Deeper Insights – thoughts on the Crisis

November 10, 2011

Global Macro

With markets so volatile and the European situation in the headlines every day it is hard to pull your eyes away from the screens and think about the bigger picture.

At the Overseas Terminal down at Circular Quay on Tuesday however Westpac did just that. For a select audience of around 250 clients the institutional part of the bank put together a line up of its key economic and market strategists together some influential and prominent outsiders.

The point was to step back from the noise and try to gain some deeper insights. Adam Spencer was MC for the afternoon and speakers included Westpac Chief Economist Bill Evans, RBA Board member and Keating Biographer John Edwards, Westpac Institutional Bank Head Rob Whitfield, Russell Jones Westpac’s Head of Global Rates strategy and as we’ve said here at MacroBusiness lately the best macro strategist in the land, Rob Rennie Head of Currency Strategy for the bank and one of my favourite thinkers and writers on all things credit Graeme Jarvis from Westpac.

I’ll concentrate on what these guys said from an economic point of view but other panelists included Westpac’s Asian guru and author of Phat Dragon, Huw McKay, Professor Michael Le Strange and Michael Wesley of the Lowy Institute, who talked geopolitics and the rise of China and Australia’s place in Asia. Former Prime Minister Paul Keating then anchored the conference with a hard hitting look and wide ranging look at where we are in this crisis where sit as a nation and where we are headed. He hasn’t lost his touch and at a time like this its too bad he’s not still in our Parliament.

For me the key takeaways were that this crisis is far from over, the chance of a Eurozone exit for Greece or other countries is high, China is coming in for a bumpy landing in the next year or so and Australia needs to grow up in our relationships with our region.

Specifically, however,  Bill kicked off proceedings with a high level summary of where he saw things.

He noted Europe simply  has too much debt at household, corporate and government level and this would be an enduring and rolling crisis  with the chance of an eventual break up high.

In the US he said he thought they were at stall speed and were facing 1-2% growth in the future. But as John Edwards pointed out he didn’t forecast recession.

He spent some time talking about the structure of debt in different countries at a government, corporate and household level and played on a theme we have been talking about for some time at MacroBusiness – deleveraging.

Bill said Australia simply has too much household debt which will lower growth in future. He noted that the Australian dollar was also impacting non-mining sectors hard and that in contrast to mining boom Mark I the current boom was not washing through the economy as money was not being spent by households and redistributed by governments. So at present we don’t need tight monetary or fiscal stances and we will get monetary and fiscal stimulus to come.

In answer to a question on how long households will take to get their balance sheets back in order, Bill alluded to an extended period of what I’ve been calling “Austerity Australian style” as he thought employment and wages growth would be weaker going forward leading to limited capacity to hold the savings rate at these levels and eat into its debt. So household balance sheet adjustment is going to take many years.

Rob Whitfield noted, like the Reserve Bank and Westpac Supremo Gail Kelly last week, that this period of debt reduction is structural but in the end positive for the economy.

Interestingly, John Edwards said he thought the savings rate would not be expected to stay around 10% for too long.

Structurally Bill was really very upbeat on China noting that the capacity to take on debt can be a positive for economic growth and wealth creation – but only up to a point. Much of the Western Developed markets are past that point and too much debt is now a problem but Chinese debt position is not to bad at a Household level (provincial governments are a different story) and so Chinese consumers have space once they feel more comfortable with Governmental safety nets in the future.

Bill noted that while China has an inflation constraint at present their is enduring room for optimism, However, their reliance on economies caught in debt strife is leading them towards  a cyclical downturn.

Bill talked about the bubbles of the last 20 years and said the seeds of the next one are sown  and it was either bonds or commodities but more likely to be commodities because supply increases were coming at a time when developed economies can’t absorb them.

The audience was asked when and if they thought there might be a commodity crash and 50% of audience thought by by 2015 while my vote was in the 24% that thought one more imminent  by 2012.

Obviously with markets all roiled up there was a discussion of the impact of evolution of capital markets, funding and Basel III. And the importance of the strong balance sheet that was born out the GFC.

As shown in their results last week WBC, holds as much as 4 times more liquid securities than it did pre-GFC. Crucially for Big 4 access to funding markets has been enduring but price volatility has increased  and therefore cost of funds is decoupling from overall rates which are biased lower. That is spreads are wider now

Interestingly the impact of Europe is being felt in many different ways in many different markets. In Asia, European banks had used the GFC as an opportunity to buy distressed businesses and assets from US banks but as they now pull back there is a shortage of USD in Asia which is causing funding difficulties. Mike Smith I’m guessing will be licking his lips at the potential fire sale of assets that might coming in the near future.

The key thing I took away from this first session, and which I agree with, was that unemployment is the clear danger to the Australian economy and the housing sector. Unemployment is heading higher but my take away is not materially so, in aggregate for the economy in Australia. So while the debt adjustment will take years there won’t be any pressure to forced sales and so house prices can drift lower but won’t crash. The consensus was that lower interest rates and improvement in household balance sheets should be enough support, as long as we get stimulus to halt any rapid or large increase in unemployment.

So will the government stimulate? Not sure, but Bill was certainly pleased that his take away from last week’s SoMP was that the RBA articulated a dual mandate (finally he said) sustainable growth and inflation.

My take away from this discussion was heaven help Australia if unemplyment rises too far.

The strategists were on next and were pretty downbeat on Europe. The audience asked the question of whether they thought  one country at least would leave euro eventually. The yes vote was in the ascendancy with a resounding 58% to 42% result.

Russell Jones highlighted that last week might have been the decisive point in the battle to save Europe because the unspeakable was spoken. By this he meant the comments from Sarkozy and Merkel that a euro exit is possible. So the Eurozone would act more like a exchange rate mechanism rather than a single currency going forward.

Rob Rennie noted that perhaps the EUR is strong because there is structural demand but maybe repatriation of capital was driving the EURs strength. He said he’d rather sell it than buy it as he reckons it should be trading 1.20ish. I agree but if they are staying together I think even lower. Rob also thought the Australian dollar would go lower as well – which I also agree with, as noted in Monday’s piece.

Graeme Jarvis said that he thought credit would get even wider but that you were finally getting paid for the risk and there was less leverage in the market so things hopefully won’t get as bad as 2008. However, I sensed a tension in his body language which suggested he is deeply concerned that we just might rerun 2008 after all.

So you get the picture – it wasnt the most upbeat conference. The worrying thing is that by the end of the day I was left with the feeling that things are as bad as they seem.

Cross posted with MacroBusiness this morning.

www.twitter.com/gregorymckenna

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