So, we go on holiday expecting the worst and when we return it’s all good! Europe is fixed (at least it was before S&P interfered), the US is powering, property and equity markets are set to boom. Holidays are wonderful things. There is no substitute for the calm that comes with relaxation and the perspective that that brings.
I remember when I was doing The Distillery at Business Spectator in 09/10, before his holidays Alan Kohler was beating a relentlessly bearish drum. But on vacation he had revelation. He returned refreshed and declared, to his embarrassment, that he’d been overly bearish, that he’d been been wrong to suspect the durability of the global recovery and, by extension, the equity rally underway at the time.
A similar revelation has overtaken me during the holidays. With a perspective cleared of the day-to-day cut and thrust of global markets, it was much easier to find clarity in long term strategic thinking. And, like my peers in global markets, I have refreshed my outlook.
The direction for the world economy I described last year, with its ceaseless crises and troubled growth, is no longer so salient to from my revitalised perspective. These crises are merely symptoms of a greater underlying shift. And that shift takes me not further from my thoughts of last year but more deeply into them.
The paradigm shift of which I speak is not some new crisis in Europe. Nor is it the US’ emergence from an older crisis. Neither is Australia facing some temporary shift away from its debt-driven growth of yesteryear. It’s not even China and its massive investment model that has driven the mining boom. The shift is that yesterday’s demand driven economy, that relied upon debt to inflate assets and drive private balance sheet growth as well as consumption, has ended. It is finished permanently (or for so long that it might as well be permanent). The global growth of the future will be driven by the forces of investment, production and intensified competition for limited demand.
This is nothing new of course. In 2009, PIMCO described it in an investment sense as the “new normal”. But the big leap one must make – of imagination and logic – is to conclude that this is a permanent change, not a passing crisis. It is easy to lose sight of this when engaged with the hysteria of daily market moves.
If you accept, as I do, that this paradigm shift has taken place, then the European “crisis” is nothing more than the latest expression of the underlying reality that countries will now need to compete successfully to grow. It reframes as visionary Germany’s recalcitrant insistence that its southern peers reform their economies in return for fiscal support (even if its various tactics for achieving this end are self-defeating). It repositions the period of relatively stable economic growth currently enjoyed in the US as little more than an oasis of demand-driven calm before the real work begins of addressing its growing fiscal burden and ongoing credit excess. It renders China, with its leadership in savings, industrial capacity and exports, the unquestionable front-runner in ideological and political economics for the future. It is the interplay of these Great Power strategies with the extant force of increasingly conservative capital market structures that forms the foundations of the great shift. All will feel it in their currencies, in their markets and in their understanding of economics itself.
For Australia it presents both opportunity and threat. On the one hand, as usual, our extraordinary endowment of cheaply produced industrial commodities and energies positions us as a natural beneficiary of the new era. On the other hand, the downsides of that very endowment – a high currency, capital shortage for non-mining sectors and the natural laziness of the lucky – leaves us languishing everywhere beyond that good fortune. The year 2011 was marked by a broad denial in policy and business circles that this was the case. Everything from employment strategies to monetary policy was geared, for much of the year, towards an impending boom that proved a mirage. And largely for reasons of mismanaged political economy, policy-makers were (and remain) unwilling to act to bring relief to this circumstance, preferring the utterly self-defeating macroeconomic approach of killing existing export sectors in manufacturing, education and tourism to make room for commodity exports.
One of the surprises I expect in 2012 is upside for these downtrodden sectors as the global business cycle limps along. The global growth drivers will be the same as last year only weaker. The current US mini-cycle will provide broken momentum but will be prevented from accelerating by its internal contradictions. Perpetual recession in Europe will weigh upon every economy. China will grow at 7%, hobbled by stimulus that must work around stalled and falling housing markets. The risks for all are to the downside. I expect the Australian dollar and commodities to also fall steadily as the US dollar rises through the year. Just as importantly, however, is that Australia’s downtrodden sectors are now cheap. Cheap as chips. They have been under the cosh since 2007 and although investment in the manufacturing sector has not grown much it hasn’t collapsed either. The sector is lean and getting leaner, productivity will be up, with relief from the dollar, profitability will jump. There should also be, surely, renewed predation to bring new life to management strategies.
But that is the good news. The bad news is that the old part of our economy, the vast majority of it, remains leveraged to leverage – asset values and consumption have only begun their long march to sustainable levels of services spending. Household debt levels are still very elevated. Oddly enough, while the denial of 2011 determined many of the major decisions of the captains of industry and policy, regular households were miles ahead. Sensing the passing of the thirty year era of frivolous borrow and spend, regular Australians responded magnificently with a drive to save their hard earned capital. Through this singular act of prudence (no, not fear, as the spruikers of the old order will call it), they succeeded in helping rebuild our broken banks. Expect that, too, to continue, even in the face of greater interest rate cuts than many are expecting.
For the services economy, the shock and denial of 2011 will slowly give way this year to creative destruction. The bloated incomes of debt-addled consumers of the 1990’s, which gave way to terms of trade spoiled consumers of the the 2000’s, will not be spent. And income growth rates will begin a long decline. Businesses will find margin in cost cuts and efficiencies. Change agents will be in demand. IT and business process services will boom. Jobs will go. Productivity will raise its head from the canvass. Inflation will be contained but housing assets will still melt. Equity markets will rally and fall, range bound. Economic growth will be lacklustre, propelled by the external sector and held back by services languor.
None of this will pass without a fight. The interests of the politico-housing complex will writh and whine, as we’ve seen already this year with the usual suspects on the hustings cheerleading a return to yesterday’s growth paradigm. There are still many investors as well who reckon the greater fool model has life. The tax laws still support it.
However, the complex is hamstrung. The ratings agencies – those freshly intolerant police of imbalances – declared in the last quarter of 2011 that the ratings of the Australia’s big four banks are reliant upon an implicit government guarantee and, in turn, that the rating of the Federal Budget depends upon a credible path to surplus. Irrespective of growth outcomes, expect more fiscal tightening in 2012. Monetary policy will also be inhibited. The RBA’s mining boom rhetoric underpinned much of the broad denial of 2011. Some, no doubt, was jawboning. But in using the Phillips Curve to guide its thoughts on growth, capacity constraints and inflation – without fully considering the effects of disleveraging – the RBA appeared dangerously close to a major policy blunder in over tightening. Thankfully, they did not move as many economists demanded; going with the data ahead of their own modeling. An even greater challenge lies ahead in 2012. The easing cycle we have embarked upon is overshadowed by the same questions that have dogged other Western central banks in recent years. Even if the falling dollar is to be welcomed, is it in the national interest to seek any acceleration in credit growth in the global context that I’ve described? If increased consumption, not borrowing, is the goal then will and should indebted households respond? Is it even possible with bank funding costs reaching unthinkable levels in the past month? Is the blunt tool of interest rates now itself obsolete on all counts?
If 2011 was the year of denial then 2012 will introduce the next phases of grief at the passing of an economic order. There will be anger, bargaining and depression as the interests of the old order seek to duck the nation’s fate. But there will also be the beginnings of acceptance amongst businesses far and wide and, with that, renewal.