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The Australian and global economies the financial year ahead Talk to a luncheon hosted by the Moir Group Institute of Chartered Accountants, Sydney Saul Eslake 20th June 2013 1 It’s easy for Australians to forget how traumatic the GFC and its aftermath have been for other countries Unemployment rate Real gross domestic product 114 13 % of the labour force Dec qtr 2007 = 100 Australia 112 110 Euro area 12 11 108 Canada 10 106 NZ US 104 102 100 Japan 98 UK 9 UK 8 US 7 Canada NZ 6 Euro area 96 Australia 5 94 4 92 Japan 3 90 08 09 10 11 12 13 08 09 10 11 12 13 Sources: Australian Bureau of Statistics; US Bureau of Economic Analysis; Japan Economic& Social Research Institute; Eurostat; UK Office of National Statistics; Statistics Canada; US Bureau of Labor Statistics; Japan Home Ministry; Statistics New Zealand. 2 The euro zone is still in recession Real GDP 1 Unemployment by country % ch from previous quarter (not annualized) 30 0 Greece 28 Spain 26 -1 24 -2 22 -3 20 07 08 09 10 11 12 13 Portugal 18 16 Unemployment 13 Dec qtr 2007 = 100 Ireland 14 % of the labour force Italy 12 12 France Netherlands 10 11 8 10 6 9 Germany 4 8 2 7 07 08 09 10 11 12 13 08 09 10 11 12 13 Sources: Eurostat.; IMF. 3 With fiscal policy paralysed and interest rates close to zero central banks have had to resort to ‘unorthodox’ policies Major central bank policy interest rates 7 Major central bank balance sheets 40 % pa % of GDP Bank of Japan European Central Bank 35 6 BoE base rate 30 5 25 4 20 US Federal Reserve 3 15 2 1 10 ECB refi rate US Fed funds rate BoJ call money rate 0 07 08 09 10 11 12 Bank of England 5 0 13 07 08 09 10 11 12 13 Sources: US Federal Reserve; Bank of Japan; European Central Bank; Bank of England. 4 The Fed is still some way from ‘tapering’ its program of ‘quantitative easing’ (‘QE’) Non-farm payroll employment Unemployment 11 10 % of labour force 400 9 8 200 7 6 -200 Change from previous month('000) 0 -400 Fed 'target' 5 4 -600 -800 07 08 09 10 11 12 07 13 08 Employment-population ratio 65 64 63 62 61 60 59 58 57 09 10 11 12 13 ‘Core’ inflation % of civilian working age population 3.0 % change from year earlier Fed 'target' 2.5 2.0 1.5 CPI 1.0 PCE deflator 0.5 80 83 86 89 92 95 98 01 04 07 10 13 0.0 07 08 09 10 11 12 13 Source: US Bureau of Labor Statistics; Bureau of Economic Analysis. 5 Fears that ‘QE’ will lead to hyper-inflation are based on a misreading of German (and other countries’) history Currency in circulation and inflation in Weimar Germany Reichsbank notes in circulation 1,000,000 100,000 Consumer prices 100,000,000,000 Bn Reichsmarks (log scale) (log scale) 10,000,000,000 10,000 1,000,000,000 1,000 100,000,000 100 10,000,000 10 1,000,000 1 100,000 0 10,000 0 1,000 0 100 0 10 0 1 20 % change from year earlier 21 22 23 21 22 23 24 25 Sources: The Economist; Global Financial Data. 6 The US Federal Reserve is not ‘printing money’ in the same sense as 1920s Germany or 1990s Zimbabwe … US Federal Reserve’s balance sheet Assets 3.5 Liabilities 3.0 US$ trn 3.0 US$ trn 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 07 08 09 Treasury securities M ortgage-backed securities Lending & liquidity facilities Other assets 10 11 12 13 Agency (FNM A, FHLM C) securities Foreign central bank liquidity swaps Support to Bear Sterns & AIG 07 08 Currency in circulation 09 10 11 Banks' reserve balances 12 13 Other liabilities Source: US Federal Reserve. 7 Broad US money growth has remained quite stable US base money and M2 3.5 US$ trn 3.0 US$ trn M2 (right scale) The ‘money multiplier’ 12.0 10.0 x 9.0 10.0 8.0 2.5 8.0 7.0 2.0 6.0 1.5 Money base (left scale) 6.0 5.0 Ratio of M2 to base money 4.0 1.0 4.0 2.0 0.5 0.0 0.0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 3.0 2.0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Source: US Federal Reserve. 