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)

Factoring in the China slump

Election season in Australia kicked off with announcements that the mining boom was over - perhaps a good opportunity to align voter's expectations prior to starting on the campaign trail.  But there does seem genuine concern of the risks to Australia from a China meltdown, not only from the RBA but also from ratings agency Standard and Poor's:

Australian banks' credit ratings would be cut by up to two notches and house prices would fall by as much as a quarter if China's economy were to slow sharply, Standard & Poor's says.

In a report assessing how Australia's financial system would respond to a ''hard landing'' in China, the credit rating agency says a dramatic slowing in Asia's growth engine would have severe ripple effects on the domestic economy.

S&P sees a hard landing in China - where growth slows from about 7.5 per cent now to 5 per cent - as unlikely, attaching only slight probability to this scenario.

But if growth did slow this sharply, it says Australian banks would face credit rating cutsbecause of their heavy exposure to the domestic economy and the $1.2 trillion mortgage market. (here)

What a commodities slowdown looks like

Kudos to the BBC for sending a correspondent into the mining regions for some images which many Australians may be familiar.  An eerie silence in the background as Linda Yueh how long growth will last as China slows (here).

The highlight was the digger loading up $1 million of iron ore an hour.  How much longer will it continue to run profitably? 

Bringing a Chinese ghost town to a city near you...

A really strange proposal is doing the rounds of Macquarie Street (headquarters of the NSW State governement).  Described in glowing terms by the Sydney Morning Herald as the brainchild of a former Macquarie banker and parliamentarian Ros Cameron (who else but infrastructure infamous MacBank?) and his backers have managed to cobble together a proposal which would tear up the fabric of Sydney and all cherished planning and development standards of the city.  Oh for a buck sure.  But do Messrs Cameron and others really think Unions would allow foreign low cost labourers to be imported with the  materials (they blocked Gina Reinhart from doing something similar)? Or that politicians would forgo the local job creation of such a large city changing project?

In case you are guessing, the Cameron led proposal seeks to take a Chinese building site and dump it in Sydney, switching some transport pathways to do so.  The plan is original and does offer a fresh approach but seems over the top - absolutely everything shipped in and dumped in the centre of Sydney  with 150 prefabricated skyscrapers?

Who would fill these?  Who would buy them?  Who would think they could pass approval? or be safe?

No it seems this is an overdone proposal - possibly for consumption only.  It seems likely that this is a PR circulation to soften up the population for some more subtle changes - low cost import workers here or poor cheaper construction there.  Watch this space.

Political objectives aside the proposed development could be seen as another world famous China export - of big, not very appropriate cities and buildings, many of them empty.  For example!

Australia is certainly taking all things Chinese to heart! (Ghost cities link here)

The $17 million kitchen... not Chinese...

Such could be a headline to do with the exit of Julia Gillard, who of late had been playing her gender cards on her sleeve, while readers from the UK and other less honest jurisdictions might expect a headline about exposed extravagance by the former prime minister.  Such would be not on the mark, but not far off point.

The Gillard exit has caused an uproar, the best manifestation of which could be the rant in the Senate by upper house member Michaelia Cash, very much in the mould of Australian rough and tumble politics.

To be sure it is a dramatic story, with Rudd facing a looming challenge to restore order and fight a rapid election campaign.  But interestingly there is quite a silence in the media on a far greater issue.  In a sense it doesn't matter who is in government, Australia faces a tsunami from China and in two ways.  First from the resources pull back.  Second from the shockwaves if the Chinese economy collapses.

On the first point there was a good overview piece in the FT which looked at Rudd's challenge and the scale of the slowdown for Australia's golden goose (resource projects worth $150 billion cancelled etc)  But more on that kitchen - a nice focal point:

Sitting in a warehouse outside Brisbane airport in Queensland is a kitchen designed to feed up to 2,000 mine workers a day. But it was never delivered to BHP Billiton, the world’s biggest mining company, because the project it was destined for was put on hold. The kitchen is now on the market for A$17m, local media say.

