Australia at risk?

According to FT Alphaville, former investment bank Merrill Lynch has done an analysis of country credit risk which, alarmingly if unsurprisingly, given the factors considered, lists Australia as the riskiest country in the world. The analysis uses seven measures “current account financing gap, FX reserves/short-term external debt ratio, exports to-GDP ratio, private credit-to-GDP ratio, private credit growth, loans-to deposits ratio and banks capital-to-assets ratio”, and you don’t need to look up the figures to know that Australia is at risk on all of these measures.

OTOH, our strong points such as large and positive public sector net worth don’t get measured here. And, given that the top 10 low-risk country list is headed by Nigeria, and includes Colombia, Indonesia and Russia, it’s obvious that this is not an index of economic health. Still, our chronic current account deficits represent a real vulnerability, a point I got tired of making during the years of easy money (Hat-tip: Felix Salmon).

I won’t get time to blog on the Mid-Year Economic Forecast for a while, but I’ll note one of the few pieces of good news. The silly idea of announcing “aspirational” tax cuts for the government’s next term has been abandoned.

27 thoughts on “Australia at risk?

  1. Hmm.. I noticed too in the business reports that ‘Lenders patience is running out’

    The big five Australian banks are owed more than $1.8 billion – much of it unsecured – by Allco and ABC, which was expected to call in administrators last night or today.

    The banks are owed another $3.9 billion by the troubled Centro property empire, which has until December 15 to negotiate another debt repayment extension, and $660 million by investment bank Babcock & Brown….

    And so-

    “Rather than letting these problems linger into 2010, there is a view that what you can get for an asset now will be more than what you will get down the track, with the financial crisis now starting to hit the real economy,” one banker said.

    You can begin to see what a blanket bank deposit guarantee is all about now with Govt coffers rapidly emptying.

  2. Awful? What about the roundup in ‘Naked, short failures’ from the Mogambo Guru today? I’m fast coming round to the view that these neo-Keynesian morons, who forever want to protect us from all bad things that go bump in the night, are now overseeing the complete demise of fiat currency. In the long run that may be their greatest blessing in disguise.

    Simply put queeny my dear-
    “monetary factors cause the [business] cycle but real phenomena constitute it”
    so hang on to your gold and silver sweetie!

  3. Since when have ML proven to be experts in risk assessment? Do they mean risk to the macro economy, or risk to themselves? While I agree Australia faces a difficult future, I cannot help agreeing with one of the commentators on the original report on ML:

    “I think the anxiety about investment bank job losses is distracting ML team. If the research has come back with some really spurious results, it should have been ditched or kept for internal use only rather than produced for the external consumption and becoming an embarrassment.”

  4. Yep, its the sort of credit rating that says far more about the raters than the party being rated.

    Nigeria, FFS!

  5. John, These ratings seem to be a bit of a joke.

    In your para 1 you say the rankings are ‘unsurprising’ then in the second ‘OTOH’ paragraph – after noting that the rankings involve ludicrous implications – you say that ‘they are not an index of economic health’.

    Not clear here what your bottom line is. Nor am I being a ‘smarty pants’ – not clear what my own bottom line is. But I think the OTOH para requires expansion.

    Ay June 2008 our gross foreign assets were about $1 trillion and our gross foreign liabilities were about $1.7 trillion of which I think $651 billion were foreign currency denominated debt – debt which involves an increased bill if the Aussie dollar depreciates.

    Given that a lot of this debt will have gone into business investment – not only mining – and that our economy has been growing strongly maybe this picture is not so terrible.

    Our net income loss to foreigners in June as a fraction of GDP was 2.5%. Again is this so bad?

    The issue is not the size of the current account deficit but where the money has gone. A fair bit has gone into sources which will yield a good return. Of course the amount going into funding a speculative housing bubble (my OTOH!) is not so good.

  6. I’ve clarified to say “unsurprisingly, given the factors considered”, and I’ll point out that, until you see the rankings it’s not at all obvious that the choice of factors is problematic.

    My bottom line is that it’s perfectly possible, in the current environment, that markets will start paying a lot more attention to factors like this, and a lot less to projections of future income generated by foreign investment. Arguably, this is already happening.

  7. Now let me see. A year ago we had all ‘decoupled’ from the US, particularly good buddies like us and the Mandarin speakers until strangely scrap steel prices hit zero. Hmm.. steel, a fundamental contributor to all our lifestyles. You don’t say?

    A few weeks ago our banks were as safe as houses and we couldn’t afford to spend old smirky’s FF piling up in Treasury. A few weeks later the world’s central bankers are dropping money from helicopters, $40 bill black holes suddenly appear in our Treasury estimates and Swanny seems to have lost the inflation figures among all the other doom and gloom reports piling up on the desk and it’s a moot point as to whether the Govt will need to bail out ABC Learning so the parents of 100,000 kids can keep going to work. Should he wait and see if that particular thorny problem resolves itself he asks himself? What would Obama do in a case like this he cogitates wistfully.

