Pearls and Irritations

“Australia is a lucky country run mainly by second rate people who share its luck”, author Donald Horne proclaimed in 1964. Horne was being ironic and hated that people took it to mean that our country is somehow special or blessed. That said, an economic recovery may well happen sooner than we think.

I’m going to have the Donald rolling over in his grave because I think Australia is about to get lucky again. Not only because we seem to have flattened the coronavirus curve. But because Asia is emerging as the big winner from this crisis, and it’ll help kick-start our export sector. Australia’s miners should get a further boost from a likely fall in the U.S. dollar thanks to America’s massive stimulus in response to COVID-19.

The Prime Minister, Scott Morrison, is almost doing a victory lap when it comes to coronavirus. That may be a bit over-the-top, though he certainly thinks that the lockdown is helping to contain the virus. His confidence isn’t misplaced as the rate of new infections is clearly slowing in Australia.

That doesn’t mean that the virus won’t accelerate again once our economy is opened up. Or that a second wave of new infections won’t appear for some other reason. At this stage, however, we are in a good spot, particularly when compared to most other developed countries.

Why the apparent success thus far? It does seem that being a remote island has helped, as has our relatively small population. Being a younger country, with a median age of 38, has almost certainly been of benefit. And our health system has held up well, with the caveat that it hasn’t been tested to the same degree as Italy, Spain or America.

If the current trends persist, the lockdown may finish much sooner than the six months outlined by government. People will get back to work and the economy will ramp up soon after.

I’ve previously suggested once the recovery beings, our economy may be held back by people being permanently scarred from this crisis. They may choose to increase savings over spending, and reduce debt over taking on new loans. Given the large contribution which consumption makes to the economy, this would be a significant negative.

On the flip side, I expect our exporters to come out of this in good shape. That may be enough to help the economy muddle through in the medium term.

The export sector will benefit from Asia coming out of COVID-19 in a strong position. The human toll of the tragedy hasn’t hit Asia anywhere near as much as Europe or the U.S. Sure, China has probably underplayed the number of deaths it’s incurred from coronavirus, though I certainly wouldn’t believe all the political propaganda on this, especially from intelligence agencies which are largely paid to lie and deceive. The same accusations can’t be levelled at Japan, Singapore, South Korea and Taiwan – all of whom have handled the virus remarkably well.

Asia’s economies are also ramping up far earlier than other regions. It’s the first in, first out principle – Asia was the first impacted by the virus and it should be the first to recover.

Economic data indicates China is already getting back on track. This week, China’s official manufacturing PMI, which focuses more on larger state-owned companies, showed a jump to 52 in March from a record low of 35.7 in February. The March result was above the 50 mark, which separates contraction from expansion. The release prompted guffaws from analysts and the media, casting doubt on the figures. But the numbers are entirely plausible given it’s a month-on-month index, and during the prior month of February, the country was totally shut down.

The data was also supported by a private survey of smaller Chinese manufacturers – The Caixin China manufacturing purchasing managers index – which rose to 50.1 in March from 40.3 in February. From this, it’s fair to conclude that larger, state-owned firms are rebounding strongly, while smaller, private ones are a little more sluggish. But the latter should rally this month.

Other indicators are positive too. Hotel occupancy rates have recovered quickly. In Wuhan, rates went from less than 10% to above 70% within three weeks. Other activity hasn’t rebounded as fast, yet are certainly on their way back.

It’s true that some other Asian countries are unlikely to rebound as quickly as China. South Korea and Taiwan are heavily reliant on exports, which will suffer from expected recessions in the U.S. and Europe. The global travel ban will hurt tourism-dependent economies like the Philippines and Thailand, where travel and tourism account for almost 25% of their respective economies. Nonetheless, Asia’s economies will emerge from this in far better condition than other regions.

Asian balance sheets will be far superior too. In general, Asia hasn’t resorted to the eye-watering stimulus packages of the West. Singapore and Taiwan have announced stimulus of US$34bn and $35bn respectively in bids to save jobs. Japan is set to announce a US$137bn spend, financed in part by deficit-covering bonds. These stimuli pale in comparison to the $2tn stimulus package of the US.

