2-Speed Economy - what does it mean for Australia?

Discussion Leader's Argument:


RBA Governor Glenn Stevens has stated that even “the proverbial pet-shop galah can by now recite the facts on Australia's trade with China and our terms of trade”. Stevens has confirmed our own modelling of Australia's suffering from a two speed economy.

My interpretation of Stevens’ intimations are that the contributors to positive GDP and inflation are the resources & energy sectors and the latte set. The contributors to negative GDP and deflation are the manufacturing & retail sectors and mainstream Australia (the non-latte drinkers).

The RBA's issue is that it can only target the trend line, even though it knows nobody lives on it. They are mandated to prevent inflation rising above 3%, stemming from the overweight contribution that Resources are making in this country.

Data showing the imbalance in our economy could not be stronger. Business Credit Growth YoY is -2.4%, which hasn’t grown since June 2009. Prior to Nov 2008 credit for business enjoyed double-digit growth yet is now falling at an accelerating pace.

Retail turnover was just 1.7% for the past 12 months. Compare this to strong GDP rates and a generational-high savings ratio of 12%. Nominal incomes growing by 8.8% only encourage people's savings to pay off debt.

Almost half of all Australia's capex is from mining, with estimates at greater than 50% by year-end 2011. The mining sector invests the most into business at 25%, dwarfing manufacturing at 16%, retail at 12% and construction below 5%. Mining also represents 60% of exports, with retail and manufacturing at 10% each.

Stevens will continue to raise rates. Despite the pain that Australian retail and manufacturing are experiencing, they are about to feel more.

1. What are your views on the impact of a 2-speed economy?

2. What measures as a country should we be taking given the varying influences of our current economic situation on different industries?

3. What level of confidence do you have in the RBA on a scale of 1 to 10 (where 1 is very low and 10 is very high)?

4. What will the next 2 rate adjustments be in terms of size and direction?

Relevant Articles:

