As exports to China boom, spiralling debt threatens AAA rating
MICHAEL HEATH
The Vancouver Sun
Australia is close to seizing the global crown for the longest streak of economic growth thanks to a mixture of policy guile and outrageous fortune. But the nation is creaking under the weight of its own success.
While growth is being underpinned by population gains and resource exports to China, failure to spur productivity has meant stagnant living standards and electoral discontent; a property bubble fuelled by record-low interest rates has driven household debt to levels that threaten financial stability; and a timid government facing political gridlock could lose the nation’s prized AAA rating as early as May because of spiralling budget deficits.
Australia’s last recession — defined locally as two straight quarters of contraction — occurred in 1991 and was a devastating conclusion to eight years of reform designed to create an open, flexible and competitive economy. But it also proved cathartic, paving the way for a low-inflation, productivity-driven expansion.
As momentum started waning, China’s re-emergence as a preeminent global economic power sent demand for Australian resources skyrocketing, helping shield the nation from the worst of the global financial crisis. But the post-crisis return of the boom proved ephemeral, failing to boost government coffers and pushing the local currency higher, eroding competitiveness and driving another nail into the coffin of a fading manufacturing sector.
“There’s no country on Earth that’s derived more benefit from the rapid growth and industrialization of China over the last 30-odd years than Australia,” said Saul Eslake, an independent economist who’s covered Australia for over three decades. “After the end of the mining-investment boom, high immigration is helping us avoid a statistical recession, but it’s also contributing to other problems” like soaring property prices and household debt.
Outside postwar Japan, the modern economic growth record is held by the Netherlands, stretching from 1980 to 2008 and fuelled by the discovery of North Sea oil. Ian Harper, an economist who sits on the board of the Reserve Bank of Australia, says the nation’s two key drivers are best summed up by how it coped following the collapse of Lehman Brothers Inc. — the crisis that saw the Netherlands finally succumb to recession.
“We benefited from the Chinese stimulus, we benefited from the exchange rate being allowed to depreciate, we benefited from direct intervention in the financial markets, we benefited from government spending,” said Harper. “That’s good management and good luck.”
Australia also didn’t have a huge jobless spike — as in 1991 — that would’ve precipitated housing foreclosures and threatened the banks. “Had housing prices collapsed we would’ve been in much deeper doo-doo,” said Harper.
It was very different almost 30 years ago. Australia was a basket case, with Singapore Prime Minister Lee Kuan Yew warning it risked becoming “the poor white trash of Asia.”
A 17-year stretch of reform driven by Labor titans Bob Hawke and Paul Keating ensued. Starting with the currency’s free float in 1983, it included financial deregulation, tax reform, slashing tariffs, ending centralized wage fixing and creating a private pension system. When Labor lost office in 1996, Liberal leader John Howard took up the cudgels, making the RBA officially independent, returning the budget to surplus and liberalizing labour laws. The introduction of a goods and services tax in 2000 was the last major successful reform.
From then on, Howard would turn fiscally flippant as cash rained from the China-driven spike in commodity prices, allowing him to spend hard while keeping the budget in surplus.
The Labor government that succeeded Howard in late 2007 was widely hailed for its response to the global financial crisis a year later, steered by Treasury officials whose anti-crisis program was forged in the fires of 1991: get cash directly to households to spend and maintain confidence. Yet from that success, Labor would stumble on climate policy and then vacate the policy field altogether.
The current Liberal government has followed suit: avoiding tough decisions for fear of electoral backlash, then being pilloried for failing to tackle problems like a budget deficit that both sides have promised to fix since 2010. As a result, ratings agencies are now circling Australia’s top credit score ahead of the treasurer’s next budget in May.
The nation has seen five changes of prime minister since 2010 — compared with just three from 1983 to 2007 — raising questions about whether its politics can still produce reformist administrations. But this has happened before. Australia had five leaders between 1966 and 1972 after just three between 1941 and 1966. Simply put, following periods of dominant leadership, the system takes some time to rebalance.
