There is no doubt that Australia’s economy is among the best in the world. Unemployment is relatively low, inflation is – for now – contained, and we have a very competitive GDP (or national income). Much of this can be put down to China. As the saying goes, Australia used to ride on the back of a sheep, now we ride on the back of a dump truck. Put simply, China is industrialising and Australia produces the raw materials China needs to achieve that end. So what else does Australia have? Is that it? And do we just look good because the rest of the world looks so bad? How does it all affect you and me? … all good questions. Let’s answer them.

This week saw the release of Australia’s official employment data. It was surprisingly robust. Over 40,000 new jobs were created last month. More people were out there actively seeking work, however (labour force rose), so the unemployment rate remained steady at 5.2 per cent. Interestingly, quite a few jobs were created in the non-mining states of the country like New South Wales and Victoria. It’s consistent with the ANZ job advertisements data we saw recently (showing employers were looking to hire more staff), and the small rise in business confidence recorded last month.

So how does that affect you and me? As far as interest rates are concerned, for those on a tight budget looking for some financial relief, the unemployment figures do nothing to boost the case for a 0.25 per cent interest rate cut in May. At least that’s the view of currency traders who sent the dollar higher immediately following the news. Their logic is that a stronger-than-expected employment read translates into more demand throughout the economy. That means a Reserve Bank focused on inflation is unlikely to stimulate demand further through dropping interest rates (all putting upwards pressure on inflation). If there’s less of a chance of interest rates moving lower, then the rates of return gained from having money in Australian term deposits remain relatively attractive. That encourages investors to buy Aussie dollars (so they can put their money into Australian bank accounts) - hence the appreciation of the currency.

Clearly, despite weakness in Australia’s manufacturing, tourism and retail sectors, China’s demand for our raw materials is providing a semi-solid base for the economy, and continues to help elevate the currency. We’ve just had to take the good with the bad and that means many Australians on the wrong side of the growth equation remain under pressure – including those looking for interest rate relief.

But is it all about to sour? Last Friday China released its first quarter GDP figures. The numbers were weaker than expected. Specifically, if you look at the year on year result, China’s economy is growing at 8.1 per cent. That’s down from 8.9 per cent in the previous quarter. The government has indeed actively sought to slow the economy to avoid it over-heating. The question is: Will it be able to stop it from slowing too far or too quickly? The jury could be out on that one. Australian economists say any growth rate above 7.5 per cent is good news for our economy. Anything south of that raises alarm bells. Paul Bloxham is the chief economist of HSBC Australia. I spoke to him yesterday and he conceded this latest reading on Chinese national income put the economy in the danger zone. He said he hoped this was the “low point” in China’s growth story. Some economists do, however, remain optimistic. A senior Chinese economist with the ANZ Bank, for instance, argues that China’s economic growth is almost certain to pick up from here.

The major concern for China, and indeed other major economies like the United States, is Europe. One of the reasons cited by the World Bank for China’s slowdown was the European debt crisis. In fact the threat from Europe is so real Chinese policy makers are actively trying to shift China’s main source of income from being led by international trade, to being led by domestic consumption. The reality of course is that the European economic crisis is showing few signs of getting better. Even the European Central Bank came out last week and warned the region that it alone could not solve the region’s financial problems and was calling on individual governments to do more to get their houses in order. Money markets within Europe are also skittish. Bond yields (a measure of how risky investors perceive debt to be) rose in both Spain and Italy last week. Despite all the rescue attempts, it seems investors are not convinced the worst is over. In fact there’s now talk Spain and Italy will be next in line, after Greece, for a financial bailout.

So it’s clear, if China really can stabilise its economy from here, Australia looks well placed for the near to medium term. But that’s as far as we can honestly forecast for now. There are too many risks, and too many unknowns to go beyond that. It may explain why so many investors are still in cash. That’s also had the side-effect of creating competition among the banks to attract their fair share of depositors. It resulted in the ANZ actually lifting the rates on its standard variable mortgages last Friday by 0.06 per cent (6 basis points). It puts a whole different spin on next month’s Reserve Bank interest rates decision. Economists and business representatives are currently lobbying the central bank to cut interest rates by 0.25 per cent. But the banks themselves are now not only moving independently of the RBA but at least one (and potentially more this week) is now also going in the opposite direction.