8 The ECB isn’t “printing money” either – although it is doing very different things with its ‘QE’ than the Fed European Central Bank’s balance sheet Assets 3.5 Liabilities €trn 3.5 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 07 08 09 10 11 12 13 €trn 07 08 09 10 11 12 13 Lending to banks Holdings of securities Currency in circulation Euro area bank deposits with ECB Gold & foreign exchange All other Other Euro area residents deposits All other Source: European Central Bank 9 In no major economy has ‘currency in circulation’ grown more rapidly since the financial crisis than it was before Currency in circulation United States 1300 Japan US$bn (seas adj) 9000 1200 ¥bn 8500 1100 1000 8000 900 7500 800 7000 700 600 6500 07 08 09 10 11 12 13 07 08 Euro area 1000 09 10 11 12 13 United Kingdom €bn 65 £bn 60 900 55 800 50 700 45 600 40 500 35 400 30 07 08 09 10 11 12 13 07 08 09 10 11 12 13 Sources: US Federal Reserve; Bank of Japan; European Central Bank; Bank of England. 10 Inflation is falling, not rising, in all of the major advanced economies Consumer price inflation in major advanced economies Euro area United States 6 % change from year earlier 5 4 'Headline' 4 % change from year earlier 'Headline' 3 2 2 'Core' 0 1 'Core' 0 -2 -1 07 08 09 10 11 12 13 07 08 Japan 3 09 10 11 12 13 United Kingdom % change from year earlier 6 2 % change from year earlier 5 'Headline' 1 'Headline' 4 0 3 -1 2 'Core' -2 'Core' 1 -3 0 07 08 09 10 11 12 13 07 08 09 10 11 12 13 Sources: US Bureau of Labor Statistics; Japan Home Ministry; Eurostat; UK Office of National Statistics. 11 US banks are starting to lend again, but European banks aren’t United States Euro area Banks tightening lending standards 90 75 60 45 30 15 0 -15 -30 Banks tightening lending standards Net balance of banks tightening 40 lending standards (%) Net balance of banks tightening lending standards (%) 30 Mortgages Loans to enterprises 20 10 0 Commercial & industrial loans 03 04 05 06 07 Mortgages -10 08 09 10 11 12 13 03 04 05 06 07 Bank lending 15 08 09 10 11 12 13 Bank lending % change from year earlier 15 10 % change from year earlier 10 5 5 0 -5 0 -10 -5 03 04 05 06 07 08 09 10 11 12 13 03 04 05 06 07 08 09 10 11 12 13 Sources: US Federal Reserve; European Central Bank. 12 Can ‘Abenomics’ revive the Japanese economy? Consumer confidence 55 % Thus far ‘Abenomics’ has included the second-largest supplementary budget in decades, a successful attempt to ‘talk down’ the yen, and a new mandate and new leadership for the Bank of Japan 50 45 40 35 30 25 01 02 03 04 05 06 07 08 09 10 11 12 13 Shokochukin small business survey 55 50 45 40 35 30 25 20 Shinzo Abe led the LDP back into Government late last year with a mandate to end deflation and revive the Japanese economy % The BoJ now has a 2% inflation target, which the new BoJ Governor has pledged to attain it in two years – including through more wholehearted ‘quantitative easing’ The BoJ will double to the size of its balance sheet over the next two years – purchasing ¥6 trn a month of JGBs and other securities (equivalent to US$65bn per month cf. US$85 bn a month by the US Fed in an economy three times the size of Japan’s) All of these measures do seem to have had a noticeable positive impact on business and consumer confidence 01 02 03 04 05 06 07 08 09 10 11 12 13 Sources: Japan Economic & Social Research Institute, Cabinet Office; Shokochukin Bank. But so far the structural reform agenda has fallen short of what was expected – and what is needed 13 The BoJ’s “QE” will could end more ‘messily’ than the Fed’s, given their different inflation objectives Japanese bond yields and inflation 2.5 9.0 % 2.0 1.5 US bond yields and inflation 8.0 10-year JGB yield 7.0 1.0 6.0 0.5 5.0 0.0 4.0 -0.5 3.0 -1.0 2.0 -1.5 % Annual 'core' inflation rate -2.0 10-year UST yield 1.0 Annual 'core' inflation rate 0.0 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 Sources: Japan Home Ministry; US Bureau of Labor Statistics; Thomson Reuters Datastream. 