FINALLY THE TRUTH IS OUT

Dear Readers

Finally the truth is out about the Australian economy: it is in recession. The real world has been telling us this for a year, but the Australian Government and much of the media has been hiding behind mining activity skewed aggregate GDP data. Could be good for some borrowers, but those that are worried about security of employment will not want to become even more indebted. Add to this the fiscal contraction from governments at all levels, and 2013 will be horrible for many people.

ASIA: WHAT NEXT?

Prominent US economist Paul Krugman called the Asian Tigers "Paper Tigers" a long time ago. But was he correct on the result, if a little mistimed? There seems to be some gloom about China, Japan, South Korea and Japan. India is slowing and Hong Kong is experiencing slower growth.

It seems likely that the major effects of transitioning these economies may now have been felt, and that growth in GDP/GSP will slow. This has happened in western economies previously.

In Australia, GSP per capita growth is a lot less than GSP/GDP overall. It may even be negative. That is why people are feeling poorer even though aggregate Australian GDP data are very strong at present.

The big dynamic though is developments in the United States. Manufacturing is being repatriated from Asia back to the US. We will see a relatively low cost, high quality economy in the US. This will give Asian countries a shock. The US will suck in capital from all over the world.

The demographic benefits that will follow for the US are losses elsewhere, including Australia if it wants to emulate Silicon Valley.

CAN AUSTRALIA BE SILICON BEACH?

Many of us have tried. Since at least 1983, there has been considerable energy put into the concept of Australia diversifying its economy through emulating Silicon Valley and other locations around the world where clusters of innovative firms prosper to become the next generation of large global corporations. There have been seemingly endless government interventions at the Australian Federal and State levels.

Many of these interventions address the issue of venture capital. It is not generally well understood in Australia that most venture finance in other countries relies on corporate venturing and wealthy individuals. In Australia, these sectors are not well developed and venture capital more often than not relies on some form of government support. The results from the industry over a long period of time have been less than spectacular and for the most part have not met the promise of high capital return. There have been some notable exceptions. For instance, Cochlear and CSL in the life sciences/derived health care sector. However, for most investors, financing start-ups is a very skilled and substantially risky business. Better strategy is to invest in enterprises where others have previously invested and profit from the sunk costs. Even better where there is/has been a lot of state financial support.

The conundrum for Australia is that the vast majority of investment offers in this sector are very early stage, with limited intellectual property estates, and, as Alan Kohler rightly points out (Business Spectator 22^nd November 2012) achieving scale. Scale means internationalisation from day 1. The problem is that there isn’t a capital market to support such a proposition. The argument normally is “prove it at home first”. Well often you can’t.

Scale problems include the obvious one of market size, but the real one is pervasive and insidious – talent. You need to be in locations where there are clusters of talent. Basel in Switzerland for biopharma, Silicon Valley are obvious examples. Other problems are self-inflicted. Employee stock and stock option plans come to mind.

With Australian dollar purchasing power, it is tempting for investors to buy into foreign transactions which are usually much better developed than Australian ones. Capital is very mobile and especially so in the world today. Entrepreneurial talent is also highly mobile and especially when armed with a valuable Australian dollar. Hence, the drain of talent to Singapore and Silicon Valley. Competitive currency devaluations may well result in an even more highly priced dollar. That will only exacerbate the problem just at the time when the Australian economy will need a big shot of activity.

THE US WILL LEAD THE WORLD OUT OF RECESSION

The United States has long been the home of post-WW2 technical innovation, entrepreneurship and venture capital. In part, this was generated by the huge military R&D investments of that war and a post-war influx of hundreds of thousands of engineers and scientists from the United Kingdom and Germany. The boom of the 1950’s was led by the application of military R&D to consumer products and, for most people, the advent of readily available credit. This was the period of Harold Macmillans’ “You’ve never had it so good” and the German “Wirtschaftswunder” (economic miracle).

This culture in the United States is there today, if somewhat buried by excessive government spending, intervention, and the advent of the welfare state.

But, the culture will resurface (this is the only way growth to reduce Federal debt can occur), and it will do it on the back of its traditional skills supplemented by:

·         Cheap Energy – yes energy at a fraction of Australian or European energy costs;

·         Competitive devaluation of the US dollar;

·         The world’s best intellectual property regime;

·         New manufacturing technologies;

·         Strategy designed to repatriate the innovation and production of high end products;

·         Cost inflation in China and other BRIC’s.

When?

2014 onwards.

www.millhouse.co

 

CHINA IMPLOSION?

Australia is very trade exposed to China. We all know that. The weekend Australian Financial Review reported “…all of the necessary pre-conditions for a banking crisis of incalculable proportions are in place in China. The primary driver of an explosion in bad loans is an explosion in credit growth…..That is unsustainable and likely to come to a messy end….”

I was in Singapore at the height of the so-called Asian crisis in former years. I was the ONLY occupant of one the large hotels there. Is this what will happen in China and what will be the impacts on the world? We shall see.

