A New Paradigm for the Australian Economy

US shares made record highs overnight on the not very surprising news that the Fed will continue with the taper if the economy remains strong, and taper the taper if it gets weak. Got it? Good. Let’s move on…

We’re not going to mention China today except for this slightly ominous bit of news reported by the Wall Street Journal.

‘China’s top legislative body Thursday designated two new national days aimed at highlighting Japanese aggression during World War II.

‘The Standing Committee of the National People’s Congress approved proposals designating Sept. 3 as “War Against Japanese Aggression Victory Day” and Dec. 13 as a day of remembrance for victims of the Nanjing Massacre, according to state media.’

We guess that’s one way to prepare for war. Get your people to remember past aggressions of the country you’re having a territorial spat with by giving them a few days off to think about it. Must be good for spurring the nationalist spirit, no?

Trade wars generally lead to real wars. Let’s see where ‘Abenomics’ — Japan’s policy to weaken the yen — takes us in the next few years.

Closer to home, the next few years are not looking good either. Yesterday’s release of actual and expected capital expenditure data tells you that the Australian economy will be very close to an official recession later this year. It was an ugly set of numbers — not that the Australian share market or even the Aussie dollar worried about it too much.

Total capital expenditure for the December quarter fell 5.2% on a seasonally adjusted basis. Over the 12 month period, it fell 5.7%. Shock, horror! Lower interest rates aren’t encouraging non-mining businesses to invest!

No they’re not. The real shocker came with the first estimate of capital expenditure intentions for the 2014/15 financial year. It came in at $124.8 billion, well below expectations. It represents a 17.5% decline on the last year’s first estimate of capital expenditure and a 25% decline on this year’s likely total investment amount.

But it’s not quite accurate to view this as a potential 25% year-on-year plunge in investment. There are five estimates provided throughout the year, and they tend to increase as the year progresses. Even so, there’s no guarantee we’ll see a big pick up in investment intentions, especially if the economic mood doesn’t improve.

That type of decline in investment is going to take a large chunk out of GDP growth. In fact, we’ll probably see very little in the way of growth at all as we head into the second half of 2014. And that’s saying something about the state of affairs in Australia’s economy.

That’s because GDP is a measure of the economy’s production. The large increases in iron ore output over the past few years have boosted GDP numbers even though much of the country ‘feels’ like it’s in recession. And the large immigration numbers also provide a boost.

But on a ‘per capita’ basis, we’ve been going backwards, and when you take the falling terms of trade into account (which effectively recognises falling commodity prices) Australia has been sailing close to recession for some time now.

So, if we manage to get into a recession on actual GDP numbers, you’ll know just how tough things actually are.

Not surprisingly, reduced investment intentions in the mining sector are behind the potentially big decline in economic growth. The ‘mining cap ex cliff’ has been in the financial lexicon for a while and now you’re seeing tangible evidence of the fall. Although if you’ve been following the performance of the mining services stocks for the past few years you’ll be very familiar with the ‘cliff’ and its real world effects.

The RBA came late to the party on recognising the severity of the drop off in mining investment, but when they did there were confident that ultra-low interest rates would promote investment elsewhere and help rebalance the Aussie economy.

So, how’s the rebalancing looking? Not good.

‘Other selected industries’ (which includes sectors like construction and wholesale and retail trade) expects to increase investment spending just 0.4% compared to last year’s first estimate, which is obviously nowhere near enough to offset the mining collapse.

And manufacturing is going the wrong way completely. Early estimates for investment intentions in the sector show a huge 19.6% decline on last year’s first estimate. Manufacturing’s been in the doldrums for years, is getting killed by a high cost structure and high dollar, and it continues to reduce investment in a rate of knots. That’s hardly good for future productivity or jobs growth.

But hey, lucky we have Australian housing right? We don’t really need a manufacturing base anyway. We simply need to produce iron ore and a few other metals, leverage ourselves on the income from it and then grow wealthy flipping houses. We’ve been doing that for years. It’s no longer in the realm of possibility.

It’s a proven economic model…a new paradigm, a permanent plateau, and clearly different this time.

The RBA will no doubt be contemplating more interest rate cuts. After all, the central banking handbook states that if past policies don’t seem to be working, just do more.

But that RBA should understand by now — before it damages the economy even more — that its policies ARE working. They’re just not working as intended. They’re inflating house prices and bank profits and pushing the ‘risk premium’ on stocks so low (which pushes stock prices high relative to earnings) that investors are in for years of very low term returns, and outright losses in the shorter term.

There are limits to the effectiveness of low interest rates, and Australia has just about reached its limit. In fact the world has reached its limit. At some point, all it does is promote speculation over investment, which simply creates bigger problems when the speculation eventually gets out of hand.

But our myopic statesmen and policymakers have the view that they can’t see or pre-empt future problems. They hope that when they occur, someone else will be around to clean up the mess and they’ll be pensioned off, living the cosy life of a former public servant.

We don’t know about you, dear reader, but we can’t see much in the way of public service being performed from where we’re sitting. All we see is a bunch of whiny ideologues droning on about this or that…twisting or ignoring facts to suit themselves and retain their grip on power.

Prolonged easy money is a curse on society. History has shown it time and time again. Yet we never learn. It’s always the same. In an interview last week, Sydney nightclub king John Ibrahim said that Gen Y were the worst generation ever, with an astounding sense of entitlement.

Well, they’ve grown up in an era of easy money. Is it any wonder?

Greg Canavan+
for Markets and Money

PS. At our upcoming World War D conference at the end of next month you can hear our keynote speakers Marc Faber and Jim Rickards talk about the perils of easy money and the implications for your investments. Check out the details here. Hope to see you there.

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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