Watch the Big Mac index and China

Given the uncertainties about rising oil prices, the impact of cut backs in new housing subsidies, the wind down of Gillard’s school halls and Rudd’s roofing follies, and the removal of small business temporary investment credits, it is not surprising that there are contradictory trends for the rest of this year.

It is interesting to note that business confidence is rising with Westpac and the Australian Chamber of Commerce reporting that conditions have exceeded expectation since the start of the year. At the same time Gary Morgan’s weekly consumer confidence survey shows that consumers are not so sure in the light of the Glenn Steven’s policy to curb inflationary pressures triggered by China’s steady growth and volatility.

It is also worth noting that ACCI economics director, Greg Evans is concerned about the difficulties firms are facing in getting finance.

“Despite the more positive headline results, we still consider there needs to be caution concerning a further tightening of monetary policy,” Evans says, urging the RBA to leave monetary policy unchanged for an extended period in the light of the lack of new orders “at this stage”.

Australian business has been cushioned by the Rudd/Swann financial packages and the massive Chinese stimulus packages that have kept both economies growing while the rest of the world continues its very sluggish recovery. As more of the central bankers begin to hear Barnaby Joyce’s debt dirge, the key is to watch the Big Mac index for signs of change in the relationship between China’s yuan and the US dollar.

According to The Economist recent renewed American calls for China to revalue its currency have so far fallen on deaf ears. China has rejected accusations that America’s huge trade deficit with is caused largely by an artificially weak yuan, which has been pegged to the dollar since July 2008. The Economist is out with a correction to their famous Big Mac index.

The Economist tracks the price of a Big Mac in various countries against its price in dollars, suggesting an over or under-valued relationship with the dollar. The yuan is unquestionably undervalued and the Aussie dollar continues to rise because it is seen as a haven for smart hedge investors who expect the RBA to continue to push interest rates up to curb domestic inflation.

According to the Big Mac index, the Norwegian krone, Canadian and Australian dollar and the euro are significantly overvalued and the Chinese yuan is significantly undervalued below its fair-value with the dollar along with a number of tiger economies in South East Asia. The Big Mac index, based on the theory of purchasing-power parity, in which exchange rates should see the price of a basket of goods across countries, suggests that the yuan is 49% below its fair-value benchmark with the dollar.

As readers of this blog will have noted, the rate of recovery appears to have stalled and is now showing a pattern that is broadening out expectations for the coming year. Consumer Confidence has fallen for the second consecutive week (down 2.7pts to 125.4) as Australians continue to worry about their personal financial situations. Now only 27% (down 5%) of Australians say their family is “better off financially” than a year ago compared to 30% (up 3%) that say their family is “worse off financially”.

Gary Morgan says: “The continuing talk by the Reserve Bank that it will make further interest rate increases in the months ahead to return interest rates to what it calls a ‘normal’ level is likely responsible for the drops in Consumer Confidence over the last two weeks — the RBA raised interest rates by 0.25% on March 3, 2010 to 4%. Despite these worries and this week’s fall, Consumer Confidence remains 31.9pts higher than a year ago — March 14/15, 2009, at the height of the GFC — a very strong year-over-year recovery.”

Smart companies will continue to wait out the RBA’s leading edge decisions to raise interest rates in this country to “normal” levels, the Government’s reluctance to release the Henry Report that is sending waves of angst to the top end of town and decisions that are about to be made in China to jump all over inflationary pressures. It is time to watch the Big Mac index to see how China reacts to US demands that it appreciate its currency, and how the US consumer reacts to rising house prices and the Fed’s plans to slow the rate of stimulus to domestic spending as the FHA raises the barriers to new housing entrants.

Noted China watcher, Alan Carroll says that there is no consensus on whether China’s economy is already overheating and inflationary pressures are building quickly but advises smart companies to watch the decisions being taken there. Alan says that easy credit has been the main factor in China’s economic recovery and it is important to recognise that their banks lent over 1.3 million yuan in January alone and a fifth of the national target of 7.5 million yuan for 2010. Only a third of China’s economy remains directly controlled through state owned enterprises (SOEs), but they still get more than 80% of state sector’s business loans and assistance in making long-term overseas investments.

The next few months will be a time for export oriented smart companies to cut costs and address a longer term strategy to build stronger links with countries that have a proven underperforming currency in the South East Asian region, rather than be concerned about the barrier to business represented by speculators in the Aussie dollar. Watch for more big investments in Australian commodities and resource stocks and hedge funds betting on the RBA continuing to raise interest rates.

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Dr Colin Benjamin is an entrepreneurship and strategic thinking consultant at Marshall Place Associates which offers a range of strategic thinking tools that open up a universe of new possibilities for individuals and organisations committed to applying the processes of innovation, creativity and entrepreneurship.

Email dr.colinbenjamin@marshallplace.com.au
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