Fake Savings, Detached Investments and the Mining Boom

Tim Colebatch from the Age has been reading the Markets and Money. Not that he admits it. He claims to have watched a Four Corners TV show about Ireland instead. But his message, at least for this article, is spot on:

‘…two fundamental truths. Booms tend to end in busts. And the busts do more harm than the boom does good.’

The answer to avoiding busts is of course to avoid the boom in the first place. But what causes the boom? Colebatch happens to have stumbled on the revelation that others miss. And congratulations to him for uncovering the evidence as it applies to our own mining boom:

‘… the real boom is not in mining, a capital-intensive sector, but in mining investment, which reaches out far more into the economy. Treasury deputy secretary David Gruen estimates that while mining is only about 10 per cent of GDP, the ”mining-related” economy is now about 20 per cent of GDP. That puts far more jobs at risk when the boom goes bust.’

It’s investment that drives the boom and bust cycle. Or, more specifically, it’s the detachment of investments from the amount of savings used to fund the investments.

But before we explain this little theory, why should you care? Well, if you had looked at the American and European housing booms with the theory in mind, you would have been able to spot the edge of that cliff well in advance. And that could have meant avoiding a 40% decline in the ASX200. The booms and busts of the future, like the mining boom, are probably worth understanding too then.

Economists consider it to be a basic truth that Savings = Investments in an economy. S = I is a basic assumption. After all, you have to finance every investment. But when central banks and banks create money out of thin air, the amount that is actually saved by people decouples from the amount invested. By creating money that wasn’t actually saved, more investments can take place. Which is a good thing, right?

The problem with this is that the investors think people have saved more money. They can’t tell the difference between real savings and artificial savings. They don’t realise that…

  1. Not enough people saved money to fund their projects. And…
  2. Not enough people saved money to be able to consume more in the future when those investments come to fruition.

We’ll deal with point two first.

When people save, they are signalling that they will consume more in the future instead of the present. Savings are delayed consumption. So if you create fake savings by printing money, it falsely signals that a larger amount of consumption will take place in the future. But that never occurs, because the savings aren’t real – no consumption was delayed.

It also happens that savings are useable investable resources. You have to forgo consuming something in order for it to be available to invest. This is like separating your seed corn from your consumption corn. The more savings, or seed corn, the more fields can be planted. But if fake seed corn is created, it tricks the economy into beginning investments that it shouldn’t have.

At some point, people will realise there are not enough real savings to complete the investments begun. And there aren’t enough savings to support the level of consumption that the level of investments needs. That’s what will happen with mining in Australia, just as it happened with housing in the US and Europe.

When the increased amount of savings in the economy turn out to be nothing more than money printing, prices rise and the game is up. Rather than more consumption, there is less.

We’ve probably botched the explanation of all this. So here is a better and far more enjoyable version. These are some of the lyrics to Fear the Boom and Bust:

The place you should study isn’t the bust
It’s the boom that should make you feel leery, that’s the thrust
Of my theory, the capital structure is key.
Malinvestments wreck the economy

The boom gets started with an expansion of credit
The Fed sets rates low, are you starting to get it?
That new money is confused for real loanable funds
But it’s just inflation that’s driving the ones

Who invest in new projects like housing construction
The boom plants the seeds for its future destruction
The savings aren’t real, consumption’s up too
And the grasping for resources reveals there’s too few

So the boom turns to bust as the interest rates rise
With the costs of production, price signals were lies
The boom was a binge that’s a matter of fact
Now its devalued capital that makes up the slack.

Whether it’s the late twenties or two thousand and five
Booming bad investments, seems like they’d thrive
You must save to invest, don’t use the printing press
Or a bust will surely follow, an economy depressed

So how big will the impact be in Australia when the mining boom becomes a mining bust?

‘Half of all the office space in Perth is now tied up with people servicing mining investment,” Gelber says. ”The same is true for a quarter of the office space in Brisbane. Think of all the jobs in the construction sector, the back-line employment. The fall in investment will see a major decline in growth.’

We’re not sure if Perth is a nice place to live, but it will be cheap at some point. Forecasters at BIS Shrapnel ‘estimate an almost two-in-three probability that the boom will end within 10 years, and 90 per cent that it will be over within 15 years.’ We’d be surprised if you have to wait more than five years.

One last thing. You might be wondering whether the Reserve Bank of Australia has even been creating any money for there to be the kind of boom and bust you’ve been reading about. Here are some quick answers:

  • The demand for our resources, which is justifying the boom, is coming from overseas, where there has been vast amounts of money creation.
  • There has been a lot of foreign investment into Australia from places with low savings
  • Central banks aren’t the only ones creating money. Banks do through the process of fractional reserve banking
  • The RBA probably has been holding interest rates below what they would be in a free market and has done so by creating money.

In the midst of all this pessimism about resource investing, Diggers and Drillers editor Alex Cowie continues to be bullish. He explained why here. By the sounds of glee coming from his side of the office at market open each morning, things are going well.


Nick Hubble
for Markets and Money

From the Archives…

Why BHP Should Be Bracing Itself For a China Slowdown
2012-03-30 – Greg Canavan

What Does “the Market” Mean to You?
2012-03-29 – Joel Bowman

Why Australian House Prices Are Set to Crash
2012-03-28 – Dan Denning

Why US Manufacturing Could Be Made in America…Again!
2012-03-27 – Chris Mayer

The Best Real Estate Bets
2012-03-26 – Eric Fry

Nick Hubble
Nick Hubble is a feature editor of Markets and Money and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about Markets and Money, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails.

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4 Comments on "Fake Savings, Detached Investments and the Mining Boom"

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HaHa… Good one, Lachlan!~ :D

Adding some rap:

“When debts are high, inflation’s your mate…
Eats away your mortgage at a 3% rate-
Now that’s per annum, but with each decade
30% of your debt’s free-paid… “


Here I am working in a declining industry and thinking, “Perhaps I should shoot for a job in the mining industry”. Well this article has given me food for thought. The question is where else to go?


All I know Ray is that the Surat basin amongst others is being turned upside down and it’s hard to imagine it’s going to stop since it’s barely begun.

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