More market noise but underlying global economy deteriorating

October 19, 2011

Global Macro

Euro volatility used to mean that the EUR/USD exchange rate had moved up or down and bounced around. These days it means that some European politicians has opened his or her mouth or, increasingly, some British newspaper has “broken” a story late in the day which has got things moving.

Such was the case again overnight with more positive hope, joy and expectation about the chances of a European plan coming together. As I write the Dow is up 1.35%, the S&P 500 is up 1.74% and the ASX 200 futures are up more than 1%. The Australian Dollar likewise has had a cracking night, if you like it higher anyway, rising 1.32% to be back just under 1.03. What a week and it’s still only Tuesday in North America and Europe.

The catalyst this morning was a Guardian article after Europe had closed so they missed the rally with the DAX up 0.3% while the FTSE and CAC were lower probably after Standard and Poors downgraded 24 Italian bank shining a light on their respective banking systems once again. Also Moodys put everyone on notice they were looking closely at France’s AAA rating once again. The Guardian article can be found here, but it essentially is another of those articles that quotes unnamed officials and holds out hope. For me the key part is this,

The growing confidence that a deal can be struck at this Sunday’s crisis summit came amid signs of market pressure on France following the warning by ratings agency Moody’s that it might review the country’s coveted AAA rating because of the cost of bailing out its banks and other members of the eurozone. The leaders of France and Germany hope to agree a deal that will assuage market uncertainties or, worse, volatility in the run-up to the G20 summit in Cannes early next month.

Ohhhh pleeeaassseee. Have a look at what this part says…I’ve helped with some bolding. Excellent more hope, hyperbole and the stuff Lisa and I put on the vege patch last weekend. But the problem is that this stuff feeds on itself – here is a Reuters article referencing the Guardian article and so we also see it’s all over the Bloomberg Screens, the radio and so on. All because the Guardian wrote that France and Germany hope to do a deal. I genuinely hope they do but lets wait and see.

Because if, as I noted above, Moody’s look like it is gunning for France’s AAA rating where is this going to leave France? they are already paying 100 basis pts more for their debt than Germany. What if they lose the AAA???


While everyone is fascinated with Europe, me too, the really underlying economic structure is being weakend around the globe because of the increased and growing uncertainty. To this end I wanted to highlight a really good and very important article by David Uren this morning in the Australian. Now readers know that for all the market gyrations and machinations it is the weak underlying economy that has my attention more than anything else. As a student of economic history and behavioural finance/economics guy I see signs of deterioration in the economic outlook.

Uren wrote,

THE International Monetary Fund has warned that the forces that caused the Great Depression in the 1930s are again at work, as households, businesses and governments all cut back their spending.

In issuing its Great Depression warning, the IMF referred to the work of economist John Maynard Keynes, who showed that when everyone tried to lift their savings simultaneously, the total savings in the economy fell because there was not enough demand for goods and services.

“The overarching risk is of a global paradox of thrift as households, firms and governments around the world reduce demand,” the IMF said.

“Downside risks have increased and are severe.”

Now we have only had this blog running since May this year, over at MacroBusiness we have been writing since February this year but in other spaces and for clients we have been singing this song since the start of the GFC and their is nothing on the radar to suggest to us that the paradox of thrift, which in 2011 parlance is the “paradox of austerity” is going to change any time soon.

Austerity Australian Style

I like this phrase, I’ve used it a few times now and I think it sums up nicely why Australia, in many ways, is no better off than the rest of the world when comes to debt and tackling it. While the Governments overall debt position may be much more manageable than its global peers that is not necesarily the case for households who after 15 years of bingeing on debt need to purge.

Uren writes,

In Australia, households have gone from spending 2 per cent more than they earned six years ago to saving more than 10 per cent of their income, a faster turnaround than any other country.

According to Australian Prudential Regulation Authority figures, banks now hold $1.4 trillion worth of deposits from Australian households and companies, up from less than $1 trillion in 2007 before the financial crisis. Households now have more than $500bn on deposit with the banks.

That’s what I mean by austerity Australian style – Australian households saving more, repaying debt faster and spending less causing the non-mining sector acute problems and a recession like feel. This is analogous to what European governments are either doing or trying to do. Rein in spending so as to make the repayment of debt easier, hopefully. But as Keynes “paradox” showed self-interest is good except for when we all save together.

Add in an Australian political class fascinated with returning the budget to surplus and we have the additive impact of the Government sector also pushing growth lower. On this Uren says,

The fund said Australia, along with Canada, Germany, South Korea and Britain, had appropriate plans for bringing their budget deficits under control.

However, it said near-term budget tightening targets should be relaxed if growth threatened to fall short of forecasts. The Gillard government has targeted a return to surplus in 2012-13.

The fund said any relaxation of the short-term budget targets should be matched with compensating stronger medium-term budget restraint.

In a speech in London on Monday night, the Treasurer said the weakness in the world economy was now affecting the government’s budget forecasts.

“Already we are seeing substantial consequences for government revenue, which makes our target of surplus by 2012-13 more difficult to achieve,” Mr Swan said.

Please forget the surplus target – here’s why.

GDP = C + I + G + (X-M)

Remembering the way we put the GDP equation together we can see there are a couple of areas under pressure straight away.

  • C  = consumption, under pressure from increased savings
  • I = investment, apparently still strong which is a positive
  • G = government under pressure from the deficit hawks and
  • (X-M) are net exports which should be superb in a mining boom such as we are having but sadly are not as strong as you would think

Now clearly I am being simplistic here, overly so, but you can see that Australia and Australian economic growth is under pressure.

Now imagine that equation for the world as a whole.

Developed world consumption is down but hopefully developing world consumptions can give some support. But the developing world is tiny on this front in comparison with the western developed nations. Hopefully developing world investment can lift us out of the quagmire with developed world investment on the slow side.  That seems to have been the case but it looks like the developing world is slowing. The big global G in the equation is almost universally under attack from austerity, spending cuts, deficit hawks and lack of fiscal space. And then we have exports and imports. Which in a closed “global’ system you could argue are irrelevant.

So Uren and the IMF are right – the paradox of austerity and its impact on global growth is the big danger lurking behind the current focus on the European crisis. Sure as we saw overnight Merkel, Sarkozy et al make good headlines and drive readership but whatever the resolution when, or if, it comes the world still has to face many years of low growth while we purge the excess debt of the past decade or more.

Unless the answer is that everyone gets to repudiate their debts, Greece, Ireland, Portugal, Spain, Italy, American home Owners, Australian Households – well everyone.

But the world can’t afford that can it so what are we left with? A low growth future certainly for the developed world and the need for the developed world to recalibrate its model toward internal consumption.

It’s going to be a tough few years interspersed with periods of great hope and extreme pessimism. Its a traders market and not one for the faint hearted. Everyone else should keep themselves to themselves and prepare for the recovery.

2017 anyone?

Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, this blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at or Greg directly on

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