million tonnes – which was up 4 per cent in a month and a staggering 60 per cent from November 2008. But this month steel mills began slashing forward prices and Macquarie Bank's Graeme Train reports steel mill margins are approaching the wafer-thin levels that led to shutdowns late in 2007.” Which, this column will add, if it persists, will trigger a new round of commodity inventory liquidation and prices will plunge. And these will be passed on to Australia's terms of trade faster than you can cry "quarterly contract!”
Making matters worse, of course, is that this is only China's internal slowdown. Yet to feed through is sagging European demand as the paradoxes that have caught southern Europe refuse to go away. There is also new evidence that the US inventory rebuild is winding down as predicted with the May Empire Manufacturing Survey coming in well below expectations. This will also hit Chinese exports.
Closest to grasping these forces is Robert Gottliebsen of Business Spectator who lists the travails of the three nations and concludes that bears now have the upper hand. However, there is one other dimension to this story of convergence that he misses. The global reflation trade that began in March 2009 relies on the decoupling thesis: that emerging markets (mostly China) will convert to internal demand, even as Western nations de-leverage and rebuild their exports. This trade has been reinforced by zero US interest rates driving down the $US and driving up $US-priced assets that have a strong emerging market association: commodities.
The peculiar combination of the troubles in the three markets means that the thesis behind the reflation trade is seriously undermined. So long as the euro keeps declining, the $US and the yuan will rise, simultaneously trashing the correction to the US external imbalance, Chinese growth and commodity prices. The reversal of the reflation rally is apparent already in a major flight to safety back to the US, with US treasury purchases surging according to new TIC data. Overnight, Bloomberg attempted to put a positive spin on this process, bizarrely dubbing it "reverse diversification”. And yes, it will make debt cheaper to all in the US. But that is where the reflation narrative hits a brick wall: we are back to the US consumer as buyer of last resort. With exports stalled, if there is no new bubble in equities or housing or both then where is US final demand going to come from?
This column sees a serious danger of this recovery cycle now collapsing. While there is hope that this can be prevented by the European Central Bank's embrace of quantitative easing, as Ambrose Evans Pritchard argues overnight – which would ironically stabilise the euro – Karen Maley of Business Spectator argues even this policy lever is in trouble. "The Germans are now inclined to see the ECB as being a captive of political interests, rather than an independent central bank, and this has sparked speculation that the ECB will be more inclined to bow to political pressure and allow an outbreak in inflation in order to reduce the burden of eurozone debt. To reassure the Germans, the ECB has been forced to act quickly to 'neutralise' its bond buying. The ECB has drained liquidity from the market, but this is making it more difficult for banks to get short-term funding. Banks are now sitting on their cash holdings, and are reluctant to lend to other banks. As a result, the interest rates that banks have to pay to borrow from other banks have increased."
If you're in the equity market, this column suggests battening down the hatches. Last week's big move down in the Dow is looking like a harbinger.
Much the same advice is offered by Steve Keen in Business Spectator when looking at housing. He argues today that the "...bullish economists may have hoped that the temporary drop off in first home buyers – created by the bringing forward of demand by the First Home Owners Boost in 2009 – would quickly pass, and that numbers and values of loans would begin to trend up again. This has not been the case – loan commitments for owner occupiers fell 3.4 per cent in March in seasonally adjusted terms, or 4.1 per cent in trend terms. This led JP Morgan to observe in a note: '…the protracted nature of the payback is something of a concern, especially given that there are still at least two more interest rate hikes yet to flow through to the data, those delivered in April and May this year'.”
This column has been expecting a bust at the margins that would stall prices for much the same reasons. However, if the global recovery comes a-cropper and Australia's terms of trade take a sudden hit just as housing slows, then we'll be confronting simultaneous internal and external shocks. Housing is also no place to be.
