The great withdrawal

Does anyone remember the late 90's when banks were fleeing their communities in savage cost cutting exercises? With the raging of the radio shock jocks as bank chiefs were quoted asking what people were complaining about (and this was before online banking had taken root)?

Well the shrinking of Aussie banking is starting again, this time at the fringes of the (now slowing) mining boom:

In order to lessen the chance of borrowers defaulting on their loans, Australia’s major banks are reassessing their exposure to risky mining towns as rental yields in some areas have become “not sustainable”.

During the height of the resources boom, demand for home loans and rental properties was enormous, however, as construction spending declines and the miners become more cost-effective with less working capital, that demand for accommodation drops making yields unsustainable (here).

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)

RBA takes the initiative sqeezes banks into gear?

This column has dwelt before on the RBA and the fundamental dilergence between the inflated Treasury information it is given and conditions in reality.  For some time now we have argued that the RBA was in denial about impending weakness in the economy, the banking system and the mining boom.

In case you missed it the contrarian view was that despite appearances, the economy is weak, the banking system is undercapitalised and the mining boom evaporating more quickly than most realised.

After previous speeches essentailly committing Australia to an ostrich policy of head in the sand isolationism, RBA Governor Glen Stevens, as this macrobusiness.com.au article explains performed an about turn and signalled accomodative monetary and fiscal policy.  Or to put it another way after denying the currency war and gathering global slump would affect Australia, Stevens now took aim:

This is a remarkable statement. Although its content is ambiguous about how effective the RBA sees its power to lower the exchange rate, the import of the analysis is that only a lower currency can deliver a ‘sustainable rebalancing’. Truly this is an epic volte-face by the central bank which was, until recently, still encouraging Australians to think of a high exchange rate as a historic boon that was here to stay. It’s not done for the central bank to say it was wrong but it sure is implicit.
...The point is it’s an economy operating at stall speed, with rising unemployment and falling business investment. Into this mix we must throw one more probable outcome....
There is a significant risk that the terms of trade will fall further and faster than Treasury forecasts (here)

And across town the banks are being squeezed hard.  Not only with a deposit levy (a form of negative interest rates to an extent, to encourage spending?) which will likely impact on capital, but also in a seeming prodding of banks to come good on interest rate cuts.  Unusually (and perhaps for the first time ever seen by this reviewer) one of the major banks has passed on and then exceeded a rate cut - could this even be too risky by the banks?  Who knows?  Certainly the dressing of the step us as "showing confidence" is absolute baloney! (here)

An optimist reassessed

It has been very interesting to read the changes in tone from respected Ross Gittins in his publications in the Sydney Morning Herald.  Gittins is a respected economist and long term contributor to the Herald and often takes an alternative viewpoint on issues.

So it was not surprising that as recently as June Gittins was still in the boom times camp (or boom times are coming again camp):

In other words, it's wrong to imagine the boom's about to leave us high and dry. Mining production and exports have a lot further to grow in coming years. Even the fall in imports (which constitutes a reduction in their negative contribution to growth) is linked to the boom: reduced investment in new mines means reduced imports of capital equipment (here)

An observer looking globally would conclude that in fact the boom is about to leave and right now is leaving all emerging economies high and dry as has been seen by the plunging currencies and poor statistics of high growth favourites like South Africa, India, Mongolia and Brazil being reported recently.

What a change then a couple of months makes:

Stevens warned that, in our efforts to get economic growth back to its trend rate of about 3 per cent a year - which is necessary to stop unemployment continuing to worsen - ''the challenges ahead are substantial''. What's more, those challenges will continue for ''the next few years''.

His speech explained those challenges. You know the basic problem: ensuring the rest of the economy takes up the slack as the stimulus from the mining investment boom tails off...

It turns out that, in our present circumstances, low interest rates don't pack the punch they used to, so we're not going to get as much increase in activity as usual.
Why not? Because, Stevens reminds us, we're not just coping with the aftermath of one boom, but two. The other is the end of the ''credit boom''.
… we should not expect a return to the sorts of growth seen in the 1995 to 2007 period' (here).

Now that's a turnaround!  If the Australian economy could rebound to such a degree (in the opposite direction), it would...oh no it won't!

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? 

Banks fine if miners default?

...senior executives at Australia’s largest banks are expecting an increase in bad debts from mining and mining services companies as the value of commodities continue to fall amidst the decline in growth in China.

According to The Australian Financial Review, the survey found that the bad debt situation in mining over the next 12 months is expected to “deteriorate somewhat” with Chinese authorities now becoming more concerned about China’s growth prospects.

The looming threat didn’t stop ANZ from offering up $1 billion in finance to Gina Rinehart last week however, in order to bridge her Western Australia iron ore project. Whilst the prospects of the mining sector have remained quite bleak in recent times,(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)

CBA makes hay while the sun shines

A good set of results out for the Commonwealth Bank of Australia, now thanks to favourable encouragement from the regulator and the lopsided economy, one of the largest banks in the world:

In an unaudited trading update Wednesday, Commonwealth Bank reported net profit of 1.90 billion Australian dollars (US$1.88 billion) in the three months to Mar. 31, up from A$1.70 billion a year earlier. The lender is Australia's largest by market value. 

