Why you should get your money out of Little China

Vested interests are everywhere, chipping away at the moral fibre of politicians, tilting taxes in their favour and diverting resources. In a more diversified economy, the vested interests compete with each other for government favours – a waste of money I’m sure, but there is some benefit in that no one type of vested interest dominates.

However, some countries – Australia and China in particular, are focussed on a particular type of economic growth which means the vested interests in that sector become more and more powerful and concentrated.  When the economic growth model is exhausted, these vested interests resist any change – using their political power to stymie a shift to a new growth model. Usually, this means that a crisis is needed before any change can occur.

The Pettis Thesis

This recent Michael Pettis video discusses the growth of China in terms of economic models:

The key point Pettis makes is that China is running a Gerschenkron economic growth model, which has been run by many countries in the last 50 years including Russia, Japan, South Korea and a number of Latin American countries. The model works like this:

  • By repressing consumption China increased their savings rate
  • This savings was diverted into investment
  • Most of the investment was centrally managed infrastructure spending (as the private sector is not good at that kind of investment)
  • China also kept interest rates low (below inflation for many years) which penalized savers and benefitted companies and governments
  • At first, the investment earned great returns (as China was in dire need of investment) and was hugely successful at increasing wealth for everyone
  • As time went on, the investment projects generated lower and lower returns
  • Finally, the return on investment fell below the return on debt and the debt burden began to grow
  • At this point, you would think that a new growth model would need to be created – but in every other country that has followed this growth model they have stuck to the old growth model and kept increasing the debt until some form of crisis forced a change.

It is not a straight line

The themes are similar to ones we have espoused on numerous occasions, and while these themes were considered outlandish 7 or 8 years ago, most economists now recognize at least some of the unsustainability of the Chinese growth model.

But the decline in growth won’t happen in a straight line, the issue is timing and takes years to play out.

For an investor, recognizing this in 2011 and 2015 was very useful for getting out of the way of falling resources and a falling Australian dollar.

Then, in 2016/2017, increased Chinese capital spending (accompanied by rapidly increasing debt) reversed the process.

From here the risks appear to be more to the downside than the upside.

But don’t forget vested interests.

Vested interests made a fortune from the rise of China, and they don’t want the party to stop. More bridges, more apartments, more airports and more train lines.

China’s growth model was unsustainable in 2010 and is less sustainable now. But there is still scope for the model to be pursued for a considerable period of time – with less and less of an effect every year.

My expectation is that we are in the grind lower phase, where minor measures will be attempted to improve growth (with little effect) until growth slows enough or vested interest bleating becomes loud enough for another round of stimulus.

China probably avoids a crisis but each bailout only guarantees steadily choked growth afterwards.

The second derivative of growth

If you were a small, open economy with significant mineral resources, should you choose to restructure your economy by allowing the currency to rise so far that manufacturing was decimated and your economy became dependent on mining capital expenditure which was in turn dependent on an unsustainable Chinese economic growth model?

But it is too late, that horse has bolted for Australia.

The question now is how to restructure the economy in the aftermath.

It appears that the first plan was to lower interest rates, and then look the other way on lending standards, international investment and money laundering as property boomed. Job done!

Now that property is coming off its highs, I’m not sure what came next in government and regulators minds – I suspect most didn’t think that far ahead. For the moment, the plan appears to be to try to keep the housing boom going as long as possible.

For my part, the next “boom” is probably going to be business investment. BUT, that is going to need a much lower Australian dollar, and probably a recession first.

My key point is that the more vested interests resist change, the more the burden is shifted onto the rest of Australia and the lower the Australian dollar will need to fall and the deeper the economic downturn will need to be in order to enact change.

So, who are the Australian vested interests?

Australian vested interests

Pettis talks about the problems of countries that have grown using a Gerschenkron economic growth model being unable to change due to the power of vested interests. But that problem is not just constrained to that particular economic model – it infects all countries who are primarily reliant on only a few avenues of growth.

The Australian vested interests who have done the best out of the last 20 years of growth are:

1. Resource Company vested interests

Mining: The vested interests who benefitted from the mining boom managed to kill the mining tax, and still to this day are hell-bent on trying to prop up the coal industry through some mix of subsidies, reduced taxes, subsidized infrastructure to the Adani mine or penalizing green energy.  Mining vested interests had a key role in deposing a Prime Minister, and so politicians are unlikely to take on the mining sector anytime soon.

Gas: The biggest wins for this sector from vested interests was the PRRT (a complicated scheme for paying royalties which basically results in most new wells not paying royalties) and managing to avoid gas reservation on the east coast. In combination, the sector pays minimal taxes and gets to charge monopoly-style prices across Eastern Australia. As both major political parties are complicit, there is little in the way of political fallout. In a macabre way, you need to respect what the vested interests in the gas sector have achieved.  For the gas sector, it is hard to know what else they could possibly want from the Australian government – what can you give the vested interests that already have everything?

