Breaking news from the International Monetary Fund (IMF) today folks…
They say Australia will be the hardest hit developed economy from the China slowdown!
What a revelation. Who would’ve thought?
Well, you certainly knew. I’ve been writing about it for years. Actually, anyone who cared to employ some common sense and restrain their wishful thinking about China wouldn’t be surprised either.
Far from being good for Australia, the long China boom turned us into a quasi-emerging market. That is, we allowed a monstrous commodity boom to change the structure of our economy.
Well, the Australian dollar rose to record highs to absorb the demand for commodities and prevent an inflation breakout. But at the same time, the rising dollar decimated many industries. Tourism and manufacturing were ‘hollowed out’ during the boom years.
The commodity induced wages boom flowed through to others sectors, pushing wages up across the board. This translated into increased borrowing power, which pushed house prices up. Meanwhile, the government distributed its increased tax receipts from the boom into political handouts…handouts that are now proving hard to claw back as the boom fades.
And this is where the IMF research is useful. The lower than expected growth rates will cause havoc with the budget. From the Financial Review:
‘An indicative interpretation of the IMF’s modelling based on Treasury budget numbers also suggests it expects Australia’s annual growth rate will be 2.5 per cent from 2020 onwards, making it harder to return the budget to surplus early next decade.
‘The findings are a reminder for Australia’s new Prime Minister, Malcolm Turnbull, and Treasurer Scott Morrison, who inherit a 10-year budget outlook that assumes the economy will grow 3.5 per cent for five years after 2017-18.’
This is the problem. The previous government assumed that Australia will return to above trend growth within a few years. That strong growth rate does wonders for the forward budget projections. But it’s not going to happen.
Instead, Australia will experience lower than expected growth for years to come. The budget will continue to deteriorate without reforms. Reforms that will prove very difficult to enact.
Recall Glenn Stevens’ hopeful comments that I included in Markets and Money yesterday. He thinks the non-mining sector will come together to boost our economy:
‘We build houses, we build things other than mines, consumers do okay and so on, and hopefully some of the export industries like tourism, education, business services, even some parts of manufacturing grow faster as they get help from the lower exchange rate. I think all those things are starting to happen. But of course it is just a forecast, so we have to wait and see how it turns out. I think there are reasonable prospects we will get those outcomes.’
We’ve definitely had a decent housing construction boom to help offset the downturn in mining. But Stevens reckons it’s only just ‘starting’ to help. Unfortunately, the housing construction boom is at an end.
Take a look at the share price of building products supplier CSR [ASX:CSR]. It peaked back in February this year and is now around 30% off its high. This chart is more ‘boom over’ than ‘boom beginning’.
What about the lower dollar? There is no doubt it’s playing its part. Industries like mining, tourism, and education increase their competitiveness very quickly via a weaker exchange rate.
And our fabled property market becomes cheaper in the eyes of mesmerised foreign investors. This keeps capital flowing into the country.
But there is a flipside to a falling dollar. A lot of the manufacturing that moved offshore over the past 15 years now faces rising costs as products become more expensive for Australian’s to consume.
You don’t get your manufacturing sector back miraculously after the currency falls for a year. It’s takes years of sustained falls for company boards to consider the cost of shifting manufacturing operations.
But even with a low dollar, Australia’s high wage and land costs will likely prohibit any manufacturing renaissance.
The other thing to keep in mind is that we’re a consuming nation. We consume more than we produce. This means we run near constant trade deficits. As our dollar falls, the cost to consume the same amount of goods and services increases.
We either earn more to pay for it (which is not happening) or we borrow more (which is happening). That’s all well and good until foreigners stop lending to us to buy their goods.
In the next few years, you’ll see more commodity boom casualties. Australia’s car industry will shut down in 2017. Thousands of job losses will result, both direct and indirect.
Bluescope Steel [ASX:BSL] wants to shut down the Port Kembla steel works unless it can extract savings of a few hundred million dollars a year. Steelworkers will find it hard to survive on internationally competitive wages and Aussie house prices.
In the next 12 months, the LNG sector will ramp up its exports. But the sad reality is, at these prices, the projects will hardly be economic. Just look at the shares prices of Santos, Woodside and Origin for evidence. They’re all at multi-year lows. It’s because the return on the significant capital they invested in the LNG projects will be very poor.
The loss of wealth is already apparent.
Something has to give for Australia to regain its competitiveness. It can’t just be a lower dollar. We need wholesale reform to drive productivity and remove incentives that encourage rent seeking and housing speculation.
It will be Malcolm Turnbull’s greatest challenge. Weaning Aussies off property will be like trying to convince a Catholic that God doesn’t exist. I don’t like his chances.
Editor, Markets and Money