Saturday, July 27, 2013

Saturday Morning Musings - economic overview

Today's Saturday Morning Musings has an economics focus. Nothing profound, just jottings on things that attracted my attention.

Globally, and leaving China aside for the moment, there are signs of continued economic strengthening.

In the UK, GDP rose 0.6 per cent in the June quarter following a rise of 0.3 per cent in the March quarter driven by the trade exposed sections of the economy. Not brilliant, but in the right direction. In Germany, the IFO Business Climate Index, a measure of business expectations, rose for the third months in a row to 106.2; a number above 100 suggests economic expansion.  In Japan, the Cabinet Office's July report stated that the Japanese economy was picking up steadily. In the US, the IMF concluded that  growth is slowly accelerating.

I expect European and US growth to continue to strengthen, if slowly, as budget contractionary effects ease and expansive monetary policy continues to support growth, The second is a problem in itself, of course, for the ending of quantitative easing is likely to be quite difficult in economic terms.

Regardless as to arguments about why and what could have been done better, Australia has been remarkably fortunate. In the UK, GDP is still below the pre GFC levels. The loss in national production and expenditure compared to Australia is huge.  

I left China aside for the moment. There Premier Li stated that 7 per cent was the bottom line below which the nation would not allow growth to fall. Mmmm! Leaving aside the miracles of Chinese statistical reporting, China faces a huge economic challenge in re-balancing its economy and moving to productivity and consumption driven growth. It also faces a growing demographic bomb, something that I have written about before.

What China really needs is economic growth in the rest of the world, growing demand for Chinese exports. This will buy time for the Chinese authorities to do the other restructuring that needs to be done. The Chinese economic engine has done its job so far as other places are concerned. It needs to refuel.

One of the interesting topics in Australian newspapers over recent weeks has been what we might call the middle income trap, How do growth countries such as China avoid stalling at middle income levels, failing to break through to higher incomes. Latin America is usually cited as the cautionary tale. For the moment, I just record. 

In Australia, ABS reported on Wednesday that the rise in the Australian all groups CPI for the June quarter was 0.4 per cent, bringing the yearly inflation figure to 2.4 per cent. This was greeted by commentators as providing evidence that inflation was under control, that the Reserve Bank had scope to further reduce the official cash rate. Now market forecasts are overwhelmingly in favour of a further reduction.

I'm not so sure. I don't do forecasts, who can know the minds of either the economy (it doesn't have one) or officials (they do). If I were the Bank. I would leave interest rates on hold. The market consensus appear to be that the Australian dollar will continue to fall. Overseas interest rates are nudging up. The Australian economy is weakening, but has not yet headed into recession territory. The Bank has the option of just letting things run, holding its powder to later.  

Staying In Australia, the end of the week was marked by reports of a ballooning Commonwealth Government deficit with projected revenue shortfalls of more than $A20 billion over the next four years. At the same time, a PWC report suggested that the combined annual deficits of Commonwealth and state/territory government could reach $A213 billion by 2040.

Expect further cuts in Government spending, another reason to reserve monetary policy weapons. We may need them.

Finally, According to newspaper reports during the week, the asset's of Australia's Future Fund passed $A100 billion as the depreciating value of the Australian dollar increased the value of the Fund's international investments. The fund was founded in 2006 to meet future pension liabilities of Commonwealth public servants. Not a bad idea considering what has been happening with Detroit and other US cities.   


Anonymous said...

Ah, the Future Fund:

the asset's of Australia's Future Fund passed $A100 billion as the depreciating value of the Australian dollar increased the value of the Fund's international investments. The fund was founded in 2006 to meet future pension liabilities of Commonwealth public servants.


The Future Fund was established to partially fund the previously ignored problem of retirement benefits due to public servants, including military personnel.

The Future Fund is to be the repository of Federal Government budget surpluses - pardon? - and was given a 'kick-start' by the arbitrary transfer of a significant part of the remaining Federal Government equity in the then recent public floatation of Telstra.

The Board of the Future Fund is not a 'board' as normally associated with any corporation; rather, it terms itself a 'Board of Guardians'.

The Board of Guardians in its 2012 annual report made quite plain its interpretation of its mandate:

The Board also determines that as it is not charged with ensuring that the Fund fully offset the pension liabilities of the Commonwealth, it should not frame its investment strategy around the risk of these obligations increasing relative to the asset base.

- which is fair enough, because that's a big ask. But accepting that, do they set themselves any sort of goal at all - or just sit round discussing the cricket, while investing all funds in, say, an ASX index-tracker?

The Board has interpreted the requirement to achieve a return of at least CPI +4.5% per annum over the long term as meaning over rolling 10 year periods

- fair enough, again. Hard times, easy times; a ten year horizon is not necessarily a bad thing. But, just asking - how'd you go this year?

Following strong positive returns over the last two years, market uncertainty resurfaced during 2011/12 with the Fund generating a modest return of 2.1% for the year.

A "modest return"? Note to self: henceforth 'modest' = 'negative'.


Jim Belshaw said...

Points noted, kvd and especially the partial qualification. But do they detract from my simple point?

Putting that aside, I found your comments on the fund's performance interesting. There is a danger here, one that I have referred to in the context of business planning. In a world of targets in which everybody is trying to achieve above average returns, it logically follows that the aggregate targets cannot be achieved and that the attempts to do so create their own dangers.

We have talked about this before, but it has significant implications for bodies like the Future Fund and indeed the entire Australian super structure.

Anonymous said...

Hi Jim

Certainly does not detract from your point, but I'm a great fan of the decision to establish the FF (one of the best things that government did IMO) so I always perk up my attention when it's mentioned.

And your comment about targets, as you have stated before several times, I very much agree with.

But back on the FF for a moment, while I accept the 'de-linking' the Guardians note, I feel it would be useful for the taxpayer if one of their highlighted bullet points in each Annual Report was a reference to the projected liability out, say 10 and 20 years.

I'd trust their actuarial projections much more than the intermittent shock-horror reportage this sometimes attracts.