That all of this is transpiring as the resource super profits tax (RSPT) debate continues is causing this column cognitive dissonance. Bryan Frith and Michael Stutchbury of The Australian discuss it today without adding anything new. Tim Colebatch of The Age joins this column in arguing that a good idea is being over-complicated, most especially at the level of equity and government guarantees. In the Australian Financial Review, Macarthur chairman Keith De Lacy has a big whinge about sovereign risk but again, this column can't see anything new. Geoff Carmody also appears in an AFR op-ed to ask: "Does the government see [slowed mining activity] as preferable to higher interest rates and exchange rates?” To which the answer is presumably, yes.
The dissonance this column referred to is that with the global recovery in jeopardy, the government faces the prospect of competing in an election with frayed budget projections, a tax that appears ill-timed and outmoded, as well as with its GFC-fighting credentials oozing away with house price falls. That double-dissolution is going to look great in retrospect.
Finally, reaffirming her credentials as the number one breaker of stories in Australian commentary, Adele Ferguson of The Age makes it two in two days with the news that Maurice Blackburn is launching a $450 million class action against NAB for allegedly delaying "...writing down 10 collateralised debt obligations by more than $1.2 billion, which influenced the share price.”
Today, commentators begin to catch up, though most see only parts of the whole. John Garnaut of The Sydney Morning Herald offers what detail there is on China's slowdown: "Chinese banks lifted minimum mortgage deposits from 20 to 30 per cent for first home buyers, and from 40 to 50 per cent for second home buyers. Beijing and some other cities went an extra step by suspending all third mortgages, banning mortgage lending to non-city residents and floating threats of a new property tax. Chinese media were required to report 'the success of government policy tightening' and otherwise guide 'healthy market expectations'."
Garnaut goes on to describe large falls in house prices in Shenzhen, Shanghai and Beijing, though he qualifies this by pointing out that these markets "...only account for 8 per cent of Chinese residential construction, according to UBS.”
He also goes on to warn against excessive pessimism because "...household debt is rising fast but remains minuscule when compared with Australia. Chinese incomes continue to outpace the rise in house prices. Slowing real-estate investment will assist with China's economic rebalancing project, so that Beijing will not become Dubai. Most importantly, when policymakers find they have over-applied the brake – as they probably will – they can simply repeat the global financial crisis recovery program ... The Beijing property price data ... doesn't look quite so frightening to investors who also read a blog on May 12 by the chairman of a real-estate company called Huayuan ... Much of the slump in average sale prices was a statistical distortion, it seems, because high-priced housing stock had been banned from the sample. 'Prices will fall … and we'll have a difficult six months,' says Stephen Green at Standard Chartered. 'But this isn't Armageddon – it's a directional change.'”
So what does this mean for Australia? Garnaut's conclusion is chilling: "Last month China produced a record 55.4 million tonnes of steel – an annualised 676 million tonnes – which was up 4 per cent in a month and a staggering 60 per cent from November 2008. But this month steel mills began slashing forward prices and Macquarie Bank's Graeme Train reports steel mill margins are approaching the wafer-thin levels that led to shutdowns late in 2007.” Which, this column will add, if it persists, will trigger a new round of commodity inventory liquidation and prices will plunge. And these will be passed on to Australia's terms of trade faster than you can cry "quarterly contract!”
Making matters worse, of course, is that this is only China's internal slowdown. Yet to feed through is sagging European demand as the paradoxes that have caught southern Europe refuse to go away. There is also new evidence that the US inventory rebuild is winding down as predicted with the May Empire Manufacturing Survey coming in well below expectations. This will also hit Chinese exports.
Closest to grasping these forces is Robert Gottliebsen of Business Spectator who lists the travails of the three nations and concludes that bears now have the upper hand. However, there is one other dimension to this story of convergence that he misses. The global reflation trade that began in March 2009 relies on the decoupling thesis: that emerging markets (mostly China) will convert to internal demand, even as Western nations de-leverage and rebuild their exports. This trade has been reinforced by zero US interest rates driving down the $US and driving up $US-priced assets that have a strong emerging market association: commodities.