In the meantime, my punt is on a US led recovery (more later) followed by recovery in German led Europe.

CONFIRMATION OF FORECASTS

For my readers who may have been sceptical of what I forecast, please look at the articles in Business Spectator (www.businessspectator.com.au) and reprinted in the Australian today (15^th November 2012). These articles are written by two of Australia’s most prescient and respected commentators, Alan Kohler and Robert Gottliebsen.

Kohler writes about the “Small to Medium Business Crisis” and suggests “alarms should be setting off in Canberra (the Australian capital), and through every bank and big company boardroom in the country”. “Non-mining businesses are in serious trouble just as the resources boom ends. There will be nothing to take its place”. How right he is. I founded my last company, MillhouseIAG, in 1991 in a serious Australian recession and today feels just like that outside of the resources sector.

Robert Gottliebsen suggests that energy developments in the United States will be used to “transform manufacturing and later transport”. Agreed. 100%. The US will lead the world out of its present funk based on cheap energy, an innovation and venture capital culture, and the consequent ability to produce quality manufactures. All assisted by competitive currency devaluations so that manufacturing exports can thrive.

Australia: A hollowed out economy and problems ahead in resources. Domestic deflation has to happen. Brisbane office rents and housing costs should not be higher than Downtown Manhattan.

THE MAINSTREAM PRESS

 The Mainstream Press are picking up the themes in my Ping Pong Pang Series. Of note is one of Australia’s most eminent economic commentators, Robert Gottliebsen. Writing in the Australian (26^th October 2012), he assesses the potential impact of competitive devaluations (so-called currency wars) on Australia. His conclusion is not pretty.

It is also consistent with my blogs. Germany will finance Europe. There is no doubt about it, and they will do it using a manufacturing base which is world competitive in terms of product differentiation, but more so given the money printing undertaken by the European Central Bank. The United States similarly in respect of its manufacturing sector. For the United States, this will be given huge impetus given that a new era of cheap energy is going to concurrently drive that economy. Australia is going to be sidelined. In the short run, the Australian dollar is likely to appreciate against these currencies, and in the medium term, significantly depreciate. I don’t know exactly when dear readers, but consider using your powerful Aussie dollars whilst you can. The end of that era is bound to come. The era of volatility will replace it.

 

WITHER NOW THE AUSTRALIAN DOLLAR?

For those of you who have followed my Ping Pong Pang Series, there is a report from Goldman Sachs this week which recommends taking long Euro and short Australian dollar positions. Please remember where you read this strategy first.

If you want long Euro positions, you can invest your dollars in Millhouse, Inc. PLC, listed on the Frankfurt Stock Exchange. If Goldman is anywhere near correct, you could possibly double your money in currency volatility alone.

The Australian media is not replete with people who understand what is happening in Europe, so please read the latest Economic Strategy from Michael Knox at RBS Morgans. Entitled “Reconstructing Europe’s Banks”, he reports the spreads in the Euribor credit market falling to their lowest since mid-2007 and concludes that “the EBA and ECB have brought the European banking crisis to an end”. Long Euro sounds good to me, especially v. the AUD, given falling terms of trade, declining commodity prices and rising Australian Federal and State government debt.

PING PONG PANG #3

Actually, this one is Pang. It is not often that I agree with Professor Ross Garnaut after his foray into climate change (Australian Financial Review 2^nd October 2012), but this article on China is spot on. His prognosis is that Australia will be hit by “three mutually reinforcing negatives underway in China”. These are shifts away from heavy industrial investment, a move to lower emissions, and a cyclical downturn. He compares the challenges faced by Australia today to those of the Great Depression and the 1970-1983 period. He talks a lot about “hardship” and “sacrifice”.

This is a long way from the “miracle economy” speak we get from the Australian government. I was in Sydney this week where even CBD drycleaners are reporting revenue drops of 30% or more. This may be anecdotal, but the For Lease and For Sale signs aren’t.

I became Foundation Chief Executive of UniQuest Limited in 1983 and we were able to build a great business, although the 1987-1993 period was tough. But volatile times do create opportunities. That’s what we have now, but perhaps not in iron and coal.

PING PONG PANG #2

Dear Readers

My last PPP (#1) Blog suggested buying USD, €, & £ sterling assets whilst the AUD is where it is. Given the money printing in all of these countries (and Japan), it seems inevitable that those currencies will devalue against the AUD and the Renminbi (if China doesn’t follow suit). One noted economist has the AUD at USD1.40. The USD has lost around 95% of its value since Richard Nixon decided to leave the Gold Standard.  Given the policy purity in the Reserve Bank and the demand for Australian Government AAA securities, it is unlikely that Australia will follow a competitive currency devaluation strategy anytime soon, if at all.

Again, it’s a great time to buy foreign assets, but it is going to get worse for trade exposed SME’s or those who want to import venture capital to build them. There is a dearth of domestic venture capital in Australia since the comparative returns do not presently justify the risks. And importing it does not work for offshore venture capitalists in this devaluation climate.

