In December 2010, David Murray, Chairman of the Future Fund and former CEO of the Commonwealth Bank, issued a stern warning on Australia’s high level of net foreign liabilities, which had reached nearly 60% of GDP.
Then in March 2011, Mr Murray warned that Australia’s high house prices make the economy vulnerable to overseas events, particularly a sharp fall in commodities prices.
And in November 2011, Mr Murray admonished the complacency evident amongst Australia’s policy makers as well as the debt-fuelled housing addiction that has compromised Australia’s economic future.
On Friday night, Mr Murray launched his biggest attack yet in the above video interview on ABC Lateline, with Emma Alberici (click here to watch original HD version). It’s a brilliant interview that covers most of the key risks facing the Australian economy, and I highly recommend that you watch it. The transcript of the interview is provided below:
EMMA ALBERICI, PRESENTER: The state of the country’s finances are in much worse shape than politicians are telling us. That is the conclusion of a new report by the Centre For Independent Studies. Its review of policy announcement and other… announcements and other budget pressures show that new commitments adopted in the last three years could add as much as $28 billion to spending by 2020. These new measures are accumulating at an alarming rate, it says, and have been given deferred start dates which means the full fiscal consequences will only become apparent well into the future. If the trend continues, Australia will face the same problems as Europe: the government sector too big to sustain.
It is an argument also being mounted by David Murray, the former head of Australia’s sovereign wealth fund, the Future Fund. Government spending now represents 36 per cent of GDP, and he says is on an alarming trajectory. David Murray joined me in the studio just a short time ago.
David Murray, thanks very much for joining us on Lateline tonight.
DAVID MURRAY, FORMER HEAD OF THE FUTURE FUND: Thanks for having me.
EMMA ALBERICI: I wanted to first of all gauge your reaction to the report released today by the Centre For Independent Studies that shows that if Australia doesn’t rein in Government spending, it faces the same sorts of crises that we’re seeing in Europe.
DAVID MURRAY: That is the very case that I have been putting recently, and the point, I think, to remember is that the profile of the Australian economy features a volatile revenue base – because we are commodity dependent and we’re price takers – but at the same time, we have a semi-permanent current account deficit – or almost permanent current account deficit – which has to be funded from offshore.
EMMA ALBERICI: Which means we buy more from overseas than we sell?
DAVID MURRAY: Yes, but for each dollar of current account deficit you’ve got to borrow a dollar from a foreigner, and… whether it is the Government or private sector. At the same time, we have very high net foreign liabilities already. So the combination of those three things, if I was giving you advice as a business, I would say you cannot afford very much debt at all in that circumstance. To keep providing more Government entitlement that is debt funded, is not very smart, and it is the track that Europe has been down. The whole point about leadership at Government level, business level, family, anywhere, is to get a grasp on reality – that is what Europe has not been doing.
And the trend in our public finances for some time has not been very sound. At the same time, there is a culture in Australia of never-ending boom and never-ending high commodity prices. I first predicted some time ago that the iron ore price would peak in 2012/13… sorry, 2013/14 and here we are in 2012 and it has already peaked. But when I made those comments, people used to say, “Well, that is just completely pessimistic”. The reason I made them was a reality check. What if the boom doesn’t go on? How do our public finances look?
EMMA ALBERICI: According to the Centre For Independent Studies, they estimate that if current commitments are followed, they will add something like $28 billion a year to Government spending from about 2020, or within a decade. It goes to the point, though, of what we want to spend our money on though, doesn’t it? I mean, the Government has made a pretty firm commitment to the National Disability Insurance Scheme; would you say they shouldn’t have done that?
DAVID MURRAY: No, the point is not what we want to spend our money on, it is what we want to spend somebody else’s money on. It is borrowed. You can accelerate growth by issuing bonds and creating activity in the economy and you can decide what that activity should be, but if it doesn’t work, you have to repay that growth. You cannot do it endlessly, as governments in Europe have done, without subjecting your own people to a future crisis. As we have seen in Europe. It has reached the point for us, with the shape of our economy, that in my view it has gone too far already.
EMMA ALBERICI: What has gone too far? The commitments?
DAVID MURRAY: The size of the debt, given the structure of our economy, combined with the shape of a lot of the state budgets.
EMMA ALBERICI: The argument, of course, from Wayne Swan is we are AAA rated, our debt is AAA rated by all three global agencies. As a proportion of GDP, our debt is the lowest in the OECD, at less than 10 per cent or thereabouts – our net public debt that is. In respect of the G7, they are 10 times larger than us, so where is the risk?
DAVID MURRAY: The risk is about the shape of the Australian economy, not the shape of somebody else’s economy. The other risk is that we’re talking about a measurement for Australia and comparing it with measurements for other countries that are severely bad. So, we are comparing 20-30 per cent of GDP in Government debt with countries that have 50-100. But 100 per cent is a ridiculous number. It shouldn’t even go close to that, ever.
So, we are comparing it with the wrong things; we’re not taking account of the peculiar shape of the Australian economy, and we are not combining that number with other things. Net foreign liabilities of 57 per cent of GDP is a very high number; and we have just been through the biggest boom in our history, the biggest mining boom in our history, yet the current account is still in deficit. So, one would have thought that if the boom was that good, we would have got to a surplus in the current account – let alone the trade – which is only a very small surplus.
EMMA ALBERICI: Do you think the Government can report a surplus?
DAVID MURRAY: My guess… I thought – and I said so at the time – that the budget was pretty rubbery; leading and lagging of revenues and expenses. And that it’s now very dependent on mining taxes. With the iron ore price where it is – and I am more in the camp that it won’t recover back to where people say – that there is a hole in the Budget, and then also with increasing job losses in the public sector and in the non-mining private sector, that that will have a second round affect on the Budget which will make it nearly impossible, in my view, to achieve a budget surplus. But, if one’s achieved by lagging expenditure – playing games with the numbers – then that makes it increasingly difficult in the subsequent year to manage the economy sensibly at all.
