Advance Australia Fair?

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Last year has fulfilled general expectations for the Australian Dollar and economy and for the global economy.

Although the Australian Dollar – high against the US Dollar – slightly exceeded expectations, our limited hopes back in January have been almost exactly met.

So, what exactly did we expect in 2011? Overall a continued battle between risk-on and risk-off, with the start of the year still driven by the positive momentum of QE2, driving global risk asset markets higher, supporting commodity prices and weakening the US Dollar. All three of these factors are supportive of the Australian economy, Australian equity markets (which are now dominated by resources and the banking sector to an unprecedented extent) and the Australian Dollar.

However, the events of Q3 last year (which had really started to surface almost six months earlier) showed us that what the carry trade gives it can also take away. The sharp snap back below parity was a stark warning of what can happen to the AUD when the problems that have dogged the global economy for over a decade finally flare up in a way that short term measures can no longer smooth over. This should be seen as a warning shot with downside risks of the Aussie sliding below 65 cents in extremis (although the jury is split as to whether that’s more likely in 2012 or 2013).

Further US and European QE and interest rate manipulation, such as the Fed’s much vaunted ‘twist’, undoubtedly bought more time, delaying the grim days of reckoning, whilst making the ultimate problems more severe. 2012 still seems the likeliest ‘red alert year’, although noted economist, Professor Nouriel Roubini, believes that the central bank masters of the universe can buy another year before reality bites.

The challenges facing the global economy largely stem from the inefficient allocation of resources and wealth across developed economies as a whole over the last three to four decades. This created the unprecedented debt bubble that hangs like a dark cloud over the global economy from America to Zimbabwe.

The most widely read economic book of 2010 was 800 years of debt, why this time will be different by Reinhart and Rogoff. It mainly concludes that this time will not be different – the bursting of the European, US, UK and Japanese debt bubbles will inevitably lead to severe global depression from which there will be few if any places to hide. The expectation is that debt crisis 2012-13 style will initially see the following result:

• A global depression

• A collapse of global equity and property markets

• A liquidity crisis

• A flight to US Dollar and US T-bills

A second phase of the crisis is likely to see the decoupling of economies like ASEAN which has low levels of external debt and healthy balance sheets as a result of the post-1997 period of adjustment.

The gorilla in the room remains China whose politicians have yet to decide how to handle the imminent slowdown. Will they take pain on the chin and encourage a period of adjustment as a pre-cursor to further growth? Or will China’s politicians copy Western mistakes of ‘extending and pretending’ putting off the inevitable but making it much worse in the process.

China, the last driver of global growth, holds all the aces in this round table discussion. What we expect with a reasonable degree of certainty is that the onset of crisis will provoke the fall in AUD, referred to earlier and a sharp correction in the ASX, where a ‘three handle’ seems inevitable. We thought we could have got there in the last couple of weeks of 2011. Any global slowdown will seriously depress commodity prices, further squeezing the Australian currency and economy.

A sustained correction in Australian property prices – now the singly most overvalued property market – will take place over several years. Although the severity will vary from region to region we expect WA along with the Gold and Sunshine coasts to be the worst affected. Residential properties could ultimately see falls exceeding 30 percent.

Australian currency, property and equity markets might not revisit recent highs again for many, many years. This is not a typical, cyclical event – the global economy, the Australian economy and global and Australian equity and currency markets are undergoing a seismic shift that has been coming down the line for over a decade. It has been looming larger and closer since the credit crunch and Global Financial Crisis but it is now inevitable.

The only real questions are how quickly will each part of the world recover and what will the world look like afterwards? China’s longer term growth potential remains the key to Australia’s bright, long term future but for the next few years the lucky country’s resources-dominated equity market, overheated housing market and carry-dependent currency appear to offer meagre rewards in return for a risk element that goes off the scale.

Expat Aussies with a range of international currency, investment and deposit choices can position themselves very nicely to make the most of the opportunities that will inevitably arise from such dislocations much more easily than the countrymen that they have left behind back home. Expect periods when the best results come from staying well away from Australia’s equity and property markets, holding very little more than an emergency reserve in AUD and working in the faster recovering, less indebted markets of South East Asia.

Aussies who can do that might turn out to the really lucky ones! Advance Australia? If it can stop still they will have done well.

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]