Wednesday, March 02, 2011

People's Republic of Western Australia

TMM had a rough start to the morning after yesterday's Mad March Hare car crash in equities, with some pretty daft (or very smart, depending on which way you look at it...) comments coming out of the PM of New Zealand about rates. Suffice to say, if you elect an ex-FX salesperson/punter as PM make sure there is someone there to remind them that in their new position of public office no one is going to compensate them for their morning wrap blast – in fact, some might see it as crimping Central Bank independence and all that. We can only hope Bollard takes a page out of Voldemort’s book and do exactly what everyone isn’t expecting or do it at an unexpected time to make a point.

However, it is during these slower, more range bound periods in the market that TMM start to daydream or try to think slightly bigger picture and deeper thoughts. A few oddly disparate thoughts have been floating around lately:

1) Cost competitiveness in a lot of basic industries is coming down less to labor than access to cheap inputs. Look below at Chalco, that old chestnut of the TMM “equities with no long term futures list”: labor is maybe, maybe 12% of costs.

And flipping over to Maanshan Iron and Steel it is plain to see that COGS are mostly just raw materials of which wages make up very little, CNY 2.5bn of the roughly CNY 58.5bn of COGS. It’s hard to see just what edge China has in this business given it doesn’t have particularly cheap power prices or any high quality iron ore.

2) Everyone is talking about re-balancing of trade/capital accounts but developing nation claim that they are only a short way along in urbanizing and developing – as such, they should be allowed to take the piss in FX markets some more. Complaints typically cite lower GNP/GDP per capita in places like China to claim they are still middle income countries and arguably lower income countries in poorer areas inland.

3) Despite an enormous amount of noise about climate change no one wants to do anything about it until other countries get involved. Some unfortunate Australian politicians have now been getting death threats. Classy.

Well folks, TMM has the solution to all these problems: The People’s Republic of Western Australia. The transaction would work as such.

  1. China gives Australia a bunch of steel and aluminum plants for free and deposits them all around Broome and Port Headland.
  2. China gives the population of Sichuan province to Australia for free (alleviates population pressures, moves a labor surplus where it is needed).
  3. Australia gets a grip and goes nuts over uranium mining and nuclear power. 4. Guangdong Nuclear builds a 15 GW of nuclear power plants in North West Australia for a fee, perhaps around Port Headland.
  4. Population of Sichuan province works in the steel industry or mining. Air is fresher, wages way better.
  5. Australia sells China steel at a fixed ROE like a utility given that it has a lock on iron and power costs. Australia’s current account improves and becomes much more stable.
The benefits of this interventionist industrial policy are hard to get out in a single post:
  • China can raise interest rates because it doesn’t have to subsidize capital for heavy industries that don’t make an economic return and thus gets asset and real estate inflation under control.
  • Inflation volatility in China would go down as key input prices get locked in.
  • China could allow FX to appreciate because it doesn’t have to defend exports of a bunch of loser high cost producers in basic materials that do not actually employ that many people.
  • US trade complaints would drop off materially.
  • World carbon emissions would go through the floor as heavy industry moves from dirty lignite and high sulfur coal to nuclear.
But back to markets. After the past couple of day's rather punishing market moves, TMM limp to the sidelines to ponder which particular instrument of torture Mr T and the A-Team are likely to bring with them to tomorrow's ECB press conference.


Anonymous said...

Think you have a good a basic concept ,but I'd say you may be a couple of years too late and looking in the wrong direction.
Seems to me with unemployment being what it is in Europe and US particularly amongst younger age groups that those young people are already taking passports in hand and moving out to rediscover without handcuffs and leg irons what their forefathers found.

Little people from Sechuan can stay where they are ,they're already surplus to requirements.

Anonymous said...

ECB are notorious liars, even sometimes apparently believing their own lies and acting on them. But crazy enough to raise rates in the midst of the ongoing EZ banking/debt crisis?

Methinks markets have been snookered by these charlatans once again. Tightening at this juncture could set off a chain reaction leading to unrest in peripheral countries...

FX said...

ECB vs Game theory, goodluck.

Bob_in_MA said...

The answer to #1 is subsidized costs of capital. Michael Pettis has explained this in great detail.

It's one of the ironies of China's convoluted state-controlled economy: must have growth to create jobs; to maintain growth rate, ever greater amounts of capital investment is needed; all this subsidized capital investment favors capital over labor.

Leftback said...

There will be a lot more talk about tightening than there will be actual tightening. The ECB are World Jawboning Champions.

This morning, I am again concerned for the welfare of those ever-present and enthusiastic exponents of goldbuggery, and am wondering what unhappy accidents might befall my dearest friends among the commodity longs if their beloved Col. Ghaddafi were to experience an early demise.

