Is Australia Running out of Luck?

An interesting article appeared in yesterday’s Sydney Morning Herald entitled “Slugging it out over our future direction” (hat tip to John Murray for alerting me to it). In the article, investment ‘experts’ are asked to make predictions on the Australian economy for 2011. While a number of analysts are fairly positive on China and the Australian economy, two comments stand out for their overwhelming bearishness:

The global head of economics at Macquarie, Richard Gibbs, has warned that the mining bonanza is a fool’s paradise.

Gibbs believes China will increasingly look to Africa and Latin America as alternative sources of crucial commodities.

”As each year goes by, we get closer to the year when the Chinese are going to bring to the table significant new competing supply,” he says.

Australia’s two-speed economy, in which mining services growth outstrips other sectors, is a liability, Gibbs says. ”In the same way the gains in China were magnified in the Australian economy, any losses in China will be magnified. It is a double-edged sword.”

Investors should position themselves for a rocky ride over the next few years, Gibbs says, because ”this is not going to be smooth sailing; it is not back to business as usual”.

”I’d be looking at companies with good cash flow … continuing to keep some of my cash locked down in term-deposit facilities”.

…”Safe as houses” is a well-worn expression, but the MLC Investments strategist Brian Parker says the notion that Australian real estate prices can move in only one direction could go out the window. ”Residential property looks absolutely obscenely overvalued and seems to offer very, very poor investment prospects,” he says.

Wow. I couldn’t have said it better myself. As I have warned many times before, Australia’s over dependence on China and debt-fuelled housing growth is its key vulnerability.

Over the past ten years, Australia’s ‘miracle’ economy has ridden on the back of twin booms: the debt-fuelled housing market and the China-led commodities market. This dynamic is illustrated by the below chart, which shows the rapid growth of household debt levels, real house prices and the terms-of-trade (ToT) since 2000. Whilst other economies experienced hardship in the wake of the technology stock market crash of the early 2000s and the recent Global Financial Crisis (GFC), Australia’s economy has marched onwards and upwards.

But to expect the ToT to remain near 100 year highs and household debt levels and house prices to rise further from their current stratospheric levels is delusional. The fact is, sooner or later China will slow and households will deleverage, bringing asset prices down, reducing consumer spending, and increasing unemployment. In short, all of the good fortune that Australia has experienced over the past decade will unwind and a deep recession will likely ensue. Australia’s economic fortunes will then need to be earned the old fashioned way: through hard work, innovation and productivity enhancements. We will no longer be able to rely on digging holes in the ground and increasing borrowings for growth. The free ride will be over. 
There is also a longer term issue that the ‘experts’ missed: Australia’s ageing demographic structure. As shown by the below chart, for the past 25 years, Australia’s total dependency ratio – the ratio of the non-working population, both children and the elderly, to the working age population – has been in a demographic sweet spot. That is, there has been a high proportion of working age people supporting only a small pool of dependents.

However, from 2011 onwards, Australia’s dependency ratio is projected to worsen progressively as the baby boomer generation enters retirement. This increase in the dependency ratio will, other things equal, act to reduce Australia’s economic growth, consumption and asset values whilst, at the same time, requiring increased taxes. Readers seeking a better understanding of the impact of Australia’s ageing population are encouraged to read these articles.

Clearly, there are significant downside risks to the Australian economy. Anyone extrapolating the past decade’s performance into the future is bound to be sorely disappointed.

Cheers Leith
Unconventional Economist


  1. Oh dear lord, did you see this other gem from that article? "But a report by the Morgan Stanley global economics team says the mining boom is less vulnerable to China-related setbacks now because it is increasingly investment driven, rather than terms-of-trade driven, as it has been." So what are we going to do when the terms of trade collapse – keep building new mines just for the sake of making the investment then start stockpiling all the unsold iron ore? Reminds me of the Australian wool stockpile, and we all know how well that turned out.

  2. Imagine a muni crisis in the US hit this year coupled with a China slowdown/crash and escalating Euro problems? Australia and its commodities sector would be decimated. After this would come the banking system with the housing market and I rekon were the next Ireland.

  3. well, 2011 is supposed to be the year of the Rabbit. Perhaps we will follow it down the hole