Is Australia’s Economy Decoupled From the Rest of the World?

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The world’s best economy, with the world’s best banks, run by the world’s best treasurer, just posted a world-beating economic growth rate of 1 per cent for the three months to September. The Australian economy is, apparently, on fire, growing at an annual rate of nearly 5 per cent over the past six months.

This raises a few questions. Why has the RBA slashed rates by 50 basis points in the past two months? And why does the stock market continue to languish, seemingly unimpressed with the economy’s growth?

Well, the RBA sees a slowdown ahead and is getting on the front foot. It’s nearly a first for them. And while we can’t bring ourselves to praise a central bank, it’s certainly good to see they have taken their eyes away from the rear-view mirror for a change.

They also realise the banks will use their privileged oligopoly position to pass on only a small amount of the interest rate cut, so these days it will take two cuts to do the work of one.

The banks really are a class act, aren’t they? A few weeks out from Christmas, they have the opportunity to pass on the cut and gain in goodwill what they would lose via a shrinking net interest margin.

But who needs to think about goodwill when you get your own way by threats and bullying anyway? Never has a business group taken so much from society and given so little in return. Shame on them.

As for the stock market, here’s a theory for you. A great deal of Australia’s economic growth has come from huge investment in resource projects to satisfy the demand from China. WA’s economic growth rate for the September quarter was 8.4 per cent, the fastest state growth ever recorded. In contrast, NSW managed just 0.5.

Chatting across the desk about it this morning down in sunny St Kilda, Dan Denning pointed out the growth rate in WA resembled that of China. Coincidence?

We think not. Here’s the deal. GDP growth rates don’t really care for profitability. But the stock market does. The market recognises the resource-led investment boom is a product of China’s credit boom. It’s looking a few years ahead and discounting the effect greater capacity will have on prices and profitability.

In other words, all those billions of dollars of investment won’t generate the returns they are expected to. If the companies and investors are lucky, the returns will just be above the cost of capital. But if things go the way of most credit-bubble-bust aftermaths, returns will be below the cost of capital, leading to writedowns…and slower future economic growth.

Mystery solved.

Greg Canavan
for The Daily Reckoning Australia

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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2 Comments on "Is Australia’s Economy Decoupled From the Rest of the World?"

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GeorgeK
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Greg , What’s you call on mortgage rates in the next 12 months and do you think the banks will carry out the threat to set their own rates ( and do they have choice )

Thanks

Chris in IT
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I’m not Greg, but my view is that the RBA will have to lower rates, and continue lowering them. To me thaey are balancing two things: 1) The housing bubble cannot be allowed to decompress as it would decapitalise the banks who have a 70% capuital exposure to residential property. 2) The carry trade effect of changing interest rates and it’s effect on our terms of trade. IMHO, as the Chinese slow spending (this is already happeneing), less income will be see from this trade partner. This will cause the AUD to drop exactly when we’re exporting less. Their role… Read more »
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