90 seconds at 9 am: Aussie risks

S&P says Aust AAA rating at risk; iron ore price drops; Chinese buy AU infrastructure; UST 10yr 2.51% NZ$1 = US$0.863, TWI = 80.2

20th May 14, 7:32am by David Chaston

Here's my summary of the key news overnight in 90 seconds at 9 am, including news from Australia today.

The latest Australian budget that forces them to face up to the fact they are spending much more than they have is proving to be a very tough sell.

Now Standard & Poor’s has warned that unless substantial cuts to that budget deficit are made this year and in the following years it could be forced to reconsider Australia’s AAA credit rating. A rating cut would drive up borrowing costs and be a huge political blow.

Compounding their issues, the price for iron ore has dropped below US$US100 a tonne overnight.

While prices are 'cheap', there is a rush on by Chinese interests to buy up mining and related infrastructure assets in Australia.

Unrelated, but interesting all the same, overnight the US charged a number of Chinese PLA officers in a major industrial espionage case.

The benchmark UST 10 year bond yield fell back in Monday trading in New York to 2.51%. Gold, which had a brief flurry above US$1,300/oz has fallen back and is now at $1,293/oz. Oil rose in the US to a 4 week high but fell in the Brent benchmark. Equities are rising in late afternoon trade, pushed ahead by smaller companies.

On the exchange rate, we start today with the NZ dollar basically unchanged at 86.3 USc, the Aussie is at 92.5 AUc. The TWI is now at 80.2.

If you want to catch up with all the changes yesterday, we have an update here.

The easiest place to stay up with today's event risk is by following our Economic Calendar here »

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12 Comments

by Andrewj | 20th May 14, 8:21am 1400530885

For two decades now mainstream Keynesian economists have been gumming about China’s remarkable economic boom and its accumulation of unprecedented foreign exchange reserves. The latter hoard has now actually crossed the $4 trillion mark.

But this whole narrative is PhD jabberwocky with a Wall Street accent. What the People’s Printing Press of China has been doing is simply passing the hot potato by converting the vast inflow of dollars, euros and yen emitted by DM central banks into a fantastic flood of RMB. This massive expansion of the domestic monetary system, in turn, enabled the greatest credit bubble in world history.

Stated differently, China’s total credit market debt outstanding did not explode from $1 trillion to $25 trillion in just the last 14 years because the sons and daughters of rice farmers working in export factories went on a savings binge, thereby enabling a healthy expansion of debt-financed investment.

To the contrary, the central banks of the world went on a money printing binge and the comrades in Beijing took the bait. Namely, they chronically and massively scooped up excess foreign exchange from trade and capital inflows and stuffed it into the vaults at the central bank. This was supposed to keep the exchange rate battened down and the growth and export miracle ramping.

The giant issue facing China, however, is that it is at the end of the money-printing chorus line. It has now absorbed so much excess debt from the West and thereby inflated its credit Ponzi to such an insensible extent, that even its current rulers can see the hand-writing on the wall.

In a recent speech, in fact, Premier Li let the cat out of the bag, calling China’s massive hoard of foreign exchange for what it is—-a vendor loan to foreign customers who buy but do not sell; who consume but do not produce. Suddenly, what has been ballyhooed for two decades as evidence of the Chinese miracle is officially labeled a “big burden”.

http://davidstockmanscontracorner.com/bingo-premier-li-keqiang-puncture…

by Stephen L | 20th May 14, 10:01am 1400536895

Andrew,

It's a good point, but something of a luxury problem for them to have. Presumably one exit for the Chinese is to use their foreign funds to buy up as many foreign hard assets as they can until the world says enough. That would certainly explain some of the foreign bubbles being blown, including here. (go to a property auction for example and see otherwise irrational prices being paid. Sovereign money laundering). Add in the Germans, Swiss and petro countries, and you have a massive swap out of hard assets from local owners to a select group of foreign countries.

These countries can all do this while slowly letting their currencies appreciate back to a level of current account balance. If the rest of the world has bubbles or inflation, then it's not really their problem. Now the Germans have bought as much of Europe as they can probably get away with for example, they appear willing to print. A bit of inflation when you own all the assets, and need then leverage to unwind wouldn't be a bad thing from their point of view.

What should New Zealand do? We should have been playing their currency wars game since the GFC, at least to a point of balance, and still should be, albeit after most of the horses have left the barn. In our case, our scale makes it an easier game to play. China is a massive super tanker which takes a bit of turning and is also readily visible to everyone else.

by Anarkist | 20th May 14, 2:11pm 1400551894

Andrewj,

The actual reality is the reverse of what the author of the article claims.