On the second point some pretty direct words of warning:

The risks are growing that China, which underwrites the Australian economy, will succumb to a financial crisis. This has not sunk in for Australian policymakers, perhaps because the implications are just too large, but it is the view that is forming among a large number of investors and economists who watch the data and investigate ground-level conditions closely.
There are huge uncertainties but, at face value, it looks like China is in the midst of one of history's great credit expansions – bigger than Japan's at the height of its bubble – and all that money is no longer generating growth in gross domestic product. The accelerator is pressed to the floor, the tank is getting low but the wheels are not getting traction like they used to. (here)

The above article refers to expert Victor Shih of Northwestern University.  A video of him explaining just how many trillions of bad debt are locked up in Chinese banks is here.

Similarly from William Pesek:

Australia has been called many things: Oz, the land Down Under, the lucky country. But the equivalent of a collateralised-debt obligation?
Canberra can't be happy to hear its AAA-rated economy likened to one of the reviled investment vehicles that blew up amid the 2008 global crisis. Yet the comparison is being made by some economists, who see the asset underlying Australia - demand from China - beginning to evaporate.
No country is more vulnerable to the much-dreaded slowdown in China than resource-rich Australia. The mining boom that fuelled nearly all of its recent growth is nearing a cliff of economic risk.
“Australia is a leveraged time bomb waiting to blow,” says Albert Edwards, Societe Generale's London-based global strategist. “It is not just a CDO, but a CDO squared. All we have in Australia is, at its simplest, a credit bubble built upon a commodity boom dependent for its sustenance on an even greater credit bubble in China.”
AdvertisementThere's a bit of hyperbole in this view. But highly-advanced Australia is about to pay the price for growing so addicted to a developing nation. Exporting natural resources led to the neglect and atrophying of other critical sectors.

Oh dear.  Where to from 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).

Dump the banks!

It is early at this stage to tell how the skid to the rally in Australian banking stocks is likely to play out, but a quick skim of the headlines is enough to suggest a real evaporation in sentiment:

Dollar puts an end to banking's party 

Our much-loved bank shares are coming under pressure, although at this stage it looks not so much a violent pricking of the bubble, but a gentle deflating like the forgotten balloon behind the couch after the raucous party (here).

and 

Australian bank stocks fell the most in a year as investors sold out of a rally that had driven financial shares to a record high last month....The rally pushed bank shares to record highs with UBS AG (UBSN) analysts led by Jonathan Mott calling Commonwealth Bank the most expensive lender in the world on May 15. 

 “The market run has been so skewed towards high-yielding stocks and financials in Australia, and now with worries about China, foreign investors are withdrawing,(here)

and also:

Foreign investors dump big four banks 

The Australian dollar faces further sharp losses in the next 12 months as it rediscovers its historic link to commodity prices, analysts say.

The dollar sank to a fresh 11-month-low of 95.94 yesterday. It was trading at 96.8 US cents this afternoon following a rollercoaster overnight session....The revised forecasts from analysts come as HSBC flagged Australia’s entry into the global “currency war”, which has seen central banks print billions in cash to push their currencies lower (here)

The trade imperative

Similar to the decision to open swap lines between the Australian and Chinese central banks in CNY, the recent announcement that the Reserve Bank of Australia will diversify 5% of its holdings into Chinese government bonds makes good political and (in terms of encouraging trade) business sense.  

But are they a valuable instrument? In terms of currency value, the Chinese currency RMB would appear to most likely to appreciate (taking stated information about fundamentals as given).  But the likelihood that there will be a decent return from the Chinese government?