Asia’s competitors have been decimated by the crisis. For Europe, it’s been a disaster at almost every level. The European Union has proven itself inept, and it’s further called into question the European project.

E.U. leaders have largely sat idle while their countries have burned. The lack of unity among leaders was highlighted by discussion around the idea of pan-European government bonds. Italy has understandably pushed for their introduction give its dire economic situation. However, such bonds are constitutionally forbidden in Germany. Anyhow, the leaders disagreed and dithered, and decided to reconvene in two weeks.

With the E.U. sitting on the sidelines, national governments have had to step up. A number of them decided to bring back control of their borders, budgets and laws – some of which is against E.U. law. The obvious question is: is taking back their currencies next on the agenda?

The US is a shambles as well. It has a president who sold the virus as a hoax until it was too late, resulting in the unnecessary deaths of thousands of people. The American health system, like Europe’s, has proven inadequate with a litany of errors, again costing lives. Though Bernie Sanders won’t be a Presidential candidate, one of his pet issues – healthcare – will surely be the issue of the election campaign.

Shutdowns in many U.S. states are already having a significant impact on the economy, with much worse to come. U.S. employers shed more jobs – 701,000 – in March than in any month since the 2007-09 recession. The unemployment rate rose from 3.5% in February to 4.4% in March, the largest one-month increase in the rate since 1975. Most expect this rate will peak in the low-to-mid teens.

The inevitable bankruptcy of many large U.S. shale oil companies will send further shock waves through the economic and financial system. These companies, with average cash cost breakeven levels of US$55-60/bbl and significant debt burdens, were already struggling before this crisis. With prices at close to half breakeven levels, most of the industry is unsustainable.

A leading producer in North Dakota’s Bakken shale, Whiting Petroleum, became the first major casualty of the oil market crash. It filed for bankruptcy this week to restructure its debt.

Some $140 billion of investment-grade energy debt is on the edge of junk status. Bond traders are pricing much of this debt at 60 or 70 cents on the dollar – in other words, at risk of defaulting. S&P Global has announced that it’s reviewing the entire oil exploration and production sector for downgrades. Such downgrades would increase the cost of debt for companies who are already struggling with crashing oil prices.

The crumbling U.S. economy and the government’s response begs the question of the nine year bull market in the U.S. dollar is coming to an end? I think the odds favour this happening.

In crises, the USD has always acted as a safe haven currency. And this time is no different. This is because most debt around the world is still denominated in USDs, which means USDs are sought after when liquidity tightens globally.

Where this crisis is different is in the scale of the American response via:

1) Opening so-called swap lines to foreign governments. In effect, this means countries outside the U.S. getting their hands on freshly minted dollars to help pay USD-denominated debts.

2) The U.S. Federal Reserve buying US$125bn in bonds per day through an open-ended quantitative easing program.

3) Lowering interest rates to near zero.

The Fed may ending up printing up to US$5tn worth of dollars this year, equivalent to 20% of GDP. That compares to Europe at less than half that amount on a GDP basis, and Asia at less than one-third. This kind of printing by the U.S. should be enough to see a significant dollar depreciation.

Other factors may see to it, too. Lower interest rates also make the U.S. a less attractive destination for investors. Don’t be surprised if rates move even lower in America, perhaps into negative territory.

Any U.S. dollar bear market is unlikely to start right away. It will probably only begin once economic recovery gathers steam and financial conditions loosen. If a bear market does happen, it should be a lengthy one, with average dollar up and down cycles lasting 6-10 years.

A U.S. dollar bear market would have huge ramifications. It would make U.S. assets and stock markets less attractive to global capital, reversing a trend of the past decade. It would also be a tailwind for commodity-producing nations as commodity prices usually move inversely to the U.S. dollar.

That’s obviously good news for Australia. Combined with a resurgent Asia driving demand for our exports (albeit tourism and education will take longer to rebound), this should be enough to offset weaker domestic consumption in the short-to-medium term.

James Gruber is a businessman and writer. He authors a blog on Australian business issues: Money, Mobs & Moguls.

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