The only thing you can do is offshore yourself. Sorry about employment prospects here, but we are talking survival, at least for a while. Rectification will take substantial reductions in nominal interest rates in Australia, further declines in commodities prices and volumes, and dealing with the flow-on effects in the Australian property finance market. If you don’t have a job, you can’t afford a mortgage. Doesn’t matter how cheap money is. 1991 here we come!

ABOUT DAVID MILLHOUSE:

An international entrepreneur based in Brisbane, with more than 30 years in venture capital and private equity internationally, David Millhouse is a specialist in venture financing and capitalisation. He is renowned for his management of high growth companies, many of which proceed to IPO and he has conducted business in the UK, Germany, Switzerland, USA, Canada, Singapore, Hong Kong, Australia and New Zealand. David is a scientist by original profession, with an MBA and LLM from Bond University in Australia.

VENTURE CAPITAL IN AUSTRALIA

My last blog referred to the paucity of venture capital in Australia and a consequential inability to fund emerging growth companies in the SME and technology sectors. If you read the Australian newspaper report on the imminent Australian Venture Capital and Private Equity Association conference (AVCAL, 18^th September 2012), it describes in more detail my blog of yesterday.

In particular, the withdrawal of public sector investment and the reluctance of superannuation fund trustees to authorise investments of this nature. The report stated that there had been NO investment from superannuation industry funds since 2008/9.

This forces entrepreneurs and companies offshore where the investment environment is more conducive, or to conduct an IPO, usually years ahead of when they should adopt this strategy.

The AVCAL Conference runs this week and there should be more reports from it. I expect that the inability of the remaining private equity and venture funds to raise new capital will feature significantly.

ABOUT DAVID MILLHOUSE:

An international entrepreneur based in Brisbane, with more than 30 years in venture capital and private equity internationally, David Millhouse is a specialist in venture financing and capitalisation. He is renowned for his management of high growth companies, many of which proceed to IPO and he has conducted business in the UK, Germany, Switzerland, USA, Canada, Singapore, Hong Kong, Australia and New Zealand. David is a scientist by original profession, with an MBA and LLM from Bond University in Australia.

WHERE HAS ALL THE CAPITAL GONE?

I am approached at least twice a week by companies and entrepreneurs trying to obtain capital. There is nothing new about this.

In 1994 I founded Corporation Builders because the lack of available venture capital was starving SME’s and technology companies. They could not develop. Most of them needed early stage equity. Hence the founding of enterpriseangels with the assistance of the Queensland Government in 1996. Since those times, Corporation Builders, with strong Australian Federal Government, State Governments, NZ Government and Singapore Government support, operated in all of those countries and states. The need for capital was universal and constrained the SME sector.

The 2000’s saw more capital flowing and more credit availability. Governments in all these countries supported the growth the venture capital sector.

That cycle stopped in 2009 and has not restarted. We are back to where we were in 1991. Private investors do not have the discretionary capital they once did, governments are tightening the seat belts apart from some headline projects like the NBN in Australia, and pension fund trustees are under increasing pressure not to approve investments in unlisted assets, although it is common practice in the United States. Hence Silicon Valley.

It is also true that many project proponents are woefully unprepared to raise capital. They can come back to Corporation Builders for some one-on-one coaching. No promises of capital, but at least it minimises the opportunity cost of valuable entrepreneurial time.

ABOUT DAVID MILLHOUSE:

An international entrepreneur based in Brisbane, with more than 30 years in venture capital and private equity internationally, David Millhouse is a specialist in venture financing and capitalisation. He is renowned for his management of high growth companies, many of which proceed to IPO and he has conducted business in the UK, Germany, Switzerland, USA, Canada, Singapore, Hong Kong, Australia and New Zealand. David is a scientist by original profession, with an MBA and LLM from Bond University in Australia.

PING, PONG, AND PANG

No, not the Puccini Turandot version of the Three Ministers in 19^th century Beijing. This is a little more serious. The three this time are the US, German-led Europe, and China.

Have a look at the Chicago Federal Reserve National Activity Index. It measures what is happening in the real United States economy. The news is more of the same – slow growth, not recessionary, although US Federal fiscal contraction could produce that. But, no indications of that wonderful energy which historically has driven the US and led the rest of the world.

German-led Europe – more of the same. The end result will probably be what the Europeans want – more political and economic integration for long run political stability. But no huge demand drivers yet.

China: read any newspaper! “The country’s growth model has changed”; “greying population”; “Does not need to continue creating low-skilled construction jobs to ensures stability”; “That’s why more steel mills are sure to cut production or close”. (AFR 1-2 September 2012). “Iron ore rout could end up in a hard landing”; “economists are speculating about the risk next year of the R-word”. (Australian September 1-2 2012). China is changing: its economy is maturing, its population expected to peak in 2015, and ageing. In short, China is going to feel more like “Old Europe” to quote a former US politician.

These three will dance around, just like Ping, Pong, and Pang. Expect competitive devaluations or other forms of domestic advantage.

