- Money Morning Australia

Why the Australian Economy’s Bet on China Will Fail


Written on 30 August 2012 by Kris Sayce

Why the Australian Economy’s Bet on China Will Fail

Yesterday we left you with the thoughts of Reserve Bank of Australia (RBA) governor, Glenn Stevens.

To recap, here’s what he told the House of Representatives economics committee last week:

‘After that the rate of resource investment is likely to decline, while the export shipments of the resources themselves will pick up. By then we might expect that some other sectors that have been weak of late, like residential and non-residential construction, might be starting to pick up.’

An issue we’ve railed at even more than the China collapse is the collapse of the Australian economy and the Australian housing market.

Well, now things are really hotting up. And to us it looks like the next 12 months could be the time when the Australian economy finally cracks. We’ll explain why below…

You can tell when an empire or political system is about to end. Those in power become desperate to stay in power.

You can learn that from history. As Suetonius wrote of Nero in The Twelve Caesars:

‘But, above all things, he most eagerly coveted popularity, being the rival of every man who obtained the applause of the people for any thing he did…

‘Because he was thought to equal Apollo in music, and the sun in chariot-driving, he resolved also to imitate the achievements of Hercules. And they say that a lion was got ready for him to kill, either with a club, or with a close hug, in view of the people in the amphitheatre; which he was to perform naked…

‘He had an insatiable desire to immortalize his name, and acquire a reputation which should last through all succeeding ages…’

Before the 2007 federal election, PM John Howard threw billions of taxpayer dollars to vested interests and those he hoped would vote for him.

2007 saw the end of the Howard Empire.

Not long after, the Fairy Ruddfather threw taxpayer dollars at his favoured vested interests as he tried to hold onto power.

The Rudd Empire ended in 2010.

And in the same sign of fear, the current government plans to spend billions of taxpayer dollars it doesn’t yet have to make sure it stays in power. As today’s Australian Financial Review (AFR) notes:

‘Even as China’s economic boom shows signs of cooling, potentially torpedoing the federal government’s revenue projections, political parties continue to raise expectations about costly future policies.

‘These include the National Disability Insurance Scheme, which is expected to require an extra $10.5 billion a year within six years, a $4 billion dental care scheme, announced yesterday, as well as $5 billion a year for education recommended by the Gonski schools review.’

Even the mainstream analysts who usually cheer for more spending admit the government has already wrung taxpayers dry. Chris Richardson, partner at Deloitte Access Economics told the AFR:

‘The politicians just don’t get it yet. Both sides are operating on a rule of thumb that worked for a decade, which is that China paid for all sorts of things, and that’s just not true anymore.’

That’s because, like Nero, politicians covet popularity. And the only way they can stay or become popular is to make promises paid for using other peoples’ money.

The Australian Economy’s Luck to Run Out

Mr Richardson is right. China can’t pay for Aussies’ luxuries anymore. Of course, we’ve said that for years…and we were criticised for it. But now all we’ve said is coming true.

Our old pal, Greg Canavan has written a report detailing how the collapse will happen and how you can profit from it and protect your investments.

But the warnings on China don’t end there. Today’s Age newspaper highlights another independent report that points to the death of the Australian economy. The Age quotes from the report, titled Australia: The Unlucky Country:

‘The mining sector has crowded out almost all other sectors of the economy and also funnelled credit and liquidity into a housing bubble in the real estate sector…

‘It will be almost impossible to move mining capacity to other sectors in Australia. This is a classic problem for economies who suffer from Dutch Disease. When the hangover arrives, writing off production capacity is often done at a considerable discount to cost.

‘In addition, the manufacturing sector is under-developed and will not be able to take up the slack for the loss of momentum in construction and mining.’

But don’t panic. The RBA says residential building will pick up where the mining boom left off. Seriously, that has to be the dumbest piece of economic analysis we’ve ever heard.

Australian Housing is Consumption, Not Production

But it’s the way most Aussies think. They think housing is an economic driver.

But it’s not. Housing is consumption.

Housing, along with other consumption (such as food, fuel, clothing, etc.) is the reward for productive labour.

