Living on borrowed money

[Kubes.Oz]

Kubes - where are you?

The Lucky Country's Burning Fuse

Written by Philip Bowring   
Wednesday, 12 May 2010

Australia's terms of trade conceal a potential net foreign debt problem


Australia is living high on hubris. In delivering his budget for 2010-2011 this week Treasurer Wayne Swan boasted that the nation had "defied economic gravity not by accident but by choice" with 1.4 percent expansion in 2009 and 2 percent growth expected in the year ending June at a time when other developed economies are only just struggling out of recession.

Canberra assumes that the good times, driven primarily by high resource prices, will continue into the foreseeable future, enabling both strong growth and a rapid rise in government revenues. Having outperformed every other OECD economy over the past year thanks to a mix of government stimulus and the rapid rebound in commodity prices, it now expects real growth of 3.5 percent in 2010-11 rising to 4 percent in the following year. At the same time as it expects the budget to return to surplus in 2012-13 after an A$57 billion deficit this year and projected A$40 billion one next year.

Much of this is based on rosy assumptions about continued massive growth in mining investment even in the face of the threat of a 40 percent excess profits tax on resources being promised by the government following the Henry Report into the taxation system.

The assumption that Australia can play tax games with its resources sector reminds some observers of the damage done by a 1970s Labor government and minerals and energy minister RFX Connor in playing a nationalist resources card when commodity markets were already peaking out.

Now the Australian Treasury remains convinced that demand from China and India will pull Australia's economy along and enable a huge rise in revenues. It assumes that China will grow 10 percent in 2010 and 9.5 percent next year and that the resource component of its growth will be as strong as ever.

For sure there is a case for a resources tax which captures price booms much better than the present fixed royalties on production, which are charged at state level. However, the details and timing will determine not only how much revenue it produces at given levels of resources prices but how much new investment is put on hold till companies know the future. Already several projects are known to have been postponed.

Australia seems to assume that the extraordinary good fortune it has enjoyed over the past six years from its terms of trade, thanks to the huge rises in most commodity prices, is destined to be sustained. They have risen by 50 percent from 2002 lows. After peaking in the third quarter of 2008, terms of trade plunged 20 percent in the first half of 2009 before rebounding. Although they have yet to regain their 2008 peaks they are now well above 2007 levels and forecast to improve by another 14 percent in 2010-2011.

The treasury also assumes that Australia will continue to attract huge amounts of capital to finance additional resource production, sustain a consumption boom and keep property prices at the astronomic level to which they have recently risen thanks to a mix of cheap credit and pressure from immigration.

In contrast to the rosy picture painted by the treasury, however, Australia faces what could be a hugely troubling combination of foreign debt exposure, potential for collapse in its terms of trade, and rising foreign resistance to its persistently very high current account deficit.

Thanks to the Greeks, Portuguese, Argentines, etc, markets have come to believe that the only debt that really matters is government debt, and particularly if it is in foreign currencies. In the case of the Eurozone's problem countries, the currency may in theory not be foreign but is actually mainly controlled by the Germans and other north Europeans so it is not a sovereign currency from the point of view of small southern EU states. But these commentators seem to have forgotten that the Asian crisis had nothing to do with government debt. It was almost entirely private sector foreign debt driven.

Australia's net foreign debt now stands at A$647 billion, or roughly (depending on exchange rates) 50 percent of GDP. As the government has only a tiny amount of foreign debt, almost all of this is private sector debt. And most of it is owed by the financial institutions – A$426 billion of the total – compared with just A$155 billion by non-financial corporations.

Nor is there any sign of it slowing. The Treasury's forecast is for the current account deficit to return to 5 percent of GDP this year and stay there next year. Few Australians bother to notice it, just as few Greeks or their lenders bothered about Greek debt until a few weeks ago.

These Australian borrowers are the very same financial institutions which have been fuelling the housing and household debt binges which recently forced the Reserve Bank into a belated series of interest rate hikes. For sure, Australian banks avoided the derivative disasters of US and European banks and now enjoy stellar credit ratings. They may be hedged. But there are some big hits to be taken if the Aussie plunges again, global interest rates rise and foreigners start to worry about Australia's predilection for a fancy lifestyle and high growth based more on debt than on a sunny climate.

