The next installment in my investigative series examines what props up our lifestyles in Australia, in other words, exports. Because we could but we don’t make everything we need. We all like cheap toothbrushes, televisions and cars. For us to enjoy these products, we need a country to produce them relatively cheaply where people are cheaper and currencies are kept deliberately low by their government (i.e. China). The reason we have enjoyed a boom in our ‘material well being’ whilst avoiding inflation is largely due to cheap Chinese imports keeping this low.

However, nothing comes for free. Australia must give something in order to get something.

So what pays for all these goodies that we enjoy today?  My computer I am writing to you, the gadgets and boxes that make up the Internet, the fridge that cooled my wine for me.

According to the Australian Department of Foreign Affairs, in 2008-2009, in order of importance, Australia’s exports were:

1) Coal ($54.7 billion)

2) Iron ore & concentrates ($34.2 billion)

3) Gold ($17.5 billion)

And (spot the odd one out)

4) Education-related travel services ($16.6 billion)

So it ends up looking like this:

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Australia’s Composition of Trade (DFAT, 2008)

Now notice the growth particularly in iron ore, and the backbone of our country, coal.  Notice the massive increase  year on year, and remember how “coal jobs” featured so prominently in the governments efforts to bring in carbon trading.  Coal is, for all due purposes, carbon.  So not only are all our fancy toothbrushes, TV’s and cars all paid for with coal, it makes Australia possibly one of the biggest polluters of carbon on the planet.  If you believe the evidence for global warming, and support limits on carbon pollution, then that is a lot of carbon pollution that our export funded lifestyles are responsible for.  However, I am not supporting any side of the argument.  I am merely presenting some interesting facts that few Australians seem to fully understand.

Now the next graph is also interesting.  Take a good look at this:

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IndexMundi (2010)

What this graph shows the value of commodities (being Australian exports) over 25 years.  Notice the recent spike in the last decade.  How many of us remember the time before the ‘boom’?  To many of us, it would seem to stretch back forever, and we would be forgiven for believing this would stretch long in to the future.  I, however, remember the Banana Republic statements in the 1980s and the difficulty in finding work in the early 1990s.

If we look back even further, the pattern continues:

(Full size version here)

Apart from a ‘small’ dip in the Great Depression (notice the bump around this time) and the GFC, it’s been going bang busters in the last 15 or so years.  But for most of human history, commodities have been, well commodities.  No more valuable or important than the potatoes you buy at the supermarket by the kilo.  Sure they are important and needed, but it would be a stretch of the imagination to see a country basing a whole economy off growing potatoes.

By good fortune however, the commodities that we dig out of the ground, are now incredibly valuable.  Possibly until the world or China realises that a new super tanker is not required every two weeks, neither are cities and skyscrapers every week or so, or cities with no people in them.  China, is an export driven economy.  However China primarily saves, while we mostly consume (import), leading to Australia actually being more in debt than Greece, except ours is all private debt (i.e. credit cards and mortgages).  China relies very heavily on foreign demand for its goods and on the deliberate efforts of the Chinese government to keep its currency low (and inflation subsequently high).  Australia relies on the goodness of strangers to keep funding our lifestyles while demand of our commodities inclines them to keep doing so.

So who is indulging our lifestyles of fancy toothbrushes and big TV’s?  You guessed it, Japan, China and Korea.  In other words, all those coal hungry people in Asia who want our carbon to heat their floors, to fire their power plants and smelt their steel to pump out super tankers and sky scrapers at a rate unimaginable only 15 years ago.  China loves our coal, almost as much as Japan does.

So where is all this taking us?  Well Australia is a consumption driven economy.  What does that mean?  It means we love debt, we love consuming and we just can’t get enough of it.  Australia is a seen as a reasonably safe place to throw money at willing consumers who just keep asking for more.

What these graphs suggest, is that the Australian economy basically consists of digging up coal and ore and selling it to the highest bidder, so we can indulge our envious lifestyles while squirreling more away in to the value of residential homes. The only problem with that is that if your grandmother is ill, it’s a little more difficult to withdraw money from an un-needed (likely still indebted) bedroom than from a savings account or even liquid shares.

