Wednesday, February 17, 2010

Conundrums in the Australian economy

The release of the minutes of the Reserve Bank Board monetary policy meeting of 2 February 2010 contained no real surprises.

In terms of the economic outlook, the global economy was strengthening, if with some downside risks; underling Australian inflation was declining; while the medium term outlook for the Australian economy was good, the immediate picture was still mixed. In these circumstances, the Board felt under no immediate pressure to shift the official cash rate.

While the minutes are interesting and provide a useful summary of the current economic position, the 16 February speech by the Bank's Guy Debelle (Assistant Governor (Financial Markets)) is far more interesting.

In that speech Guy Debelle discusses the unfolding of the global financial crisis and the Bank's response. Certainly the Bank had a far easier time of it than its overseas counterparts simply because the crisis was less here. However, it also appears that the Bank's operating mechanisms - its experience, policies and processes - proved to be more robust. Crisis it may have been, but it could still be managed.

I found the description quite fascinating.

Looking to the longer term, Debelle made a clear distinction between the financial markets in the major Northern Hemisphere economies and those in Asia. To his mind, To his mind, there was still some distance to go before the effects of the asset bubble (my words) were fully unwound. This was likely to affect the US financial system outside the major banks. By contrast, Asian was expanding faster, while bank balance sheets were better there.

This brings me to the first conundrum in the Australian economy, China.

Reading Michael Pettis, I get the strong impression that Chinese banks are by no means as secure as Guy Debelle's analysis would suggest. The huge expansion in bank credit has been associated with something of an asset bubble, especially in real estate much loved by so many Chinese. The numbers I have seen quoted are staggering.

I just don't feel confident about China.

The second conundrum lies in the Australian data itself. Some economic data is good, some not. What does seem clear, but subject to China, is that a two stream economy is re-emerging again.

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