THE ECONOMY: by Peter WestmoreNews Weekly
Debt crisis may force 'severe correction'
, June 24, 2006
Australia is now highly vulnerable to economic shocks, because the economy is structurally imbalanced towards the finance sector and non-tradable services, warns economist Dr Peter Brain. Peter Westmore reports.Unless Australia's economic direction is reversed, the country faces the possibility of a "severe correction" by 2010, a leading economist has warned.
Economist and author Dr Peter Brain, who is executive director of the National Institute of Economic and Industry Research (NIEIR), gave a keynote address to a conference on the future of manufacturing industry in Australia, held by the Society for Australian Industry and Employment on June 6.
The fundamental danger to Australia's economy, he said, arises from the unsustainable growth in Australia's net foreign debt, now about $500 billion, making Australia highly vulnerable to economic shocks, because the economy is now structurally unbalanced towards the finance sector and non-tradable services.
Dr Brain said Australia had reached this position as a result of the effective abandonment of monetary policy; failed superannuation policy, which had made superannuation a form of deferred income; and the absence of an industry policy.Danger level
He said the predictors of an economic shock in Australia included the growth of the current account deficit, which, for the first quarter of 2006, came in at almost $12 billion. This was a rise of 15 per cent on the same quarter in 2005. For the past year, the CAD is about $45 billion, which is above the generally accepted danger level of 5 per cent of GDP.
Dr Brain said that, additionally, credit growth is continuing to expand faster than nominal GDP, and foreign debt continues to grow as a percentage of GDP. He said that net foreign liabilities, as a percentage of GDP, had risen from 38 per cent in 1988 to about 58 per cent in December 2005, and continues to trend upwards.
Dr Brain cited statistics to show that Australia seems to have peaked in terms of its attractiveness to foreign lenders, while the key driver of Australia's growth has been credit-driven household net wealth expansion, i.e., higher house prices.
He also showed figures which indicated that the ratio of debt to household net disposable income had steadily risen from 50 per cent in September 1983 to about 180 per cent in September 2005.
Contradicting the prevailing orthodoxy that superannuation had been one of the principal successes in the Australian economy, Dr Brain said he believed that the compulsory superannuation scheme had been "a complete failure", because it had been accompanied by a massive growth in personal indebtedness, so that when people retired, their superannuation was increasingly being used to retire debt. Although the targeted savings rate in Australia is 15 per cent, actual savings ratios in Australia had fallen from 9 per cent in the 1990s to 2 per cent today.
Peter Brain is author of a number of books on the Australian and international economies; and National Economics - the shorthand title of NIEIR - has provided economic consulting services to industry and government for some 20 years. It is also in the forefront of economic modelling, which is used for forecasting and analysis of the national and regional economies.
Dr Brain achieved great prominence in 1997, when he was among the first to correctly predict the severity of the Asian crisis, sparked off by a run on the Thai currency (the baht), which ultimately caused an economic collapse in Indonesia and other countries.
He said that the rise of the finance economy had caused a fall in manufacturing in Australia, because resources committed to the financial sector had "crowded out" other parts of the economy, including manufacturing.
In particular, he singled out inflated land prices, and described how the higher returns achieved on investment in this area had damaged other parts of the economy, including manufacturing.
He estimated that the doubling of house prices in the metropolitan areas had led to a 10 per cent fall in manufacturing capacity in the long run, and concluded that the Australian economy was fundamentally unbalanced, and there would be a correction as had happened recently in Iceland and New Zealand.
In Iceland, a program of deregulation and encouraging foreign investment has led to a widening trade deficit and high inflation, now above 7 per cent, while interest rates have risen above 12 per cent, more than four times higher than in the euro zone.
Credit-rating agencies, including Standard and Poor's, have downgraded the Icelandic economy; the currency has depreciated against both the euro and the US dollar; and the stock market has taken a battering. The Prime Minister of Iceland recently resigned.
Standard and Poor's placed Australia in the category of countries with unsustainable external liabilities. Warning about the consequences of the country's growing foreign debt, a spokesman for the rating agency said that "there is always a likelihood that investors will lose confidence in the ability of borrowers in Australia to meet their obligations".
Unless the Australian economy undertakes a fundamental change of direction, foreign lenders could lose confidence in the Australian economy, which is now being sustained by its role as a supplier of raw materials to China.