Where does Australia fit? Recession probably if the Gillard-Swan governments still try to achieve a surplus. Where do Australians fit? Use the A Dollar whilst it is at these levels. At some point, it will not be when international investors and sovereign investors realise that it is priced on an evaporating commodities boom. Today, invest offshore in USD or Euro denominated assets. Sell Australian domestic equities and property. The likelihood is deflation. You will be able to buy them cheaper later with much stronger foreign currencies v/v the AUD.

PROFITS TO BE MADE IF YOU HOLD AUSTRALIAN DOLLARS

The likelihood is that the Australian dollar will rise further against the USD, Euro, and pound sterling. This will continue to damage much of the Australian SME sector. For Australian investors, though, it will provide a generational opportunity to acquire assets in other countries. The time to buy German property was before 2010. Investment grade asset prices on ASX are relatively high, so asset allocations should be increased in non-Australian $ assets.  You will need to be careful with Swiss and German real estate: the flood of liquidity in Europe is driving prices up. The China slowdown is likely to mean easing of Chinese monetary policy which in effect means exchange rates will change making Chinese exports cheaper for consumers. That will also damage the Australian SME sector. That slowdown will also mean less demand for some commodities. Australian imports will rise, exports drop. Hope Wayne Swan doesn’t want a balanced Federal budget since he won’t be getting his revenue, especially now the States are increasing minerals royalties. The aggregate macroeconomic numbers are not going to look as great in 2013.

It’s a great time to be an investor if you have the wherewithal to invest offshore: not so great if you’re trying to run a business in Australia, or only have limited capital to invest.

IS THE GLASS HALF FULL?

(click image to enlarge)

The world press almost uniformly predicts slow or no economic growth for the next few years and devastating economic consequences for many countries and individuals. However, there have been suggestions this week that the “bottom” may have been reached, whatever that means.

If you look at the chart, this is the (US) S&P composite returns index since 1900. What it demonstrates is long cycle periodicity in investor composite returns. What it doesn’t show (without my annotations) is the source of wealth creation in periods of rising equities prices.

After WW1, equities price upswings were largely driven by consumption spending, home construction for the soldiers, and innovation based manufactures. After WW2, military R&D investment generated completely new industries in plastics, aerospace, vehicles, consumer electronics etc, financed by the advent of readily available consumer credit for the first time. In the 1980’s, US military R&D expenditure on the development of the internet, the revolution in molecular biology, and the advent of a venture capital market led directly to the iPhone and modern medical care. Fortunes were made by technical entrepreneurs in these sectors based on science, government funded R&D, commercialisation skills, and access to venture capital. The 1987 stock market crash destroyed some of what had been created, but then rising Asian demand for commodities and western lifestyles underpinned yields even if equity prices themselves remained static. That came to end, other than in resources at least, in 2008.

So where am I investing for the future? And when?

Firstly, the when. The glass is half full. Equity markets will improve. Capital will become more readily available. From 2013 onwards.

Where? Please have a look at www.millhouse.co  The demand drivers will be: the entrepreneurial United States, becoming once again an energy independent economy with the worlds’ best Universities. Supported by German- led Europe with tremendous science and engineering skills enabling manufacture of best of breed products in a high cost economy. Selling to: SE Asia, China, and other countries in those regions who can afford western-style consumption products, food, and healthcare for an ageing population. These dynamics will drive trade and investment for the next cycle and companies with these exposures will benefit from an upturn in their equity prices.

These dynamics will govern the world as we shall know it from 2013 onwards.

davidmillhouse.com.au

IS CAMPBELL RIGHT: QUEENSLAND THE NEW SPAIN?

No, he isn’t, but there are some similarities.

(For my international readers this is purely a local blog, but the next one is written for you).

One of Australia’s most eminent economists writing under the nom de plume, Henry Thornton, is a sceptic when it comes to official unemployment statistics. He thinks that the official unemployment statistics greatly understate the true position here in Australia. Since Queensland has the highest mainland official unemployment rate, that implies Queensland has a bigger real problem. Add the officially unemployed (you only have to work one hour a week) to the underemployed, those in family businesses that are employed but not taking home any cash, and those that have given up looking for work (statistically eliminated from the data), and you get a Spanish type real unemployment number, especially in people under 25 and over 50. You can see the effect of that in the streets if you care to walk, the For Lease signs, and the closed and emptying cafes and coffee shops.

Official unemployment data is always a lagging statistic. The end of the construction cycle in mining, tunnels and apartments is upon us, and, with the AUD at USD 1.05+, expect to see more business closures in all sectors and higher official and real unemployment numbers.

That doesn’t make Queensland Spain. Sorry Campbell.

The big difference is that, whilst Queensland is having a property bust in coastal and lifestyle regions, the effects on the banks is spread across the nation and internationally. If these property risks were purely restricted to Queensland banks, then, yes, we would have Spain. Some of those banks would need a bail out. Fortunately, the Bank of Queensland was able to raise nearly AUD 500 billion in new equity.

www.davidmillhouse.com.au

IMAGINE A NATION WITHOUT ENTREPRENEURS

In 1988 I hosted a major international conference “The Third Symposium on Technical Innovation and Entrepreneurship”. This was part of an international series held in the United States and the United Kingdom with the support of the Utah Innovation Foundation, IC2 Institute from Austin, Texas, and UniQuest.

