Australian Disease enters fatal stage

Let’s reprise some vestigial Goldman Sachs analysis from 2016:

A sharp turn in Australia’s national income dynamic, which we flagged in early August, now looks likely to move significantly higher following the spikes in coal and iron ore prices in the closing months of 2016. Although we expect prices to fall from current levels for these commodities, the recent surge transforms our expectation for a modest rise in Australia’s terms of trade in 2017 to a material 8% gain with most of the export price spike to be registered in late 2016 an early 2017. This is likely to set off a chain of events through the Australian economy in coming months. The resulting surge in national income should be reflected via much stronger mining profits, a large taxation windfall for the Federal government (and elimination of the threat of a sovereign downgrade), a restarting of idle capacity in the coal sector, a better climate for broader business investment and ultimately better employment and wage outcomes. It also sows the seeds for a more material handover of the economic growth baton to the private sector, and importantly this transition can proceed despite our forecast of a sharp decline in new dwelling investment in 2017-18. Perhaps the most dramatic transformation will come via Australia’s external accounts with a run of trade surpluses now in prospect for 2017 – indeed the combination stronger commodity prices and the ramp-up of LNG production suggests Australia will post the largest trade surpluses as a share of GDP during 2017 since any time since the early 1970s. Ultimately the state of the external accounts is the truth serum for the currency, and as such we acknowledge clear upside risk to the A$ from current levels.

How will the RBA respond? We continue to forecast that the RBA will commence increasing interest rates from 1Q18; however, the skew is now towards an earlier kick-off in 2H17…we have kept our forecast for the RBA to commence its hiking cycle in 1Q18 with the RBA forecast to increase interest rates 75bps through 2018 and a further 75bps spread over 2019 and 2020 to a 3.0% cash rate. Nevertheless, the risk of the RBA increasing the cash rate in 2H17 has risen materially and the evolution of financial conditions, house prices and underlying inflation will ultimately guide the decision.

The commodity prices analysis was spot on. The economic flow on is what the RBA hoped for too. So, how did GS and the RBA get the actual economic, wages, inflation and interest rate outcomes so horribly wrong? After all, two and half years later, commodity prices are even higher yet we’re about to see rate cuts.

BHP offers a hint, via The Australian:

Mining giant BHP is set to slash more than 700 jobs from its white-collar workforce, even as the iron ore price hits heights not seen since the heady days of the mining boom.

BHP chief financial officer Peter Beaven last week flagged staff cuts of up to 20 per cent to his 900-strong finance team at a company “town hall” briefing last week, with a wave of redundancies likely to start as early as next week.

It is understood BHP’s technology group also faces deep cuts, as chief technology officer Diane Jurgens kicks off a restructure that could see as much as 30 per cent of her 2000 Australian and Singaporean workforce exit.

This despite iron ore margins literally at China mining boom highs:

Seriously, why aren’t we all rolling in dough? There are five reasons.

The first is that this is a cyclical boom not a resumption of the structural change that the rise of China brought after the Millennium. The first round mining boom caught the commodity supply chain short to the tune of hundreds of billions of tonnes of capacity. The real economic boom was the build out of said capacity, which was based in the real economy. This time around the miners are cutting capacity because they so overdid it the first time around. That means there is very little impact on the real economy and, as seen above in the BHP move, it might even be a net negative.

Second, the first round boom was boosted by massive fiscal transfers to households via tax cuts funded by mining profit inflows. This time around, the Budget has been under so much pressure from the post-boom bust that that has not been possible. It is just starting to flow now. Too late.

Third, the first round boom triggered a massive stock bull market as the income flows sloshed around every corner of the economy. This time around miners have risen, eve if nowhere near new highs, and we’ve been stuck in a bear market for a decade as the income never arrived in the real economy to drive broader profits.

Fourth, and perhaps most important, the mining boom economy was always an illusion. It wasn’t built on competitive edge or national endeavour. It was the good fortune of the dirt under our feet. As such the income gains were mostly shared by what they did to wider asset prices, not a permanent lift in productive capacity. As a nation we took that income and we leveraged it in global markets via defacto policy banks that hosed cheap mortgages to all corners of the nation, driving house prices and consumption wild. But, as the underlying income dried up, the lack of any real gains in productive capacity left us exposed to a debilitating income recession without end. As that has steadily undermined household balance sheets, the former leveraging party has ended as we run out of room to boost debt at an effective zero bound for interest rates.

Fifth, and most stupid, all of the above has been misdiagnosed and worsened ever step of the way by the can-kicking economics of Australian monetary and fiscal policy. At no stage of the boom can you say we had effective management. There was never enough saving of the income. Never effective nor equitable taxation. Never enough care for domestic inflation nor the currency.

One horrific example is the apocalyptic mismanagement of the nation’s gas reserves. It takes a special gift for economic suicide to position gas exports in a way that any rise in their price results in a fall in domestic income.  Another example is the use of Quantitative Peopling, a grotesquely distorted mass immigration program that attempts to hold up asset prices even as it destroys living standards, chokes productivity and cuts per capita output.

