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SECURITIES
 
WHY I LIKE AUSTRALIAN TREASURIES

(Last updated October 18, 2003 by William Fox)

 

The US economy and dollar are both in very serious trouble. A key question for conservative investors is what foreign currency might provide the best safe haven and a better rate of return on government-guaranteed investments.

For readers who need a refresher on America’s economic and dollar woes, I recommend that they read my article “A Bear Case Overview” which discusses dangerous economic fundamentals and my article “Amidst Bullish Hoopla: A Behind the Curtain Look At Fed Desperation and Intervention Wizardry” which discusses the beginning of a global investment trend out of “paper” (stocks, bonds, and real estate) and into “things” (commodities) reminiscent of the 1970’s stagflationary period. It also discusses the potential for hyperinflation in America. (Shorter versions of both articles that were published in a nationally-distributed newspaper are available in my web site archives section). The Prudent Bear Power Point Presentations are worth reviewing, to include the presentation “Is the Dollar At Risk” which shows how the dollar slide trend is likely to last for many more years. I also like James Puplava’s article “The Golden Bull: Bullish on Things” listed in his Storm Watch update archives.

CNBC interviewed the famous global investor John Templeton on Monday, May 20, 2002. Templeton had warned investors away from US stocks in 1999 and stated words to the effect that: “The other stock markets have been influenced by the great insanity in America, so there aren't any world markets that I think are truly bargains. Therefore, the thing to do is to buy bonds and wait for the time when the psychology of stocks is different. So the thing to do is to buy high-quality bonds in nations where the money is likely to remain valuable, such as Canada or Australia or New Zealand.” Templeton still advocates that US investors avoid US bonds and instead buy Australian, New Zealand, and Canadian bonds in the October 18, 2003 Sarasota, Florida Herald-Tribune story, “Templeton Feeling Bearish: The Legendary Investor Predicts the U.S. dollar Will Lose 40% of its Value.” Templeton stated that he is now more bearish on the US stock market than he has ever been and believes that the dollar will lose 40 percent of its value against foreign currencies in coming months.

CBS Marketwatch columnist Thom Calandra in his Jan 6, 2003 article, “Currencies: Harvesting Yield, Gains,” quotes Chuck Butler, the President of Everbank World Markets and a veteran currency trader. Butler sees the dollar decline extending into 2004. “We’re about half way through this,” he said. According to Calandra, for more than a year Butler has favored the dollars of New Zealand and Australia.

The Australia and New Zealand Bank correctly predicted a rise in the Australian dollar in its September Quarter 2003 “ANZ Economic Snapshot” prepared Sept 5, 2003. It noted that “The A$ [then around .58 $US], has risen by 28% against the US$ since January 2002, mainly as a result of US$ weakness…a large US current account deficit and increasing budget deficit [is likely to] drive a resumption in the US$ decline. This will benefit the A$, which is expected to reach a peak around US $0.70 within six to nine months.”

As of the date of this paper, (18 Oct 2003) the Australian dollar had already moved to .68 $US. But there could be much more upside. Australia’s economy has a strong resource base which would benefit from a global investment trend change from “paper” (stocks, bonds, and real estate) to “things” (commodities) similar to what happened during the stagflationary 1970’s. According to The Economist magazine “In 2000/01 rural and mineral exports (including processed goods) accounted for 65% of total merchandise exports.” According to The Economist’s 2002 profile of the Australian economy, metal ores, minerals & metals comprised 21% of exports. Coal, coke & petroleum comprised 20%, and gold 5% of exports. Add in agriculture to get to 65% of total merchandise exports.

The Australian dollar, along with the Canadian and New Zealand dollars and South African Rand, have historically correlated with global commodity prices. Commodity prices may continue to rise based upon global reflationary trends (similar to the 1970’s) and rising commodity demand in China. The strong correlation between the Australian dollar exchange rate with the US dollar and a global commodities index is graphed in the 1984 to 2002 chart provided on page 25 of “An Introduction to the Australian Economy” prepared in July 2002 by Saul Eslake, Chief Economist for the Australia and New Zealand Banking Group. The chart shows the Australian dollar at .95 $US in 1984, which followed the tail end of the global commodity price surge of the 1970’s. Gold and other commodities have been in a bullish up trend for more than two years. I believe that we are in barely the third inning of a new cycle, and this next go around gold may spike way beyond the $850 an ounce it achieved in 2000. The Australian dollar may achieve a new high against the US dollar.
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Just to get back up to .68 $US, the Australian dollar has rebounded from an extremely depressed position. The Economist magazine’s April 24, 2003 article “The Big Mac Index” observed that “Among rich economies, the most undervalued currency is the Australian dollar. The Aussie dollar is still 31% below PPP (Purchase Power Parity) against its American counterpart; its rise over the past year has been largely offset by a fall in the relative price of burgers in Australia.” For readers unfamiliar with the Big Mac Index and the Purchase Power Parity concept, I would refer them to my web site’s article about foreign fixed income where I explain all of this in some detail. Suffice to say here, over the long run currencies tend to converge back to parity, and The Economist’s Big Mac index has attracted some serious academic attention based upon its demonstrated predictive powers.