Don't bank on it.  It is a reflection of the broader alignment of the Australian economy too - and looking at the recent headlines doesn't make good reading:

The economic weakness in China clearly appears to be taking a toll on the Aussie economy.... (here)

Aussie dollar poison

Poor South Australia.  Last year it lost the Olympic Dam megaproject and now the Economist points out that Holden (the local GM subsidiary) is looking to cut jobs in the state.  Not only that, the magazine lists whole industries which are being struck off as uncompetitive thanks to the record high Aussie dollar:

....Holden, a subsidiary of General Motors and one of Australia’s biggest carmakers, cut 500 jobs, most of them in Adelaide, the state capital. The job cuts and Australia’s trade boom with China have a common thread: Australia’s mighty dollar. Chinese trade not only helped Australia survive the global downturn. It has also boosted the currency’s strength, and made it harder for manufacturers to find markets for their exports. The problem is unevenly distributed around the country. South Australia has suffered the greatest pain: in no other state does manufacturing account for such a big share of the economy....
.....Australia’s dollar recently soared to its highest level in nearly 28 years, on a trade-weighted basis.... The currency’s rise [has] meant that making things in Australia is almost three-fifths dearer than it was ten years ago. It has overwhelmed successive governments’ efforts to steady the carmakers with subsidies. Five years ago, Mitsubishi closed its plant in Adelaide. Australia’s remaining carmakers, Holden, Ford and Toyota, have shed jobs steadily since then. Australians are buying imported cars more cheaply than ever, especially from Japan; their dollar has risen by 26% against the yen since October (here).

As the article notes Julia Gillard is pressing onwards and upwards in engaging with China.  Her own constituents may wish for more efforts directed at home.

Penny dropping?

Thanks to FMG magnate Andrew Forrest, the Australian media has been abuzz with an enhanced sense of importance, reporting from the sidelines on the political-investment shindig the miner organised for China and Australia's business and political elite in Hainan, the "Boao Forum".

More interestingly was reports from another regional conference and comments from RBA Governor Glenn Stevens:

...RBA Governor Glenn Stevens has some concerns about China’s “shadow banking” system. He poses questions about the role of non-bank entities in the Middle Kingdom. (here)

The linked Crikey article gives a good run down of the shadow banking problem in China and quotes from Fitch analyst Charlene Chu, who has led the pack in rating the Chinese bank sector in recent years:

“The [Chinese] banking sector is significantly exposed to shadow banking. We could see an asset quality problem in the financial sector in fairly sizable magnitude within the next few years.”

Actually I disagree with Charlene on one point.  The asset quality problem is happening now. A senior auditor warned China's local government debt (to which the banking system is tied) is "out of control" (here).

And yes Australia is exposed front and centre.  The economy is at risk.

The China connection...

Australian financiers must be worried.... what better way to stifle concerns that you are too exposed to the pitfalls of your biggest trading partner and engine of growth (or as Niall Fergusson would put it, your new colonial master), than to have a serious heavyweight economist interview to dispel any concerns about all those annoying images of ghost cities which have been making the press recently.

Over to Professor Garnaut (whose son John Garnaut is a top China analyst) batting away some pointed questions from Tony Jones and not an upbeat conclusion:

ROSS GARNAUT: Yeah. I think we've got some big adjustments coming and that's going to be quite difficult for us. China's growth being a couple of percentage points below the average of the few decades past does take the edge of things, but more important for Australia is the big structural change occurring in China. That's all written into the 12th five-year plan from 2011 to 2015, a deliberate policy of trying to increase the consumption share of total expenditure....

In fact the interview is excellent and covers a number of key aspects - link here.

Of course this would not be a worry for Australian banks in particular if they did not have a large exposure to China and rest of Asia (or was it just China?)...

....Australia’s banks have more-than quadrupled their exposure to Asia in the past five years as they seek to cash in on the resource-rich nation’s growing trade ties with the region, the country’s central bank said.....That hasn’t substantially increased their risk profile, the central bank said, although credit risk remains an “an area to watch.”... (here).

Oh dear...