Cash profit, which smoothes out one-off items, was also A$1.90 billion, compared with A$1.75 billion a year earlier and A$1.85 billion in the immediately preceding quarter....

...Their shares have been among the best-performing on the Australian stock exchange as investors have flocked to their high-yielding stocks. Commonwealth Bank and Westpac topped the A$100 billion value mark this month, at one point making each worth more than the Australian listing of the world's largest mining company, BHP Billiton (BHP).(here)

But note some words of gloom looking forward for the sector:

But behind the headline results, Australia's banks are struggling to keep growing profit amid slowing economic growth. Together, the revenue of the big four banks was largely flat from a year ago, while much of the profit improvement came from cost cutting and a reduction in combined bad debt, which fell 17% from the previous half.

Credit Suisse analyst James Ellis said the lender's result was "supported by a cyclically-low bad debt charge" and pointed to worse times ahead for Australia's banks.

"For the sector the result suggests that the optimisation of bank earnings is reaching its limit, with bad debt charges as feasibly low as they can get, margin expansion and the pace of productivity improvements fading," he said in a note to clients.

The article also mentions declining business confidence, capital levels and the end of the mining boom as factors at play.

Meanwhile a new Occupy-style movement is reported to be stirring in the UK (http://breakupthebanks.org.uk/).  When things start to go wrong will there be significant protests in Oz against the banks? 

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) 

Aussie dollar poison III - the mining and resources industry

It's just too expensive, apparently.  Oh and add to that increased competition and changing markets.  That's the message about the expected cutbacks in Australian mining projects according to a new report by ANZ which was profiled by Macro Business.

....We have again revised lower the potential pipeline of major projects in Australia to AUD440bn as at March 2013 from AUD474bn in October 2012 and AUD498bn in July 2012..... A considerable degree of uncertainty remains for currently uncommitted projects with only 60% (i.e. AUD270bn of the AUD440bn total) of the potential pipeline either committed or already under construction....
... the possible next wave of LNG investment in Australia faces a variety of challenges related to escalating labour costs, the high Australian dollar and the potential competitive threat of LNG exports from the United States. As a result, there is now only a very small likelihood of further onshore greenfield LNG developments being commissioned. ...
...Note that in effect that is $30 billion dollar’s worth projects disappearing per year for the next three years. That’s 2% of GDP per annum for three years gone. My goodness, that is a lot. And that’s before we add any multipliers which the RBA so loves to do.... (here).

And this at a time when new chief of BHP Andrew McKenzie is starting a slash and burn exercise in flattening the senior management and cutting projects.

Squeezing monetary policy

Nothing unusual in politicians seeking to pull the levers of supposedly independent monetary policy with some public comments and a coming election in mind.  Question is, in the midst of a currency war with central bankers from Japan, Cyprus, Europe, UK and US all feeling the politcal heat to abandon orthodoxy and print, will Julia begin a trend of greater pressure on the RBA?

...Prime Minister Julia Gillard says that the federal government’s ‘‘tight’’ fiscal stance leaves room for the central bank to cut interest rates as manufacturers try to cope with sustained currency strength....
...‘‘Our success as a resources economy, as an economy that’s emerged from the global financial crisis strong, has meant that our Australian dollar has been very high,’’ Ms Gillard said hours after meeting with business leaders advising the government on its 2014 presidency of the Group of 20 nations..... (here)

As has been posted, Garnaut and others have discounted the comfort such statements and assumptions propagate - the Asian mining boom is ending and income and growth will drop but FTAlphaville noted another reason why this is dangerous:

Hot Money

It turns out Australia is being funded by non-conventional sources, with the implication being it is "hot" and can be withdrawn very quickly in a crisis (and quick hot money withdrawal means currency crisis and/or collapse):

...At face value, given the share of foreign companies involved, the analysis implies that around half of the investment during the boom has been funded from offshore. However, the actual use of foreign sources of funds is much higher than that. This is because wherever companies are partly foreign owned, funding from internal sources is equivalent to partial funding from foreign sources. Consequently, since the Australian listed resources sector is around three-quarters foreign owned, the same large proportion of internal funding is attributable to foreign sources.... Taking all this together suggests that around four-fifths of the investment funding has been sourced from offshore (here).

Lunacy

Distinguished Australian Professor Ross Garnaut has reportedly called for a cap on the Aussie Dollar to slow inflows and cushion the impact from falls when the commodities cycle turns:

...Ross Garnaut, one of the authors of the float of the Australian dollar 30 years ago, warns that the Reserve Bank might have to consider intervening to push it down to minimise the recession he sees coming as the mining boom goes bust....Professor Garnaut, of the University of Melbourne, says he would rather see the RBA cushion the economy’s looming fall and bring down the overvalued dollar by cutting interest rates sharply to bring them closer to those of other Western countries.......But if conventional means fail to cut the dollar’s value and relieve the pressure on other tradeable industries, he told a seminar at the Australian National University, the Reserve should consider following its Swiss counterpart’s example and put a cap on the dollar’s value (here).