THE AUSTRALIAN VERSUS THE U.S. ECONOMY

Generally speaking, the Australian economy is in better shape that the US economy, especially when it comes to the prospects of weathering a financial storm. .

The Australian Government does not share America’s rising debt exposure.

Although the US Government debt is officially over 65% of GDP, it could actually be more than double this amount if off-balance sheet liabilities such as Social Security are factored in (c.f. The Grandfather Economic Report). Total American debt, to include not only government but corporate and personal debt, is now over 3.5 times America’s GDP. Even worse, the U.S. economy is exposed to over $160 trillion (16 times GDP) in unregulated derivatives, which billionaire investor Warren Buffet has referred to as “weapons of mass financial destruction.” In contrast, The Economist lists Australian public debt for 2002 at 18.5% of GDP. Relatively lower debt means the Australian Government is not under significant pressure to hike taxes that could slow the economy down or to issue more debt to help carry current debt to make ends meet. It also means the Australian Government has more reserves to handle a crisis. The US is running out of reserve borrowing capacity, and if foreigners balk at buying any more of its debt, it may be forced to hyperinflate. Currently foreigners buy about 45% of US Treasuries.

Over the last five years Australia’s public debt has been steadily declining and its currency has actually been strengthening while the US dollar has become shakier. According to the Bloomberg.com article “Australian Dollar Rises to Highest Since June 2000” dated Feb 24, 2003, “Standard & Poor's last week raised Australia's foreign currency credit rating one level to AAA, the top ranking, citing four budget deficits in five years and falling foreign debt. Moody's Investors Service raised the nation's foreign currency credit rating to its top-ranked Aaa on Oct. 21. “

The Australian government does not have major open-ended military commitments around the globe.

The Australian Defense Force has had 2,000 personnel in “Operation Falconer” who supported America’s Iraq operation, about 450 Special Forces in Afghanistan, and a lesser commitment in the Solomon Islands. There are no evident plans for major mobilization. Australian Prime Minister John Howard denied a comment by President George Bush that Australia’s military has a “sheriff” role in the Asia-Pacific region.

In contrast, according to the Oct 15-21, 2003 Village Voice article, “Bush’s War Plan Is Scarier Than He’s Saying: The Widening Crusade” by Sydney H. Schanberg, the Bush Administration has signaled a strong interest in not only continuing the occupation of Afghanistan and Iraq, but also in deploying troops in Syria, Iran, Lebanon, Libya, Somalia, and Sudan. In the extended version of my paper “A Bear Case Overview,” I discussed how Larry Lindsay, President Bush’s former economic advisor, low balled an estimate of $200 billion to go to war with Iraq, and suggested that the longer term “tab” for “nation rebuilding” and prolonged occupation for more than five years could exceed a trillion dollars.

Australia has missed the global recession and has shown resilience and steady economic strength.

According to the article: “Down Wonder,” April 4, 2002, The Economist Magazine: “Australia is the lucky country; yet its recent performance is more than a one-year wonder. Over the past ten years, Australia has enjoyed the fastest growth rate of any big developed economy. A series of reforms over the past two decades-from financial deregulation and reduced import barriers to the overhaul of taxes and labour relations-has made the economy much more competitive. Good policy has counted for more than good luck”

I do not mean to paint a picture that the Australian economy is utopian; however, even where it has weaknesses one can make the case that they are significantly “less bad” than comparable weaknesses faced by the U.S. economy and the U.S. dollar. For starters, Australia has experienced longstanding balance of trade deficits that have fluctuated between 2.5% to 5.5% of GDP over the last decade. However, American balance of trade deficits have accelerated beyond 5% of GDP in part due to the fact that manufacturing has declined from 30% of American jobs down to 15%, and American consumers are going out further in debt to buy foreign goods. They are exporting “paper” in return for goods partly because they have declining tangibles to offer, such as manufactured goods. In contrast, 65% of Australia’s exports already consist of natural resource-related tangibles, and jobs and infrastructure in those industries can not be exported overseas. It appears likely that Australia’s balance of trade deficits will not stray beyond the 2.5% to 5.5% band.

Australia has a relatively low personal savings rate in the vicinity of 5%. This makes Australia more reliant on foreign equity capital and debt than if it had a higher savings rate. Net foreign loans are roughly about half of GDP. However, unlike a typical third world country, much of the foreign debt is owed by privately owned companies rather than by the government. The debt appears to be adequately serviceable and secured by economically viable projects. While it would make Australia look economically stronger to have higher savings, low net foreign debt, and trade surpluses, Australia does not seem to be facing a crisis in any of these areas, unlike the United States.