In the economy, time is less forgiving. A record-low 1.5 per cent cash rate designed to steer Australia from mining investment back toward services is creating problems of its own. Sydney house prices have more than doubled since 2009 and Melbourne’s have also soared, sending private debt to a record-high 187 per cent of income. The RBA frets that anemic wage growth will force heavily indebted households to slash consumption, which could prove disastrous given their spending accounts for more than half of gross domestic product.
Australia’s banking regulator further tightened lending curbs Friday to try to cool investor demand for residential property that’s helped drive up prices. Under the new restrictions, home lenders will have to restrict interest-only loans to 30 per cent of total new residential mortgages, the Australian Prudential Regulation Authority said in a statement. Home values in Sydney rose at the fastest pace in 14 years last month, surging 18.4 per cent from a year earlier, according to data provider CoreLogic Inc.
While China’s demand for resources should keep Australia’s growth ticking over for many years yet, much of the spoils are going to overseas investors now that the mining boom’s investment phase is done. As iron ore prices surged from 2004 in response to Chinese steel demand, cash poured into new Western Australian mines and, together with associated industries, mining employed about 10 per cent of the workforce.
Australia has since become the developed world’s most dependent economy on China, which buys a third of its exports, compared with just two per cent back in 1991. But iron ore prices have more than halved since 2011, when the local dollar hit a post-float record of US$1.10. The Aussie would hover at or above parity with the greenback for the next two years.
The currency’s strength then saw off the car industry: two of the three manufacturers in 2013 said they were quitting Australia, with the last following suit the next year. While the currency would eventually retreat to the 70s, the damage had been done. Worse still, the trillion-dollar windfall from the boom had been spent, not saved, leaving no cash to plug yawning budget deficits or build much-needed infrastructure for an expanding population that would also support growth.
So while Australia’s ability to avoid recession is lauded, it’s also been argued it missed the cleansing fires of a slump to shake out areas of excess such as housing. Serious casualties of 2008 such as the U.S. and U.K. are now at or near full employment and growing robustly having cleared out their dead wood.
RBA’s Harper disagrees. Economists, at least since John Maynard Keynes, have been “raised on a steady diet of stabilization policy” because its alternative is “extremely destructive” due to the indiscriminate nature of recessions, he says.
“Central banks have published data — well look at Andy Haldane’s work at the Bank of England — just estimating the economic cost of downturns, particularly financial market collapses relative to the cost of intervention,” he said. “And you pretty soon see that this is a good bargain, being stabilized.”
There’s also debate on consecutive quarters of contraction as a definition of recession. Eslake says his preferred measure is whether unemployment has risen by 1.5 percentage points or more in 18 months or less. “It doesn’t really give any false signals,” he says of his measure, which occurred in Australia during the financial crisis.
In truth, Australia pretty much has a healthy starting point of 2.5 per cent expansion each year: about 1.5 per cent from population growth and one per cent from increased resource-export volumes due to the mining investment.
Australia’s then-Treasury Secretary Martin Parkinson highlighted the approaching growth record in a 2014 speech, when he put the Netherlands’ expansion at 26.5 years. That’s one year away from where Australia stands now. However, OECD data shows the Dutch grew from the fourth quarter of 1980 through the second quarter of 2008, or 27 3/4 years.
Eslake has crunched his own numbers and found that once OECD data is taken to two decimal points, the Netherlands had a technical recession in 2003 and so is already behind Australia. His analysis also has the Dutch tying with Austria, and includes Taiwan.
As for Australia’s recession risk, slumps have traditionally come from the RBA slamming on the brakes to try to rein in inflation — as before 1991 when interest rates hit 18 per cent. Given low wage growth and weak inflation, that seems less likely now.
Bob Gregory, a professor at Australian National University in Canberra who specializes in the labour market and has studied the economy for almost half a century, shares Eslake’s skepticism about two negative quarters to define recession. He instead focuses on full-time employment as a share of population, a measure which has been sliding markedly.
“What’s happening in Australia now is a long, drawn out, sort of slow recession,” said Gregory, who was on the RBA board from 1985 to 1995. “Nothing dramatic is happening, but each year it’s not quite so good as it was the year before.”
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