The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Friday, August 27, 2010

Why the US does not matter much--part II

Today I will drill further into the detail of why the US is not especially relevant to Australia's long-term economic fortunes. This is not something that appears to be recognised by the equities or debt markets. For one reason or another, the correlation between the US and Australian securities markets has been remarkably high in recent times despite the fact that the US is declining in its importance to us. Looking forward, I expect to see these correlations collapse.

The charts that follow are extracted from a recent report by UBS's Scott Haslem. The first compares the differential between Australia's trading partner growth and world growth since 1995 through to the end of 2011. The red bars show that there is a positive and widening gap between these two variables that emerged in 2009 and is forecast to continue for the next few years. Critically, this was not the case in decades past--Australia's trading partner growth tracked world growth quite closely. This positive divergence has been driven by the change in Australia's export partner mix with a striking increase in the significance of China and India, and commensurate declines in the influence of the likes of the US and Japan.

Of course, Australia has second-order linkages to the US via its trade with China. In 2009 the US accounted for around 30% of Chinese exports. But these tend to be cheaper goods and have proven to be relatively resilient to the US downturn. Policymakers in China are also actively seeking to reduce its reliance on the US specifically, and export markets generally, through fostering internal demand via real wage increases and an uber slow appreciation of the currency.

The next chart provides insights into the historical evolution of Australia's trading partners. In particular, it illustrates the time-series change in the share of Australian exports bought by China, India, Europe, Korea, Japan and the US since 1990. The big movers are: India, which has risen sharply from sub 3% in 2003-04 to 9% by 2010; China, which has also increased from less than 3% in 1992 to more than 21% today (and is our number one trading partner); Japan, which has fallen from circa 28% to 18% over the same period; and the US, which has also declined from a peak of over 12% in 1990-91 to a tad under 6% today.

The table below fleshes this out further by showing IMF analysis of the change in the share of Australian exports directed to key trading partners since 2000. And the findings are stunning. According to the IMF, China will account for more than 33% of all Australian exports by 2015 whereas less than 4% will go to the US. India will increase its take from 1.7% in 2000 to 11.3% by 2015. Japan's significance will also continue to fade, albeit from a very high base. By 2015 China and India together will capture around 6x the value of the exports that we send to the US.

The RBA and Treasury expect the ratio of the value of Australia's exports to our imports to remain at record levels. The next chart shows this and the strongly positive relationship between changes in the terms of trade and new business investment, which is expressed as percentage of national income. This is one of the reasons why the RBA is forecasting a big increase in private investment in coming years, which was also reinforced by yesterday's capex plans (projected to rise by 30% in 2010-11).

An important ingredient in our medium-term economic story is elevated population growth (although these growth rates are well down on recent 2% plus peaks), which will underpin aggregate demand. Based on Australia's population growth, the IMF believes that our potential (and sustainable) economic growth rate is higher than any other major advanced economy.