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Kohler: suffering China’s structural slowdown

The rapid fall in the iron ore price in the past few weeks has exposed the core risk to the Australian economy: the currency needs to fall, but the banks still need foreign funding.

The rising terms of trade and/or high Australian interest rates have kept the money flowing in for three decades to cover a persistently negative current account, despite the resources export boom.

Banks are now desperately trying to increase domestic deposits, with some success, but still need to get 40% of their funding from offshore. If that dried up because of a run on the Australian dollar, the Reserve Bank would have to step in and support the banks.

Three weeks ago the spot price of iron ore fell below the supposed “floor price” of $US110 and then kept going down — to below $US90 on Friday. So far the currency has more or less held — drifting from 106 US cents to 103 — but a report late last week from a US-based research house called Variant Perception highlighted its vulnerability.

The essential point made by Variant Perception is that Australia’s currency is overvalued and needs to be undervalued for an extended period to unwind the effects of “Dutch disease”, or what Treasury and the Reserve Bank call the two-speed economy: that is, the process by which a resources boom increases the currency and stifles the tradeable sector, principally manufacturing.

However, the Australian banking system relies on external funding because of an extended period of household borrowing, caused by the housing boom and debt-funded consumption.

Australia’s current account has been negative for a long time now, and has never caused much of a problem because foreign capital has been readily available due to high interest rates here and Australia’s exposure to China via resource investment.

However, we are now in the rare position of cutting interest rates at the same time as the Chinese economy slows, leading, among other things, to a sudden meltdown in the iron ore spot market.

Of course, this is not the end of the world. Most of the resource investment is for LNG exports, and the oil price is strong and rising thanks to the expectation that Ben Bernanke will soon launch QE3.

But QE3 will not materially change the global economy’s prospects and the oil and gas prices are likely to weaken eventually, especially with all the shale gas coming out of the US.

Australia’s terms of trade may now be in structural decline. If so, the Reserve Bank will soon have a choice: raise interest rates to defend the currency or directly support the banks with a European-style LTRO operation — printing money and supplying liquidity to them.

It’s more likely to be the latter. As the RBA itself has pointed out, defending the currency, either directly by buying it or by raising interest rates, is a mug’s game and usually doesn’t work anyway.

As Variant Perception points out, the main problem for Australia lies in the structural slowdown we are likely to see in China.

At the same time “there is considerable deleveraging ahead for the Australian consumer with household debt still at significant levels”. However, unlike China and Japan, the demographics here are “relatively sound” and the savings rate has increased substantially, which are positives.

*This article was first published at Business Spectator

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  • 1
    Hamis Hill
    Posted Monday, 3 September 2012 at 1:59 pm | Permalink

    So if everyone else is buying the Australian Dollar then it makes sense to print more for sale.
    More sense than selling the farm and easier to buy back.
    But what about selling more overpriced real estate to foreigners to put more money in the bank?
    Baby Boomers might be enticed into early retirement and sea changing to some declining tourist resorts and ploughing some of that foreign sourced income back into the banks.
    One thing is certain, thanks to the Howard-Costello mortgage debt binge, their grandchildren cannot afford to buy these homes.
    And there is a limit to how many new migrants without employment can be housed in “investment homes” at taxpayers’ rent susbsidy expense.
    Isn’t there a charming tent resort going up right now on a wonderful pacific island, perfect for cashed up Baby Boomers?
    Would the Banks buy it?

  • 2
    Owen Gary
    Posted Monday, 3 September 2012 at 2:15 pm | Permalink

    The market system hegemony controlled by the banksters is slowly being digested by some of the worlds population, thats why the revolutionary reaction is slow. Although there are some positive signs in Greece & Spain.
    We are being routed by the same regimes here in Australia yet as George Carlin said “nobody seems to notice, nobody seems to care”

    Many believe as do I that the system is being brought to collapse to usher in a more tyranical era of governance by the much touted NWO, but this can go 2 ways but that depends on those who react & I guess that timing is also critical to the end scenario.

    One things for sure the capitalist market system controlled by those who would be king has gone way past it’s use by date and is unsustainable especially when the “corpse” are running riot. For the system to suddenly crash would bring on a global food panic, that is why a transition from the current hegemon to community based co-ops would be a far more desired model. We would once again be eating food produced in localities rather than this tightly controlled WTO monopoly of poisoned produce, which only serves to keep the big Pharmaceuticals in business.

    We are entering what is tagged the age of enlightenment, but that remains to be seen as the Coal Seam Gas industry is destroying the aquifers & waterways that irrigate those crops needed to sustain us all, this is happening worlwide. Is this an attempt to cause death disease & famine by means of lack of availability of unpolluted tracts of arable land & water supply or is this merely another coincidence????

    Certainly here in Australia the CSG & mining industry seems to be targetting all the food bowl & arable land locations, & whether they get them all or not, most underground Aquifers are interconnected.

  • 3
    Mike Flanagan
    Posted Monday, 3 September 2012 at 3:16 pm | Permalink

    The essential point of the Variant report is the shallowness of the commentator’s, like you, reaction.
    It is intriguing to observe that Murdoch’s WSJ on Monday last week featured a glowing tribute to our banks and prudential regime and then followed up in the Murdoch FT at the end of week with the Variant Perceptions report. One has to wonder whether the News International Treasury Department took a ‘long’ or ‘short’ position in the forex and share markets in the intervening period with its shareholder’s cash horde.
    Yes Owen Gary, it is not only the fossil fuel barons that are raping the common but also the influence pedalling moguls that are raping and pillaging the super savings of the average man by their manipulation of the markets and our so called journalistic fraternity are complicit.

  • 4
    Liamj
    Posted Tuesday, 4 September 2012 at 12:40 am | Permalink

    Will Gina now go broke faster than Fairfax?! Palmer will go first of course, made a bad investment in that LNP mob, fell for the old “potent synergies” line. The banks will cut him off at the knees and everyone else they can, but it wont save them - we can’t have infinite growth on a finite & now post-peak world.

    @ Mike Flanagan - thats an interesting observation. A global media empire would be the perfect tool for market manipulation, puts a new meaning on “buy the rumor, sell the news”. Even assuming there was evidence, are there any international regulators that could prosecute?

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