Reluctant Praise for Australia's Economy

Before I get stuck into today’s Daily Reckoning, let me remind you that I’m still gathering evidence about whether your money in the bank is really yours. I don’t want to be an alarmist. But there’s nothing wrong with reporting the facts. Lots of useful links have been sent my way. A full report awaits tomorrow.

But while we’re on the subject of money, what about gold? Is it money? Or is it just shiny metal with a pleasing heft? And more to the point, with geopolitical tensions from Ukraine to Iraq at sky high levels, why has the gold price barely budged?

If you’re looking for answers, try the Gold Symposium in Sydney on October 8th and 9th. My mate Greg Canavan is one of the keynote speakers. He’ll be joined by three of my favourites — James Turk, Bob Moriarity, and David Baker. You cansign up for the show here.

This will be the first time in six years I’m not speaking at the show. I’ve been involved because Marcus Matthews and Kerry Stevenson manage to attract some world-class speakers to present on an important topic. It’s Australia’s best conference on precious metals.

And, if I’m not mistaken, the platinum group metals (palladium and platinum) have been added to this year’s roster. Russia, as you know, is a key supplier of those metals. If Western sanctions on Russia ratchet up, could the Russians turn off the supply of PGMs the way they’ve threated to turn of Europe’s natural gas? They certainly could.

Let us take pause from our worrying, however, to praise Australia. Yesterday’s GDP figures showed that Australia is on track for a 23rd consecutive year of recessionless expansion. The only other Western industrial economy to manage a similar streak was the Netherlands. The Dutch strung together a 27 year streak from 1981 to 2008.

Australia is now top of the table for growth without pause. And as someone who has called for the inevitability of a recession this year, I doff my cap. Well played economy. Well played.

The actual numbers were solid, if not spectacular. GDP grew by 0.5% from the March quarter to the June quarter. GDP is up 3.1% since June of 2013. The big contributor in the latest quarter was a rise in inventories (0.9%).

Yet it wouldn’t be The Daily Reckoning if I couldn’t find a cloud enclosed in the silver lining. The cloud is that Australia’s national income is falling. That means, all other things being equal, its standard of living will fall too. The mining boom giveth. And the mining boom taketh away. Looketh at the chart below.

The terms of trade fell 4.1% in the June quarter, in seasonally adjusted terms. You wouldn’t find that surprising if you own any junior iron ore stocks. With iron ore prices down, and iron ore being Australia’s largest value contributor to exports, its decline has been felt in the nation’s wallet. But that only tells part of the story.

During the mining boom, purchasing power grew faster than GDP. The huge increase in commodity prices delivered extra income without any extra production. From 2001 to 2103, GDP grew by 3.1% per year. But real gross domestic incomes (RGDI) grew by 4% over the same time.

The ABS says, ‘RGDI measures the purchasing power of total incomes generated by domestic production by including the impact of the Terms of trade on GDP.’ In other words, the booming terms of trade gave all Australians a little more bang for their buck. And now?

Well now, the terms of trade appear to be mean-reverting. They are gently declining to a new equilibrium, as the economists say. The only thing that might reverse that decline is a big increase in energy prices, to go along with a big increase in LNG exports. That, by the way, is what BHP Billiton is counting on.

Iron and coal are out. Energy and potash (which is potential energy in the form of food) are in. BHP CEO Andrew Mackenzie outlined the strategy in today’s Australian. He said, ‘The bigger investment will be energy, and the issue with energy is we need diversification within the energy space because the world hasn’t got a magic or clear pathway through to the energy supply of the future.’

By ‘diversification’ he means geographic and by fuel type. BHP has on-shore shale gas assets in America. It has offshore oil assets all over the world. So far, it doesn’t have any onshore unconventional gas assets in Australia (shale gas). Perhaps it’s waiting for Australia’s regulatory regime to provide some certainty before committing billions in capital.

You can see the company’s strategy for yourself in this presentation. Potash and Petroleum president Tim Cutt shows how the company plans to sell off non-core assets in its portfolio. It reckons that energy is a much higher margin business. And the map below, which ties in with a point I made poorly yesterday, proves the point.

70% of the world’s population will live in cities by 2045, according to a study by the UK Ministry of Defence. Today, it’s 50%. The Global Strategic Trends report paints an intriguing (even alarming) picture about our urban future. You can see on the chart above that most of the world’s cities with more than 20 million people are directly to Australia’s north. Many of those cities have been built, from the ground up, with steel that started as red dirt from the Pilbara.

But once those cities are there, they need food, water, and power. They’re all important. But you don’t get food and clean water without energy. Modern infrastructure systems require reliable and abundant power to keep the trains running and refrigeration cold. The Big Australian is right to focus on energy. And the punters who focus on exploration companies are probably on to something too.

-Still…what do you think it would be like living in a city of 40 million people? That’s a single city with a population roughly twice the size of Australia. You can see why so many Chinese investors are eager to find a patch of beach on Australia’s east coast, or an inner city apartment in Sydney or Melbourne.

But there’s a level of civic planning and social investing required for cities that large to even exist. You begin to wonder — at least I do — whether cities of that size are unnatural. How much food and water is required just to keep them running? And doesn’t size equate to a certain systemic vulnerability?

This is the point I tried to make yesterday. Governments, like Shinzo Abe’s in Japan, have taken it upon themselves to produce growth by directing large parts of the economy. It’s a kind of urbanisation on a national scale. This trend will only continue. But can a city of 40 million really be planned and managed by anyone?

‘If you avoided all the other threats,’ Vernor Vinge once wrote, ‘the complexity of your own success would eventually get to you.’ The bigger and more interconnected we are, the more fragile our civilisation gets. And that’s fragile without assuming the malice of non-state actors and world burners. In tomorrow’s episode, I’ll look at the modern world’s reliance on a technocratic elite. And I’ll get back to the question of whether your money is really yours. Until then!

Dan Denning+
For The Daily Reckoning Australia

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