The Australian Economy Has Failed to Transition

What Transition?

A house price crash. Sick of us writing about it?

Get used to it.

We’ve slowly moved back to the subject over the past year or so. That’s after giving up on the matter for a good three years.

It’s good to take a break.

With the benefit of hindsight, it was a good move. House prices didn’t crash. So writing about the possibility for three years really wouldn’t have helped much.

But why are we getting back on the subject now?

One of the things we remember with our last dalliance with the subject of falling house prices, was the argument that house prices wouldn’t collapse because…it was the rich and well-off who had most of the debt.

To us it was a nonsense argument.

As a visit to any bankruptcy court will inform you, the ‘rich’ and ‘well-off’ have more than their fair share of financial problems.

Furthermore, we saw it as a negative. If it was true that most of the debt is in the hands of the few, that’s a major risk. It’s the equivalent of having either a balanced portfolio or a lop-sided portfolio.

A lop-sided portfolio can do incredibly well if you back the right stocks. But if you back the wrong stocks, or if the market turns sharply, the lop-sided portfolio may receive a bigger hit than a balanced portfolio.

When the market is going up, it’s just fine to have a concentration of risk. Hungry borrowers will borrow, and willing bankers will lend.

But what happens when the market turns the other way? Especially in ‘trophy’ suburbs, where the rich and well-off seem to congregate? Well, then it may not turn out so well.

But what does it matter? The housing market isn’t about to fall, and therefore the rich and well-off won’t get into financial trouble, right?

Maybe that’s not right. As an article from the Australian Financial Review revealed last week:

Property buyers in some of the nation’s swankiest suburbs are among those under most stress keeping up mortgage repayments, according to an analysis by postcode of income and debt levels.

The young affluent in plush inner suburbs living the high life are more likely to be financially derailed by rising costs than battlers in new estates on the suburban outer fringes, the analysis reveals.

Households in Melbourne’s gilt-edged Toorak, about 8 kilometres south-east of the central business district, where median house prices are $3.5m and $845,000 for apartments, are five times more likely to default on mortgage payments than the national average.

It’s the same probability in Bondi, about 8 kilometres south-west of the central business district, where median house prices are about $2.5m for a house and $1m for an apartment.

Oh dear.

Naturally, it will take more than one big-time default in a plush suburb in order for house prices to crash.

But the truth is, it’s not so much the actual default levels, or even extrapolations about what they could be in the future. The point of most interest is that the data reveals the Australian economy can’t be in as good shape as most folks think.

The almost constant refrain we see from so-called market experts is that the Aussie economy is transitioning well. It’s moving from a resources-based economy to a services-based economy.

Nice. If only it were true. But it isn’t necessarily so. Not based on the numbers supplied by the government’s Austrade. Check out the following chart (note, the annotation is from the original):

Australian export performance goods vs services
Source: Austrade

The chart on the left plots commodity and other physical exports. The chart on the right plots services exports.

Based on the latest numbers, Australia exported $250 billion of merchandise in the year to September 2016. For the same period, Australia exported $66 billion of services.

As a percentage, services accounted for 21% of exports.

Roll the clock back to January 2009. Australia exported $225 billion of merchandise during the prior year. For the same period it exported $52 billion of services.

As a percentage, services accounted for 19% of exports.

Go back further, to January 2005. During the previous year, Australia exported around $120 billion of merchandise. For the same period, it exported around $37 billion of services.

As a percentage, services accounted for 23.5% of exports.

And if we go back to the beginning of the chart in 2001, for the previous year, Australia exported around $112 billion of merchandise, and for the same period it exported around $35 billion of services.

As a percentage, services accounted for 23.8% of exports.

Our point is, we fail to see exactly how Australia’s economy has transitioned at all. As far as we can see, the make-up of the Aussie economy has been fairly constant for the past 16 years.

Commodities and other goods account for between three-quarters and four-fifths of exports. Services account for the remainder.

If the Aussie economy really is switching from a commodities exporter to a services exporter, all we can say is that it has a blooming long way to go.

Because, even though service sector exports have nearly doubled over 16 years, merchandise exports have more than doubled…even after the last three years of decline.

And in nominal dollar terms, service sector exports are way, way behind — $65 billion, against $250 billion for merchandise.

We ask: where is the growth going to come from for services to take on the role as a major economic driver?

We don’t see it. The kind of services Australia specialises in are difficult to export (coffee shops, education, and lawn mowing services for example). And where they can be exported, they face intense competition.

This brings us back to housing. What is the profile of the ‘affluent young’ in Toorak and Bondi? Are they mining executives who are struggling to make ends meet after the downturn?

Or are they services industry executives who are struggling to make ends meet after failing to achieve the breakthroughs and growth they expected?

Or are they from both groups?

We don’t know for sure. But if we’re right about the direction of the Aussie property market (down), 2017 could be the year when we find out.


Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Markets and Money e-newsletter in 2005. He is the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service, Markets & Money.

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