One of the most quoted adages in economics is: “If something cannot go on forever, it will stop.” 1 1 Close Herbert Stein: "A Symposium on the 40th Anniversary of the Joint Economic Committee, Hearings Before the Joint Economic Committee, Congress of the United States, Ninety-Ninth Congress, First Session; Panel Discussion: The Macroeconomics of Growth, Full Employment, and Price Stability," January 16, 1976. It is called … anyone … anyone … “Stein’s Law” after American economist Herbert Stein who was perhaps better known as the father of actor and game show host Ben Stein. 2 2 Close Herbert Stein was also Chair of the Council of Economic Advisors during the Nixon Administration. Stein’s Law is often invoked to warn people that economic trends can be more fragile than they appear. Seemingly stable growth may hide unsustainable debt or spending levels, which at some point will reverse. We’ve seen plenty of examples of Stein’s Law in practice: Bubbles have inflated and burst, economies have grown and shrunk. However, despite his law’s enduring relevance and popularity, it’s possible that Dr. Stein hadn’t anticipated the Australian economy. Australia, sometimes known as the “wonder down-under” in market circles, has defied any economic principle that implies mean reversion. Its last recession came in 1990-1991, which was so long ago that you probably don’t remember that it was the year in which Bodhi traveled to Bells Beach in Victoria to surf the 50-year storm. 3 3 Close It’s been so long since the last recession that it’s impossible to remember any of the pop-culture references from that time. Back off Warchild, seriously. Australia has enjoyed positive GDP every year since – it even managed to grow 2.63% in 2008 when most other countries’ economies contracted. 4 4 Close Their economic motto might as well be: “100% Pure Adrenaline.” Sources: Bloomberg, Australian Bureau of Statistics.
Housing has been particularly puzzling. As in many other countries, housing prices in Australia rose sharply in the early 2000s. They fell a bit during the global financial crisis, but unlike many others, the decline was mild and prices quickly resumed their ascent. 5 5 Close Other countries such as Canada had a similar pattern. U.S. and Spain, not as much. These increases came despite falling affordability and signs that some borrowers were stretched. A few years ago, some economists postulated that Australia had avoided the housing collapse because its cities were able to build out into the desert. This prevented small clustered areas from being bid up too much. 6 6 Close One famous example of this phenomenon was in Tokyo real estate in the late 1980s, which became very expensive due to its scarcity. There are counterexamples such as cities in the Southwestern United States which saw some price volatility despite having lots of room to build. However, as prices continued to rise, this explanation became less credible.
Another peculiar facet to the Australian economy had been the persistence of its current account deficit. Australia has run a current account deficit every year since the mid-1970s. At times, this deficit has exceeded 6% of GDP. 7 7 Close Sources: Bloomberg, Australian Bureau of Statistics. An astute investor might think that this would result in currency depreciation, which has at times happened. But the Australian dollar has also had some large rallies as well. One reason for the currency’s resiliency had been its persistently high interest rates – at least relative to other developed countries. It was a popular destination for foreign investment.
One of the areas that attracted foreign investment was the real estate sector, but it was not the only, or even the largest, magnet for dollars and yuan. Australia has an enormous mining industry, especially in iron. As China grew rapidly over the past twenty years, it poured billions of dollars into Australia to extract the materials it needed for its industrial base. Australia was able to finance its current account, at least partly, with these inflows, which proved to be far more consistent than current account skeptics had thought.
Like many other businesses, resource extraction has a lifecycle of investment and production. Some economists forecasted that after investment peaked, Australia would have trouble financing its current account and the inevitable adjustment would cause economic problems. 8 8 Close Note that even after investment slows, production and demand for Australian metals can remain high. There just may not be as much need for big, new projects. It made sense: if foreign investment was driving the economy and the real estate market, then any slowdown in flows would put an end to the economy’s winning streak. But as we’ve learned many times, when it comes to economics even the best logic can prove to be wrong. In the past few years, the current account deficit has narrowed a bit, but there has been no recession.