Australia has one cushion. About 45 percent of its net debt is in its own currency so that the foreign exchange risks for its borrowers are mitigated. If the Aussie falls out of bed as it did in late 2008 and early 2009 when it fell to 54 to the US dollar or to the 48 cents it hit in 2001, half the brunt will be borne by Japanese pensioners and the various sovereign wealth funds which have been picking up Aussie debt as they attempt to diversify away from US dollars.

On a trade weighted basis the Aussie is now 33 percent above its January 2009 level. But somewhere down the line there are probably going to be big bills to be paid by those who ended up on the wrong side of an Aussie dollar slump back to, say, 60 US cents or 50 yen.

There could be a double terms of trade whammy. Just as a commodity price plunge would take the Aussie with it, so a general rise in Asian currencies such as the yuan and won would raise prices of its consumer imports, most of which are from Asia and deliver a big hit to consumption.

Between 2003 and 2008 Australia was able to be close to the top of the OECD growth table partly because of an extraordinary gain – cumulative almost 50 percent -- in its terms of trade after more than a decade of weakness. But instead of using this as a base for building its net asset position it also simultaneously indulged in a borrowing binge, with its current account deficit persistently being around 4 percent of GDP. Net foreign debt has gone from 35 percent to 50 percent of GDP over a decade.

For sure, some of this deficit was associated with a revival in mining investment, primarily to meet the China demand. But the debt burden, which has gone unnoticed in an era of easy and cheap money, may bite hard before long. As it is, even at today's very low interest rates, net interest payments amount to some 2.3 percent of GDP and net equity payments to another 1.3 percent. So even if Australia gets back to trade balance it will still have a current account deficit of 3.5 percent of GDP. That is likely to rise if interest rates return to more normal levels even if equity payments fall if commodity prices weaken.

A mostly complacent Australia argues that the 3.5 percent of GDP level of payment on debt and equity has been the case for many years so there is nothing to worry about. But in reality the debt proportion has been rising even though interest rates have been at historically low levels. Thus Australia is particularly vulnerable to an end in easy money conditions, particularly if this is accompanied by a commodity price retreat.

The trade account looks unlikely to improve unless either domestic demand slumps or commodity prices regain the peaks of early 2008. As it is, though the latter have recovered a long way from the end 2008 bottom and terms of trade are back to 2007 levels, the Australian trade deficit is still running at about 2 percent of GDP. A sharp improvement in early 2009 was not sustained.

So if ever there was a sell in sight it is the Aussie at 90 cents, and shares in the self-congratulatory Aussie banks.

[Yes for sure]

10% is probably not too far off the mark.

[scorn]

"Kubes.oz, I think it make sense to put this article into perspective - yep external debt seems to stand at around 50% of GDP.  Checkout how this compares against the rest of the world (and the company the SG keeps):"

Well, it doesn't really involve Singapore at all because the article is about external debt, of which Singapore has basically zero. Singapore's debt is internal and a fairly large portion of that is CPF money owed to the public, and I believe this is fully backed by cash reserves.

[TheWrathOfGrapes]

Kubes.oz, I think it make sense to put this article into perspective - yep external debt seems to stand at around 50% of GDP.  Checkout how this compares against the rest of the world (and the company the SG keeps):

http://en.wikipedia.org/wiki/List_of_countries_by_public_debt

Kubes.SG - just a couple of errors - I am sure you don't intend to distort or lie.  I thought I have taught you how to get the data from the CIA World Factbook?

1) Those figures in Wiki that you quoted, they are percentages of GDP and not US$ billions. So, Singapore's public debt is 117.6% of GDP, and not around 50%.

2) As we have gone through this before in the old thread, what is crucial and pertinent is the external debt and not public debt.  Singapore is cash rich with more US$188 billion in reserves, and it doesn't need to resort to external borrowing or even internal borrowing.  A large chunk of the public debt is the issuance of government securities to broaden, deepen and develop the local bond market.

3) Singapore's external debt is only US$19.2 billion - 8.1% of GDP (ppp) or 11.6% of GDP (official exchange rate).  Contrast this to Australia's external debt of US$920 billion - 111.6% of GDP (ppp) or 98.8% of GDP (official exchange rate).

4) Yes, Australia is in good company like Greece and the other PIIGS countries.

https://www.cia.gov/library/publications/the-world-factbook/geos/sn.html

[Muppetkubes]

Malaysia has also raised its interest rates, twice! So what you are saying is that Australian economy is as well managed as Malaysia's!

[Top Aussie.]