There is some academic sense to this, but to be clear, whilst the Swiss Central Bank has maintained a floor against the Euro in the last couple of years (i) it started with a huge haul of reserves to defend the floor (buying up enormous quantities of Euro securities to keep the Euro relative to the Swiss Franc high and the Franc low), (ii) it was tested by the market, (iii) domestic inflation resulted and (iv) quite probably it had a role in precipitating the scandal in which the chief of the bank, Hildebrand left (though ostensibly because of his wife's trading activities).

Australia is not a financialised economy like Switzerland and will not have the reserves to do so, nor will it be able to survive under even more inflationary conditions that would result.  Professor Garnaut's reasoning is fair but its unlikely to be implemented.

Interestingly, the Reserve Bank of New Zealand has looked at the same question and concluded it's a non-starter:

...If New Zealand decided to cap the NZ dollar, depending on where the cap is enforced, similar levels of intervention might be required as global foreign exchange turnover in NZ dollars relative to GDP is similar to that in Swiss francs. The OCR would need to drop to zero first in order to eliminate the interest arbitrage motivation for NZ dollar inflows. Any attempt to retain non-zero interest rates by “sterilising” such massive intervention would be very difficult. In effect therefore, a Swiss type operation to cap the value of the NZ dollar through large scale FX intervention would also amount to quantitative easing. As I mentioned, this would be highly inflationary in the NZ context.(here)

It could be argued that the horse has bolted already anyway - yes Australia will suffer the falls in GDP from China slowdown (and Professor Garnaut should know as his son is a top China focussed journalist), but to use the expression of Julia Gillard, these losses are "baked in" - there is little Australia can do now to change course, especially since the real economy has been hollowed out.

Australia is entering the currency war, but there are questions as to what can be achieved.

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)

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)

Like a Sydney cappuccino

One of the delights to be enjoyed in Sydney thanks to the heritage of the city's Italian community, is a decent espresso and Sydneysiders all over come to depend on their regular "cuppas".  Of these the cappuccino is a particularly popular variety, which stands out for the amount of its froth - the hot aerated milk at the top of the cup (usually with a signature sprinkling of chocolate powder).

The other Sydney love affair is with property and glowing reports of a return of buyer interest in the Sydney property market and statewide (in New South Wales) was reported in a number of publications.  "Back to boom time" screamed the Sydney Morning Herald:

...LOW interest rates, rising confidence, an improving sharemarket and Chinese buyers all helped Sydney achieve a ''boom time'' auction day as the property market faced its first big test of the year on Saturday.........''Sydney's 76.3 per cent rate is the highest recorded for years and reflects boom-time activity similar to what the market experienced in 2010,'' the senior economist for Australian Property Monitors, Andrew Wilson, said.....(here).

This is froth.  Pure and simple.  A market divorced from fundamentals.  And the optimism on display was elsewhere, in other markets - reporters wrote of an expected bull year in the sharemarket (here), while bank regulators voiced concern about perceived increase in business lending (here). A glowing advertorial for some financial advisers told the story of Tim with all his amassed savings and how he was getting ready for the "good life" (with more saving and spending to come)(here).

So what is really going on? Businesses are looking to cut costs drastically - Insurer QBE noted to be ruling out job cuts (here) and one mining town is dying (here).  Anyone paying attention to global developments is right to think that Australia will not be immune for much longer.  Time to move from frothy cappuccino to regular black coffee...

Tall tales

There is a level of confusion as to the state of the Australian economy and likely risks and even those at the top can't agree.

...Three of Australia's big four banks have given market updates this month. You'd be forgiven for wondering if they were discussing the same market....The discrepancy in viewpoints is partly explained by the different business models of the three banks. Commonwealth Bank is the country's biggest retail lender, which means it benefits most from rising consumer confidence....
.
..NAB and ANZ are both more exposed to business lending, where sentiment is weaker. A survey from East & Partners, for instance, last week found that demand for all types of business banking services fell between November and January by an average of 1.9%....Despite their differing outlooks, investors overall still seem to like Australia's banks, deemed to be among the most credit worthy in the world. (here).

Yet meanwhile the central narrative underpinning the actual (or purported) growth was in fact being unwound by the central bank, the RBA:

...The Reserve Bank of Australia (RBA) says the mining investment boom will peak sooner and at a lower level than previously expected.

The central bank also says that while commodity prices are likely to drift lower over the next few years, Australia will continue to benefit from China's economic expansion...."And as mining investment tails away, we'll increasingly move into the operational phase of the mining boom," he said.(here)

Just to spell it out - the mining boom has been and gone....and there is not so much to prop up the Oz economy...