14 China’s economic slowdown appears to have resumed Chinese economy Real GDP 16 Merchandise exports % change from year earlier 60 14 40 12 20 10 0 8 -20 6 -40 07 08 09 10 11 12 % change from year earlier Monthly data 3-mth centred moving average 07 13 Industrial production 25 Monthly data 15 10 5 3-mth centred moving average 0 07 08 09 10 11 09 10 11 12 13 Property construction % change from year earlier 20 08 12 13 50 40 30 20 10 0 -10 -20 % change from year earlier 07 08 09 10 11 12 13 Sources: China National Bureau of Statistics; UBS. 15 Demographic factors are working to slow China’s sustainable growth rate Growth rate of China’s workingage population 3.5 % pa China’s population growth rate 3 % pa One Child policy introduced 2 3.0 1 2.5 0 2.0 Mao's "Great Leap Forward" -1 50 1.5 55 60 65 70 75 80 85 90 95 00 05 10 Employment as a pc of population 1.0 60 % 0.5 55 0.0 50 -0.5 45 -1.0 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 Five years ended 40 50 55 60 65 70 75 80 85 90 95 00 05 10 Sources: United Nations; The Conference Board Total Economy Database January 2013. 16 China is trying to reduce its dependence on investmentled growth – which is bound to affect overall growth Fixed capital investment as a pc of China’s GDP 50 Pc point contribution to annual growth in real GDP 16 % pa % pts 14 12 45 10 40 8 6 35 4 2 30 0 -2 25 -4 -6 20 1981 1986 1991 1996 2001 2006 2011 Net exports Investment Consumption (Q1) 00 01 02 03 04 05 06 07 08 09 10 11 12 13* Sources: CEIC; China National Bureau of Statistics. 17 7% growth in China now contributes more to global GDP growth than 10% a decade ago China’s real GDP growth rate and contribution to global GDP growth 35 % of total % China's share of change in world GDP (left scale) 30 16 14 China's real GDP growth rate (right scale) 12 25 10 20 8 15 6 10 4 5 2 0 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 (f) Note: Contribution to global GDP growth is derived from IMF estimates of Chinese and global GDP in current international dollars based on PPP valuations of GDP. 2009 figure is not meaningful given that global fell 2.1% in 2009 while Chinese GDP rose. Source: IMF World Economic Outlook database (April 2013). Forecasts are IMF WEO forecasts 18 Resources export prices peaked over 18 months ago, and resources investment is approaching its peak Minerals and energy export commodity prices 120 Index - 2011-12 = 100 Mining investment as a pc of GDP 7 % 6 100 5 80 4 60 3 40 2 20 1 0 0 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 Sources: RBA; ABS. 19 Two pieces of evidence that the resources investment boom is peaking Engineering construction work – oil & gas fields and mines 120 7.0 $bn Construction work yet to be done 100 Unemployment rate in Western Australia % of labour force 6.5 6.0 5.5 80 Trend 5.0 4.5 60 4.0 40 3.5 Commencements (4-qtr rolling total) 20 3.0 2.5 Seas. adj. 2.0 0 02 03 04 05 06 07 08 09 10 11 12 13 02 03 04 05 06 07 08 09 10 11 12 13 Source: ABS. 20 Resources investment will remain at high levels for another two years but then fall off sharply Two alternative scenarios for resources and energy investment ‘Likely’ scenario ‘Possible’ scenario Source: Bureau of Resources and Energy Economics. Resources and Major Energy Projects (April 2013). 