A key guest speaker at the 1988 Symposium was Mr Wan Run Nan from the Peoples’ Republic of China. Mr Wan was one of the first Chinese IT entrepreneurs. He developed technology, employed lots of people, and made money.

He could not return to China without the risk of imprisonment! His crime: he was an entrepreneur. Run Nan now lives in the United States.

The Australian labour government of the time, and notably John Button and Barry Jones, were highly supportive of employing people in Australia. They recognised, as John Button made very clear when he opened the facilities of then ASX listed Laser Dynamics Ltd on the Gold Coast, that it is entrepreneurs who build businesses, employ people and make profits. They understood the role of venture capital.

Contrast that with what is now emanating from the highest levels of the Australian labour Government in Canberra. There, it seems, we as entrepreneurs are enemy number one. Henry Ergas’ comments in the Australian (6^th August) “ .…instead of celebrating entrepreneurs, Swan despises them…Swan wallows in the nostalgia of Bruce Springsteen’s rustbelt past”. He goes on to say: “It is difficult to imagine a worse way of preparing for the daunting challenges Australia faces as the era of sky high commodity prices draws to a close. And it is difficult to imagine a starker contrast to John Button…” (For my international readers, Mr Swan is the Deputy Prime Minister and Treasurer of Australia).

Like Wan Run Nan in the PRC, the present Australian government doesn’t like entrepreneurs and publicly embarrasses some of them internationally. No wonder that many Australians are going or intending to go to more friendly destinations, Singapore for example.

WHO WILL LEAD THE UPTURN?

I recently gave a short presentation in Brisbane where I told the audience of very senior business people that I thought the Australian media reporting of European political economy was “shrill” and “often ill-informed”. There are some exceptions to that including the article in todays’ Weekend Australian by Robert Gottliebsen, and a recent publication from my good friend Michael Knox of RBS Morgans. Michael reports that of the “5000 banks in the Euro area, there are 27 which were undercapitalised under the supervision of the European Banking Authority”. He concludes: “All that remains of the European banking crisis is that market participants learn that it is over”. That is exactly my conclusion.

Gottliebsen is not taking a bet and acknowledges that there are tough times in Europe. Not, however, as tough as the post-war years: it is these years that define European political economy today and for the foreseeable future. My bet is that Europe will get its act together.

In the meantime, the China story is over as we knew it. Australian resources producers in minerals and gas are getting towards the top of the costs curve in a world of declining real prices and huge energy developments in the United States and elsewhere.

Mark my words, the US will lead the world out of its present woes, and German led Europe will recover in much better financial shape as its primary partner. That defines our corporate strategy. The German experience with its postwar Wirtschaftswunder (miracle economy) will prevail and enable its European colleagues to become competitive in the world. Gain follows pain.

Where does that leave Australia? In short, a hollowed out economy which will need significant new multi-industry investment as resources investment declines and stops. There will be rising unemployment, more company failures, more house mortgages and small business loans underwater. Roger Montgomery (www.rogermontgomery.com) is worth reading: “Now that the tide is going out, we are about to find out who has been swimming naked”.

Add a bloated government sector which will need to wound back by the next Federal Government. There is pain ahead. So don’t provide your house as security to the bank for your business loan.

G20 HUBRIS

For my readers in other countries, you probably were bemused by the lecture recently given to the statesmen and women at the G20 by the Australian Prime Minister. For many of us here, it made us cringe. This woman is an old style British socialist from the valleys of South Wales (UK). She will only ever be a footnote to history as the first female PM in Australia, for destroying her very reputable predecessor (Kevin Rudd), and lying to the electorate.

What her admonishments at the G20 omitted was the chaos in Australian economic policy. This chaos is being masked by the booming resources sector, without which Australia would be headed down the European road right now. So called climate change policy is destroying large swathes of manufacturing with massive job losses. Banks will not finance electricity generators. What does she do? She gives large amounts of taxpayers money to companies which otherwise would have to sack their workforces so that they can pay her carbon tax she said she would not introduce. Similarly, a return to industrial relations policies which belong to another age where “workers” doffed their caps to “bosses” is scything through the SME sector.

Australia today, readers, is like an obese person who does not want to get on the scales to see how heavy they are. There is a heap of bad news out there, masked only by iron ore, coal and LNG exports to China and India. If that slows, there will be no option but to get on the scales and take the medicine.

There have been recent Australian statesmen who should proudly and properly address the G20, from both sides of politics. She isn’t one of them. Sorry.

IS THIS AUSTRALIA'S INDIAN (CHINESE) SUMMER?