    As for absolute rankings it can all be somewhat relative and academic if your’e smugly top of the heap that’s all merely a whisker away from Zimbabwe and Iceland at the bottom.

  8. And can you tell me, Greenspan, why I still can’t get to sleep?
    And why the Reserve Bank chopper chills me to my feet?
    And what’s this cash that comes and goes, can you tell me what it means?
    God help me, I wish it had some sheen.

  9. John, it makes you wonder about what is going on in the real world when businesses which boast of having highly experienced management teams with proven track records end up in voluntary administration and are not worth a crumpet.

  10. “OTOH, our strong points such as large and positive public sector net worth don’t get measured here.”

    I think the apparently strong financial position of the federal government in recent times is something of a mirage.

    In recent years the Commonwealth budget surplus has largely been underpinned by dramatic increases in company tax revenue. And company tax revenue is more dependent on the economic cycle. When there is a downturn and business profits start falling, company tax receipts will fall more sharply. Then if people start losing their jobs, income tax receipts will fall heavily as well.

    So for the most part the strong fiscal position of the federal government has been entirely the result of a short-term windfall revenue, rather than the result of any underlying strength in the revenue base and spending discipline. Once the tide turns, we are headed for massive deficits.

    But on a broader point, the size of the federal deficit/surplus matters less than the overall level of national debt (particularly foreign debt). The federal deficit/surplus only really matters to the extent that the federal government is either paying down debt/increasing national savings or adding to the national debt. Compared to the current level of private sector debt, the accumulated budget surpluses are small by comparison.

  11. I can’t remember where I read it so forgive me if I have this wrong, but I understand that until recently Australia was the only resource based economy in the world that was still running a current account deficit. The terms of trade for resource exporters were so strong that all of them (execpt us) had current account surplus’s.

    If we can’t get to a surplus during the best terms of trade in a generation, imagine what is going to happen to our current account deficit during a time of weak resources prices.

    We have strong banks, relatively little government debt and quite a bit of room to move on interest rates. Against that we have, perhaps, the highest property prices in the world (in terms of income) or in other words a very very big property bubble and an enormous private debt to GDP ratio. What will happen when we add rapidly diminishing terms of trade?

    1) We keep our domestic spending the same by racking up more overseas debt to make up for the loss of export income. In other words our poor current account deficit goes through the roof leading to banana republic territory.

    2) Or, we cut back on spending, keeping our current account deficit reasonable, but inducing a recession.

    Anyone see other options here?

  12. “Or, we cut back on spending, keeping our current account deficit reasonable, but inducing a recession”

    And who is “we” in this context?

  13. “it makes you wonder about what is going on in the real world when businesses which boast of having highly experienced management teams with proven track records end up in voluntary administration and are not worth a crumpet.”

    Because ultimately they are fooled by meaningless prices and interest rates that bear no resemblance to any real or underlying opportunity cost. That starts with slow creeping inflation (that 2-3% deliberate targetting) that must encourage borrowing and leverage because the loan principal is real savings (ie real forgone consumption), but in a years time with nominal repayment, the lender has been cheated. Neither the borrower or govt taxers show any real mercy in that ultimate theft. That being the case the lender is thereby encouraged to seek higher nominal returns (with tax free or indexed capital gain?)and what lesson has he learned? Logically to lend it to those who can gear it for him further to earn higher returns. ie more risky. If real interest rates should be zero or negative, gearing ever riskier investments can become even more lucrative and systemic. Such systemic theft cannot go on forever unchecked and it’s come to an abrupt halt now with everyone asking who stole what when and let’s all square up. Basically it’s a Herculean task with a real economy to run at the same time, so something has to give.

    Notice you could tackle the original problem in a couple of ways. Either the money is strictly disciplined so it can’t buy less in a year’s time or all principal lending and taxation must be indexed. ie real. In the latter case then you’d have to expect any real interest return above that to reflect real productivity return to capital. In fact when you think about it noone would lend or borrow if it didn’t, unlike the situation currently where legal theft is rampant.

  14. The current account deficit was always the elephant in the room during the Howard/Costello years when we heard about wonderful economic management.

    Even the regulatory system is fragmented and generally takes the cooperative and educative approach with a few exceptions when the corporate behaviours became too bad to ignore – but even Rodney Adler is out of jail and many mates never went there. The government’s stated position that we have good regulations moderating behaviours in Australia is optimistic.

    Merrill Lynch shows why the analysis of players is so often suspect. They must be touting for work in Indonesia, Columbia or the like.