2. Real Estate Vested Interests

Direct: The real estate sector has a considerable hold already over Australian policy. Start with the strategy of running a “big Australia” policy and record immigration. Then add first home buyer grants, special taxation treatment for negative gearing, no capital gains tax on own property, half capital gains on anything held longer than a year, no land taxes, allowing gearing in a superannuation fund to buy property, no compliance with anti-money laundering requirements, and I’m probably missed a bunch of others.

Indirect: Banks, furniture retail,  basically anyone benefitting from a big Australia policy.

Investment Outlook

All of the vested interests are busy working on making sure that the models that made them rich over the last 20 years don’t change. But economic conditions are changing, and these the growth that drove each of these models is becoming exhausted. The question is will Australia need some sort of crisis before the old economic models are abandoned?  If history is any guide, then yes.

The gas sector is going to be a drag on growth for the rest of the Australian economy through higher gas and electricity prices. Both miners and gas companies are “under represented” in the tax tables.

But we are probably at the peak for both mining and gas in terms of skewing the playing field in their favour.

If the property market really starts to gather some losses, I’m sure there are more policy initiatives that can be instigated. Larger first home buyer grants, stamp duty cuts, allowing people to dip into superannuation, more immigration, more tax rorts – there is lots more that can be done. The current Australian Federal Treasurer’s job used to be National Manager, Policy and Research Property Council of Australia – i.e. his job was literally to come up new policies for property companies to lobby the government to skew the playing field in their favour.

So, my expectation is that as the end of the property cycle becomes more apparent, the playing field will actually become more skewed to property vested interests until a serious enough shakeout clears them out.

Where does that leave us?

Vested interests have skewed the playing field in their favour, and so the more the burden is shifted onto the rest of Australia. The Australian dollar will need to fall further and the deeper the economic downturn will need to be in order to enact change.

From an investment perspective, I’m keeping our investors out of Australian equities for now, through a mix of international stocks (valuation dependent), government bonds and cash. And will not return them until the cleansing shock has ‘drained the swamp’.


Damien Klassen is Head of Investments at the Macrobusiness Fund, which is powered by Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.

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  1. ChinajimMEMBER

    Yeah, but the weather is nice.

    Seriously, brilliant piece. I’m glad my money is still all offshore.

    • Superb read. The model is exactly what Australia has evolved and exactly why Australia needs a major socio economic revolution..

      On this…

      but in every other country that has followed this growth model they have stuck to the old growth model and kept increasing the debt until some form of crisis forced a change.

      …..you could easily argue that no country identified has ever moved far beyond the model, and that attempts to move beyond the model involve violent revolution (i’m a big fan of Pettis too)

      handy investment advice too – Australia would be right up there with the worst places on the planet to ‘invest’ at the moment. I have a theory that the only way for individuals to play the rigged system is to take on as much debt as is humanly possible, make minimum payment and hope that so many are doing this that the implication of them all going under is so profound that nobody running the show wants that to happen – for mine it is the RBA & Treasury model too.

      • I have thought about offshoring a shitload of cash by loading up with (unsecured) debt, and then just leaving. If you have a few hundred grand and take a few hundred more that banks offer then you can get yourself set up quite nicely abroad. House, car, business, investments, etc. And all debt free.

        Australia is a hollowed out society, to the point it no longer has a heart. It’s all vested interests gobbling their pound of flesh.

      • + many Gunna ……….. personally, I gain from the housing ponzi due to great quality purchases made up to 25+ yrs ago with the specific plan to provide for myself and family, free of any dependence on any form of government payment and free of dependence on the super ponzi scheme ………. I could have bought more (was being pressured by the ex to buy into Sydney inner city in early 2000’s) but refused to participate in what I saw as a bubble market ……….. chose to invest in the US instead and will continue to change as much AUD denominated assets to USD as I can

        Call me a perma bear or anything else for that matter, but I see no hope for Oz until a large, really bad crash happens that triggers a re-set. Unfortunately, I also think the interest groups and individuals most responsible for this disgusting mess are on average, also the people who will probably be least impacted by the social and economic fallout of the re-set

    • Pettis just described Australia. Except all our savings went into debt to buy houses (and shite to fill them up with)

  2. rj2k000MEMBER

    One can rebel against the biggest vested interest parasites, the banks, by using your funds to buy assets you legally own safe from GFC 2.0, instead of losing it in a bank bail-in.

    The banks use *your funds* and leverage it x20 to lend to bidders that bid against you at auctions, pumping up property prices and making *you* a debt slave using *your* own money.

