End of Days

All around you see corporate Australia in trouble.  Big names taking hits QBE Insurance profits down, QANTAS bonds rated as junk and the car industry imploding. 

...More than $5 billion has been wiped off QBE's market value in two days, as investors punish the company for repeatedly disappointing and analysts warn that further pain could follow this week's profit downgrade.
In another blow to the insurer, Moody's on Tuesday downgraded its credit to Baa2, two notches above the rating it gives ''junk'' or speculative assets. It cited a weaker outlook for profits and higher debts.(here)

and meanwhile it seems S&P forgot to factor in the likelihood of possible future adverse macro events when they tried to bring some positive spin to current events...

Credit rating agency Standard & Poor’s has said the troubles faced by two of Australia’s most iconic brand names, Qantas and Holden, should not be regarded as a sign that the nation’s economy is derailing. [note it absolutely IS a sign!]
In a rare comment piece, the global rating agency said its decision to downgrade Qantas was a reflection of the competition the airline sector, which hit its earnings, and not the result of a change in consumer sentiment, and therefore it does not reflect broader economic conditions.

A drop in sentiment could further stall the much-needed pick-up in business and household spending. As it is, Standard & Poor’s currently forecasts ongoing subdued economic growth in 2014, with the fall in mining investment not fully offset by a very slowly re-emerging non-mining sector,” the agency said.(here)

And note this is also optimistic because it appears a lot of companies are fiddling the books - misstating their accounts to paint a more healthy picture (see this announcement by ASIC about its concerns of what is essentially degrees of fraud, or at least not complying with the spirit of accounting rules and principles).

 Part of the blame must surely lie with the resource curse - the substitutional effects the mining and resources economy has on the rest of the economy and a point well made in Britain's Telegraph:

The country is exhibiting clear signs of the “resource curse” as other sectors of industry whither on the vine, literally in the case of struggling vineyards. The beautiful wine-growing region of Hunter Valley is being “ripped apart” by coal mines, according to local activists. (here)

Risky banks with lousy service

Some big numbers being mentioned regarding a large class action over Australian banking fees - the biggest ever class action in fact - following a path which saw the UK banks' overdraft fees challenged a few years ago, Aussie banks are now in the spotlight:

THE $57 million class action against ANZ Bank could turn into a multibillion-dollar claim against the nation's banks.

The three week Federal Court hearing involving 43,500 ANZ customers must decide whether the bank's fees of $25-$45 for over limit, late payment and other issues were illegal and unconscionable penalties disproportionate to its actual costs (here).

 And let it not be forgotten the banks are wringing the last drops out of the mortgage boom:

A BOOMING residential housing market, particularly in Sydney, is firing up mortgage applications at Australia's banks, with Westpac to enjoy some of its strongest mortgage applications for several years.

However, in an interview to mark two years since the creation of the AFS division, Mr Hartzer said that business confidence around the nation was still elusive.

"The kind of confidence that Australia needs is commercial confidence," the Westpac chief said (here).

While not doing enough to mitigate risk:

Australia’s biggest banks, whose lending standards helped the nation avoid a property crash during the global credit crisis, are raising concern with home loans helping to fuel record house prices.

The proportion of mortgages that represented more than 80 percent of a home’s value -- the loan-to-value ratio -- rose in the third quarter to the highest since the second quarter of 2009,data from the banking regulator show. Mortgages in which borrowers pay only interest also increased to the highest in at least five years, according to the figures (here).

Everything is not alright - Australian businesses

So the Chinese economic miracle has come to Australia?  In the form of the mining boom and... the real economy bust... or was that fair competition:

STRUGGLING Australian fruit processor SPC Ardmona has urgently appealed to the Coalition government to give it $25 million promised by Kevin Rudd four weeks ago or risk watching the company go broke. 

SPCA chief executive Peter Kelly said that it was already "five minutes to midnight" and that the Shepparton-based business, despite being owned by giant Coca-Cola Amatil, could not keep going much longer. 

He said SPC, as one of the largest food processing businesses in Australia, had a much brighter future than the moribund Australian car industry and needed much less government assistance. But Mr Kelly bluntly warned yesterday that time was running out. 