Traditionally, when these five economic dynamics have appeared in a developed economy they have been called “Dutch Disease”; the hollowing out of non-mining tradable sectors by an overly inflated real exchange rate. In Australia’s case they are so much more advanced and toxic than they ever were in Holland that they are more akin to the kind of “commodities curse” economics that we see in tin pot Banana Republics run by a vampiric and plutocratic elite plundering a broad underclass. And if you think it is bad today, then consider what it will be like as China goes ex-growth over the next five years and commodity prices sink permanently to levels well below 2015.

So, what is the cure to Australian Disease? The same as it was when we entered the boom. The same as it was when we entered the bust. It’s the same today as we pretend this new little echo boom will last. The Australian real exchange rate must be repaired via a lower currency and higher productivity or the dose will be fatal.

Comments

  1. TailorTrashMEMBER

    “Quantative peopling”……..now that’s worthy of finding a place in the economic text books of Harvard .

  2. Well written.
    I just hope more of the same ( in effect) “(a) real exchange rate must be repaired via a lower currency ( and interest rates)” doesn’t prove fatal before ” higher productivity ” gallops over the hill to save the day. But, I suspect it’s too late….
    Maybe Australia can do a Rourke’s Drift, but Isandlwana is more likely, and that battle changes the way the British conducted their defenses…forever. Surviving what’s coming may just entrench the status quo with a shrug of the regulatory shoulders and a ” Well. That worked out ok, didn’t it!”

    • Interesting analogy BUT
      Do we still know how to fight like trapped rats?
      Do we still enjoy the technology advantage of using rifles to defend against spears?
      Do we still have the cultural cohesive strength to see this as an Us vs Them battle?
      Rourke’s Drift was a very Black and White battle with very clear social distinctions these differences made it easy to know your enemy, I suspect our enemy won’t make it that easy for us, will we know him? will we know ourselves?
      Maybe a different cultural approach is more appropriate for our upcoming battle
      “If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”
      ― Sun Tzu, The Art of War

  3. So, what is the cure to Australian Disease?

    I think the Talking Heads had the answer…
    Same as it ever was.
    Same as it ever was.
    Same as it ever was.

  4. To cheat CAD is a power only one has achieved, but if we work together I know we can discover the secret…..

  5. So, what is the cure to Australian Disease? The same as it was when we entered the boom. The same as it was when we entered the bust.
    Yep that’s what we need to assume, if for no other reason than our own sanity, but is it true?
    Or do solutions have a use by date?
    To be successful in Technology businesses you always need to shoot ahead of the target, but that requires the ability to determine ahead of the masses just where the market is heading. If you lack the technology foresight to know just when and where the battle will be fought than don’t be surprised if your solutions are viewed as useless because they don’t intersect the markets needs at precisely the moment that the market needs your solutions.

    We need to honestly ask ourselves if we have the skills to build the products of tomorrow.

    • “We need to honestly ask ourselves if we have the skills to build the products of tomorrow.” – We Don’t.
      Most of our creative minds are heading overseas and the ones that stay back don’t make critical mass to develop anything let alone to bring the innovation to production level. As Colin once said whatever we come up with we need to send it overseas for others to fully develop and then sell it back to us as finished product.

      The energy policy in itself is making sure no one will invest in any substantial manufacturing here.

      When most of uni educated young people can’t grasp that without wage growth there can not be perpetual house price growth you get the idea of how smart our young are.

      Even with our natural resources.. we only go as far as to produce concentrate – in some cases not even that but we simply ship raw dirt to be processed in Indonesia or China.

  6. tin pot Banana Republics run by a vampiric and plutocratic elite plundering a broad underclass.

    Isn’t that what we have now?

  7. BabundaMEMBER

    Bravo.

    But you missed one important point: raising productivity alone is not enough to save the day. It is necessary but not sufficient. We also need the national policies that link productivity to growth to wages. These linkages aren’t automatic. Neoliberalism broke them and they must be restored.

  8. ‘So, what is the cure to Australian Disease?’
    Well, lets cut massive Third World immigration for starters, surely an Australian disease.
    The massive immigration program must cut because it’s unsustainable, the sooner we do it the better.
    Greedy business and Asianists won’t like it – too bad. Business has never had conditions so good if they can’t make a go of it by now they never will. The Asianists have had forty years of imposed social engineering, this social experiment is way,way overdue for closure.

  9. The MB Perm-a-bears!
    Total superannuation assets = $2.7 trillion and rising.
    Value of Australian housing stock = $6.8 trillion
    Value of cash sitting in Australian banks = $2.2 trillion.
    Savings from the Mining boom.
    Richest country on earth!

  10. I reckon if you peeled back the hoodie on that Grim Reaper you’d have Martin North’s boat peering out at you…