Is there a way out? That is the question today’s Markets and Money takes up. A way out of what? Why a severe, prolonged, and painful Australian recession of course.
In the “no” corner, weighing in with some theatrically negative comments, is IMF managing director Dominique Strauss-Kahn. He told reporters yesterday that, “2009 will almost certainly be an awful year – we expect global growth to enter deeply negative territory. This is a truly global crisis, and nobody is escaping.”
Nobody Wayne Swan. Did you hear that? Nobody! That means YOU!
Before we get to Australia’s capital crisis and its Chinese future, just a quick note to say we won’t be taking up the question we left you with at the end of yesterday’s Markets and Money. It’s the “what should we do” part of a world where the fiat money system cracks up, leading to a hyperinflationary/deflationary depression.
It’s an important question-probably the most important you can ask these days. So we’re going to collect and write up our thoughts over the weekend. Stay tuned! And if you want to send us your plan, don’t be shy. email@example.com
Meanwhile, what about the present? The IMF issues its World Economic Outlook twice a year. When times are good, the forecasts are too optimistic. When times are bad, the forecasts tend to be too pessimistic. And when times are really bad??
There is a problem for Australia buried in the IMF’s comments we want to explore today. The problem is capital. Where is it going to come from over the next five years? Will Australia have a capital crisis?
The report says that one big consequence of the GFC is declining capital flows to emerging markets. With banks not lending at home in Europe and America, they certainly aren’t lending abroad. The IMF said the decline in these capital flows, “may be protracted, given the solvency problems facing advanced economy banks that provide significant financing to emerging economies.”
You could argue that Australia is not an emerging economy but an advanced, developed economy with two (and perhaps only two) world class industries (finance and resources). But what you cannot argue is that Australia is a net importer of capital and has been so for two hundred years. We didn’t make that up. It’s what the Australian Office of Financial Management told investors in a slide show in Dubai late last month (see slide 14). The AOFM hit the road-an investment road show-to entice investors to buy Aussie bonds. More on that in a second.
But first a question: would a prolonged credit depression choke of the capital imports that are the lifeblood of Australia’s modern economy? After all, the Aussie housing boom was financed with a great deal of money borrowed from abroad. And the resource boom continues to depend on foreign capital (especially China) to expand. So is there a risk that Australia will experience a capital shortage in the coming years if the GFC drags out as the IMF expects?
We may surprise you and say the answer is “no.” It’s a qualified “no,” though. First off, the banks are the largest importers of capital. If they have trouble importing capital, it’s going to affect the Australian property market, both residential and commercial. But the government has already promised to fill this gap in two ways.
First, the AOFM was told by the Treasurer late last year to begin buying Residential Mortgage Backed Securities (RMBS) from non-bank lenders. It’s been doing just that. And one interesting question is how much of the nearly $4 billion in RMBs the AOFM has already bought represent new loans made by non-bank lenders to First Home Buyers taking advantage of the big government grant.
If that doesn’t sound like Fannie and Freddie buying subprime loans originated by Countrywide, we don’t know what does. And we suspect that if the government wants to keep the housing market propped up, it will have to extend the first home buyer’s grant past June 30th AND increase the role of the AOFM in buying securitised mortgages. After all, who else is going to buy them?
But while the government essentially underwrites residential property values via the AOFM, you can expect it to get busier providing capital to the commercial property sector too, via Ruddbank. You may have noticed that General Growth Properties, the second largest mall owner in America, filed for bankruptcy overnight. But even if you didn’t notice it, we think this means the other shoe to drop in the second half of this year is major trouble in the Australian commercial property market. Why?
The Australian consumer is not much better off (by some measures he’s worse off) than his American counterpart. Australians are growing their credit card balances, but paying off less and less each month, according to data published this week by the Reserve Bank. Credit card debt grew by 1.7% to $45.4 billion. But Aussies cut their repayments on that debt by 7.1%.
You’d have to expect major reverberations in the commercial property sector later this year if the Aussie consumer reaches his limit or loses his job. We expect that will lead to increased government borrowing and lending to prop the sector up in the same way it’s propping the housing market up. It won’t be cheap, either.