RBA speaks Chinese, happy outlook

Before you worry that RBA bank governor has availed himself of Mandarin or Cantonese, fear not as this post relates to RBA policies and announcements.  This blog has been advocating for a while that, possibly owing to great trade flows, the RBA has chosen to throw its lot very much in with its biggest trade partner and not join the currency war (or even talk about the currency war).  The RBA is in denial, about the need for radical banking regulatory overhaul, the need to recognise the high AUD is hollowing out the economy and the failure to recognise the rapid end of the mining boom.

Recent announcements on this point that banking reform had gone too far (or would shortly go too far) were made this week by APRA and the RBA- ironically as Australia is one of the first to abandon interest rate quotes for fixings in favour of actual trades following the LIBOR scandal.

So perhaps even more ironically to discover today that this argument is doing the rounds in respect of China's weaker banks.  The Chinese banking sector is a constant battleground between entrenched state owned enterprise interests and reformers:

...The China Banking Regulatory Commission’s decision Wednesday to tighten rules covering increasingly popular wealth-management products ....Although bank stocks were getting slammed on Thursday – with small- and medium-sized lenders hit much harder than the Big Four ...Analysts at Barclays said the larger lenders could be less impacted by the CBRC regulations, given that their exposure to wealth-management products is lower as a percentage of total assets... (here).

Will Australia want to be joined up with Chinese financial policy for much longer?

Pettis on risks to Australia...

Great interview out (here).  Some highlights: (in response to the impact changing Chiinese growth will have)

...First of all investment growth will slow down significantly and maybe even go negative which means that China, which is a disproportionately large source of demand for hard commodities, 60 per cent of iron ore, 40 per cent of global copper, etc, that demand is going to go down significantly. That will hurt the commodity exporting sector which is unfortunately very important in Australia.

The other important consequence is that as China rebalances almost by definition that means China’s export competitiveness will be eroded which is very good for the manufacturing sectors around the world. So in Australia we’ll see the commodity sector get badly hurt, the manufacturing sector do relatively well but in the short term the balance will be negative. I think growth rates will slow down significantly here....

Calling a market top

Life's pretty good for the Oz Corporate Sector.  Shares are looking up and for banks particularly.  A giddy piece by Myriam Robin painted a rosy picture, especially for the banks which "became more valuable by market capitalisation than all of those in the eurozone".

No worries about banking systems and debts exceeding the size and capacity of the underlying economy a la Cyprus then.  The Commonwealth Bank gets a special mention as it hit highest equity valuation for a day

...CBA has certainly been a very strong contributor, particularly because it’s attractive for investors seeking a lower risk.... Part of the reason why the banks, and indeed the whole economy, got through the GFC relatively unscathed is because of government-mandated limits on the amount of risks banks could take on. Our banks had relatively low levels of sub-prime debt, and were less highly leveraged than those overseas....(here)

A conventional view if not truly accurate.  CBA's mammoth position in the market is a result of it having swallowed up ailing Bankwest in a shotgun takeover in the midst of the outbreak of the GFC in 2008 (more details here).  And for better or for worse, the major banks oversized position has left them gouging their customers on deposits and mortgages and vulnerable to a turn in the wholesale markets.  Or to put it another way - being a large bank in a world where all other banks are trying to rapidly downsize is a bad thing!

As if to add to the sense that things can only head downhill, Chinese buyers are increasing their interest in Australia's financial sector:

..."What hasn't happened in a big way, but is starting to, is banking. Chinese banks finance a lot of banks around the world and we're starting to see them open branches in Perth and Sydney, looking to service Chinese clients here, but it is the beginning of what might be significant growth in the industry for China," he said....(here).

What bad could come from foreign investment and new funds? Well with Chinese investors, though capital rich, are not always successful investors.  In the mining sector, the most notorious failure is the $2.6bn Karara iron ore joint venture between China’s Anshan Iron and Steel and Australia’s Gindalbie Metals which has been weighed down by infrastructure design changes, rising material and labour costs, and currency movements and seen its budget blow out to $8 billion, then up to $10 billion (here).

