I recorded this interview with Your Money journalist Helen Dalley at the Australian Governance Summit on 5 March.

In this week’s update I cover the domestic and global issues I have been following, what they are and why they matter for directors.

The issues I cover include:

  • Lending to Australian households for dwellings declined again in January, indicating further weakness ahead for house prices.
  • Business confidence and business conditions both fell in February.
  • Consumer sentiment worsened in March, falling to its lowest level since September 2017.
  • In three historic votes, the UK parliament first voted to reject Prime Minister May’s Brexit deal, then voted to reject a no-deal Brexit the following day, and then voted to delay the UK’s exit from the EU the day after that . Despite all the parliamentary dramatics, however, no-one is too sure what comes next, with the range of possibilities including yet another last, last ditch attempt to pass May’s deal, a second referendum or even a General Election.
  • The OECD’s composite leading indicators show a loss of growth momentum across the OECD. That’s consistent with a run of international data releases that have surprised to the downside, indicating that the world economy got off to a weak start this year.
  • In an essay, Reserve Bank of Australia (RBA) Deputy Governor Guy Debelle highlights the ‘scale, persistence and systemic risk of climate change’.
  • Head of Research at the RBA, John Simon, discusses the changing nature of economic research ten years on from the financial crisis: more microeconomic data, more ‘big data’ and an increased focus on financial market plumbing and structures.

What I’ve been following in Australia . . .

What happened:

Data released by the ABS showed lending to households in January falling by 2.4 per cent (seasonally adjusted) over the month. That follows a (revised) 3.6 per cent drop in December. The value of lending commitments excluding refinancing for owner occupier dwellings was down 1.3 per cent while the value of lending commitments for investment dwellings excluding refinancing was down 4.1 per cent.

New lending for dwellings overall was down by more than 20 per cent from January 2018, with lending for owner-occupier dwellings down by about 17 per cent over the year and for investment dwellings down more than 28 per cent.

econ1

Why it matters:

The ongoing decline in lending to both investors and owner occupiers points to further weakness in the housing market and hence continued stress for (some) household balance sheets.

What happened:

The NAB monthly business survey for February showed business conditions falling by three points and business confidence dropping by two points.

econ2

The deterioration in business conditions was driven by falls in the profitability and trading sub-indices. On a more positive note, the employment sub-index was unchanged. By industry, the decline in conditions was relatively broad-based, although construction and mining saw particularly sharp falls and retail continues to be the worst-performing sector.

Why it matters:

Following on from last week’s disappointing quarterly GDP result, the decline in business conditions and confidence suggests that the opening months of 2019 may have seen continued weakness. The poor performance of the retail sector points to weak consumer spending. Still, the employment result offers some hope for the current resilience of the labour market.

What happened:

The Westpac-Melbourne Institute Index of Consumer Sentiment (pdf) fell 4.8 per cent to 98.8 in March, its lowest level since September 2017.

econ3

With the index back below 100, pessimists now (slightly) outnumber optimists, although we are still above the average level recorded in 2017. Factors denting consumer confidence included the weak Q4 GDP outcome and the subsequent discussion of a ‘per capita recession’ (there was a marked drop-off in survey response in the days following the GDP print relative to the days prior to it) along with the housing market downturn.

Why it matters:

All components of the sentiment index fell in March, with a marked deterioration in near-term expectations for the economic outlook, weaker views on family finances and a sharp increase in concerns about unemployment. That unemployment indicator jumped to an 18-month high in March right after hitting a seven year low in February, marking a dramatic and surprising turnaround given the latest set of labour market readings.

Overall, and together with the decline in business confidence noted above, this result suggests a significant softening in overall sentiment regarding the economic outlook.

. . . and what I’ve been following in the global economy

What happened:

On 12 March the UK parliament voted to reject PM Theresa May’s Brexit deal. The following day, parliament voted to take a no-deal Brexit off the table permanently, and on 14 March it then voted to delay the UK’s exit from the EU, which was scheduled to take place on 29 March. At the time of writing, no-one was too sure what comes next given the range of possibilities now in play including yet another last, last ditch attempt to pass May’s deal, a second referendum or a General Election. And the EU has still to have its say, with Michel Barnier, the EU’s chief negotiator, reportedly telling the European parliament that the chance of Britain accidentally leaving the EU without a deal was rising by the day.

Why it matters:

Parliament’s continued inability to reach a consensus on what the UK approach to Brexit should be (as opposed to what it should not be) is keeping UK policy uncertainty at high levels.

econ7

Inevitably, this is taking a toll on UK business and therefore on the economy’s longer-term growth prospects. As of the end of last year, UK private business investment had fallen for four consecutive quarters, the weakest run since the 2008-2009 financial crisis.

econ6

What happened:

The March release of the OECD’s composite leading indicators showed that the impetus for growth continued to ease across the OECD in January, reflecting softening growth momentum in the United States, Canada, the United Kingdom and the euro area as a whole. There were also signs that momentum was easing in Japan.

econ5

Outside the club of rich countries, one relative bright spot was China, where there the OECD reported signs of stabilisation in that economy’s growth momentum.

Those OECD numbers are consistent with a run of international data releases that have surprised to the downside. Citi’s economic surprises indices (which capture whether key data releases exceed or fall short of market forecasts) are now negative across all major markets, despite some signs of a turnaround in the euro area (Note that we’d expect this indicator to be mean-reverting (have a natural tendency to return to zero), as seen in the chart. That’s because if economic data consistently surprises on the downside (say), then forecasters will start to cut their forecasts in response). As of early March, the overall global index had fallen to its weakest level since 2013.

econ10

The JP Morgan Global Composite PMI (pdf) provides a monthly overview of conditions in global manufacturing and services. There was actually some good news here, as the overall indicator rose slightly in February, moving up to 52.6 from January’s 28-month low of 52.1. That increase was the first rise in three months and reflected a stronger performance by services, with the Global Services PMI up from 52.6 in January to 53.3 last month. Even so, it was still the second weakest reading since September 2016.

According to IHS Markit, at this level the Global PMI is consistent with world GDP growth running at a rate of around two per cent in the first quarter of this year, which would likely represent a further slowdown from what was already a weak final quarter of 2018.

econ4

Note also that while the services story was more positive last month, in contrast the Global Manufacturing PMI fell to 50.6 in February, down from 50.8 in January. That marked the weakest outcome since June 2016, indicating that global manufacturing output was close to stagnating last month. Some 13 of the 30 countries surveyed (including Japan, China and Germany) now have manufacturing PMIs below the 50 ‘no change’ level, compared to just two economies at this stage last year.

Why it matters:

Last week we flagged that the OECD had cut its growth forecasts for nearly all major economies, citing high levels of policy uncertainty, continuing trade tensions and sliding business and consumer confidence as contributory factors to the loss of global momentum. The current data flow and the OECD’s leading indicators all provide support for the proposition that the weak end to last year has continued into the first quarter of 2019.

