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.