Is Australia suffering from Dutch Disease?

Dutch disease

In 1959, the Netherlands discovered a significant natural gas field, and the subsequent focus on exploiting the resource resulted in a decline in sectors such as manufacturing leading to a new term being coined in 1977: Dutch Disease. In a case of Dutch Disease, there is usually a booming sector such as, for example, oil or the mining of gold and copper, and a lagging sector, such as manufacture or perhaps agriculture.

Production (and labour) can shift towards the new resources industry and the extra revenue the resources boom brings shifts in spending patterns.

Dr. Lowe of the Reserve Bank of Australia has argued that Australia is "unlikely" to suffer from Dutch Disease, instead seeing the mining construction boom as part of a "structural adjustment" 

"The process of development in Asia is going to take many decades, and Australia has to supply the resource needs to Asia for a number of decades.

"If that is the case, the economy has to go through some structural adjustment, and my sense is that we're not losing the skills that will make us competitive in the medium term."

There would be plenty who disagree strongly with that view.

Higher dollar

One of the problems facing Australia has been that our relatively higher interest rates and perceived 'safe-haven' status, has led to us having a significantly stronger dollar in recent years, which has made the going very tough for some exporting industries. Lowe again:

"The effects of the high exchange rate are evident in the manufacturing, tourism and education sectors, as well as some parts of the agriculture sector and, more recently, in some business services sectors," he said.

"In some cases, this is prompting renewed investment to improve firms' international competitiveness.

"But in other cases, businesses are scaling back their operations in Australia and some are closing down."

The good news is that the dollar hit new 12 month lows today, falling to just 88.9 cents as interest rates have been lowered and the mining construction boom begins to unwind.

Reality

Australia's economy has benefited from the mining construction boom while other industries have suffered to some extent, and this is likely to be an ongoing theme.

In keeping with the theory of competitive advantage, the reality is that with China in the midst of an unprecedented construction boom, Australia is going to be looking to its resources exports as a key cornerstone of the economy in the years to come.

If you include both mining and 'mining-related' economy, that comprises around a fifth of Australia's GDP (services is by far and away the largest sector as you might expect in a developed country), so in reality there is a heavy reliance on our mining industry transitioning from construction to production.

For this reason, Australia will place a lot of emphasis on the health or otherwise of the index of commodity prices, which fell 1.5% in July after falling by a revised 3.9% in June, with falls in the prices of coal and gold to some extent offset by an increase in the iron ore price.

Sadly, the index is back to levels last seen in 2010.

However, the falling Australian dollar means that the index in Australian dollar terms increased in July and sits at a 12 month high, which is more heartening news.

Key themes

I write about all manner of subjects on this blog, but a lot of them fall under just three broad headings.

1 - Property trends

After the great leveraging up of Australian households between 1990 and 2005, a number of Australian property markets will experience severe headwinds going forward (especially in a large number of the regional markets), and some of them may experience severe declines when the next downturn hits. 

On the flip side, in the popular suburbs of Sydney close to the CBD and amenities (i.e. where people actually want to live) construction of appropriate dwellings will fail to keep pace with the massively booming demand and I have always argued strongly that the widely-touted price crash c.2008 was unrealistic in these market sectors. Prices in Sydney's 'broad middle market' have jumped way past previous highs and I expect them to continue increasing in coming months.

Similarly, while UK property has been through a very weak five years, I've suggested that if you were invested in London or key hubs of the south-east of England, prices would not be impacted unduly and a massive housing shortage in the pipeline will likely push price on to all-time highs there too. And, in fact, that has already happened.

In these days of higher household leverage, real estate can be a risky asset class if you adopt the approach of chasing yields and looking for new regional 'hotspots', and personally I stick to suburbs with key transport hubs and do not venture outside Sydney's inner 5-6km ring (or towns and cities within easy commuting distance of the city of London). Far less risk over the longer term.

2 - Stock market success

Stock markets will continue to be irrational beasts, in some cases being impacted by monetary stimulus being pumped in and then withdrawn. 

Contrary to popular belief, the strongest performing Australian stocks over the long haul are unlikely to be those in resources (or property trusts): history shows that resources companies operate in a capital-intensive industry and pay weaker dividends, particularly in market downturns. 

For most investors, a superior approach is likely to be to continue to contribute regularly in to a well-established low-cost diversified LIC which has a strong focus on industrial and financial stocks. The exporting industrials with US dollar-denominated exposure will in particular be firing at the moment. When the market is cheap and 'on sale', buy more. 

3 - No Australian recession

This third theme is the one which is generating a lot of debate at the moment. My position has always been that Australia has had a lot of ammunition in its relatively higher interest rates, and as the mining construction boom unwinds the RBA would be able to drop interest rates leading to a lower Australian dollar while simulataneously stimulating other sectors of the economy.

While a downturn in the economy was perhaps at some point inevitable and some risk of a recession always exists, I have felt that the risk was relatively low and Australian growth will continue at a slower pace before rebounding. 

This debate is still very much a live one...watch this space!