Beware Australian exceptionalism

We’ve seen in the person of Jeremy Grantham that sometimes it takes an external observer to cut through the local fog and understand the risks facing the nation. Today, in an exclusive interview with the AFR, economist Willem Buiter joins Grantham:

“Australia is a small, open economy with a floating exchange rate,” Mr Buiter said.

“Countries like that are vulnerable to shocks from China, liquidity shocks in global funding markets and lots of things you can’t do a damn thing about but that would hit you as surely as the tsunami that hit Japan.

“So one worries sometimes about the difference between being satisfied and being self-satisfied: one can be the first but not the second. The message is ‘beware Australian exceptionalism’.”

Such words are music to my ears. MacroBusiness was in part founded to track the risks that surround the Australian economic miracle. It’s often a thankless task in which we are labeled doomsayers, doom and gloomers etc, but nothing could be further from the truth. Risk analysis is essential if both the nation and/or your finances aren’t simply going to sail blithely off a cliff one day. Buiter lists all of the risks that exercise us often at MB. First, an over-reliance on China and Dutch disease:

…“Even though we don’t consider China to be at risk of a hard landing, it will be highly cyclical and Australia is going to be the tail wagged by the Chinese commodity dog. It’s great while the going is good, but it makes you vulnerable.”

…Mr Buiter claimed that as a result of strong global demand for resources, Australia had caught “a bad case of Dutch disease” – the de-industrialisation of a nation’s economy that occurs when a natural resource boom raises the value of its currency and hits exporters such as manufacturers.

Next, the big banks reliance on external funding and very importantly excessive private debt, as opposed to the small public debt so often trumpeted:

“Now that everyone else is in the process of de-leveraging and restructuring, Australian banks are still funded to a significant extent in global wholesale markets – not a place you really want to find yourself, given the storms raging through it.”

…“It’s the private debt, of course, that is an issue,” Mr Buiter said. “It has brought countries like Portugal, Spain and Ireland almost to breaking point – and of course in bad times private debt often then becomes public debt.

“It should look at corporate leverage and banking sector funding needs and ask itself ‘should we go in for more regulation … such as tighter loan-to-valuation ratios for mortgages’.”

Again, well worth consideration. Macroprudential tools could enable the RBA and/or APRA to, on occasion, control the distribution of credit as well as its price, and would be very useful. Consider for instance that the bank could cut interest rates and tighten LVRs, ensuring that lower interest rates were passed more precisely to parts of the economy that they wished.  It is a crude example, but right now the RBA could use such a mix of policies to free more discretionary spending and lower the dollar without boosting mortgage issuance. Of course no such thing is possible when there is no discussion of risk. Finally, Buiter fingers housing:

…“It is clear one has to pay close attention to the sustainability of the Australian housing market and the associated household mortgage debt burden, because there hasn’t been a serious run of house price inflation in any advanced economy in the last 30 years or so that hasn’t ended in tears.

…He added: “One should always be concerned about housing because the longer a strong housing market lasts without a crunch the more households will leverage up, borrowing against strong or rising house prices to fund all the good things in life.

Bravo Willem Buiter, and taking his advice I’ll reaffirm my view on Chinese and local growth. Buiter’s Citibank sees Chinese growth at 8.5% and Australian growth at 3.5% this year. I’ll take the under on both.

Houses and Holes
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  1. …Australian growth at 3.5% this year

    this guy seemed very credible until that.

        • GDP figures (indeed, any government data) cannot be taken seriously.

          The fine print of MYEFO 2009/10 stated thus:

          * The 2008-09 Annual National Accounts show a substantial increase in the level of GDP over history due to the ABS adopting the new System of National Accounts 2008. Given the degree of increase in the level of nominal GDP, the Government has released updated tables of fiscal aggregates contained within Appendix D of the 2009-10 MYEFO.

          Comparing the originally published FBO data in previous years, to the “revised” data under the new “System of National Accounts”, shows an increase of approx. 4.5% to nominal GDP thanks to the new system of accounting. We don’t know what 2008/09 GDP would have been under the prior system.

          Most convenient that in the GFC year – when all thanks to wonderful economic management, we “escaped” a technical recession – that a new system of accounting was introduced resulting in a magical extra 4.5% of GDP for prior years … and who knows how much extra in 2008/09.

          When we then consider that then-Finance Minister Tanner later admitted in his book “Sideshow” to having engaged in the “dark arts”, including “standard tricks” such as “changing methods of accounting”, one wonders why anyone takes GDP figures seriously.

          • Good find. Thank you. I calculated it manually.

            Even more interesting that the admission to this “substantial increase” in GDP was buried in the fine print of the MYEFO, released 2 November 2009. The Treasurer’s press release more openly admitting it that you’ve linked above, dated 9 December 2009. Over a month later. Just before Christmas.

