On the 18th of December 2013, the U.S. Federal Reserve finally announced it would begin to taper or wind down QE3 – an $85 billion a month shot in the arm to keep the economy afloat after the worst recession since the 1930s.
Starting in January 2014, the Fed will wind total purchases down a notch to $75 billion a month. Depending on how the economy reacts, the Fed will continue to cut in each meeting throughout the year. Fed chairman Ben Bernanke said “If we’re making progress in terms of inflation and continued job gains, then I imagine we’ll continue to do, probably at each meeting, a measured reduction” in purchases. However, if the economy slows, Bernanke says they will consider skipping a reduction in a meeting or two, or if the economy accelerates could taper a bit faster.
Reactions are mixed. Some believe the Fed will have difficulty removing the stimulus fast enough to prevent inflation, while many others believe the only reason there are signs of growth in the U.S. economy is due to the sheer size of QE3. Take it away, and the unsustainable, fragile economy will quickly falter.
Opinions also vary as to why the Fed has announced the taper. While some believe the U.S. economy is showing good progress. Others some warn QE3 has only served to create more asset bubbles – namely a stock and new housing bubble, but has done little to improve the broader economy and support job growth. And now the Fed needed to act decisively to prevent these bubbles getting much bigger.
The only thing for certain is after such a large and prolonged stimulus, the result to global stability of the tapering will be a wildcard this year – Anything could happen.
China Economic Growth Model “Unsustainable” – Deputy Finance Minister Wang Bao’an
The other global wildcard for 2014 is China and has far greater implications for Australia. Last year we raised the question if the second stage of the GFC would be made in China and if WMPs would replace CDOs as the buzz word in this crisis. (GFC2 – Will it be made in China? – June 30th 2013)
At the time, a credit freeze in China had caused the Shanghai Interbank Offered Rate (Shibor) – a measure of the cost of commercial banks to lend to each other, to surge. After a couple of days of abstaining, the People’s Bank of China (PBoC) was forced to intervene and inject liquidity into the market. Only two weeks prior, ratings agency Fitch warned China’s credit bubble was now unprecedented in modern world history.
In the days before Christmas, and not long after the Fed taper was announced, it was happening again with lending benchmark rates hitting the highest levels since the June crisis. Once again, the PBoC came to the rescue injecting 29 billion Yuan to provide short term relief. Minsheng Securities Macroeconomics analyst, Zhang Lei told the Global Times “The cash injection can only ease the problem in the short run, Banks will face tight liquidity until mid-2014, as an increasing number of financial instruments will be maturing in the first half of next year.”
The concern is a plethora of loans taken out by State owned Enterprises (SoEs) to fund public infrastructure and real estate investments, many empty or under utilised and with low returns – if at all. The projects are an attempt to keep economic growth chugging along, but at some stage the debt must be refinanced.
In an rare and unusual stand, China’s Deputy Finance Minister Wang Bao’an wrote an article in the latest issue of Qiushi, a bi-monthly political theory periodical of the Central Committee of the Communist Party of China saying China’s current economic growth model is “unsustainable.” He described the Chinese economy as “high input, high resource consumption, high pollution, high growth” with “low output, low efficiency, low profit, low tech”.
In a recent column for the Project Syndicate website, billionaire investor George Soros believes the biggest risk in the World Economy now is China – you can forget the USA. No doubt we will see more in this space as the year progresses.
Back home, trends are somewhat clearer barring any external shocks. The Australia Dollar is expected to continue falling this year resulting in broad price increases on imports. The RBA said it will be comfortable with 85 cents. One of the world’s largest investment firms, BlackRock, believes the dollar could fall to 80 cents this year (Aussie dollar headed for US80¢ with RBA to cut rates again, says BlackRock – SMH.) A crisis in China could push it below 80.
After an approximate 15 per cent fall since April, already we are starting to hear the odd whinge about petrol prices at $1.65 litre. Most Australian’s have taken the overpriced Australian dollar for granted without a second though – cheap petrol, cheap electronics, cheap apparel even cheap overseas holidays. The depreciating dollar is coming as a shock. It’s not so much of a case of prices are getting expensive, but a case that prices were abnormally cheap and are just returning to where they should have been had we not had a resource boom. In December, we quoted from Professor Ross Garnaut’s latest book – “No developed country has experienced as large a sustained appreciation in its real exchange rate as Australia has through the China resources boom,” “In turn, this means that no developed country has ever successfully worked through such a fall in the real exchange rate and associated contraction of incomes.”
The other shock will be income growth or rather the lack thereof. Treasury’s chief economist David Gruen told a conference in November last year, “Our estimates say that if we achieve productivity growth similar to its long run average, the next decade will see the slowest income growth in Australia for half a century by a lot.” This comes from an expected decline in Australia’s terms of trade and is consistent with views from the International Monetary Fund (IMF) and the Australian Productivity Commission. (Slowest living standards growth in ‘our lifetimes’ – SMH)
The Australian Bureau of Statistics (ABS) Wage Price Index for the September 2013 quarter reported an seasonally adjusted 0.5 per cent increase, the second lowest increase since the introduction of the Index in 1997. Over the year to September, wage growth was 2.7 per cent, the lowest annual rate since 2000 (Tech Wreck).
Late last year an Organisation for Economic Co-operation and Development (OECD) report (House prices, labour costs leave economy vulnerable: OECD – AFR) showed Australia had the largest appreciation in relative unit labour costs in the OECD effectively putting Australia at a competitive disadvantage to the world. This coupled with the high cost of living and constrained discretionary spending from Australia’s housing bubble (High housing costs make Australia’s economy uncompetitive – ABC) and household debt overhang is expected to see unemployment continue to accelerate this year.
All eyes will also be on the May budget after the Mid-Year Economic and Fiscal Outlook (MYEFO) showed a substantial deterioration in the domestic economy. During the boom years, Australia’s wealth was squandered on various tax relief’s. Cuts will now need to be made placing Australian households under even more pressure.
Finally, there seems little scope for double digit house price growth the experts are once again predicting (annual tradition around the holiday period). As per the Australian headline, House prices [are] at the mercy of the budget (outside of an external shock). In the article, Dr Andrew Wilson talks some sense, “Nothing will stop a housing market quicker than a declining business cycle and that’s certainly what we have the prospects for in NSW and Victoria,” “Rising unemployment will cause lower wage growth, which reduces the capacity of buyers to borrow.”
What are your predictions for 2014?
» Slowest living standards growth in ‘our lifetimes’ – The Sydney Morning Herald, 21st November 2013.
» Low wage growth, job fears hold inflation down – The Australian, 18th November 2013.
» Aussie dollar forecast to fall to 80 cents in 2014 – The ABC, 31st December 2013.
» U.S. and China: When the giants unwind Commentary: Withdrawal of stimulus could well cause a fresh crisis – Market Watch, 30th December 2013.
» Vice-minister calls for new economic growth model – China Daily, 3rd January 2014.
» China tries to deal with its mountain of debt – The Sydney Morning Herald, 30th December 2013.
» House price growth at mercy of budget – The Australian, 1st January 2014.
» China move calms credit concerns – The BBC, 24th December 2013.