  15. Re 17. swio, I agree with your point 2) in 14 being a desirable objective but how would it be implemented? Via foreign exchange control?

  16. Oh, Observa, paraphrasing Redgum. Well done!

    The ML stuff just leaves me wanting some competence to show up somewhere, somewhen…

    Now in the heat of the moment, I remembered my ABCs. A private company went public via IPO, borrowed and expanded, safe in the knowledge that its favourite government sponsors (ie Howard and Costello) would pay the interest bill via kiddy subsidies.

    I simplify and perhaps skipped some fine detail I admit – for that I apologise. However, the near monopoly of ABC Learning in the Australian market came about largely through H&C largesse. We taxpayers had a lot of tax transfer to this mob.

    Then the multi-billion dollar expansion into the US, funded largely by debt of course. What were they all thinking? Is not the public teat of one country enough?

    So here we are now: a new government effectively committed to continuing to transfer our taxes to the post-ABC wreckage. And now they probably have little alternative but to resume government control of daycare. Otherwise there will be a total collapse of daycare in this country.

    Another free market economic miracle, brought to you by the previous mob. Another billion or so smackers cut from the surplus (it must be at least that, because Julia Gillard wouldn’t say how much when asked today). Any more of these and the Labor mob will be deep in deficit even before they get any of their own initiatives out the door. Talk about a poisoning of the well by the previous government. Keep ’em coming Howard, keep ’em coming…

  17. “So here we are now: a new government effectively committed to continuing to transfer our taxes to the post-ABC wreckage.”
    Well Donald some might say it might have been a whole lot better not to have taxed and transferred any of their hard earned in the first place, not to mention expanding M1 by 163% over the past decade or so, so that fast Eddy had some poor market signals about the long run cost and availability of credit. Still there’s always the other lot of households than the 42.2% that pay no income tax, to soak now, in order to fix up any poor judgement and lack of oversight in the past. That’s what big Govt is for. Too big to fail.

  18. swio says “I can’t remember where I read it so forgive me if I have this wrong, but I understand that until recently Australia was the only resource based economy in the world that was still running a current account deficit. The terms of trade for resource exporters were so strong that all of them (execpt us) had current account surplus’s.
    If we can’t get to a surplus during the best terms of trade in a generation, imagine what is going to happen to our current account deficit during a time of weak resources prices.”

    I think it was Hans Redeker, head of global currency exchange at BNP Paribus, who has been making these points about the vulnerability of Australia’s economy. He has a pretty good record of predicting economic events in recent times.

  19. Donald,
    A “…free market economic miracle” brought to you by the government? I hope you spot the contradiction in your own statement there. What next – racial tolerance brought to you by the KKK?

  20. Hi Andrew: the comment of mine that you quote in #23 is intended as sarcasm. The Liberal government for some reason gave ‘Fast’ Eddy Grove’s company a big leg-up, so much so that it quickly became the dominant company in the Australian daycare sector.

    Why would a political party, that promotes free markets, give such a financial boost to one company? Just seems weird to me.

  21. We have political economists and economists that observe the political,and then Australia has transvestpolitico-tight economists.So whilst they analse,find chooks search for eggheads in business to sell their wares,Australia’s agenda isn’t any other countries.Thus Observa gets close to the mark.Recommend a trip to DavidIcke.com Headlines and see a couple of videos with one man speaking,…a Mr.Tarpley. Like his name,I use to roll tarpaulins,rail ones , at the age of 14 and in winter too.All wet,in my school uniform.Rice hulls were in the rail trucks.My efforts after school paid the rental,in part on the rail house,that had a copper in the laundry in the sixties.The other job,I did was light the rail signals,my father had a fear of heights,and had a stomach..I was volunteered.It wasn’t Victorian Railway Regulations.And neither are Tarpley’s impressions,that seem to me,not conspiracy theory,or even deep cynicism,but,someone observing.A Time and Motion man,who is on the livings side.

  22. I think that what ML are getting at is that certain countries have financial profiles that make them very vulnerable to economic collapse in the event of adverse financial shocks either interest rate rises or capital flows.

    That is the ticklish situation we must somehow extricate ourselves from is deleveraging in an era of economic downturn.

    Being a “small, open market economy” we are especially vulnerable to the swings and arrows of outrageous financial fortunes. Unfortunately rather than trying to dampen such volatility by following a moderating financial policy we have amplified it with a reckless one.

    There are three main props that are currently keeping us out of economic hot water:

    – good AUD-adjusted mineral price revenues

    – high flows of relatively skilled immigrants

    – massive credit of fed and state governments

    The first two will become negatives if the PRC scales back exports, a real possibility if the USA and USE go into recession.

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