Australia’s Economy is a House of Cards

Australia’s Economy is a House of Cards, by Matt Barrie.

Australia has just snatched the world record from the Netherlands, achieving its 104th quarter of growth without a recession, making this achievement the longest streak for any OECD country since 1970. …

For over a quarter of a century our economy mostly grew because of dumb luck. Luck because our country is relatively large and abundant in natural resources, resources that have been in huge demand from a close neighbour, … China.

Out of all OECD nations, Australia is the most dependent on China by a huge margin…

The Chinese bubble is built on relatively huge amounts of debt, which may implode sometime soon as debt-driven expansions always do:

As a whole, the Australian economy has grown through a property bubble inflating on top of a mining bubble, built on top of a commodities bubble, driven by a China bubble.

Unfortunately for Australia, that “lucky” free ride is just about to end. Societe Generale’s China economist Wei Yao said recently, “Chinese banks are looking down the barrel of a staggering $1.7 trillion— worth of losses”. …

A hard landing for China is a catastrophic landing for Australia …

What makes this especially dangerous is that it is unwinding in what increasingly looks like a global recession — perhaps even depression, in an environment where the U.S. Federal Reserve (1.25%), Bank of Canada (1.0%) and Bank of England (0.25%) interest rates are pretty much zero, and the European Central Bank (0.0%), Bank of Japan (-0.10%), and Central Banks of Sweden (-0.50%) and Switzerland (-0.75%) are at zero or negative interest rates.

The world is already in an emergency stance of cheap money and minor printing, since the GFC in 2008, which marked the end of the huge debt expansion in the West that started in 1982.

In theory making money cheap to borrow stimulates investment in the economy; it encourages households and companies to borrow, employ more people and spend more money. An alternative theory for QE is that it encourages buying hard assets by making people freak out that the value of the currency they are holding is being counterfeited into oblivion.

In reality, the ability to borrow cheap money was mainly used by companies to buy back their own shares, and combined with QE [quantitative easing, i.e. printing] being used to buy stock index funds (otherwise known as exchange traded funds or “ETFs”), this propelled stock markets to hit record high after record high even though this wasn’t justified the underlying corporate performance. …

David Evans Debt GDP ratio welfare, 2015, graph

The inevitable result of a casino economy of asset flipping and central bank stimulus is that, like in a real casino due to “gambler’s ruin”, the casino ends up owning everything. Japan went into emergency stimulation in 1992, 16 years before the rest of the West followed in 2008:

On September 11, 2017, it was reported that the central bank of Japan now holds 75% of all ETFs. No, not ‘owns units in three out of four ETFs’ — the Bank of Japan now owns three quarters of all assets by market value in all Japanese exchange traded funds. …

QE was only intended as a temporary emergency measure, but now a decade into printing and the central banks of the United States, Europe, Japan and China have now collectively purchased over US$19 trillion of assets. Despite the lowest interest rates in 5,000 years, the global economic growth in response to this money printing has continued to be anaemic. Instead, this stimulus has served to blow asset bubbles everywhere. …

When the next recession comes along, the only tool the central banks have left is to print. So they will print. Print and buy.

The initial rally in commodities at the beginning of 2016 was caused by a bet that more economic stimulus and industrial reform in China would lead to a spike in demand for commodities used in construction. That bet rapidly turned into full blown mania as Chinese investors, starved of opportunity and restricted by government clamp downs in equities, piled into commodities markets. …

While volume exploded, open interest didn’t. New contracts were not being created, volume instead was churning as the hot potato passed between speculators, most commonly in the night session, as consumers traded after work. So much so that sometimes analysts wondered whether the price of iron ore is set by the market tensions between iron ore miners and steel producers, or by Chinese taxi drivers trading on apps.

In April 2016, the average holding period for steel rebar and iron ore contracts was less than 3 hours. The Chief Executive of the London Metal Exchange, said “Why should steel rebar be one of the world’s most actively-traded futures contracts? I don’t think most people who trade it know what it is”.

Steel, of course, is made from iron ore, Australia’s biggest export, and frequently the country’s main driver of a trade surplus and GDP growth. … In May 2017, stockpiles at Chinese ports were at an all time high, with enough to build 13,000 Eiffel Towers. …

Over the last six years, the price of iron ore has fallen 60%. …

Global capital goes to where returns are best. Because of the resource curse (a high currency value during commodity booms) and lack of scale due to a small population, Australia is not the place to do manufacturing:

In the 1970s, Australia was ranked 10th in the world for motor vehicle manufacturing. No other industry has replaced it. Today, the entire output of manufacturing as a share of GDP in Australia is half of the levels where they called it “hollowed out” in the U.S. and U.K.

In Australia in 2017, manufacturing as a share of GDP is on par with a financial haven like Luxembourg. Australia doesn’t make anything anymore. …

In Australia, the returns to capital are best in mining, agriculture, finance, and real estate:

In 2016, 67% of Australia’s GDP growth came from the cities of Sydney and Melbourne where both State and Federal governments have done everything they can to fuel a runaway housing market. The small area from the Sydney CBD to Macquarie Park is in the middle of an apartment building frenzy, alone contributing 24% of the country’s entire GDP growth for 2016, according to SGS Economics & Planning.

According to the Rider Levett Bucknall Crane Index, in Q4 2017 between Sydney, Melbourne and Brisbane, there are now 586 cranes in operation, with a total of 685 across all capital cities, 80% of which are focused on building apartments. There are 350 cranes in Sydney alone.

