America and Australia

By David Dittman • November 7, 2012 • Pacific Digest

President Barack Obama won a second term Tuesday in America, signaling the end of one long and contentious political season and the beginning of another short and contentious one.

Upcoming are negotiations among the re-minted administration, a Democratic Senate and a Republican House of Representatives that will or will not help the US avoid the now-proverbial “fiscal cliff” that threatens not only domestic economic growth but the global recovery as well.

Electoral numbers shifted slightly, but we’re left with the same general dynamic that’s allowed us to wade further into this muck: a lower legislative chamber captive to hard-and-fast Tea Party elements, an upper chamber constricted by arcane parliamentary rules that mean basically nothing of note passes without a two-thirds majority and an executive too removed from what’s happening on Capitol Hill.

Members of Congress will return from the campaign trail to Washington, DC, for an abnormally consequential “lame duck” legislative session that could make or break what’s looking more and more like a durable domestic recovery.

The rest of the world must wait out the 49 days as efforts to hammer out a consensus that avoids the expiration of dozens of tax breaks and the adoption of deep cuts to government spending.

In its most recent analysis of the problem the Congressional Budget Office warned that without action to avoid it going over the fiscal cliff will lead to a “significant recession” and the loss of 2 million American jobs.

Failure to find a more orderly path to reducing the federal budget deficit–allowing approximately USD600 billion in expiring tax cuts and automatic spending reductions set for 2013–would trigger fiscal contraction not seen since 1969 tax increases to pay for the Vietnam War. The CBO estimates that US gross domestic product (GDP) would shrink by 0.5 percent in 2013, a debilitating 2.9 percent in the first half.

The International Monetary Fund estimates a fiscal-cliff dive would shave four percentage points off US GDP, clearly sufficient to push the world’s biggest economy back into full-fledged recession.

Consequences for global exporters, including China, Australia’s key market, would be significant. Demand from Europe is already shrinking, to the extent that the US is again China’s biggest export market. Goods shipped to the US in 2011 worth USD324 billion accounted for 17.1 percent of China’s total exports and represented 4.4 percent of Mainland GDP. Europe accounted for 18.8 percent in 2011, but shipments have declined significantly in 2012.

Assuming Democrats and Republicans can’t find a way to solve this latest potential crisis and CBO and IMF estimates about the impact on US growth are in the ballpark, China’s two biggest trade partners would be in recession.

The IMF found that a 4.8 percentage point reduction in GDP growth in the US could result in a 1.2 percentage point reduction in Chinese GDP growth in 2013. Knock-on effects leading to a renewed financial crisis would make these scenarios seem rosy by comparison: If market stress ratchets up more than assumed China could shrink by 2.4 percent.

In its final communique following a two-day summit in Mexico City the G20 noted, “Global growth remains modest and downside risks are still elevated.” The statement cited “possible delays in the complex implementation of recent policy announcements in Europe” and a “potential sharp fiscal tightening in the United States.”

G20 officials urged the winner of Tuesday’s election to reach a deal with Congress after the vote. “The US leadership needs to address quickly the so-called ‘fiscal cliff,’” said IMF Managing Director Christine Lagarde. Ms. Lagarde warned that there were “clearly factors of uncertainty not only for the US economy, but also for the global economy, given the size of the US economy.”

At the same time the G20 expressed the optimistic view that Washington will “carefully calibrate” the pace of its fiscal tightening so that public finances are placed on a “sustainable long-run path while avoiding a sharp fiscal contraction.”

Meanwhile, Spanish Economy Minister Luis de Guindos warned that the US fiscal cliff hung over the world like the “Sword of Damocles.”

The implications for the Land Down Under are clear, as Australian Treasurer Wayne Swan, in Washington during Tuesday’s election for meetings with US Treasury Secretary Timothy Geithner, US Federal Reserve Chairman Ben Bernanke and Ms. Lagarde of the IMF, noted in an interview with Sky News.

“There is a lot of uncertainty in the global economy, and that uncertainty relates to Europe but also to how America will deal with the impending fiscal cliff,” said Mr. Swan.  “That [the fiscal cliff] would have a dramatic impact and flow-on effect to the global economy, and in turn would impact on Australia.”

China is the largest destination for exports from Australia, and it’s the largest source of Australian imports. A quarter of Australia’s exports, representing about 5 percent of GDP, go to China. There are signs that the Middle Kingdom is stabilizing, but growth is not yet assured.

Recent official and unofficial Purchasing Managers Index data from the National Bureau of Statistics of China and the China Federation of Logistics and Purchasing and HSBC-Markit suggest efforts to boost the economy, including the acceleration of large projects beginning last spring, have begun to take effect. China’s growth plan for 2011 through 2015 and its still-rising demand for commodities such as iron ore and coal should continue to spur growth in Australia.

Although demand for minerals has softened in the short term, Chen Yuming, China’s Ambassador to Australia, recently asserted that “from a long-term perspective, it is unnecessary for us to worry about the Chinese economy and its demand or to hold any doubts about the closer bilateral economic and trade relations between China and Australia.”

“China will continue to be the growth engine of the Australian and global economies in the next five years,” said Mr. Chen in early October.

Officials in both Australia and China–as well as Japan and Europe–will have keenly interested eyes on Washington, DC, between now and Jan. 1, 2013, when the tax and spending cuts that comprise the fiscal cliff are set to take effect.

