ECONOMIC UPDATE (2022) with Professor Sarath Delpachitra, Chairman AIOFP

You may recall I shared two previous updates including a subsequent presentation at AIOFP conference held in Hobart. I am also aware John Hewson, former Liberal Party leader also shared some similar concerns and predictions at the same conference.

In my presentation I expressed my real concerns of the experimenting with monetary and fiscal policies at a time the whole world was facing the challenges of Covin-19. The Cheque Book Economics/Quantitative Easing/Fiscal Stimulus and failure of RBA’s monetary policy during low interest rate experiments which I highlighted during my presentations in both Adelaide and Hobart.

In my first update I gave some information on the pandemic and an analysis based on epidemiology and biostatistics. The key message therein was that there was a delay in making strategic preparations by the Australian government for the arrival of COVID19 despite the fact that they were well aware that country could not shield itself from its early arrival in the absence of an immediate strict closing of the nation’s borders, regardless of the objections by severely affected industries such as higher education and tourism. The delay in procuring millions of testing kits, health-care equipment such as ventilators and personal protective equipment (PPE) for health-care workers are a few examples. The key transformation here was that the government changed its position following health advice to political advice resulting prolong covid period to current levels and recording third highest death rates that has not seen in most affected counties such as Vietnam.

The second part of the update provided an economic analysis of the Commonwealth Government’s efforts in reducing the impact on the economy, based on the economic outlook and some key information from the financial system. In comparison to the global financial markets’ responses to the GFC, the impact of COVID19 was still less than that experienced during the GFC. This is mainly because the impact of the GFC on the global financial system was direct while the impact of COVID19 was indirect.  The full impact of COVID19 is now clear with global impacts and national impacts are more widespread. These impacts were compounded by the war between Russia and Ukraine.

In this report I will update on the key topics that I covered in the previous report.

The global growth outlook: Prior to COVID19, the global economic growth measured by GDP was expected to be sluggish. The World Bank’s then forecasted, global growth was set to rise by 2.5% this year, a small uptick from 2.4% in 2019, as trade and investment gradually improved. (World Bank’s semi-annual Global Economic Prospects forecasts). Growth in advanced economies was expected to slow to 1.4% from 1.6%, mainly reflecting lingering weakness in manufacturing. Emerging market and developing economies were expected see growth accelerate to 4.1% from 3.5% previously with China and India contributing 6.6 to 7.5 % growth. The pickup was anticipated to come largely from a small number of large emerging economies, such as China and India, shaking off economic doldrums or stabilizing after recession or turbulence.  For many other economies, growth was expected to decelerate as exports and investment remained weak.

As predicted, the advent of COVID19 made these forecasts largely inaccurate with major contributors to global economic growth, China, India and other developing Asian nations have been impacted. My basic forecasts suggested that these economies may not be able to achieve even half of their forecasted economic growth over the remaining quarters of 2020. With European countries and the US significantly impacted, global economic growth was expected to be poor and probably negative.

What has been happening in the global oil and gas industry also mentioned in my previous report in early 2020. Here too, the oil and gas industry gave not only a double whammy effect on the global economy but also compounded further with Russia and Ukraine war. The proposal to introduce an import tariff by Trump is a clear sign of the impact felt by the oil and gas related industries in the US, but it has proved ineffective. The impacts of the delay in Australia’s taking appropriate action to reduce the impact on related industries and consumers are now obvious.

The results of Open Cheque Book philosophy or quantitative easing is also now obvious. US has begun monetary tightening and it has already shown resulting spillover effects on the other countries.  In particular, the US Federal Reserve’s aggressive tightening could erode financial stability of most counties by creating capital outflows and exchange rate fluctuations. The Fed has raised interest rates by 150 basis points already this year. Yet, it is expected to announce another rate hike of 75 basis points shortly week to tame inflation, and the European Central Bank lifted interest rates by half a percentage point on Thursday for the first time in 11 years. All the other countries follow suit except China. Australia too had no option but to follow suit.

Inflation: Global inflation also show some contrasting evidence. Interestingly, changes in the US’ inflation rate from January 1965 to June 2022. Inflation in the US surged to a fresh 41-year high in June (8.6% compared little over 5% in Australia with is expected reach 7% by the end of the year) despite a series of interest rate increases (compared to Great Inflation of 1980). This overall impact on the world economy means drop in industrial output, investment and consumer spending. Most foreign exchange markets in other countries were not capable of absorbing US pressure on investors with some developing countries such as Sri Lanka have been hardest hit.   This information suggests that those who believe in fundamentals-based analysts and Chart-based analysts to come together and compare 1980 Great Inflation and current crisis baring in mind that the world is yet to bring an effective controlling mechanism to reduce the mutation speed of corona virus (compared to Spanish Flu).

Virtual currency markets: The global cryptocurrency market was projected to grow from $910.3 million in 2021 to $1,902.5 million in 2028 and this too has now become just a dream. The most popular Bitcoin prices fell nearly 38% in June, finishing the month less than $20,000. Ethereum prices dropped more than 42% month over month to less than $1,100 as the network prepares to transition from a proof of work consensus mechanism to a more energy-friendly proof of stake model later this year. ETH is now down more than 50% year to date, while BTC is down 60% over the same period. Popular altcoins Avalanche (AVAX), Polkadot (DOT), and Binance Coin (BNB) were all down by more than 28% month-over-month in June.

The market was plague by misuse of social media platforms, patented Libra digital currency by terrorist financiers and money launderers. As predicted at the Adelaide AIOFP conference there is no adverse time to see this happened in 2022.