    When these debt slaves are burning in GFC 2.0, you can hop down from your safe perch on the sidelines and pick over the well cooked remains (firesale properties).

      • How? If I send AUS$1m “offshore”, say to a SGD bank account, I have to first sell my $1m AUD to someone for SGD.

        The person who sells me SGD now has AUD$1m …pretty sure that will be in an Australian bank account.

      • Peachy,

        Yes it is still in the banking system but where it is matters as different locations cost banks different rates.

        At call account
        Term deposit accounts
        Proceeds of bond sales
        Proceeds of share sales

        Persuading mum and pop Aussie to lock up funds costs for a period more than an offshore ZIRP source.

        Plus if I withdraw my deposit and use it to buy a bond from the bank or a new share issued by the bank, it is still in the bank but it is no longer a deposit.

        Finance/banking is full of expressions like ‘drains’ that obscure what is going on. I think that is no accident.

      • Pfh – yes to all that.

        So you just end up with a *possibility* that the $1m won’t end up in an at-call account.

        It may well work the other way – my AUD$1m might have been in a 12mo term deposit that I broke In order to by SGD, while the seller of the SGD might keep he money at call.

        So, basically, “sending money offshore” doesn’t work as a method of ‘depriving Aus banks of funds’.

        Cash under mattress is better, because while there is only $50b, banks actually NEED it to function and putting under mattress does actually deprive them of it …. but only if done by many people all *at once* (ie large bank run).

        If it happens over a few weeks, it won’t do squat, because RBA will have time to physically print and distribute new notes.

      • Peachy,


        Money doesn’t go offshore. Even the drug dealers are not shipping large wads of $50 notes offshore except in rare situations.

        Not many people are changing FX into AUD offshore At least not ones who deal with drug dealers.

        Drug dealers need to get their dough into the banking system so they can move it offshore using the banking system.

        That is really the main reason for the private banks in the public monetary system.

        Helping the shonks move their money about and helping conceal ownership.

        The greatest bit of crookedness are the operation of Eurodollars accounts by the banking system.

        Basically a parallel private monetary system which uses the banks to connect it to the public monetary systems.

        A system designed for gun runners, dictators, money launderers and tax dodgers.

      • Lama,

        It depends.

        If you withdraw amounts in cash from your bank account to buy gold – the bank deposits are reduced,
        If the person who you are buying the gold from deposits your cash into their bank account, bank deposits are restored.
        If the you stick the cash under the bed or the person you bought the gold from does then the bank deposits are not restored.
        If the bank’s finds that its supplies of cash are falling low it can buy some more cash from the RBA using some of the balance of its ES account at the RBA.
        If too many banks are buying cash with their ES balances at the RBA there will be upward pressure on the target rate (the rate that the RBA sets)
        To offset that pressure the RBA will ‘buy’ some govt bonds from the banks and by doing so increase the ES balances of the banks so that the upward pressure on the target rate is reduced.

        What happens if everyone rushes the banks and seeks to convert all of their deposits into cash and hide it under their beds?
        The banks will eventually run out of bonds to sell the RBA as they run down their ES balances to buy supplies of cash from the RBA.
        What happens then?
        The RBA will decide that some other ‘asset’ held by the banks are worth ‘buying’
        The RBA might start buying up mortgages from the banks and putting the proceeds into the banks ES accounts.
        In other words the idea that everyone can bring the banking system to its knees by withdrawing their deposits is a myth.

        if you want to bring the private banks to their knees you need to do the following

        1. Demand the right to have an account at the RBA
        2. Move your at call deposits from the private banks to your RBA account.

        Once the banks no longer have at call deposits they are effectively no longer banks in our monetary system.
        They are just investment companies raising money at various terms and lending it out at term.

      • I think allowing the RBA to take deposits and lend to the average punter is the single and most fundamental reform that would transform our whole banking system for the better

      • Everyone can buy hard assets like gold.
        The gold miners get lots of $AUS.
        The gold miners buy non AUS supplies/assets.
        The conversion middlemen end up with a lot of $AUS with little demand for it (our exports increase demand for $AUS from conversion middlemen).
        With excess $AUS around, its value drops.
        Imports then cost more and manufacturing becomes competitive.
        It is in the national interest to dump the banks.

  3. What does one do if they have, say, 1.5m or so in the bank in Aus??? How does one go from all cash to a properly diversified investment portfolio? Tried speaking to financial planners before but they didn’t end up being able to help apart from the usual “Oh we have this property development you might want to invest in”

    • Pick an international mutual fund or funds with a long term track record of 10%+ returns. Even buy a piece of property provided you’re paying cash. Keep 3 to 6 months expenses as an emergency fund. This is all the typical millionaire does. I’m assuming you did that to get to this point.