Extraordinary isn’t it? Nearly 4 years on, and the waves and ripple effects of the global financial crisis are still making their way around the world.

David Taylor
 

China and David Jones... what do they have in common? Both are trying to navigate their way through periods of change, both have faced intense media scrutiny in the past few months, and both have developed strategies they hope will guide them through to the next phase of growth. Will it be easy for them? Far from it!

In David Jones' case, last week the department store announced it had suffered a 20 per cent hit to its first half earnings. Catching media headlines though was the retailer's full year earnings guidance with profits predicted to slump around 40 per cent. Much of that pain has been attributed to the company's new turnaround - or Omni Channel - strategy which will see it roll out new stores, increase floor staff, and develop its online presence in the market place. The company is throwing $70 to $80 million at the re-development.

Analysts have argued that it's the right thing to do but that David Jones should have done it at least 2 years ago. Given how much market share other retailers have taken up in the meantime - both domestically and overseas - it'll will be a true test of DJ's metal to see if it can catch-up the required ground.

Complicating matters somewhat is the weight that David Jones has had to throw behind this new venture. It's a lot of money but the board is confident it will work. The big assumption though is that retail conditions will improve and consumers will return to the stores. If they don't, or if it takes much, much longer than anticipated, David Jones will be facing some very difficult decisions.

Then there's China. Last week the HSBC Flash China Manufacturing PMI showed manufacturing activity at 48.1 for March (below the 50 level which separates expansion from contraction). In other words, China's manufacturing sector continues to go backwards. It's added to concerns about the economy and the potential implications for Australia.

Add to that though the comments from Premier Wen Jiabao about the economy slowing to 7.5 per cent, and BHP Billiton's comments that the price of iron ore was set to flatten, and you'd be excused for thinking the case for a hard landing in Chinese economic growth was beginning to build.

The policy response is a complicated one. Economists have warned that rumblings of a property market bubble could prevent the people's bank from cutting interest rates too far. What the authorities do have up their sleeves, however, is control over the reserve requirement ratios at the banks. By reducing the amount banks are required to keep as reserves, analysts argue the money will then be lent out to small-to-medium sized enterprises rather than the big property developers. I guess their reasoning is that they are smaller amounts of money and can be specifically tailored to individual projects. It's certainly an alternative - and potentially safer - policy response.

Whether you're looking at David Jones or China, it's clear both require swift and 'imaginative' policy responses. There has to be strong commitment too from all sides. I would consider that both are also in the 'danger zone'. That is, one significant wrong move from either David Jones or China could see growth de-railed altogether. It's a genuinely testing time.

David Taylor 
 

The entire discipline of finance centres on the concept of risk. Without risk, you forgo any opportunity to take reward, or a premium, on your investment. If you were to invest in cash for instance (the closest you can get to a risk-free asset) you simply secure the minimum return (presently anywhere between 4.5 and 6.5 per cent). The question is, when do you take on more risk? The answer essentially lies in your personality and how much you need a high return. The overall economic environment also plays a big role - as I will explain...

To say the current economic environment (both domestically and internationally) is challenging at present is quite an understatement. The world's major economic powerhouses are undergoing critical financial surgery and there are no guarantees any of them will emerge in a state worthy of holding their current rankings on the world stage. It's made investing, especially in companies exposed to offshore machinations, very challenging.

If you were, for instance, to hold the view that China was going to be an on-going source of supreme economic growth well into the next decade, you might invest heavily in Australian miners. The risk you take though is that commodities prices tumble as China pulls investment back from Australia as Europe puts a big dent in its GDP. Is that likely? Who's to say at this point? It's certainly a possibility. Then there's the US. Its debt position is clearly unsustainable. Do you obtain exposure to US growth now and hope the bond vigilantes don't grab hold of the US treasury market? They are tough decisions.

One thing you can be a little surer of is that, generally speaking, many in the market are aware that the future is both unclear and uncertain. Volumes on the share market alone are indicative of that - many investors are simply just 'sitting on the sidelines'.