One of the more sober assessments of the European situation came this week from the New Zealand Prime Minister, John Key, speaking from Berlin. Key is a smart and very experienced operator and worth listening to. He commented that Greece is such a small economy that is it not likely to cause the collapse of the euro. Nor is it likely that Greeks will vote to leave the Eurozone. This contrasts with much of the hype in the Australian media.

That hype went into overdrive this week on the release of the Australian economic data. What it misses, but has been picked up a little by Alan Kohler, also an experienced operator, is that you must look behind the aggregate GDP data. If you do, you see a much different picture. As Peter Switzer commented in the Weekend Australian, if the economy is so good, why don’t we have inflation?

By far the bulk of the reported GDP gains were in resources extraction and from a relatively small group of people. Hence the per capita productivity data reported this week. Take out resources (and i suspect some of the GDP growth should be reported as GSP growth since whilst it may be Australian companies that are reporting, there is a huge amount of imported capital equipment which you can see affecting the current account data), and you see a very different economy.

Is this Australia’s Indian Summer?

www.millhouse.co

THE VALUE OF LOW SOVEREIGN RISK

Last week, the German government was able to issue bonds (“Bunds”) with a yield of 0.07%. That is a negative real interest rate. Few countries can do this: the United States can when it issues Treasuries. What does this mean for business capital costs. Typically the cost of raising capital for companies is a function of the so-called risk free rate (government bond rate). If you an Australian business you therefore pay substantially higher debt cost than a German or United States business since Australian Commonwealth bonds are considerably higher yielding. That means there are fewer Australian businesses that can attract capital since resulting hurdle rates are higher in Australia than those other two countries.

What we now see is business credit constrained by the adoption of Basel 3 rules etc. because of that tighter prudential regulation and more costly because of higher Australian sovereign risk.

WITHER CHINA?

What I did not comment on yesterday was WHY some manufacturing is moving to Europe from China. Dr Clint Laurent from Global Demographics reports that “Asia is turning into a content of empty nesters” and that “the Chinese labour” market peaked in 2010”. In the coming 10 years he says, “ the workforce will shrink by 40 million”. China “has no spare capacity in terms of labour.  Everyone  who can work is working”. “Its industrial boom had been helped in part by an influx of people from rural areas…and that resource too had all but run out with most young people having already migrated” to the cities”.

The “current steep rises in labour costs in China are due to the ageing of the population” and are “set to rise as much as 14% p.a.” “Chinese demographic shift is real and is happening now” he says.

“He also says that “the youngest age brackets in India are no longer growing”.

This is one of the reasons that some manufacturing is moving to Europe – ageing of the population and the exhaustion of hitherto cheap labour pools is starving the Chinese economy of lower cost workers.  (www.theaustralian.com.au/

business/paulgarvey)

I have long known that the real cost of a skilled IT or science based worker is cheaper in some European countries than it is in China or India. Now that paradigm is being extended to lesser skilled workers. Hence my long standing focus on Berlin as it regains its economic hinterland.

www.millhouse.co

Yesterday, I commented on the evolving and essential role of Germany in the world economy and the move of some manufacturing TO Europe. And how present events suit  long term German political economy. Reported this week is that the German trade surplus is around USD 200 billion. For Australian readers, this is around 60% of the present Federal Governments annual budget and around 15% of Australian GDP.

THE INCREASING IMPORTANCE OF GERMANY

I opened an office in Berlin in 2000 and have conducted business in that city since 1986. Times were very different then. Some of my colleagues took a lot of convincing that we should have an office there. We did so for a number of reasons. One of them is that Germany has approximately half of the worlds’ post-doctoral talent in the hard sciences. This generates investment opportunity. I also took a long term view that Germany would regain its prewar(s) status as an economic and political powerhouse and so it has proved to be. Interesting to note that the new French President flew to Berlin within a week of taking office.

There is a report from Dr Clint Laurent of Global Demographics noting that some manufacturing production is moving from China to Eastern Europe. “There is a large underused workforce…..eastern Europe’s GDP will grow very rapidly as a result of the change in the size of the labour force of the Chinese economy”.

My long term analysis was based on the fact that East European countries are like the Mexico of Europe: cheap skilled labour, proximity to markets, the Euro (much maligned at present), great transport infrastructure, and huge manufacturing infrastructure in Germany which leads the world. Some of this is happening in former German lands: all of it is happening in Berlin’s former economic hinterland.

Add German manufacturing competence and product innovation to low cost labour: that will produce a world powerhouse of the future provided the Euro does not appreciate in value too much. Keeping some countries on life support might be a small price to pay for such a prize.

www.millhouse.co

Reality Check...

Several prominent business leaders and quality journalists this week have commented on the true state of the Australian economy as it is and as it is likely to be. These include David Murray (Future Fund reported in live interview) and Jac Nasser (reported by John Durie in the Australian). The Wall St Journal reported that the Reserve Bank cut to the Australian cash rate “may only be a band aid solution unlikely to reinvigorate growth”whilst the London Financial Times said “investors should be worried about Australia: it was dangerously exposed to China with much of the resource windfall having been squandered”….. and “Australia was one of only three countries in the world to have run a current account deficit for 30 years” (Greece and NZ were the others) and “warned Australia would suffer like Greece when access to global funds was cut”.