Superannuation and savings: For the first time since the global financial crisis (2008) most Australians are seeing their super savings have shrunk. Among large number of funds (may be inclusive of SMSF), only three balanced funds managed to break into the positive returns this year: namely Hostplus, QANTAS Super Gateway and Christian Super. However, the highest yield reported to be just around 1.6% return. The median figure for the rest of the funds sits around a 3.1 per cent decline.

Potential Structural adjustments:   As predicted, the shifts in sectorial composition in response to COVOD19 has happened. It has created structural adjustment in those economies with prominence in primary industries and we may see a quite different in the way of thinking in the short to medium terms. Most countries including Australia are yet to focus on new industry plans with less reliance of the modern theories of comparative advantage. Furthermore, sectors such as agriculture and lives stock industries become prominent and counties with high proportion of agriculture and livestock related industries will show more structural adjustments. With Australia producing approximately three times its domestic demand for agriculture and livestock related products, the country is now in a in a relatively strongest position to absorb the impact on its food supply drive exports but the impact on Australian consumers is obvious. Unfortunately, the same cannot be said for other industries in Australia where successive government policies have ensured some key strategic industries like manufacturing have been exported. (Modern manufacturing plants can often be re-tooled quickly to produce vitally needed goods which otherwise would all have to be imported and may indeed not be available due to high global demand.

Cheque Book Economics/Quantitative Easing/Fiscal Stimulus: Unlike in the case of case of the GFC, we can’t predict that many countries in the world could come to the rescue (ie BRICSA: Brazil, Russia, India, China and South Africa) with debt funding because the impact of COVID19 has been universal and there is a universality in the government responses. This means most governments need to raise funds while only few countries could raise these debts with sound asset backing (ie US and China).

In the case of Australia, the funds allocated in response to COVID19 exceed AUD $583 billion (by 2020) at federal level with state-level debts yet to be counted. All signs are that new Labor Government Will continue to provide Covid-19 assistance. The important question was how such massive funding is magically created in an economy with the majority of its income generated by taxation and this is continued to be a question.  Furthermore, the country, having for decades followed a neo-liberal path of small government and minimisation of fiscal solutions to economic management, now has to follow the classical Keynesian approach of government borrowing from savers whether they be national or international. Undoubtedly, the government has no other options except to use borrowed funds to help rescue the economy.

Pressure on the Financial System: In terms of a response to COVID19’s impacts, the Australian Government policy has been quite convincing until the end of 2021. However, how long it can sustain such a response is questionable with governments universally raising debts and so far, ignoring theoretical “crowding out” was questioned. The private-sector response of capitalizing interest payments to provide relief to borrowers who have lost their jobs or have been stood down is appropriate in the short term of six months or so, but we now know it didn’t last long. The prolonged occurrence of COVID19 has now put pressure not only on the bond market, the credit ratings of many governments, but also on the banking systems. This is something commentators may have underestimated. Given most Australian’s are heavily relied on mortgages and the impact on may be clearly visible once their fixed mortgage interest rate periods are to be renewed.

Consumer response: The post COVID19 response may never be the same as before, if not, it may take quite some time for consumers to adjust themselves to the pre COVID19 behaviour.  It is also worth noting the long-term implication on COVID19 on grassroot-level economic units such as self-funded retirees, SMSFs, Mum and Dad investors, mortgaged householders and young workers and entrepreneurs locked in investment properties. The lessened ability to sell their properties on sluggish property markets may create runs on the banking systems in Australia and worldwide.

Fortunately, the impact of the above is still to be felt by the banking system in Australia, nor globally. However, at the current speed of COVID19’s spread and until governments are able to control the virus, the current financial market response to the COVID19 pandemic within the foreseeable future (ie at least for the next two years).

To AIOFP Advisory Community: In summary the advisory community will see a most challenging period that has not seen for the past 4 decades. However, there should be a settled period once winners and losers are absorbed the impacts even though the exact time period is unpredictable. I believe this would be the time for the advisor community to engage on investor education more aggressively. It is important remind that strong advice is needed not only at when the markets are growing but also at a time when markets are struggling to sustain.

The most integral part of this advice must include the basic accounting equation that has been sustained many decades without change:

Assets (A) = Liabilities (L) + Opening equity (E) + Income (I) – Expenditure (I)

In an environment where A is falling, liabilities on the rise and real income falling only manageable option is to cut expenditure at the most difficult current circumstances.

I sincerely believe selling of long-term investment assets is the solution to the problem. As we seen before markets should get adjusted and return to a new equilibrium and investors should look for new buying opportunities than liquidation under rising inflationary environment. As you may have seen in the media, regardless of what you think its value is, there’s a certain truth to the old saying that something is only worth what someone else is prepared to pay and I believe this will still be the case. Surely the role of advisor community is not to provide advice on short-term investment.

Government: Since Covid -19 began, the Australian Government too an aggressive approach against China, one of its major trading partners. This has affected significantly export industries to China and in particular the education industry. This trade has now been diverted the West including Europe. The new government should make a concerted effort reestablish those trading relationship instead of warmongering and speculation as it was done against Indonesia few decades ago. What we need from government at critical time a head is to bring policies to promote export led industries in China and Japan.

Disclosure: Writer is a Professor of Finance and current Chairman of the Association of the Independently Owned Financial Professionals (AIOFP). However, the views expressed in this update are purely independent and do not reflect the views of AIOFP and not constitute giving financial advise. Readers should not make any decisions based purely on the predictions provided above. Contact 0414682629

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