US Steps Back From Fiscal Brink…

16th October 2013

“We can’t allow 30 or 40 people to hijack the Republican Party.” Republican Congressman Peter King, speaking this week

The Tea Party zealots have been belatedly reined in by the Republican establishment (forced into compromise by collapsing poll numbers and furious corporate donors); for a party that wraps itself shamelessly in the flag, threatening to allow military pay checks to bounce at the end of the month was always political suicide. While the bipartisan committee tasked by December to agree a long-term budget deal will have its work cut out, investors can now refocus on pretty decent near-term fundamentals, despite a backdrop of longer-term structural risks from ever rising US income inequality to slowing EM trend growth. Having seen net speculative positioning move short on the debt ceiling brinkmanship, the USD index now looks very cheap, back to its five year average despite the improving current account trend, 2% plus growth and Fed tapering by Q1, and could well rally over 20% to test the 100 level in 2014.With energy imports having accounted for over 50% of the current account deficit over the past decade, the shale output boom (allied to on-going efficiency gains from hybrid cars, LED lights etc.) will be a structural dollar tailwind through end-decade, particularly as the fiscal deficit is on track to fall sub 2% of GDP in FY 2015.

The polarization of politics in Washington is fuelled by unprecedented income inequality and the fraying of the ‘American Dream’, to which neither party has a coherent response.  While the steadily rising profit/falling labour share of GDP is a pattern evident globally, it is proving particularly traumatic for the US.  Real median household incomes have fallen in each of the last five years (a similar pattern is evident in many other developed economies like the UK) and have barely grown over the last couple of decades. The sustained QE program has contributed to increasing economic inequality by enforced negative real interest rates on holders of cash, while boosting prices of riskier financial assets, more commonly held by the top decile of earners.

The market capitalization of the Wilshire 5000 is up $11.4trn, or 166%, to a record $18.5trn since March 9, 2009 while the median existing single-family home price is up over 37% through August since it bottomed during January 2012 and is now just 8% below its record (nominal) high during July 2006. With earnings growing at just 2% y/y, one source of relief for discretionary spending power may come from US gasoline prices as the EPA adjusts federal ethanol mandates (the 2005 Clean Air Act), which have artificially boosted prices by forcing refiners to buy ethanol credits as gasoline demand has fallen to decade lows due to lower average mileage and a more efficient car fleet.  A gasoline price falling back toward $3 a gallon would be a very useful windfall in coming months, after the hit to consumer confidence from the idiocy in Washington.

Political Populism Means Thailand Continues to Underachieve…

9th October 2013

Thailand is probably the most disappointing emerging economy in Asia and possibly across GEM, in terms of economic and political progress over the past decade. While unemployment is practically non-existent, productivity has stagnated. Graduates from local universities are generally only fit for (and satisfied with) low skill call centre/retail work, while factories face a labour shortage as farm workers enjoying the subsidy bonanza stay in the rice paddies. Infrastructure investment has been a paltry 1.5% of GDP and trend GDP growth has stalled at around 4% over the past decade, while private sector credit to GDP has risen to 150%, after a consumer lending boom. Overall, the country’s competitiveness has been slipping versus regional peers; in the World Economic Forum’s latest competitiveness rankings, Thailand ranks 74st globally in health and primary education provision and 85th in the quality of its institutions, 50 places lower than Malaysia and significantly weaker even than Indonesia. The seven year build out of infrastructure to integrate the wider sub-region around Thailand as a logistics and finance hub will be critical to boosting the medium-term growth trend toward 5%.

The long-term challenges facing Thailand include a fast ageing population, out-dated infrastructure/ industrial plant and a weak education system at all levels. To boost trend growth to mid-single digits, Thailand will have to bring significantly more workers into the formal economy, boost productivity enhancing investment and reduce glaring income inequalities that have undermined political cohesion. For investors, a sustained period of political stability is important in tackling these structural issues, although the current subsidy program to boost rural incomes, while reducing extreme income inequality, is having unintended consequences.

Indeed, the central bank governor warned recently that the populist subsidies “add to micro-level risks by making households addicted to ‘easy’ money, while also adding to macro-level risks by stretching fiscal resources without enhancing competitiveness in any meaningful way.” Corn famers for instance have been protesting to force the government to extend the current subsidy program due to end in December for another four months. The country has seen a range of other special interest groups from rubber to corn farmers demand hand-outs of their own. The subsidies are adding to rising public spending, led by the 700bn baht, or $22bn to support rice farmers since the 2011 election. Thailand’s rice subsidies, which bought up rice from farmers at double the market price, also have knocked the country from its position as the world’s largest exporter of the grain as huge domestic inventories build, as cheaper rice from India and Vietnam took market share.

Thailand’s finance ministry recently cut its growth forecast for this year to 3.7% from 4.5%, which still looks a bit high – growth should rebound to 4.5% next year if the delayed infrastructure program begins to be implemented. Exports account for around 60% of GDP but Thailand is trapped in low end assembly operations, without the education system or infrastructure to move up the value chain. At the same time, the government’s goal of raising living standards and consumer spending in rural areas appears to be having unintended consequences. Some farmers are using the promise of guaranteed future incomes as a basis for borrowing more money. High prices guaranteed by the government are encouraging over-investment in farming.

Tax revenues are only 18% of GDP, and a proposed corporate tax cut to compensate for higher mandated wage costs will be hard to offset elsewhere. By law, public debt must not exceed 60% of gross domestic product, from 44% currently, but is forecast by the IMF to rise to 52% by 2018. On a net debt basis and excluding the liabilities of majority government-owned state-enterprises current debt is around 21% of GDP. While those debt levels look modest, private debt is the key concern, and the public debt picture is clouded by Thailand’s population ageing faster than any other in Southeast Asia apart from Singapore, with the proportion of the population over 60 in Thailand will reach 20% by 2025 with minimal pension provision, as mortality and fertility decrease steadily. Only South Korea and China face a similar demographic challenge in the wider Asian region while net foreign investment has been trending downwards, helping to exacerbate an overall shortfall in investment, which has run at under 30% of GDP in recent years.

The 2011 election campaign focused on tackling income inequality, which has become a key regional theme. Income inequality in Thailand is more extreme than in other regional emerging economies such as Indonesia, Malaysia and the Philippines, with the wealthiest 20% of Thais earning over 14 times more than the poorest 20%, compared to 9-11 times elsewhere in the region and 5-8 times in Europe and the US. The Puea Thai party offered to guarantee a uniform daily minimum wage of 300 baht ($10) throughout the country, rising to 1,000 baht by 2020, universal medical care for under a dollar a visit, a $500 monthly starting salary for graduates and a debt moratorium focused on low earning civil servants and farmers although the most expensive promise was the rice subsidy.

Despite the robust real growth in manufacturing since 2000 (an average of over 6% annually) the share of the workforce employed in factories has stayed at about 14%, with another 3% employed in export related logistics. Increased automation and worker productivity supported higher output, but did not contribute to integrating more Thai workers into the higher value-added export sectors.   The weak employment performance of manufacturing has fed the core political problem of growing wealth concentration (one which China also now faces). The country’s income inequality is the result of many divisions including the oft cited urban-rural divide, but also one between Bangkok and the rest of the country. Less than 20% of the Thai population lives in Bangkok and along the Eastern coastal region but generate over 70% of the country’s GDP and consume the bulk of public resources such as education and healthcare. This deep rooted inequality will continue to be a source of recurrent political instability in the months and years ahead, particularly if economic growth continues to lose momentum…