EMMA ALBERICI: Now, the Commonwealth budget is providing more than $20 billion in equity to the National Broadband Network; it is all funded by debt. The Opposition says it wasn’t a necessary or affordable expenditure at this time. Are they right?
DAVID MURRAY: My view about that is, you know… in a great country, there is a government – and we’re talking all governments of any persuasion – there is a government that wants to be held accountable, and an electorate that wants to hold their government accountable. And 24/7 spin in the media and rubbery budgets and all sorts of pronouncements every day about little things – without any comprehension of the larger issue – make it very hard for people to hold their government accountable. The issue with the NBN is that there is no system of accountability which demonstrates the effectiveness, the productivity outcome of large public infrastructure investments. No transparency of cost-benefit analysis that proceeds a decision – and, of course, the issue with the NBN is it is extremely expensive and it is being funded off-budget, but it does require the debt. There should be ways of trying to do that less expensively, but the real issue is one of accountability and doing the publicly transparent cost-benefit analysis up front and that wasn’t done.
EMMA ALBERICI: How much of a constraint to business is the industrial relations framework as it sits now, because there is a lot of criticism about it from company bosses, and directors all over Australia. How big an impediment are the current IR laws?
DAVID MURRAY: I think they are substantial. But the issue for Australia is that our cost structure has just got too high, and it is in that regime that that has happened, and that will be hard to turn around when the terms of trade… as the terms of trade continue to come back to a more normal position.
EMMA ALBERICI: Where people find it difficult to break through on this issue is: you have Government saying that what business is asking for is lower wages. Is that what business is asking for, the ability to cut the cost of the payroll?
DAVID MURRAY: No, that is rhetoric.
EMMA ALBERICI: What is it about industrial relations that is hampering growth in business?
DAVID MURRAY: Usually it is flexibility.
EMMA ALBERICI: What sort of flexibility, can you give us some detail?
DAVID MURRAY: What happens normally: with new technology, which is the basis for future prosperity and productivity improvement, there must be a change process to adapt to it. And new technology has the affect of fracturing work. So in a great company, people will be trying to make continuous improvements in their work processes to reflect new methods – new technology and new methods. Many of the structures in Australia prevent companies from making those continuous improvements because you have got to change the work requirements of an individual, change their authorities; and often the industrial relations law is so intrusive that you can’t do that without a complete renegotiation.
EMMA ALBERICI: When we talk about what is holding the country back, you have discussed leadership generally and said there is a cultural problem. What do you mean by that?
DAVID MURRAY: Well, any organisation or country needs a culture that will naturally drive its productivity and prosperity. That culture is affected by what goes on around people – by mythologies – and if people do not have the freedoms, and the mythologies are about the wrong things… for example one mythology is “debt is OK”. It is OK to fund entitlements with debt because it has been happening for so long it must be OK.
EMMA ALBERICI: But neither side of government says that is OK. In fact both of them talk about trying to cut the debt.
DAVID MURRAY: Yes, but whilst governments have been saying that, they have been doing the opposite, and that is the issue. It is about leader behaviour and… so the system has to work to allow the productivity to come out, and the leader behaviour has to sit behind that to make sure that people understand what is affordable and what is not affordable, and we’re not really having that debate. People have been allowed to continue in a belief that this commodity boom would go on a long, long time and it was never going to go on a very long time. That is a mythology that leaders allow to continue, for somehow in their own interest, and it is not a smart thing to do as a leader.
EMMA ALBERICI: And just finally, you have been a critic of the quality of political debate generally in this country. Is that an inevitability of what was a hung parliament, and can you offer any suggestions that would improve the situation?
DAVID MURRAY: Look, a hung parliament is never easy. I wouldn’t… I probably couldn’t do the job that many try to do faithfully in Canberra today. It is a very difficult structure. But I think, you know, at the same time, perhaps the structure of political parties has matured, and that we have moved on so far. One would have thought that with the reforms that Hawke and Keating undertook, it moved Australia a very long way in a fairly short time. I don’t think there has been a lot of reinforcing further structural improvements in the economy since that time. There has been some high quality financial management since, but neither side of politics, in my view, is putting up some serious structural reforms, and I think that is tiredness of the structure of the parties.
EMMA ALBERICI: We have to leave it there. Thanks so much for coming in this evening.
DAVID MURRAY: Thank you.
The arguments put forward by Mr Murray remind me of similar warnings by Professor Michael Pettis, who in mid-2010 made the following remarks about the risks inherent in highly-indebted commodity producing nations, like Australia:
Not only are commodity prices volatile, there is a long history suggesting that global liquidity dries up at the same time that commodity prices collapse. This is a deadly combination for highly indebted economies with big commodity sectors…
Countries with a lot of short-term debt, external debt, and asset-lending-based banks, especially large amounts of real estate lending, are far more vulnerable than they might at first seem because the debt burden is likely to soar at the worst time possible – just when everything else is going wrong…
In fact some of the recent “star” sovereign performers [Australia?] may very well be the biggest risks, since their great performance may have been caused in part by highly inverted balance sheets. These kinds of debt structures ensure that good times are magnified, but they also ensure that bad times are exacerbated…
When the economy is doing well, rising asset prices make existing loans seem less risky and encourage riskier debt structures (i.e. loans whose servicing cannot be covered out of minimum expected cash flows) because creditworthiness seems constantly to rise. But once the crunch comes, asset values and creditworthiness chase each other in a downward spiral…
Twitter: Leith van Onselen. Leith is the Chief Economist of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.