The fundamentals of our society and our economy have altered dramatically in 15 years, and strangely few of us seem to remember anything different to now. We save less, we spend more, and we borrow more to buy ever more expensive houses, bigger TVs and bigger and better cars, funding all this to a significant degree from Chinese savers and consumers of coal and ore.

If you believe the reports on China, we have nothing to fear, this will continue for at least 50 years (by which time a home loan will be measured in generations).

If you believe some other suggestions .. I’ll leave that up to speculation.

What I do know is that if I owned a sandwich shop called Australian Sandwiches, and most of my income was from one type of sandwich to one very generous customer, I would be wondering if I should look at spreading my business out a little in case that one customer suddenly changed their tastes or decided to buy sandwiches from someone else. With kids to feed, I would be wondering very much about this.

However, we seem to take this for granted. This explosion in wealth appears to have shortened our memories so that we do not seem to clearly recall the times when commodities like coal and iron were not so valuable. As I keep saying, nothing lasts forever.

However, I would not write this without balancing this with some good news, as to use my analogy of a sandwich shop, I could look at the strengths of my business and wonder if there is any reason why I should stick to only making sandwiches. Granted, the mining sector driving up the Australian Dollar can make life very difficult for other exporters, but even so, many countries would love to have the problems that we have. Greece being one of them.

And I will lead in to my next blog post which will touch on our education exports, and what this means for Australia as a services economy as a whole. I believe that Australia, this time by good management rather than just good fortune, has built up an asset that money can’t buy, and that resources can’t provide. As long as Australia recognises and nurtures this strength, there is no reason why a post-mining Australia can not be even wealthier while contributing to making the world a better place.

It will, however, require Australia to shed the cultural cringe and recognise its strengths. It will require us to become a nation of smarter savers, and smarter investors. We already have the foundations in place.

One of which, possibly one of the most important to our future, is illustrated in this diagram that I will discuss in my next post.

This is a map of perceptions of corruption care of Transparency International, which is but one of many indicators of corruption, transparency and general friendliness to business and investment that Australia excels at.  I believe following the GFC, Australia was left at about number 3 in the world (reference required).

You will notice that the countries in light blue that are resource rich like Canada and Australia are also the countries that receive the greatest interest from mining investors. This is no coincidence. It makes one wonder what else these low corruption nations like Australia can achieve if they put their minds to some creative ideas.  The converse is that Australia is a victim of its own success, as foreign investors are only too willing to keep shoving foreign money to Australian consumers who are more likely to repay debt than (apparently) consumers in many other nations.  It would be preferable if Australian consumers were a little less willing to consume debt, as this may lead to significant economic instability if left unchecked or if we experience a ‘correction’, however as mentioned previously, many nations would be only too happy to suffer from these problems.

The once bastions of the financial world, the USA and the UK, due to the fallout from the GFC are now regarded as significantly more prone to corruption than Australia.  This is more a positive reflection on Australia than a poor reflection on other nations.

One has to dig deep to find this.  It is not reported widely, although (thankfully) our willingness to consume debt now is reported more widely.

However, this window of opportunity will not be open for long.  I will explain what I mean by this in my next article.

For a full breakdown of countries by perception of corruption, see this table.

In this weekend’s Australian Financial Review (Perspective, May 15-16, 2010, p. 30), I note with concern a small comment buried in the article “The Great Property Puzzle” written by Ben Hurley investigating an ‘unexplainable’ drop in home owner occupied loan approvals, now sitting at a 9 year low, and falling for several months in a row.  Conversely, investor loans have increased for five consecutive months.

Hurley proposes two explanations:

Firstly, “Investors with existing portfolios who are buying with their equity, which will have swelled nicely in the last year.  Loans to investors have increased for five out of six consecutive months, ABS figures show, and the quantum dollar value of loans to investors in March was 34 per cent higher than one year earlier”

Secondly, Chinese investors are acting through resident family proxies to bypass foreign investment regulations.  These ‘invisible investors’ would be subject to the vagaries of foreign exchange fluctuations rather than the whims of Glen Stevens from the RBA.  It would also be difficult to quantify how much this is occurring.

