There’s a classic line in the film Bad Santa, where the elf says to (bad) Santa, ‘You have many, many, problems…’
It’s a movie my wife and I watch each Christmas, just to get us in the festive mood. It’s a Christmas classic, if a little on the dark side.
I bring it up because yesterday a mate from work mentioned it as one of his favourite movies. The elf’s line I quoted above also reminded me of the Australian economy. It has many, many, problems. But like Bad Santa, it’s in a state of denial…completely ignorant of what’s about to happen if it continues on its unhealthy path.
With this in mind, let’s continue where we left off. In yesterday’s Markets and Money, I mentioned Australia’s chronic current account deficit. The cumulative result of decades of deficits has left us with a foreign debt load of around $865 billion, and an annual interest bill of around $40 billion.
If you ask most conventional economists, they’d tell you this debt doesn’t really matter. They say it reflects the fact that foreigners want to lend to us. They see Australia as offering better relative returns on their investment. They’ll tell you the country has a solid legal framework that respects property rights. And, while it has a bunch of cowboys and clowns running — or attempting to run — the place, at least they’re not about to nationalise assets or roll out the tanks.
All this is true…which makes Australia an attractive place to invest when times are good.
But when times are not so good, things will get very interesting for Australia.
As I mentioned yesterday, Australian banks hold a good portion of that debt on their balance sheets. According to data from the Reserve Bank, international liabilities of Australian banks are over $800 billion.
Thanks to the global ‘search for yield’ and the complete disregard for risk, Australian banks have been able to borrow offshore at the lowest rates since before the crisis of 2008. That’s ‘good’ for local borrowers, and pushes the cost of obtaining a mortgage even lower than what the RBA intended via its 2011–13 rate cutting cycle.
As a result, the willingness of foreigners to keep lending at increasingly low rates has given the great Australian property boom one more leg up.
But the big risk for Australia is what happens when the next global financial crisis hits. And it will hit. It’s practically ‘baked into the cake’ because authorities have no solution to the world’s economic problems. They think the creation of more and more debt will lead to economic growth hitting ‘escape velocity’.
It’s a nonsense argument. It simply won’t happen. But instead of questioning the effectiveness of worldwide QE, our politicians and mainstream analysts see it as the only solution. It’s insane.
When the next crisis hits, Australia will feel it…big time.
That’s because in a crisis situation, our current indifferent lenders will suddenly reassess risk. Funds will dry up and banks will struggle to roll over maturing debt. That will restrict credit to Australian households…the very same credit that sustains our current standard of living.
Let me put that a different way. Australia’s current account deficit is somewhere around $50 billion per annum. That means we consume around $50 billion in goods and services in excess of what we produce.
This difference is made up through borrowing…and we depend on foreigners lending us this additional $50 billion each year to go on living the way we do. That is, speculating on residential property every weekend, taking overseas holidays, and sipping coffees at leisure.
Not to say that this shouldn’t happen, or to cast moral judgements on it. But you should understand that it’s the kindness of strangers that sustains the Aussie way of life.
This seems to be an Anglo-Saxon phenomenon. The US famously lives beyond its means and has done so since the 1960s. But its greatest export is the world’s reserve currency. The greenback gives the US borrowing power that no other country can match.
The UK also lives well beyond its means. The pound was the former global reserve currency and the UK’s famously secure property rights make it a magnet for foreign capital seeking safety. It’s made London property one of the UK’s greatest exports.
For better or worse, property is also becoming an export market for Australia. The influx of foreign capital into our property market in the past year or two has been huge. And now Abbott is selling citizenship at a price of $15 million. You can live the dream…as long as you’re rich.
But Australia is not the UK, and it’s not the US. We’re a small, open economy and our largest customer is changing direction. When the next crisis hits, foreign capital will dry up. The Aussie dollar will plunge, and interest rates will rise.
The government will guarantee the banks, and the RBA will open its doors as a lender of last resort. These actions will send the dollar lower.
A sharply lower dollar is the market’s way of trying to get us to curb our profligate ways. It makes imports more expensive and exports cheaper. So there will be winners…eventually. But the Australian economy is not structured for such an adjustment. It will cause pain, and the restructure will take time.
Throw in the fact that we have politicians in denial and we’ll be in for a rough few years.
You don’t have to worry about this now. In fact, you might not have to worry about it for a few years. But when the crisis hits, you can’t say you weren’t warned.
What to do then? That’s what the various editors here our trying to figure out. They write to their subscribers each week about the problems we face and the potential solutions.
I’m currently working on a major report that sets out these problems in detail…and I’m working on some solutions. But to be honest…it won’t be easy. As a hint though, you may want to look into currency diversification.
The report is not quite ready to publish yet. But I’ll let you know when it is.
For Markets and Money