Put it this way; you can only afford to buy a house, food, and clothing after you’ve produced something that someone else needs.

So for the central bank to claim that residential building will fill the void left by the end of the resources boom is just barmy.

It’s the worst kind of lazy thinking. It’s a lack of knowledge about how an economy works. The fact is the resources boom has a much bigger impact on the Australian economy than most people think.

Put simply, when companies like BHP Billiton [ASX: BHP], Rio Tinto [ASX: RIO], and Fortescue Metals [ASX: FMG] export raw materials, they receive payment for it.

These big miners use the money to buy labour, goods and services to support their mining activities. The money flows from these service providers to other areas of the Aussie economy: housing, car industry, retailers, etc.

But that’s only part of it. Before the money flows to other sectors it goes into the banking system first. And this is where the important stuff happens. This is where you get the leverage effect.

Thanks to the fractional reserve banking system, banks can use $10 of deposits to lend $90 to borrowers. It’s this newly created money that has the biggest effect when it spreads through the economy.

Because it’s not the $10 deposited in the bank that filters through the economy, it’s the $90 created by the banks from thin air that filters through the economy.

Or put another way, the $60 billion of exports to China doesn’t mean a $60 billion benefit to the Australian economy…it means there’s a $600 billion benefit to the Australian economy.

The money flows in from China, it goes into bank accounts, and then the banks leverage this to create new loans. It explains why the Australian housing market was strong despite crashes elsewhere in the world.

Australian Economy to Take $100 Billion Hit

But as anyone who knows about leverage will tell you, leverage is a double-edged sword. It magnifies returns when the market goes your way, but it magnifies losses when the market goes against you.

In this case, even if exports to China only fell to $50 billion, it wouldn’t mean a $10 billion hit to the Australian economy. Because of the leverage used by the banks to drive up credit, it would actually be a $100 billion hit to the economy.

That’s simply because there’s less money flowing into the economy for the banks to use as capital for new loans.

That should be a warning for you. And that’s why even a small drop in China’s resources spending will have a big impact on the Australian economy.

So for anyone to think that housing will boom once the resources boom ends, they’re in for a rude awakening.

The fact is, contrary to what the brains trust at the RBA may think, far from leading the Australian economy to recovery, housing will be the worst investment to own when the resources boom finally ends.

Cheers,
Kris

PS. Our old buddy Greg Canavan recently told his readers to prepare for an Aussie dollar crash. In his latest newsletter he revealed the best way to protect the value of your Aussie dollar assets when the Aussie’s dream run comes to an end. Find out more details here

Related Articles

Market Pullback Exposes Five Stocks to Buy

How China’s Anti-Entrepreneurial Economy is Failing

Why China’s Monetary Policy is Bad News For Australian Resource Stocks



Already a subscriber to Money Morning... or simply, just like what you're reading? Then show your support and spread the word...
Share this post on...
Share

Kris Sayce
Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the investment director for Australian Small-Cap Investigator, Diggers and Drillers and Revolutionary Tech Investor. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays. Read more about Publisher and Investment Director Kris Sayce.

Leave a Comment

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.

If you would prefer to email the editor, you can do so by sending an email to moneymorning@moneymorning.com.au


Comments are closed.



How Money Morning Can Help You Can Become a Smarter, Better, Investor


Privacy Statement
We will collect and handle your personal information in accordance with our Privacy Policy.
You can cancel your subscription at any time

Diggers and Drillers

A 3-Point Plan to Re-Engage with the Aussie Mining Boom


This new video reveals a way for Aussie share investors like you to RE-ENGAGE with the next phase of the mining boom…while valuations are still dirt-cheap…


The plan centres round three specific stocks.


To find out what they are, click here.

Australian Small-Cap Investigator

The Australian wildcatter
exploring oil's 'final frontier'


The US Geological Survey says this area contains up to 71 billion barrels of oil.

Only a few explorers have secured licences to drill.

One of them is a daring little Aussie firm that begins drilling 'in early 2014'.

According to small-cap analysts Tim Dohrmann it's impossible to speculate just how high this one could go. Find out why here.