21 LNG exports will rise sharply when the big projects are finished, but employment will fall Employment directly associated with major LNG projects Australian LNG exports 100 Mt 2012-13 $ bn 60 12 50 10 '000s 90 80 Volume (left scale) Value (right scale) 70 Capex phase 40 8 30 6 20 4 Opex phase 60 50 40 30 20 10 2 10 0 0 2011 2012 2013 2014 2015 2016 2017 2018 Financial years ended 30 June 0 Gorgon Ichthys Wheatstone A-PLNG Qld Curtis GLNG Project Source: Bureau of Resources & Energy Economics. 22 To forestall a significant slowing in overall growth, other domestic demand components will have to grow faster Private sector residential building approvals 220 '000 (annual rate) Non-mining business investment as a pc of GDP 6.0 200 % 5.5 Seas. adj. 180 5.0 160 4.5 140 4.0 Trend 120 3.5 100 3.0 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 Source: ABS. 23 Households and businesses are proving very cautious about borrowing, even at very low rates Interest rates 11.0 10.0 Credit growth % pa 25 Weighted average rate paid by 9.0 % change from year earlier 20 small businesses 15 8.0 10 7.0 6.0 Standard variable mortgage rate 5.0 Housing 5 0 4.0 -5 3.0 Business RBA cash rate 2.0 -10 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 Note: Dotted lines indicate 15-year average of each interest rate shown. Source: RBA. 24 The recovery in housing has been unusually sluggish, and overly reliant on investors Housing finance commitments to investors First-time buyers as a pc of total housing finance commitments $bn per month 9 8 45 40 Seas. adj. 7 % of total 35 6 5 Trend 30 4 25 3 20 2 15 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 Housing finance commitments to owner-occupiers 13 12 11 10 9 8 7 6 5 4 Lending for new housing as a pc of total, by borrower $bn per month 25 Seas. adj. % of total 20 15 Owner-occupiers Trend 10 Investors 5 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 Source: ABS. 25 From late 2011 until early May this year, the A$ diverged markedly from its traditional ‘fundamentals’ Commodity prices and the A$ 120 2011-12 = 100 Interest rate differentials and the A$ US$ 1.10 500 A$ vs US$ 110 450 (right scale) 1.00 100 90 0.90 US$ Australia-US 2 yr bond yield spread (left scale) 1.10 1.00 400 350 0.90 300 80 0.80 70 0.80 250 200 60 0.70 50 40 30 Basis points RBA commodity price index 0.60 100 A$ vs US$ (right scale) 0.60 50 (inverted, left scale) 0.50 20 0.70 150 01 02 03 04 05 06 07 08 09 10 11 12 13 0.50 0 01 02 03 04 05 06 07 08 09 10 11 12 13 Note: RBA commodity price index is in US$. Sources: Datastream; Bloomberg; RBA. 26 … which has been one of a number of factors weighing on business confidence and investment intentions … Business capex intentions – NAB survey Business confidence Net balance (%) 20 Trend 10 40 Net balance planning increase (%) 30 20 0 10 -10 Seas. adj. 0 -20 -10 -30 -20 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 SMEs approval of Federal government 40 Net balance positive (%) Business capex intentions – Sensis survey (SMEs) 10 Net balance planning increase (%) 5 20 0 0 -5 -20 -10 -15 -40 -20 -60 -25 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 Sources: NAB monthly and quarterly business surveys; Sensis SME survey. 