Trump’s self-destructive economic act
Trade wars, the US dollar and the RBA cash rate.
‘Entertaining’ isn’t a word normally associated with speeches from economists, so Westpac Group Chief Economist, Luci Ellis’ keynote talk at last week’s Morningstar investor conference in Sydney came as a surprise. And it was informative to boot.
Ellis is a former Assistant Governor at the RBA and known not only for her knowledge of the central bank but also the intricacies of the domestic economy.
In the speech, she first delved into the potential impact of the trade wars and she didn’t hold back. Ellis described the tariffs episode as a “self-destructive act” by the United States. She thought some commonsense would prevail and tariffs for most countries would end up between 10% and 20%, with China, Mexico, and Canada being somewhat higher.
She said the tariffs would result in a major economic shock for the US, though it shouldn’t end with a recession, either in America or globally:
“We will see trade patterns shift but what we won’t see is a huge amount of production relocating back into the US. They’re not going to start making the bicycles and T-shirts in the US again.”
Part of the reason for this was that the US dollar remained 15% overvalued, making America “quite uncompetitive”, according to Ellis. She described the dollar as more overvalued than at any time since the Plaza Accord in 1985.
How did she come to this conclusion? She highlighted this chart measuring real effective exchange rates:
Ellis also supported her case by asking the audience of financial advisers if anyone had visited the US recently as she had – and cited how expensive things like restaurants were there, even without the tips. She said that’s currency overvaluation at work.
By contrast, she then asked the crowd if they had been to Japan of late. A lot more people raised their hands than for the US. Ellis said most of the audience wouldn’t have been able to afford a holiday in Japan 20 years ago. And the change in exchange rates was behind this.
The US dollar overvaluation and senseless tariff wars were two big reasons why investors were starting to invest more outside of the US, Ellis believed:
“… they’re not getting out [of the US] entirely, but everyone just wants to be a bit less long.”
She cited two triggers for the unravelling of the ‘US exceptionalism’ narrative. First, the Oval Office meeting with the Ukrainian leader, which made investors realise that America could no longer be counted on as a reliable ally and trade partner. Second, Germany changing its constitution to allow more defence spending. Investors were looking into the opportunities presented by more spending in Europe.
Ellis said there were other challenges to US exceptionalism. While tariffs would provide an inflationary impulse to America, the rest of the world would continue to experience a deflationary shock from China due to its weak domestic demand and inflation.
Implications for Australia
Ellis said the RBA had been a reluctant rate cutter but the global risk shift combined with slowing inflation and wages led it to reduce interest rates in May. And we’re likely to get two more rate cuts this year.
All data on inflation indicate it’s headed lower.
Rental inflation is part of the picture. It’s fallen faster than Ellis expected as population growth normalised.
Ellis said the housing market was caught in a tug of war between slowing population growth and cuts to rates. It’s expected to result in moderate house price increases.
The other issue is housing supply. Ellis suggested there’s a severe backlog in construction, with homes being approved but not being built due to high costs. A gradual increase in supply is going to be another part of the tug of war that will keep a lid on house prices.
Ellis said the economy was being held back by subdued household spending. She cited proprietary Westpac data on all of its individual customers (as a Westpac customer, this had me a little concerned) that showed people only spent 20% of the recent tax cuts.
Consumer sentiment remains subdued despite a recent uptick in wages growth. And that’s despite most having a secure job, with the country’s unemployment rate remaining low.
Ellis said that’s deceptive though. In 2023-2024, 80% of jobs growth came from the ‘care economy’, which constituted only 28% of total employment.
What happens in 2026?
Ellis said the outlook for Australia hinged on how the global trade disputes panned out. She doesn’t expect a global recession. For Australia, the election result implied no big changes to the outlook for government spending, and she thought consumer spending would remain weak.
Does the RBA end up providing extra support via more rate cuts? That’s not Ellis’ base case, though most of the risks were on that side.
One bonus chart
This chart from Ellis on Australian exports was fascinating:
It showed that the largest sectors for exports – iron ore, coal, LNG, and university education – were flatlining.
They all had a huge ramp-up in the first couple of decades of this century, and they’re now “capped out”, in Ellis’ words.
On iron ore, Ellis said China had reached peak steel, though it would remain steel intensive. While that means iron volumes and prices won’t increase much, they won’t tank either.
Was Ellis worried about the big four exports being capped out? Not especially. She thought growth would come from elsewhere. For instance, we have a growing export industry called software licensing, worth about $7.5 billion. Think Canva, WiseTech, and Atlassian. We now export more in software licensing than we do in copper, aluminum, barley, or rice.
I’m not so convinced on Ellis’ optimistic take on the issue given software remains small fry compared to the likes or iron ore and coal.
One bonus thought
Ellis was asked about our productivity issues. Given all the moaning from business leaders for the Government to do something about it, Ellis’ answer was refreshing:
“I want to make it clear that Australia is the only country that thinks that productivity is something the Government does to you, and it’s somehow the Government’s responsibility to fix our productivity problem.”
She said aside from the US, the whole world has had a productivity issue. And America may be a statistical anomaly as some of its labor force wasn’t documented, thereby impacting the data.
Ellis thought it’s our responsibility to fix the productivity problem, not the Government’s. We need to ask ourselves how we can be more productive. How can we change business processes? What can we invest in? What technology should we adopt?
To that I say: hear-hear.
