Can a US recovery save Australia?

Firstly, let me make it plain that what is happening in the US economy in the first few months of the year is absolutely no surprise. The first quarter of each year of the past four has been the best and I expect the same this year. My forecast since the year began has been for 2.6% or so growth this year and I have not changed that at all.

The pattern of the past four years has been some combination of the global inventory cycle associated with Christmas, the timing of monetary policy interventions and its amplification of Christmas stock market Christmas. The pattern is most howlingly obvious in US employment numbers:

That is not to say that beneath this cycle the US is not moving towards some kind of virtuous cycle (escape velocity if you like) that will accelerate both growth and monetary tightening. But we aren’t there yet in my view.

There is, nonetheless, increasing hoopla about this “accelerating” recovery and concomitant repricing of various markets.

The AFR has a report today on the return of the Australian yield curve to  a more normal pattern:

Bond traders are rapidly paring back their expectations of cuts to the official cash rate as global stocks surge and the US economic recovery gathers pace.

On Monday, the three-year bond yield rose above the Reserve Bank of Australia’s overnight cash rate, now at 3 per cent, for the first time since July 2011. Another rise in bond yields on Tuesday implied bond traders were predicting the cash rate was unlikely to be cut by even 25 basis points.

The three-year rate, which hit 3.03 per cent Tuesday, has risen by more than 100 basis points off its low of 1.96 per cent in June 2012 as investors dump their bonds. The rise has ­produced a “more normal”, positively sloping yield curve, which bodes well for the economy.

“Given the front end of the yield curve was inverted for most of 2012, the fact that it is positively sloping again is a sign that the economic outlook is improving,” said Tim Carleton of hedge fund Auscap Asset Management.

Well…maybe. But to determine that we must first determine how the US economy matters to Australia. The channels include:

  • stock market risk premiums are set in New York, we follow;
  • US monetary and fiscal settings determine the value of the US dollar. This in turn effects the price of commodities and the Australian dollar. A rising USD will damage commodity price, espeically if the AUD stays strong;
  • the trade channel is small, representing only 3.7% of export value, the US consumes only small amounts of bulk commodities;
  • however, the US is very large importer of Chinese goods so there is a positive flow effect to Australia in better Chinese growth.

So, the vast majority of the channels via which the US can effect Australia are in the financial not real economy. The corollary is that if you think we’re in for some kind financialised recovery, as the stock market currently does, then the US is about to launch us all into a fabulous new cycle.

If, however, you think that the real economy is what matters these days, as I do, then the US recovery and any effects it is having upon market pricing, are going to be temporary.

This is a rather long-winded way of saying that the US recovery, such as it is, does not change my view that Australia faces a bull trap in the next twelve months. That is, even as assets increase in value on the back of rising US risk tolerance, Australia still confronts a mining investment cliff and declining terms of trade. The attempt by the RBA to rebalance Australian economy growth drivers back towards asset inflation and dwelling construction is certainly being assisted by the US recovery, such as it is.

But in truth, these days the real economy is yoked completely to just one oxen: China. If the terms of trade continue to fall, which is my base case, then the US recovery is only going to mitigate the real economic downside that comes with falling mining investment. 

Yet, for the first time in many months, local interest rate markets are close to pricing rate cuts out completely and the yield curve has finally righted after twelve months of inversion:

At best, these markets are ahead of real economic prospects and may in fact be approaching dislocation.

Houses and Holes
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  1. Agree with market dislocation here – and even in the US.

    But all that funny money has got to go somewhere, and the markets “know” that no matter what happens, there will always (now) be more!

    I think we should all get ready to be further (and increasingly) fooled by the appearance of nominal figures from around the world, where “X goes up!” but household and business margins are getting squeezed, such that the nominal figures don’t mean what they used to. God help us when the market starts to realise that (the divergence) as well…

    It’s Stagflationary, IMHO.

    • Oh, and i’m seriously starting to doubt that public companies are effectively representing economy-wide business performance anymore – such that I question how their published results really reflect the non-listed businesses….which are most of the economy, as far as I am concerned…

        • Even if the US recovers, it will mean an increase in interest rates which will be disastrous for us with our mortgage debt and over-valued housing.

