My colleague Greg Canavan over at The Daily Reckoning Australia is on the record with his forecast that 2013 is the year the Global Financial Crisis becomes an Australian Financial Crisis. Greg cites the usual suspects for a crisis in his report: high private debt levels, high house prices, low productivity and a host of other macro-economic factors.
This week there were at least two signs that Greg might be right. The Australian Industry Group’s private survey of manufacturing indicated the 10th straight month of contraction in Australia. A reading under 50 indicates contraction. Not a single sub-group in the index reported expansion.
The weakness in Australian manufacturing is more than just a strong dollar story. The strong Australian dollar certainly hurts manufacturers to the extent that it makes Aussie goods more expensive overseas. The strong dollar is great for tourists but not so great for Aussie competitiveness.
But there are other factors at work in the weak manufacturing performance of the Australian economy. Manufacturing has been globalised in the last thirty years. The cost of labour is cheaper in many other places and puts pressure on already industrialised countries like Australia and the US. Productivity – output per person – is also an issue in Australia.
Of course you’d have to be an idiot to advocate for wages to be reduced to what they are in China or Vietnam. No one would argue that the way for Australia to be more competitive is to pay wages that no one can live on. That’s not a solution.
But that’s the real trouble here. In a globalised word, if you can’t compete on wage costs, you have to pick and choose your industries carefully. The Germans and the Japanese make their living in high-quality, high-tech manufacturing processes. The Koreans and Taiwanese focus on value-added in electronics. A few Aussie companies like CSL might be able to compete globally on a similar basis.
However, investors face the reality that outside commodity producers like BHP Billiton and Rio Tinto, Australia has very few world-class, best-of-breed companies, manufacturing or otherwise. This is an investment problem, as it leaves you with nothing to rotate into should the dollar weaken. But it’s an even larger economic problem for which there is no easy or obvious solution.
The one solution you’ll see offered most often is that Australia’s banks are world class and can carry the economy. How? By creating another housing bubble, of course!
The only trouble is that it’s not happening. The RBA’s cash rate stood at 4.75% on November 1st, 2011. Since then, the bank has cut it five times. At 3%, the cash rate now is exactly where it was at the worst of the Global Financial Crisis. Why have crisis-level rates if there’s not a crisis?
A housing crisis doesn’t work in the same way as a share-market crash. Housing markets are less liquid. Owners have the option of holding on, hoping for a recovery, or even renting to ride out weak periods in prices. But those weak periods can be weaker and last longer than most people like to think.
Australian capital city house prices were down 0.3% in December and 0.4% for the year, according to data released this week from RP Data and Riskmark. Prices were up 8.9% in Darwin for the year. But they were down 2.9% in Melbourne and down nationally for the second year in a row.
During the US subprime crisis, the disappearance of non-bank mortgage lenders led directly to big drops in home prices. Without those lenders making high-risk loans, and with no one else to fill the breach, the stream of new buyers into the market ended. Once prices began falling quickly, the incentive for new buyers – rising prices – ended altogether.
Australia may be different in the sense that since 2007, the lending market has become ever more consolidated. The Big Four banks now own over 80% of Aussie mortgages, more than in 2007. They are unlikely to stop making housing loans altogether. That would hurt the value of their existing loans and remove a key plank to their growth.
What you’ll have instead is a slow grinding bear market in Australian housing. It will be a market in which new buyers still find houses unaffordable, but investors remain reluctant to sell. And that’s a best case scenario. Don’t rule out a crisis either. You never know when they’re coming.
Australian Commodities Price Update
Finally, the RBA has also updated its index of commodity prices to close out 2012. You’ll see the chart below. The index was down 11.5% in Australian dollar terms. Greg reckons falling commodity prices and the falling terms of trade are two factors which will bring home the pain to Australia’s economy in 2013.
Iron ore prices DID rally in December. But you can see the trend for the RBA index is pretty convincingly down. And despite the rise in prices in November and December, Rio Tinto’s head of iron ore, Sam Walsh, reckons the iron ore resurgence is temporary. He told the Australian this week, ‘We’re seeing an unusual situation at the moment where there’s some nervousness from the steel mills in relation to supply. I’m sure it will settle down after the cyclone season.’
That means that even if shares do rally in the first quarter on the back of the ‘risk trade,’ you may see the iron ore producers (especially the juniors) ‘decouple’ from the rally. All in all, it’s going to be a year for stock pickers. The general trends are more confusing and contradictory than ever.
Dan Denning,
for Money Morning Australia
