Hubris and other signs of trouble ‘down under’

Australia is rich in iron ore, coal and copper … and its stock of hubris seems to be growing.

After a recent trip to the “quarry in China’s backyard” SocGen’s Dylan Grice is even more worried about its economy than he was beforehand. It seems a book describing Australia’s economic success as “a miracle” was the catalyst (more on that below). In a note to clients Grice is recommending shorting the aussie dollar. And, if you’re lucky enough to be Australian, stockpiling gold.

But let’s rewind. His point is that the commodity boom has masked the full extent of the credit expansion and has fooled some into thinking the country’s economy is stronger than it really is. Or as he puts it:

When you scratch the surface of the Australian ‘miracle’ you don’’t just find an unmiraculous commodity super-cycle: you also find an equally unmiraculous credit super-cycle as well. A credit bubble built on a commodity market built on an even bigger Chinese credit bubble, Australia looks like leveraged leverage, a CDO squared.

Ouch. As he notes, debt to disposable income has risen from 40 per cent in the 1990s to around 150 per cent today, or in chart form:

Partly as a result, Australia now has five of the world’s top 15 most expensive cities. But a potential housing crash looks unlikely as there was no residential housing construction boom. The boom in construction engineering projects, however, is a problem.

Australia has been investing in mines as if Chinese demand is just going to keep growing.

And Grice doesn’t think putting all your chips on China is a good idea (emphasis ours):

How healthy is China’s iron ore demand? If its steel prospects were so attractive why does Wuhan Iron & Steel for one think pigs are the future? Why has the company recently announced plans to invest nearly $5bn over the next five years in industries in which it has no expertise, such as pig, fish and organic vegetable farming? Probably because steelmakers are now loss making and there is excess capacity. And if they have no confidence in the Chinese steel industry, why should Australia?

Coal, Australia’s other major commodity export, has an export capacity chart that looks a lot like the one above. And it’s also facing headwinds as China’s growth slows, while shale gas is a growing threat. “Though it’s predominantly a US story today, it’s going to go global,” says Grice.

There are worrying mutterings elsewhere. Andrew Liveris, Dow Chemical’s Darwin-born chief excutive, said last month that Australia’s economy had become too reliant on China for growth and blamed the strong Aussie dollar for its growing uncompetitiveness. ”We are seeing troubling signs for our economy at large – maybe even signs of a coming downturn,” he added.

Grice argues there may be trouble in Australia even China’s resource demand somehow holds up, because of the strength of its currency (emphasis ours):

The improvement in Australia’’s terms of trade (the ratio of its export prices to its import prices) has been spectacular thanks to the bull run in commodities. It should be running large current account surpluses, like Norway. But it isn’’t. It’’s running a deficit of 3 per cent. So the AUD is overvalued and vulnerable. For Australians, buying bonds makes some sense to me … while buying gold makes a lot of sense (because gold is very cheap in AUD terms). For foreigners, the AUD’’s own day of reckoning provides a very good hedge against any great leap backwards in China.

As an aside, we’re hearing anecdotally that Australians are increasingly buying electronics and books on Amazon US. Even after the shipping costs and various taxes and duties, apparently it is often significantly cheaper than buying domestically. It may one of the reasons why the share price of Harvey Norman, “Australia’s leading retailer”, is down 28 per cent in the past year.

If you’re interested in the book Grice stumbled across and want to know more about why Australians were “made for these times”, here it is. Unfortunately for the aussie readers, it doesn’t look like it’s available on Amazon.

Related links:
Could US natural gas run out of storage capacity? – FT Alphaville
China steel mills diversify to lift profits – FT
The supercycle is so over, iron ore edition – FT Alphaville