The source of the majority of monetary flows leading up to the Global Financial Crisis were the oil producing nations, the commodity exporters of South America and Australia, and the emerging industrial powerhouses of South East Asia. Very little monetary growth happened in the United States. America played the role of absorbing and recycling excess capital created in the emerging economies, particularly to direct them towards funding the housing bubble and the U.S. budget deficit. It was a political choice to do so, because it allowed China to undervalue their exchange rate to allow their exports to have advantageous competitive advantage on world markets. Why were American policymakers willing to allow this to take place? Because the primary beneficiaries were the U.S. multinationals who invested in global supply chains to to gain cost arbitrage due to lower wages and inducements by the Chinese government to set up factories there. Most trade flows between China and the United States is between branches of the same corporate firm.

"gillies — the fed isn’t actually issuing that many dollars. look at the data on the fed’s balance sheet. it isn’t growing that fast — as a senior economist at a major wall street firm noted privately to me. Neither the fed’s total assets nor total liabilities have increased much (there have been big changes in the composition of its assets but that is a different story). The fed has been able to lower policy rates without printing much money/ growing its balance sheet.

the really fast money growth these days is found in the emerging world (China, the Gulf, Argentina) not the US. You don’t need a committee to control dollar issuance to change that; these countries could stop pegging to the dollar. Their central bank balance sheets are growing fast — on both the asset and liability side.

Incidentally, if the US cuts rates and it pushes the dollar down, the logic above suggests that dollar weakness would contribute to an improvement in the trade balance — though I would concede that to the extent $ weakness contributes to the rising $ price of oil, there is now an important offset that is slowing the adjustment."

http://blogs.cfr.org/setser/2008/06/10/shhh-don%E2%80%99t-tell-any-one-…

Manufacturing and exports are just a sideshow. Employment in manufacturing peaked in the 1990s and its official Chinese governnment policy to allow the shuttering of thousands of factories in the industrial heartland to close, because there output is inefficient and low value, with slim margins. They prioritiese investment in cleaner, higher value produce, which requires fewer workers and lower volumes to be profitable. Its a reprise of the austerity programme carried out by the Chinese government in 1990 to curb a surge in inflation which resulted from price reforms which had been implemented in the 1980s.

http://www.businessweek.com/stories/2008-03-26/chinas-factory-blues

http://articles.latimes.com/1990-06-29/news/mn-659_1_china-facing

The other engine of capital formation in China is infrastructure investment. In many regions it comprises up to 75% of spending. How can you say with a straight face that China is a free market country when the State is responsible for that proportion of economic activity?

http://www.tealeafnation.com/2013/08/infographic-is-chinas-massive-infr…

by Andrewj | 20th May 14, 2:45pm 1400553934

Thanks Anarkist, but can you clear a few things up for me.

I thought that the oil industry was all conducted in US$ and the major sourse of US $ creation.

My understanding of Chinese US and EU trade is that the Chinese make stuff and sell it to the US or the EU, when the foreign dollars return to China the government takes them and gives the exporter Yuan, they then take the Foriegn currency and buy treasuries. I find this hard to understand.

As the West contracts can Chine really grow its way out of the problem?

by Anarkist | 21st May 14, 10:42am 1400625759

Hey Andrewj. Sure oil does comprise a significant proportion of transactions denominated in USD. These transactions are managed primarily by multinational investment banks. Oil is denominated in USD due to a historic bargain between America and Saudi Arabia. Security in exchange for US Treasuries. Recently the Saudis have moved towards providing for their own defense. The primary beneficiaries of this new strategy have been the German armaments industry.

In the case of China, you need to acccount for the investment phase of the business cycle. In the early stage of Chinese industrial development thecountry received tremendous amounts of Foreign Direct Investment by American corporates and financial firms. They would have exchanged USD for Yuan to pay for payroll and local

ly sou

rced materials. USD would have been used for importing fuel and capital equipment.

I guess in their intrafirm transactions the US HQ would have payed their Chinese subsidiary in USD.

by Boatman | 20th May 14, 9:14am 1400534083

To be fair , its a pity the Aussie economy is not as agile as we are , by that I mean , we allow uncompetitive businesses to close and dont prop up or protect unsound industries with taxpayer money .