I'm in Malaysia right now, and the IMD World Competitiveness Report has just been released.  Australia is now the world's 5th most competitiveness economy.  And of course, things are getting worse for NZ, they slipped to 20th.  All good news for Australia!


Malaysia Jumps Eight Notches To Emerge World's 10th Most Competitive Nation


KUALA LUMPUR, May 19 (Bernama) -- Malaysia has emerged the world's 10th most competitive nation from 18th previously, a remarkable jump brought on by significant improvements in economic performance due to a host of factors such as influx of quality investments, pragmatic government policies and low risk political instability.

In giving Malaysia high marks and propelling its position by eight notches, the International Institute for Management Development (IMD) in its World Competitiveness Yearbook 2010, said other telling factors were its effective implementation of government decisions, mainly attributable to the able stewardship of the economy by Prime Minister Datuk Seri Najib Tun Razak.

Also commendable was the adaptability of government policies to economic changes, it said in apparent reference to the RM67 billion stimulus package unveiled by Najib, who is also Finance Minister, to mitigate the economy from the global slowdown due to the fallout from the US subprime credit crisis.

Najib's unveiling of the New Economic Model (NEM) aimed at transforming the nation into a high-income economy has been able to sustain and position Malaysia on the right path towards attaining developed nation status by 2020 also was a strong feature of the adaptability of government policies to changes in the economy.

The IMD World Competitiveness Yearbook (WCY) is the world's most renowned and comprehensive annual report on the competitiveness of nations, ranking and analysing how a nation's environment creates and sustains the competitiveness of enterprises.

It also said in the first 10 places, Australia was at fifth spot, Taiwan at eighth and Malaysia at 10th placing, benefited from strong demand in Asia and implementation of efficient policies.

"The three nations rank very well in government efficiency," the IMD said.

Malaysia was also ranked highly, thanks to what IMD said was the strong resilience of the economy to (down) cycles, sufficient transparency among financial institutions and government bureaucracy not being a hindrance to business activity as evident from the rapid expansion in the economy over the past year.

After languishing from the global economic crisis, the economy recovered in fourth quarter of last year by 4.4 per cent and even more remarkable by a 10.1 per cent in the first quarter of this year.

Among Malaysia's strength which ranked it to the top was its economic diversification and exchange rate while for current account balance it was ranked second and third for exports of goods.

The competitive cost of capital, which encourages business development, the ageing society not being a burden for economic development and unemployment legislation providing an incentive to look for work were also strong points of the econony.

The good news for corporate employers in Malaysia was that competent senior managers were readily available in the country, corporate *** supervise the management of companies effectively while entrepreneurship of managers was widespread in business.

Malaysia also continued to intensify life-long learning and nurture a talented workforce while it also drove productivity and competitiveness through creative and innovative mindsets.

The IMD also said the transparency of government policies was satisfactory, having improved from 3.94 per cent to 5.98 per cent, while protectionism was not a factor in Malaysia's economy as it did not impair the conduct of business.

It said the high rating was also due to quality investments which strengthened the economy and action to groom the small-and medium-sized enterprises for global competition.

Improvements were made in other areas including corruption, bureaucracy, transparency, political stability, long-term unemployment, corporate debt and consumer price index.

In sub-sector rankings, Malaysia topped in financial institutions transparency and low risk factor in financial institutions.

Malaysia's financial sector remained resilient despite the meltdown in the US and Europe financial sectors, having managed to strengthen further its presence in the financial landscape especially in Islamic finance and banking.

Malaysia is now a world leader in Islamic finance, capital market and takaful industries and there is huge potential to become a hub for integrated Islamic financial services.

For instance, Bank Negara Malaysia was currently finalising the establishment of a physical Islamic financial centre and the imminent approval of two mega Islamic bank licences.

The ringgit, at a high of 3.1 to a US dollar, has been the strongest performing emerging Asian currency against the greenback so far this year, gaining more than seven per cent on the country's strong growth prospects.

It also appreciated against the euro by 19 per cent against the euro and 16 per cent compared with the pound.

For public and private sector ventures, funding for technologies, science in schools and high technology exports, the country was ranked fourth best, the IMD said.

The IMD said science in school was sufficiently emphasised.

Under the government efficiency sub-ranking, Malaysia was ranked second for capital cost as there was support for business development.

It was also ranked second for adapting government policies to changes in the economy.

The IMD however did point out some weaknesses in its ranking for Malaysia, including high government subsidies to private and public companies as a percentage of Gross Domestic Product, redundancy costs, government's budget deficit and high number of procedures to start a business.

