Is Aussie Luck About To Run Out?

Australia avoided recession entirely in 2007-9. Its house prices are the only pre-crisis bubble on the planet still inflated.

Chinese demand for Australian commodities from agriculture to iron ore and steel looks insatiable, and even the Perth Mint say their biggest source of new customers is China.

Yet Australians who know their history might recall what happened in the Great Depression of the 1930s. Up until then Australia had enjoyed a record 50 years of unbroken expansion, having sailed through the First World War in economic terms if bloodied on the beaches of Gallipoli.

However that did not stop Australia plunging into one of the worst depressions of the Great Depression. Commodity prices crashed at a time when the economy was horribly over-borrowed. Banks failed, businesses went bankrupt and people used to the good life found themselves literally scratching a living as so-called diggers. Only the approaching Second World War brought higher commodity prices and economic growth back down under.

Are things so different today? The Australian economy, particularly the personal sector and housing, is horribly over-borrowed. It’s become massively geared against the higher and higher commodity prices of the 2000s, almost entirely due to the huge expansion of the Chinese economy in that period and infrastructure building that relies on digging stuff out of Oz to create roads, railways and skyscrapers in China. What if the Chinese economic miracle turned sour? Nothing goes up forever, not even Chinese skyscrapers.

There was a lot more discussion of this possible scenario a year ago than now. China watchers have long argued that the necessary policy levers to achieve a soft landing are in place. It seems to have happened.

The real worry has to be that China is the archetypal state colossus with hidden subsidies, an unknown shadow banking sector and corrupt officials issuing blatantly fraudulent statistics. You don’t know what is going on beneath the hood.

No economy can expand at this pace forever. Japan hit a brick wall in 1990. Nobody predicted that. The Japanese economy was supposed to have overtaken the US by now. When will China’s day of reckoning come?

When it does so will Australia’s. Such a long boom is terrible for distorting perceptions of reality and dependence. Economies always look terribly solid and prosperous until they are not, and the downturns will be asymmetrical, that is to say some groups of society get hit much harder than others.

For example being unemployed in a high-cost society is much tougher than the marginal impact of recession on living standards for a wealthy man.

However, we do think Australians should be planning for a world in which house prices do not rise forever and in which interest rates go up, making mortgages expensive and ruinously so for the new entrants to the housing market.

The chances are that the average Australian investor is also horribly exposed to local stocks through the seemingly unshakably good national superannuation pension scheme. Again it’s a humdinger if the commodities boom lasts forever.

A small population living in a huge landmass with incredible natural resources does have an advantage. But being rich is no protection against over-borrowing.

You could imagine a 1930s type of scenario with a property crash devastating the banks and ruining millions of homeowners. Could the government move quickly enough to save the banks?

Actually we now know that without the support of the Federal Reserve in the global financial crisis the big banks of Australia would have gone bust then. That’s not a very good precedent for the next crisis. If I was Australian I would be hacking back on personal debt and turning highly valued shares into cash. China’s luck won’t last forever either.