Australia: The Submerging Market

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Is Australia an emerging market? Is the Aussie dollar akin to an emerging market currency? It’s sure looking that way. We’ll have a crack at answering those questions in today’s Daily Reckoning, because the emerging markets rout is back on.

You’ll probably remember that it began back in mid-2013. That was when the US Federal Reserve started talking about slowing its rate of quantitative easing (QE). It was also around the time that China had its first credit market scare, with its interbank interest rate, the ‘shibor’, spiking higher.

The combination of less easy Fed money and the first signs of trouble in China saw capital begin its long haul from the periphery to the core. That is, capital began fleeing emerging markets, moving to the safety of the ‘core’ global financial centres.

There was some respite throughout the second half of the year. The Fed backed off on its commitment to slowly end QE and China, spooked at the prospect of a slowing economy and credit market troubles, tried to pump up its economy once again.

But the Fed finally announced the start of the QE wind-down in December, providing a good excuse to sell emerging market assets and currencies. At the same time, more strains began showing up in China’s money and credit markets. In the New Year, we discovered that economic growth in China is slowing and the latest manufacturing data shows the sector is no longer expanding.

Over the past five years, China has no doubt been the best customer for many emerging market economies. Slowing economic growth there will cause some pain for months to come.

It’s no surprise that you’re seeing the Fed’s ‘taper’ and a slowdown in China at the same time. China loosely pegs its currency to the US dollar. As a result, it broadly imports US monetary policy. Low US interest rates and QE provided plenty of fuel for China to light a credit fire in 2009/10. The problem was that it got completely out of hand over the next few years.

Continuing QE in the US and unwillingness by China’s leaders to tame the flames saw China’s economic growth become hopelessly unbalanced…and unproductive. Now, at the same time the Fed is pulling back, China seems to have a new found resolve to restructure its economy.

No doubt this will be a good thing for China in the long run. And that means it will be a good thing for Australia too. But what happens in the ‘short run’? After all, that’s all politicians and central bankers in the West care about. The next 12 months, the next election, the next ‘upswing’, the next recession to be avoided at all costs.

The short run, we think, will tough for Australia. That means you could see your first recession since the early 1990s. We’re not an emerging economy by definition, but we’re going to feel like one pretty soon.

We’re overly reliant on China and overly reliant on iron ore for a large part of our export income. Around 35% of our exports go to China. That’s a fair few eggs in the one basket. If China slows, the iron ore price will take a hit, and our national income could even contract, a very unusual event.

Like other emerging economies, we’re very dependent on foreign capital. That’s because we consume more than we produce. Over the past 12 months, our current account deficit was around 3.2% of GDP. That’s not as bad as, say, Turkey, with a deficit of around 7% of GDP, but it’s still dangerous because of our dependence on China.

If China slows and our export income falls, the current account deficit could widen. This combination of events would see foreign capital reassess the risk of investing in Australia. Foreigners will still lend to us, but it might be at a higher rate of interest or a lower exchange rate. So Australia could find itself in a situation where we slip into recession, but see market based interest rates rising as risks to the economy increase. That’s classic emerging market stuff.

You’re certainly seeing this view factored into the currency. During the first emerging markets rout in May and June, the Aussie dollar suffered a huge fall. It recovered on the hope that China would continue sucking in iron ore and growing at 7.5% per year for ever. But it was just a technical bounce back towards the 200-day moving average (red line)

 a
click to enlarge
Source: StockCharts

From there’s it’s been all downhill. While we wouldn’t be surprised to see another rally in the next few weeks, the Aussie dollar is now in a definitive downtrend. Expect to see the dollar with a seven in front of it before it’s all over.

We’re not just jumping on board a trend here. We’ve been bearish on the dollar for years. We recommended our Sound Money. Sound Investments subscribers to buy the US dollar and the euro ETFs back in 2012. And we think there are more gains ahead…

That’s because 2014 will be the year when investors wake up and realise that Australia is much closer to an emerging economy than a developed one. Our export base is thin and overly reliant on one customer. Our debt levels remain large and we rely on foreigners to provide the debt that we crave.

Our wealth, or at least our perception of it, consists of property…property buoying bank share prices and property filling up our investment portfolios and self-managed super funds. Why property always goes up is a question never really asked. It just does, and that’s become good enough for a nation of property speculators.