Ahmed Fahour is the man designated to run the Australian Business and Investment Partnership (ABIP aka Ruddbank). He is already expanding the mission of the bank beyond the backstopping of commercial real estate. He told the Australian Financial Review earlier this week that, “Right now, we’re focusing on commercial real estate, but it does have the potential with all five shareholders to go beyond commercial real estate” (the five shareholders are the Big Four banks and the government).
Fahour has said the Ruddbank is a “backup plan” and not a bailout. But if things go to form in Australia-if capital remains scarce and the global economy continues to contract-Ruddbank will be a conduit between government money borrowed in the global bond market and Australian businesses that can’t get capital any other way.
So how much is all this going to cost? A lot more than anyone expects, that’s for sure. In its road show in Dubai last month, the AOFM produced a few slides that showed that Australia’s net debt and debt-to-GDP ratios are quite favourable to other countries. And then it showed the chart below which projects the government’s borrowing needs over the next few years. Have a look.
Australia to borrow over $40 billion each of the next three years
Source: Australian Office of Financial Management
So the Rudd government, through the AOFM, is hitting the road to hawk Australian government debt in order to pay for…well…for a lot of things. For the stimulus. For infrastructure. And, we reckon, for the funds to keep commercial property developers from going up and residential home prices from falling.
Of course there’s no sin in being a net importer of capital. It means foreign investors are attracted to the rate of return on Aussie investments. But this is a trend that should worry any Australian who’s had a chance to see what America has done to itself. It makes the country’s economic growth dependent on foreign creditors.
A society that thinks it owes itself cash payouts and all sorts of other projects it can’t pay for will happily borrow from the future to pay for the present. This is not so good for the future, though. What starts out as a temporary dip into debt to ride out a recession becomes a chronic habit of living above your means with borrowed money. Politicians support it because it’s a way to keep the promises flowing without having to find ways to pay for them with current revenues.
The question we began with, however, is will foreign creditors like the Chinese and Japanese or the Petrol States simply cut Australia off and invest their money elsewhere (or in their own economies)? Right now the Federal Government enjoys a triple A credit rating from Standard and Poor’s. But if the Federal government steps in to guarantee the borrowings of State governments (the same way it’s guaranteed the borrowing of the big four) then the credit rating might not be so gold plated.
This means rising borrowing costs for the AOFM. This means the habit of paying for your projects with money borrowed from the future gets even more expensive (even if you call it ‘investment’ rather than say, ‘plundering from the future’). This also means your taxes are probably going up (GST).
But it does not mean China will not be interested in Australian resources. And this brings us to the “yes” part of the question we set out to answer at the beginning of today’s journey. Australia can mitigate the effects of severe recession, perhaps, by opening its arms wide to embrace its Chinese investors. Very wide.
Even though it was at a ten-year low, Chinese GDP grew by 6.1%, according to data released yesterday. That’s good news. But as Michael Pascoe writes in today’s Age, the better news is that the GFC is accelerating China’s exit from its huge U.S. dollar reserves…and into tangible assets.
Pascoe points out that the commodities bubble has definitely popped, but that the boom is still on trend. Base metals and bulk commodity prices are lower than they were in 2008…but a lot higher than 2006 and mid-2007. He says prices have reverted to the rising trend, not crashed.
He also quotes Nobu Su, the head of a Taiwanese commodity firm, “China has woken up,” Nobu says. “The West is a black hole with all this money being printed. The Chinese are buying raw materials because it is a much better way to use their $1.9 trillion of reserves. They get ten times the impact and can cover their infrastructure for 50 years. The next industrial revolution is going to be led by hybrid cars, and that needs copper. You can see the subtle way that China is moving into 30 or 40 countries with resources.”
We hope Nobu is right. Over at the Australian Small Cap Investigator, Kris Sayce has tipped two Aussie rare-earth metal companies that could benefit from a boom in hybrid cars. That would be welcome news indeed.
But the larger argument and question is if Australia will ride out the GFC on China’s foreign investment coat tails. Even that is no sure thing. It’s one thing to sell Aussie resource firms to Chinese partners. But how will that halt rising unemployment? How will it save the retail economy? What will it do for house prices and commercial real estate?
Despite the “glimmers of hope” and “signs of stability” alluded to by talking heads and politicians, we see nothing of the sort. This kind of talk is just self delusion. It wouldn’t surprise us at all if the people saying these things are in the meantime burying gold in the backyard and hoarding bottled water in the spare bedroom. More on survival strategies for the rest of the year next week!
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