Outside the Box

Australia: Running Out of Luck Down Under

August 27, 2012

While it is summer in the Northern Hemisphere, it is winter "down under." Today we turn our attention to Australia. In Endgame, Jonathan Tepper and I devoted a full chapter to talking about the problems we saw looming in Australia, and for that we have taken some heat! What's not to like about the Land of Oz? In our view, it might be the bubbles that are building. I asked Jonathan to update us on Australia, and in today's Outside the Box he gives us an in-depth look. Let me quote from a point near the end, in case you might decide to look just at the summary:

"The search for yield and essentially diversification out of sovereign debt markets in distress has led to a surge in the foreign holdings of Australian government bonds. According to the latest data from the Australian Office of Financial Management, the total foreign ownership of Australian government bonds now stands at 80% of the total outstanding debt, up from 60% in 2006.

"Although this may sound high, government debt to GDP in Australia is low, at 30% (although is up from 16% in 2008). This low ratio is a result of running a budget surplus for most of the last 15 years. But, even though the situation looks good optically, the fact of the matter is Australia would have to backstop its banks in the event of a crisis, and this low number masks the real debt burden. Two countries that also had low debt burdens before banking crises were Spain and Ireland. They've both required bailouts, so Australian politicians and economists should not be complacent about their public debt levels."

Tonight I get to have dinner with good friends Neil Howe and David Tice. It is always a fascinating conversation with these guys around. But for now, down under we go.

Your trying to catch up with his shadow analyst,

John Mauldin, Editor
Outside the Box

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Australia: Running Out of Luck Down Under

Australia has been described as the lucky country, but it is running out of luck and has a terrible combination of fundamental factors. In fact, Australia reminds us in many ways of the housing bubbles in the UK, Spain and Ireland. In each case, the country experienced a banking crisis.

Australian growth has been dependent on two huge bubbles: a domestic…

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Alex Pauza

Sep. 23, 2012, 9:22 p.m.

This analysis is wrong on a number of fronts.  I got bored and stopped reading about 1/3 of the way into the article, but I would like to point out considerable errors.

1. The assertion of Dutch Disease is completely incorrect. Yes, the mining sector has been strong - although I strongly suspect we are about to get economic data coming through that shows a considerable weakening and vastly reduced “investment pipeline”.  However, during the period of strength, all other sectors of the economy except manufacturing kept growing.  Manufacturing has been shrinking as a sector for at least 40 years, and continued shrinking AT AROUND TREND.  The assertion of Dutch Disease shows that you have not bothered to look into the underlying economic fundamentals, or perhaps do not understand what Dutch Disease is.  Manufacturing exports (and mining exports) have been battling a high Australian dollar, which seems now to be driven by the state of the rest of the world more so than commodity prices - evidence of which is the gravity-defying levels it maintains despite plummeting commodity prices (that would normally result in a falling currency).

2. You assert that the A$ is overvalued, but international investors (as I assume your target audience are) should stay long Aust Govt bonds, and Australian stocks.  This is a bit Irish isn’t it?

At this point I couldn’t be bothered to continue reading the rest of this rubbish.

Bart Tichelman

Sep. 8, 2012, 1:01 p.m.

It would be interesting to see an similar analysis on Canada.  On the surface there are a lot of parallels with Australia: Big commodity exports, recent run-up in currency, increasing talk of “Dutch Disease”, national housing bubble, finance sector dominated by 6 big banks,etc.

Simon Maughan 48114

Sep. 4, 2012, 7:30 a.m.

The USD/AUD basis swap chart is a most interesting one because bank share prices have typically risen when the yield pick up in AUD is increasing. Investors see the banks as a source of AUD and hence beneficiaries of higher spread. The author sees the banks as users of AUD funding and hence losers when the spread rises. As the positive relationship between spread and bank share prices held through the crisis and recovery (the spread collapsed in Q4 2008 when the AUD fell and bank share prices dropped) this suggests that the banks’ results over the last five years have supported the investors’ view over the authors.

David Boyce

Sep. 2, 2012, 2:48 a.m.

I have to wonder, when I see top-down analysis of the Aussie banks like this, whether the writer has considered the materiality of the banks’ offshore assets and matched funding. All four, for instance, have substantial assets (and deposits) in New Zealand, NAB has operations in the UK, and ANZ is growing in Asia, where it has excess deposits and is able to stream the FX portion back to Aus.
In all cases I suggest that the external funding requirement for foreign assets should probably be ring-fenced for the purposes of this kind of analysis.
Likewise, the writer needs to consider that the Australian corporate bond market is under-developed, and Australian corporates largely use Aussie bank funding for domestic and offshore operations - it’s probably reasonable for the Aussie banks to fund part of these offshore assets with offshore funding.
The presumption that bank margins will fall if the RBA cuts the OCR also probably needs a bit more analysis - the opposite has happened over the last year or so as the banks have decoupled variable lending rates from the OCR.
While the rapid fall in the terms of trade is a huge concern, and could well bring about a recession, the reason for the huge increase in foreign ownership of Govt bonds and the rise in the AUD surely shows that this is a beauty contest and, relative to the rest of the developed world, Australia looks like a pretty steady place to park funds. The currency is a shock absorber too - the writer needs to consider what a drop in the AUD would do to the foreign investment income flows and the current account.
The article had me asking more questions than finding conclusions.

Peter J Taylor

Aug. 28, 2012, 8:04 p.m.

Seven times, this article says the Chinese economy is “slowing”. It is not slowing; it is merely accelerating less rapidly. It is rather like a car that accelerates from 0 to 30 mph in 5 seconds, then takes another 10 seconds to reach 60 mph and another half-minute to reach 90 mph. You wouldn’t say the car is slowing!
If Chinese industrial production and construction have risen by 10% since last year, and the increase reduces to 5% next year, they are still going to be using 5% more oil, copper and concrete than they did this year. They may reduce stockpiling, but cannot do so indefinitely.
Most people would define a slowing economy as one in recession, when production actually declines. No-one is suggesting that for China.

Kristi Rohtsalu

Aug. 28, 2012, 1:03 p.m.

When I read this kind of analyses, and look into the data and other details by myself for my Logic of Finance blog, I (still) keep wondering how building up such bubbles and imbalances has been possible and generally tolerated or simply ignored so far. Something needs to be fundamentally re-considered and re-designed indeed.

Michael Saunders

Aug. 28, 2012, 2:22 a.m.

Good analysis and agree with all, but… Sitting down here in Australia I’m seeing many conflicting signals = the banks are lending, consumer sentiment is falling, business is reluctant to invest - both high costs and uncertain markets. There is no doubt Australia is a “dig-it-up & ship-it-out” economy and re-establishing manufacturing is going to be painful.

Real estate bubble?  For now, it appears to be muddling through.  Mortgage arrears only total 0.3 percent of all loans, similar to where it was in 1995. And surprisingly, only 35% of Australians have a mortgage. 

Is the A$ worth better than US$ parity - no.  Would I sell down Aus real estate and move to USD? Yes.

It’s going to be interesting….