"The pain is wearing thin; if this business wasn't owned by CCA we would be shut already," a defiant Mr Kelly said.
"Without ($25m from government) we are in trouble; and that's not just a problem for SPC but for our people, the town, the region and the nation."(here)

One interesting point from the article is the political aspect - who survives depends on who has political connections.  An interesting game indeed!

Everything is going to be alright - JP Morgan

See the below and attached link to judge for yourself the pronouncement from JP Morgan.  Let's all hope their right (but see the next post): 

THE major banks are well placed to endure the end of the mining investment boom, with a new report finding no smoking gun from the hit caused by Western Australia's cooling mining market on small businesses. 

The report by JPMorgan and Digital Finance Analytics (DFA) also says the economy's transition away from mining investment growth will be "bumpy" but less painful than expected. 

The findings, which downplay fears of a big spike in bad debts for the banks, came as business confidence last month surged to a more than three-year high, reducing the chances of interest rate cuts by the Reserve Bank this year (here).

The cricket analogy

Fresh from another unsuccessful Ashes series against England the Australian team may be licking their wounds and economy watchers may feel salt is being rubbed into those aforementioned wounds by Larry Elliot of Britain's Guardian newspaper who sees a clear and comparable trend in failure on a big scale ahead for Australia:

It may prove to be a similar story with the economy. Australia was one of the few developed economies to emerge from the global recessionlargely unscathed. Growth has been good for a quarter of a century, public debt is low, the banking system proved resilient during thefinancial crisis and it is one of only a handful of countries that still retains a AAA credit rating.

Australia now bears all the hallmarks of a country where its industrial base has hollowed out. The decision by Ford Australia to close its manufacturing plants at Broadmeadows and Geelong is evidence of what economists call Dutch disease: a natural resource boom drives up the exchange rate and makes all other exports deeply uncompetitive....

...As the economist John Llewellyn has pointed out, household debt in Australia rose sharply in the 1990s and 2000s and now stands at 150% of GDP. Noting that the housing market may already be in bubble territory, he adds: "Depending on a strong pickup in housing as a means to sustain growth and rebalance the economy would therefore appear to be fraught with danger.....The Reserve Bank of Australia is now cutting interest rates and talking down the currency in an attempt to rebalance the economy. That is easier said than done when your economy amounts to a large hole in the ground ringed by some expensive property.(here)

Money running out in WA?

Or are politicians just playing politics with the budget ahead of elections? Either way the state at the centre of Australia's now bust former mining boom looks in trouble already:

The West Australian opposition has accused the state government of unleashing a "$28 billion debt monster", with the latest state budget showing ballooning liabilities. 

Opposition Leader Mark McGowan immediately took to social media to respond to the once-boom state's balance sheet. 

He labelled the second-term Liberal government "economic vandals" for adding a projected $10 billion to the state's net debt over the five years to 2016/17.(here)

One miner feeling the heat...

Not only those falling gold prices it seems but lawyers are getting involved...

Besieged gold producer Newcrest Mining could face multiple legal claims within the next month as former contractors push for millions of dollars worth of compensation, and shareholders mull a possible class action.

Fresh from dealing with an ASIC probe into the share price slump that preceded last week's corporate restructure, Newcrest is believed to be preparing to front two mediation hearings in coming weeks on disputes linked to the troubled Lihir project in Papua New Guinea.

An engineering, procurement and management contractor is believed to be demanding more than $7million as part of a dispute over a cancelled contract....A Queensland-based labour hire company is also believed to be claiming it is owed almost $5 million under a contract it previously held on the Lihir project.

That company is expected to launch legal action to recover the money unless a resolution is reached at mediation sessions.Newcrest declined to comment.
Maurice Blackburn principal Andrew Watson said he was investigating whether shareholders could launch an action over potential breaches of market disclosure laws.''It beggars belief that Newcrest knew nothing of the catastrophic impact that the gold price slump would have on the value of its assets until the day it announced the write-down,'' he said. (here)

A collateralised economy?