Lastly, we have a political class that is utterly clueless. They’ve grown fat and lazy on Australia’s good fortune. They have no stomach for the hard decisions that are coming. When the pressure is on, they will go for the short term fix, and get us into even more trouble.

We can hardly wait…
  
Regards,

Greg Canavan+
for The Daily Reckoning Australia

Join The Daily Reckoning on Google+

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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10 Comments on "Australia: The Submerging Market"

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Harquebus
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Greg is wrong. QE, debt and deficit are all the consequences of peak oil. There will be no recovery. Manufacturing is in decline and will continue to, the automotive industry is dead and the aviation industry is dying. Without an increase in crude oil production, you can kiss economic growth goodbye which, is a good thing. The growth deadheads have for too long been sacrificing our environment for their precious economy.

Harquebus
Guest

Greg is wrong. QE, debt and deficit are all the consequences of peak oil. There will be no recovery. Manufacturing is in decline and will continue to, the automotive industry is dead and the aviation industry is dying. Without an increase in crude oil production, you can kiss economic growth goodbye which, is a good thing. The growth deadheads have for too long been sacrificing our environment for their precious economy.

rob
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If the rba stopped printing money our dollar would be a lot better.

rob
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If the rba stopped printing money our dollar would be a lot better.

slewie the pi-rat
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“China loosely pegs its currency to the US dollar. As a result, it broadly imports US monetary policy. Low US interest rates and QE provided plenty of fuel for China to light a credit fire in 2009/10. The problem was that it got completely out of hand over the next few years.” this formulation seems generally valid, to moi. at the risk of repeating myself… …since the USDX hit the low of ~73 in mid-2011 [today, USDX = ~80.6; USDX hit 84 once in 2012, and cleared 84 twice in 2013], in slewienomics: >==> QE + ‘strong’ U$ Dollar =… Read more »
slewie the pi-rat
Guest
“China loosely pegs its currency to the US dollar. As a result, it broadly imports US monetary policy. Low US interest rates and QE provided plenty of fuel for China to light a credit fire in 2009/10. The problem was that it got completely out of hand over the next few years.” this formulation seems generally valid, to moi. at the risk of repeating myself… …since the USDX hit the low of ~73 in mid-2011 [today, USDX = ~80.6; USDX hit 84 once in 2012, and cleared 84 twice in 2013], in slewienomics: >==> QE + ‘strong’ U$ Dollar =… Read more »
Barry
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Fundamentally,a major if not the major cause behind our problems is demography. If nations embark on a policy of culling the next generation, then they must expect the consequences. The birth rate in every nation within the Western democratic orbit is below repacement rate, and has been for decades; since the 60’s/70’s era. We have been culling our future citizens and consumers at the rate of about 70,000 or more per year for nearly half a century, and now we start wondering why consumption and entreprenurialism is down. We, and by we I mean all the nations within the Western… Read more »
Barry
Guest
Fundamentally,a major if not the major cause behind our problems is demography. If nations embark on a policy of culling the next generation, then they must expect the consequences. The birth rate in every nation within the Western democratic orbit is below repacement rate, and has been for decades; since the 60’s/70’s era. We have been culling our future citizens and consumers at the rate of about 70,000 or more per year for nearly half a century, and now we start wondering why consumption and entreprenurialism is down. We, and by we I mean all the nations within the Western… Read more »
Jason
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Dachshund Australia is in deep shit when ‘Mastster’ (China) keels over. But the one thing people seem to overlook is the fact that China, like the rest of the world, still need US dollars to buy oil. Oh, and world oil production peaked in 2008 and has been flat ever since, decline willbe soon so don’t expect any ‘recovery’, instead recession will turn into the Second Great Depression. Check out the history of the world between 1929 and 1945 for a glimpse of things to come.

Jason
Guest

Dachshund Australia is in deep shit when ‘Mastster’ (China) keels over. But the one thing people seem to overlook is the fact that China, like the rest of the world, still need US dollars to buy oil. Oh, and world oil production peaked in 2008 and has been flat ever since, decline willbe soon so don’t expect any ‘recovery’, instead recession will turn into the Second Great Depression. Check out the history of the world between 1929 and 1945 for a glimpse of things to come.

wpDiscuz
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