What I’ve been reading: articles and essays

RBA Deputy Governor Guy Debelle on climate change and the economy. Debelle highlights the ‘scale, persistence and systemic risk of climate change,’ arguing that policymakers need to think about changes in climate as an ongoing trend associated with an increase in the frequency and severity of climate events. Monetary policy will need to consider both the direct physical impact of climate change and the nature of the economy’s adjustment path. (Debelle gives two examples of how climate is already affecting economic outcomes, citing a marked pick-up in investment spending on renewable energy and the shifting impact of China’s environmental policies on the demand for Australian coal, LNG and lithium.) Debelle also touches on implications for financial stability, including the potential for ‘large, unanticipated payouts’ by insurers, for ‘reputational damage or legal liability’ for significant polluters, and the risk that regulatory changes ‘could cause previously valuable assets to become uneconomic.’ All of which could trigger big moves in asset prices. He also stresses the need for businesses to implement the recommendations of the Task Force for Climate-related Financial Disclosures.

Also from the RBA, John Simon, Head of Research at the RBA, discusses the changing nature of economic research ten years on from the financial crisis: more microeconomic data, more ‘big data’ and an increased focus on financial market plumbing and structures.

CEDA’s new report on the federal budget and Australia’s social compact offers a long list of recommendations including: improved fiscal transparency via an enhanced role for the Parliamentary Budget Office (PBO); upgrades to (a proposed PBO-helmed) intergenerational report; regular reviews of all Commonwealth government funded programs; tighter access to industry assistance; health system reform; limits to work-related tax deductions; cuts to the capital gains tax discount; removal of dividend imputation refundability; personal income tax relief targeted at middle income earners; and more generous tax allowances for corporate investment.

Drawing on a recent paper by Lukasz Rachel and Larry Summers, Martin Wolf’s latest column in the FT argues that low real equilibrium interest rates, likely reflecting some combination of population ageing, slower productivity growth, higher inequality, less competition and lower prices for investment goods, mean that conventional monetary policy may have run its course in much of the developed world. As a result, in a world of secular stagnation (that’s Summers’ claim that the private sector will be prone to sluggish growth due to weak demand, unless stimulated by extraordinary monetary or fiscal stimulus or by excessive private borrowing), Wolf argues that fiscal policy will have to play a more important role.

Related, Emmanuel Farhi and Francois Gourio review the drivers behind an apparent contradiction in macro-finance trends: the large falls in real risk-free interest rates noted above plus weak business investment on the one hand vs. a slight increase in the profitability of private capital on the other. (Their measure of) rising risk premia along with increased market power are at the heart of the story they tell about the divergence in public and private rates of return, with an important supporting role for the growing importance of harder-to-measure intangibles investment.

Brad Setser thinks about what a US-China trade deal could look like. Closing the US-China bilateral trade deficit via increased US exports ‘just isn’t going to happen’, he reckons, but there is a case for pushing China harder on manufacturing trade.

This draft Brookings paper providing a forensic examination of China’s national accounts has been receiving a fair bit of attention. Estimates of China’s GDP have long been skewed by incentives encouraging local governments to mis-report data (in fact, they tended to under-report GDP in the 1990s but then from 2003 started to over-report). While China’s National Bureau of Statistics (NBS) has taken this into account and made offsetting adjustments to its estimate of national GDP, the authors find that when the scale of over-reporting jumped after 2008, the NBS didn’t take that shift into account. As a result, the paper suggests that ‘true’ nominal GDP growth between 2008 and 2016 was 1.7 percentage points lower than the official estimates, that the actual savings and investment rates in 2016 were seven percentage points lower than official figures, and that the overall size of the nominal economy was about 12 per cent smaller in 2016 than indicated by the published data. The implications are that China’s post-2008 slowdown has been even steeper than the official numbers suggest, but also that the process of rebalancing growth away from investment and towards consumption is more advanced than those same numbers imply.

Another one from the FT, where Gideon Rachman writes on the emergence of a two-bloc world, with countries increasingly forced to make a (geo-)political choice on critical issues including their attitude to China’s belt and road (BRI) initiative and their willingness to adopt Huawei’s 5G technology.

After last week’s reference to Paul Collier’s ideas for reforming (UK) capitalism, here’s the editor of Forbes (and some billionaires) on re-imagining US capitalism: what’s needed is more Alexis de Tocqueville and less Milton Friedman, apparently.

Finally, this one works as a listen or as a read: Tyler Cowen in conversation with Raghuram Rajan.


In this week’s update I cover the domestic and global issues I have been following, what they are and why they matter for directors.

The issues I cover include:

  • In a weak result, the Australian economy grew by just 0.2 per cent in the final quarter of 2018 and expanded by only 2.3 per cent over the year. Growth in household spending was subdued and the household savings rate ticked up. In per capita terms, GDP has now fallen for two consecutive quarters, triggering media commentary about a ‘per capita recession’.
  • The day before the GDP release, the Reserve Bank of Australia (RBA) again held the cash rate steady at 1.5 per cent, marking a grand total of 28 consecutive meetings without a change. Despite growing market expectations of a rate cut this year – subsequently given further impetus by the GDP print – the accompanying statement gave no indication that the RBA thinks any policy change is imminent.
  • The day after the RBA meeting, Governor Lowe gave a speech arguing, “The adjustment in our housing market is manageable for the overall economy. It is unlikely to derail our economic expansion.”
  • Retail sales results for January were soft, providing further evidence of a household sector that is now tightening its belt.
  • Australia’s current account deficit fell to $7.2 billion in the December 2018 quarter, equivalent to about 1.5 per cent of GDP. We have travelled quite some distance from old fears of unsustainable external imbalances.
  • Reinforcing that message, January saw Australia record its second highest trade surplus on record.
  • On the first day of China’s National People’s Congress, Premier Li Keqiang announced that Beijing was cutting its growth target for 2019 to a range of 6 – 6.5 per cent from last year’s goal of ‘around’ 6.5 per cent.
  • The US trade deficit for 2018 blew out to US$621 billion, its highest in ten years, potentially putting pressure on President Trump over the results of his trade policies.
  • The OECD updated its forecasts for the world economy. It warned that the global economy is weakening, dragged down by slower growth in Europe in particular.

What I’ve been following in Australia . . .

What happened:

On 5 March the RBA Board again decided to leave the cash rate unchanged at 1.5 per cent, marking the 28th consecutive meeting without a shift in policy.

RBA Cash Rate

While noting that the economy likely slowed over the second half of last year (a prediction subsequently confirmed by the GDP release), the RBA reckons that the ‘central scenario is still for the Australian economy to grow by around 3 per cent this year. The growth outlook is being supported by rising business investment, higher levels of spending on public infrastructure and increased employment.’ The main domestic risk to this relatively rosy perspective continues to be the outlook for household consumption ‘in the context of weak growth in household income and falling housing prices in some cities.’

Why it matters:

As noted in previous updates, financial markets and now a growing share of market economists are predicting that the RBA will have to cut rates over the year ahead, as falling house prices and subdued wage growth undermine consumer spending. But for now, the RBA continues to signal that it sees no need for a change in its policy settings, betting on a further decline in the unemployment rate and an increase in wage growth to support households’ financial health.

What happened:

The Australian economy grew by 0.2 per cent (seasonally adjusted) in the December 2018 quarter, and was up 2.3 per cent over the year. That was softer than market expectations of a 0.3 per cent print for the quarter.

Real GDP

Quarterly growth was supported by a modest contribution from household spending and a strong contribution from public demand, while falling dwelling investment represented a significant drag.

GDP

The result that grabbed media attention was a second consecutive quarter of falling GDP per capita, prompting headlines that Australia had entered a ‘per capita recession’.

