A global research firm compares Australia’s debt position to periphery countries in Europe – the likes of Spain and Portugal – and argues that the Aussie dollar is due for a plunge.
Research firm Variant Perception hasn’t a great deal of good news to offer Aussie punters – except to avoid miners and financials, and to stick to defensive sectors like consumer staples and health care.
The research house says that the Australian economy resembles the UK economy – notably our overvalued property market and excessive household debt, which is now in the process of deflating. But most worrying for Australia is that we suffer from what’s commonly termed ‘Dutch Disease,’ and an unwinding of this position will not be easy.
For well over a decade the mining sector has crowded out all other sectors of the economy, resulting in an overvalued real exchange rate and a housing bubble, the researcher house writes. As a result, our manufacturing and industrial sectors are weak and a recovery will be slow (and will necessitate a substantial devaluing of the Aussie dollar).
Since 1989 the two booming sectors of the economy – mining and construction (housing and real estate) – have fuelled economic growth. “Both of these…are no longer viable as growth engines,” the researcher warns. Our long-running resources boom has caused excessive wage growth in non-tradeable sectors, has appreciated the Aussie dollar and has crushed our manufacturing and industrial sectors.
It’s not difficult to spot the carnage – companies from packaging company PaperLinx, Qantas, Billabong, Myer, Harvey Norman; these are examples of once-strong blue chip stocks that have been pummelled by Dutch Disease. But the problem is, to unwind the damage already done, we need an undervalued currency for an extended period of time.
Australia’s debt position isn’t something that many economists harp on about, but interestingly, Variant Perception regards our debt with alarm. “Australia has been running a persistent current account deficit since 1980 and the country’s negative net international investment position is one of the largest in the world.” The researchers compare Australia to South Africa in that we’ve run current account deficits for most of the last decade despite the mining boom and our sizeable export sector.
And in a similar vein to the Eurozone periphery economies, Australia’s net international investment position (measured by the difference in stock value between assets held abroad and assets held domestically by foreigners) is negative. Out of 19 countries that include Japan, Canada, Italy, Mexico and others – Australia ranks in the bottom 5; we’re worse off than Turkey and Brazil, and only marginally better than Portugal, Spain, New Zealand and Greece.
What does this mean? Variant thinks that the RBA will be forced to take similar action to developed market central banks – by either aggressively cutting interest rates or propping up banks through domestic market operations akin to the liquidity injections of the European Central Bank. Quantative easing is also a possibility, if the RBA is forced to buy bank debt to try to stave off a financial crisis.
A sudden sell off in the Aussie dollar would result.
Australian banks would be caught in the crossfire; a slowing domestic market would put pressure on their earnings and with the majority of Australia’s external debt held in the country’s banking sector, the banks dependence on international funding could become problematic. “A total funding need from external sources at 40% of total funding is extraordinarily high,” Variant notes. “Moreover, about half of this external debt is short term. This increases risk yet further should Australia face a funding shock, driven either by events at home (a severely slowing economy) or abroad (a euro-driven credit event).”
The Aussie dollar has displayed some weakness over the past few weeks, especially against the British Pound and the Euro. Variant Perspective thinks that this trend will continue over the longer term – and that the Aussie dollar will indeed depreciate as the effects of Dutch Disease unwind. “Economic headwinds in the form of a slowing Chinese economy and a continued slump in the domestic housing market will force the RBA to reduce interest rates further.”
Based on this, the research house advises investors to go long Australian bonds.
Interestingly, two charts show the strong connection between growth in Australia and China. The first chart (below) overlays a leading indicator for industrial production in China will annual changes in the AUD/USD.
“The strong correspondence between the charts clearly shows that the currency has been tightly correlated to the cycle in China in the last decade.’ The importance of iron ore to the mining export boom in Australia is represented by the charts below.
Variant argues that Australia’s strong dependence on China will turn into a disadvantage as the Chinese economy slows. “Australia will suffer as the trend growth of the Chinese economy slows down.”
The other major factor plaguing growth long term is the highly-indebted Australian consumer – which is set to undergo a process of deleveraging – at the same time as the country also slows from an aging population. “Both in combination mean lower growth,” they note.