Transcript of Michael Pascoe's interview with economist Mark Tierney

Mark Tierney: The thing which everyone got wrong this year was not just the strength of the US dollar, it was the strength of the dollar against the yen. Everyone thought, 'Well, if there was going to be any strength at all this year it would be against the euro', and to some extent that happened, but it’s been ever stronger against the yen. Now there is no sign of that changing. While there is some indication that perhaps that the euro mightn’t do terribly much more, there is no sign of the capital outflows from Japan stopping just yet. The Japanese are taking a bit more risk and they are just flooding the world with their savings at the moment.

Michael Pascoe: So how much of the global stockmarket lift we’ve seen in the past few months is coming from that?

MT: I think it’s a lot. I mean, for example, in October alone the Japanese exported about $US30 billion into bond markets. Now much of that would have gone to the United States, perhaps some would have gone to Europe. That’s a huge amount of money in just one month to be putting out. Of course, that has helped to depress the level of global bond yields or, at least in the case of the United States, stopped them rising at a faster pace and that has undoubtedly spurred equity markets. The fact is that you’ve still got very low interest rates around the world.

MP: The impact on the equities market of bond rates staying down, has that unleashed another wind?

MT: I think it has made people confident that the equity market rally’s not going to be terminated by a tremendous spike in interest rates. At least in the near term anyway. I mean there was a fear perhaps a couple of months ago that the US Federal Reserve might hit it. There was a fear that we might get a big spike in long-term interest rates; that’s now largely evaporated. Whether that lasts remains to be seen but nevertheless the Japanese flow and flows from other parts of the world from the oil exporters have really, I think, done wonders to calm people’s nerves. And so, perhaps long-term interest rates may go up but perhaps they won’t go up at a very rapid pace.

MP: And stockmarkets just can’t be frightened at present.

MT: Well it’s very difficult because what has happened is something quite different to what we saw earlier in this year. Earlier on this year there was some speculation for example that the Europeans were about to lower interest rates. Now it’s exactly the opposite: interest rates in Europe are probably about to go up. Despite this, equity markets are rallying everywhere. What that means is that equity investors are far more confident about growth. This is not just a pure interest rate driven rally in equity markets; this is basic optimism about economic growth and the reason for that is that all of a sudden people have come to the conclusion that while they’ve had an oil price shock, it hasn’t made a scrap of difference. The global economy has barely missed a beat. Now if we can cope with an oil shock of that magnitude and still produce strong growth the underlying dynamics of the global economy are obviously incredibly strong, therefore equities deserve to go up.

MP: At the same time that the US dollar has been rallying gold has as well, which is against the usual relationship.

MT: Well that’s true. I mean, it’s not unprecedented but it is very uncommon. Now I think that the implications of that are quite stark because it’s not just gold. I mean copper is another excellent example; you would expect the copper price to be weak; you would not expect it to be at record highs under these conditions. What it is, I think, is another dimension of this optimism about growth: that people are prepared to say that, 'OK, maybe we’re prepared to buy hard assets because they do perform better when growth is strong', and I think that’s quite important because it’s also a dimension of the equity market rallying on the back of growth rather than lower interest rates; in other words you don’t require lower interest rates for the equity market to rally. You don’t require a weaker US dollar for gold to rally. It is overwhelming everything, this optimism about growth. And that I think is a very different dynamic for all investors.

MP: Copper has a more fundamental side to it though than gold, doesn’t it?

MT: It has, but it’s amazing when you do get the dollar moving up and down; fundamentals or not, you would expect a little bit of weakness. I mean even if it was just stable with a rising US dollar, but to be setting record highs day after day after day is quite extraordinary. What I think is interesting, however, is another aspect of this growth overwhelming interest rate or dollar effects: the demand for copper is so strong it doesn’t matter what the US dollar is saying. Same with gold, same with equity markets '¦ doesn’t matter. Growth and the perception about strong growth is now swamping all other considerations.

MP: Where is the Australian dollar fitting in all this?

MT: It’s a positive fact that investors believe that growth is going to be strong. That’s always an undoubted positive for the Australian dollar. As is the fact that our interest rates are still relatively high. Now the gap with the rest of the world, particularly the United States, is narrowing and the US dollar strength is also a bit of a negative so there are all these cross-currents. What it means to me, I think, is that the Australian dollar is left broadly stable. And it’s not going to do terribly much at all, I don’t think. If the US dollar suddenly weakened, I think the Australian dollar would shoot up quite a bit, but that is unlikely to happen. I think we’re going to be left with an Australian dollar in a very narrow range, somewhere around US73–75¢.

MP: The other currency factor is the Chinese, the renminbi. It’s not doing quite what people expected.

MT: Except in one very interesting way '” it is now broadly stable against the US dollar but it’s rising against everything else because the US dollar is rising against everything else. For example, if you look at the renminbi versus the yen it has exploded this year; that’s the only way to describe it. A huge gain of the renminbi because, obviously, the US dollar has risen a lot against the yen. The renminbi has risen a lot against the euro, even against the Australian dollar. This year, the renminbi is actually stronger now than it was in the beginning of the year, considerably stronger. Of course, that was after a significant depreciation but nevertheless it has reversed course so it’s the renminbi versus the US dollar that is the problem. That’s why you don’t see many complaints. Earlier on this year, the biggest complainers about the renminbi were not the Americans, it was the Europeans, desperately worried that the euro was too strong against the renminbi. You just don’t hear a peep from the Europeans these days. You don’t hear a peep from the Japanese about it. In fact no one’s complaining except for American politicians.

MP: Is the undervalued currency now the yen?

MT: I think the yen is extraordinarily undervalued. If you look at it in real terms; take, for example, the trade-weighted index. Then you strip out inflation and Japan has had a long period of deflation. As a result, their corporations are very competitive now, very lean. So if you take inflation into account, put it in a trade-weighted basis, the yen is now virtually at record lows, almost as low as it was, for example, back in 1985 just before the Plaza Accord when they boosted the value of the yen. It is incredibly low and that’s the reason why the Japanese stockmarket is at its high for the year. They are incredibly competitive at the moment. They have a large trade surplus as well. When you look at it and say the yen is extraordinarily undervalued so if there is a risk and at some point there will be a reversal, now the Americans so far are not pressuring the Japanese; they prefer to pressure the Chinese for a whole variety of reasons but I do believe this can’t go on indefinitely. At some point the Americans will require the Japanese to do something about the yen and the yen will then have to rise significantly; probably not in the short term but I definitely think it’s a risk for 2006.