Real GDP percapita

Real GDP growth for 2018 overall actually came in at a fairly respectable 2.8 per cent, roughly in line with potential growth. But this was very much a story of two halves, with annualised growth running at close to four per cent over the first half before slumping to about one per cent in the second.

State final demand declined over the quarter in New South Wales, Western Australia and the Northern Territory but was up everywhere else. Household consumption grew everywhere except the Northern Territory, while private investment fell in all states except Victoria, Tasmania and the ACT.

Economics

Why it matters:

The recent data flow has painted a mixed picture, with healthy employment growth, strong increases in government spending and some signs of a recovery in business investment set against falling house prices, sluggish wage growth and a fall in dwelling investment. The GDP release added more detail to the picture, including emphasising both the weakness of the household sector and the offsetting contribution from government spending.

As noted above, falling dwelling investment (plus falling ownership transfer costs) subtracted about 0.3 percentage points from the quarterly growth rate. And while household consumption did contribute about 0.2 percentage points, its growth (at 0.3 per cent over the quarter and two per cent over the year) was fairly subdued, reflecting weakness in household real disposable incomes.

Real household disposable Income

Some additional evidence that households may now be adjusting their behaviour in response to weaker balance sheets and slow income growth came in a change in the household savings rate, which rose slightly to 2.5 per cent.

Household savings ratio

Private business investment added nothing to growth in the December quarter, although with new investment up 0.7 per cent over the previous quarter, there were some tentative signs that the anticipated recovery in capital spending might have started.

What about that ‘per capita recession’? You might remember that in last week’s piece I suggested that a useful gauge of living standards was real net national disposable income (RNNDI) per capita. And it’s true that here the story was a bit more positive, with RNNDI up 0.8 per cent over the December quarter and 2.1 per cent over the year. Still, we can’t place too much comfort in that result either, since RNNDI per capita had fallen in each of the two previous quarters.

The December quarter bump in RNNDI reflects an improvement in Australia’s terms of trade (the ratio of the prices of our exports and imports), which were up about three per cent over the quarter and six per cent over the year.

Terms of trade

That rise also contributed to a stronger performance in nominal GDP growth, which grew by 1.2 on a quarterly basis and by more than five per cent in annual terms. That’s important because faster nominal growth is good news for the size of the tax base, which will in turn be important for the upcoming budget.

What happened:

Governor Lowe gave a speech on the housing market and the economy on 6 March.

Why it matters:

With the RBA flagging falling house prices in some key markets as one of the major risks to its otherwise sanguine outlook for the economy, it’s useful to understand its views on the housing market.

Lowe’s speech focussed on the impact of changes in housing wealth on household consumption. The RBA estimates that a ten per cent increase in net housing wealth will increase the level of consumption by around ¾ per cent in the short run and 1.5 per cent in the longer run. Wealth effects from housing are thought to be sizeable for spending on motor vehicles and household furnishings, but much lower for other kinds of consumption.

Wealth effects

While it follows that falls in household wealth will have a negative impact on some key components of consumer spending (borne out in January’s retail sales results – see below), the RBA’s view is that this kind of wealth effect is a much less important driver of consumer spending than changes in household incomes – both current income and what households expect their future income to be. Lowe judges that although negative wealth effects are now having an impact on consumption, ‘they are working mainly through expectations of future income growth . . . they are not the main issue.’

So, since the RBA’s central case continues to be that the labour market will improve further, and consequently that wage growth will pick up, it also believes that household incomes will rise, and that this will be enough to offset any drag on consumption from falling house prices. Lowe’s conclusion was that ‘the adjustment in our housing market is manageable for the overall economy. It is unlikely to derail our economic expansion.’

Finally, Lowe also touched on the implications of falling house prices for financial stability. Here too, the RBA currently sees little cause for alarm. While non-preforming housing loans have increased recently, they still account for less than one per cent of total loans outstanding. The central bank estimates that ‘less than five per cent of indebted owner-occupier households have negative equity, and the vast bulk of these households continue to meet their mortgage obligations.’

It follows from all this that the labour market will be critical in determining whether the RBA’s optimism is warranted. Lowe pointed to several factors support his positive assessment, including strong employment growth, high vacancy rates, and positive hiring intentions. But as discussed a couple of weeks back, the wage response to date has been disappointingly sluggish. And the GDP results were similarly lacklustre.

What happened:

Australian retail sales in January rose by 0.1 per cent over the previous month (seasonally adjusted) and were up 2.7 per cent over the year.

Retail sales

Why it matters:

After retail sales had slumped by 0.4 per cent in December 2018, market economists had been hoping for a stronger bounce back in the January data (consensus had been for a 0.3 per cent monthly rise). The actual outcome was a fair bit weaker, consistent with the general story of households feeling constrained by a combination of weak income growth and stretched balance sheets. The details were also consistent with an adverse wealth effect on some items of consumer spending.

What happened:

According to the ABS, Australia’s current account deficit fell to $7.2 billion (seasonally adjusted) in the December 2018 quarter, down from $10.8 billion in September.

Australia's current account

For the year, the current account deficit fell from $46.4 billion in 2017 to $40.8 billion in 2018.

Why it matters:

For virtually its entire history, Australia has run a current account deficit. That’s because we’ve consistently invested more than we’ve saved, and consequently have had to import capital from oversees to cover the difference. The counterpart of that capital inflow has been a deficit on the current account.

In the post-war period, and prior to the floating of the dollar in 1983, the typical deficit was quite small – averaging around two per cent of GDP in the 1960s and 1970s. After the float, however, the average deficit increased quite markedly, running at about four per cent of GDP for the next three decades until the onset of the global financial crisis. Since the crisis, the deficit has again narrowed as a share of GDP.

Attitudes towards current account deficits in Australia have fluctuated alongside these swings in their relative size. Back before the float, concerns tended to focus on sustainability and any potential incompatibility with a fixed exchange rate and the maintenance of internal and external balance. In the post-float period, the subsequent sharp increase in the size of deficits and the accompanying rapid accumulation of external debt prompted fears about the resultant vulnerability to any adverse swings in investor sentiment. But by the early 1990s, the so-called ‘consenting adults’ view of the current account (which held that, to the extent that deficits represented the rational decisions of private households and firms about savings and investment , policymakers should refrain from targeting the current account) was in the ascendant.

While this view has largely held sway over local policymakers ever since, there have still been periodic discussions about the size of the external deficit, our consequent reliance on international capital, and the need to maintain foreign investor confidence. But at its current modest share of GDP, it’s very difficult to see the deficit sending any warning signals about external vulnerability.

What happened:

Australia’s trade balance recorded a $4.5 billion surplus in January, the second highest on record and well above expectations of a $3 billion outcome. Exports of non-monetary gold jumped by $1.4 billion, explaining a large part of the monthly increase.

Trade balance

Why it matters:

While there are clouds hanging over the domestic economy, the external economy has been having a much better time of it, helped by a combination of higher commodity prices, stronger LNG export volumes and a weaker dollar.

. . . and what I’ve been following in the global economy

What happened:

On the first day of the NPC in Beijing, Premier Li Keqiang announced that China was cutting its 2019 target for economic growth. After setting a point target of ‘around’ 6.5 per cent for the past two years, this year there will be a target range of six to 6.5 per cent.

Real GDP

China’s Ministry of Finance said that it would cut the rate of value added tax to stimulate the manufacturing sector. It also said it would target a budget deficit of 2.8 per cent of GDP this year (up from 2.6 per cent in 2018).

