Australia's 'dumb luck' about to run out with economy on the brink of collapse
15 November 2017, Written by Matt Barrie, CEO Freelancer.com
I RECENTLY watched the federal treasurer, Scott Morrison, proudly proclaim that Australia was in "surprisingly good shape".
I was pretty shocked at the complacency, because after twenty six years of economic expansion, the country has very little to show for it.
"For over a quarter of a century our economy mostly grew because of dumb luck. Luck because our country is relatively large and abundant in natural resources, resources that have been in huge demand from a close neighbour."
That neighbour is China.
Out of all OECD nations, Australia is the most dependent on China by a huge margin, according to the IMF. Over one third of all merchandise exports from this country go to China - where 'merchandise exports' includes all physical products, including the things we dig out of the ground.
"As a whole, the Australian economy has grown through a property bubble inflating on top of a mining bubble, built on top of a commodities bubble, driven by a China bubble."
Unfortunately for Australia, that "lucky" free ride is just about to end.
When that didn't work to curb rising unemployment and stop growth stagnating, central banks across the globe started printing money which they used to buy up financial securities in an effort to drive up prices. This process was called "quantitative easing" ("QE"), to confuse the average person in the street into thinking it wasn't anything more than conjuring trillions of dollars out of thin air and using that money to buy things in an effort to drive their prices up.
"An alternative theory for QE is that it encourages buying hard assets by making people freak out that the value of the currency they are holding is being counterfeited into oblivion."
In reality, the ability to borrow cheap money was mainly used by companies to buy back their own shares, and combined with QE being used to buy stock index funds (otherwise known as exchange traded funds or "ETFs"), this propelled stock markets to hit record high after record high even though this wasn't justified the underlying corporate performance.
"Of course this then led to a tsunami of Chinese hot money fleeing the country and blowing real estate bubbles from Vancouver to Auckland as it sought more affordable property in cities whose air, food and water didn't kill you."
QE was only intended as a temporary emergency measure, but now a decade into printing and the central banks of the United States, Europe, Japan and China have now collectively purchased over US$19 trillion of assets. Despite the the lowest interest rates in 5,000 years, the global economic growth in response to this money printing has continued to be anaemic. Instead, this stimulus has served to blow asset bubbles everywhere.
Market turnover on the three Chinese exchanges jumped from a daily average of about $78 billion in February to a peak of $261 billion on April 22, 2016 -- exceeding the GDP of Ireland. By comparison, Nasdaq's daily turnover peaked in early 2000 at $150 billion.
While volume exploded, open interest didn't. New contracts were not being created, volume instead was churning as the hot potato passed between speculators, most commonly in the night session, as consumers traded after work. So much so that sometimes analysts wondered whether the price of iron ore is set by the market tensions between iron ore miners and steel producers, or by Chinese taxi drivers trading on apps.
Over the last six years, the price of iron ore has fallen 60 per cent.
Australia's second biggest export is coal, being the largest exporter in the world supplying about 38 per cent of the world's demand. Production has been on a tear, with exports increasing from 261Mt in 2008 to 388Mt in 2016.
Losing coal as an export will blow a $34 billion dollar per annum hole in the current account, and there's been no foresight by successive governments to find or encourage modern industries to supplant it.
"What is more shocking is that despite the gargantuan amount of money that China has been pumping into the system since 2014, Australia's entire mining industry - which is completely dependent on China - has struggled to make any money at all."
Across the entire industry revenue has dropped significantly while costs have continued to rise.
According to the Australian Bureau of Statistics, in 2015-16 the entire Australian mining industry which includes coal, oil and gas, iron ore, the mining of metallic & non-metallic minerals and exploration and support services made a grand total of $179 billion in revenue with $171 billion of costs, generating an operating profit before tax of $7 billion which representing a wafer thin 3.9 per cent margin on an operating basis. In the year before it made a 8.4 per cent margin.
Collectively, the entire Australian mining industry (ex-services) would be loss making in 2016-17 if revenue continued to drop and costs stayed the same. Yes, the entire Australian mining industry.
Our "economic miracle" of 104 quarters of GDP growth without a recession today doesn't come from digging rocks out of the ground, shipping the by-products of dead fossils and selling stuff we grow any more. Mining, which used to be 19 per cent of GDP, is now 6.8 per cent and falling. Mining has fallen to the sixth largest industry in the country. Even combined with agriculture the total is now only 10 per cent of GDP.
"With an economy that is 68 per cent services, as I believe John Hewson put it, the entire country is basically sitting around serving each other cups of coffee or, as the Chief Scientist of Australia would prefer, smashed avocado."
The Reserve Bank of Australia has cut interest rates by 325 basis points since the end of 2011, in order to stimulate the economy, but I can't for the life of me see how that will affect the fundamental problem of gyrating commodity prices where we are a price taker, not a price maker, into an oversupplied market in China.
"Successive Australian governments have achieved economic growth by blowing a property bubble on a scale like no other."
A bubble that has lasted for 55 years and seen prices increase 6556 per cent since 1961, making this the longest running property bubble in the world (on average, "upswings" last 13 years).
In 2016, 67 per cent of Australia's GDP growth came from the cities of Sydney and Melbourne where both State and Federal governments have done everything they can to fuel a runaway housing market. The small area from the Sydney CBD to Macquarie Park is in the middle of an apartment building frenzy, alone contributing 24 per cent of the country's entire GDP growth for 2016, according to SGS Economics & Planning.