Continuing with the “less bad” line of reasoning, in my web site article about domestic fixed income, I point out that if the free market were to set interest rates, I could see interest rates right now approaching 12-15% in the U.S. I derived this estimate by taking the five year average average annual money supply (M3) growth rate of 10%, deducting 2% for productivity growth, and then adding a 3% historical real rate of return premium. I added another 2% to compensate for the additional riskiness of buying US government debt since the U.S. is doing nothing serious to avert a very real trend towards bankruptcy.

Since the US has been the major global economic locomotive since World War I, and the dollar has acted as the global reserve currency, other countries feel they have to dance to America’s tune. So when the Fed lowers its funds rates to 1%, the European central bank, Australian Reserve Bank, and other central banks have felt that they need to lower rates as well. However, the Australian Reserve Bank raised its cash rate .25% back up to 4.75% in June 2002 and stopped lowering further for fear they would overly stimulate money and credit inflation. With lower interest rates, Australia has experienced a boom in personal consumption and housing prices much like in the U.S. Since the Australian economy remains relatively robust, the Australian Reserve Bank has not seen a need to drop to 1%. The spread of over 3% hence reflects a healthier economy, not a sicker one. This anomaly stands in contrast to various Latin economies such as Brazil and Argentina that have historically had higher interest rates because their economies were in worse shape than America’s.

From the Reserve Bank of Australia monetary aggregate numbers, I have computed the following trailing five year data: Aug 2003 over Jan 2003, 5.7% Year to date, which is 8.5% annualized. Jan 2003 over Jan 2002 (2002 growth), 7.2%, 2001: 14.2%, 2000: 5.4%, 2000: 9.5%, 1999: 8.2%. The average growth: 10.6%, which is in line with U.S. M3 growth during the same period. However, according to The Economist, economic growth has averaged about 4%, which suggests about 6% real inflation. The Australian government has reported inflation more in the 3% range. But then again, so has the U.S. Government. Ace global investor Jim Rogers has a few comments about government inflation figures in his archived article “They Are Lying to us Again” at his web site www.jimrogers.com.

Most major countries around the world have been debauching their currencies in line with the U.S., such as Switzerland, China, and Japan. Normally currency debauchment reflects a lack of financial discipline on the home front. But the Australians, Swiss, Chinese and Japanese are not exactly undisciplined peoples. A more likely explanation is that they are playing a game of “follow the leader” (also known as “beggar thy neighbor”) with the U.S. to keep their exports more competitive by preventing their currencies from rising too much against the dollar. The “leader” who they are following is running balance of trade deficits over 6% of GDP, has lost half its manufacturing base over the last thirty years, has very little savings, and has record indebtedness relative to GDP. As the U.S. accelerates its production of “paper” in increasingly desperate efforts to handle increasing indebtedness and pay for trade deficits, we are likely to see a continued global bull market in commodities that benefits from global money supply inflation.

For any readers who want more background, please refer to my web site article “Other Experts: Learning the Score,” David Tice’s archived articles at www.prudentbear.com, James Puplava’s storm watch update archives at www.financialsense.com, and the Grandfather Economic Report. These sources help to explain the paradox in which we can simultaneously see pockets of both inflation and deflation on many different levels, such as increasing inflation in money stock created by central banks to try to arrest deflation in overly inflated asset prices in stocks, bonds, and real estate. We see a steady rise in consumer nondurable prices while we simultaneously see a loss in pricing power from outsourcing to low cost third world countries such as China and India.

As mentioned in my web site’s foreign fixed income article, investing in foreign denominated fixed income is a relativity game. As long as Australian economic policy stays relatively more conservative than the US, and we see a continued global shift away from “paper” and towards “things,” the American investor in Australian Treasuries should come out ahead in the long run.

 

Links:

A Victoria Teachers Assoc. listing of Australian Economic Sources; see also Australian Economic Current Affairs.

Australia New Zealand Bank ANZ Economic Snapshot

Free graphical displays of foreign exchange rates around the world by Oanda.

Economist Magazine country briefings:
After selecting country, click on left “In this country” toolbar for “economic data.” Figures on current account balance (balance of trade deficit) and public debt as % of GDP provide clues about whether or not stress building for a currency devaluation fault shift.

International Monetary Fund Country Information. Provides links to country central banks that typically provide money supply growth data.

The World Bank Group Countries & Regions

Central Intelligence Agency World Fact Book country profiles.

Australia: Reserve Bank of Australia monetary aggregates; 2,5, and 10 year treasury bond yields updated monthly

 



 

 
     

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© Text and web design by William Fox. Sometimes William Fox offers viewpoints that are not necessarily his own to provide additional perspectives.