The Big Picture for Australia Has Some Concerns

June 17th, 2014
in contributors, syndication

Written by Paul Hanly

This is written by an observer in Autralia who would suggest that the situation in Australia is somewhat more complex and problematic that described by Ari Charney in a recent GEI Investing article:  Australia: Economy Posts A Strong First Quarter.

Follow up:

1. The size of the twenty-first century boom in construction of mines, LNG plants and mining/processing infrastructure was huge and is likely to wind rapidly down over the next few years. This will have an impact on employment (the construction phase employs about 8 times as many people as the operations phase) and wages (wages in the remote areas and in regional cities and towns that had to attract a lot of people (mainly to fly in and fly out) were very high compared to averages in capital cities. Many expect that while volumes might be higher, prices will be lower and higher cost and lower grade iron ore producers are potentially being re-rated down.

If China slows its fixed asset investment levels, as most expect some time before say 2020, there could be some problems for the marginal iron ore producers. Even if net revenues and even profits hold up, there will be a change in the income distribution away from labour towards shareholders and creditors and the flow on effects of the loss of and to labor could cause some issues in some areas. Temporary workers from overseas may have to leave to avoid increased unemployment Perth, Darwin and Townsville. There will also likely be some flow on effects to other industries and impact on property prices in those areas.

2. Australia is shuttering its car manufacturing industry in 2015/6/7. Many see this as a symptom of Dutch Disease and a second blow to employment and wages, particularly in the places where the industry is a major employer. Geelong, home to Ford, about 1 hour 30 minutes drive from Melbourne is particularly vulnerable to a 3 to 5 year downturn. Whether component manufacturers can compete in overseas markets remains to be seen but is considered doubtful. Geelong real estate might also be subdued for a few years.

3. Coupled with the reduction in resources related construction and likely falls in resource prices is focus on the likely level of the AUD. While it has already fallen against EUR and GBP it has only fallen about 12% against the USD so further falls are possible. While many see falls against USD as  potentially good for manufacturing they will have a broad harmful impact on cost of living and the manufacturing base will have become so small that there might be less  benefit to the economy after rises in input costs such as petroleum products and consumer goods is taken into account. A lower currency might help tourism and education, but fuel is a big input into mining and agriculture, including shipping costs to export markets.

4. There is a sense of political uncertainty at present regarding the budget. Australia faces medium term issues regarding aging of the population. The lower house of representatives controlled by the Liberal/National coalition (like Republicans in the US) has framed a budget which continues big tax concessions to the well off (tax expenditures are the second highest in the OECD) while making drastic cuts in the net disposable income of the lower quintiles and making the major burden of adjustment be at the expense of middle quintile households. The Senate (upper house like US) is not controlled by the Liberal/National coalition and there are small groups with potential balance of power, mainly the Greens and the Palmer United Party (which deserves a story in itself, being led by a presently populist billionaire resource magnate who may or may not be able to hold his party together). The electorate has had a severe backlash against the budget on the basis of broken promises by the Prime Minister Tony Abbott and the unfair cuts to the incomes of the middle and lower quintiles while cuts for the highest quintile and politicians are temporary. Consumer confidence has fallen significantly. Abbott's polling is the worst post budget polling in living memory. The sense of class warfare by the well off against the least capable and the middle class is palpable. And Abbott imported the Republican style politics of divisiveness from the US, so there is no feeling of common good or shared responsibility to solve any emerging problems. There is potential for high business and consumer uncertainty for the next 3 to 4 months. Blocking of supply to bring on a new general election has been mentioned but is highly unlikely.

5. The possible offsets to decline in resource/processing construction has been housing and infrastructure, but Australian housing prices have almost universally risen significantly over the last 18 months and housing is among the most expensive in the world based on rent returns and multiples of income. The problem I see is twofold. First the relative scale of impact on GDP of the resource construction boom is so great that it cannot be replicated in housing and infrastructure even in the short term so there will be a headwind. Secondly, the time to plan, approve, acquire the land and actually start significant new employment in capital city infrastructure is likely to mean that there might not sufficient boost in the next 3 to 4 years where it is most likely to be needed.

Anyone considering investing in Australian assets other than at fair weighting might want to consider these issues much more deeply.

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