Why it matters:

China’s role as a key trading partner for Australia (see last week’s piece for details) means that Australian financial markets are sensitive to swings in China’s growth prospects, and the RBA has repeatedly emphasised that one of the key external risks to our outlook is slowing Chinese growth. And of course, China is an increasingly important driver of global economic conditions too.

At the start of last year, Beijing was worried about financial stability, with rapid credit growth having contributed to growing balance sheet vulnerabilities across the corporate, local government and financial sectors. As the World Bank points out in its recent Global Economic Prospects (GEP), both the level and growth rate of China’s private sector debt stocks have been well above those observed during credit booms in other emerging markets. With two thirds of those examples ending in significant slowdowns and more than a third of them resulting in financial crises, the risks are substantial.

Emerging markets

Emerging markets

The authorities responded by introducing regulations limiting bank exposures to China’s shadow financing sector along with stricter controls over off-budget borrowing by local governments. But while this regulatory tightening was successful in slowing credit growth to the non-financial sector, as last year unfolded and the economy stuttered, policymakers changed tack again and sought to boost growth. Policy tightening at home plus a more challenging external environment marked by rising trade tensions with the United States and tighter global financial conditions had seen the economy slow by more than Beijing was comfortable with. The response comprised a range of measures including cuts to bank reserve requirements, tax breaks for lending to SMEs, increased export tax rebates and encouragement of infrastructure spending. Despite this stimulus, growth dropped to 6.4 per cent in the final quarter, and overall growth in 2018 was just 6.6 per cent, its slowest pace in almost 30 years.

Nominal and real GDP

Furthermore, that cyclical fall in GDP growth has also been accompanied by a structural downturn in line with the economy’s declining potential growth.

Still, it’s worth remembering that this slower growth is operating on a much bigger economic base than in the past. As a result, absolute changes in the size of the Chinese economy, as captured for example by annual changes in the value of nominal GDP, remain substantial: the increase in nominal GDP in 2018 was equivalent to more than 70 per cent of the total size of the economy back in 2000, for example.

What happened:

The US trade deficit rose to a decade-high of US$621 billion in 2018. The goods deficit was US$891 billion, the largest on record.

US annual trade balance

Why it matters:

Last year’s deficit represented the biggest splash of red ink since 2008. With President Trump having made closing the US trade gap a key priority of his administration, the outcome, although not surprising, is somewhat embarrassing and provides ammunition for political opponents. Still, it’s possible that this might serve to encourage progress on the much-anticipated US-China trade agreement, as a deal could offer ‘Tariff Man’ a compensating political win.

What happened:

The OECD released its latest set of economic forecasts. It’s trimmed its projections for global growth, which it now expects to run at 3.3 per cent this year and 3.4 per cent in 2020 (down from its November forecast of 3.5 per cent growth in both years). The biggest cuts came in Europe, with predicted 2019 growth in Germany (down 0.9 percentage points), Italy (down 1.1 percentage points) and the UK (down 0.8 percentage points) all suffering large downgrades, and with the OECD noting a disorderly Brexit would mean even worse outcomes for the region.

OECD

Downgrades to the OECD’s forecast for Australia were relatively modest in comparison, with a cut of 0.2 percentage points this year and 0.1 next year, leaving growth projected to slow to 2.5 per cent by 2020.

Why it matters:

The OECD is now markedly less optimistic about the global economic outlook than it was towards the end of last year and is particularly concerned about prospects in Europe. A weaker global economy will provide a more challenging environment for Australia’s own economic trajectory, adding to the downside risks we’re currently facing.

What I’ve been reading: articles and essays

According to new work from economists at the US Fed and Princeton and Columbia Universities, President Trump’s trade war is estimated to have cost the US economy US$12.3 billion in added tax costs and US$6.9 billion in welfare losses. They also find significant disruption to global supply chains, with US$136 billion of imports and US$29 billion of exports either being lost or redirected to avoid tariffs.

The BIS has released its latest quarterly review. The opening section provides a useful review of international financial market developments over the past three months, with the period split in two by January’s shift to a more accommodative policy stance by the world’s major central banks.

The ‘biggest puzzle in economics’: are US ‘superstar’ firms really that super?

The FT’s Gavyn Davies on ways that the US Fed can flex policy to avoid the low inflation traps currently ensnaring Japan and the Eurozone.

The NYRB on the forces behind France’s gilets jaunes.

Tyler Cowen makes the case that the Book of Genesis can be read as a story of technology-led economic growth.

What I’ve been reading: books

Paul Collier’s new book on The Future of Capitalism. Unsurprisingly, its pretty UK-centric, but his argument – that the power of a well-functioning capitalism to generate enormous prosperity has been undermined by a series of ethical failures – has wider applicability. Collier focuses on the emergence of major geographical, educational and moral divides and what might be done to close them, and the book ranges across the family, the firm, the state and the world economy. The short chapter on the ‘ethical firm’ covers some familiar territory, looking at culture, control and the regulatory framework and includes a proposal to change the British Companies Act to ‘make due consideration of the public interest mandatory for all board members’, citing as a precedent the US category of Public Interest Companies, which Collier sees as a kind of pilot scheme for his approach. Collier’s self-identified ‘hard centrism’ and communitarian-style approach certainly won’t work for everyone, but there are enough interesting ideas here to make for an engaging read.

1 Assuming there are no major distortions influencing those savings and investment decisions.

2 It may be that any political downside will be offset by the fact that a significant part of the story is US economic outperformance relative to the rest of the world.


In this update , I cover the domestic and global issues I have been following and why they matter for directors including:

  • The International Monetary Fund (the IMF, or ‘the Fund’) gave Australia a reasonably clean bill of health in its latest assessments of the economy and the financial sector. The Fund did flag some familiar downside risks, including the possibility of a severe housing market downturn. It also sketched out a medium-term economic trajectory which implies depressingly slow growth in living standards.
  • The recent flurry of news around potential Chinese restrictions on Australian coal imports signals continued concern about the degree of our exposure to the Chinese economy – both economic and geo-economic / geo-political. While there’s no doubt about the critical importance of China to our economic prospects, sometimes the level of dependence gets overplayed.
  • According to the Australian Bureau of Statistics, total construction work done in the economy slumped by 3.1 per cent in the final quarter of 2018 and was down 2.6 per cent over the year. The numbers were much weaker than economists had been expecting.
  • Financial data released by the Reserve Bank of Australia showed monthly growth in housing credit dropping to just 0.2 per cent in January, the weakest outcome since 1984.
  • Private capital expenditure in Australia rose at a solid two per cent quarterly rate in the December 2018 quarter. Early results for investment intentions for 2019-20 look quite decent too.
  • The clashes between India and Pakistan in Kashmir are a reminder that – despite a few relatively quiet months – geopolitical risk in the world economy has been trending higher.
  • Talks between Washington and Beijing have progressed well enough that President Trump said he would postpone the 1 March deadline for another round of tariff increases on imports from China. But US officials have subsequently warned that there is still a long way to go before any deal can be finalised.
  • Prime Minister May conceded that the current timeline for Brexit is unrealistic and that a delay will be needed. The UK government’s recently published assessment is that British businesses, particularly in the SME sector, are unprepared for a ‘no deal’ exit from the EU, apparently because they refuse to believe any government could be that crazy.

What I’ve been following in Australia . . .