The peculiar combination of the troubles in the three markets means that the thesis behind the reflation trade is seriously undermined. So long as the euro keeps declining, the $US and the yuan will rise, simultaneously trashing the correction to the US external imbalance, Chinese growth and commodity prices. The reversal of the reflation rally is apparent already in a major flight to safety back to the US, with US treasury purchases surging according to new TIC data. Overnight, Bloomberg attempted to put a positive spin on this process, bizarrely dubbing it "reverse diversification”. And yes, it will make debt cheaper to all in the US. But that is where the reflation narrative hits a brick wall: we are back to the US consumer as buyer of last resort. With exports stalled, if there is no new bubble in equities or housing or both then where is US final demand going to come from?
This column sees a serious danger of this recovery cycle now collapsing. While there is hope that this can be prevented by the European Central Bank's embrace of quantitative easing, as Ambrose Evans Pritchard argues overnight – which would ironically stabilise the euro – Karen Maley of Business Spectator argues even this policy lever is in trouble. "The Germans are now inclined to see the ECB as being a captive of political interests, rather than an independent central bank, and this has sparked speculation that the ECB will be more inclined to bow to political pressure and allow an outbreak in inflation in order to reduce the burden of eurozone debt. To reassure the Germans, the ECB has been forced to act quickly to 'neutralise' its bond buying. The ECB has drained liquidity from the market, but this is making it more difficult for banks to get short-term funding. Banks are now sitting on their cash holdings, and are reluctant to lend to other banks. As a result, the interest rates that banks have to pay to borrow from other banks have increased."
If you're in the equity market, this column suggests battening down the hatches. Last week's big move down in the Dow is looking like a harbinger.
Much the same advice is offered by Steve Keen in Business Spectator when looking at housing. He argues today that the "...bullish economists may have hoped that the temporary drop off in first home buyers – created by the bringing forward of demand by the First Home Owners Boost in 2009 – would quickly pass, and that numbers and values of loans would begin to trend up again. This has not been the case – loan commitments for owner occupiers fell 3.4 per cent in March in seasonally adjusted terms, or 4.1 per cent in trend terms. This led JP Morgan to observe in a note: '…the protracted nature of the payback is something of a concern, especially given that there are still at least two more interest rate hikes yet to flow through to the data, those delivered in April and May this year'.”
This column has been expecting a bust at the margins that would stall prices for much the same reasons. However, if the global recovery comes a-cropper and Australia's terms of trade take a sudden hit just as housing slows, then we'll be confronting simultaneous internal and external shocks. Housing is also no place to be.
That all of this is transpiring as the resource super profits tax (RSPT) debate continues is causing this column cognitive dissonance. Bryan Frith and Michael Stutchbury of The Australian discuss it today without adding anything new. Tim Colebatch of The Age joins this column in arguing that a good idea is being over-complicated, most especially at the level of equity and government guarantees. In the Australian Financial Review, Macarthur chairman Keith De Lacy has a big whinge about sovereign risk but again, this column can't see anything new. Geoff Carmody also appears in an AFR op-ed to ask: "Does the government see [slowed mining activity] as preferable to higher interest rates and exchange rates?” To which the answer is presumably, yes.
The dissonance this column referred to is that with the global recovery in jeopardy, the government faces the prospect of competing in an election with frayed budget projections, a tax that appears ill-timed and outmoded, as well as with its GFC-fighting credentials oozing away with house price falls. That double-dissolution is going to look great in retrospect.
Finally, reaffirming her credentials as the number one breaker of stories in Australian commentary, Adele Ferguson of The Age makes it two in two days with the news that Maurice Blackburn is launching a $450 million class action against NAB for allegedly delaying "...writing down 10 collateralised debt obligations by more than $1.2 billion, which influenced the share price.”
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