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Global Economy: “When Elephants Fight, The Grass Suffers”

Australia, Business, China, Company Strategy, Economics, Japan, Oil & Gas, Singapore, US
By John Richardson on 04-Feb-2015

HERE are some very disturbing statistics:

  • Over the last five years, US oil and gas companies have issued bonds and taken out loans that are together worth $1.2 trillion, according to data from Uneven Match - Elephants of CoimbatoreDealogic. This has created at least 200,000 jobs in oil and gas companies in the States, according to the US Bureau of Labor Statistics.
  • To give you an idea of the magnitude of this debt, the size of the Australian economy is estimated at $1 trillion.
  • Talking about Australia again, no less than one Australian dollar in every five Australian dollars of export revenues are earned from one single product – iron ore. What makes Australia even more vulnerable is that only one country drives global iron ore demand – and that country is, of course, China.

What does this further illustrate? It once again illustrates that US quantitative easing (QE) policies have been nothing short of an economic disaster for the world.

Overinvestment in energy in the US is one of the results of QE. The Federal Reserve’s decision to print vast quantities of money encouraged the speculation in oil which drove prices to its recent highs. This was despite the long-standing evidence that oil prices were not justified by supply and demand fundamentals.

As QE is being wound back, this tide of liquidity is retreating and the US dollar has become the new “store of value”, or rather, as events further unfold later this year, it will become one of the few havens in a storm.

The greenback is up by over 18.8% over the last nine months. Over the next few months, I suspect the US dollar will strengthen even further.

A stronger dollar means cheaper oil, as does the realisation that crude supply is now well in excess of real demand. Despite this week’s price rallies, I can only see crude falling again.

This will result in an end to the US economic recovery, as it becomes apparent that it was largely based on new oil and gas jobs. Energy is the new “sub-prime”.  Many of those 200,000 new jobs will therefore go.

Meanwhile, at the same time as US QE is being wound back, China is reducing its central bank stimulus. This is a much bigger deal for the world economy – and is another factor behind weaker oil and the broader sell-off in commodities.

Australia has  been left in a terrible bind because, like the US dollar, its currency has long been used as a “store of value” by investors. Its high interest rates and the promise of acquiring triple-A rated bonds have ensured a steady inflow of capital for many years.

This has left the Australian dollar overvalued. Further upward pressure on Australia’s currency has been exerted by  recent interest rate cuts in Canada, Singapore, and Turkey  – and by the EU’s misguided decision to launch QE.

Australian policymakers hope that if the Aussie dollar is driven-down in value, this  will provide compensation for huge overinvestment in iron ore, coal and other commodities that will, again, lead to lots more  job losses. This explains why the Reserve Bank of Australia decided to lower  interest rates yesterday.

The trouble is that this has now become a global race to the bottom.

“We are in the midst of an age of competitive devaluation and beggar-thy-neighbour policy. When elephants fight the grass suffers,” said Raghuram Rajan, deputy governor of the Reserve Bank of India, yesterday.

These policies will do nothing to support sustainable growth, but will instead merely make global deflation worse.

One day, hopefully, though, a new consensus will emerge as policymakers across the world recognise this: You can print money, but you cannot print babies.