Australia fragilis

Australia’s future prospects rest uneasily upon a Chinese property boom.

By Gary Scarrabelotti*

It is a comforting thought that the next Coalition government will “under promise and over perform”, as Opposition Leader, Tony Abbott, recently promised once more.  

In the years of Coalition government set to begin sometime later this year — do not imagine, dear reader, that Julia Gillard’s election date of September 14 is set in stone! — Australia could experience such times that a Coalition government will have abundant opportunity to excel in under promising and over performing. 

In all probability, the Coalition’s richest prospects for over delivery will lie in under promising.  That’s because, in the years ahead, there might not be much to promise the voters apart from no more – and maybe even less — of what they’ve become used to during Australia’s 20-year boom. 

The writing is on the wall. 

The federal government’s finances are in “underlying” or “structural deficit”: a reality that has been papered over by boom time company tax receipts. 

Built-in deficits

Now, what is a “structural deficit” Australian style? 

It means that, if you take into consideration the fact that the Commonwealth has benefitted from an abnormally high company tax take, contributed by the mining boom and sometime stellar commodity prices, then its historically normal level of income does not match the expenditures the Commonwealth is presently making, let alone those to which it has committed itself for the future. 

The implication is that the real magnitude of the deficit in the Commonwealth account has been obscured. 

Figures released on March 3 by the Minerals Council of Australia, backed by modelling undertaken by Canberra economic consultancy Macroeconomics, shows just how big this underlying deficit really is. 

An Abbott government’s richest prospects for over delivery will lie in under promising.

According to the MCA: 

“The structural budget balance is estimated by subtracting what is regarded as the ‘cyclical’ component of the budget balance (due mainly to high commodity prices) from the actual or forecast level of the budget balance. 

“The 2011-12 Budget outcome registered a cash deficit of $43.7 billion in the same financial year which saw the terms of trade reach an historic high. This implies a Commonwealth Budget in deep structural deficit – estimated by the modelling firm Macroeconomics at almost $80 billion in 2011-12 (5.4 per cent of GDP). While the Government has emphasised the impact on Federal revenues from lower commodity prices, a structural analysis finds that commodity prices are still contributing to windfall budget revenues to the tune of around $27 billion in each year of the outlook.” (Minerals Council of Australia: 2013 – 2014 Pre-Budget Submission, p.39) 

The MCA accompanied its analysis with a sobering chart projecting the Structural Budget Balance out to 2025 – 26. The chart shows that “the budget is in structural deficit ‘as far as the eye can see’.”

Structural Budget Balance Projections to 2025 – 26 (Republished with permission.)

Well, just imagine how the federal budget would look if there were no mining boom or, to put it another way, if our China trade collapsed. 

Not possible you say: the mining boom has years to run; falling commodity prices will be replaced by increasing volumes. 

Perhaps. Perhaps not. Some China experts say that China is an economic disaster waiting to happen. 

China private debt

According, for example, to Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management: 

“Since 2008, China’s total public and private debt has exploded to more than 200 per cent of GDP. Yet the consensus still sees little risk to the financial system  or to economic growth in China.” 

Sharma was writing in The Wall Street Journal the day after the MCA released its disturbing projections on Australia’s structural budget deficit. 

Sharma points out that studies undertaken since the GFC into the origins of financial crises indicate that 

“more than the level of debt is the rate of increase of debt – particularly private debt.” 

When does the rate of increase in private debt begin to signal a potential crisis? 

Two measures have been developed to mark when the tipping point has been reached. 

The Bank of International Settlements (BIS) says that the alarm bells start ringing when private debt as a share of GDP zooms up to 6 per cent higher than its previous 10-year trend. 

The IMF’s researches lead it to believe that an economy enters crisis territory when private debt as a proportion of GDP grows faster than the economy for 3 to 5 years. 

Well, China’s private debt far exceeds both these measures. 

On that of the BIS, private debt in China is now 12 per cent above the ten-year trend. 

On the IMF scale, private debt has been outstripping the rate of economic growth since 2008. 

China private debt “now in the flashing-red zone” — Ruchir Sharma

The Chinese government knows that something is very wrong.  That is why it has moved to dampen down China’s furnace-hot property market. A capital gains tax has been slapped on property sales; the cost of mortgages has been increased for second-property buyers; and deposits have been increased for multi-home investors. 

A great deal of Australian coal and iron ore goes into China’s splurge on apartment- and office-block construction. 

According to Andy Xie of Rosetta Stone Advisors, property investment represents 25 per cent of all Chinese fixed asset investment. 

When China’s property bubble bursts – as all such speculations will – then Australia’s mining income will suffer a heavy hit.  When that day comes, Macroeconomics’ present forecasts of future Commonwealth budget deficits will look like an understatement. 

We used to say Australia felix. I suggest a more realistic motto: Australia fragilis.

*Gary Scarrabelotti is the Director of Canberra-based business Aequum: political & business consulting. This article was also published on the HenryThornton blog

Leave a Reply