The FT Alphaville has a fascinating blog examining the trend for distortions in long term pricing trends of commodities due to monetary easing and negative inflationary expectations.  The journalists have noticed that monetary easing by the Federal Reserve has adjusted the yield curve for commodities and for the last few years encouraged holding of commodities as collateral (rather than to be used for  industrial and traditional purposes).  All well and good but the amount of money tied up has led to an overhang which stands to be wiped out when rates rise - which they are doing now and money moves from commodities into finanical instruments again.

Link here:  http://ftalphaville.ft.com/2013/06/05/1525542/the-rise-of-the-real-collateral-mining-business/

The article explains a lot of the distortions in commodity markets and consequentially the financial markets.  But it seems to raise a question - while all of the above is bad for individual entities or whole industries which suffer from commodity stockpiles, could a whole economy with a sufficient commodity weighting be at risk?

Meanwhile Aussie banks are suffering from the outflow of liquidity in the primary instance anyway - so  Australia learns it is now an unpredictable emerging (resources) nmarket as far as international financiers are concerned?!

Given that the near costless credit and liquidity the Fed, the European Central Bank and the Bank of Japan have been pumping into the global financial system has spawned a multitude of carry trades and a global search for yield, even the slightest prospect that the US might begin scaling back its quantitative easing program was likely to spark a rush for the exits from those trades. (here)

Big risks come home to roost

So you thought China was simply a customer for Ozzie raw materials?  Well yes but there's a whole lot more.  Some infrastructure financing apparently:

Roads such as the F3-M2 and WestConnex will be partly paid for by Chinese immigrants under a state government plan to snap up Treasurer Mike Baird's previously poorly subscribed Waratah Bonds.
Desperate to sell Waratah Bonds to pay for roads and rail, the state government found a solution - joining forces with the federal government to get Chinese immigrants to invest in them (here).

But more significantly China contagion presents an ugly prospect for Australia: 

Today, the home of shadow banking is China. Rating agency Moody’s estimates that shadow banking is equal to 55 per cent of China’s GDP, or $US4.74 trillion....If returns on capital in China are in the high teens but credit is restricted by regulators, then borrowers and lenders will find an informal way to interact so that each party can make the high returns available. The result has been an explosion in shadow credit which Chinese regulators have battled to control.... 

...The RBA is keeping an eye on China’s shadow banks and sees a twofold problem. One is that the shadow banking sector collapses and creates a credit crisis in China with knock-on effects for Australia. The other is that as Chinese regulators rein in the shadow banks, Australia will find out just how much of a role informal credit has played in our own growth story (here).

And as forecast journeyman Ross Garnaut explains we are at the end of the line for the Kangaroo bounce:

The prosperity of the past two decades has been a wonderful thing. Since the recession of 1990-91, Australians have had the longest period of economic expansion unbroken by recession of any developed country.
The China resources boom has passed its highest point and will soon end. Export prices are falling. Resources investment is about to decline. We will be left with an extraordinarily high exchange rate, forcing contraction of trade-exposed industries essential for the expansion of employment and output as the boom recedes (here).

And the adjustment is happening right now:

Running out of cash, Australian miners get creative to survive (here)Construction hit by $1 billion slump (here)

Ross Garnaut on Australia's China Bust

Hat tip to MacroBusiness.com.au.  Excellent video (with summary, here).

For a bit of perspective there is also an encompassing piece by Roger Montgomery on what has gone wrong in Australia (here).

Now back to the real economy...oh...

Things are not looking bright for corporate bellweather Telstra (the monopoly domestic telecommunications provider):

Telstra is poised to make deep cuts to its 30,000 strong Australian workforce, amid a slump in consumer confidence and falling mining investment.
The telecommunications giant unveiled a sweeping overhaul of the divisions that contain half its staff on Wednesday, in a move that could lead to substantial job losses. 

The announcement came as federal Treasury and the new Parliamentary Budget Office blamed both sides of politics for Australia's slide into a structural budget deficit - a deficit Treasury warns is now likely to remain for another six years. 

The news was a blow to government hopes that jobs growth would pick up outside the mining sector. Record low interest rates have so far failed to reignite the economy and the latest data will add to pressure for further rate cuts.(here)

Learning to live with a deficit...

