Why Our Net Foreign Debt Is Now at $1 Trillion

Girl counting Australian money
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What to make of yesterday’s booming jobs number?

The Australian Bureau of Statistics reported that the Aussie economy created 71,400 jobs in November. Combined with October’s strong number, it was the biggest two month rise in employment since 1988!

According to the Financial Review:

Taken at face value, the biggest one-month burst in hiring since 1994 suggests parts of the economy now resemble boom-time conditions, particularly in NSW, which was home to the equivalent of almost 60 per cent of the total 127,000 national jobs gain over the past two months.

That’s the catch isn’t it? Do we take the numbers at face value? The national accounts, released just last week, showed the domestic economy actually contracted in the three months to 30 September. It was only a very strong export number that pushed up overall growth.

Given market expectations were for a slight reduction in jobs in November, you can take the large official rise with a grain of salt. Expect to see weaker employment numbers in the months to come.

The jobs figures are notoriously volatile and have come under a lot of criticism in recent years. ABS statisticians have had to deal with lower funding levels and the quality of data output has deteriorated.

Still, they can’t be that wrong, can they?

My guess is the employment situation is nowhere near as rosy as the ABS figures portray…but it’s not as bad as the economic growth number suggests either.

This disconnect makes it difficult to get a read on the economy. Is the economy improving as it rebalances away from mining investment? Or are we stuck in a slow growth world, weighed down by a long and grinding iron ore bear market, which will continue to reduce Australia’s terms of trade and national income.

Iron ore prices, by the way, fell another 1.4% yesterday. It now trades at US$38.50 per tonne. And there’s no relief from a lower dollar.

The strong employment number yesterday saw the Aussie dollar rally strongly. Why? It takes pressure off the Reserve Bank to ease rates, so currency traders aren’t as confident in betting on a lower dollar.

They should be though. As the terms of trade bust rolls on throughout 2016, the dollar will come under pressure. It will say goodbye to the 70 US cent range for a long time.

Perversely, the strong employment number was bad news for the banking sector. All the banks fell heavily yesterday. That’s because the prospect of another interest rate cut became a little less certain.

Banks are already facing a number of headwinds. They will struggle to maintain their world-beating levels of profitability in the years to come. Lower profitability means lower share prices.

Another interest rate cut or two is about the only thing you can rely on to push bank share prices higher from here. That may come, but probably not as soon as some investors had hoped. Hence yesterday’s sell-off.

The other point to note about the employment numbers is that a large part of the gains happened in NSW. Throw in Victoria and you’re looking at the vast majority of employment gains taking place in two states.

They’re the biggest states, so it makes sense. But they’re also both going through a house price and construction boom. The price boom is still strong (although the heat has come out of the market) while the construction boom has peaked.

Employment is a lagging indicator, so it’s not a surprise to see strong employment data after the building peak. But my point is that employment is occurring in sectors that are the product of the economy taking on more debt.

That is, more debt pushes house prices higher, transferring wealth from ageing sellers to younger buyers. It encourages excess consumption by those recipients of the wealth transfer…overseas holidays, eating out, etc.

Higher prices also encourage the construction of more dwellings. Higher prices rely on more debt, because wages growth across the country is stagnant.

What we have then is employment growth not on the back of a sustainable economic rebound…but on more and more debt accumulation and house price growth.

This is the problem with modern economic growth. It relies on an increase in debt to provide the impetus for spending, taxation, etc. Without it, there is stagnation and recession.

It doesn’t help that Australia doesn’t produce anything that the rest of the world wants, apart from no-value-added raw materials that are in the process of ‘mean reverting’. That is, heading back towards their long term price…which is the marginal cost of production.

That means the structure of our economy, which relies on debt expansion for economic growth, produces trade and current account deficits because we consume more than we produce.

That’s why our net foreign debt level is now around $1 trillion (it was $994 billion at 30 September).

As long as the majority of people don’t really care about this, and as long as foreign creditors in Europe and Asia continue to funnel money our way, then this ‘unsustainable’ growth model can go on for some time.

Who knows, it could continue for another 10 or 20 years. Or it could blow up next year. Nothing would surprise me. We’re in uncharted waters.

We’re in a world where central banks are the market makers. Considering this is meant to be free market capitalism, that is very worrying indeed.

Regards,

Greg Canavan,

For The Daily Reckoning

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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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