Australia's economy: The Murphy's Law forecast for 2017

Updated

Australia's economy has benefitted from a tremendous amount of luck in posting a quarter of a century of unbroken growth.

Through a combination of good management and fortuitous timing, and arguably more of the latter, Australia narrowly dodged the full effects of the Asian financial crisis, the dot-com bust and, the mother of them all, the global financial crisis.

But what if our luck is about to run out?

What if, like the Irish after their Celtic Tiger boom, local excesses conspire with global factors to generate a once in a generation, or even once in a lifetime, bust?

What if Murphy's Law — that anything that can go wrong will go wrong — finally catches up with Australia?

There's certainly a lot that can go wrong with the Australian economy next year, and it's unlikely that most of it will go wrong all at once, but what if it did?

This is the uber-bear, Murphy's Law guide to Australia's economy in 2017, starting with the major risks and ending with what might happen if they all occur later this year.

Risk 1: Car industry shutdown

Ford's manufacturing shut down late last year saw around 600 jobs lost, with unions estimating as many as seven staff are employed in related components firms for every one working directly for the auto maker.

Holden and Toyota will follow Ford's exit later this year, with automotive industry groups estimating that 40,000 jobs could be lost across the sector as a result of the closures.

Australia's unemployment rate is already stubbornly high at 5.7 per cent (around a percentage point above the US) and if none of those 40,000 auto-related workers found new jobs it would rise back above 6 per cent.

Even more worrying is the underemployment rate.

Around 8.5 per cent of the workforce are employed but not getting as many hours as they want or need.

There are now far more underemployed Australians than there were during the early-1990s recession, although unemployment was around twice as high back then.

The risk is the auto industry shutdown adds considerably to both unemployment and underemployment, as well-paid full-time manufacturing jobs are replaced with lower paid, part-time and casual service sector work.

Risk 2: Mining investment bust continues

The same risk of rising unemployment and underemployment applies to mining investment.

The Reserve Bank recently estimated that at least three-quarters of the decline in mining-related construction work has passed.

But well-respected private economic consultancy BIS Shrapnel reckons Australia is only about halfway through the resources investment downturn.

The difference in estimates is worth tens of billions of dollars and tens of thousands of jobs.

Mining-related construction generates far more employment than the projects do when they are up and running, often at rates of 10 or 20 to one.

Risk 3: Commodity price snap back

The other key commodity-related risk is that the resources price rally of 2016 snaps back to the reality of an oversupplied world with tepid demand.

That was already happening in earnest with coal prices in late-2016 as China looked to rein in both commodity and property speculation (less construction = less steel demand = less need for coking coal and iron ore).

While the Reserve Bank doesn't expect commodity prices to remain where they are now, it isn't expecting them to fall back to the lows seen in early 2016 either.

Australia's terms of trade (prices of exports versus imports) and national income are highly dependent on these prices and a decline would see renewed downward pressure on profits, wages and government revenue.

Risk 4: Property price fall

I have been banging on about this for years and it hasn't happened. But that doesn't mean it won't.

In this article from late 2016 about why Gen Y should consider waiting before buying a home, I explained how expensive Australian housing is relative to history and the rest of the world.

And in this piece from 2015, I tore apart bank arguments as to why Australian property wasn't in a bubble.

If you haven't read them, suffice it to say that homes in Sydney and Melbourne in particular have never been more expensive on pretty much any measure, including relative to incomes or rents.

Moreover, even if there was a housing supply shortage in these cities that resulted in inflated prices (and I think there is strong evidence there wasn't) there definitely won't be by the end of 2017, in fact it is far more likely to be a glut.

With banks likely to be under even more pressure to uphold higher lending standards and global interest rates on the rise, plus new taxes on foreign buyers and a Chinese crackdown on money leaving the country, 2017 is likely to see a definitive decline in investor demand.

Declining demand, increasing supply and an already expensive product sounds like a pretty good recipe for prices to start falling at some point later this year, which is certainly what many analysts expect.

And if you think Australian property prices never fall, just ask someone in Perth or Darwin, or one of the regional towns or cities in a mining area.

Risk 5: Construction boom peaks

Over the past few years Australia has embarked on the most epic apartment building boom in the nation's history.

Barring permanently high and increasing levels of immigration, such a boom must inevitably come to an end when the nation has more than enough dwellings for its population.

It will come to an end even more abruptly if property prices start falling, sending many developers to the wall.

With the construction industry accounting for almost 10 per cent of employment, not to mention hundreds of thousands of extra jobs in the broader real estate sector, this is another huge economic risk facing Australia this year or next.

Investment bank Morgan Stanley has predicted that 200,000 jobs could be lost as the building boom rolls over into bust — that could drive unemployment up to 6.5 per cent.

Risk 6: AAA lost

The Federal Government's AAA credit rating survived its pre-Christmas Mid-Year Economic and Fiscal Outlook (MYEFO), but is unlikely to last past the May budget.

Many analysts now see it as a matter simply of when, not if, Australia is stripped of its AAA rating by Standard & Poor's.

While this won't matter much for the Government's finances — possibly adding a few hundred million dollars a year onto interest costs, possibly not — it may cause other problems.

Firstly, it is indicative of the Federal Government's increasingly limited capacity to respond to economic challenges with increased spending, assuming it had the will to do so anyway.

Secondly, it could undermine international confidence in the Australian economic narrative, seeing money pour out of a country that relies heavily on foreign funding of its businesses, houses and large trade deficit.

Thirdly, it will see the cost of offshore funding rise for Australia's banks, probably by much more than it will for the Government, because their credit ratings will be automatically downgraded with the sovereign.