            “Oh dear, Julia, we missed the boat for press coverage of this substantial revision … what a shame!”

            Casts the government’s much-touted pledge to keep spending growth restricted to 2% of GDP in rather different light, doesn’t it.

          • And Treasurer’s press release issues 2 weeks after Parliamentary sittings closed for the holidays … and the eyes of the world’s press (and a huge Australian contingent) focussed on the IPCC Copenhagen Conference, which began 2 days prior.

            “Dark arts” and “standard tricks” “in order to maximise political appearances”, ‘eh Mr Tanner?


      • I’ve said a few times that if housing continues to drift down at the same rate as last year, plus the government actually does try and pull back spending to get a surplus next year, then under 1.5-2.0% by year end but testing negative in Q1 next year.

        • I dont ever trust any numbers from China so its hard to make a call but I agree it will become negative next year. Of course the bulls will tell you its going to boom forever. LOL

  2. “I’m not as worried about Australia as the Scandinavian economies, but just because Australia was either wise or lucky, or both, in the run-up to the current crises doesn’t mean it’s immune and unique. One has to practise eternal vigilance.”

    Sounds a bit like Bodin (Six Books of the Commonwealth) on a type of myopia induced by natural resources wealth (blessings of the land) –

    “…men of fat and fertile soil, are most commonly effeminate and cowards; whereas contrarywise a barren country makes men temperate by necessity and by consequence careful, vigilant and industrious.”

    Anyway he notes that countries such as Australia can be hit by a range of ‘shocks’ many “things you can’t do a damn thing about”. Apart from maintain a certain vigilance!

    We haven’t caught a bad case of Dutch Disease (more appropriately applied to resource rich developing nations) but like Canada, we may have China Syndrome.

    • Commodities boom = high dollar = Dutch disease

      I will accept the rationale that these forces have been worsened by currency wars. But worsened not caused.

      • Dutch Disease, so passé, an easy journalistic phrase – move with the times:

        “This paper examines the extent to which the Canadian economy is suffering from ‘Dutch
        disease.’ It presents empirical evidence about the degree to which the booming resource sector is affecting the rest of the Canadian economy.
        Contrary to expectations, the paper finds that Canada is not in the throes of ‘Dutch disease.’
        Rather, the empirical investigation suggests that the Canadian economy and labour market have
        proven themselves flexible enough to adjust to a higher commodity price and higher dollar
        environment. Moreover, although both the Netherlands and Canada experienced a currency
        appreciation in conjunction with a resource boom, the sources of the boom are distinctly
        different and are leading to different adjustment paths.”

        Just as we are in the process of adjusting right now!

        • Sure we are adjusting but it is because of Dutch disease, not because we don’t have it.

          When resources fall in price, close surplus capacity or run out, that is when we realise that we let our economy become overly dependent on one sector. That is the terminal stage of Dutch disease.

          The current stage is where you limp a bit to offset the pain in the gangrenous foot and apply local remedies. In the terminal stage you realise that your leg has been amputated above the knee and you can’t stand up.

          • No. We are adjusting because with have China Syndrome! Just as the Canadian economy adjusted, so are/have we.

            The challenges are magnified by the simultaneous end of the credit era and softening of the property market much Australian household ‘wealth’ was built on.

            Dutch Disease more properly belongs to developing nations (and even then with strong caveats), solely dependent on a natural resource base. Australia has a sophisticated and diversified economy, strong institutional framework etc and is not as reliant on a single resource, as say Nigeria is reliant on oil. End of oil in Nigeria, disaster. End of mining boom here, difficult adjustment but a substantial economic infrastructure remains.


          • But doesn’t mining make up 80% of our economy? I mean it makes up over 80% of articles about the economy.

            Don’t confuse me with facts.

      • so a carry trade funded by large interest rate differentials is not a major cause of a high currency?

        • Are you arguing the commodities boom is irrelevant to the interest rate?

          Come on you two, give us a break from this mining bias. There are downsides to the boom. It won’t help your cause to deny them. You’ll just slowly but surely put the people off.

          • HnH, no mining bias in what I have said here – simply calling attention to the Canadian position, another strong resource economy and a report that did not find Dutch Disease, but rather a phenomenon, ‘China Syndrome’. Read the paper, sounds a bit like Oz.

          • when the dollar fell back to 95c a few months ago it was it because the commodities boom ceased?

          • Moderator should not allow personal attacks even if it is on a Clown.
            China GDP_was 12% now its 8% ish.
            That is a drop of a third right?
            So does that translate to a third less Iron Ore?
            I have shorted FMG because I think the answer is yes! Time will tell.

