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Debt disease

Philip Bowring

HONG KONG What is it about English-speaking countries that they make a virtue of going into debt? Recent statistics from the United States, Britain, Australia and New Zealand show alarming rises in borrowing from foreigners to finance consumption. How much longer will it be before some financial grim reaper comes to reminds them of Benjamin Franklin's advice: "Rather go to bed supperless than rise in debt".
The current U.S. deficit, $800 billion or 6.5 percent of gross domestic product, attracts some attention if only to enable Pollyanna economists to emphasize its irrelevance and look forward to another year of fast (debt-driven) GDP growth. Britain's external deficit has also ballooned and could well hit 4 percent of GDP, or $85 billion, this year. Most Britons have yet to wake up to the fact that they are now energy importers; meanwhile they are doing almost nothing about nuclear or renewable alternatives.
But perhaps the most remarkable examples of Anglo-Saxon profligacy are to be found south of the Equator. New Zealand's current account deficit is now running at 8 percent of GDP. A small country's problems are unlikely to shake financial markets, whatever the debt may do for future generations. But Australia, which has net foreign obligations of $400 billion, is another matter. It just reported another ballooning trade deficit that shocked even normally complacent local commentators. Its current deficit for 2005 will likely come in only a fraction under 6 percent of GDP. That is an astonishing figure for a year that has seen huge rises in the prices of most of its major mineral exports - coal, iron ore, natural gas, copper and gold.
Australia has been receiving huge amounts of foreign money on the back of its mineral and land resources and the assumptions about Chinese demand. It is has relatively attractive interest rates - yields of 1 percent or so above U.S. rates. But where is all this leading the Lucky Country?
Australia boasts of having almost the highest growth rate among developed countries. Some of that has been thanks to a more competitive business environment. But the most important ingredient has seldom been noticed. Over the past 12 years, Australia's terms of trade (the difference between import and export prices) has improved by an extraordinary 38 percent. Some of that was the impact of lower import prices in the wake of the 1997-98 Asian currency devaluations and the rise of low-cost Chinese production. For the past two years however, when the index has gained 23 percent, the cause has been the boom in mineral prices.
The terms-of-trade boost has coincided with very low global interest rates. The result has been that domestic demand in Australia, backed by high real estate prices that peaked two years ago but then hit a plateau rather than a bust, has been growing steadily. Import demand has grown even faster, helped by an Australian dollar that is now 50 percent higher against the U.S. dollar compared with its 2002 nadir because of its perception as a "commodity currency."
Australia's ability to continue on this path depends on two factors: stabilization of the terms of trade at this exalted level, and continuation of high international liquidity and low real interest rates. Commodity exports look well enough underpinned for now by the supply/demand equation after years of low investment. But the import side of the terms of trade could be in for some rude shocks if the Asian countries that supply most of Australia's manufactured imports allow the major revaluations that the United States is urging on China and others. A 20 percent gain by yen, won and yuan would hurt Australia.
Although most of Australia's net foreign debt is denominated in or hedged into its own currency, it is still vulnerable to rises in international rates that would further increase its current account deficit. Rises in local interest rates to choke off imported inflation or support flows into the currency could easily push the real estate market into the dive needed to bring house prices - especially in Sydney - back to their long-term trend line. The alternative? A collapse of the currency, at least against Asian ones.
This may seem an altogether too gloomy picture for an economy that has better demographics than most of the OECD countries, plus investment and environmental attractions for cash-rich Asian neighbors. Nor does Australia have an American- or British-style fiscal deficit to worry about. Nonetheless, Australia seems to have as severe a case as any of the Anglo-Saxon debt disease - and, given its terms-of-trade gains, even less excuse.
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