What happened:

The IMF published its latest assessments of the Australian economy and financial sector.

Each year the IMF visits member countries to assess their policies and outlook. This Article IV process provides an annual economic health check and Australia received its latest visit last November. The IMF also conducts regular in-depth analyses of members’ financial sectors and the outcome of the latest Financial Sector Assessment Program (FSAP) for Australia has also been published.

As well as highlighting some familiar near-term risks including the housing market, household debt, trade protectionism and China’s economic rebalancing, the Fund also suggested that Australia’s real GDP growth will run at 2.6 per cent in the medium-term, implying a subdued outlook for Australian living standards.

Why it matters:

The IMF’s base case for Australia is cautiously upbeat, and not greatly dissimilar to the RBA’s perspective (which likely reflects that much of November’s consultations will have involved discussions with Australian officials). The Fund sees the unemployment rate falling to 4.8 per cent this year, economic growth slowing gradually towards what it thinks is Australia’s potential growth rate (about 2.6 per cent) by 2020, and inflation hitting the midpoint of the RBA’s target range by 2021. The housing market correction is expected to be ‘mild and short-lived’, lasting for a year or so before demand from population growth provides renewed support for house prices, while the drag on growth from weaker dwelling investment is predicted to be more than offset by strong growth in private and public investment.

The IMF also highlights a range of risks to this outlook, most of them to the downside. Domestically, it cautions that ‘the housing market correction may be deeper and longer than anticipated’ and that low wage growth could also lead to softer consumption growth. Internationally, it flags rising global protectionism and the possibility of weaker growth in China as key risks, along with geopolitical and security concerns.

Below, I’ve had a go at translating this into a simple risk matrix. Based on the usual convention that the top right corner indicates the greatest risks, we can see that, aside from a possible housing market crash, the Fund sees global risks as the most worrying for Australia.

IMF Risk Matrix

The IMF also reviewed medium-term growth prospects. It estimates that Australia’s potential real GDP growth rate has now fallen to around 2.6 per cent, due to a smaller contribution from investment that has only been partially offset by a modest increase in trend productivity growth. Population growth – including from net overseas migration – is assumed to continue at around its current relatively rapid pace.

IMF potential output

Source: IMF Australia 2018 Article IV

That would put potential growth broadly in line with our (diminished) average post-crisis growth rate.

GDP growth

It also translates into very modest projections for medium-term growth in real net national disposable income per capita – a good measure of trends in actual living standards. The Fund has this growing at less than one per cent out to 2024. That’s below the post-crisis average and well below the kind of growth in living standards we enjoyed in the period before 2008. As such, it seems unlikely to be particularly supportive of consumer – or voter – optimism.

Australian net growth

So how might we do better? The Fund has several suggestions, none of which will surprise.

(1) We could continue to boost spending on infrastructure. While recognising there’s already been progress here, the Fund reckons Australia continues to suffer from a ‘notable infrastructure gap compared to other advanced economies.’

IMF infrastructure gap

(2) Despite some relative improvement over the past decade, it judges that we also continue to lag our peers in terms of spending on research and development (R&D).

IMF R&D expenditure

(3) The Fund continues to advocate broad tax reform, arguing for a rebalancing away from our current relatively high reliance on direct taxes to a greater role for indirect taxes, via broadening the base and increasing the rate of the GST.

(4) It also thinks that a reduction of policy uncertainty around energy investment decisions would help.

One factor that we already have going for us – along with relatively fast population and labour force growth by OECD standards – is rapid trading partner growth compared to many of our peers, reflecting our ties to the dynamic Asian region.

IMF trading partner growth

Finally, the IMF’s FSAP (which was completed in September last year) highlights what the Fund sees as improvements to financial sector strength based around higher levels of bank capital, lower funding risks and previous macro-prudential efforts to reign in some of the riskier lending associated with the mortgage market. But the Fund also judges that ‘[s]tretched real estate valuations and high household leverage pose significant macrofinancial risks.’ It also cautions that with the major banks all running similar business models with a similarly high exposure to the real estate sector, the system is vulnerable to common shocks, including to external funding.

What happened:

News reports suggesting that officials at the Chinese port of Dalian may have blocked imports of Australian coal – a claim since denied by Beijing – prompted another round of debate over the degree of Australia’s export dependence on China.

Why it matters:

One major driver of that strong trading partner growth highlighted by the IMF has been the rise in importance of China as an Australian export market. By 2017-18, China was the destination of almost 34 per cent of Australian merchandise exports, equivalent to about 5.8 per cent of nominal GDP. The last time Australia was that dependent on a single market was all the way back in the early 1950s when the market was the UK.

Australian Merchandise exports

China is slightly less important as an export market for Australian services than it is for goods, with a share of 19.2 per cent in 2017-18. But it’s still the top destination in that category too. Combined Australian exports of goods and services to China were worth A$123.3 billion, equivalent to 30.6 per cent of total goods and services exports or about 6.7 per cent of GDP. Our iron ore exports to China alone accounted for more than 12 per cent of all Australian export earnings in 2017-18, with other significant contributions coming from coal, education services and LNG.

Direction and composition of exports

These numbers provide some useful perspective on the Dalian coal affair.

On the one hand, China is Australia’s second largest export market for Australian coal, accounting for almost 22 per cent of all coal exports in 2017-18. And coal is our second-largest export earner, accounting for 15 per cent of export values, just behind iron ore. Hence the headlines.

On the other, Australian coal exports to China represented only a bit more than three per cent of all Australian exports in 2017-18, or less than one per cent of GDP. And only a small fraction of our coal exports to China – roughly two per cent – were routed through Dalian and therefore subject to the potential ban (although Australian coal exports more generally had previously been reported to have been caught up in general customs delays).

Those numbers confirm that much of the reaction to the Dalian story was less about any likely direct economic impact than about general concerns regarding Australia’s economic exposure to China.

Sometimes those concerns about Australia’s China exposure are based around risks to China’s own economic outlook, while at other times they focus on the health of the political bilateral relationship and Australia’s vulnerability to any exertion by Beijing of geo-economic pressure. This looks to have been an example of the latter, and readers might remember stories in May and June last year when there was a similar focus on delays affecting Australian exports of wine to the Chinese market.

Just how exposed are we to China? Clearly, there are a range of potential pressure points across our goods and services sectors, and many Australian businesses are reliant on Chinese demand. As a result, a disruption to bilateral trade – say because of a China downturn – represents a high impact risk for Australia (see that risk matrix from earlier). It’s also common to hear about Australia’s position as the OECD economy most reliant on China as an export market as a reflection of our relatively high degree of vulnerability.

China export exposure

All of which is true. But it’s also useful to keep it in perspective.

For example, our overall risk exposure is tempered somewhat by the fact that the share of trade in our GDP is relatively low by OECD standards: in fact, only two OECD members (the United States and Japan) have trade ratios lower than ours. As a result, if we measure trade exposure to China by share of GDP rather than by share of total exports, our relative position in the OECD rankings moves down a couple of places, albeit still leaving us very much at the high end of the OECD distribution.

China trade exposure

Another useful way of thinking about this is to consider the overall concentration of our export markets. One simple measure of this is the Herfindahl-Hirschman (HH) index of export concentration. This shows that while our export market concentration is indeed high by OECD standards, it’s also nothing like the kind of overwhelming dependence Canada and Mexico have on their US neighbour.

