There’s a concept in sales that works like this: if the salesman says something, it might be a lie. If the prospect says it, it’s true. So the trick for the salesman is to find a way to get the prospect to sell themselves.
One way to do that is to use a technique called a tie down.
The tie down is an open-ended question that the prospect will agree to. Something like, ‘Quality is important, isn’t it?’
The question for investors is this: will the Australian government use mainstream economists and industry to sell a budget deficit to the public?
The answer is probably yes. The tie down will be the classic Keynesian response to lower growth – ‘when things are struggling the government should step in to create jobs and support the economy, shouldn’t it?’
It’s a sell job and nothing else. But it’s the task of today’s Money Weekend to see if there is a dangerous catch to this idea – and how this will play out on the share market.
Why the Aussie Government Can’t Hold the Line
You might have seen this on the front page of Thursday’s Australian Financial Review:
‘Federal Treasury is advising the government to dump its commitment to a budget surplus as a slump in Australia’s nominal growth rate poses a threat to revenue.’
The surplus is based on projections. As usual, the projections won’t materialise. The economy is supposed to be growing at a certain rate (‘at trend’), but the economy isn’t growing at that rate.
That means goodbye surplus. So the government needs to get out of the promise but limit the loss of face. Enter the media campaign to change the goalposts.
Take a look at this chart:
This gives you some idea of what the Australian government is trying to pull off. None of the world’s major economies are anywhere near running budget surpluses and won’t be for years.
You’d think this should make the sell job easier for the Aussie government because it can point to its peers as doing the same thing. Eventually it probably will.
The government could also use the current demand for Australian assets to lock in cheap financing and use infrastructure spending as the reason for running a deficit.
So why the hold out?
You might say that the credibility of the government is at stake. It made a commitment. It intends to keep it.
That seems less likely to us than the second reason. That is…
How Bank Bailouts Ruin an Economy
A budget deficit would put the AAA rating of the Aussie government at risk. Australian governments could barely balance the budget after the biggest resources boom in Australian history. So it’s hard to picture a balanced budget during a recession.
And as with any form of debt or deficit, once you go into the red it takes a lot of effort to get back on track. One budget deficit seems certain to lead to another.
That means the sovereign risk of Australia would take on a negative outlook. Remember the Aussie terms of trade hit a 140 year high in 2011. The boom in Chinese demand flooded Australia with money.
But the Chinese economy has slowed. There’s a debate about whether that’s a managed slow down or not. But you can see the effect in the meantime on Australia here…
This chart is taken from our colleague Greg Canavan’s new research project, ‘The Fuse is Lit‘. His position is that 2013 will be the year the financial crisis comes to Australia.
Now there’s a conventional view that Australia’s low debt-to-GDP is a saving grace should any trouble hit here. But there were two other countries that enjoyed this distinction too: Spain and Ireland.
The reason they no longer enjoy it is they both backstopped their failed banking systems with government money.
You might remember the Aussie government ‘lent’ its AAA rating to the Australian banks during the global financial crisis so they weren’t shut out of foreign money markets.
So any threat to the Australian government AAA ranking is a direct threat to the Aussie banking system.
And as Greg also points out in his new report, in a strange way, while the global financial crisis was good for Aussie banks, it was bad for Australia. Why? The banks increased their market share by gobbling up smaller rivals.
That’s bad for Australia because it concentrates the risk in the financial system.
The Big Australian Banks
But if you’re wondering if there’s an imminent risk, the stock market says no. The financial sector has actually been the best performer on the ASX this year.
Indeed, there was the news this week that the Commonwealth Bank (ASX: CBA) now ‘has a market value of more than US$100 billion dollars, more than the entire banking system of Germany, Singapore or Italy, according to data from the Datastream Global Banking Index.’
What’s interesting about this is that it also says that ‘the banks’ conservative approach to business has helped shield them from the turmoil that has seen European giants like UBS AG gut their operations in recent weeks.’
But it’s hard to see the Australian banks as conservative. After all Australians have one of the highest household-debt-to-GDP ratios. That’s mostly thanks to mortgage lending.
Debt isn’t a problem if you can pay it back. That’s where Greg’s research leads him to believe Australia has a problem, and if he’s right, it’s a big problem.
But the short take now is that the sovereign debt rating is important because it affects the cost of capital in Australia. So riskier borrowers pay a higher interest rate.
Raising that cost would hurt the Aussie banks and impact on their earnings and share prices. The Aussie banks have had a good run this year. 2013 might prove a lot more challenging.
Callum Newman
Editor, Money Weekend
The Most Important Story this Week
There’s always plenty of debate about the direction of Aussie property. People watch for any move in the interest rate that will make their mortgage repayments cheaper or more expensive. But there’s another big driver when it comes to property: demographics. See what Dr. Alex Cowie has to say about this when it comes to Aussie housing in The Long, Drawn Out Retreat in Australian House Prices
Highlights in Money Morning This Week…
Murray Dawes on The Price of Risk in the Stock Market: ‘Our stock market has been rallying for six months and is retesting multi-year highs. Something doesn’t add up. Either the stock market is getting ahead of itself or the pessimism in business is misplaced…’
Byron King on Peak Oil: Why the US Oil Boom Can’t Solve this Big Problem: ‘I’ve stated many times that the Peak Oil concept is a tool. It’s a lens through which one can observe the world of energy, both to figure out what’s happening now and to forecast possible future scenarios. In simple terms we’re talking about natural depletion.’
Shah Gilani on Why the Federal Reserve is Socialism’s Insidious Tool: ‘The Fed fosters underdevelopment of third-world nations, props up corrupt governments, protects the greedy, self-serving banking constituency it serves, and by design promotes socialism to further its mandate to enrich its masters.’
Dr. Alex Cowie on Why Silver Could Be the Best Investment in 2013: ‘When the technical price action backs up the fundamental picture – it can often translate into a great investment opportunity. In other words, if the idea is good, and the timing also looks right, then the shot could be a winning one.’
