Boom and Bust

One of the most endearing traits of the Aussies is their reluctance to bear fools easily. They have a tendency to speak up and speak their mind when challenged and are likely to put down anyone who might disagree by spouting a colorful Aussie phrase such as, “Don’t come the raw prawn with me, old son,” or some other even more lurid exclamation.

A major topic of conversation in Australia, as in many parts of the globe in these disruptive times, is the economy. The argument is based on a mixture of views in which is expressed a great deal of ignorance about the true nature of Australia’s current economic situation. Sadly, the most foolish of arguments too often emanate from the so-called experts who should be cutting to the truth on this vital subject instead of selling their fellow Aussies the raw prawn on the status of their national economy.

Paradoxically, at a time when the United States was leading debt-ridden nations in the Western world in the size and frequency of its aggressive cuts in interest rates, Australia actually hiked its own. As a number of national economies—in particular America and Britain—increasingly bled from economic woes that daily made the headlines, blamed on the U.S. subprime mortgage meltdown, on the surface Australia seemed to be continuing in a boom phase largely propelled by the significant rise in commodity prices.

The price of Australian exports of minerals, in particular, skyrocketed as demand escalated dramatically fuelled by the rapid expansion of China and the East Asian economies. This in turn led Australia’s reserve bank to enact measures to curb resultant inflation. A surface evaluation of the country indicated that Australia was having a dream run while the slaughter continued on Wall Street.

Yet, is the Australian economy really insulated against a global credit crunch to the degree that some say? Dig a bit below the surface hype and a different picture begins to emerge. Australia has some deeply entrenched systemic problems affecting its economy that are too easily masked by any temporary high demand for its mineral wealth.

Economic History

The year is 1985. One of Australia’s most successful businessmen, John Leard, former chief executive of Australian National Industries, has begun posting full-page advertisements in major Australian newspapers. He pays for the ads out of his personal funds. The advertisements decry the parlous state of the Australian economy. Leard placed one such advertisement in 10 national newspapers on August 22, 1985, under the headline “Why aren’t we told the truth? Australia is going broke!”

In that advertisement, Leard cast an eye over Australia’s past. He declared, “At the turn of the century, Australia had the highest standard of living in the Western world and the Australian dollar [pound] was worth us$2.40. During this century we have slipped to No. 21 on the list of national prosperity and our dollar is now worth approximately us$0.70. What has happened?”

John Leard went on to answer his own question thus, “Over this period the nation has suffered terribly from weak, misguided and ineffective leadership at the national government level (Australia, the Worst is Yet to Come.).”

One of the observations that this true-blue Australian business leader made in the same advertisement was that the country’s “problems have accelerated over the past 15 years.” That took his perspective on Australia’s accelerating economic decline clear back to 1970.

Track forward a little over a decade on from John Leard’s 1985 advertising campaign. In 1998 a former adviser to Dame Margaret Thatcher, Christopher Story, declares that Australia is technically broke! In other words, by the end of the 20th century, in Story’s view, John Leard’s prophecy of a decade earlier about Australia being on the road to going broke has been fulfilled. Story mused at the time, “Australians seem liable to suffer the worst of all possible combinations: a weak and vulnerable exchange rate … soft to declining commodity prices, eroding reserves of foreign exchange (already at precariously low levels), increasing or persisting trade and current account deficits, and ever rising external debt and, of course, net external liabilities” (Economic Intelligence Review, September 1998).

Just a decade ago, Australia was bracketed together with East Asia by analysts in their overall assessments of economic and financial developments. This led to the Australian dollar suffering along with the East Asian currencies, which had fallen drastically due to the East Asian economic meltdown. In just two years, between 1996 and 1998, the Aussie dollar declined 21 percent in relation to the U.S. dollar.

Story commented at that point that, “To match the country’s net external liabilities, Australia’s official foreign exchange reserves would need to grow by more than 15 times” (ibid.). This was an untenable position for any country to be in. In fact, so painful was the realization of the country’s financial and economic predicament that both the government and the bureaucracy tended to just bury their heads in the sand over it. The result was that “the authorities console[d] themselves with spurious calculations, when, in point of fact, Australia is technically bankrupt” (ibid.).