Short-term positives and long-term growth depend on these negotiations.

The Roundup

The Australian dollar surged to a five-week high Nov. 6 after the Reserve Bank of Australia (RBA) held its overnight cash rate at 3.25 percent.

Before the decision economists had been broadly split on whether the RBA would cut its rate. RBA Governor Glenn Stevens’ statement concluded that “with prices data slightly higher than expected and recent information on the world economy slightly more positive, the board judged that the stance of monetary policy was appropriate for the time being.”

The aussie traded up to USD1.0435 at Tuesday’s close from USD1.0365 on Monday.

Mr. Stevens noted improved activity in the US and signs that growth in China, Australia’s biggest trading partner, had “stabilized.” He also said that the full impact of 1.5 percentage points of interest-rate cuts in the past year have yet to flow through.

“Further effects of actions already taken to ease monetary policy can be expected over time,” Mr. Stevens said.

Chinese manufacturing grew for the first time in three months in October to above the threshold that signals expansion, suggesting the world’s second-largest economy is regaining momentum.

Data from the Australian Bureau of Statistics (ABS) showed Australian inflation rose by more than anticipated, as the new carbon tax Down Under drove energy prices higher. The RBA maintained its view that inflation will remain “consistent” with its 2 percent to 3 percent target range over the next one or two years despite the third-quarter blip.

According to the ABS Australia’s consumer price index rose 1.2 percent in seasonally adjusted terms from the second quarter and 1.4 percent in more closely watched non-adjusted terms. Economists had expected a rise of 1.1 percent in non-adjusted terms. The year-over-year increase was 2 percent in non-adjusted terms, compared with economist expectations of a 1.7 percent increase.

The decision to hold rates comes even though Australia’s unemployment rate ticked up to 5.4 percent.

Mr. Stevens said that Europe still poses a major risk to the global growth outlook–as does the fiscal cliff in the US.

Here’s the full text of Mr. Stevens’ Nov. 6 statement:

At its meeting today, the Board decided to leave the cash rate unchanged at 3.25 per cent.

Global growth is forecast to be a little below average for a time. Risks to the outlook are still seen to be on the downside, largely as a result of the situation in Europe, where economic activity is still contracting. Risks elsewhere seem more balanced. The United States is recording moderate growth, while recent data from China suggest growth there has stabilised. Around Asia generally, growth has been dampened by the more moderate Chinese expansion and the weakness in Europe.

Key commodity prices for Australia remain significantly lower than earlier in the year, though trends have been more mixed over the past couple of months, with some prices recovering some ground while others declined further. The terms of trade have declined by about 13 per cent since the peak last year, but are likely to remain historically high.

Financial markets have responded positively over the past few months to signs of progress in addressing Europe’s financial problems, but expectations for further progress remain high. Long-term interest rates faced by highly rated sovereigns, including Australia, remain at exceptionally low levels. Capital markets remain open to corporations and well-rated banks, and Australian banks have had no difficulty accessing funding, including on an unsecured basis. Borrowing conditions for large corporations are similarly attractive. Share markets have generally risen over recent months.

In Australia, most indicators available for this meeting suggest that growth has been running close to trend over the past year, led by very large increases in capital spending in the resources sector. Looking ahead, the peak in resource investment is likely to occur next year, at a lower level than expected six months ago. As this peak approaches, the Board will be monitoring the strength of other components of demand.

Some of the consumption strength in the first half of 2012 was temporary, but there have been some signs of ongoing growth, though a return to very strong growth in consumption is unlikely. While investment in dwellings has been subdued for some time, over recent months there have been some indications of a prospective improvement. Non-residential building investment has remained weak. Public spending is forecast to be subdued.

Recent outcomes on inflation were slightly higher than expected, though they still show inflation consistent with the medium-term target, with underlying measures around 2½ per cent over the year to September, and headline CPI inflation a little lower than that. The introduction of the carbon price affected consumer prices in the September quarter, and there could be some further small effects over the next couple of quarters. With the labour market having generally softened somewhat in recent months, and unemployment edging higher, conditions should work to contain pressure on labour costs in sectors other than those directly affected by the current strength in resources. This and some continuing improvement in productivity performance will be needed to keep inflation low, since the effects on prices of the earlier exchange rate appreciation are now waning. The Bank’s assessment remains that inflation will be consistent with the target over the next one to two years.

Over the past year, monetary policy has become more accommodative. Interest rates for borrowers have declined to be clearly below their medium-term averages and savers are facing increased incentives to look for assets with higher returns. While the impact of these changes takes some time to work through the economy, there are signs of easier conditions starting to have some of the expected effects. Business demand for external funding has increased this year, the housing market has strengthened and share prices have risen in line with markets overseas. The exchange rate, though, remains higher than might have been expected, given the observed decline in export prices and the weaker global outlook.

Further effects of actions already taken to ease monetary policy can be expected over time. The Board will continue to monitor those effects, together with information about the various other factors affecting the outlook for growth and inflation. At today’s meeting, with prices data slightly higher than expected and recent information on the world economy slightly more positive, the Board judged that the stance of monetary policy was appropriate for the time being.

Following are links to our discussion and analysis of the most recently announced financial and operating results for Portfolio Holdings.

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