So while there's increased risk in the market, and no doubt much money to be made, in many cases those risks are too abstract and murky to calculate properly and then make an informed decision around. In fact rather than looking at the risks, a lot of investors are simply looking at the return side of the equation and making investment decisions that way. I recently spoke with a senior equities strategist at a leading investment house in Sydney. He said the firm's strategy was now a conservative one - investing in cash and the more predictable emerging markets. He said 'playing it safe' at the moment was the only real option. David Murray's Future Fund (the fund that guarantee's the superannuation of government sector workers) is working a similar strategy.

The risks have increased in recent times, and even though that may mean super-normal returns are hiding in dark corners, many know all-too-well the pain of being burned and have decided that the best offense is a good defence. Even those with a healthy appetite for risk now know it's not always wise to indulge.

David Taylor

It's a big weekend. Some have even suggested it could herald a new wave of optimism for global financial markets.

Last night we received better-than-expected news on the US jobs front, and Sunday may see a successful (and final) meeting between European finance leaders and private Greek bond holders. Both Greece and the US are considered flashpoints in the global economy and so positive developments over the weekend will go along way to boosting confidence. Keep in mind though that it's taken a heck of a lot of stimulus to get to this point.

The US unemployment rate is now sitting at 8.3 per cent. Not bad. At least it's coming down. The big question though is whether the economy can sustain further job gains. There's been billions of dollars thrown at the economy. In a normal economic environment that would have resulted in near full employment. So with the debt ceiling as politically controversial as it is, we are now at a critical point where if the number of jobless doesn't continue to fall, it will be extremely difficult to find further stimulus in order to get it down again. The US has already thrown money at the problem, we need to continue to see further evidence it's working. The alternative is that growth will stall and the US will slide back into recession.

Greece is also a significant focal point this weekend. European finance leaders are set to meet with private Greek bond holders on Sunday night or early Monday morning Australian time. A successful outcome is crucial. The Greek government needs its private bond holders to accept a 70 per cent 'haircut' on their investments. That's a very bitter pill to swallow. Without that agreement the Greeks will likely forgo further aid from the bailout fund and will default on its debt payments due in the middle of March. I think this time the market's expecting more than just, 'the talks have been productive and we've agreed to meet again'. The markets are counting on a positive, concrete outcome.

In many ways if we had the opportunity to see ourselves where we are now when times were good, we would be shocked. The markets too have essentially priced that sort of shock in. Even the Australian share market has barely moved since 2005. We're essentially used to dealing with a critical situation, but make no mistake, the markets really are counting on something other than a worst-case scenario ending at this stage. And this weekend is part of the story.

A successful meeting on Sunday night in Greece will be another foothold the market can stand on in what has become a very hair-raising ascent. Greece simply can't afford to slip. Time is running out.

David Taylor

 

As the year grows a few weeks old, more business headlines have worked their way onto the front pages of our metropolitan broadsheets, and more data is being digested by the country's top analysts and economists. There's just so much of it. And is it all important? Where do you begin?
 
Well a good place to start is at the top. The World Bank for instance. It's just released a report showing the previously assumed economic growth rates (for the world and for some of the globe's developed economies) ain't going to materialise. Most notably it's cut its global growth forecast for 2012 from 3.6 per cent to 2.5 per cent. That's not confidence inspiring. What the banker to the world's bankers is saying is that this year could likely see a credit squeeze or economic crisis the likes of which will be greater in magnitude than the global financial crisis of 2008/09. Harvard Professor Niall Ferguson has already compared the banking conditions in Europe to that which existed in the lead up to the Great Depression.
 
So then we look to China, right? That's our great economic saviour. Yesterday it produced some important (and some would argue quite reassuring) economic numbers. Growing at an annual basis of around 9 per cent, it's clear there's no immediate threat of a 'hard economic landing' and it seems plain to me that it stands at the ready to cut interest rates if so required.
 
We've also just now had a good run of economic data in Germany and the U.S.. Germany's investor confidence figure overnight was encouraging, and the U.S. through up some satisfactory manufacturing data. All important. Given, however, the sheer amount of fiscal and monetary stimulus provided to these countries over the last three years, it's all a bit pathetic.
 
At some point we also have to come back to the U.S. deficit and debt position. We are likely to face a real threat at some stage this year when U.S. Treasury holders demand much higher rates of return (to counter the ever-growing default risk of U.S. debt) on their IOU's. Combine that with a severe credit crunch in Europe, as Greece - and potentially Spain and Portugal -  become insolvent, and it's every man for himself. Make no mistake that China will also suffer at this point too - unless it has successfully managed to structurally re-adjust its economy to be relatively autonomous with  the rest of the world (relying more on consumption than exports for growth).
 
