For a more comprehensive round up of the week, listen to Stephen’s full report here.
The global and Australian economies are slowly improving and look set to progress at similar pace through the rest of 2014 and probably 2015 as well. While most commentaries recognise that the global economy and local economy are improving, a significant proportion of commentators are also looking for an “x” factor that will stymie progress, possibly even collapse activity driving the global economy into a worse version of the 2008 global financial crisis. Some point to excessive credit growth in China unraveling in a credit crunch severely cutting into growth prospects. Others point to the old bogie of too much government debt and austerity budgets for the foreseeable future. An Australian version of the escalating government debt concern is in vogue currently, ahead of the Abbott Government’s first budget next month. Other concerns include too high household debt, although some also point to the prospect of too cautious households spending not enough. In the Australian context, the sharp decline in resource investment spending also looms large.
In our view all of these risks to growth prospects exist, but it seems much more likely that the factors that are already driving stronger growth will continue to dominate. China, now the world’s second biggest economy, represents perhaps the biggest risk in either direction to global and Australian growth prospects. Rapid credit growth in China over recent years and its links to property speculation and escalation in unorthodox wealth management products invite comparison to the credit crises in the US and Europe in 2008. However, there are important points of difference. The authorities in China have been leaning against the credit build up for more than a year by tightening monetary conditions – something that was absent in the US and Europe in 2007 and 2008. Also, the authorities in China are very well versed in the events leading up to and after the Lehman Brothers collapse in September 2008. In short they are working with a textbook of what happens when a systemically important financial institution is allowed to fail and they are unlikely to risk having a “Lehman event” of their own.
China’s authorities also have another huge asset that was not available to the US or European authorities in 2008, a massive war chest (nearly $US3 trillion in foreign exchange reserves) that with a little intra-governmental department creative accounting can help to re-capitalise China’s banks in need. We are not denying that a credit crisis could happen in China, but it does look much more manageable than the variety that occurred in the US and Europe.
It is also worth noting that part of the slowing in China’s growth rate is a consequence of a broad range of economic reforms that will help to generate better-balanced and more sustainable Chinese economic growth over the medium to longer term. The most recent set of economic readings from China seem to indicate that the cost to economic growth is no greater than the authorities have planned. Despite soft exports and moderating growth in investment spending, GDP in China in Q1 2014 was up by 7.4% y-o-y – the official target for 2014 is 7.5%.
Turning to the risk that government may overdo it in cutting back their budget spending; again fears seem to be over-blown to us. The US has been through a phase of aggressive reduction in its budget spending reducing its budget deficit as a percentage of GDP from near 10% three years ago to under 3% in the current fiscal year. The important point is that the phase where deficit reduction represented the strongest headwind to US economic growth was back in 2012 and 2013 and the economy came through the period growing modestly, adding jobs and reducing its unemployment rate. Economic growth is now doing the job of reducing the US budget deficit from here and the headwind to growth from deliberate policy cuts to spending is almost non-existent.
Europe is not quite in the same position as the US, although its unemployment rate has peaked and even the very high number of youths unemployed has declined by over 130,000 over the past year. Further budget cuts still lie ahead in Europe but they are of a much smaller size than those that have already occurred. There is not a compelling reason why budget cuts will somehow derail the modest economic recovery now underway in Europe.
In Australia, budget cuts still mostly lie ahead, but they would seem to be aligned to ensuring that government payments go more squarely to those who need them. Also, it seems that the federal and state governments will actually be spending more on infrastructure, going some way to directly offset the pullback in engineering construction spending as mining investment falls.
All told we see a much greater probability that moderate global and Australian economic growth will continue than that it will be cut short by a cataclysm in China, or overly aggressive cuts to government spending around the world. A well-crafted horror story will always find a more eager readership than a reasoned analysis of why global growth is progressing relatively well. However, the odds seem to be stacked in favour of continuing improvement rather the various horror stories doing the rounds at present.