By comparison, there are currently 28 cranes in New York, 24 in San Francisco and 40 in Los Angeles. …

What could possibly be wrong in selling overpriced Australian houses to the Chinese? I am not sure who is getting the last laugh here, because as we subsequently found out, many of those Chinese borrowed the money to buy these houses from Australian banks, using fake statements of foreign income. Indeed, according to the AFR, this was not sophisticated documentation?—?Australian banks were being tricked with photoshopped bank statements that can be bought online for as little as $20. …

The astronomical rise in house prices certainly isn’t supported by employment data. … The average Australian weekly income has gone up $27 to $1,009 since 2008, that’s about $3 a year. …

At the end of July 2017, according to Domain Group, the median house price in Sydney was $1,178,417 and the Australian Bureau of Statistics has the latest average pre-tax wage at $80,277.60 and average household income of $91,000 for this city. This makes the median house price to household income ratio for Sydney 13x, or over 2.6 times the threshold of “severely unaffordable”. Melbourne is 9.6x. … Looking at all regional Australian housing markets, they found 33 of 54 markets “severely unaffordable”. …

I’m not sure how the fundamentals can possibly be justified when the average person in Sydney can’t actually afford to buy the average house in Sydney, no matter how many decades they try to push the loan out. ….

When the Australian housing bubble pops, it will take out the banks with it:

Unsurprisingly, the CEOs of the Big Four banks in Australia think that these prices are “justified by the fundamentals”. More likely because the Big Four, who issue over 80% of residential mortgages in the country, are more exposed as a percentage of loans than any other banks in the world, over double that of the U.S. and triple that of the U.K., and remarkably quadruple that of Hong Kong, which is the least affordable place in the world for real estate. Today, over 60% of the Australian banks’ loan books are residential mortgages. Houston, we have a problem.

It’s actually worse in regional areas where Bendigo Bank and the Bank of Queensland are holding huge portfolios of mortgages between 700 to 900% of their market capitalisation, because there’s no other meaningful businesses to lend to. …

Governments will bail out the banks with … newly printed money.

This is not good debt, this is bad debt. It’s not debt being used by businesses to fund capital purchases and increase productivity. This is not debt that is being used to produce, it is debt being used to consume.

The media?

You don’t read objective reporting on property in the Australian media, which Llewelyn-Smith from Macro Business calls “a duopoly between a conservative Murdoch press and liberal Fairfax press. But both are loss-making old media empires whose only major growth profit centres are the nation’s two largest real estate portals, realestate.com.au and Domain. Neither report real estate with any objective other than the further inflation of prices. In the event that the Australian bubble were to pop then Australians will certainly be the last to know and the propaganda is so thick that they may never find out until they actually try to sell.” …

Immigration:

This brings me onto Australia’s third largest export which is $22 billion in “education-related travel services”. Ask the average person in the street, and they would have no idea what that is and, at least in some part, it is an $18.8 billion dollar immigration industry dressed up as “education”. You now know what all these tinpot “english”, “IT” and “business colleges” that have popped up downtown are about. They’re not about providing quality education, they are about gaming the immigration system. …

The number one country for student visa applications by far was, you guessed it, China.

A long article that credibly paints a picture of Sydney and Melbourne as on course for a perfect financial storm.

Technology story 1 (which I can personally vouch for):

I ended up doing Electrical Engineering completely by accident. I went to one of the best private schools in the country. When I graduated, at careers day, nobody talked about engineering. In fact, nobody even mentioned the word engineering throughout my entire schooling. I honestly thought it had something to do with driving a train.

I was disheartened to go back to that same school, Sydney Grammar, to talk at careers day. The students still thought that engineering had something to do with driving a train.

This is completely nuts, when I told the students that by working in engineering you get to design satellites, self driving cars, virtual reality helmets, design rockets like those SpaceX will one day send to Mars or build the next Facebook, many in the room got excited. Just they didn’t have a clue how to head towards a career in engineering because it wasn’t mentioned once to them in thirteen years of schooling. It’s not just my old school, almost all the schools are like this.

Technology story 2 (which sounds about right — I used to work in Silicon Valley but chose to come back to Australia for personal reasons and could never find a job here that made use of my experience and abilities):

I’ll tell you what my experience was like trying to attract senior technology talent from Silicon Valley.

I called the top recruiter for engineering in Silicon Valley not so long ago for Vice President role. We are talking a top role, very highly paid. The recruiter that placed the role would earn a hefty six figure commission. This recruiter had placed VPs at Twitter, Uber, Pinterest.

The call with their principal lasted less than a minute “Look, as much as I would like to help you, the answer is no. We just turned down [another billion dollar Australian technology company] for a similar role. We tried placing a split role, half time in Australia and half time in the US. Nobody wanted that. We’ve tried in the past looking, nobody from Silicon Valley wants to come to Australia for any role. We used to think maybe someone would move for a lifestyle thing, but they don’t want to do that anymore.

“It’s not just that they are being paid well, it’s that it’s a backwater and they consider it as two moves — they have to move once to get over there but more importantly when they finish they have to move back and it’s hard from them to break back in being out of the action.

“I’m really sorry but we won’t even look at taking a placement for Australia”.

Australia has almost totally missed the boat on technology, without even realizing it. Paul Keating’s banana republic warning is still warranted.