[TheWrathOfGrapes]

And of course, accordingly to Kubes - Singapore is last on the list - from the bottom up.

The IMD World Competitiveness Yearbook (WCY) is the world's most renowned and comprehensive annual report on the competitiveness of nations, ranking and analysing how a nation's environment creates and sustains the competitiveness of enterprises.

And of course Kubes will dispute that - how can it be?  Must be the local media shamelessly putting on a positive spin.

All bad news for Singapore - dropped from 3rd last to last - again from the bottom up.

[TheWrathOfGrapes]

Kubes - what happened to those "Lucky Country" alternative headlines that you wrote in this thread - they seemed to have been withdrawn by you.  Lucky you, otherwise you have to eat your words.  Here is part 2 of the Lucky Country for you:

The Lucky Country's Fuse Burns Out
Written by Philip Bowring   
Monday, 31 May 2010

It could be a long time before Australia's fuse is relit

"So if ever there was a sell in sight it is the Aussie at 90 cents, and shares in the self-congratulatory Aussie banks" – Asia Sentinel, 12 May 2010

Since we advised hardly three weeks ago of the danger of investing in either Aussie dollars or Aussie banks, both have fallen out of bed – and look to fall further as the investment community finally seems to be waking up to the extent of Australia's debts and the vulnerability of its household sector – and hence by extension the banks.

Since we wrote, the share prices of the largest banks, Westpac and National Australia Bank, have tumbled by some 20 percent and the currency has fallen from 90 cents to the US to just 82. A drop back to 75 looks on the cards soon and perhaps back down over the next few months to the 55 it hit in late 2008 at the height of the global financial panic.

Further still down the track it could look to test the 48 cents nadir of 2002, before commodity prices started their five-year boom which has given Australia unprecedented gains of almost 50 percent in its terms of trade. Yet despite this bonanza, the current account remains in deficit to the tune of 4-5 percent of GDP. Australia likes to think of itself as a developing country which needs capital. But it is a mature economy which if doesn't watch out could one day go the way of Argentina, which a century ago shared with Australia the distinction of being the world's richest nation per capita.

This time around, the bottom does not seem likely to fall out of commodity prices quite yet. But who knows how much of Chinese buying, particularly of iron ore, has been stimulated by a mix of cheap money encouraging stockpiling and an unrepeatable surge in spending on heavy infrastructure products which may have scant economic return but are huge consumers of steel? Even now, Chinese planners may be having second thoughts about, for example, spending trillions of yuan on high speed railways which few can afford and which cost a mint to run. China's urbanization rate is also slowing thanks to its demographics.

This time around the commodity bust impact on the Aussie dollar could be even greater because of the increase in net foreign debt from A$330 billion in 2002 to A$650 billion now. As a proportion of GDP it has risen from 35 percent to 50 percent. The Reserve Bank of Australia may well want to engineer a further sharp currency decline. Australia after all is well accustomed to a volatile exchange rate and unlikely to panic when it happens. But some people, somewhere will have to bear the tens of billions of dollars cost of the increased local currency value of the 55 percent of the foreign debt which is not denominated in local currency. How well spread that will be has yet to be determined.

Meanwhile Australia's inward-looking markets and commentators are tending to blame much of the stock and currency falls on the Rudd Labor government's promise/threat of a resources tax which would tax profits above the government bond yield benchmark as cost- of-capital level at 40 percent. In response mining groups big and small have announced freezes on their investment plans.

Debate on the subject has been extremely partisan and couched more in political than pragmatic terms of aiming to maximize the growth of the industry with maximising returns to the nation from its natural resources.

The Rudd government's timing has been particularly unfortunate, coming as it did on the eve of a sharp correction in mineral prices which probably has further to run. However, Rudd may have been doing the miners a favour by giving them cover for putting on hold some massive projects which might not turn out to be viable anyway. Or, if they were completed, would worsen oversupply situations and return prices to the levels in real terms they faced in the decade and a half to 2002.

The long lead times in new mining ventures make estimates of future prices extraordinarily difficult. That is particularly the case for the likes of iron ore, which has massive up-front costs but very low marginal operating costs per ton.

The miners must also face the fact that exponential growth in Chinese, Indian and other developing country demand may not continue. Or that the shale gas boom now spreading from the US to Europe and China could kill off many of the profit expectations of Australia's offshore gas fields, which are huge but have massive capital costs.

