China Invests 50 Billion in Australian Gas Project

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Does the surge of Asian and especially Chinese interest mean a new source of strength for the Aussie dollar? Robert Gottliebsen thinks so. He made an interesting point yesterday over at Business Spectator. He wrote that, "The Chinese now know that they can invest in Australia and not face a serious currency risk. We are going to see them buy property in the eastern states and they will support our debt markets on a much larger scale."

--He added that, "There is enormous concern in China about the US currency and the fact that there could be huge losses ahead for China if the American dollar falls...HSBC research shows that China does not face that risk in Australia. Global investors who want to invest in China can do so via Australia with far less risk. Accordingly, our share market is set to follow China."

--He may be right. It's certainly true that trading U.S. dollars for Australian real assets (be it LNG, coal, iron ore, or real estate on the east coast) is probably a good trade for China. It has several trillion in foreign currency reserves, the bulk of which are denominated in U.S. dollars. There are going to be heaps more dollars printed in the coming years, given the reluctance of the U.S. government to either increase taxes or reduce spending in order to tame its deficits. Inflation is the way out.

--Here in Australia, that apparently means more debt is acceptable. Treasury secretary Ken Henry says that because of Australia's privileged position relative to the China boom, the country can run higher current account deficits without having to worry about a run on the dollar. Henry has said Australia "might attract an even greater share of global capital flows, and quite possibly even larger capital flows in aggregate."

--Because the Aussie dollar is not the U.S. dollar, let us add more debt!

--There are many factors that might make Australia a desirable place for foreign capital. It has a stable political system, a fairly sensible regulatory framework, a commodity currency, and a whole lot of beach front property. But we'd be wary of using that as an excuse to run higher current account deficits, importing more than you export. It's a bad habit to get into. Just ask Warren Buffett.

--Buffett wrote an op-ed in the New York Times pointing out that America's Federal deficit of $1.8 trillion is not just 13% of GDP. It's "unchartered territory." "Because of this gigantic deficit," he wrote, "our country's 'net debt' (that is, the amount held publicly) is mushrooming. During this fiscal year, it will increase more than one percentage point per month, climbing to about 56 percent of G.D.P. from 41 percent."

--Australia's net debt, by the way, is around 56% of Aussie GDP. This growth of that figure indicates you owe more and more to foreigners and that your own domestic growth is financed by foreign borrowing. It also means the income from your national assets may increasingly go to foreign bond holders. A high net-debt to GDP position is not a good one to be in.

--"Admittedly," Buffett adds, "other countries, like Japan and Italy, have far higher ratios and no one can know the precise level of net debt to GDP at which the United States will lose its reputation for financial integrity. But a few more years like this one and we will find out."

--"The Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington's printing presses will need to work overtime. Slowing them down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can't come close to bridging that sort of gap."

--So Buffett has admitted that you can't grow an economy out of that much debt. That is bad news for America and the U.S. dollar. But what does it mean for Australia? Well, that's a good question.

--It might mean that U.S. creditors (like China and Japan) would be happy to fund Australia's modest debt levels, given the higher yield on a stronger currency. That might lessen Australia's vulnerability as a capital importer. It might even mean that interest rates have to go up less fast than Glenn Stevens currently thinks.

--But does it also mean Australia is slowly becoming a vassal state to China? The economy is dependent on Chinese trade. The funding of government deficits and a larger net debt position will be dependent on Chinese capital. If the government has little leverage in the Stern Hu case now, how much more will it have in ten years if these trends continue? And is there anything that can be done about it? More on this tomorrow.

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