Boom-Bust Cycle

Fast forward a further seven years to the year 2005. The weak commodity prices of the 1980s have morphed into a commodity boom. Australia is riding a wave of high demand and increasing prices for its raw materials. But has this changed the fundamentals of its monetary policy so that it can take full advantage of this boom?

In essence, still nothing has changed in the mindset of those who control the nation’s purse strings. The same problems are extant at the Treasury and the Reserve Bank of Australia as have been there, so entrenched, for over 35 years! The failure to grasp the fundamentals of economic reality is still then leading to spurious calculations and they in turn are conveying a picture to the Australian public about the Australian economy that is just not valid.

Gerard Jackson, economics editor for BrookesNews.com, commented in May 2005, “The current state of the money supply suggests that the Australian economy is heading for a recession. As expected, the role that monetary policy plays in causing the boom-bust cycle is completely lost on the Australian Treasury” (May 9, 2005).

Both Story and Jackson mouthed the very same warnings to Australia as John Leard did back in 1985, though their opinions were separated by more than a decade. Simply put, these economic realists believe that Canberra, together with Australia’s economics intelligentsia, generally lacks a basic understanding of the laws of finance and economics. Jackson pinpoints “the awful state of economic debate in this country regarding booms and busts and the nature of inflation. … Without a doubt, monetary policy is in an awful mess in this country because those who are paid to know better have no real understanding of the power and nature of money” (ibid.).

Move forward another year. In 2006, the results of the “experts” failing to grasp and apply economic and financial fundamentals has produced a blowout in Australia’s trade deficit. “… September [2006] saw Australia’s trade deficit nearly double …. In addition, exports dropped by 1 percent …. Despite these figures some economists are making still Pollyannish statements about resources helping out by expanding early next year. How can anyone with any genuine economic training [be] optimistic about these figures. Month after month and year after year we have been running a deficit” (ibid., Nov. 20, 2006).

Nearly a year before the subprime mortgage bust hit, Jackson explained the cycle that led to the housing market crisis in respect of Australia this way: “The Reserve Bank has kept interest rates artificially low which in turn caused the banking system to recklessly expand credit thus fueling the housing boom, domestic borrowing and the demand for imports” (ibid.).

So what was the verdict of this economic realist at that time? “Australia has been running a reckless monetary policy for about 10 years” (ibid., Nov. 13, 2006). Once again, John Leard’s earlier prognosis is given strength by latter-day evidence.

Today’s Economy

This all brings us up to the present. Again we ask the question, has anything changed to awaken Australia’s leaders to the realities of the true state of the national economy?

In the lead-up to the Australian federal elections of November 2007, the Australian public was sold the line that Aussie banks had no real exposure to the U.S. subprime fiasco. Nonetheless, anz bank ceo Michael Smith soon after described the credit problems that subsequently escalated within Australia as a “financial services bloodbath” (Daily Reckoning, Feb. 19, 2008). Australian banks have in fact been just as worried as their overseas counterparts about their level of exposure to falling asset values and the escalation in borrowing costs.

Writing from Melbourne, the Daily Reckoning’s Dan Denning observed, “The banks have become the front line in the war between investors and deflation. Deflation is winning as asset values are falling for stocks, bonds and other securitized assets” (ibid.).

As Denning mused, “[I]t’s pretty obvious there’s some major instability in Australia’s financial markets. In the age of leverage (or deleveraging), it looks like it’s going to be tough for banks and financial stocks to increase earnings” (ibid., March 31, 2008).

On March 31, 2008, the Australian Broadcasting Commission aired a program on Australia’s debt crisis called Debtland. The abc’s overview of it read: “Mortgages doled out to people on disability support pensions; loans to refugees with no English and no jobs that leave their families with next to nothing to live on; home loans so large they push borrowers below the poverty line …. This isn’t America’s subprime meltdown—it’s Australia’s debt debacle, the legacy of a credit binge that’s sent household debt through the roof and lending standards through the floor. Now the hangover is kicking in.

“As many as 300,000 Australian households may be at risk of losing their homes. It mightn’t take much—another rate rise or two, a family illness or maybe just the car breaking down—to send people under. And for thousands more who are better off but feeling the pressure, this credit crisis is getting too close to home.”

