THE DISTILLERY: Land of the free money
The dynamics of the next boom-and-bail cycle are clear in today’s commentary.
A brilliant piece is available this morning from John Garnaut of The Sydney Morning Herald. Garnaut attacks one half of the global imbalances story: Chinese overcapacity. “On October 14, 10 top economic agencies and regulators jointly declared China's steel production capacity had exceeded actual production by 160 million tonnes – as much as this year's expected combined output from Japan and America – and would soon be exacerbated by 58 million tonnes of "mostly illegal" capacity under construction ... But the concept of overcapacity doesn't make sense in China. Mostly, it has turned out to be nothing more than investors getting marginally ahead of a very steep demand growth curve. The figure of 160 million tonnes was momentarily correct, when Chinese steel production was falling towards 400 million tonnes during the worst of the global crash. But by June the steel factories were producing more than 600 million tonnes and they have stayed there since ... This is the fourth time in seven years that the government has sounded the alarm about overcapacity in steel, cement and other heavy industries. It has been wrong every time. China has simply grown into its seemingly idle capacity, and this cycle will be no different.”
Fantastic stuff: well researched, original quotes, breakthrough angle, well written. Moreover, Garnaut is taking the opposite side in a global debate that includes recent reports from the European Chamber of Commerce and the New York Times. Such reports see China using unfair currency manipulation to sustain overcapacity and export unemployment.
And it is on that subject that there is one criticism this column can offer the Garnaut line. If China’s capacity is to grow so strongly, then the idea that stronger consumption is going to shift the trade imbalances with the US is deeply suspect. Looks rather more likely that any growth in demand will be offset by local capacity-building, leaving precious little new net demand for imports (outside of commodities). That spells political trouble and protectionism in the US. Garnaut’s contention that the PRC can step into the breach with further stimulus looks likely to this column. But let’s remember that that means higher costs of capital in the US as China spends more of its money at home. We have here the outline of the slow decay of Chimerica.
And it’s on that subject that David Uren of The Australian chimes in with another good piece. Uren uses the occasion of the Dubai default to argue “The Reserve Bank's confident belief that China will carry Australia's economy aloft, regardless of what happens across the North Atlantic, may soon be punctured by financial reality.” Uren believes that the risks of a global growth relapse mean the RBA may be “repeating its misjudged campaign against inflation in the first half of last year as the financial crisis was exploding as a global threat.” This column agrees with the premise but not the conclusion. Global growth will be weaker than the past cycle, but the RBA is right to be raising rates to hose down asset prices, and it has plenty of room to move upward and still remain in expansionary mode. If anything, the Dubai mess will give some relief to the currency as the global risk trade wavers, enabling ongoing rate hikes. Whether they do so is another matter. Michael Stutchbury of The Australian joins in to support Uren with a prediction that rates will not rise until February.
The Australian Financial Review editorial agrees that the Dubai default is not the end of the world. But it goes much further than this column and dons a huge pair of Panglossian glasses in forecasting immaculate recovery for the US. Looking like Dame Edna Everage, the AFR sees “everything from corporate profits, commodity prices, stock prices, department store sales, housing sales, manufacturing indices, productivity and credit spreads suggest the US economy has bottomed and started to recover.” It concludes “The prospect of big profits may yet prove to be the silver lining of the economic recovery, spurring more capital investment and helping the economy swing back to health faster than many expect.” This is simply too much balderdash for one column to address. For those looking to understand why the US economy is headed for a dreadful decade, this column suggests regular reading of the following blogs: nakedcapitalism, calculatedrisk, creditwritedowns, zerohedge, thebigpicture and mish’sglobaleconomicanalysis. You will be able to mark the end of the great bear market bounce at the precise instant that stock markets acknowledge the US is not going to recover. It is anticipation of this sad fact that continues to push gold toward the moon, as the inevitable consequence will be free money from the Fed, pretty much for ever.
Still, until such a time, it is, this column supposes, fair enough to discuss the coming recovery in Australia. And that’s where Alan Mitchell of the AFR takes us today. Lagging Michael Stutchbury of The Australian by a month or so, Mitchell has commenced a campaign in support of economic reform to “boost productivity growth”. He nominates defence procurement as an “obvious candidate” for liberalisation, and castigates Rudd’s failure to limit protections in the car industry and NSW government procurement. According to Mitchell, “ ... there will be more pressure ... to assist weak industries as the expansion of the mining sector and the strong Australian dollar suck productive resources away from manufacturing. But there is a heavy price for resisting structural change, and it is slow long-term productivity growth”. As a general supporter of such principles, this column is growing increasingly frustrated with a total lack of creative thinking on this subject. The likes of Mitchell and Stutchbury wave these totemic economic platitudes at readers like they’re holy crosses. How do they account for the market failures inherent in the GFC? How do these failures affect theories of specialisation? How could the danger of the economy titling towards houses and holes be offset? What other ways are there to boost productivity? It’s simply a cop-out to pass the load on to the ‘invisible hand’.
From time to time that hand does, of course, force a firm to go bust. Which is leading to a debate on Australia’s insolvency regime. According to Adele Ferguson of The Age: “When the Senate launched an inquiry into corporate undertakers last week, it sent the insolvency industry into PR overdrive and opened up a can of worms for the Australian Securities and Investments Commission, still stinging from its One.Tel loss.” Ferguson applauds the decision and offers some staggering statistics: “ASIC estimates insolvency practitioner complaints account for fewer than 2 per cent of total complaints and breach notifications. At face value this might seem small but there are only 576 practising liquidators in the country, compared to the millions of companies and other entities that ASIC monitors. The more obvious conclusion is we have a systemic problem that needs to be addressed.” Ferguson also links ASIC complacency with the specific case of liquidator, Stuart Ariff. “Ariff, who until recently had a powerful network of business associates, and who scored a number of his administrative appointments courtesy of Tom Karas, a financier to underworld figures including Mick Gatto, was banned for life as a liquidator in August 2009 and ordered to pay $4.9 million compensation to the myriad companies he gouged while charged with trying to salvage them. But the ordeal for the victims continues. Ariff has since been declared bankrupt and BusinessDay can reveal that his professional indemnity and fidelity insurance was cancelled in September 2008, which will make it difficult to claim from this policy. If ASIC had been more vigilant when working on its case against Ariff last year, it would have discovered this and acted to cancel his registration.” As usual, it's penetrating stuff.
On the same topic, and no doubt arising from the same PR assault identified by Ferguson, the AFR runs a still useful op-ed by Morgan Kelly of corporate recovery firm Ferrier Hodgson. Kelly argues the central issue in insolvency reform should be “the automatic termination of contracts when a company enters a formal administration”. According to Kelly, “ ... insolvency practitioners will tell you businesses they have nursed through liquidation could have survived if restructuring opportunities has been explored earlier. There is an argument for the introduction of a “business judgement rule” to enable directors to exercise their judgement for the benefit of all stakeholders.” Well, yes, but the US Chapter 11 system, which captures these principles, has also been critiqued for keeping productivity-zapping zombie firms and overcapacity alive.