Roger Donnelly is Chief Economist with the Export Finance and Insurance Corporation.
A day doesn't pass nowadays without at least a score of headlines asking 'Is the resource boom over?' A London research firm named Variant Perception (VP) has been getting in on the act with its own contribution, a report called Australia: The Unlucky Country. As you can gather, it takes a somewhat different tack from RBA Governor Glenn Stevens in his July speech, The Lucky Country, and in his June one, The Glass Half Full.
According to VP, Australia is unlucky for four reasons (except for 'Dutch disease', the labels below are mine):
- Dutch disease: 'The Australian economy needs a substantially weaker currency to regain competitiveness outside the mining sector...Australia is likely sitting on significant overcapacity in the mining sector which will be difficult to transfer to other sectors.'
- Eurotrash resemblance: 'Australia's external finances resemble a country in the European periphery...The RBA will have to become much more activist in supporting its major banks as the structural slowdown in China and the housing market continues.'
- British syndrome: 'The Australian economy is very similar to the UK economy in several respects (overvalued property market, excessive household debt, etc).'
- China dependence: 'Australia is levered to a slowing Chinese economy...The economy is likely to suffer from substantial overcapacity relative to a slowing Chinese economy.'
In other words, the economy has four weaknesses making it prone to three shocks. The weaknesses are: an uncompetitive non-resource export sector, banks over-dependent on foreign funding, over-geared households, and a housing bubble. The shocks? A bank funding shock, a housing bubble burst, and a 'structural' slowdown in China. Even if the economy manages to avoid a bank funding shock and a burst housing bubble, it will need to undergo a large currency depreciation and official interest rate cuts to reallocate resources back to the non-mining sector as the boom ends and commodity prices mean-revert.
The report is worth a read as a representative example of the view that Australia has over-invested in the resource boom, and is now going to suffer a hangover as it corrects its past mistakes.
It stands in sharp contrast to the alternative view that an enlarged mining sector, and associated high commodity prices and strong exchange rate, are here to stay (indefinitely, if not permanently). Thanks to soaring Asian commodity demand (and 'peak' minerals), commodity prices and the Aussie dollar aren't going to mean-revert.
The first 'Unlucky Country' view is largely adopted by foreign observers: not just Variant Perception, but the Financial Times, the Economist, and sundry Wall Street and City types. Mining promoters also join this group (they would, wouldn't they?). Being unkind, one might call this view 'sensationalist' or 'alarmist'. The second view is largely adopted by Australian observers: Glenn Stevens, Ken Henry, Martin Parkinson, most market economists. Being unkind, one might call the holders of this view 'smug'. I elaborate on the differences between the two viewpoints in this table (if you find it difficult to read, here's a PDF version):
All in all, I believe VP overdoes the pessimism.
It is way off the mark in its point about eurozone resemblances. As it has to remind itself, 'Australia is not in the same boat as the European periphery'; it has a flexible exchange rate and runs an independent monetary policy. In a pinch, the RBA can be a lender of last resort to the banks. The government also has the room to administer fiscal stimulus in the event of another severe downturn, brought on by, say, a 'hard landing' in China.
The London research firm also exaggerates the plight of Australia's banks. They didn't engage in reckless lending and investment to the extent the Europeans and Americans did. Yes, in the dark days following the Lehman bankruptcy, they needed a government guarantee of their offshore borrowings. But they paid for it. And none needed to be nationalised. (The sting in the tail here is, the Aussie banks didn't have surplus funds to play with as their North Atlantic counterparts did. Everything they borrowed, they shoveled into mortgage and corporate lending. This arguably kept them out of mischief.)
One can argue back and forth endlessly on dwelling prices, but notice that the arguments against a sharp adjustment seem to be about as strong as the arguments for.
Perhaps the biggest fault of the Unlucky Country camp is the omission of any mention of the additional commodity export volumes that will emerge from the current mammoth investment boom. These could bring about a deep and transformational structural change.
Photo by Flickr user davidwhitedesign.