The paper, “Australia, the lucky country (or is it?): How sectoral balances point to a lower Australian dollar and interest rates”, outlines how Australian households are bearing the brunt of the Government’s determination to eliminate its deficit, with potentially serious consequences for Australia’s economic outlook.
Chris Bedingfield, author of the paper and Portfolio Manager at Quay Global Investors (Quay), says the commonly held view is that Australia’s luck just never seems to run out, but Quay is not confident this is the case.
“Many commentators believe the country’s 26-year economic run with no recession is showing no signs of ending any time soon. Consequently, the Australian dollar and bond yields are rising, and the widely-held expectation is that the next interest rate move will be up.
“At Quay, we are not so optimistic. Indeed, we believe interest rates will ultimately move significantly lower,” he says.
The paper outlines the relationship between private domestic savings, the fiscal budget and foreign savings (that is, the current account), and what this means for Australia’s economic outlook.
It says that with the mining capex cycle having ended in 2012 and the Federal Government determined to minimise the fiscal deficit, it has fallen to households to step up by running a deficit.
“In a world where politicians in Canberra are terrified of credit ratings agencies opining on our fiscal outlook, government deficits are not increasing any time soon. And while foreigners continue to net save, households will eventually crack under the weight of debt.
“Today policy makers and commentators are aware of the economic risks associated with excessive household debt, but often wrongly blame a housing boom as the culprit. As a result, APRA and the RBA are trying to place limits on household credit, without realising the increase in household credit has been the main driver of economic performance since 2012.
“The reality is that household debt is too high because government debt is too low. And we are fast approaching our limit on household debt because interest rates can’t get much lower.”
The paper says so long as the government seeks to balance the budget, one (or both) of the following scenarios is all but inevitable:
- the RBA continues to drop interest rates so the non-government domestic sector can increase credit and debt; and/or
- the foreign sector demand for AUD savings diminishes, resulting in a sharp drop in the Australian dollar to create a sustainable trade and current account surplus.
Quay has long held the view that Australian interest rates are eventually heading to zero, but the paper questions: what happens after that?
“When households are no longer willing or able to take on more leverage and the Government maintains a policy of achieving a balanced budget, the only moving part remaining is the foreign sector reducing its appetite to save in Australian dollars. In order for this to occur, Australia needs to run large sustained trade surpluses. It is almost certain this will require a significantly lower Australian dollar.
“As a result, interest rates will likely be lower for longer?not only in Australia, but around the world where private debt levels are high. History will show Japan is not the exception?it’s the rule.
“By the time Australia hits ZIRP (zero interest rate policy), the only moving part in the sectoral balances will be the Australian dollar, which will almost certainly be lower. This may not happen soon, but based on the laws of the sectoral balances there is almost no other outcome over the long term (outside a significant government fiscal response).”
The Government may eventually change its stance, but unless it acts soon, it may come too late, the paper concludes.