Client Page Member Comments

Equity Sales (Investment Banking Client Page Member)
Question to Marcel I am a latte drinker but I am feeling the pinch (mainly as a result of my share portfolio suffering), are you sure latte drinkers are contributing positively to GDP? What is the evidence on that score?
Equity Sales (Investment Banking Client Page Member)
I rate the RBA management 9/10. There is a difficult line to tread between stifling economic activity on the one hand and letting inflation re-ignite on the other. With only a few blunt instruments to use on a complex diverse economy, I think the RBA have walked the tight rope well. I believe the RBA will leave interest rates at current levels for the remainder of the year. Inflation is barely within the acceptable upper limits, so they will not loosen monetary policy. On the other side of the ledger there is no need to tighten further in the next few months as weakening consumer and business conditions are likely to help keep a lid on inflation.
Director (Corporate Client Page Member)
This is 1980 style stagflation all over again. The Government has sown the seeds for real inflationary problems over the next 4-5 years. The RBA needs to be firm now in order to minimise problems ahead. I expect the next two rate movements will be 25 point cuts. I am not confident that the RBA has the courage to hold / increase rates, i give them 3 points.
CFO (Corporate Client Page Member)
I think we have more than a 2 speed economy with a number of sectors outside of mining all performing at varying levels. The RBA have a very difficult job but rate a 5 at best.The next two rate movements will be 25 point cuts.
Investment Manager (Institutional Client Page Member)
1) The 2-speed economy has arisen from exogenous structural changes - a global resources boom including large infrastructure spends by Governments whose inflationary effects affected all sectors and easy and low cost credit – the song remains the same. The manufacturing sector’s share (including downstream resources and energy construction) has risen by around 6% to 16% of GDP since 2002. Asset and consumer prices have been again driven at one speed by costs and wages. A persistently high Aussie dollar that did not ease the inflation pain as the RBA mistakenly expected. In fact, the $A was telling the story of erosion of real purchasing power parity, an inverted yield curve kept inverted for too long whilst the RBA allowed inflation to remain outside the 2-3% band for over two and half years up to 2009. With its latest report showing large foreign exchange losses suggests the RBA punted the $A would fall. Regulators thought the boom in resources and infrastructure sectors would be counterbalanced by structural changes in financial services sector via new payments systems, new foreign banks, merchant banks, investment banking, new trading platforms. It was counterbalanced to the extent that wages and costs have maintained inflation at high levels. Cheap loans on speculative property prices have in fact contributed to a rebound in unemployment that is expected to increase further as infrastructure spend is expected to wind down. The share market pull back is a double whammy. The resources and infrastructure boom, Australia’s (technological) knowledge nation and rising property prices appeared to be an incomes and wealth creating phenomena. Easy personal and business credit, rising property prices, leveraged equities and negative gearing made a combined property and share portfolio in reach of every person or company. Further, a Federal Government Minister on Consumer department went to the extent advising consumers that investment properties should be sold every two years – in some guarantee of appreciation. The shortest economic cycles are four years. What held the RBA back in 2007 from raising interest rates was an erroneous assumption, that any interest rate hikes would drive the $A higher and cause a sell-off in long term bonds that would feed into the shorter end. The $A was destined to rise further with bank borrowing offshore that has only recently reversed. Yet it seems the RBA punted the $A would fall given its large foreign exchange losses last financial year. This V-shaped yield has now happened in 3Q 2011 with a sell-off at both ends of the curve – evidence that long bond yields do not translate back to the short end as they do in say the US in view of the differing structure of Australia’s financial system. The current shape of the yield curve shows how the Australian financial landscape looked more competitive with new players, old players dressed up in new entities, new payments and technology systems, new smaller players including the Henry Kaye style mogul with company and trust structures in self-perpetuating style spurred on by negative gearing and 30% (and mooted 28%) and 15% tax treatments lower than personal rates. It was as “safe as houses” to the misguided or property industry. The money multiplier took on a life of its own outside the financial system. A succession of 25bp brake pumping; makes hawkish statements; and the financial media front paging further speculative property inflation at odds with rising official interest rates, slowing consumer spending and rising unemployment in a stagflation warning scenario. When combined with easy credit at both business and consumer levels, overstretched valuations, the speculative property bubble continued. Did investors see public commercial building construction as a sign of rising prices and to this would flow onto to other property sectors including the residential sector? The problem was that Australia was too outward looking rather focussing on external demand and prices whilst neglecting domestic market fundamentals. US authorities noted that Australians on average have leveraged the wealth in their home to higher levels than in their country. Property prices became overstretched too hard and too strong with wages and material costs assisting the push and mad rush. The property market is too often characterised by information asymmetries because the math is too dry compared with looking at pictures, new price tags and new sales - particularly in residential markets. A savings ratio back to Thai Baht Asian crisis days of 1997 and 1989 Black Friday levels speaks this has been attained by foreclosure and distressed property sales with further to go based on if vacancy rates are any indication – look around. If person or groups of persons bought property with loans at 90 to 150 per cent of valuations for the purposes of owning the asset for two years as the Government’s Consumer Dept. advised, then it matters whether: a) the loans were forcibly put to them or they were fraudulently obtained; and whether the person is b) a home owner facing unemployment and is not in resources, infrastructure and technology industry; or c) a home owner with a leveraged equity account who’s share portfolio is worthless; or d) is a property and share portfolio owner who created a company or SMSF scheme between family and friends for the 30% or 15% tax treatment. 2) Demand pull is needed and technology is not the panacea. It’s become a commodity yet wages in this and sales/marketing and distribution industries have skyrocketed like we are all keeping up with the latest upgrade. To be a technology patent attorney or intellectual property lawyer imbued with markets analytical skills would be like valuing a laptop after three years for taxation purposes – easy no salvage value and now on to the next innovation. No more regulation? There was none. It wasn’t too big to fail. Rather, it was small enough to be under the radar. Step in the IMF’s current review of Australia’s banking system. With standardised rail gauges across Australia and expectations of a fall in cargo shipping rates from a fleet glut perhaps when I go to buy my tomatoes or bananas prices will decline. For the moment, it is apparently cheaper to import compost from China than to source from domestic market. Perhaps Australian agriculture land owners now realise that you can only use fertiliser mad from gas as a one-off boost lest you ruin the soil - somewhat like the fable of the farmer going out each night to his crop and tugging at the new shoots. 3) On a scale of 1to 10, I give the RBA a score of 6.5 as it did not increase interest rates end 2007 due to its underestimation of the impact of financial markets on the wider public. 4) On-hold and 25bpt down (50bpt “lick” in Australia is unheard of) while the legal and accounting industries have a field day. These countercyclical players are not likely to listen to the Treasurer warning of “not to milk it” with higher fees or property ownership in lieu of rising and more unaffordable fees. Since property outperforms bonds and equities on a 20 years basis and equities outperform bonds on a 10 years basis equities outperform bonds then these new property owners could be a good thing as valuations return to realistic levels. However, if the two speed economy continues to revolve around property and other textbook speculative assets of resources and manager funds in the so called alternative asset class then any type of investing will become far from as “safe as houses”. We should then all buy a boat and deck it out with 24-kt fittings and hope we don’t encounter pirates when making physical collection or deliveries.
Director (Institutional Client Page Member)
Australia has had a 2-speed economy on and off since the 1851 gold rush. Successive resources booms have undoubtedly added to our national wealth, especially by comparison to the previous economic drivers (convicts and sheep). With 160 years\' experience we should have worked out the best way to handle the complications associated with resources booms. Selectively taxing the most successful parts of the economy has never been an intelligent response. Consider the example of South Africa, a resources rich economy whose policies have excluded it from the current boom: between 2001 and 2008 the South African mining sector actually fell by 1% a year. A sovereign wealth fund was always a better choice than the Howard era tax cuts and handouts - see the example of Norway. The whingeing from the suffering sectors often drowns out the clear evidence that much of their problems are structural rather than cyclical. Few of the established Australian retailers bothered to create an online offer, print media and TV are still clinging to the pre-Internet business model, and the Australian taxpayer has spent 30 years giving the car industry billions of dollars in adjustment subsidies. Governments still have to deal with structural problems, but not in the same way as cyclical downturns. Resources booms are always temporary: after some years, supply rises to meet the new demand. For Australia the end of a resources boom means a domestic recession, rising unemployment, and the migration of capital and labour to other sectors and other countries. In this context an interest rate cut is better policy than a rise, given that we now have some of the highest interest rates in the developed world. Lower cash and fixed interest yields would reduce the attraction of the AUD, and a lower AUD benefits the non-resources sectors. So: the RBA has done quite well with the one blunt instrument at its disposal - rate it a 6. The next two rate cuts will be down, by 50 to 75 bp in total.

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