Concerns remain. Rising house prices and debt levels have drawn the attention of authorities. Perhaps in an effort to enforce Stein’s Law, the Reserve Bank of Australia along with two Australian regulatory agencies with acronyms beginning with the letter “A” worked on instituting so-called macro-prudential measures to cut back on what they perceived as excessive borrowing in the real estate sector. 9 9 Close APRA and ASIC are tasked with ensuring financial stability in Australia. In general, central banks seem to be moving in the direction of using or encouraging regulatory action to fight alleged bubbles instead of using tighter monetary policy. Macro-pru is very trendy right now. The Australian Prudential Regulation Authority (APRA) ultimately announced a cap on interest-only loans and strengthened bank lending guidelines. These measures were successful in slowing activity in the housing market, maybe a little too successful. 10 10 Close It is also possible that the housing market has weakened for other reasons, but that seems a bit too coincidental. As of the third quarter the house price index was down almost 2% YoY, and there are signs the real estate market may cool further. 11 11 Close Australia House Prices for Established Homes are down -1.9% YoY as of the end of Q3 2018. Sources: Bloomberg, Australian Bureau of Statistics. Building approvals have fallen by more than 30% YoY. 12 12 Close Australia Building Approvals are down -32.8% YoY as of November 2018. Sources: Bloomberg, Australian Bureau of Statistics. The data has gotten regulators so concerned that they are starting to reverse some of the measures. There is some speculation that the RBA may cut rates as well, though its members have not given clear guidance.
Australian GDP has remained positive (2.8% YoY as of Q3), if a bit below consensus forecasts. 13 13 Close Australia’s Q3 2018 GDP of 2.8% YoY was below Bloomberg’s economist survey median forecasts of 3.3%. Sources: Bloomberg, Australian Bureau of Statistics. Brisk population growth, strong consumer spending and continued demand for Australian metals in China have helped keep the economy afloat despite the slowdown in housing and mining investment. So Australia remains in violation of Stein’s Law. 14 14 Close Laws in economics are not always strictly enforced. They really should be called guidelines. Perhaps Dr. Stein chose the word “forever,” because it makes the statement impossible to disprove. Still, Australia has shown that growth can go on for what seems like forever and not stop. 15 15 Close Just like Ben Stein’s lecture in Ferris Bueller’s Day Off. It also seems like we are finally getting closer to seeing the point where it does stop. The RBA probably has enough room to engineer one more soft landing if consumer spending and external demand slows as many forecast they will. Two would probably break some other “law” of economics.
What We Are Watching
FOMC Meeting (Wednesday) The Fed raised rates four times in 2018, most recently at its meeting in December. While the post-meeting statement, economic projections, and press conference signaled that the committee expected to continue raising rates in 2019, recent communications have been more equivocal. For example, a recent speech from Vice Chair Richard Clarida acknowledged that “developments in the global economy and financial markets represent crosswinds to the U.S. economy,” 16 16 Close Vice Chairman Richard H. Clarida: “Monetary Policy Outlook for 2019,” 1/10/19. and Chair Powell commented in a panel discussion on January 4th that “[the committee] will be patient as we watch to see how the economy evolves.” 17 17 Close Washington Post: “Powell says Fed will be ‘patient’ on rate hikes and that he won’t resign if Trump asks,” 1/4/19. The Fed’s shift towards a more cautious and data-dependent approach may have contributed to a rebound in market sentiment over the last few weeks. The upcoming FOMC meeting, which will feature a post-meeting press conference from Chair Powell, 18 18 Close Press conferences will accompany all eight FOMC meetings this year, compared to the quarterly press conference schedule of previous years. will provide an opportunity for policymakers to communicate their current thinking to market participants. With many major data releases delayed due to the government shutdown, Chair Powell will likely signal a wait-and-see approach to policy until the committee is in a better position to gauge the strength of the U.S. expansion.
China Manufacturing PMIs (CFLP Thursday, Caixin/Markit Friday) Chinese Manufacturing PMIs for January will be released on Thursday (Chinese Federation of Logistics and Purchases PMI) and Friday (Caixin/Markit PMI). The releases will come out amid a noticeable slowdown in the global manufacturing cycle, as recent surveys have suggested that weakness in European and Chinese data may now be spilling over to the U.S. Trade tensions between China and the U.S., as well as regulatory changes to curb non-bank lending, have weighed on Chinese growth and sentiment, and both Chinese manufacturing PMIs fell into contractionary territory in December. In response to the slowdown, Chinese authorities have implemented measures to ease credit conditions, but the impact remains to be seen. January survey data may offer a glimpse at initial effects of these measures on sentiment.
U.S. ISM Manufacturing PMI (Friday) Falling from 59.3 in November to 54.1 in December, the most recent reading of the ISM Manufacturing PMI suggested a meaningful deceleration in U.S. growth. The drivers of the weaker reading were a sharp fall in the readings for new orders, backlog of orders and production. The January reading will be watched closely to see if the weaker growth trend continues. Thus far, regional surveys for January have been mixed, giving no clear indication of whether conditions have improved or deteriorated in recent weeks. While there could be some noise in this report due to the government shutdown, it will be one of the first indications of where growth stands to start the new year. A downside surprise to the January data would likely be viewed as concerning to growth prospects and could have an outsized impact on market sentiment, which has only partially recovered from the weakness seen in December.