Australia, at least for the short to medium term, will be reliant on China. That to one side, our key concerns are on the dollar (the higher it gets the less competitive our all-important mining sector becomes) and the unemployment rate. Without people in jobs, you can kiss the property market good-bye and any meaningful level of economic growth with that. At this point the job losses appear mainly to be centred in retail and finance. As unfortunate as those redundancies are, let's hope that's where it stops.
 
As was the case through most of last year, a lot is riding on the success of current policy development in the euro zone. A failure to come up with a credible plan or strategy to navigate the region out of its current economic malaise will see the first of the dominos tumble.
 
David Taylor
 

Over the past few weeks markets have risen and fallen, and we've seen numerous meetings and summits, and warnings from European institutions and political leaders. Have we made any progress? Sure, but it's been limited. Essentially what we have now is a world very clear on the fact that the European economy is in dire need of rescuing and that there's much work that needs to be done to resolve the crisis - at least that's further than we were this time last year.

The latest European Union meeting in Brussels focused on the idea of fiscal consolidation. That's important because a big part of the present problem is fiscal disunity - that is, each country is doing its own thing. It's a mess. Not only does each country have a different idea about how to resolve their budget dilemmas but have serious problems selling their ideas to the people. The Summit however resolved to make some uniform fiscal rules to promote some cohesion within the single currency block - cohesion that already exists within the framework of monetary policy.

Important progress was made last weekend in establishing rules that will help keep potentially rogue countries in-check. Rules that will mean that if a country goes beyond an acceptable fiscal or budget position, it will face penalties. This is a way of stabilising the region. After all, if all member countries are under the same monetary policy, there should be some uniformity with regard to fiscal policy. Unfortunately, Britain opted out of this latest agreement which has created its own political wave over in the UK. 

European leaders are also currently trying to nut-out how to replace the current European Financial Stability Facility (short term fix) with the European Stability Mechanism (longer term solution). Both are designed to insulate or protect the Euro zone from a major economic shock. They are essentially bailout funds - in addition to monetary support from the European Central Bank and the IMF. Member states though still have to have their inclusion in the mechanism ratified by their parliaments, and generating investor interest from other countries is proving an enormous challenge (especially with China).

The other battle front is the attention member states are getting from the ratings agencies. Most countries are under the watchful eyes of Standard&Poor's, Moody's and Fitch Ratings. It's understood that there are likely to be several downgrades to come right across the Eurozone. The key for investors will be to watch what happens to the more financially solid countries like Germany and France. To put in bluntly, if France, Germany and Italy all lose their economic credibility, it's unlikely the euro will be able to survive and more likely we'll see a break-up of the entire region.

Resolving the European debt crisis remains a significant challenge. To quote a famous line from the American novel, The Great Gatsby: So we beat on, boats against the current, borne back ceaselessly into the past.

David Taylor 

Shortly after the main wave of the global financial crisis passed in mid 2009, the key word being thrown around was "confidence". The idea was that we needed to see a return of confidence in the market. That's because investors were shell-shocked. Billions of dollars had been wiped off the market and analysts were still trying to get their heads around what had happened. We'd been caught napping. We had ignored the signs of impending financial distress and had chosen instead to believe the economic story (of endlessly rising asset prices). This time is significantly different because we are all too aware of what's dragging us down. The trouble is, agreeing on a solution is causing the majority of the on-going financial turmoil.

It comes down to partisan politics. Members of parliament are accountable to their constituents, and they don't want to upset them! They also simply have different political ideologies and different ways of approaching the same problem. Either way, it's meant that significant financial problems have gone unsolved.

The result has been to ask the question, what financial institutions are exposed to these governments that seem unable to pay their bills? Or what institutions are vulnerable to financial contagion? It's seen extra-ordinary volatility on share and bond markets. Last Thursday night it also saw, perhaps for the first time, US banking officials express some concern about the degree of exposure their, and other foreign banks, have to Europe.

