Do you get the feeling the situation is heating up a bit in the Australian economy? I mean, the government’s budget is in tatters, iron ore prices are at new lows and the rent seekers are getting worried.
I’ll look at iron ore first. This is the one commodity that has underpinned our prosperity for the past decade, and it just dropped to new lows for the year. The spot price is around US$88 per tonne, within sight of the September 2012 low of US$86/t.
Don’t worry; it will get there…just give it time. I’ve been saying for a while to expect an iron ore price of around US$80/t by the end of the year or early 2015. It could even go lower if Chinese steel demand weakens in the face of a wall of new supply coming next year.
I know many people have an enduring faith in ‘Chinese demand’. It will always be there, apparently. Urbanisation…people need somewhere to live…the government will prop things up and blah blah blah….
Yes, Chinese demand will always be there, but it’s the rate of growth you have to worry about. China’s economy, as I constantly bang on about, just experienced (over the past five or six years at least) a credit boom unrivalled in economic history.
This means that debt levels have gone ballistic. Debt is such a commonly used term these days that its actual meaning is lost. So let me remind you what it is: future consumption brought forward.
Yep, China’s credit and property development binge jammed many, many years of future consumption into the past few years. Now it’s getting ugly. The Financial Times reports that property developers are struggling to get rid of excess inventory…
‘In the latest sign of Chinese developers’ desperation to unload inventory into a weak property market, China Vanke Co is offering discounts of up to $325,000 to homebuyers who shop on Alibaba’s Taobao, an e-commerce platform. ’
Another article warns that the mood towards property is changing…
‘A change in mindset among Chinese homebuyers — away from pure speculation towards a system based on fundamental demand for accommodation — is leading to a profound shift in the way the country’s housing market operates.
‘“Previously parents told their kids: don’t squander your money…save it and buy a house. After you buy a house, save more and buy another house,” says Du Jinsong, property analyst at Credit Suisse, the bank. “Now even parents are saying: don’t buy houses any more — it’s not worth it. I think this is a very big change.”’
Government in China can do a lot of things, but it can’t bring animal spirits back. This has grave ramifications for the Australian economy, and we are not even remotely prepared. (More on ‘animal spirits’ and the effect of debt in tomorrow’s DR.)
Which brings us back to iron ore. The price is weak and will get weaker over the long term. This will place pressure on government budget revenues because iron ore is our biggest income earner, by far.
The WA state government, blissfully suspended in a bubble of ignorance and wishful thinking, has budgeted for an average iron ore price of nearly US$120/t this year. Their budget deficit will be huge. But who could have seen it coming?!
The federal treasury’s forecasts are better (around US$95/t from memory), but even so, pressure will be on the budget this year…and next year, and the year after.
Which brings me back to my initial point…things seems like they are heating up, no? I mean, Australians vociferously rejected the governments’ ham-fisted attempts to live more within its means. The budget as handed down in May is unrecognizable.
After 23 years of economic good times, Australians are in no mood for even mild ‘austerity’ (that’s what we call living slightly above our means these days). Having little idea of where the wealth came from, we have no idea that it could disappear just as quickly.
And the government seems to have no real intention of initiating genuine structural reform to improve the long term budget outlook. Tax reform is badly needed, but would tread on the toes of a whole range of powerful rent seekers (politicians being amongst them) and so won’t happen until it’s too late.
Still, there are increasing calls for genuine reform. The Financial Review reports:
‘Billions of dollars of tax breaks for investors in superannuation, property and shares need to be reconsidered to encourage investment in the economy, according to one of the big accounting firms.
‘KPMG’s submission to the ¬Murray financial system inquiry said a number of tax breaks distort household savings, including negative gearing, dividend imputation and super concessions.’
The upcoming final Murray report could be a major catalyst for change in the way the financial system interacts with the real economy. Or not…it depends on how belligerent the rent seekers get.
Australia’s biggest rent seekers of all, the banks, will surely put a lot of effort into maintaining the status quo. They are already complaining about the interim report, saying Murray’s calls to increase bank capital ratios are off the mark and that they are financially sound.
Of course they are…all banks are sound until a crisis hits. When it does, you then find out where the problems are. A crisis doesn’t have to hit Australia, but the way we’re going, I wouldn’t be surprised.
Well, how about a blind and overwhelming reliance on China and iron ore…good fortune that we have leveraged up to punt on tax advantaged property…using funds borrowed from offshore to do so.
What could possibly go wrong with this arrangement?
Nothing has to ‘go wrong’. Things just need continue as they are (China slowing, us with head in the sand) and soon enough a crisis will be at our door step.
Ironically enough, the banks are the principle ‘head in the sand’ agents. In another article from the Financial Review, the big four banks just want the budget passed so we can all get happy and go about borrowing and spending like we used to.
‘Australia’s four leading bank economists have a blunt message for Canberra: pass the budget or risk destroying already fragile consumer confidence.
‘On the day Parliament resumed, with Treasurer Joe Hockey’s federal budget still up in the air, Bill Evans from ¬Westpac, Alan Oster from National ¬Australia Bank, Michael Blythe from Commonwealth Bank of Australia and Warren Hogan from ANZ found themselves in the same room at the same time and made it clear that a failure to strike a fiscal compromise could lead to a shock to the household sector.’
Pardon my cynicism, but when the chief economists from the big four banks all lobby for something, you can bet that they are not doing so on your behalf.
They are concerned that all this talk about budget ‘austerity’ will knock people’s confidence. Better to remain in ignorance, huh? Let’s just assume that our extraordinary run of luck will continue. That’s how it’s worked in the past.
for The Daily Reckoning Australia