    • Damien KlassenMEMBER

      Shameless plug: 1300 623 863 or click the “invest with mb” button at the top of this page

      • HadronCollision

        I have two use cases
        1. I want an account I can drip feed $ to each month with a low start up minimum – can you do
        2. I want a retail super I can divert a portion of my pay to as well as start 2 accounts for my kids (or, use the above for them) – can you do


    • The Traveling Wilbur

      Shamefaced observation. Superfunds are a great place to park extra money you’re putting away for the longer term. Even at non-discount tax rates. Q-Super and Uni-Super being brilliant performers on a cost comparison basis (with Retail funds).

      • UniSuper is putting massive signage up at the top of its Melbourne building.

        This does not come cheap. Expect this to be a sign (haha, “sign”) that Uni-Super cost performance in the next 5 years will be much poorer than the last 5.

      • Bit of a risk locking your money into Super – who makes the rules about when you can access it and what it will cost to access it at the time…..and who is good at influencing the rule makers…..

      • HadronCollision

        Thanks for these. QSuper Balanced and Moderate look good. I am in First State as the insurance is way cheap

        But looking to open 2 x super accounts for our 3yo and as yet unborn #2 and starting to accumulate for them

      • Mining BoganMEMBER

        Yep, QSuper. If it wasn’t for their history I’d move to MB in a flash when it comes about.

    • scottb1978MEMBER

      MB fund is definitely one of the best options I know of – low fees, transparent, based on strategy like this

      • reusachtigeMEMBER

        If I wasn’t getting rich putting every dime, and 1000 fold gearing, into brilliantly value appreciating Aus property (discounting current short term relaxing) I would definitely consider this fund, well if it was 100% geared to foreign property. But if property isn’t your thing then look into this one a bit more.

  4. MB readerMEMBER

    Damien, does that mean you are staying out of all Australian equities including those with sizeable exposure to earnings in foreign currencies, particularly the USD?

    • Damien KlassenMEMBER

      We have set up all of our funds with limits on how far under or overweight they can be in particular sectors or countries. We are at our lower limit for Australian stocks in most portfolios.

  5. Is there a ‘Kogan Event’ coming to the Australian Economy in general? Where the Vested Interests know with uncommon certainty ‘what’s coming’ and take any and all last chances to get out – even if that is a lower price than they are ‘willing to accept’? Could be! If that’s the case then no amount of artificial support is going to hide that fact; that The Reset is upon the economy, and as usual, those who pay the price will be least able to afford it. ( Look at the way The Banks are trying to suck back in loaned funds from wherever they can. That might be indicative of ‘taking every and all last chance’)

    • The Traveling Wilbur

      That’s exactly what I’m hoping for, and the conditions for it occurring may be starting to form like a caucus of politicians around a pork barrel, but, in any scenario I can think of, equities have at least one more massive push to new highs left in them. And… if the crash comes simply from a loss of confidence in housing rather than an economic trigger (a black swan / Minsky moment) then they will stay there too.

      Nice to see you back btw. You were missed.

  6. Who are the next vested interest parties? Maybe all the financial firms who got theirs and their clients funds offshore before SHTF?

  7. What you have described is a Pacific Argentina, particularly in Oz’s case.. We are a long way down that path, much, much more than people realise.

    • I have been calling Australia the next Argentina for over a decade, same with urban fringe as favelas. What I didn’t see coming was flammable high-rise dog boxes, not sure how common they are in South America. I guess that’s more of a Chinese touch to ensure our cities become world-class slums.

      • nice to know someone else was thinking in these terms MrM …… I suspect I’m older than you so actually was seeing the Argentina comparison quite a while back. My personal lesson has been to understand that these things can drag out much longer than anybody would have thought ………

        My emphasis on the benefits of USD and direct US property investment is all part of the final retirement moves ……

  8. Ronin8317MEMBER

    The whole ‘investment return is low’ is more complicated. Look at the out of business savings in China : they must be making money in order to have saving. However, how did the business make money? Real estate development. Either directly or indirectly, it became the only game in town because the return on capital dwarves everything else.

    If you want to see what a country that has sold its soul for high house prices looks like, you just have to look at China. It is a culture that is ‘eating’ their young.

  9. Steve GlossopMEMBER

    Damien – any comment on the merit of investing in Chinese businesses such as Tencent and 51 Jobs? Are there domestic opportunities big enough to offset the long term risk of economic decline in China?

  10. Simple solution: swap fiat currency for sound money. Muchos pain in the short-term, great gain in the long. Straya would rebuild its economy on much firmer foundations and speculators would be consigned to the dust-bin of history.

    The Govt guiding a ‘transition’ of the economy is an utterly appalling idea. They can’t get anything else right so how would they get that right!