Tuesday, September 21, 2004

If you think the US is teetering on the financial precipice, check out Australia (from yesterday's Financial Times, sub. only). Housing bubble, massive debt, huge current account deficits of over 6% of GDP, no savings, tax-cut driven consumption -- the Land Down Under has got it all.

One note on comparing the US and Australian balance of payments problems. As Roubini and Setser point out in their very good discussion on "The US as a Net Debtor," it is far easier for a small country which exports a significant amount relative to GDP to bear the burden of a large CA deficit. Australia's exports-to-GDP ratio is around 16-17% while for the US it is only 10%. Thus Australia can bear a heavier debt burden because it can more easily finance it through exports than can the US. Plus, the United States has the USD and its global role to worry about, while nobody is using the AUD to stock their reserves.

The "Lucky Country" is enjoying a remarkable streak. Australia's economy looks set to expand for the 14th year in a row, with gross domestic product forecast to grow by about 4 per cent in 2004.

The stock market is at a record high, having risen more than a third over the past 18 months, and a massive property boom - house prices have more than doubled since 1997 according to the Economist's house price index - has left Australians feeling richer than ever before.

But economic upswings do not last forever and Australia's boom is starting to show parallels with the final stages of the US technology bubble of the 1990s. As in the US, consumer spending has been the main motor of the economy - final domestic demand has been rising at 5-6 per cent in real terms over the past few years, faster than overall GDP. This household spending has been driven by real estate rather than stock market gains, as was the case in the US, but the wealth effect has been the same.

In some respects, Australians are even out-doing Americans in their willingness to gamble with their financial health. The US household savings rate is still marginally positive, while Australia's stands at minus 3 per cent. Equity withdrawals from property are running at twice the US level and household debt averages 150 per cent of household incomes, compared to 120 per cent in the US.

Inevitably, Australian consumers, like their American counterparts, will have to start deleveraging at some point and that will hit their ability to spend, and hence overall growth. The pre-election budget in March, which included record tax cuts and give-aways, might delay this for a quarter or two, but no longer. Although there is no single definitive measure, house prices - on which the whole boom has been built - probably peaked at the end of 2003. Already, car sales are falling and retailers are increasing their discounting to keep volumes up.

This will have a disproportionate effect on equities. Although Australia is often still perceived internationally as "a mine with a farm attached", it is a modern service economy, says Gerard Minack, Australian strategist for ABN Amro. Mining and farming each contribute just 5 per cent to GDP and resource companies make up 15 per cent of the stock market, while financials are at 42 per cent. The latter have been growing their earnings at more or less double-digit rates for the past decade and if they slow down that will far outweigh the positive effects of China's demand for commodity imports and a weaker Australian dollar.

How bad will the downturn be? In its favour, Australian valuations, with a prospective price/earnings ratio of 15 times, have not reached the crazy levels of Nasdaq. And corporate, as opposed to personal, balance sheets are much more solid than they were in the US at the end of the 1990s.

On the other hand, Canberra is liberally distributing the budget surplus in the good times, giving it less flexibility to cut taxes and stimulate demand than the Bush administration. With a supportive White House and an ultra-accommodative Federal Reserve, America's exit from its bubble has probably been managed about as well as it could have been. Yet four years later, the S&P 500 is still a quarter below its peak in the spring of 2000. Australia will need all its luck to deflate as gently.


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