John Mauldin: We wrote about Australia in a full chapter of Endgame. Their economy never really suffered in the recent debt crisis, in large part due to their growing housing market and their trade with China. If you talk to the average Aussie, they think that all is right with the world. They acknowledge a few issues but see nothing major like the rest of the world has experienced. Jonathan and I think otherwise. Their housing market is by recent standards in a clear bubble (which I know will get me a lot of email). Their banking system is dominated by foreign deposits (shades of Northern Rock, but not as bad as Iceland). They are vulnerable to a Chinese economic slowdown. I should note that Chinese GDP growth was “down” to 7.6% last quarter. That China might slow down should not come as a surprise. No country can grow at 10% forever. Eventually the laws of large numbers and compounding take over. All that being said, Australian government debt and deficits are under control. Any problems should be of the nature of “normal” business cycle recessions and accompanying issues.
Comment:~ Massive Chinese stimulus saved Australia from the GFC but that is no reason to become complacent. As Steve Keen recently pointed out, Australia is in a similar position to Spain in 2006. Spain was generating a fiscal surplus which it used to reduce government debt below 40% of GDP, but its banks were exposed to a large housing bubble funded by offshore deposits. Australian banks are similarly exposed to offshore funding and are leveraged 50 to 1 on residential mortgages (Macrobusiness May 4, 2012) — even after adjusting for mortgage insurance — leaving them highly vulnerable to a contraction. We also need to recognize that Australia is not exposed to a slowdown in China’s GDP growth, but to a slowdown in Chinese spending on infrastructure and housing. While GDP growth may fall to zero, the Chinese economy will still survive, but what are Australia’s chances if that is accompanied by say a 50 percent fall in new infrastructure and housing projects? The fall in iron ore and coking coal exports would have a far greater impact on the Australian economy.
We need to recognize that mining is not Australia’s salvation:
1. We are mining a depleting resource that is unsustainable in the long term;
2. It exposes us to a boom-bust commodity cycle rather than stable growth; and
3. The impact of the boom-bust cycle on exchange rates does irreparable harm to other export industries — whether manufacturing, tourism or education — and exposes importers to large cyclical fluctuations in costs.
Unless we can find a way to protect the rest of the economy from the commodity cycle, in 50 years we could end up as just another abandoned quarry — with no other viable exports. And nothing to show for our efforts.
One of the problems is that the miners have such a large war chests to use for advertising to protect their interests, that a federal government of either colour is afraid to take action that might damage the miners profits and cause a miner lead anti government campaign.
It is useful to remember that the miners do not employ large numbers of people and that that a substantial part of the profits go to overseas investors. The miners make nothing, they merely dig up and send away something that is already there and something that cannot be replaced.
The RBA has a great fear of inflation but it should increase the level of inflation it will accept and at the same time reduce interest rates. This action would cause the value of the AUD to fall and give other industries a chance to export.
I agree with your sentiments but wary of inflation as a potential cure. The primary tool for raising inflation is lower interest rates to encourage credit expansion. While we could all use lower interest charges, private debt levels are already dangerously high.
In a normal setting you would expect lower interest rates to encourage credit growth and increase the money supply. In Australia, currency is being bought up to take advantage of high interest rates. Doesn’t that increase the money supply? And doesn’t this mean that in Australia (and whenever a country has high interest rates by international standards) lowering interest rates will mean a reduction in the money supply?
It also looks like this effect is exagerated by the movements in exchange rates which trigger drops in stock prices as investors move their money out of Australian investments to avoid losing money on currency devaluations.
The risk is that high interest rates needed to draw in foreign investment also risk collapsing the housing market as local home owners struggle to pay part of their higher home repayments (admittedly indirectly) to foreign investors.
The sole purpose of lower interest rates is to accelerate credit expansion; higher interest rates will slow credit expansion. Inflation is a by-product of credit expansion as it expands the money supply.
Higher interest rates attract offshore investment in bonds but discourage investment in stocks (as the economy slows). If there is a large inflow of offshore investment into bonds this can counter-act central bank operations to raise interest rates. This happened under Greenspan in the US: the Fed lifted short-term rates but long-term rates failed to respond because of large capital inflows from China. That would simply prompt stronger action from the RBA in order to slow credit expansion.
One possible method of quarantining the rest of the economy from the commodity cycle would be a tax on mining profits that is invested offshore via a sovereign wealth fund. The capital outflows would help offset revenue inflows and the wealth fund would provide a replacement income when the holes in the ground are emptied.
Comment 3 above is the crux of our long term viable economic survival. We are selling the silverware at an unprecedented rate and replacing it with a hole in the ground and government rhetoric, to bequeath our progeny
a depleted shell.
Any nation that does not nuture manufacturing, education and innovation is doomed to second rate status and if “Big Brother” USA deserts us we are in dire straits.
RJH
“Any nation that does not nuture manufacturing, education and innovation is doomed to second rate status…”
I agree. And education and innovation are essential for a competitive manufacturing sector.