Many Australians – and especially in the SME (Mittelstand) sector understand very clearly that things are tough. “Blood on the streets” in that sector was a comment made to be me today. State Governments also understand that their budgets are going to be tough. They will have no option but to increase resource royalties to balance budgets.

Australia’s present political leadership in the Peoples’ Republic of Canberra will of course squeal like hell. Having squandered a sound inherited budgetary position, the ground is now laid for an Australian tragedy of operatic proportions. Turandot here we come. Except there is no magical music from Puccini to ameliorate the hurt.

Massive increases in recurrent social expenditure will bind future governments for years to come. This is the Greek route. The revenue supposed to fund this from the new Minerals Resource Rent Tax is unlikely to eventuate: the Australian States royalties will gut it. Carbon Tax revenue will not eventuate either: businesses categorised as polluters by the People’s Republic will move offshore or change their operations. The only way to fund these new expenditures is large taxation increases on the working Australian population.

That is the pain of the SME’s, their owners and employees who are now losing their jobs. Australia needs a wake-up call and the slowdown in China is likely to provide it.

www.millhouse.co 

One of the ways that China manages the ups and downs in its economy is through the Reserve Ratio. In effect, this is the amount of capital Chinese banks are required to have as a prudential reserve. Last week, the ratio was lowered, meaning that their banks can lend more money per unit of deposits. This is a signal that the Chinese economy has been slowing and their government wishes to increase liquidity in the credit system, especially for businesses.

It is actually the opposite of what is happening in Europe and Australia, where Basel 3 has the effect of increasing the capital adequacy requirement of banks and thereby reducing credit availability per unit of deposit.

In Europe, there is a counter effect in that quantitative easing (printing money) is capitalising the banking system, and for those that are credit worthy in accordance with German credit standards, have access to long term finance at competitive interest rates. However the barriers to obtaining credit are historically higher than in the Anglo economies. Australia does not have quantitative easing and has higher real interest rates.

What all this means is that, for the foreseeable future, access to credit (and equity) is an international exercise for serious companies. For Australian investors and companies, domestic credit will be far more constrained, especially in the SME (German Mittelstand) sector, and more expensive. For Australian large companies with access to international capital markets, credit may be easier and cheaper to obtain.

For most Australians, the so called two tier economy is therefore likely to become more so and especially given fiscal contraction at Federal and State levels. i.e. less money will be spent by those governments with SME’s. This is likely to mirror the (North) European situation. However the big difference is that European companies are better linked into a much more substantial and broader large corporate base which can and does provide finance to SME’s. There is also more equity in the form of venture capital and true private equity.

For those of you who have been following my blogs will see that the forecasts are correct. Every day, companies in Australia are finding themselves in difficulty and the listed resources sector is finding it increasingly difficult to raise capital and operate at required levels of profitability. This is before the tax on the basis of life: Carbon and Carbon Dioxide.

For SME’s there are strategies you can put into place and networks that you can access to manage the future. The first step is to understand very clearly that the future is going to be different from the past. These steps include managing solvency and liquidity in a constrained capital and cash flow environment where you have lost pricing power.

Please contact me: dmillhouse@millhouse.co

Some weeks ago, I wrote that US manufacturing would lead the western world out of its recession. That is still my view. The US and Germany are both producers of very high quality manufactured goods where innovation and technical skill form a substantial component of products. There are similarities in the macro environment for both countries. Germany is benefiting from the regaining of its economic hinterland, its large investments into R&D and engineering skills, and from the relatively low value of the euro. The United States has low cost producers on its doorstep, large investments into R&D, and a low value dollar. It is also becoming self sufficient in many forms of energy.

In short, the US will lead the Atlantic Community and Germany will lead Europe.

The major difference between those economies is that most US GDP is internally generated whereas most German GDP relies on internationally tradeable goods. Both are reliant on Asia – the US for capital to fund Federal debt issuance and Germany for tradeable goods markets.

Whither Australia in this mix? Under present leadership, probably nowhere. Not a leader in sight in the present Federal Government. Generational opportunity sacrificed on the altar of latter day socialism. Why create wealth when you can spend other peoples?

How out of touch is the Mistress of the Peoples’ Republic of Canberra? As Germany has (re) discovered the benefits of a market economy driven by entrepreneurship and less regulation, so Australian political leadership publicly disparages its entrepreneurs and wants to fight the next Federal Election between the so-called privileged few v. the workers. Arise Karl Marx from your London grave. Australia (at least Julia and Wayne) wants you.

Chickens coming home to roost

There was an interesting commentary from Wall St last week on the true state of the Australian economy (reported in the Australian). Whilst I am not in total agreement with Harry Dent, he does make very good reading (that article was not written by Harry). Basically, we are in for a period of deflation and deleveraging. David Uren wrote recently in the Australian about it.

Australians since the Second World War ended have been brought up on a diet of ever increasing property prices. That is the foundation stone of almost every Australian family’s wealth. That period now appears to be over for sometime.

