Bursting down under / 謝國忠
Australia has a foreign debt cum property bubble. Its bursting is soon. As commodity prices slide, Australia will face income decline and/or declining inflow of foreign money chasing after its resource sector. Australia has to choose between adjusting through devaluation, while accepting inflation, or a property collapse, which may bring down the financial system. Australia has adjusted through devaluation in the past. It will likely do so again. The Australian dollar may decline by 30% or more in the coming year.
Australia has been on a roll in the past decade. Its nominal GDP doubled between 2001-11, the Australian dollar also doubled. Australia's per capita income reached A$65k and, at the current exchange rate, 30% above the US's, 60% above Germany's, 70% above the UK's, and 11 times China's. When a country's nominal income rises so fast, it is usually a bubble.
Ten years ago I suggested that Australian investors could pick up commodity stocks at home to capitalize on China's growth after its joining the WTO. Iron ore price was about USD10/ton then. It peaked at 190 and is now between 130-140. The iron ore story is the symbol of Australia's good fortune.
In 2008 Australia was on the verge of collapsing. Commodity prices were collapsing. Australian companies were over-levered for financing expansion. Rio Tinto sold big stakes to Chinalco, borrowing China's balance sheet to stay afloat. When China launched a massive stimulus program in late 2008 and commodity prices came back, Rio reneged on the deal. Chinalco probably lost $20 billion in potential gains. If China had not stimulated, it could have bought Australia's major mining companies for a song. Australia is just a lucky country.
The good fortune cannot fully explain Australia's surge in relative income. The investment bubble in the mining sector may have done more. Australia has run up net foreign debt by 150% in the past decade, reaching above 50% of GDP and one of the highest in the world. It is the most important factor in Australian economy's resilence in the current global downturn, because mining investments take time to complete. It also explains the Australian dollar's resilience: the ongoing projects continnue to suck in money.
The investment bubble is a bigger factor in pushing Australia's wages into stratosphere. The salaries of its truck drivers and miners have risen above lawyers and doctors. This income bubble has pumped up Australia's property price to extraordinary levels. Its average house price is 120% above the US's. Australia is a sparsely populated country. Its property price is supposed to be cheap, close to construction cost. The mushrooming land value is really a foreign liquidity phenomenon.
A bubble bursts when something happens to disturb the snowballing of liquidity. In the case of Australia, the declining commodity prices are decreasing export income and increasing difficulties for mining projects to raise funding. On the margin, the shortfall is likely to shrink the bubble. The Australian dollar is down about one tenth in the past two months. And the Australian property price has been declining for nearly two years, down 9.4% from the peak.
As mentioned at the beginning, Australia can adjust through exchange rate or property price. The housing value is 208% of 2011 GDP. If it drops by half, the negative wealth effect will trigger a recession of two to three years with 5% of GDP contraction. The damage due to a burst of the financial system will add to it considerably. From what occurred in the US and Spain, it could be big, causing double digit unemployment rate and widespread bankruptcies. I don't see how Australia can go through asset deflation of such magnitude.
The easy way out is to devalue the currency by 30-40% and accept inflation of similar magnitude. It protects the financial system and keeps the unemployment rate low. As Australia's net foreign debt is over 50% of GDP, devaluation is in the country's interest. It happens when the RBA ditches its concern for inflation and focuses on financial stability.
Like in 1998, 2001 and 2008, the A$ is in for a big fall.