23 Aug 2021
Global Macro-economic and Geo-political Update
Covid-19 continues to impact on economies around the world. In Australia, with shutdowns occurring in most states and territories it means economic growth will fall with Government debt increasing as new financial assistance programs, e.g. Job Saver, are rolled out. The Australian Government spent AUD25 billion on Job Keeper alone which represents about 5% of total Federal Government revenue (AUD552 billion). The Job Saver program is less generous although it may have wider application as the lock downs are now occurring across all major capital cities and regions, except WA.
Australia is lagging the rest of the world with its vaccine rollout and this is delaying any further opening of the Australian economy and its impacting on consumer confidence and economic growth. Many folks are saving which is both sensible financial behaviour and a positive in reducing overall household debt. The good news is that the Federal Government does have a 4-step plan to re-open the economy so the lock downs can end although there may still be restrictions.
A major positive is that work practices have changed and many businesses have found that staff working remotely is not ineffective and is family friendly. It also means that companies will not be so reluctant to shift their head offices to suburban or regional centres. This may be attractive to many folks as there will be shorter commuting times with reduced distances to travel to work and less traffic congestion. It also should mean access to more affordable housing.
We are watching inflation closely and the CPI for the 12 months to 30 June 2021 was 3.8% which is a tick up in average levels of the last few years. What this highlights is the importance of seeking notional returns greater than 3.8% so you earn a real return. This is something we are focussed on.
On September 6th, 7.5 million Americans will lose all income support benefits unless they have a job (US unemployment is about 10 million), while US consumers who believe things will improve has fallen to 32% down from 49% in July and 50% in June. This lack of consumer confidence is in stark contrast to the bullish stock, bond and property markets. Consistent with this fall in consumer confidence is that the 50 day moving average of the S&P500 index is lower for all stocks except the FANGs (Facebook, Amazon, Netflix, Google) which dominate the index and are driving it higher. The average office occupancy rate is 32%.
Inflation levels in the US are up (5.4% in July) and would be higher if the US Federal Reserve did not remove food and energy from its core inflation measure. It is these non-discretionary items, e.g. food where prices have jumped up. It is likely that consumer prices on discretionary items will fall in line with consumer sentiment. International (including US) bonds are negative yielding (near zero interest rates - cost of currency hedge – inflation rate) and it is for this reason we moved out of international bonds a few years back.
Global growth is being driven by debt and this is unsustainable in the long run. 27% of US GDP goes to paying interest payments on US National debt of around USD30 trillion. The US budget deficit is running at USD3.5 trillion which means that US Treasury is issuing more and more bonds to pay for the debt which the US Federal Reserve is buying it back to the tune of USD20 billion per month. The US Federal Reserve Balance sheet is now USD8 trillion and increasing. If the US did not have the world reserve currency, then the party would have ended long ago. Despite inflationary pressures in the US and its twin deficit (current account and budget) the USD has appreciated against all currencies recently, including the AUD. Normally, it would be expected that the USD would fall in those circumstances; however, Quantitative Easing and slow down in the velocity of money (money supply is up) is causing a shortage of US dollars and is helping drive its appreciation.
The US Federal Reserve and then by implication the RBA and other central banks are trapped and cannot raise interest rates. So real interest rates (after inflation) will continue to be negative, particularly in international markets. If central banks do raise rates (not likely before 2023), then equity markets will respond negatively.
Chinese exports have reached record levels as China has worked hard to minimise the economic impact of covid-19. Despite this, factory production is down and household debt has risen from 18% of GDP in 2008 to 62% in 2020 which is well below its OECD counterparts. In the same time frame, Chinese GDP has nearly tripled to USD14.3 trillion (2019) firmly placing it as the second largest economy in the world.
Global Economic Outlook
Economic uncertainty continues to be the case with central banks manipulating yield curves and driving interest rates very low while driving up asset prices, e.g. residential property, while governments are engaging in massive stimulus programs (running budget deficits) and companies are re-structuring and changing their business practices. With the covid Delta strain running rampant and consumer confidence falling while the effects of government stimulus programs being short lived, it is anticipated that economic growth will be weak. In this environment we continue to believe asset, country and currency diversification is the best strategy.
The inflation vs deflation debate continues to rage amongst economists and market commentators despite early inflationary figures in OECD economies. Some commentators are arguing that inflation is transitory while others are saying its sustainable and will be around for some time although not at the levels of the 1970/80s. Those in the deflationary camp are arguing prices will fall as supply of goods/services is greater than demand (global trade has declined), real wages are static and Quantitative Easing are all deflationary.
Despite the above negatives we are very positive about the future because humans are very resilient. There are wonderful and exciting developments occurring across an array of areas, e.g. robotics, biotech, artificial intelligence, agriculture, clean energy and storage which provide good investment opportunities.
Historical Economic Milestone
On 15th August 1971, some 50 years ago is the anniversary of President Nixon “temporarily” ending the convertibility of US dollars to gold which was a hallmark outcome of the Bretton Woods Conference at the end of WW2. The Bretton Woods agreement required a currency be pegged to the US dollar which was in turn pegged to the price of gold. Nixon’s decision meant that currencies either freely floated or continued to be tied to the US dollar. The Australian dollar remained tied to the US dollar until 9 December 1983 when the Hawke Government announced the AUD would freely float.
The aim was to create a currency system that is less rigid than the gold standard while providing greater flexibility and financial stability.
This decision by Nixon was critical as it meant that the strength of a currency in the future would reflect a number of economic factors, these being the strength of a local economy, e.g. GDP growth, level of interest rates, unemployment rate, etc. It also in part reflected the strength of the economies of the that country’s major trading partners, as well as the US economy. A floating currency model has served the world well for the last 50 years and despite claims of better models, e.g. return to the gold standard and private crypto currencies, e.g. Bitcoin, there is no obvious new model that addresses the flaws of the current model.
Historically, world reserve currencies average life span has been about 70 years. Does that mean the USD as the world reserve currency has only another 20 years? No, although the trend is for less trade being priced in USD (currently about 70% of world trade is in USD) and we are seeing the Chinese and other international investors buying less US treasuries because they are negatively yielding and concerns over the US national debt.
We believe recognising this 50th anniversary milestone is important given its significance in global financial history and because many commentators are questioning the long term future of the USD as the world’s reserve currency.
As usual if you wish to discuss with us any matters regarding investing or debt management please feel free to contact us.