          • And any increase in interest rates will then in turn put the USA back into deep poo.

            Their current and ever growing debt burden will be unserviceable if rates rise, considering they are coming off such a low base.

            A mere doubling of interest rates will destroy any recovery in its tracks.

            Rocks and hard places are all that is left for the world at the moment.

            So print print print it is until the whole show goes up in smoke.

  2. The USA seems to have the capacity to save the world. Some countries in the EUzone might be in recession for some years, and it looks a bit ugly in the UK.

    Bernanke has handed the rest of the world a lesson.

      • Not all have learnt it well though. The UK Pound seems to have fallen through ineptitude rather than clear design.

        Gold may actually become a winner through default in many countries.

        • Peter You have that teh wrong way round. The world cannot do what the US has done. The US has been such a giant economically that even the substantial weakening it has undergone the last few years still leaves it relatively strong. The reason the GDP is going down is precisely because they are doing what Bernanke is doing but nobody wants the pounds they are printing.

          The US, so far, has been able to totally ignore its external account. It consumes and has been able to exchange assets. What’s going to eventually happen to those assets is the massive question. The UK is now finding that it cannot ignore its external account. printing money is now NOT working. Many more of us are eventually going to find this is the case…including your mate Bill Mitchell

          Again the US, like us, is stealing from its children.

          Stan Druckenmiller is worth listening to

          “Who gets rich from QE?”

          • Yes I think that the UK is struggling, but the EU, Japan and China have plenty of ability to manipulate their currency, although the EU is restrained by its structure.

            I rarely read Bill Mitchell.

          • Sorry I thought you were a fan!

            Re Yes Japan and China can move about because they are owed money. As you say EU can fool around as long as Germans prepared to keep giving all the rest the money to live in eh manner to which they’ve become accustomed.
            The rest of us are going to run into big problems sooner or later.

      • A few points to note on that one Phil

        I agree that those states may help to save the US (and may indeed be doing so)……and also note the word ‘affordable’ in the description applied to them early – sure as hell wont help Australia much.

        I dont think they are a hope in hell of saving the rest of the world apart from helping put a fig leaf over the ugly debt dynamics of the US to make the rest of the world feel mildly better.

        Also currency manipulation in the rest of the world (following on from the Bernanke lead) probably isnt going to see them outperform in anything but localised and specific sectors.

        • True…..
          As I say HERE:

          “…..If the US South was a separate country it would be powering off into the distance now with minimal debt, having had no debt-based bubble splurge, no finance sector rent-seeking, no crash, no bailouts, and no quantitative easing: just strong and steady real growth. The people and businesses flooding to the South from the coasts would actually be international immigrants bettering their fiscal futures by a much wider margin than they currently are…..”

          • Crocodile Chuck


            ‘no debt based bubble splurge’: ever hear of state called Florida? How about the resi r/e markets of Atlanta, GA and Research Triangle, NC? And for that matter, Northern VA?

            ‘no crash, no bailouts, no finance sector rent seeking..’: the last time I looked, these southern states were part of the US union, and all the terrors name checked here apply equally to them as they do for the rest of their stablemates.

            Last, and most embarrassingly, you’ll find that almost all of the Southern states are net recipients of US fiscal revenues. TRANSLATION: PERMANENT BAILOUTS, YEAR AFTER YEAR, from New York, Illinois, Ohio, Minnesota, California, etc to infra third world states such as Mississippi and South Carolina (among others)

            Been to USA? Ever?

          • Florida is a tenuous “member” of “the US Southern States”. It is “Southeast”. Southern California is not part of “the South” either.

            In “….the resi r/e markets of Atlanta, GA and Research Triangle, NC….” house PRICES did not bubble. The average value of mortgages defaulted on was about one third the average size in CA, and there was a rate of default of about half.

            Guess what “Northern VA” is adjacent to? Probably doesn’t help.

            So tell the Federal Govt to stop transferring wealth from the newly stagnant States to the newly thriving ones, if this is even true any more. It would not surprise me during the bubble period, because bubbles create artificial incomes and artificial tax revenue. So being a bubble State would tend to make it a higher than usual contributor to Federal revenue – temporarily. Not after the bust, though.

