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Oz a ‘time bomb waiting to blow’

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TOKYO — Australia has been called many things: Oz; the land Down Under; the lucky country. But the equivalent of a collateralized-debt obligation?

Canberra can’t be happy to hear its AAA-rated economy likened to one of the reviled investment vehicles that blew up amid the 2008 global crisis. Yet the comparison is being made by some economists, who see the asset underlying Australia — demand from China — beginning to evaporate. No country is more vulnerable to the much-dreaded slowdown in China than resource- rich Australia. The mining boom that fueled nearly all of its recent growth is nearing a cliff of economic risk.

"Australia is a leveraged time bomb waiting to blow," says Albert Edwards, Societe Generale’s London-based global strategist. "It is not just a CDO, but a CDO squared. All we have in Australia is, at its simplest, a credit bubble built upon a commodity boom dependent for its sustenance on an even greater credit bubble in China."

There’s a bit of hyperbole in this view. But highly-advanced Australia is about to pay the price for growing so addicted to a developing nation. Exporting natural resources led to the neglect and atrophying of other critical sectors. It’s created a two-speed economy: The commodities-rich western states and Queensland raced ahead on China’s once insatiable demand for metals, while the rest of the country lagged behind. Now, even as mining giants BHP Billiton and Rio Tinto continue to ramp up production, the price for Western Australia’s iron ore has fallen to $115 per ton — a far cry from the $180 paid by Chinese steel mills when the Australian dollar was touching highs of $1.10.

Now that the easy China-driven growth is drying up, how are officials in Canberra responding? With a maudlin and distracting political soap opera. On Wednesday, the ruling Labour party ousted the unpopular Julia Gillard as prime minister. Her replacement, Kevin Rudd, is the same unpopular lawmaker Gillard ejected from the job in 2010. Treasurer Wayne Swan, frenemies with Rudd, quit. The ill-timed game of musical chairs has Australians and outside observers wondering what these last three years were about. Rudd’s comeback probably won’t stop opposition leader Tony Abbott from winning an election scheduled for September.

Personalities aren’t Australia’s problem; policies are. Whoever is in power needs to focus intensely on increasing investments in infrastructure, education and training. They need to revamp a high-tax system that encourages all too many of the workforce’s best, brightest and most productive people to seek opportunities abroad. Officials in Canberra must think creatively about spreading the benefits of the vast wealth being amassed by mining companies. Rudd lost his post three years ago in part because of his proposed "super tax" on their profits; Abbott might well want to revive the idea.

Australia matters because it’s in the vanguard of nations, rich and poor, who are grappling with how to adjust to a slowing China. As Chinese officials act to restrain runaway credit growth and rebalance the economy away from overinvestment and exports, China’s growth is likely to be closer to five per cent than 10 per cent. This year’s 28 per cent tumble in iron ore prices since February is a harbinger of pain to come. So is the 11 per cent drop in the Australian dollar this quarter alone.

The shockwaves caused by even modest attempts by China’s central bank to clamp down on credit show how profoundly this downshift will affect the globe. It will result in slower growth from Japan to Brazil and slam industries like autos, chemicals, heavy manufacturing, energy and steel. If China needs to dump some of its $1.3 trillion of U.S. Treasuries to bail out state-owned banks, markets everywhere will quake.

Australia is a microcosm of what awaits the world. How officials respond will offer clues to policy makers everywhere.

The key for Australia is to return to the liberalizing instincts of the 1980s and 1990s, when there was no behemoth gobbling up resources at record prices. Opportunities for transitioning back to a non-mining economy abound. Boosting funding for research and development will create high-paying jobs in technology, science and education. Australia boasts great exporting potential in agriculture, medical supplies and high-end machinery.

But progress in any of these sectors will require a level of political will and forward thinking that’s been lacking for nearly 20 years.

"Our worry is that tourism, manufacturing and other trade-exposed sectors haven’t been investing for years now, having been brow-beaten by the unrelenting strength of the currency and the diversion of resources into the mining sector," says Ray Attrill, a currency strategist at National Australia Bank Ltd. in Sydney. "So it’s not obvious these sectors are in a position to quickly plug the hole from which the hissing sound of a deflating commodity bubble is emanating."

There will be a premium on policy flexibility. Nimbleness is everything. That means taking an even bigger step away from the budget surpluses of the last decade and increasing fiscal stimulus. For Reserve Bank of Australia Governor Glenn Stevens, it means adopting a less-dogmatic attitude toward inflation trends. A Chinese swoon, after all, will be a deflationary event globally.

Australia should indeed sell all the underground treasures it can to fast-growing developing nations. But in the long run, it’s more important for the country to cultivate what’s above ground. Australia’s future lies in ideas, innovation and the ingenuity of its 23 million people — not in a China that’s ripe for a crash.

 

William Pesek is a Bloomberg View columnist.

 

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