Optimistic Australians are taking some getting used to the idea that the good times are over.  At least those in government.  While it has been pointed out that being in a small deficit is no huge deal for a country like Australia, the huge disappointment due to misaligned expectations is indicative of a ruling class which is out of touch with the economic mood - needing to tighten instead of dreaming up grand spending plans:

Collapsing revenue from lower company profits has blown a $12 billion hole in the federal budget this financial year, Prime Minister Julia Gillard will reveal on Monday...What she will categorise as a ''significant fiscal gap'' has forced a Hobson's choice on the government as it crafts the budget to be delivered on May 14: either trim or delay expensive recurrent programs, including the $14 billion disability insurance scheme and the $6 billion school education reforms or, hand down an even larger deficit in place of what only months ago was confidently forecast to be a small surplus (here)

And it is only down from here:

Australia's economy is the envy of the developed world but there is a question lurking at the back of economists' heads: when will the good times end?One prominent economist warns we could be in recession within two years once investment in the resources sector - the great driver of the economy for much of the past decade - drops off.....Meanwhile Dr Robert Gay, a former senior economist with the US Federal Reserve now working in the private sector with Fenwick Advisors, says Australia faces the prospect of a "perfect storm" of economic dangers in the not-too-distant future.....He warns a fall in commodity prices could be the catalyst for a particularly unpleasant economic downturn. (here)

Farewell good times

Colebatch in the Sydney Morning Herald with a firm take down on the Australian economy's growth aspirations.  Building on Ross Garnaut's recent assessment which was profiled in this blog, it makes for a really shocking read - the China bust, uncompetitive currency and interest rates, falling tax revenue, unfunded commitments and an aging society.  Ouch.  Is this the opening of a door into the bad old days of the recession we had to have?

Our economy is poised to go bust and only tax rises and spending cuts can save us.... One of Australia's most respected economists, Ross Garnaut, of the University of Melbourne, warns that when the mining boom busts, the economy is likely to bust with it. History is on his side. Since 2005, mining investment has reared up like a tidal wave, from 2 per cent of GDP to more than 8 per cent. If it breaks like a tidal wave, it will swamp the economy.... 

The bottom line is that something's got to give. Australia cannot continue this level of spending with this level of revenue.....

The end of the mining boom, however, could throw all this out. Garnaut, a former ambassador to China, says we underestimate the seriousness of China's rulers in planning to shift its economy to a more gradual, less resource-intensive growth path...But every mining boom since the war has ended in a bust, and there is no reason to think this time will be different. It was a very big boom, so it could be a very big bust. (here) 

The law of unintended consequences...

Wikipedia defines the law, popularised by American sociologist Merton as follows:

that an intervention in a complex system tends to create unanticipated and often undesirable outcomes..(here)

This is being seen in Australia.  Deutsche Bank's efforts to assist Sri Lankans affected by the 2004 Tsunami have resulted in firm-branded boats entering Australian waters carrying the 'Lankans seeking refugee status (only for the boat and occupants to be detained upon reaching Australia) (here).  Similarly and more expectedly, the boom in commodities and in particular the labour costs for Ozzie workers and new infrastructure costs are crippling big Ozzie projects, including the offshore Browse LNG field:

....Yet mothballing four years of work implies Australia has become too expensive a destination for big greenfield development. The industry will be watching what happens next with interest because many of the biggest projects are almost as costly. ...Analysts previously estimated that floating LNG could take $9bn off the $40bn-plus cost of Browse. Nice.. (here)

Unprofitable projects means asset sales:

...THE list of assets Rio Tinto is seeking to sell keeps getting longer. So does the list of banks getting a slice of Rio Tinto's business....Investment banks ranging from the best-known names on Wall Street to small Australian boutiques are on the roster as Rio Tinto, under new leadership, embarks on a program to sell off assets. (here).

and declining industries:

...Contraction of the industry has been blamed on the strength of the Australian dollar and fierce competition from overseas rivals who enjoy lower costs on wages, power and raw materials. Some manufacturers have called for industry to get access to cheap gas by government decree, but large resources companies such as Santos and BHP have fought such a market intervention....Mr Nasser said as recently as two years ago he was confident the car industry could survive in Australia, but had become more pessimistic since then. (here)

You've been warned...