Of course, corporate spreadsheets presenting data on extremely complex monetary instruments, viewed through rose-tinted glasses and swallowed hook, line and sinker by a largely ignorant mass media, to be foisted off by them onto a largely gullible public, shade a lot of the murk underlying the current risks to the Australian economy.

“[T]his reduction of a complex economy to a massive pile of spreadsheets and economic data has its roots in an obscure group of German economists called the Historicists. … The Historicists didn’t believe in general, universal economic laws” (Daily Reckoning, Feb. 6, 2008).

The root cause of Australia’s and the rest of the world’s current economic woes is simply that their monetary policies are not underpinned by the basic laws of finance and economics.

Too Few Eggs—Too Few Baskets

The average Aussie may think the massive demand for Australia’s raw materials will bail the country out of any economic hole into which it risks sinking. On the surface that may appear to be so—as long as the demand is spread across a number of customers and as long as the strength in demand continues. Australia’s problem with this is that it has too few eggs in too few baskets.

The largest Australian commodity eggs are iron ore and coal, with bauxite, uranium, diamonds, heavy and precious metals figuring also as sizably in demand. Many of the largest baskets are, unfortunately, from nations that historically do not rate very high on the scale of respect for human rights. China is the main contender at this point, followed closely by Japan, with Russia and India looming large in the background.

As nations compete to secure the raw materials and energy necessary to feed their expanding economies at competitive prices, China leads the way via a huge expansion into Australia’s minerals extraction and processing industries, especially in the Pilbara region of Western Australia.

This will be a test issue for Australia’s Mandarin-speaking prime minister, Kevin Rudd. Chinese enterprises are seeking to invest heavily in Australia’s natural resources—primarily iron ore, bauxite and uranium—by seeking an increasing slice of the companies that mine and process these raw materials. In the process they are coming up against government legislation designed to fend off prospects of Australia engaging in a fire sale of the greatest assets the country possesses, its mineral wealth. With its rural industry ravaged by years of drought, if Australia yields to foreign pressure to sell off major shareholdings of its mining companies, it will simply destroy any prospect of developing a sound economy.

Dennis Shanahan, political editor for the Australian newspaper, highlighted the challenge that faces the Australian government. “China has complained to the Rudd government that its application of foreign investment rules blocks Chinese-backed companies from bidding for natural resources in a growing commercial and economic dispute between the two nations.

“Kevin Rudd faces a diplomatic wrangle … against a background of rising trade and investment tension behind China’s expansion into Australia’s resources boom” (March 19, 2008).

Economically, Australia is caught between the proverbial rock and a hard place. Being a credit-based economy, its banks and financial institutions are nakedly exposed to the global credit crunch. Its systemic trade and current account deficits, overvalued dollar and burden of external debt hardly place it in a sound bargaining position when it comes to arguing against selling off the farm to major customers such as China. Australia’s economic future simply rides on the back of world commodity prices and continuing demand from Asia, principally China. Australia’s gamble is that the demand from the growth economies of East Asia will continue to bail it out of its systemic economic woes.

A Country at Risk

It’s easy to list the high risks that the Australian economy is currently facing: the fact that rising commodity prices and rapid monetary expansion—the driving forces behind Australia’s 10-year boom—are simply unsustainable; the fact that, because Australia’s economic future is so highly dependent upon that of China, any sharp slowdown in China poses a threat to the Australian economy; an already collapsing monetary-induced housing-price bubble; a sharp decline in household savings from 5.1 percent in 1991 to 2.7 percent in 1999 to minus 1.7 percent in 2004.

Given the systemic economic problems that the Australian economy has endured for decades, the country is hardly in a decent position to weather the storm of any rolling, global economic crunch.

Dan Denning put the problem that Australia and its brother Anglo-Saxon nations face today into easy-to-understand terms: “[D]ebt-based wealth—whether in the UK, the U.S., or Australia—is the road to ruin. Some people are just now finding out how far along that road we are. We’re very far indeed” (Daily Reckoning, Feb. 6, 2008).

Over 20 years ago, John Leard warned of the results if the nation refused to return to workable economic policies. Australia is on the verge of finding out just how right he was.