We have more robust free market systems , and a flexible labour market and unrestricted market acces for the most part . They are also full of unnnecesary regulation for smalll business , which we have eliminated

There are some exceptions to what I have said , such as Tiwai Point , but there was too much at stake in letting that go

With respect to Aus , I refer for example to the Aussie Auto industry , among others, which survives only on hanouts and import protection .

The mining boom has overshadowed all the ills brewing in the manufacturing sector which is now beyond its sell by date

Everyone knows there have to be major structural changes in their economic fundamentals , but here is little political will and a weak government to grab the bull by the horns and make it happen

by KH | 20th May 14, 12:53pm 1400547231

But Boatman, just remember we don't really have the discipline of a market economy, except for the small business sector.

Mostly we have a crony monoply economy, mostly for the big stuff like energy and banking. And much of those excess gouged profits go to Australia.

by Alter Ego | 20th May 14, 9:34am 1400535296

Ah, but, IT also helps if you have a hand in the cookie jar and want to spend some of that ill-gotten gain on future endeavors, but want a head start without spending your own dime.

I spy with my little eye, future opportunities, at someone elses expense. Another big burden. Cyber spying is rife.

http://www.bloomberg.com/news/2014-05-19/u-s-said-to-charge-chinese-mil…

China is also buying up oil and stock piling it, in preparation for what?.

All this printing and be damned is just a paper war, not a real one. Each trying to out do the other.

We are taking part in a small way.

My worries, is it becoming over heated. Now they are ramping up for something else.

Bluff and bluster, is all very well.

Pump and dump is affecting us all.

Pump and save, when you have no oil to speak of, speaks volumes to me.

by Gareth Vaughan | 20th May 14, 11:07am 1400540841

“This case shows that no financial institution, no matter its size or global reach, is above the law."

Credit Suisse to pay US$2.6b in penalties for conspiring to aid tax evasion - http://dealbook.nytimes.com/2014/05/19/credit-suisse-set-to-plead-guilt…

by Andrewj | 20th May 14, 12:21pm 1400545319

So who went to jail? Or did the shareholders get fined?

by antonymouse | 20th May 14, 2:00pm 1400551251

This, sort of, explains it:

http://www.salon.com/2014/05/19/it%E2%80%99s_total_moral_surrender_matt…

Here a part of the article:

Holder, as deputy attorney general in the Clinton years, outlined what was actually sort of a “get tough on crime” document. He gave prosecutors all these tools to go after big corporations. But, at the bottom [of the memo], he outlined this policy called “collateral consequences,” which was — all it really said was, if you’re a prosecutor and you’re going after a big corporation that employs a lot of people, and you’re worried about innocent victims, you can seek other remedies. Instead of criminally prosecuting, you can do a deferred prosecution agreement, a non-prosecution agreement or, especially, you can levy fines.

When he wrote that, it was nearly a decade before the too-big-to-fail era, but when he came back to office [as Obama's attorney general], this idea, which initially had been completely ignored when he first wrote it, suddenly [becomes] the law of the land now, insofar as these systemically important institutions are concerned. The administration’s come out and overtly talked about collateral consequences and talked about [how] they can’t go against companies like HSBC and UBS because they’re worried about what the impact might be on the world economy.

What’s interesting about it is that this idea suddenly matches this thing that happened with our economy where we have the collapse of the economy in 2008, [and] instead of breaking up these bad companies, we merged them together and made them bigger and more dangerous. Now they’re even more unprosecutable than before, now this collateral consequences idea is even more applicable. And that’s the reality we live in now; it’s just this world where if you can commit an offense within the auspices of a company like that, the resolution won’t be a criminal resolution, it will be something else.

The argument is similar to why they said they couldn’t prosecute people for torture: because the CIA is systemically important, because we can’t risk pissing off the national security community, because we can’t risk disturbing the national security system.

by Alter Ego | 20th May 14, 4:40pm 1400560842

It actually nails it, AM.

But no matter what anyone says, nothing really will be done about it. There is no political will nor total honesty left, nor right.

Matt Taibbi is the one of the few who reports the true state of affairs.

MSM is there to hide the truth, not tell the truth. Most mugs, do not even know they were mugged.

But there is an exception to every rule.

At least Matt does not get censored, unlike some countries media.

In Eygypt he would be locked up and the key thrown away. In others, shot.

Cannot have reporters telling the truth, can we.

He actually would make more sense as a Treasury official, than anyone I have ever come across. But we would need one of his ilk in this Country too.

Maybe then we could revert back to the fact that fraud is actually a crime, instead of a way of life.

Maybe then we could actually trust the systems, rather than let others embellish it to their advangate.