Many years have passed since the Economist identified a large, US-subprime style property boom in Australia.  A recent analysis by Leith van Onselen has drawn parallels with the disaster-prone Irish economy:

...Ireland’s house values have collapsed by 50%, on average, since 2007 and the island nation’s home owners have collectively lost the equivalent of A$315bn....Van Onselen notes that in 2004, Ireland was the ‘toast of Europe’, a country with a GDP per capita roughly 20% above the European average....“How things change… As is the case with most housing bubbles, Ireland’s was fuelled by a number of inter-related drivers: easy credit, speculation, and unresponsive supply.” ...

...“The risk for Australia is it basically hinges on the mining boom. If we had a big, big drop-off in mining, we could have a pretty big drastic adjustment. But it’s hard to say what the price adjustment would be if that happened. I couldn’t see Australia being anywhere near 50% [reduction in home values] but 20% could be possible.” (here)

This is what a post boom world looks like...

The market oracles have been showing a glimpse of the future, with an Aussie miner suffering a share price slump following a buyout to a Chinese investor falling through:

...SUNDANCE Resources plunged in early trading after the iron-ore explorer terminated a planned takeover by China's Sichuan Hanlong Group....Sundance shares tumbled by more than half after the mining company said late yesterday that the $1.38 billion takeover wouldn't proceed because the Chinese investment group had missed key deadlines to finance the deal. (here).

...“They have to start from scratch now when economic conditions are a lot more difficult,” said Mine Life’s Wendt. “It’s not going to be easy for them to go out there to find investors because of the more concerning outlook for iron ore demand and iron ore prices and it’s significantly harder to attract funding for high capex projects.”(here).

Meanwhile in other sectors:

...Fitch Ratings has delivered a fresh blow to the upstream liquefied natural gas industry in Australia, tipping more cost blowouts and delays and calling into question the viability of some projects in the pipeline. ...Australia's competitive advantage in the sector is eroding on the back of increased costs and risks, and likely lower gas prices over the medium term, the agency said....

...Fitch also said predicted producers would be forced to sell-down assets...."Rising execution and development risks will force project sponsors of these LNG projects to dilute equity stakes or undertake sales of infrastructure and reserves," Fitch said in a statement. (here).

And with a slowdown comes more fraud:

...A Melbourne professor has warned that hardware and software used for tax fraud is likely in secret use by Australian businesses....The technologies, known as zappers or phantomware, can help a business remove sales from their tax records....Zappers are physical devices used to prevent sales transactions from appearing on a business' records... Phantomware is a class of software that creates virtual sales terminals. It can be used for legitimate staff training, but is also used to keep sales transactions off the books... (here).

Will Australia rebalance? Has any economy rebalanced?

No and no.  Not in the short term anyway.  Whenever you read about politicians and/or bureaucrats having to engineer a rebalancing or engineer a soft landing, you know they will not succeed.  An excellent FT article paints the picture: 


...many forecasters are still worried. They do not believe business investment will be a major driver of growth and argue the Australian economy will have to rely even more heavily on housing construction to meet the RBA’s 2013 GDP growth forecast of 2.5 per cent....As such, they reckon the central bank, which has lowered its benchmark cash rate by 175 basis points since November 2011, will be forced to cut again to stimulate demand....

....“I think we are more of a quarry than what we were 50 years ago and that worries me. The strong mining cycle can’t last forever, that’s inevitable,” Bob Every, the chairman of retail and resources conglomerate Wesfarmers, told a gathering of business leaders in Sydney earlier this month. (here)

Home sales slide...

While the mining boom flickers out, Australia's other, real economy has tanked and no the Ozzie dream of the quarter acre block will not save all...

MacroBusiness economist Leith van Onselen said that sales in the detached new homes market were now tracking at their lowest annual level in the 16-year history of the series...."It's the worst February on record," he said....

