Apparently More Debt is Now Acceptable in Australia

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It was a good night for oil stocks in New York and a bad night for all stocks in China. China’s benchmark index in Shanghai fell 4.3%. The index has now fallen almost 20% since early August. Bubble? Popping?

Meanwhile, oil stocks in New York surged along with crude oil. The Department of Energy in the U.S. said crude stock piles were down. This, among other things, sent front-month crude futures up 4.7% to $72.72.

By “other things” we mean that the market realises not enough money has been invested in new energy projects to meet new demand. The International Energy Agency reckons the credit crunch led to the cancelling of over $170 billion worth of oil and energy projects worldwide. This explains the feeding frenzy around LNG projects in Australia.

And speaking of that, Pluto is catching up with the Gorgon. The energy story is dominating the resource sector at the moment. Yesterday it was Woodside Petroleum saying it would triple production from its Pluto LNG plant by 2014. Pluto is scheduled to enter into production ahead of the Gorgon project, which was all over the papers yesterday.

Woodside’s shares reacted to the favourable production schedule yesterday. They were nearly up 3.5% while the rest of the market stagnated. And there was movement in the eastern LNG projects too. You may have seen earlier this week that Origin Energy selected a site for its LNG terminal in its LNG joint venture with Conoco Phillips.

The final investment decision won’t be made until next year. And if it’s a go, the project won’t begin production until 2014. Kris Sayce reckons his small cap tip is a better bet for making punters money now. It will enter production much sooner. The only big difference is that the share Kris has recommended in his Small Cap Letter is involved in a smaller project.

“The project will deliver 1.5 million tonnes of LNG per year,” says Kris. “But it’s going to be the first project that actually produces LNG in the region. It’s located closer to the coast. And it’s scalable. The LNG terminal it’s building can take production from other players in the region. And it will already be up and running when other trains get into production.”

Does the surge of Asian and especially Chinese interest mean a new source of strength for the Aussie dollar? Robert Gottliebsen thinks so. He made an interesting point yesterday over at Business Spectator. He wrote that, “The Chinese now know that they can invest in Australia and not face a serious currency risk. We are going to see them buy property in the eastern states and they will support our debt markets on a much larger scale.”

He added that, “There is enormous concern in China about the US currency and the fact that there could be huge losses ahead for China if the American dollar falls…HSBC research shows that China does not face that risk in Australia. Global investors who want to invest in China can do so via Australia with far less risk. Accordingly, our share market is set to follow China.”

He may be right. It’s certainly true that trading U.S. dollars for Australian real assets (be it LNG, coal, iron ore, or real estate on the east coast) is probably a good trade for China. It has several trillion in foreign currency reserves, the bulk of which are denominated in U.S. dollars. There are going to be heaps more dollars printed in the coming years, given the reluctance of the U.S. government to either increase taxes or reduce spending in order to tame its deficits. Inflation is the way out.

Here in Australia, that apparently means more debt is acceptable. Treasury secretary Ken Henry says that because of Australia’s privileged position relative to the China boom, the country can run higher current account deficits without having to worry about a run on the dollar. Henry has said Australia “might attract an even greater share of global capital flows, and quite possibly even larger capital flows in aggregate.”

Because the Aussie dollar is not the U.S. dollar, let us add more debt!

There are many factors that might make Australia a desirable place for foreign capital. It has a stable political system, a fairly sensible regulatory framework, a commodity currency, and a whole lot of beach front property. But we’d be wary of using that as an excuse to run higher current account deficits, importing more than you export. It’s a bad habit to get into. Just ask Warren Buffett.

Buffett wrote an op-ed in the New York Times pointing out that America’s Federal deficit of $1.8 trillion is not just 13% of GDP. It’s “unchartered territory.” “Because of this gigantic deficit,” he wrote, “our country’s ‘net debt’ (that is, the amount held publicly) is mushrooming. During this fiscal year, it will increase more than one percentage point per month, climbing to about 56 percent of G.D.P. from 41 percent.”

Australia’s net debt, by the way, is around 56% of Aussie GDP. This growth of that figure indicates you owe more and more to foreigners and that your own domestic growth is financed by foreign borrowing. It also means the income from your national assets may increasingly go to foreign bond holders. A high net-debt to GDP position is not a good one to be in.