Let's hope the new masters can handle the ride down from the top of the cycle when banks turn sour..

Where it all went wrong...

Nice piece in the Sydney Morning Herald which hits all the major factors.  No one cause and no simple solution.  In particular with he banking system - as elsewhere private sector risk is now sovereign risk.

...On one half of the pincer, government does not have any choice but to aim for surpluses. This is because the federal budget guarantees Australian banks’ offshore debts, which funds much of the service sector’s growth.....The other half of the pincer inhibits monetary policy.  The lower interest rates get, the greater the likelihood that the banks will need to resume borrowing offshore to fund renewed credit expansion as deposit growth falters and credit demand climbs (here)

...In short, whatever mix of monetary and fiscal policies Australia chooses, growth will be squeezed by the legacy of yesteryear’s offshore bank borrowing binge....The only way to grow out of this in the long run is via productivity gains and/or external demand. So far that has been gifted to us by China. But to keep growing as the mining boom ends we will need to be competitive at both the fundamental and currency levels....

....Basically, Australia’s entire macroeconomic structure is geared towards a dated growth model of borrowing offshore to fund excessive and unearned income inflation. The astute might also observe that this set-up is entrenched also in both political parties....

Black gold to go to storage?

Rather than the Beijing residents, a few journos have noticed that the real victims of Beijing's smog or "airpocalypse" may in fact be Australian exporters as Chinese authorities look to clamp down on coal use.

....The first sign of change came last week when China’s State Council set a total primary energy consumption target (including renewable energy and transport fuel) ...[which] translates to annual growth in energy consumption of about 3.5 per cent over the next three years, down from 6.6 per cent a year in the five years to 2010...  Jiang Kejun, leader of the modelling team that advised the State Council on energy use ... said. “there’s no market for further development of energy-intensive industry.” If Jiang is right that will affect growth in our iron ore exports because steel making is energy intensive (here).

..."Within the (Chinese) thermal power sector there will be a greater reliance on natural gas," Prof Garnaut said....However huge reserves of gas in China and the US mean Australia will face more competition selling to China. (here)

Do you trust Wayne Swan?

Whilst there is an argument to be had about whether it even matters if Australia maintains a budget surplus (as rapidly retreating capital flows, currency and property collapse could dwarf any impacts from fiscal policy), it is probably worth considering the Treasurer's credibility as Australia soldiers on into 2013.  A couple of headlines gave food for thought on this.

....The Treasurer - facing a united push from the Coalition and the Greens in the Senate for the tax office to provide details of the budget's projected $2 billion payments this financial year for the minerals resource rent tax - has fobbed off demands to release details of revenue forecasts....Since Mr Swan's pledge last October, there have not been any monthly forecasts or outlooks published of MRRT revenue....It is clear none of the big three miners - BHP Billiton, Rio Tinto and Xstrata, which are liable for more than 90 per cent of the MRRT payments - has made any payments in the first six months of this financial year (here).

...“I’m optimistic that 2013 will be a better year for the global economy,” Swan said yesterday in his weekly economic note. “One cause of optimism is recent evidence that China’s economy appears to be stabilizing after economic conditions moderated in 2012.”....(here)

AUD - breaking China's fall?

....The Aussie dipped below the 1.0400 level once again in Asian session trade today, after a report by the S&P suggested that China’s investment boom will have to cool considerably in the foreseeable future. According to S&P economists, who’ve come up with a model to determine the vulnerability of economies to an investment led collapse, China ranks number one on the list....(here).

Traders seized on the line stating the benign inflation outlook "would afford scope to ease policy further, should that be necessary to support demand.".....That was enough to send the Aussie dollar to an intraday low of US$1.0391 following the RBA decision from US$1.0448 before the bank announced its move (here)

...Retail trade fell 0.2 per cent in December, Australian Bureau of Statistics said, which was below market expectations of a 0.3 per cent rise. (here)