What Australia’s Trillion Dollar Foreign Debt Really Means

Australia’s foreign debt position is bad, and it’s getting worse by the month.

Net foreign debt is fast approaching the trillion dollar mark. It ballooned to $967 billion in the quarter to June. That’s up 10% from the $871 billion deficit in March.

Since 2010, foreign debt has increased by almost $350 billion. And it now represents almost 60% of Australia’s GDP.

If you weren’t already aware, foreign debt is simply what we owe to foreigners. It represents the amount we’re obligated to pay back — with interest.

High foreign debt could be a sign that we’re living beyond our means. But you’d be hard pressed convincing everyone of this. Some think that raising alarm over net foreign debt is nothing but scaremongering.

Even our very own government is dismissive of its importance. Here’s a quote from the Parliament of Australia website:

‘[Foreign debt] hardly represents anything new. Australia has always been a net recipient of overseas funds because investment opportunities in Australia have always exceed what can be funded from the domestic savings of its population.

This has led to capital inflow that has built up capital, income and wages, but has also increased our net foreign liabilities, most of which are foreign debt rather than foreign equity.

The size of Australia’s foreign debt would be a cause for concern if it was mainly caused by increased consumption rather than increased investment, raising concerns that Australia was living beyond its means. However, Australia’s national saving and national investment levels are both above their long-term average, suggesting Australia is well able to cover the servicing of its debt’.

They don’t really believe that, do they?

How can anyone conclude that soaring foreign debt is financing investment, and not consumption? The figures speak for themselves.

Capital expenditures (capex) fell 3.9% in the quarter to June. Year-on-year capex is down by 10%. At the same time, retail consumption rose 4.7% over the same period.

That tells us rising foreign debt is going towards something. But it can’t business investments. So what does that leave? Consumption, of course. Business spending is at its lowest level in years. And it’s in stark contrast to robust consumption levels. What gives?

Reading between the lines, the answer is obvious. Here’s a passage from that quote above one more time:

The size of Australia’s foreign debt would be a cause for concern if it was mainly caused by increased consumption rather than increased investment, raising concerns that Australia was living beyond its mean.

What conclusion can we draw from this? Australia is already living beyond its means.

Net foreign debt is rising, and nothing suggests it will start falling anytime soon. How do we know this? Because, as we’ll see, Australia’s trade position is getting worse.

Current account deficit falls 41% in June quarter

Foreign debt is rising partly as a result of Australia’s growing trade deficit. The current account deficit fell 41% in the June quarter, to $19 billion.

What is the current account deficit? Simply put, this deficit measures the difference between total exports and imports. And right now it’s showing that, as a country, we’re importing more than we export.

Now, the fact that the deficit slumped isn’t all that surprising. Amid sluggish commodity prices, a widening deficit was expected. But nobody expected such a dramatic drop. At $5.5 billion, it amounts to the single largest quarterly drop this decade.

The outcome of this is that foreign debt is growing rapidly.

Yet getting out of this situation is something Australia has little control over. Why? Because China was, at one time, our safety valve. But we can’t rely on it anymore as its economy slows.

We’d need a Chinese recovery to lift demand for Aussie exports again. But that won’t be happening anytime soon.

China manufacturing dips again

China is in terminal decline. There’s no getting away from this. Everything, from trade to manufacturing, is falling. And it’s adding to Australia’s foreign debt crisis.

Just look at the latest manufacturing figures coming out of China.

The Purchasing Managers’ Index (PMI) fell to 49.7 this month. That’s down from a 50 reading last month. It doesn’t sound like much. But a 50 index reading indicates a steady manufacturing sector. Any reading below this suggests shrinking manufacturing activity.

That’s just one example of many.

Just today, ANZ predicted Chinese growth to slow to 6.4% in the second quarter. That’s well short of the 7% target the government set earlier. But that’s the direction China is heading in. Every metric points to a drawn out economic slowdown.

Why is China so important to our foreign debt position?

Australia’s entire exporting sector depends on robust Chinese demand. With commodity demand slowing, we’ll continue importing more than we export. And that ensures we’ll require more foreign debt to fund this deficit.

Rising net foreign debt is a big problem, contrary to what some may say. And this debt isn’t going towards business investments. Rather, it’s ending up as the source of funding for consumption.

That’s a sure sign as any that we really are living beyond our means.

Mat Spasic,

Contributor, Markets and Money

PS: According to Markets and Money’s Greg Canavan, the Aussie economy is sleepwalking into a recession.

In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why economic growth is going to fall sharply over the next five months.

Falling mining revenues, and higher trade deficits, are already taking their toll on the economy. Government revenues are down, household debt is up, and business spending is falling too. It’s a grim outlook, and one which could shock the economy to the core.

But there are actions you can take right now to lessen the blows of the recession.

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