The first reason concerns me the most.  Either these loans are taken out against the rising prices of property as security, or the sale price of property is used to fund ever increasing property purchases.  Both rely to varying degree on continued rising of property asset values to continue to prop up, and secure these loans, and to continue the upward spiral of property prices.  Both are built on sand.  Loans secured on the premise of forever rising property values, is alarmingly similar to that which occurred in Detroit, USA, in 2007 that ignited the the GFC raging financial bushfire.

The second reason concerns me to a lesser although still significant degree, as this further exposes how reliant the Australian economy is on Chinese money.  Any investment adviser will always suggest spreading your investment portfolio over a range of investments to average out risk.   The Australian economy, however, has invested greatly in China.

And all the while this is occurring, in a part of the economy that does not produce anything unlike factories, chip shops and cafes.   Houses do not add any productive capacity to the economy, in fact the resident density in homes is falling, so if homes were productive, even this figure would be weak.

This strengthens my argument that the Australian economy must be re-engineered to invest in the productive sector, away from residential homes, thereby lessening the pressure on struggling home buyers, and boosting our productive capacity beyond digging colossal holes and planting vast fields of crops.  In short, Australia should make hay while the sun shines, because nothing lasts forever.

Populist calls to ‘extract’ a greater communal return from the mining sector will amount to nothing, if that revenue is not invested in maintaining and capitalising on Australia’s competitive strengths in the services sector (corruption, stability and competitive education and other service provision).

Failure to do so will condemn our children to a protracted period of the ‘depression we had to have’, when the combined effects of rising interest rates and inevitable challenges in the Chinese economy exert their full influence.

Success in doing so, will entrench the Australian economy as a long term valued member of the global economy, and ensure our children enjoy a prosperous and stable future to fulfill their needs, and their dreams.

The Resources Tax has been a subject of considerable discussion in the news this week.  While I endevour to remain objective and apolitical on this blog, I feel compelled to highlight the reasons I question the viability of the proposed increase taxation on the mining sector.  Some simple economic theory provides a context:

Risk = Government Bond Rate + Uncertainty

Business = Investment + Risk

Investment = Expected Return – Risk

If Expected Return – Risk is Less than Zero, then Investment will be Zero.

Profits + Business = Economy.

Economy = Jobs + Taxes

Taxes = Police, health, foreign affairs, schools, parks, roads and support for those in need.

My concern is the that if changing the rules of the game after investment has been committed leads to a higher perceived risk (Legislative Risk), then Australia’s investment rating may soon be downgraded.  Business rarely objects to a stable environment where projections and strategies can be laid out with a degree of certainty.  What impacts investment and business is uncertainty, and to compensate for a level of uncertainty, expected return must be increased.  I.e. if government bonds are returning 4%, why would you invest in anything of higher risk that does not return more than 4%?  That’s poor financial management.  Unless something can return more than government bonds or the ‘cash rate’, it makes no sense to invest in it.

What businesses and the economy require is certainty.  And a way to ensure that current committed investment receives a level of certainty.  If increased mining taxes are required to plug the budget hole left by the ‘fiscal stimulus’, then this could be applied to future rather than current investments, or at least work with the impacted businesses to minimise impact on investors by allowing them time to adjust.

The other concern I have is where this revenue will go.  Australia is blessed with a low corruption rating.  If the revenue raised from the mining tax were to be directed at encouraging new business to capitalise on this low corruption rating, then the mining tax could be regarded as an investment in our economic future.  One example is leveraging our low corruption / high political stability rating in the export of financial services and fund management.  Also, education as an export should be supported, as after mining, this is our biggest export.  Foreign students should be treated with the same level of attention as any high spending client in any business – like gold.  I believe these measures would be cost effective.

Because nothing lasts forever, and mining is no exception to that.  There have been periods in Australia’s history where our commodities were not very valuable, and we suffered as a result.  Those times can return again, and more quickly than we may expect, as we are very reliant on one particular customer.

To ensure our economic security, Australia must diversify its products, and it’s market.  It is of questionable merit to continue relying on a small number of temporarily valuable products and one temporarily valuable client (China).