World War D

Couldn’t make it to our
‘War Summit’?


Don’t sweat it. Click here for the next best thing…


World War D was the most important meeting of minds of the decade so far. What came out of it will almost certainly force you to reshape your investment plan for the rest of the decade. There's no way to go back in time and get inside the Savoy Ballroom of the Grand Hyatt.

But you can do the next best thing…
to find out what it is, click here.

  • ^NDX3534.532+1.446 - +0.04%
  • ^FTSE6625.25+41.08 - +0.62%
  • ^AORD5444.800+32.200 - +0.59%
  • ^AXJO5454.200+33.900 - +0.63%
  • AUDUSD=X0.933
  • USDJPY=X102.405

Graphic Ad 1 – Blue Chip Stocks Report


Revolutionary Tech Investor

This report is about TECH MOON-SHOTS


Four of them, to be precise.


It's an early-days project. But one biotech aiming for the cancer moon-shot is already up - get this - 497.14% since tipped.


For four more tech moon-shots, click here.

Gowdie Family Wealth

WARNING:
The worst mistake you can make when handing wealth on to your kids


This brand new investor briefing shows you what your family’s in for if you don’t take care to leave your wealth to them in exactly the right way.


And it shows you precisely how to prevent infighting, recklessness and misunderstanding over money.


Read it here.

The Money For Life Letter

Holden. Toyota. Qantas. BUST


Do you really expect the share market to boom in times like these? That's why Nick Hubble says the best thing you can do right now is invest for safety and income.


This brand new video shows you how you can get predictable, reliable and rock solid cash flow no matter what happens in the wider economy.


You could lock in up to $20,000 a year - and that's just the start. See how here.



Sound Money. Sound Investments. [bullish prediction]

Greg Canavan's first bullish prediction in four years


Greg Canavan
doesn't make forecasts like this often.


When he does, it's because he’s found something that could make you money for years to come.


Read more here.

Is the Australian Housing Boom Really Back?

The Denning Report

2014 Predicted


Dan Denning accurately forecast 2013's flight from
bonds to stocks, the commodities crash and the
Aussie dollar top…to the exact week


In this brand new forecast report, he shares his
three critical predictions for 2014…

More Recommended Reading Below...

The Pursuit of Happiness & The Daily Reckoning

  • The Pursuit of Happiness
  • The Daily Reckoning Australia

Done properly, a retirement business can not only help fill a retiree’s time and replace their work [Read More...]

Free speech is no longer really a right at all. Governments, vested interests, and lobby groups are [Read More...]

Australian house prices are going to remain high. Perhaps finally, when the last baby boomer retires [Read More...]

Make sure that the changes you make to your financial plan are from a credible source. Otherwise the [Read More...]

It was day two of the World War D conference, and the final session was starting. We were closing th [Read More...]

Since the US Federal Reserve’s relief efforts began, total world debt has gone up by $30 trillion, w [Read More...]

A one size fits all strategy or rollover to your own self managed super fund with the ability to tai [Read More...]

Services will boom according to the Reserve Bank of Australia. Sales assistants and tour guides are [Read More...]

In the many years since the creation of the US Federal Reserve System as America's central bank [Read More...]

In business, as in other things, we are being roughened up… and toughened up. We promised a grim acc [Read More...]

TESTIMONIALS

"I think you're fantastic! I love to read what you write...you're so interesting and amusing and I've learned so much" -
Money Morning reader, Chris Gadd

"You guys are brilliant. I feel more relaxed about the future than ever simply because I know what is going on rather than floundering around with smoke screens and mirrors from the government and mainstream" -
Money Morning reader, Helen Carter

"Wow what can I say? I was an economically confused moron until I read your newsletter and even though I've been a subscriber for a short period I can now see how easy it is to understand, if you use common sense and can have the spin translated into everyday language. Thanks for an entertaining read." -
Money Morning reader, John

"Keep up the good independent and well thought out articles offering a view that often debunks mainstream myths." -
Money Morning reader, Craig

"I do admire your straight talking and simple analysis of the situation, I think of you as the Jeremy Clarkson of finance." -
Money Morning reader, Jeffery