"The government decided to further fuel the fire by "streamlining" the administrative requirements for the Foreign Investment Review Board so that temporary residents could purchase real estate in Australia without having to report or gain approval. It may be a stretch, but one could possibly argue that this move was cunningly calculated, as what could possibly be wrong in selling overpriced Australian houses to the Chinese?"
I am not sure who is getting the last laugh here, because as we subsequently found out, many of those Chinese borrowed the money to buy these houses from Australian banks, using fake statements of foreign income. Indeed, according to the AFR, this was not sophisticated documentation - Australian banks were being tricked with photoshopped bank statements that can be bought online for as little as $20.
Foreign buying driving up housing prices has been a major factor in Australian housing affordability, or rather unaffordability.
It's actually worse in regional areas where Bendigo Bank and the Bank of Queensland are holding huge portfolios of mortgages between 700 to 900 per cent of their market capitalisation, because there's no other meaningful businesses to lend to.
"I'm not sure how the fundamentals can possibly be justified when the average person in Sydney can't actually afford to buy the average house in Sydney, no matter how many decades they try to push the loan out."
Indeed Digital Finance Analytics estimated in a October 2017 report that 910,000 households are now estimated to be in mortgage stress where net income does not covering ongoing costs. This has skyrocketed up 50 per cent in less than a year and now represents 29.2 per cent of all households in Australia. Things are about to get real.
Australia's household debt servicing ratio (DSR) ties with Norway as the second worst in the world. Despite record low interest rates, Australians are forking out more of their income to pay off interest than when we had record mortgage rates back in 1989-90 which are over double what they are now.
"Everyone's too busy watching Netflix and cash strapped paying off their mortgage to have much in the way of any discretionary spending. No wonder retail is collapsing in Australia."
Governments fan the flame of this rising unsustainable debt fuelled growth as both a source of tax revenue and as false proof to voters of their policies resulting in economic success. Rather than modernising the economy, they have us on a debt fuelled housing binge, a binge we can't afford.
"This is rapidly approaching ponzi financing. This is the final stage of an asset bubble before it pops."
Today residential property as an asset class is four times larger than the sharemarket. It's illiquid, and the $1.5 trillion of leverage is roughly equivalent in size to the entire market capitalisation of the ASX 200. Any time there is illiquidity and leverage, there is a recipe for disaster - when prices move south, equity is rapidly wiped out precipitating panic selling into a freefall market with no bids to hit.
Ken Sayer, Chief Executive of non-bank Mortgage House said "It is much bigger than everyone is making it out to be. The numbers could be astronomical".
"The total number of FIRB approvals from China was 30,611. By comparison. The United States had 481 approvals."
Foreign investment across all countries into real estate as a whole was the largest sector for foreign investment approval at $112 billion, accounting for around 50% of all FIRB approvals by value and 97% by count across all sectors - agriculture, forestry, manufacturing, tourism - you name it in 2015-16.
According to Credit Suisse, foreigners are acquiring 25 per cent of newly completed housing supply in NSW, worth a total of $39 billion.
In some circumstances, the numbers however could be much higher. Lend Lease, the Australian construction goliath with over $15 billion in revenue in 2016, stated in that year's annual report that over 40% of Lend Lease's apartment sales were to foreigners.
"I wouldn't have a problem with this if it weren't for the fact that this is all a byproduct of central bank madness, not true supply and demand, and people vital for running the economy can't afford to live here any more."
What is also remarkable about all of this is that technically, the Chinese are not allowed to send large sums of money overseas. Citizens of China can normally only convert US$50,000 a year in foreign currency and have long been barred from buying property overseas, but those rules have not been enforced. They've only started cracking down on this now.
"But combined with our lack of future proof industries and exports, our economy is completely stuffed. And it's only going to get worse unless we make a major transformation of the Australian economy."
Instead of relying on a property bubble as pretense that our economy is strong, we need serious structural change to the composition of GDP that's substantially more sophisticated in terms of the industries that contribute to it.
"That's why we need to seriously talk about technology, because technology is the great wealth and productivity multiplier. However the thinking at the top of government is all wrong."
The largest four companies by market capitalisation globally as of the end of Q2 2017 globally were Apple, Alphabet, Microsoft and Amazon. Facebook is eight. Together, these five companies generate over half a trillion dollars in revenue per annum. That's equivalent to about half of Australia's entire GDP. And many of these companies are still growing revenue at rates of 30 per cent or more per annum.
"Today Australia's economy is in the stone age. Literally. "By comparison, Australia's top 10 companies are a bank, a bank, a bank, a mine, a bank, a biotechnology company (yay!), a conglomerate of mines and supermarkets, a monopoly telephone company, a supermarket and a bank."
We live in a monumental time in history where technology is remapping and reshaping industry after industry - as Marc Andreessen said "Software is eating the world!" - many people would be well aware we are in a technology gold rush.
"What about trying to attract more senior people to Sydney? I'll tell you what my experience was like trying to attract senior technology talent from Silicon Valley."
I called the top recruiter for engineering in Silicon Valley not so long ago for Vice President role. We are talking a top role, very highly paid. The recruiter that placed the role would earn a hefty six figure commission. This recruiter had placed VPs at Twitter, Uber, Pinterest.
"Australia ranks off the deep end of the scale at 77th place. 77th and falling. After Tajikistan, Australia had the fourth highest loss in Economic Complexity over the last decade, falling 18 places."
Thirty years ago, a time when our Economic Complexity ranked substantially higher, these words rocked the nation:
Business News Australia
Author: Matt Barrie, CEO Freelancer.com