Just looking at the other side, here, but a change in the state of play in Libya might lead to a reversal in crude that would spark a relief rally in the dollar and equities at the expense of bonds and PMs.

Anonymous said...

Thanks for the concern. I mean, we are a big $3 off the all-time high. It's only a flesh wound.

Charles Butler said...

Anon - much of the Muslim world coming apart at the seams and still can't make a new high? There's ample room for a second opinion here.

Anonymous said...


Charles, That all-time high was made two hours ago.

Leftback said...

The yield on gold still seems low. Relatively speaking. Especially for something that often involves leverage. That can sometimes impact investment decisions, especially on the way down.

Nah, couldn't possibly happen....

Anonymous said...

Of course it could happen, anything could happen. But that's why we have stops and risk management, right?

Charles Butler said...

OK. I'll pass it on up the line.

Anonymous said...

The yield on gold may be low,but isn't actually negative is it?
And I speak as someone who might usually see some merit in goverment bonds.

Anonymous said...

By way of response to that please don't quote me cpi as the benchmark as I do have ot live in the real world where real costs exist.

Leftback said...

Only a Central Banker would quote CPI as being anything to do with inflation. But the argument about govies versus inflation is rather different depending on where one is standing, isn't it?

As TMM have pointed out, those countries with strong wage inflation (India), too much liquidity (China), more vulnerable currencies (Vietnam) and smaller output gaps (UK), are in a different inflationary environment than countries where a QE of $0.6T, roughly equivalent to 4% of GDP, results in a 2.8% growth rate (US), revealing a persistent deflationary backdrop that is familiar to other veterans of unnatural CB interventions (Japan).

Everyone is always right about everything, except in regard to the timing. JGBs will blow up. Eventually. but that train is already 20 years late arriving. When it does, USTs are the new JGBs.

Anonymous said...

That's a worthy reply ,but let me put this to you.
Your argument stands or falls on whther or not the US in effect becomes the old Japan for goverment debt purposes ? that's what you appear to be saying.

Now let's think about this.Was Japan the holder of the worlds currency and able to expand there money supply in the way the US has?

Did Japanese attempts at the above result in any massive uplift to the prices of commodities in general and this global input costs?

Did Japanese attempts to reflate take place against the same global backcloth where every other major economies were simultaneously trying to reflate?
Therefore was the scale of reflation anything of the order we have seen at this point?

Did Japanese reflation occur when simultaneously when investment flows to China,India and swathes of Latin America and Asia were at record levels promoting growth and demand from popuylation heavy countries?

What should be obvious is I am pointing out that the simplistic equating of the US now with Japan over th last 20 years is full of problems.The two could be so far apart as to offer no real outlook on where the US goes from here and indeed I'd say that als applies to Japan. They may have been inflation flat with goverment debt yields to match for 20 years ,but that does not mean they will continue to be. In fact when something has been uniform for long enough we should know from market experience that the shock comes when that picture changes.

I don't necessarily disagree with you .I am however a lot less confident than you in the picture you paint and I certainly wouldn't be marrying my capital to that specific outcome.

Anonymous said...

Apologies for the lack of spellcheck !

Leftback said...

A cogent and clearly expounded set of counter-arguments. We certainly don't have to hurry this discussion, as by some models we will have at least twenty years to rehash it... all your points are valid, and this is obviously a unique situation. It's my best guess, and I'm not married to it.

Japan is more or less the only laboratory that we have to study the effects of ZIRP, and since I tend to be data driven I am heavily influenced by their experience, while integrating the obvious and not-so-obvious demographic similarities and differences into the picture.

One parallel that may well be critical to predicting the trajectory is a projected growth of US domestic savings (Boomers retiring and turning to the piggy bank after discovering states, cities and corporations have reneged on pension agreements) and an increased domestic share of the UST market (banks required to hold more Tier 1 capital).

After a while in Japan, domestic share of JGBs became self-sustaining, and in the US, another large scale equity crash on withdrawal of Fed support might well provide a lifetime's reinforcement for late re-entrants to the casino.

In the meantime there are zillions of amusing short term trades to put on. Bon chance!

Carry Trader said...

I for one welcome our new overlords.

Anonymous said...

In the red corner,
-state credit
-wage and price inflation
-overcapacity, excess fixed asset investment
-weak household sector consumption
-negative real rates
-a demographic rollover

In the blue corner,
-government monetization of debt?
-massive housing hangover/deflationary pressures
-expanding deficits, structural current account deficit, entitlement programs
-a wave of municipal bankruptcies?
-a demographic rollover

Anonymous said...

japan goes, if it does, because china did

Anonymous said...

"It’s hard to see just what edge China has in this business given it doesn’t have particularly cheap power prices or any high quality iron ore."

It has the overwhelming advantage that it can force the primary marginal consumers to Buy Chinese no matter what, without any explicit tariff.