Australia Budgeting on China’s Economy

He came, he saw, he budgeted.

If you ignore that fact that Joe the Budgeter missed a great opportunity to bring about long term tax reform, last night’s budget wasn’t too bad. Joe’s first crack at pulling the purse strings expects to reap an extra $37 billion over the next four years as a result of spending cuts and tax increases like the new deficit and fuel tax. We’ll show you why that’s not going to happen in a moment.

On the topic of new taxes, let’s just ignore the fact that Tony Abbott campaigned hard on a no new taxes platform, and gave Julia Gillard a pasting for bringing in the carbon tax. But of course that was before the new government came in and, shock, horror, saw the state of the books that Labor left.

‘It was a disgrace’, the Libs say…‘we had no option but to increase taxes…our future prosperity is at risk’. Blah blah blah…

Anyway, $37 billion in savings over four years? It won’t happen. In the face of a low growth economy, the projections on the revenue side are too optimistic. According to the budget papers, over the next two years the government expects to grow total revenues by 6.1% and 6.4%.

That’s faster than the forecast rate of economic growth, meaning total government receipts as a percentage of GDP (economic output) will increase from 23% this year to 25% by 2016/17. In other words, despite the no new tax rhetoric, in a few years’ time to government will take 25% of the nations’ output. That’s a decent impost on the economy.

Meanwhile, it’s currently spending 26.2% of GDP back into the Australian economy, spending which is only forecast to drop to 25.3% by 2016/17.

It goes to show the structural problems inherent in the long term budget forecasts. Even with these so called tough decisions, the government will take a greater slice of the economic pie for years to come.

As we’ve pointed out previously, the government has been too optimistic in projecting revenue growth. It’s not making any allowance for the fact the China’s historic credit bubble is deflating. Whether this deflation will occur fast or slow is still uncertain…it’s early days…but historical precedent says it will happen.

Yet the budget papers forecast a benign 7.25% economic growth for China in 2014 and 2015, falling gently to 7% in 2016. Credit bubble? What credit bubble?

It’s an unwritten rule that no senior bureaucrat — whether it’s a central banker or a Treasury forecaster — will EVER mention the likelihood of a bust or the prospect of weaker than expected growth. These guys are the embodiment of consensus and group think. You don’t get to the top of the bureaucratic tree by challenging conventional wisdom.

But given all the recent nasty historical outcomes we’ve had from credit bubbles and overinvestment, wouldn’t you think that a discussion about China’s near term economic fate would feature highly in the national conversation?

We certainly would, which is why we bring the topic to The Daily Reckoning regularly. We cop our fair share of abuse for it too. We get regular emails telling us to shut up about China and just go there and see how extraordinary it is before passing judgment.

Which gives us confidence we’re onto something…when you’re ruffling feathers you’re doing something right.

But we’re not passing judgment on China. We’re making a statement grounded in historical fact. That is, credit booms all end one way or another. It can be in the form of a catastrophic bust, or a slow melt into a long term low growth environment.

The probability lies with China’s economy falling into an extended low growth environment. It will be difficult, but it won’t be the end of the world for them. It will be much tougher for Australia though, because we’re not even ready for it.

Treasury sees China as business as usual, with an almost unaltered growth path over the next few years. We beg to differ. By this time next year, economic growth numbers in China will start with a six. By 2016, we’ll be talking fives. 

Meanwhile, more data came out of the Middle Kingdom yesterday showing the economic slowdown is gathering pace. Industrial production, retail sales and fixed asset investment for April all came in below expectations. Property sales fell 7.8% by value in the first four months of the year.

Obviously concerned about the property slowdown, yesterday the Chinese authorities ordered banks to pick up the pace of mortgage lending. Will it work? Only if confidence among the population remains.

That’s because banks don’t make loans by themselves. They need someone to come in and request a loan. And that request is usually a byproduct of confidence.

During boom times, confidence is sky high, which is why credit growth is so rapid. But once confidence goes, banks can try all they like but they won’t be able to create credit from nothing.

An article from the Financial Times indicates buying confidence in China is starting to wane. Apparently New Century Real Estate dropped prices on apartments in Hangzhou by 15% in March and encouraged buyers to rush in and buy during this ‘one-time’ opportunity.

After getting a flood of enquiries initially, other developers started doing the same thing and New Century hasn’t been able to sell its stock of inventory. People are slowly beginning to realise that property in China isn’t a one-way bet. The result of that realisation is a drop in confidence.

From the FT

‘For several months it has been clear that housing markets in smaller, less-developed cities were beginning to suffer downturns. However, the government and analysts long believed that bigger, wealthier cities were better insulated from the pressures.

‘Hangzhou has shaken that belief. Capital of Zhejiang province, it has a population of nearly 9m and is one of China’s richest cities. If its property market is in trouble, it is an ominous sign for the country as a whole.’

‘Property investment directly accounts for nearly a fifth of Chinese gross domestic product, so if bulging inventories lead to slower construction, as they should, the consequences for economic growth will be unpleasant.

‘Observers could be forgiven for thinking that China has been here before. The housing market briefly wobbled in 2008 and 2011, only to rebound with great vigour. But on both those occasions, the slowdowns occurred because the government had deployed a battery of tightening measures to try to rein in runaway prices. This time, it is market forces leading the way. “This downturn is almost entirely because of the oversupply,” Mr Du says.’

But don’t you worry about it. The Treasury says China will keep on growing at 7% or better. And Joe the Budgeter says we’ll be back in surplus by 2018/19. She’ll be right.


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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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