“Admittedly,” Buffett adds, “other countries, like Japan and Italy, have far higher ratios and no one can know the precise level of net debt to GDP at which the United States will lose its reputation for financial integrity. But a few more years like this one and we will find out.”

“The Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington’s printing presses will need to work overtime. Slowing them down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap.”

So Buffett has admitted that you can’t grow an economy out of that much debt. That is bad news for America and the U.S. dollar. But what does it mean for Australia? Well, that’s a good question.

It might mean that U.S. creditors (like China and Japan) would be happy to fund Australia’s modest debt levels, given the higher yield on a stronger currency. That might lessen Australia’s vulnerability as a capital importer. It might even mean that interest rates have to go up less fast than Glenn Stevens currently thinks.

But does it also mean Australia is slowly becoming a vassal state to China? The economy is dependent on Chinese trade. The funding of government deficits and a larger net debt position will be dependent on Chinese capital. If the government has little leverage in the Stern Hu case now, how much more will it have in ten years if these trends continue? And is there anything that can be done about it? More on this tomorrow.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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7 Comments on "Apparently More Debt is Now Acceptable in Australia"

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Coffee Addict
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Dan. It’s risky business for everyone at the moment but in the absence of a cautious spouse, debt is still a very cheap way of funding selected speculations . I was caught out spending too much (mortgage line of credit) on BDL prior to the ALS merger (in reality a T/O bid) and my wings have been trimmed for the time being . ALS has (probably) secured BLD very very cheaply but both have significant order books and upsides. BDL has a growing relationship with CITIC while ASL is a preferred supplier for Anglo Ashanti’s African operations. The key risk… Read more »
Ross
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Ken Henry is yesterday’s man and still fronting the narrative for what has sunk us in such a quagmire that brinkmanship is all that is left. Rudd and Swann groupthink is yet to identify what the RBA already has behind the scenes. Even Battelino in his narrative defines what any impartial reader will immediately identify as teh 1-2-3 of the Australian economy. It is a ponzi scheme. Living standards cannot be maintained by 5% resources impetus releveraged into 95% consumption. Yes leagues of worlds have run this scheme before and for a time the raw power of belief (or happy… Read more »
rick e
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Hi ca and gang a quick one I would like to talk to you and all other d&d and sm cap online secured, type in a password and talk about our timing as what we like in the tips, as there are so many of. How can dr keep following them all? May be like a message board or something? Do you think the dr can put a password so we can talk about the stocks on line? I suppose what I am asking if you agree but I don’t know how or if it possible or worth while for… Read more »
Coffee Addict
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Hi rick e. Much as I would love to have a drink or two with the gang I don’t live in Melbourne. Maybe the end of year DR drinks will coincide with a business trip one year. Clearly some people don’t like me posting my investment views, strategies and comments from time to time. Others appreciate postings of raw views – even if they disagree – as the discourse can be useful. Another porthole on this site would, I guess, be more appropriate. Dan D did try a shares & investment forum about 12 months ago but moderation (and posting)… Read more »
rick e
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Ca I picket up this book in year 2000 it is a share trading by Daryl Guppy it’s a great read It reminds me of the DR style read His current one is a 10 th edition I got lost after half way threw and did again :) recently It all about charting and puts a perspective to it I might buy his program. I also do as you do with the dr recommendation and follow other stocks similarly company’s that have not taken off as fast. Using Google finance and typing in the stock and down the bottom of… Read more »
rick e
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1 more thing I do that is risky is to buy newly floated options from company’s at around 1 or 2 cents they usually expire around 2 years.
Now is a good time to gamble as the trends are still rising and the stimulus won’t slow down.
I see it this way if you spend around a grand and they expire, you put the loss over 2 years and it does not seem that bad. Eventually you’ll get 1 e.g. look at asx: irdo
I know it’s only a stupid dump unlucky gamble

Coffee Addict
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rick e I also like the occasional punt. That’s why I threw a thousand bucks in the direction of Drillsearch prior to Chilton 1 spudding. Like a game of two up the stock will now rise rise further or collapse on the back of the Marino 1 drill results. I don’t know much about new floats or how new float options are going at the moment. To some extent the risk will be priced in BUT you seem to be going very long on a very volatile market (if you are talking about more than some pocket change punts that… Read more »
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