Australia’s Broken Economic Model

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Boring!

The Fed finished up another meeting overnight and it was same old, same old. That is, ‘we’re probably going to raise rates this year but it still depends on incoming employment and inflation data’.

Don’t be surprised if you hear the same thing for the rest of the year. The unemployment rate has fallen from 10% in 2010 to 5.2% now. But the Fed is still looking for more improvements. With inflation comfortably below their 2% target, and no immediate price pressures, there’s no certainty you’ll see a rate rise this year.

The markets liked the sound of it. Europe and US stocks finished higher, which should set the stage for another good session on the Aussie market today. And with iron ore surging more than 5%, the big miners should lead the charge for a change.

Funnily enough though, gold hardly reacted to the Fed ‘news’. That tells you the gold market think’s the Fed’s first rate rise in years is not too far off. Either that or gold is completely friendless these days, where not even mildly bullish news is good enough to move the price higher.

Gold needs to rally pretty soon to give it some semblance of strength. Otherwise, you may soon see another plunge lower as the bears grow in confidence.

But who needs gold when you’ve got property! Last week, I wrote about capital flight from China supporting the Aussie property market. That support may be beginning to falter. I’ll get to that in a moment. But first, understand this is not unique to Australia. It’s a global phenomenon.

For example, the UK’s economic model is very similar to Australia’s. That is, encourage consumption over production and sell off prime land assets to finance that excess consumption.

Check this out from the London Telegraph:

There is a new block of flats being built just up the road from where I live. On enquiring about prices, I was told not to bother. The whole lot was being sold to overseas “investors”, mainly off plan. This kind of thing has long been common enough in central London, but not in the wilds of Brent for heaven’s sake.

I cite this story not to criticise foreigners for buying up London property – that’s their affair – but to point out that it is precisely this sort of thing which is underpinning Britain’s economic recovery. It’s fair to say that it is not an entirely healthy state of affairs, never mind growing evidence that London property is being quite extensively used for money laundering purposes.

The UK, however, is in a much worse state than Australia. Thanks to prolonged near zero interest rates, it now has a record current account deficit of 5.9% of GDP. That’s massive. It’s the stuff of currency crises. I wouldn’t want to own pounds when the market turns on the UK.

That’s the big question, isn’t it? When, or will, markets turn their attention to these profligate economies? Right now it’s not an issue. Why not?

Western, Anglo-Saxon economies like the UK, Australia, the US and Canada all follow a similar economic model. They consume more than they produce thanks to a consumerist, debt-based economic structure.

When you consume more than you produce as a nation, it means you have to borrow from countries that produce more than they consume. These surplus producing areas are Europe and Asia.

These surplus producers are happy to lend their funds to the Anglo west, despite the unsustainability of the economic model. Thanks to secure property rights and the fact that these countries are historically war or invasion free zones, surplus capital feels safe from confiscation there.

It is this flow of capital that enables countries like Australia and Britain to live beyond their means. And while ever the savers of Europe and Asia are happy to lend to our banks or purchase our property directly, we’ll keep living the good life.

But now, in Australia at least, the screws are tightening on foreign capital coming directly into our property market. From the afr.com:

The Chinese sharemarket correction and tightening of local banks’ lending to overseas investors could slow foreign investment in Australian property markets, according to property specialists.

Andrew Fawell, director of the Beller Group, a diversified property group with offices in Shanghai selling Australian property to Chinese investors, said there is anecdotal evidence some investments could be axed because buyers have suffered heavy losses on China’s bourses.

“Reports are coming in of investors claiming they have lost all their capital on the stock market and cannot go through with the deal,” Mr Fawell said. “The Australian market has to be braced for unexpected events.”

It is actually against the law for foreigners to buy established residential property in Australia. But for years now these laws have been roundly ignored. Everyone — banks, real estate agents and law firms — have gone about their business as thought the law didn’t exist.

And the government made no attempt to enforce the rules either. Everyone was making too much money.

But thanks to a growing groundswell of public outrage, the government has decided it really should impose the law. That means banks, lawyers and real estate agents must now start to toe the line.

It remains to be seen whether the government will really do anything to curb illegal foreign buying of established homes, or whether determined capital inflows will just get around the stricter controls.

Maybe the Chinese stock market just needs to collapse good and proper to see a noticeable effect? Which it will, in good time.

On top of this, you’ve also got the big banks and now AMP imposing higher rates and increased restrictions on property investor loans. Given the property boom is predominantly investor led, this is another blow to the ongoing property bull.

It’s by no means dead, but it has copped a few ‘banderillas’ in the shoulders. You should start to see a drop off in auction clearance rates in the next month or two.

But remember, selling property (either directly or via bank debt) to finance our excess consumption is a key plank of our economic growth model. As flawed as it might be, politicians and regulators will do just about everything to keep this model going.

Regards,

Greg Canavan+,

For The Daily Reckoning, Australia

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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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