That concided with a move by the Swiss National Bank to ask the US Federal Reserve for a $200 million swap arrangement (to help devalue their currency). They essentially used those US dollars to buy their own bonds (to reduce their interest rates) and hence devalue the Swiss Franc. Investors were unimpressed that one of the world's stongest economies was looking to the Fed for help. Like us though, the Swiss are getting tired of forex traders buying up their currency (considered to be a 'safe haven').

We need confidence to return to markets. That will occur when markets believe that the engine rooms of world growth are on a sustainable path of growth again. That will occur when governments around the world get their fiscal houses in order and learn to sell the idea that some medium term consumer financial pain is necessary for overall longer term gain.

Until that time, volatility and uncertainty are likely to remain. There is, however, a better future, at some point, to look forward to.

David Taylor

There are a few stories today for which...for what it's worth...I thought I'd write down a few of my thoughts.

Greece:

Yes it's true the resilient George Papandreou won a no confidence vote earlier this week. Markets are funny though - they're high maintenance and at present are very short term in their thinking. Yes it was an important step in the right direction and it means it's more likely that the parliament will be able to pass the austerity measures that the IMF is seeking. But there's still a long way to go. It's also mind blowing that there are reports today that they're still trying to weasel their way out of some of the measures. European Union leaders have had to fend off attempts by Greece to water down some of the austerity measures and the privatisation package. It really seems to me that the Greek financial crisis is more to do with a mentality than not being able to manage their books - though that needs some serious work too.

US:

The latest figures on jobless claims (rising 9000 to 429,000) and some weak housing numbers points to further evidence the US economy is just sputtering along. The Federal Reserve downgraded the country's growth forecasts this week and basically said that the economy's in some serious doo doo and we're not entirely sure how to manage it now. Oh and the unemployment rate should be down to 8 per cent (still seriously high for a developed nation) by the end of next year. The US is arguably in a worse situation that Greece, but there's no chance you'll ever hear a banking economist say that. They'd lose their job.

Australia:

A leading rating agency has suggested the exposure of our banks to the unfolding European debt crisis is in fact material. Truth is the further Greece (and Europe) goes down the path of financial disorder, the more expensive money will become. That'll raise the funding costs for banks and lead to higher interest rates (as they pass those higher funding costs onto consumers). Is it any wonder then that Australia's in the midst of a savings boom? Yes investors want to take advantage of higher returns for their money (in bank deposits) but there are also so many investment risks out there that shareholders are simply voting with their feet - and putting their money in cash. Keep watching the savings rate, that's the real test for investment muscle out there.

David Taylor

Make no mistake, the sovereign debt crisis currently playing out in the euro zone is serious. Meetings, followed by more meetings, followed by mass - often violent - demonstrations, show a region on the brink of  a financial disaster. We're not talking about a fiscal crisis, that's already here. Greece has already asked for financial assistance and helped cause a slump in the Euro to record lows. We're talking about an impending financial disaster.

What is astonishing is that the same mentality that got many countries like Greece into this mess is the same mentality preventing them from an immediate recovery. There's no fiscal discipline. Even the government's last ditch attempt to save the economy by selling off public assets is being met by strong criticism because people are afraid of pay cuts or losing their jobs - something that simply must happen. This isn't about being fair, it's about surviving, and there will be casualties.

Other, more well-off countries and financial authorities understandably also do not want to share in the burden. Everyone's trying to pass the buck...literally. It's a tough environment for many developed countries to grow in the first place, let alone trying to support another country in the process - for no obvious benefit. But there in lies the issue. The benefit would simply be the maintenance of the financial stability of the euro zone. Unless other governments insist the private sector shoulder some of the debt burden, we may well see Greece default on its debt obligations (declare bankruptcy). If that happens, a run on banks and a full-blown credit crisis would be a real possibility.

IMF acting managing director, John Lipsky, said recently "the implications would be much more serious if (the crisis) were to have consequences on the financial system of the core economies." That's the train wreck.

So we're waiting/relying on several things. For Greece to enact further austerity measures and raise funds through the privatisation of many public assets, for other, stronger, euro zone countries to lend financial support, and for the private sector to shoulder some of the debt burden. It's a race against time, but much of the evidence points to a train that has already derailed and headed over the edge.

It may well be time for the authorities to prepare the markets for a Greek debt default. That's akin to sending the emergency service vehicles to the crash site before the train's even come to a halt.

David Taylor