Davos and world trade in the spotlight
Trump's desire for trade agreements to be "fair and reciprocal" will mean a race to the bottom in the inputs that determine a country's competitive advantage.
Your Money Weekly
President Trump wants trade agreements to be "fair and reciprocal". This will mean greater emphasis on the competitive advantages of individual countries. It will mean a race to the bottom in the inputs that determine competitive advantage.
Manipulation on a scale yet experienced is likely to follow. The race to the bottom has already started in corporate taxes, incorporating investment incentives, sucking revenue from government coffers. The expectant offset being greater activity, higher profits and wages and therefore higher tax revenue in the longer term. If it was just that simple.
One race to the bottom that will not be held will be the wage rate race. There will always be those undeveloped countries where wage rates are significantly below those of developed nations. Politicians in the developed world, beholden to their constituents, strive to increase the standard of living with an environment supportive of higher wage levels and wages growth.
Low wages and higher productivity will continue to be an advantage of the undeveloped world. In the developed economies, higher wages and marginal growth in productivity in tightening labour markets will need to be offset by lower taxes and incentives. But these are one-offs.
When all competitors have done their best to maximise their competitive advantage, the final arbiter will be currency. A race to the bottom here could leave world trade in upheaval and possibly be the final nail. President Trump has already accused China of currency manipulation.
But aren't lower corporate taxes and associated investment tax incentives a form of manipulation? Should it come down to a currency arm wrestle, those countries with the largest foreign reserves have the upper hand.
The most recent information available reveals the following Top 10 rankings as at December 2017.
Exhibit 1: Foreign Reserves (excluding gold)
Source: Trading Economics
The US is well down the list at US$123 billion, below Singapore, Poland, Israel, Czech Republic, Mexico (embarrassing?), Indonesia, Thailand and the United Kingdom. Be careful what you wish for Mr President. This is a marathon not a sprint, although after another three years Donald Trump will not care, as I don't believe he will run again.
The naivety of Secretary of the Treasury Steven Mnuchin was there for all to see at Davos. His "weak dollar" scenario was a reminder that investment bankers are generally not too well-versed in economics. The BYJAR (Bugger You Jack I'm Alright) principle is not a sound long-term strategy in the global village.
Despite the unfunded tax package, the US is unlikely to become a net exporter as result of a lower currency. The US trade deficit may be trimmed but not expunged. The expectation there would be no retaliation is alarming.
Mnuchin has already ticked off on an unfunded stimulatory tax package which drives the deficit higher and makes the Federal Reserve's job in normalising monetary policy much more difficult. The government will sell US$66 billion of long-term bonds in the March quarter, the first boost in borrowing since 2009.
Prolonged currency weakness could also weaken the US$'s reserve currency status, perhaps providing an opening for the Chinese in the longer term. That would be a turn up for the books.
While President Trump wants a fair and reciprocal playing field and will no longer ignore unfair economic practices including industrial subsidies, he should look in his own backyard at the meaningful subsidies provided to protect the US farm sector.
Australian farmers have battled for decades against unfair US policies and a far from level playing field, where fair and reciprocal have gone missing.
Is US and global growth convincing?
US 4Q17 GDP growth of 2.6 per cent was below consensus expectations of 3 per cent. Both inventories (-0.7 per cent) and net exports (-1.1 per cent) leaned while consumption (+3.8 per cent) and business fixed investment (+6.8 per cent) lifted.
The savings rate fell to a 12-year low at 2.6 per cent in 4Q and the consumer credit card took a hammering and must be repaid. Hurricane rebuild also helped.
Growth for 2017 will come in closer to 2.5 per cent than 3 per cent, with expectations for 2018 also in a 2.5 per cent-2.8 per cent range. The International Monetary Fund (IMF) forecasts global growth of 3.9 per cent for both 2018 and 2019 after 3.7 per cent in 2017.
The growth in 2017 and forecasts for the ensuing years follows stimulatory policies of developed nations exceeding US$15 trillion and belatedly the US threw in the kitchen sink with unfunded fiscal policies, adding to the already massive leverage in the global financial system.
Given the strength and duration of the remedial treatment delivered to the global economy, I believe the response from the patient has been mediocre. The IMF suggests "risks to the global growth forecast appear broadly balanced in the near term but remain skewed to the downside over the medium term".
Continuing, the IMF says, "On the upside, the cyclical rebound could prove stronger in the near term as the pickup in activity and easier financial conditions reinforce each other. On the downside, rich asset valuations and very compressed term premiums raise the possibility of a financial market correction, which could dampen growth and confidence".
"Inward-looking policies, geopolitical tensions, and political uncertainty in some countries also pose downside risks."
Short-sighted equity markets embraced the data, blinded by greed. CNBC's Mad Money host Jim Cramer makes a classic observation of investor behaviour in frothy markets with the comment: "Bulls make money; bears make money; pigs get slaughtered." I suggest, become squirrel-like.
Opportunity foregone--Yellen's final coo-coo
The Federal Open Market Committee (FOMC) missed an opportunity to get closer to a surging 10-year bond yield by leaving the federal funds rate unchanged at Janet Yellen's last meeting. It sets up Jerome Powell's maiden FOMC meeting as chairman in March to deliver the first hike for 2018. He will need to be busier than markets currently think.
Perhaps the Fed is far from convinced about the health of the US economic recovery. While waiting for inflation to reach the magical 2 per cent, the horse (the bond yield) has bolted and inaction, the capture made more difficult. The FOMC voting rotation sees three doves vacate the FOMC and two hawks arrive.
As James (Jes) Staley, CEO Barclays Plc, proffers: "We've got a monetary policy that still seems like it is in the remnants of a Depression era."
Over the past eight years investors have gorged courtesy of the Bernanke Put and the cooing of Janet Yellen.
Private health insurance increase adds to household burden
We should all celebrate and get down on bended knee to thank everyone concerned with the 3.95 per cent average increase in private healthcare insurance premiums for the year starting 1 April 2018. Be jubilant and grateful, despite the increase being basically twice the rate of official inflation and private sector wages growth.
The increase underpins returns on equity of over 25 per cent for both listed health insurers, Medibank Private (ASX: MPL) and NIB Holdings (ASX: NHF). I know who the April fools are, and they are not the health insurers.
Health minister Greg Hunt trumpets this is the lowest increase in years following increases of 6.18 per cent, 5.59 per cent and 4.84 per cent in 2015, 2016 and 2017 respectively. Is it any wonder affordability is the main reason for a decline in private health insurance participation? In four years premiums are up 22 per cent and benefits have not kept pace.
Legislated premium increases, rather than those based on competition, have provided a "free kick" for health insurers for years, with returns on equity now sitting above a generous 25 per cent. These increases are designed to ensure health insurers are profitable and stay in business to provide private health insurance for the maximum number of policyholders who can afford it.
The less people privately insured, the more who spill over into the overstretched public system, pushing the health component in the government's burgeoning welfare budget higher.
The government guarantee of increases in annual premiums underwrites the longevity of returns on invested capital exceeding the weighted average cost of capital of listed insurers and hence their economic moats. Governments see this as a cheaper alternative to the massive investment required to adequately service the entire population in the public hospital sector.
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Peter Warnes is Morningstar's head of equities research. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.
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