Australia’s Debt Build-up Is Even Worse than China’s!


With trading on Wall Street closed overnight due to the Memorial Day holiday (the US version of ANZAC Day), there’s not much for the Aussie market to go on today.

As I pointed out yesterday, the move above 4,500 points on the ASX 200 wasn’t at all convincing. Yesterday the index put on a measly two points. It will be lucky to hold that level today.

There just isn’t a lot of momentum to push stocks sustainably higher from here.

I mentioned last week that any major mover higher would probably need to come from the banks. While you’re not seeing it yet, underlying conditions are improving for the big four.

That is, the flood of easy money around the world is pushing down their borrowing costs. As the Australian reports:

Improving global debt markets are providing major banks with cheaper funds, limiting the big four’s ability to blame higher ­financing costs for further mortgage and business loan ­repricing.

The fall has pulled banks’ credit default swap spreads down to 93 basis points, significantly lower than the year’s high of about 145 basis points, according to Deutsche Bank.

Record low official interest rates around the world, including negative interest rates in Europe and Japan, are pushing funds into commercial financing markets to seek improved yields.

With net foreign debt levels now over $1 trillion, this is not a good thing. But in the short term, it’s beneficial for banks because it lowers their borrowing costs. If they don’t pass the lower costs on, it improves their margins.

Longer term it’s anything but good. The interest bill on the debt is over $40 billion per annum. That’s money that flows back to our foreign creditors every year. Along with the trade deficit, the capital outflow from Australia (based on December quarter data) is around $125 billion per annum.

We’ll get March quarter data today. You might see an improvement on those numbers thanks to a rebound in the iron ore price, but not by much.

The reality of the situation is that, with such a large amount of capital flowing out of the country each year, we need to offset it with capital inflows to maintain our living standards.

The balancing mechanism is the price of the currency. Capital outflows must equal inflows. But the real issue is at what exchange rate do the outflows and inflows meet?

As a general rule, a rising exchange rate means more capital is coming into Australia than is leaving. When the exchange rate falls, it’s the opposite.

Given the Aussie dollar has been reasonably stable lately, you can assume that capital inflows are broadly matching the capital outflows.

What does this capital inflow actually represent?

A big chunk of it is offshore borrowing by the big banks — borrowing to fund the property boom.

But it’s more than that. It also involves the outright selling of assets. In other words, we’re selling assets to maintain current spending levels. We’re selling agricultural land, listed assets (a Chinese firm just bought a 13% stake in Virgin Airlines) and residential land and property.

Everyone knows the Chinese have been huge buyers of Australian residential housing and apartments over the past few years. It’s a contentious issue. But the reality is that this is Australia’s economic policy. We simply must continue to borrow and sell assets in order to keep the current economic structure going.

In an enlightened country, this short term and unsustainable economic model might come up for some serious debate in an election campaign. But we haven’t heard a whisper of it.

My guess is that most politicians don’t get it. And the ones that do think the electorate are too dumb to comprehend it. So the elephant in the room becomes a non-issue.

And because it’s a non-issue, Australia continues with the same dumb economic policies that are putting us deeper and deeper into debt. That just increases our ‘riskiness’ for when the next global downturn arrives.

Have you noticed that whenever there is a bout of ‘global risk aversion’ (market panic) the Aussie dollar plunges? It happened last year when China got the wobbles. The Aussie dollar sank to 68 US cents.

That reflected the slowdown of capital flowing into Australia. As a result, the Aussie dollar had to fall sharply to entice capital in and match it with the ongoing capital outflows. Remember, inflows and outflows must always match. A sharply falling dollar tells you foreign creditors are pulling back on their willingness to lend to us.

This is what happens when you have a lot of debt. When times get tough, our creditors become nervous.

Recent research by Morgan Stanley, published in the Financial Review, showed that ‘total household, corporate and government debt has reached a staggering 243 per cent, a level that has increased the nation’s vulnerability to a deep downturn or even recession.’

According to the research, the problem with the debt is that it is incredibly unproductive.

Calculations by the investment bank show Australia last year used up more than $9 of debt for every $1 of extra gross domestic product, which is around three times more than the debt needed to produce the same amount of growth in the US economy.

Even more concerning, according to Morgan Stanley, is the comparison to China — where a so-called “debt productivity ratio” of $6 has stoked deep-seated global financial market fears this year about the sustainability of the world’s second-largest economy.

Geez. So our borrowing is even less productive than China’s, our largest trading partner?

And Australia is still the wonder of the developed economic world?


Greg Canavan,
Editor, The Daily Reckoning

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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