International Herald Tribune
Bowring: Australia: Bad times for 'lucky country'
Monday, December 15, 2008

SYDNEY: The "lucky country" has always been burdened by the "tyranny of distance." Thus it is taking time for the news to arrive that - for the time being - luck has run out.

Difficult times may lie ahead, something that is likely to frustrate Australia's ambition to become a global exemplar on climate change rather than the laggard it currently is, with one of the highest carbon emissions per capita in the world.

There is recognition here as elsewhere that stocks and the Australian dollar are down and unemployment and home foreclosures are rising, despite government efforts to boost the economy through infrastructure projects and drastic cuts in interest rates and taxes.

The workaholic Labor prime minister, Kevin Rudd, now in office for one year, is just the man to devise multiple initiatives to counter the global slump.

But what does not seem to have sunk in here is that, after a decade of favorable external circumstances, the shocks may go deeper than elsewhere in the developed world, let alone among the country's industrializing Asian neighbors. Rudd's initiatives may well fall on stony ground for the simple reason that Australia has had it too good for too long and that a decade of high economic performance has been due more to good luck than good management.

The impression given by media commentators here is that Australia will continue to do better than most of the Western world. The common view is that Asia in general and China in particular will ensure that the dip in demand for Australia's raw materials will be short-lived.

The government's very low debt levels give it plenty of leeway to run big deficits to offset falls in exports and investment. Its central bank is highly regarded, and though Australian banks have plenty of local bad debt, they have generally avoided the worst of the financial contagion in the West. Debt accumulation here partly reflects strong investment, not just consumption.

All this is true enough, but there is a darker story. Australian household debt relative to the size of the economy is among the highest in the world thanks mainly to a decade of rising property prices. This would not matter too much, given the low level of government debt, if Australians owed the money to one another, as is the case with Japan. But on a per capita basis Australia has quietly become the most heavily indebted major country in the developed world. Net foreign debt now amounts to $650 billion Australian dollars. Some of this is in Australian currency, whose high yield long made it attractive to Asian investors. But half is in foreign currency, so the farther the Australian dollar depreciates - and it is down 30 percent in the past four months - the bigger the burden on local borrowers and financial institutions.

This debt has mostly been accumulated over a decade in which Australia enjoyed an almost unprecedented, 40 percent leap in trade - the relative prices of imports and exports. This was due first to a decline in manufactured imports prices from China and elsewhere in Asia after 1998, and over the past five years to the rise in commodity prices, which peaked in mid-2008. Despite this windfall, Australia has been running an annual current account deficit of 4 to 5 percent of GDP - bigger than that of the United States.

The outlook now is for a commodity price downturn that could last five years, if past cycles are a judge. Meanwhile, Australia must pay more for manufactured goods from Asia, where currencies have been appreciating.

The true horror of Australia's external deficit will become clearer when prices of iron ore, coal and other raw materials negotiated during the boom fall closer to current spot levels, and when tighter global money exposes the cost of servicing foreign liabilities - currently about 4 percent of GDP.

Indeed, although its currency has fallen sharply, Australia can count itself lucky that it has not had the panicky flight seen in South Korea, a country with fewer debts and vastly greater foreign exchange reserves. In the future, Australia may have to decide whether to accept a lower standard of living, or sell more of its mines and farms to China.

For sure, the downturn in commodity prices may be short-lived. China's demand for materials may offset increases in supply. The terms of trade may not fall as fast as they rose. But be sure that it is these external factors, not Rudd's initiatives, that will drive the economy in the medium term.

Meanwhile expect a less confident Australia, dependent on coal for exports and power generation, to lag Europe and the United States in emission reductions.