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Markets ignore Australia's safe harbour

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COMMENTS

8 August 2011 12:51

You might think Australia's economic strength would stand out among the advanced countries, like a marvelous beacon in a bleak and confused world. When you look at the actual stand-alone performance, things are going well. When you look at comparative performance, the difference is stunning. Why, then, can't financial markets see the difference?

 

As last week's graph showed, Australia grew through the Global Financial Crisis, hardly missing a beat: a unique performance among the developed countries. Most advanced countries are not yet back to where they were in 2008 (and some, like the UK, are way below).

In contrast, our output is 5% higher. Unemployment is under 5%, lower than it has been for three decades. Profits are generally good. Our terms of trade have decisively broken the long-term secular decline historically associated with commodity producers. The improvement has added a further 15% to our living standards, over and above the already-respectable growth dividend.

The profitability of Australian commodity producers reflects this. Rio Tinto has just announced record profits and has more cash than it knows what do with, so it is giving $7 billion back to shareholders. The big miners have even managed to bluff their way out of sharing the windfall in the form of an effective resources tax.

The GFC was good news for the big banks, which now have less competition and the opportunity to fatten up their lending margins. There was no housing over-building, so there is no wreckage from a housing collapse. The banks demonstrated in 2008 that they can survive the worst a global meltdown can hand out.

Macro policy is in good shape, with the budget headed for surplus and interest rates around normal, giving room for maneuver if needed. Government debt is negligible. The obverse of the commodity price boom is that inflation is a bit higher than normal, but wages are growing moderately, suggesting a stable inflation outlook.

Of course there are counter-points to this long merit list. The minerals boom will require a painful restructuring in other industries to make room for the extra investment. The appreciated exchange rate makes life uncomfortable for the non-resource traded sector. Households are rebuilding their balance sheets and re-thinking their savings strategies.

What about that weak government in Canberra? It's easy to get depressed by the compromises and prevarications of democratic politics, but compared with Washington, Canberra seems an oasis of rationality. There are some lost opportunities to do better, but that's life. The carbon tax was predicted to be the end of Wollongong and the entire coal industry, but even its critics are coming to realise that, compared with other forces impinging on profitability, this is small beer.

How does this compare with the rest of the advanced world? Even leaving aside the basket-cases of Greece and Ireland, both the US and Europe are in a mess, and Japan still isn't over its 1990 bubble-burst. The GFC recession has left most countries with budget deficits of around 10% of GDP and debt escalating upwards of 100% of GDP.

With unemployment at an unacceptable 9.2%, the US has long ago fired off all the ammunition in its macro armoury, with budget deficits already high and monetary policy settings at zero. The burst housing bubble has left a messy legacy for both home-owners and banks. US politics is so dysfunctional that a doctrinal arm-wrestle between the two parties brought the country to the brink of default, totally distracting policy from the underlying problems and triggering a rating down-grade.

Europe is making such a mess of the Greek rescue that contagion is now threatening Italy and Spain, countries with quite different fundamentals. The UK is on a forced-march to get its official debt position under control, with austerity as far ahead as the eye can see.

Seeing Australia's stellar performance and the parlous position overseas, you might think that overseas investment funds would be flooding in our direction, pushing up the exchange rate and equity prices to levels which pose serious risk of over-valuation. You might expect to see bond yields forced down by eager foreign investors seeking safe yield (Australia retains its AAA rating) in a risky world.

So how did markets react to last week's sharp fall in US share prices? Australian equity prices fell more than foreign markets, and the exchange rate lost five cents against a weakening US dollar. A US investor holding Australian shares at the beginning of last week would now be 15% poorer on this investment. Far from seeing bond yields bid down by eager investors, our bonds offer almost twice the yield of US bonds, and not far short of the yields which embattled Italy and Spain pay.

Perhaps, as some observers say, the market is worried about our dependence on China, and as the US weakens, this will end China's growth, dragging Australia down with it. But the GFC gave us a real-life stress-test of this possibility: China sailed through largely unaffected, thanks to active macro-policy and its own intrinsic domestic dynamic.

That leaves the possibility that our own financial markets have managed to talk themselves into discounting the product. Rather than attempt serious analysis of the underlying fundamentals, decisions are taken on the basis of some facile rule of thumb: Australia is a 'risk play'. Henny Penny professional doom-sayers with a proven track record of forecast failure are still given space on the soap-box, to proclaim that they might have been wrong about the sky falling last week, but it will fall next week for sure. Policy pundits can argue that the central bank should have raised interest rates two days before this world melt-down, and no-one blows a raspberry in their face.

If we predict disaster loudly and long, it might just happen.

Photo by Flickr user old.pappous.

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