Very importantly, it is that wealth that provides the security for almost every business loan in the country to SME’s. My recent blog about China is most likely to hit companies listed on the ASX. Not so much the SME sector unless they are directly servicing the resources sector. What will hit the SME’s is breaching of their loan covenants where they are secured against depreciating real estate prices. Some banks are likely to want to reduce or eliminate credit lines as a result. Inevitably this will result in insolvencies and a domino effect across the economy, including into the professional services sector.

Add to this, deflationary fiscal policy at Federal and State level, and we have the preconditions in Australia for the scenario painted by Dent. The nightmare storm: Slowdown in China, domestic deflation, and enforced SME deleveraging. Since SME’s are the largest employer by far, employment……………future blog.

Is anyone employed any more?

The official unemployment stats cant possibly tell the whole truth about employment. Look around the streets at the number of offices and shops for lease, and the (daily) anecdotal evidence on retrenchments, and it may explain why shops and cafes are emptying. People cant afford it. For those of  us lucky enough to live and work in the inner city we tend to be insulated from the hardships in the 'burbs and some of the regions. There are recent reports which indicate that real unemployment is a multiple of the reported figures from the Federal Government. They will say go to the mines. But they are not big employers. That is the land of small and medium businesses - the ones that are hurting and now laying off staff. Wait for the official unemployment figures to rise later this year. Hopefully burglaries wont!

David Millhouse
www.millhouse.co

Financial services reform

It is interesting to note that the requirement for a financial adviser to act in a fiduciary capacity for their client is only now being written into the law. Surely, there was always a presumption that this was the case. Not so apparently. No wonder some financial planning &wealth management firms became little more than product sellers earning a commission or other incentive. I have had this done to me from well known organisations in Australia. Needless to say, i didnt usually buy and the one time i did, lost everything in that investment - almost as million dollars.

David Millhouse
www.millhouse.co

I am an international entrepreneur with over 30 years in venture capital and private equity internationally. A specialist in venture financing and capitalisation, and the management of high growth companies, many of which proceed to IPO.  I have 30 years of publications and media on my professional activities and have had a stellar career at CEO level since 1983

Rome Burns 2

David Millhouse reporting that there was comment in the weekend press about the lack of a venture capital market in Australia. This is true in part. Most of the unlisted investment is leveraged buy-out private equity capital. Except that its mostly debt. There is a huge pool of venture capital. Problem is, its in government hands and is used to porkbarrel the electorate to win elections. Go to Federal websites and see how much taxpayer venture capital is (mis-) allocated to car manufacturing, "green"technologies etc. Most of this taxpayer venture capital will be wasted. Down the drain. Gone. Kaputt. At MillhouseIAG we were ranked very highly by the independent Private Equity Performance Monitor on a world scale for venture and private equity investing. If these returns were matched by the returns on this Federal Governments' profligacy, then tax rates could be lower for everyone.

David Millhouse
www.millhouse.co

Developing Brisbane

I took a City Cat from the City to Hamilton on the weekend. It was interesting to reflect on the development of Brisbane from 1983 when i became the Foundation Chief Executive of UniQuest at UQ, to now. In 1983 UQ was a very good regional teaching University with some research capacity. Now, it is a major world renowned research University ranking in the top 3 in Australia and with signficant research endowment from non-government sources. There are many articles written by or on David Millhouse which illustrate how this process occurred and what the benefits to Brisbane have been.

David Millhouse
www.millhouse.co

CAPITAL FOR COMPANIES

Raising capital for small to medium sized companies has never been easy. It is even more difficult now with limited sources of finance and then usually requiring real estate and personal securities. Very dangerous for the owners. David Millhouse says the new Australian credit laws make it even harder and people who would previously had access to credit will no longer have that access. This particularly affects small and medium sized businesses, many of which are family owned. Banks treat so called self employed people differently to PAYG earners.

This was a huge problem post the 1991 recession in Australia and MillhouseIAG established Corporation Builders to address it. Corporation Builders developed the Queensland Leaders project in 2007, which still continues in Brisbane.

David Millhouse also says that, presently, business owners and managers also face declining exit values for their assets. There is little in the way of true venture capital available and very limited opportunities for IPO's on the Australian Securities Exchange.

David Millhouse
www.millhouse.co

BERLIN BOOMS

David Millhouse has been visiting Berlin since 1986. David has had an office there since 2000 and operated for ten years as Millhouse AG, a wholly owned subsidiary of MillhouseIAG Limited. The economic and monetary developments are more readily understandable when viewed through a German prism rather than an Australian one.

David Millhouse
www.millhouse.co

Rome Burns

While Canberra fiddles, much of the Australian economy burns. David Millhouse has spend 30 years building small and medium sized enterprises. David says conditions are tougher in that sector now than in 1991. The Federal Government looks at the aggregate economic data, not at what is happening at street level.

An Old Video - David Millhouse to be on a visit to Condat AG in Berlin Germany