          • Punchy — water off a ducks back. If you are not anti-mining here you get that.

            regarding ore:

            General comment: Reduction in growth does not equate to a reduction of demand, it equates to a reduction in the growth of demand.

            If for example China’s steel industry paralleled China’s GDP that would mean it would grow by 8% which in turn would mean that demand for ore would grow by similar levels.

            Much has been written about the Chinese steel industry — too much to discuss in a couple of sentences. The bottom line is that at this stage it is not declining demand that is likely to cause problems for ore volumes over the next 2-3 years.

          • Reduction in growth does not equate to a reduction of demand

            Krusty: Chovanec thinks investment could actually decline as a result of a bursting property bubble.

            I want to emphasize that the calculations I’ve played with here are not meant as a precise prediction of what actually will happen in 2012, but as a thought exercise that highlights just how dependent China’s rate of GDP growth has become on not just high, but ever-rising, levels of real estate investment. The main take-away being, you don’t need a collapse, you just need the runaway rate of growth to slow, in order to drain the pool.

            If investment actually declines — which is hardly unthinkable based on other property booms and busts — the picture is even worse. For instance, if property investment falls 10% (in real terms) in 2012, GDP growth drops to 5.3%. Even if investment grows at 10% (half last year’s growth rate, in real terms), GDP still drops to 7.9% — below the magic 8%. You can plug in any numbers you like, and see what you get. The point is, real estate has been a huge driver of growth, and even a modest real estate slowdown matters — it can’t just be brushed aside as though it were of minimal consequence for the broader Chinese economy.

            I also want to emphasize — before we get totally preoccupied with the fate of the property bubble — that the property story is really just one aspect of a much broader investment boom that has been driving the economy. If real estate accounts for 10-13% of GDP, investment in fixed assets accounts for roughly half. The health of the property sector is particularly important in China because of the pervasive role that land values play in underwriting lending, but the risks to China’s economy extend far beyond the market for homes and offices. For China, real estate is just the tip of a much larger iceberg, one that I’ll explore in my next “China data” installment.

            As Chovanec points out often. China faces a massive challenge just to build the same amount of stuff it built last year, let alone build more.

          • Reduction in growth does not equate to a reduction of demand

            Krusty: Chovanec thinks investment could actually decline as a result of a bursting property bubble.

            Lorax that answer is written in reply to Punchy wondering if a drop in growth by one third would mean a drop in demand for ore by one third. Hence a generic answer that a drop in growth from 12 to 8% doesn’t mean one third as much steel gets made. etc. etc.

            Nothing to see here. Move along.

  3. reusachtigeMEMBER

    This guy doesn’t know what he is talking about. Aussie, Aussie, Aussie, Oi, Oi, Oi !!!

  4. Jeremy Grantham says that Commodity prices have entered a new paradigm and backs it up with a statistical analysis of the probabilities of so many commodity prices escalating at one time.

    He also has spoken about climate change, a finite world and resources, how would a corporation value the damage to the environment in 20 years time or the impact on your grandchilds life of the delayed impact of today’s investment decisions.

    Some will argue that he’s wrong, but he seems to be thinking more deeply and more long term than most in the FIRE sector.

    • If I remember that letter correctly, he admits he may be wrong himself – it is a big call as it goes against a long history of falling prices – plus I’m also pretty sure he says to expect some volatility in those prices.

      The only way to really find out is to wait and see, although based on history I think it would be smart for the federal govt to maintain support for the manufacturing sector as a kind of insurance policy.

  5. We lecture the rest of the world on debt, but our combined private, business, state and Federal debt on a per capita basis is pretty large, and this is an economy that has little other than mining, and housing. Amazing really, and I can’t see how, in a few years time we’ll be smiling about how we got here.

    At the same time we’re cutting back on R&D, and education.

    I was at the Tyabb air show yesterday, and found out our last real aircraft manufacturer is being sold to India.

    Shame on Australia…

    • When you have 50 years of current account deficits it means you have 50 years of foreigners accumulating our dollars. They have to do something with them.

      Persistent structural CADs must lead to selling off the farm.

      • Krusty, the clown replacing Flawse, the CAD?

        BTW, RP Data has responded to your query – As I predicted, they need to ask Rismark about the statistical error.

        • I reckon I’ve been banging on about the CAD for at least as long as Flawse — but not as frequently. It is the reason why I don’t think we should have a SWF, i.e. we are accumulating sovereign debt not sovereign wealth.

          I’ll check out the RPData response. thanks.

  6. Krusty, the AUD is the carry trade.

    Total Australian Exports Annually (Iron, Coal, Wheat, Wine, Ear Widgets etc) are in the low $200B area.

    AUD traded DAILY is over $300B.

    One years exports don’t equate to one days traded AUD volume. Don’t get drawn into it.