Export market concentration

What happened:

The ABS released preliminary data on construction work completed in the December 2018 quarter.

The value of work done fell by 3.1 per cent over the previous quarter (sa) and was down 2.6 per cent over the year. That was much weaker than the consensus forecast, which had expected a 0.5 per cent quarterly gain.

Engineering work dropped by five per cent relative to the September quarter, while residential construction was down 3.6 per cent over the same period.

Why it matters:

While the fall in engineering work was consistent with the long-running story of the steady winding down of the big resource investment projects, the drop in residential construction flags weakness in dwelling investment and risks to future employment levels in the construction sector.

What happened:

The ABS released data on private new capital expenditure and expected expenditure.

Total new capital expenditure in the December quarter was up two per cent (sa) over the previous quarter and 1.9 per cent over the year. By sector, mining investment fell 4.3 per cent over the quarter and manufacturing investment was down 4.4 per cent. In contrast, investment in other selected industries was up 3.7 per cent.

Real capital expenditure

By type of expenditure, spending on buildings and structures was up 3.2 per cent over the quarter while equipment, plant and machinery expenditure rose by 0.7 per cent.

The latest estimate (Estimate 5) for total capital expenditure in 2018-19 was $118.4 billion, four per cent up on Estimate 4 and 3.6 per cent higher than Estimate 5 in 2017-18.

Capital expenditure estimates

‘Other selected industries’ were the main driver of the increase, up nearly nine per cent over the 2017-18 outcome and close to five per cent higher than Estimate 4 this year. Estimate 5 for mining was almost seven per cent down on last year’s result, but up 3.8 per cent over Estimate 4 this year.

Capital expenditure estimates other industries

The first estimate for total capital expenditure for 2019-20 came in at $92.1 billion. That’s 11 per cent higher than the first estimate for 2018-19 and reflects a 21.4 per cent increase in estimated mining expenditure, along with a more modest 6.8 per cent increase for other selected industries.

Capital expenditure estimates mining

Why it matters:

If the cautiously optimistic growth forecasts of the RBA and the IMF are to be realised, then business investment will have to play an important role, helping offset an expected fall in dwelling investment. In part, growth in business investment should be driven by the end of the long-running contraction in mining investment, which would transition from being a significant headwind to growth to delivering some positive support. But it also requires continued growth in non-mining investment.

This set of numbers is not inconsistent with that kind of story, with mining firms reporting that they are planning to boost investment by more than 21 per cent in 2019-20 and non-mining firms by more than six per cent. While it’s important to keep in mind that these early estimates of investment intentions can turn out to be quite different from actual outcomes, the growth rates at this point at least imply a decent investment result for next year.

What happened:

The RBA published financial aggregates for January this year.

Total credit growth grew by 0.2 per cent over the month (seasonally adjusted) and was up 4.3 per cent over the year. Monthly growth in housing credit slowed to just 0.2 per cent (up 4.4 per cent on an annual basis) while person credit growth fell by 0.6 per cent relative to December. Credit to business was up 0.3 per cent month on month and 5.2 per cent over the year.

Why it matters:

The credit data show the monthly rate of growth in housing credit falling to its lowest level since July 1984. That reflects a combination of lower demand for housing finance along with tighter lending standards.

Australian Housing Credit

. . . and what I’ve been following in the global economy

What happened:

Tensions between India and Pakistan soared after India launched airstrikes on 26 February, targeting what it said was a jihadist training camp in Pakistan, in retaliation for a 14 February suicide bombing in Kashmir. Pakistan responded with airstrikes of its own the following day and subsequently claimed to have shot down two Indian jets. Footage of a captured Indian pilot aired on Pakistan television.

Why it matters:

Regional analysts reckon that tensions between the two nuclear powers are now at their highest since the 1971 Indo-Pakistani war.

As noted above, the IMF’s latest risk assessment for Australia places geopolitical risks in the ‘high’ impact and ‘medium’ likelihood categories. Yet until recently the readings on geo-political uncertainty had been mixed, with, for example, the Geopolitical Risk Index having fallen back from the highs it had reached around the time of President Trump’s ‘fire and fury’ speech targeting North Korea. Current developments in South Asia serve as a reminder that on a trend basis, geopolitical risks have been increasing over the past decade.

Geopolitical risk index

What happened:

President Trump announced that the current round of US-China negotiations had gone well enough to persuade him to postpone his 1 March 2019 deadline to increase US tariffs from 10 per cent to 25 per cent on US$200 billion of Chinese imports (and perhaps impose new tariffs on another US$267 billion of Chinese products). The positive news prompted a rally in the US and China share markets, although that optimism was subsequently reversed after US officials stressed that there was still some distance to travel before any agreement could be reached.

Media speculation suggests that any potential agreement would likely involve some mix of Chinese promises to make sizeable purchases of US exports, deliver enhanced intellectual property protection and increased access for foreign investors and businesses, and a commitment on the value of the renminbi. Whether that would be enough to meet what at times seems to be calls from Washington for a complete reworking of the China model remains an open question, however. And of course, even if agreement can be reached, that would still leave open the problematic question of enforcement.

Why it matters:

As discussed in last week’s piece and as noted in the risk matrix, any escalation in the US-China trade conflict (or in trade conflicts more broadly) would be bad news for the world economy and for Australia’s economic outlook. More generally, the ongoing dispute between Washington and Beijing is one potent source of a cloud of economic policy uncertainty that has been looming over the global economy in recent years. So, for example, when RBA Governor Lowe testified to the House of Representatives Standing Committee on Economics on 22 February, he identified a range of global political risks including ‘the trade and technology tensions between China and the United States; Brexit; the rise of populism; and strains in some western European economies.’

Measures of global economic policy uncertainty are currently at very high levels (albeit down slightly from a December 2018 record high), and this level of uncertainty seems likely to be serving to discourage at least some international trade and investment.

Global economic policy uncertainty index

What happened:

Prime Minister May has indicated that the UK may not be leaving the EU on 29 March.

May has now promised Parliament a vote on a new Brexit deal by 12 March, and if that deal is rejected, she will allow a vote on whether the UK should leave the EU without a deal by 13 March. If Parliament also votes to reject the no-deal option, there will then be a vote on an extension to the 29 March deadline.

Germany’s Chancellor Angela Merkel said she was open to the idea of a delay if it would support an ‘orderly exit of the UK’, but France’s President Emmanuel Macron has expressed a bit more scepticism.

The UK government has published its assessment of the implications for business and trade of a no-deal exit, which found ‘little evidence that businesses are preparing in earnest for a no deal scenario, and … that readiness of small and medium-sized enterprises in particular is low.’ The judgement is that this is ‘often because a no deal scenario is not seen as a sufficiently credible outcome to take action or outlay expenditure.’ In other words, it seems that most British businesses just can’t bring themselves to believe that a UK government could be that crazy. The same assessment also concluded (completely unsurprisingly) that there would be substantial economic disruption in the event of a no-deal exit.

Why it matters:

Uncertainties around the timing and shape of any Brexit deal and hence on the likely impact on the UK and other EU economies are another important contributor to the general sense of international policy uncertainty noted above.

Brexit is also a powerful case study in how the prevailing political and social environment in several developed economies appears to lend itself to rapid and dramatic shifts in public sentiment, which can then in turn trigger equally dramatic policy changes. Prior to then Prime Minister Cameron announcing in early 2016 he would call a referendum on the UK’s membership of the EU, less than six per cent of Britons cited Europe or the EU as one of the most important issues facing the country. Now it’s all consuming.