Risk 7: Australian banking crisis

The combination of a property and construction bust with the possibility of lower credit ratings for the major banks raises the risk of a local financial meltdown — think Ireland in 2008/09.

Australia has had the good fortune that its banks and their regulators received the wake-up call of the financial crisis, resulting in some tighter lending regulation and bank capital rules.

However, while the worst excesses in home lending have been curtailed — think sub-15 per cent mortgage risk weightings — there is still evidence that local banks are far from conservative in personal lending and that many home loans may be going to people who shouldn't be getting them.

Australia's major banks are around 60 per cent reliant on home lending, making them almost uniquely vulnerable amongst banks globally to a severe real estate downturn.

The big four are also quite reliant on overseas funding, making them vulnerable to foreign financial crises that result in credit markets drying up.

The federal government saved them from this reliance by guaranteeing much of their debt during the GFC, but will it be willing and able to do the same again as its own financial position deteriorates?

Risk 8: China slowdown

An ever-present risk for Australia is the economic health of its dominant trading partner.

China's private debt is up there with Australia's as one of the world's highest, with its loosely regulated "shadow banking" sector seen as a key risk for financial crises.

Beyond a full-scale financial meltdown, there are indications the Chinese Government is planning to renew its economic shift away from heavy industry and construction towards services.

Last year, China boosted commodity prices through increasing infrastructure spending and relaxing restrictions on real estate investment, as well as cutting its own coal production.

Even moderate moves to limit growth in those sectors, plus a return to higher Chinese coal output, could see much of last year's commodity price gains unwind and, along with them, the boost to Australia's national income.

Risk 9: The Trump factor

All the positive share market sentiment around Donald Trump after his shock victory in the US presidential election completely ignores the risks of his policy platform — which is a risk in itself.

If Mr Trump fails to live up to his stimulus promises, the US share market could suffer, with global fallout.

On the other hand, if Mr Trump does fulfil his commitment to build infrastructure, the stimulus to the US economy could see the Federal Reserve raise interest rates more quickly than expected.

That will cause unease in developing markets as money floods back to the US, and will also increase the cost of debt, much of which is denominated in greenbacks.

The rising US dollar and interest rates could also undermine the very economic recovery that is prompting them higher.

That's not to mention the fallout if Mr Trump carries out his promises to roll back various free trade agreements and effectively imposes new tariffs on many major trading partners.

Risk 10: European disintegration

Britain's decision to leave the European Union was the shock of 2016, until Mr Trump won his spot in the White House.

This year the attention will shift to France and Germany, which have key elections.

In France, euro-sceptic right-wing candidate Marine Le Pen looks like a realistic prospect of victory.

In Germany, Chancellor Angela Merkel is also under increasing pressure due to her policies welcoming a large number of refugees from the Syrian conflict.

Italy already lost a prime minister in 2016 after his constitutional referendum was rejected, and there is every chance it will go to elections this year, instead of the scheduled 2018 polls.

If any of Italy, France or Germany fall to an anti-EU party and pull out of the common currency, it is highly likely the whole union will fall apart.

That will make the Greek debt crisis look like a tiny sideshow.

The doomsday scenario

While unlikely, it is possible that one or more of these international risks will become reality at the same time as a number of the domestic risks are realised.

Imagine, as tens of thousands more jobs are shed from the mining and automotive sectors (as we know will happen), that 200,000 workers start drifting out of residential construction and related industries.

Unemployment passes 6.5 per cent, heading for 7, as underemployment climbs to fresh records.

As many home owners and 'mum and dad' property investors lose work, they are forced to put their real estate on the market.

At the same time, late 2017 sees developers desperate to offload tens of thousands of new apartments that have just been completed, but where the off-the-plan buyers have dropped out.

Property prices start falling, sending some developers broke (with more job losses) and pushing many recent buyers into negative equity, forced sales and bankruptcy.

The growing property market collapse severely dents bank balance sheets with rapidly rising bad debts just months after their credit ratings had already been downgraded along with the Federal Government. Funding costs rise, pushing mortgage rates up in spite of Reserve Bank interest rate cuts, leading to even more defaults.

Just as Australia's real estate-driven domestic economy is teetering, Chinese authorities engineer a slowdown in property speculation and allow several loss-making state-owned enterprises to go under.

These moves spark several large shadow banks to collapse, leading to financial panic.

Several other large Chinese businesses and financial institutions fall over under the weight of rising US dollar denominated debt repayments, while other emerging markets are hit by capital outflows back to the USA.

At the same time, Marine Le Pen wins the French presidential election, sparking financial jitters in Europe as traders prepare for a "Frexit", while populist and anti-EU parties also perform strongly in the German and Italian polls.

Global credit markets start drying up and Australian banks find their borrowing rates surging as already jittery global investors take note of the emerging Australian housing market downturn that many have long feared.

The banks are forced to further raise interest rates and curtail home lending, again exacerbating the housing market downturn.

Rising bad debts force the banks into heavily discounted capital raisings which, in some cases, are still under-subscribed.

The Federal Government steps in to inject capital into two of the big four, which prompts a further downgrade in its credit rating.

Australia posts a quarter of economic contraction in September 2017 and another in the December quarter, as unemployment passes 7 per cent and continues to rise fast.

The country is in both a technical and real recession, ending more than a quarter of a century without one, and with no sign of recovery in 2018.

Most likely this exact scenario won't happen this year and Australia will keep muddling through with below par economic growth and weak employment and wages outcomes.

But the fact that it is even plausible highlights how fragile the nation's economy has become.

Topics: economic-trends, money-and-monetary-policy, housing-industry, mining-industry, building-and-construction, australia

First posted