...Victoria posted the weakest performance by far, with detached home sales dropping 13.7 per cent...."Victoria's detached new homes market is extremely sick," Mr van Onselen said, noting that the problem has been exasperated by the cancellation of the $13,000 first home bonus in July last year....

...The slide has come despite many developers offering steep incentives – including cars, cash rebates and home decorating packages – in bid to entice buyers back into the market.... (here)

Liquidity v Solvency again

One man's assistance is another man's bailout...

In the world of bank recapitalisations little is clear and labels are important as substance.  Of the many banks which imploded or suffered from the ongoing implosion in Europe, a vast number had been given a clean bill of health by the European Banking Agency during post-2007 stress tests.  In fairness the tests were focussed on liquidity management (liquidity strain being identified as the immediate cause of failures of banks like Bear Stearns and Lehman which kicked off the crisis), while as many now know (except it seems the heads of the EU and the ECB, the crisis has morphed into one of solvency - banks just don't have enough capital in general (as opposed to immediate funds to hand and agreed credit lines to see off a sharp rise in demand for return of funds).

And so it is that the same debate is playing out in Australia in respect of its new bank liquidity facility.  As noted several times in this blog, this has been characterised as a backstop, a safety measure which should not have to be used, or if used, only to cover temporary liquidity demands.  Taking this at face value there are fair questions to answer, but interestingly Michael West had an article out where he disputes the purpose - that the facility is in fact, simply a bailout fund from the RBA - with the suggestion being that Australia's banks are much weaker than they represent.

Over to Michael:

...Glenn Stevens doesn't think it's a bailout fund. It's a Committed Liquidity Facility - the $380 billion in Reserve Bank rescue money, sorry ''liquidity'' that is, which the banks can access should they find themselves in strife....Under this thingamajig, one must select one's words with care, if you are a bank and you are about to bite the dust then you can forget about a bailout. If you are even tempted to whisper the word bailout, snap out of it!...

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...If, however, you encounter ''an acute stress scenario'', why not shimmy on down to Martin Place - but only if you need a little something to facilitate your liquidity in a committed kind of way - flop out the old paw for a spot of lazy taxpayer liquidity, say $20 billion, and Bob's your uncle. Or rather Glenn's your lender. This is no freebie. You will pay dearly - a heinous 40 basis points over the official cash rate....

...Yes, you can only access this exciting opportunity if you are a bank and you are ''illiquid'', but not ''insolvent''. It is beyond this mere chronicler to explore the fathomless schism between a bank that finds itself illiquid and one that finds itself insolvent....(here)

This is not too different from some schemes tried elsewhere and the main message from the crisis in other jurisdictions is that early recognition and writedown of bad banks is necessary (this is the difference between the US and EU response).  Given that thanks to the EU, we are now in a world of depositor bail-ins (with New Zealand and Canada indicating they are considering such contributions so that bondholders, depositors and all sorts of creditors likely to be hit if a bank fails), the strong suspicion is that, notwithstanding the arrangements discussed beforehand, any stress at a major Australian bank will be messy.

Dumbest guys in the room?

As has been recounted in plenty of famous financial tales, a big crisis requires dumb money.  People who come to the party late and end up holding the can, or missing the musical chair.  In the 2007-8 crisis it was the German landesbanks who ended up holding worthless subprime paper.  Now in an interesting exercise in market timing - the Azerbaijanis are coming!

..."We plan to travel to Australia in order to meet with the leading market participants including regulators, developers, asset owners, and overseas investors to gain deeper understanding of the market," said the State Oil Fund of the Republic of Azerbaijan, or Sofaz, in an emailed response to questions from The Wall Street Journal. "This trip is planned to take place during the course of this year."...

...Sofaz, the wealth fund was set up in 1999 to capture revenues flowing from the Caspian nation's vast oil and gas fields, said that it's ramping up its investments in Australia after buying shares in "major" Aussie companies that appear in the MSCI World Index for the first time last year and government debt..

.....But investment in Australia isn't without risk for the Azeri fund. ...(here).

And to be sure, the smart money is leaving the market...the Japanese are quits