[TheWrathOfGrapes]

Kubes.oz, I think it make sense to put this article into perspective - yep external debt seems to stand at around 50% of GDP.  Checkout how this compares against the rest of the world (and the company the SG keeps):

http://en.wikipedia.org/wiki/List_of_countries_by_public_debt

Kubes.SG - just a couple of errors - I am sure you don't intend to distort or lie.  I thought I have taught you how to get the data from the CIA World Factbook?

1) Those figures in Wiki that you quoted, they are percentages of GDP and not US$ billions. So, Singapore's public debt is 117.6% of GDP, and not around 50%.

2) As we have gone through this before in the old thread, what is crucial and pertinent is the external debt and not public debt.  Singapore is cash rich with more US$188 billion in reserves, and it doesn't need to resort to external borrowing or even internal borrowing.  A large chunk of the public debt is the issuance of government securities to broaden, deepen and develop the local bond market.

3) Singapore's external debt is only US$19.2 billion - 8.1% of GDP (ppp) or 11.6% of GDP (official exchange rate).  Contrast this to Australia's external debt of US$920 billion - 111.6% of GDP (ppp) or 98.8% of GDP (official exchange rate).

4) Yes, Australia is in good company like Greece and the other PIIGS countries.

https://www.cia.gov/library/publications/the-world-factbook/geos/sn.html

Kubes - do you go around deleting your own posts which showed that you were lying, spinning or plain wrong?

Remember your perspective about Singapore's public debt which should be more than 100% of GDP and not just 50% as you quoted.

More importantly, it is what those pubic debt are used for.

Well, now the CIA has heard us - they have put in a note to distinguish Singapore's public debt.

https://www.cia.gov/library/publications/the-world-factbook/geos/sn.html

 note:  for Singapore, public debt consists largely of Singapore Government Securities (SGS) issued to assist the Central Provident Fund (CPF), which administers Singapore's defined contribution pension fund; special issues of SGS are held by the CPF, and are non-tradeable; the government has not borrowed to finance deficit expenditures for more than 20 years

Kubes - there we go again - I told you so!!!

[Kubes.SG]

Grapes:  here is what happened:

1) Some goose posted a silly article written by some loser who could not keep a job at toilet paper rag the FEER
2) I shared the facts that were in the public domain (CIA) that showed AU was not so bad, and SG was not so good.
3) Grapes got all upset and climbed on his high horse, ranting and raving, playing the man not the ball
4) Ministry of Propaganda and Nation Building detected the public domain information I shared here.  They told this site's BMs to delete my posts and cover up all evidence that showed SG in a negative light.
5) M of P&NB held a secret inquiry across all SG Govt Agencies to figure what the story was and how to defend SG's reputation.
6) Ministry of Defense and MofP&NB called in all their favours with the US Govt to get to the CIA to publish a "disclaimer" that the SG Govt is very rich, very successful and never ever has needed to borrow money for 20 years.
7) M of P&NB (for whom Grapes is an informant) "suddenly" discovers the new revelation on the CIA website (hmmm, why? how?), and tells us all here that:  Look, SG is rich and Kubes is wrong.

Good job, Grapes.  I agree SG Govt is rich.  Why did it take nearly 4 months to get this little issue resolved?  Seems the SG authorities aren't the BSDs with the yanks they thought were.

[TheWrathOfGrapes]

Good job, Grapes.  I agree SG Govt is rich.  Why did it take nearly 4 months to get this little issue resolved?  Seems the SG authorities aren't the BSDs with the yanks they thought were.

You should direct that question to the CIA.  They did not have the note (details on Singapore's public debt) before on their website.  But the spooks there must have seen this thread and thought they should do the right thing by Singapore and make sure that people like you are not misled by the high public debt numbers for Singapore, thinking that SG is as profligate as AU and living on borrowed money.

[ha ha ha ha]

Kubes is well aware of the shit OZ is in. That is why he refuses to go back.

[keep outta it]

 If theres one bubble thats going to burst its down under.

[Kubes.SG]

Kubes is well aware of the shit OZ is in. That is why he refuses to go back.

Let's look at the facts.

Number of recessions in Australia over the last 18 years:   0
Number of recessions in Singapore over the last 18 years: 4

Australian Housing to Income affordability ratio:  6.5
Singaporean Housing to Income affordability ratio: 19.5

Australian Public Debt as % of GDP:  17.6%
Singaporean Public Debt as % of GDP:  113.1%

[last word]

kubes wins