Last week we skeptically wrote of the “breakthrough” deal the IMF achieved for Greece with its international creditors; that is to pretend Greece can stave off bankruptcy and extend a further €10.3bn bailout. Bear in mind that with over €320bn public indebtedness and a required yield of 7% on Greek 10 year debt the new bailout funds are just about enough to cover 6 months of interest payments. So all those involved will be hoping for a similar deal again before November this year (and then again in May and November 2017…).
One man no longer directly involved with the can kicking of Greece’s debt negotiations is Yanis Varoufakis who was himself kicked from the negotiating table almost a year ago. “The emerging rock star of Europe’s anti-austerity uprising” (Telegraph) has since become an increasingly influential figure in policy reform and libertarian thinking. Although his recent book (And the Weak Suffer What They Must?) received mixed reviews it gives a, perhaps “tendentious”, perspective on the deeper historical roots of the ongoing European debt crisis and why it will continue to be so difficult to resolve. We doubt his thesis will have much influence in the entrenched Eurozone but his untangling of the underlying causes of the crisis carry some relevance and to other countries with growing debts - as well as their respective creditors.
In a recent interview, Mr Varoufakis highlighted one particular country that has a similarly systemic debt problem to Greece which has yet to be taken seriously; the symptoms however present themselves differently. We also recently wrote about this country which, “runs twin deficits and since 2009 debt to GDP has risen faster than any of the other AAA sovereign credit” and “relies on some generous economic growth and commodity price estimates to bolster the tax revenue line.”
Obviously the country in point is Australia. But what debt problems does it have that are as noticeable as Greece’s were when it’s gross government debt to GDP is 34.5% (compared to the 42.8% average for AAA rated countries)? Varoufakis (who lived in Australia for 12 years) clarifies that ,unlike Greece, “Australia does not have a public debt problem, it has a private debt problem.” This is why public debt figures alone are not a useful indicator for assessing a country’s creditworthiness. At Stratton Street we take a Net Foreign Asset approach which, for example, would have excluded Greece as an investment since 2002 - shortly after it joined the Euro and was lured into excessively cheap (at the time) financing. After surpassing Net Foreign Liabilities of 50% of GDP in 2002 to then surpassing 100% in 2007, anyone who was looking at Greece as a whole could clearly see that there was a problem. So is anyone looking at Australia?
Despite volatility in the Australian dollar and ASX 200, the country remains AAA rated by all 3 major rating agencies with Moody’s citing “a record of strong growth… and low public debt ratios”. But these are only part of the picture. Excessive private debt and habits are just as hard to kick as public debts and the average Aussie has been living beyond their means for over five decades. They continue to do so despite average household debts this year exceeding 125% of GDP making them the most heavily indebted in the world.
Such an achievement that has taken this long to accomplish will take a similar spans of time to unwind; but a shock or a burst of this credit bubble could come very quickly when such an inversion begins. The country needs to be creating value and supporting industries but instead has made a number of recent “major errors” according to Varoufakis citing recent failed subsidy negotiations that saw Holden and Toyota exit from car manufacturing in Australia along with 200,000 jobs.“Once you lose this capacity to manufacture you can’t get it back,” he says. “It took centuries to develop it.” Furthermore, “When this flow of capital from China to Australia severs, or comes to a natural end, the crash is going to be much much bigger and the foundations of the society - which are the sectors that produce stuff - are going to be much weaker.”
For Australia at AAA it’s 10-year government bonds yielding 2.3% may seem attractive to some; but when one accommodates for the real risk factors including its unsustainable Net Foreign Liabilities - driven by the private sector and undergoing increasing pressure from shrunken commodity profits and investment - such a rating seems dislocated from the real risks on a forward looking basis and the returns available are far from sufficient to compensate for such a fattening of tail risk. Recent history tells us (e.g. in US, Iceland and Ireland) that in such crises household debt can quickly become corporate financial losses which in turn may be inefficiently absorbed by a Government in an attempt to stabilize the situation. Such could be the scenario in Australia and thus one should factor for potential liabilities in tandem with its comparatively healthy (though deteriorating) public finances and economic environment.