What I’ve been reading: short form

The IMF summarises its economic outlook for Australia in six charts.

The story of China’s economy as told through the world’s biggest building. An Economist essay musing on land, cronyism and debt.

The Road to Digital Serfdom? Shoshana Zuboff on Surveillance Capitalism, riffing on Smith, Hayek…and Zuckerberg. Sometimes heavy going, but an interesting perspective. Zuboff’s new book has been picking up a bit of media attention.

Douglas Irwin on Understanding Trump’s Trade War. Irwin says watch the president’s approach to autos, China, the WTO and the trade deficit.

Stephen Letts on China’s policy on Australian coal: ‘as dark and impenetrable as the night’.

The East Asia Forum describes how Canada has found itself caught between Washington and Beijing in their tussle over Huawei.

1 Growth in real GDP is the standard measure of economic growth but has several shortcomings when it comes to measuring changes in living standards. Real net national disposable income (RNNDI) adjusts GDP for changes in the terms of trade, net income flows between us and the rest of the world, and depreciation of the capital stock. In per capita terms it captures the impact on individual Australians.

2 Note that the data only cover private investment for a subset of industries. They exclude Agriculture, Forestry and Fishing, Public Administration and Super Funds. They also omit Education and Training and Health Care and Social Assistance, although the ABS does now produce experimental estimates for this second group.

3 Based on the Ipsos Mori issues index. See here for example.


25 February 2019

Over the past week or so we’ve seen minutes from the RBA and the Fed explaining why both central banks have become more cautious about their respective outlooks, witnessed continued negotiations over global trade policy, and received a couple of useful updates on the health of the Australian labour market. Oh, and the Brexit process continued to grind... well, perhaps not forward exactly... but on. (Nothing more on Brexit this week, but with a critical vote looming at the end of February, I’ll aim to discuss the state of play in a future Weekly.)

In this update, I cover the domestic and global issues I have been following and why they matter for directors including:

What I’ve been following in Australia...

What happened:

The RBA published the minutes of the 5 February monetary policy meeting.

After the bumper crop of RBA commentary at the start of this month, including February’s Statement on Monetary Policy (SMP), arguably there wasn’t a whole lot of ‘new’ news here. Still, members seemed to be increasingly mindful of downside risks, highlighting global trade tensions and a challenging outlook for the Chinese economy. A key focus was on the correction in the housing market where their glass-half-full take was that, given the scale of the preceding run up in prices, ‘the effect of the recent price falls on overall economic activity was expected to be relatively small.’ On the other hand, they also conceded that ‘if prices were to fall much further, consumption could be weaker than forecast, which would result in lower GDP growth, higher unemployment and lower inflation than forecast.’

Why it matters:

This confirms the story told by the SMP: that the economic outlook is now weaker than the RBA had previously expected, with concerns about the nexus between falling house prices and future consumption growth. That signals changes to both the RBA’s judgment and market expectations about when and how a change to the cash rate might come. So (1) the timing of the next move has probably been pushed back, absent any major change to the outlook and (2) contrary to the RBA’s previous mantra that the next move was likely to be up, market expectations have a cut as more likely.

What happened:

The ABS released the December 2018 quarter Wage Price Index (WPI) followed by the January 2019 Labour Force survey.

The WPI was up 0.5 per cent over the previous quarter (seasonally adjusted or sa) and 2.3 per cent over the year. Quarterly growth was slightly below market expectations (0.6 per cent) but the annual outcome was on target. Growth in the WPI including bonuses was slightly stronger, up 2.7 per cent over the year.

Wage price index

Private sector wages grew by 2.3 per cent while public sector wages were up 2.5 per cent over the year.

Wage price index YOY

By State, the weakest wage outcome was in Western Australia (up just 1.6 per cent over the year in the December quarter) while the fastest growth was in Victoria (up 2.7 per cent).

Wage price index by state

In contrast to the relatively soft outcome for wages, employment jumped by 39,100 persons in January (sa). Full-time employment increased by 65,400, more than offsetting a 26,300 fall in part-time employment. Full-time employment has now increased by 236,100 persons since January 2018, while part-time employment has grown by 35,200.

Change in employment

The unemployment rate stayed unchanged at five per cent (sa) - the lowest monthly result since April 2012 - while the underemployment rate dropped by 0.2 percentage points to 8.1 per cent, leaving the underutilisation rate down slightly at 13.2 per cent.

Unemployment and underemployment

Across the States, New South Wales saw employment surge by 47,200 in January (sa), while employment increased by 2,200 in Victoria and 800 in Western Australia. In contrast, Queensland saw a fall of 19,900 and South Australia a 4,500 drop. The unemployment rate in New South Wales has now fallen to below four per cent for the first time this century, while it is still six per cent or higher in Queensland, South Australia, Western Australia and Tasmania.

Unemployment rate by state

Why it matters:

As already noted, the RBA is paying a lot of attention to the outlook for household consumption – no surprise given that it accounts for a bit over half of all GDP. Part of that consumption story revolves around the potential size of any negative wealth effects on spending from falling house prices. In the past, the RBA has tended to be cautious about the scale of such effects, judging that consumers are likely to look through short-term fluctuations in wealth and be driven more by changes in income. Hence another part of the story is the state of the labour market. In February’s RBA minutes, for example, members were recorded as noting ‘the continued improvement in conditions in the labour market’ and as a result were still expecting a gradual rise in wages which, combined with continued employment growth, would boost consumer spending.

Yet, despite what appears to be a relatively healthy labour market, wage growth has been painfully slow in getting traction. Potential explanations include structural changes driven by the combined impact of technology and globalisation working to reduce the relative bargaining power of workers; the rising importance of underemployment relative to unemployment as a determinant of labour market slack (the two used to track each other quite closely, but that’s no longer the case); and the impact of low inflation expectations on nominal wage demands.

In this context, the latest set of data points tells a familiar story, suggesting that: (1) we look to have hit the bottom of the wage cycle in early 2017, but (2) any consequent strengthening in wages continues to be extremely sluggish and therefore offers limited support for consumption in the face of any headwinds arising from lower housing wealth. On the other hand, (3) employment growth continues to be strong, which will offer the RBA at least some grounds for hope that its forecast acceleration in wage growth may yet play out.

... and what I’ve been following in the global economy

What happened:

US and Chinese trade negotiators met in Washington DC last week to hold another round of talks on trade policy. President Trump also received the results of an investigation imports of cars and car parts, triggering a round of threat and counter-threat with the European Commission.

After spending much of 2018 levying tariffs on each other’s products, Washington and Beijing agreed to a temporary truce in their bilateral trade war at the G20 last December. The idea was to buy time to forge a deal covering the size of the US bilateral trade deficit with China, Beijing’s attitude to intellectual property (IP) rights, and investor access to the Chinese market. (Although it’s worth noting here that the most cynical take on the negotiations – that Washington is actually targeting the China economic model in its entirety – would effectively rule out any meaningful compromise.) December’s trade ceasefire came with a deadline attached: if no agreement was reached by 1 March this year, then US tariffs of 10 per cent currently being levied on Chinese imports would be bumped up to 25 per cent.