27 … and encouraging businesses to focus on lifting productivity and cutting costs – with adverse effects on employment Labour productivity growth 3.0 % pa (5-year rolling average) 20 2.5 'Market' sector 2.0 Business employment intentions Net balance (%) Trend 10 0 1.5 -10 1.0 0.5 Whole economy 0.0 Seas. adj. -20 -30 90 92 94 96 98 00 02 04 06 08 10 12 01 02 03 04 05 06 07 08 09 10 11 12 13 ‘Multi-factor’ productivity growth 3.0 % pa (5-year rolling average) 2.5 2.0 Unemployment rate 8 % of the labour force Trend 7 'Market' sector 1.5 1.0 6 5 0.5 0.0 Seas. adj. 4 -0.5 -1.0 3 90 92 94 96 98 00 02 04 06 08 10 12 01 02 03 04 05 06 07 08 09 10 11 12 13 Sources: ABS; NAB. 28 This has been one of a number of things detracting from consumer confidence and spending Consumer confidence 130 Retail sales Ratio of optimists to pessimists (%) 12 % change from year earlier 125 10 120 Trend 115 8 * * 110 105 Government 'cash splashes' 6 * 100 * 4 95 90 2 85 Seas. adj. 80 Trend Seas. adj. 0 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 Sources: Westpac-Melbourne Institute; ABS. 29 Households are unlikely to lower saving and spend more, given employment fears and falling asset prices Unemployment expectations and household saving % of HDI Ratio of pessimists to optimists (%) 200 180 Household net worth and household saving Households expecting higher unemployment (left scale) 14 12 400 10 450 8 160 350 6 140 % of HDI % of HDI 12 Net worth (left scale, inverted) 10 Saving rate (right scale) 8 500 6 550 4 4 600 2 2 120 0 100 -2 14 650 0 700 -2 750 -4 Saving rate (right scale) -4 80 90 92 94 96 98 00 02 04 06 08 10 12 90 92 94 96 98 00 02 04 06 08 10 12 Sources: Westpac-Melbourne Institute; RBA; ABS. 30 Manufacturers and wholesalers seem to be carrying a lot of inventories Inventory-sales ratios for large inventory-holding sectors Manufacturing 58 46 44 42 40 38 36 34 32 30 % 56 54 52 50 48 46 95 Retailing % 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 Wholesaling Mining % 90 40 % 35 85 30 80 25 75 70 20 01 02 03 04 05 06 07 08 09 10 11 12 13 01 02 03 04 05 06 07 08 09 10 11 12 13 Source: ABS. 31 Fiscal policy could be used to cushion the post-mining boom slowdown – but probably won’t be AAA-rated sovereigns – net public debt to GDP ratios 40 10-year Australian Government bond yields 18 % of GDP, 2012 % pa 16 20 14 0 12 -20 10 -40 8 -60 6 -80 -165.5% -100 4 ay rw No * ore gap Sin d l an Fin en ed Sw ark nm De da na a ali str Au d an erl ti z Sw Ca 2 0 45 50 55 60 65 70 75 80 85 90 96 00 05 10 Sources: IMF World Economic Outlook database; S&P; Global Financial Data; RBA. 32 Some concluding thoughts The global economy presents a decidedly mixed picture at the moment ― ― ― ― the US economy does seem poised for sustainable growth but Europe still looks dire China’s maximum sustainable rate of growth is now slowing Japan’s aggressive new policy stance may work, but the exit from it will be problematic Australia’s economy has performed much better than other ‘advanced’ economies over the past six years ― through a combination of good luck and good management ― ― the ‘resources investment boom’ has probably passed its peak and although resources exports will rise strongly as projects come on-stream, a those exports won’t create much employment, and a lot of the income from them will flow overseas and the required transition to other sources of growth may not be as smooth as the RBA and the Government hope However this period of relative out-performance may be drawing to a close ― The decline in the A$ that is now under way, if sustained, will assist this transition – but its effects will be felt less promptly than during similar episodes in the past Nor will lower interest rates stimulate increased domestic demand as efficaciously as they have in the past ― and there’s much less room to cut rates in the event of a further downturn than there has been prior to previous downturns Fiscal policy could play a useful role in sustaining growth, if appropriately targeted towards worthwhile infrastructure projects ― but, for political reasons, it probably won’t be allowed to play that role 33