07/12/2011 - 11:14

Australia needs an economic stress test

07/12/2011 - 11:14


Upgrade your subscription to use this feature.

Business and political leaders need to consider what happens after there’s nothing left to dig up.

Business and political leaders need to consider what happens after there’s nothing left to dig up.

AUSTRALIA’S resources-driven economy is starting to hit top gear with what looks to be a brilliant future ahead; but if the outlook is so good, and export earnings have just topped $48 billion for the September quarter, why are some seasoned observers nervous?

The answer lies in a single word – resources – and the explanation is that what now stands as the country’s greatest strength could eventually become its greatest weakness.

Before dismissing that sort of comment as churlish nonsense, think about one of life’s oldest wise-sayings: ‘don’t put all your eggs in one basket’.

Everyone thinks they know what that means, but to actually see the consequences is quite different, which is what I’ve been doing for the past week; observing first-hand what happens when the dominant driving forces of an economy dies.

The place where the death of an economy is on partial display is Europe, especially the lazy nations basking in the crisp Mediterranean winter sun. It is in Greece, Italy, Portugal and Spain that citizens are asking: ‘What is it that we do apart from enjoy a beautiful lifestyle, and what is it that we make that the world wants to buy?’

For a full-blown demonstration (in more ways than one), however, the place to be is Britain, where the death of banking, and other financial services, has decimated the domestic economy to the point where even optimists are talking about a lost decade.

Last week’s strike by government employees and their mass march through the streets of London was a symptom of the crisis that is gripping the country; but that’s all it was, a symptom. The cause is much more interesting.

What Britain did wrong up to 30 years ago was two-fold: firstly it believed that being part of Europe made more sense than retaining a close working relationship with its former colonies, Australia, Canada and South Africa; and secondly, it believed it could remain a global banking centre even as traditional manufacturing industries shrank or migrated.

It was after those two disastrous decisions were made that the GFC hit – banks closed, jobs disappeared, government revenue shrivelled, and civil servants discovered that there wasn’t enough cash to pay even their modest retirement pensions.

Australia is a long way behind the British experience but it’s travelling the same road; and while it is not yet possible to see the end of the resources boom (just as Britain couldn’t see the end of its banking boom), an end point will be reached. 

Long before we get there, however, it would be wise to ‘stress test’ the Australian economy.

What that means is that, in the same way a bank tests the strength of its customers to continue servicing their loans, and that depositors continue to trust the bank with their money, the government of a resources-driven economy should be asking what happens if commodity demand slows, and prices revert to their long-term trend.

The long-term trend price for iron ore, for example, is closer to $US70 a tonne than today’s $US140/t. Enthusiasts say the price will never fall back to the long-term trend. Realists suspect that it will, as it always has in the past, and to believe otherwise is to also believe one of the business world’s great lies – ‘this time it will be different’.

Consider just one possibility; the day when African iron ore can be produced cheaper than Australian iron ore, if only because labour in Australia is at least three times more expensive. Coal from Asia and Africa will also one day undercut the cost of Australian coal.

High taxes on mining and carbon-emitting industries will add to the cost of doing business in Australia, and while it is possible to argue that a super-tax on some highly-profitable forms of mining might make sense today, it is impossible to argue that the proceeds should be squandered on social welfare spending.

Banking and resources, said quickly, appear to have little in common, until you appreciate how both industries can disappear when circumstances change – which they always do.

That’s why Australia should be planning for the next stage of the resources boom – a time when there isn’t one.

Someone’s gotta pay

ONE topic conspicuously absent from mainstream conversation in Europe today is alternative and renewable electricity, which has disappeared almost as if someone had turned off a light bulb.

The reason is obvious, not that true believers in windmills, solar panels and tidal power want to admit that green power costs a lot more than coal, nuclear or gas power. 

Simply put, now is a terrible time to be incurring more debt to replace an existing power system with an alternative which may, or may not, work as promised.

Europe’s debt bomb has exploded at a most unfortunate time for the green energy crusaders, who have been chatting in the South African east coast city of Durban for the past week. But as the talk there dragged on, reality was breaking over 4,500 workers at Britain’s Carillion group, which installs solar-power roof panels. They were warned that they could lose their jobs because the British government has been forced to cut in half the subsidy it pays for power bought from households.

While everyone in Durban agrees that green power is the way to go, no-one can answer the core question of who pays.

Guessing game?

IF one good thing can come from Europe’s debt crisis it will be the death of forecasting, especially the nonsense of seeking an answer in an Excel spreadsheet.

In Britain’s case the margins of error on its debt crisis have proven to be wrong by $30 billion, but what’s even more astonishing is that the error is on numbers that are just nine months old.

In other words, an austerity package costed at $200 billion as recently as March is now $230 billion, a difference that should embarrass anyone who relies on forecasts and spreadsheets and remind them of the GIGO principal – garbage in, garbage out.


 “Governments never learn. Only people learn.” 

Milton Friedman


Subscription Options