            And how about taking population per State into account? And previous Federal spending? NYC gets massive Federal funding to transport high income workers into and around Manhattan. Nicely done, rent-seekers.

            Did you bother to read the Joel Kotkin article I linked to? Deny all you like, this trend is here to stay, and lefty-libbewwal types are going to be “eating that” for a long time to come.

  3. I have to question if printing $85billion per month to buy mbs and treasuries is really a recovery at all. In my mind, as long as this continues, the US is on life support.

    • As long as the asset quality supports the purchase. Whether it be the government or any other investor, any quality asset purchase should pay off in the long term.

      • Eventually the federal reserve is going to have to offload its purchases. That will be highly inflationary. How exactly will it pay off in the long term? Maybe Im missing something.

        • When the Fed offloads its purchases it will actually be disinflationary. The Fed creates new money when it purchases securities. It transfers freshly created money to the sellers of those securities, typically banks. The banks then lend out that money, which through the fractional reserve system ends up creating far more money (as credit) than the money initially created by the Fed.

          At least, that is what happens in theory. In practice the massive amounts of new money created by the Fed through the various QE programs have not been particularly inflationary (perhaps they’ve staved off deflation, so the effect has been more pronounced than it seems, unfortunately we can’t really do the counterfactual). This is primarily because banks have not been lending out the money into the economy, partly owing to tighter credit standards but mainly because the private sector has been deleveraging and so credit demand has been low.

          If this situation were to reverse, and there was a flood lending into the economy, then you would see inflation of some form or another, be it asset price inflation or goods and services inflation. Should this transpire, assuming the Fed is serious about its remit, it would begin withdrawing its monetary stimulus from the economy. It could do so by lifting the discount rate, or by selling securities, thereby reducing the size of its balance sheet.

          It may seem counterintuitive, but when the Fed sells securities in the open market, it is withdrawing liquidity from the economy. The increased supply of securities in the secondary market drives interest rates higher, and the proceeds from the sales represent US dollars that have been ‘killed off’ by the Fed.

      • Peter…So we just go on with the merry-go-round forever? You think Ben can just keep pumping in $85B a month. The US over-consumes and the Chinese and Arabs keep picking up the difference forever? That bits of paper can be just printed like confetti and will always hold their value?
        Herb Stein “If something cannot go on forever it will stop!”

        • Sure the fed will have to sell those assets when the market appetite has been restored, and I expect that they will sell them gradually.

          When they do it will offer some good income earning investments to the community and it will make a profit.

          • Show me where the hyperinflation is Phil?

            Please don’t mention Zimbabwe – that’s not a valid example.

            Let’s discuss countries with production and exports. Which one is suffering from hyperinflation?

          • My comment was a bit short.

            I mean, when the Fed tries to start mopping up the re-expansion of credit by the banks when it occurs, by selling Treasury Bonds etc; IF no-one buys those Bonds, there will be hyperinflation. I thought this would be clear from the context of the preceding comment.

          • Phil – the banks have to buy the bonds, and if the banks don’t mop up enough the fed will buy them.

            The rate will only increase if the fed wants them to.

      • Thought the problem was the banks were offloading their shit onto the Fed in return for good cash.

  4. John Williams of shows that there is no real recovery and the consumer is not “back”:


    Danielle Park underlines the fragility of the current situation:


    Listen to those two, Dave, then tell us about the 2+% growth rate you predict 😀

    • It’s just an arbitrary number. If the authorities want a growth number of “X”, they will produce one.

      “We can thus conclude that the GDP framework is an empty abstraction devoid of any link to the real world. Notwithstanding this, the GDP framework is in big demand by governments and central bank officials since it provides justification for their interference with businesses. It also provides an illusory frame of reference to assess the performance of government officials.” – Frank Shostak

      “The GDP figures are as much a fallacy as the unemployment and inflation (CPI) figures. If you solely account for CPI the way it was calculated in the 1990s, before the government learned how to hedonisticly take all the price increases out of the CPI Index, the US has been in a depression for the last 10 years.”