The Global Economy
2010 was characterised by a solid rebound in global economic activity (+4.7%), although not all countries enjoyed similar experiences.
Whilst many developing economies, particularly in the Asian region, were significant outperformers, many developed nations saw only modest growth in consumer spending and housing market activity. These two sectors are crucial to many economies, particularly in the U.S where consumer demand comprises 70% of the economy.
Consumer demand relies on consumer confidence. In the U.S, low interest rates are an attempt to encourage businesses to employ more people, which underpins consumer confidence.
Whilst the U.S economy has grown for five consecutive quarters and the recession ‘officially’ ended in June 2009, unemployment remains just below 10%. This statistic contributed to a recent poll that showed 74% of Americans still didn’t believe the recession had ended .
Worries Persist for Some
It’s human nature to view our present or future situation through the prism of recent experiences. Many fear that every little dip in markets is a prelude to the next collapse.
But good news is becoming more prevalent.
In the U.S, retail sales are up 7.3%. The Dow Jones index is up 70% from 2009 lows. Most large company balance sheets have never been in better shape. China’s growth is moderating towards a more sustainable 8.5% pa.
However, public indebtedness remains a growing concern, particularly for the U.S and many European economies. Many wonder how successful the massive bail out packages have been in fixing problems exacerbated by the GFC.
Ireland was recently bailed out by the European Union (EU), but is now paying the EU an interest rate of 5.8% pa which is likely to be higher than economic growth, causing its debt/Gross Domestic Product (GDP) ratio to continue to grow. A devaluation of Ireland’s currency would help make its exports more competitive to stimulate economic growth, but being part of the Euro currency means this is not an option.
Challenges in Europe
A root cause of Ireland’s current mire is how the EU operates.
Each member country of the EU has the power to control its own fiscal policy (e.g. government spending), but cannot control its own monetary policy (e.g. interest rates). So over the past decade when low EU interest rates were prudent for its largest economy, Germany, they were a disaster in Ireland where the economy was particularly strong. As a result, cheap debt fuelled an Irish property bubble that has spectacularly exploded and resulted in massive bank losses.
Whilst these matters present a medium term challenge for Europe, there remain larger, longer term issues to be confronted.
The main issue is government pension schemes, which are simply not sustainable. The table below illustrates the ageing populations of the five largest EU economies:
The rising number of pensioners is why France has recently been trying to raise the retirement age for its citizens by two years to 62 (still below Australia’s 65), as future welfare liabilities can’t be funded by a smaller population of workers/taxpayers.
And which country has the most sustainable pension system in the world? Australia is the answer, thanks to our compulsory superannuation system.
Whilst public finances paint a sorry picture in many countries, the global corporate sector is looking increasingly robust. The morality of this situation so near to the end of the GFC may be perverse, but it is the reality we are left with. One way or another, the public debt hangover needs to be resolved.
The build-up of debt was caused by developed economies using cheap and readily available funds to buy goods and services from the developing economies. The solution now appears to be the cashed up developing economies spending their wealth for the benefit of all.
The Australian Economy
The continuing strength of Australia’s major trading partners, namely China & India, has provided a huge boost to the domestic economy.
In 2009, China accounted for 46% of global coal consumption and used twice as much crude steel as the EU, US and Japan combined . In 2010, China will account for 20% to 25% of world growth and will buy more mobile phones than the rest of the world put together.
Australia’s challenges will be stark compared to the EU – how to manage our prosperity?
The increasing importance of Australia’s resources boom in our growing prosperity is evident in our terms of trade (TOT).
Our standard of living is impacted not just by the value of our physical output – as measured by GDP – but also by our purchasing power relative to the rest of the world. TOT measures export values relative to import values.
In a recent speech, Reserve Bank of Australia (RBA) Governor Glenn Stevens gave a wonderful example of how our TOT is impacting our economy.
In 2005, one ship load of iron ore going to China was worth 2,200 flat screen TVs coming back the other way. Today, due to the surge in iron ore prices and falling price of TVs, one ship load of iron ore is equivalent to 22,000 TVs. That’s a 900% improvement in five years.
The general point is that all other things being equal, a rising TOT raises our financial living standards. Australia’s TOT has never been higher and has recently reversed a downward trend over the past century, as the graph below highlights:
Whilst part of this higher income goes to foreign investors, a good proportion remains with local shareholders, employees and the government via taxes.
It is difficult to determine if the rise in TOT is permanent or temporary, but past peaks have not proven sustainable. This raises the issue of whether the current large investment in resource extraction will be profitable if commodity prices fall. The RBA is anticipating a 30% fall in iron ore prices in the medium term. Despite this, the RBA foresees a prominent role for the resources sector over the long term.
The strength of mining investment and the limited spare capacity in the economy – as evidenced by an unemployment rate nearing 5% – has caused the RBA to continue to lift interest rates. Higher rates have recently dented household confidence, resulting in people saving almost 9% of their income today, compared to -1% five years ago.
However, a moderation in consumer spending and housing investment is not necessarily a bad thing, as it provides room for mining investment without overheating the economy, which would lead to further interest rate rises.
Australia’s economy is truly a standout in the developed world at present. However, importantly we must remember that no connection exists between a country’s economic growth outlook and the performance of its equity and bond markets. For that reason, maintaining a diversified portfolio that includes exposure to Australia, U.S, Europe, Japan and the emerging markets remains as prudent as ever.
Although the U.S is experiencing growing GDP, consumer sentiment remains subdued. You could conclude that economic prosperity doesn’t necessarily make people happy.
The UK Prime Minister David Cameron agrees. He has requested the Office of National Statistics devise a ‘Happiness Index’ to measure the British public’s wellbeing, stating that ‘there’s more to life than money’. France and Canada have launched similar initiatives.
Measuring a country’s progress beyond solely GDP statistics sounds like a great idea to us.
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