International trade disputes have not been confined to the clash between Washington and Beijing. Back in May 2018 President Trump asked the US Department of Commerce to start a so-called Section 232 investigation into the effects of imports of cars and car parts on US national security (it was another Section 232 action that saw Washington impose tariffs on steel and aluminium in H1:2018). That threatens US auto trade with the EU (as well as markets like Japan and South Korea) with the prospect of tariffs of up to 25 per cent. Within Europe, Germany feels particularly vulnerable, with cars the economy’s biggest export and the United States its biggest car export market. According to one study by Germany’s ifo Institute, US tariffs at that level could cut German car exports to the United States by almost half in the long term. President Trump has 90 days to respond to the report and has already warned that he will impose tariffs if the United States and the EU fail to reach agreement on a trade deal. For its part, the European Commission has promised retaliation in the event of any US tariff action.

Why it matters:

There has been a marked increase in measures of US trade policy uncertainty during the Trump presidency.

US Trade Policy Uncertainty Index

All up, new US tariffs introduced during 2018 and the subsequent retaliation from trading partners have hit close to US$430 billion of global imports. To date, that’s only around 2.5 per cent of global goods trade, but more than five per cent is vulnerable.

Share of imports

About 12 per cent of US goods imports and 6.5 per cent of China’s imports have been slugged so far, but if every potential tariff measure was implemented, then nearly all goods trade between the two economies could be impacted. Strikingly, that would see the average US tariff rate more than quadruple, returning the country to levels of protectionism last seen in the 1960s.

US average import tariffs

Any renewed escalation in global trade conflicts would impose significant damage on the world economy both in the short-term through the hit to confidence (financial markets have been tracking developments closely, with share and currency markets reacting to the changing probabilities of conflict), to production and to investment, and in the longer-term due to the consequences for productivity growth, the organisation of production and a likely ratcheting up in geopolitical risk. The recent flow of data from Germany to Japan suggests that sluggish world trade growth is already showing up in the statistics. And given Australia’s large direct (almost a quarter of two-way trade and more than 30 per cent of export sales) and indirect (via our ties to other Asia-Pacific markets, and through confidence effects on the ASX and the Australian dollar) exposure to the Chinese economy, any new blow up in the US-China trade conflicts would be obviously be bad news for us.

Then there is the risk of adverse demonstration effects in the form of the increasing normalisation of trade policy as a weapon that can be wielded to punish recalcitrant trading partners. At the time of writing, there were (unconfirmed) reports that the port of Dalian in Northern China might have banned coal imports from Australia, possibly in retaliation for Australia locking out Huawei from our 5G network. Confirmed or not, the story itself was enough to trigger a fall in the Australian dollar.

Australian Directors are certainly aware of the risks: according to the AICD’s own Director Sentiment Index (H2:2018), rising global protectionism was seen as the main economic challenge facing Australian businesses last year, followed by general global economic uncertainty.

Economic challenges facing Australian businesses

What happened:

The minutes of the 29-30 January 2019 Federal Open Market Committee (FOMC) were published.

FOMC participants recognised that ‘some risks to the downside had increased’, listing the possibility of sharp growth downturns in China and Europe, the waning stimulus from the Trump tax cuts, rising policy uncertainties around Brexit and international trade, and the possibility of tighter financial market conditions. As a result, they advocated ‘a patient approach to monetary policy.’

The minutes also highlighted a shift in managing the reduction in the Fed’s balance sheet: ‘[a]lmost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve's asset holdings later this year.’

On the prospect of further rate hikes, they reported that, ‘[m]any participants suggested that it was not yet clear what adjustments to the target range for the federal funds rate may be appropriate later this year; several . . . argued that rate increases might prove necessary only if inflation outcomes were higher than in their baseline outlook. Several other[s] . . . that, if the economy evolved as they expected, they would view it as appropriate to raise the target range for the federal funds rate later this year.’ So, maybe they won’t hike, or maybe they will . . .

Why it matters:

With a central, dominant place in the international financial system, the Fed is the closest thing we have to a global central bank. As such, Fed policy decisions have a major impact on global financial conditions, currency movements, risk appetite and overall market sentiment.

Following a prolonged period of super-stimulative monetary policy in the aftermath of the global financial crisis, the Fed started ‘normalising’ rates in late 2015, with an initial 25bp hike, followed by a gradual upward adjustment through until last December, when it delivered the ninth rate increase of the current tightening cycle, lifting the target range for the Fed Funds rate to 2.25-2.5 per cent. At the time, the FOMC noted that it was planning ‘some further gradual increases’ in rates this year.

The Fed has also been shrinking its balance sheet. During the financial crisis and subsequent US economic downturn, this had expanded from less than US$1 trillion to around US$4.5 trillion at its peak, reflecting the impact of Quantitative Easing (QE). Starting in 2017, the Fed started to reverse the process, with QE replaced by ‘Quantitative Tightening’ (QT).

Then, at the January 2019 meeting, the Fed abruptly changed its tone, leaving rates unchanged and stating only that ‘the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate’. Talk of future rate increases had vanished, prompting the world’s financial press to proclaim a dramatic policy U-turn and fuelling speculation about the end of the tightening cycle.

January’s minutes help shed some light on this.

First, they highlighted a divide between those FOMC officials who think rates will be now be on hold unless US inflation surprises on the upside and those who think that further rate increases might still be warranted later this year. They didn’t, however, reveal a constituency for a rate cut.

Second, they provided some additional guidance on the Fed’s approach to balance sheet adjustment, indicating that the adjustment process will now come to an end this year and in scale be towards the more modest end of the spectrum.

What I’ve been reading: short form

The FT on Germany’s export model: One of the world’s most successful exporting nations is facing a tough external environment.

The Nikkei Asian Review on the Chinese housing market: Up to 65 million urban residences – or more than 20 per cent of housing – may stand unoccupied, mainly in China’s second- and third-tier cities.

The Munich Security Report 2019: The opening essay, which asks who will pick up the pieces of a crumbling international order, captures the prevailing sense of unease felt by many Western security analysts regarding the current strategic situation.

Barry Eichengreen and others deliver a fascinating history of public debt, covering both the positive contribution to state-building and the parallel story of debt debasement and restructuring – a duality matching the paper’s opening description of sovereign debt as a ‘Janus-faced asset class’ that is associated both with safe haven investment and economic crises.

The RBA on low wage growth: This piece from the RBA Bulletin in March 2017 starts from the proposition that the Bank’s forecasts have consistently over-estimated future wage growth. Useful background for the current debate over wages and the labour market.

The SCMP on how China is developing some of the world’s youngest AI weapons scientists. (This piece from last year basically caught my attention because of Marginal Revolution’s clever linking to what it called ‘Ender’s Game in China.’ Yes, I am into science fiction.)

What I’ve been reading: long form

I recently finished Oliver Bullough’s Moneyland which for a book on finance, money-laundering and kleptocracies turned out to be a great holiday read.

I usually enjoy John Lanchester’s non-fiction pieces for the LRB and was keen to pick up his latest novel, The Wall: it’s a gripping future dystopian tale, revolving around catastrophic climate change, extreme policy responses and intergenerational guilt. If that sounds interesting, you can hear Lanchester talk about his book on this podcast.


With a Federal Election looming and the global outlook marked by high levels of uncertainty, the economic environment will play a crucial role in the decisions directors and organisational leaders will make.

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I look forward to the work ahead of us at this critical time for the Australian economy and the future of governance.