My Ping Pong Pang blogs on this site generate a lot of interest. Here is my prognosis for how Australian industry is being trapped between the rapidly shifting tectonic plates of the United States, German-led Europe, and China. If this prognosis is correct, it will have profound implications for investors.
The US dollar is certain to rise against most major currencies. It is still the only safe haven currency in an increasingly volatile world and this will attract a premium. Federal budgets are becoming increasingly under control and much of the money printing replaces the money which evaporated since 2008. Hence no signs of inflation.
Add in near self sufficiency in energy, comparatively low energy costs, low unit labour costs in manufacturing, and the world's best technology base, and you have the ingredients for a strongly growing economy and a fiery US dollar rally.
US$ investments in emerging markets are likely to be repatriated with severe consequences for emerging market economies which might include the collapse of shadow banking systems in those countries. More on China in a minute.
The US today is probably at its most competitive since the 1950's consumer product revolution. It is sucking in talent and innovation from around the world, and can make and export products very competitively across multiple industries. These products include military equipment, the demand for which may supplant rapidly declining demand for mining equipment.
The US can also meet its own consumption of almost everything, so will not be as exposed as others to unfolding events elsewhere.
In German-led Europe, monetary policy is akin to a return to the Gold Standard of the 20th Century with a constrained supply of credit. For the moment, this is adding to the intrinsic competitiveness of German industrial exports. Unless there is a Damascene conversion of monetary policy in Frankfurt (unlikely), only rising bond yields in the US are likely to have an effect on the cost and availability of euro denominated credit.
German industry is in prime position to capitalise on the next wave of development in China: the move towards a consumer society. German vehicles, machine tools, pharmaceuticals and chemicals are sold as soon as they are made for Asian consumers with less regard to the price point than virtually any other country's exports. The value of the German brand: even in Australia, advertising for German cars includes German language. German industry captures not only manufacturing profits, but also brand profits.
These products are often produced by privately owned and run Mittelstand companies. These are small and medium sized enterprises often located in smaller towns and villages. Usually without external equity financing.
China is the big enigma. The war games are likely to generate an increase in armaments production in Japan, Sth Korea and the US. Perhaps 2014 reflects 1914, except that the players are different. Gunboats and sabre rattling to detract from major internal problems.
Chinese credit growth has been explosive and unprecedented. As any CEO and political leader will tell you, it is far harder to tell people to tighten their belts than it is to inflate an economy with cheap money. Many Americans have learned this lesson the hard way. Australians are about to learn.
So whereto for China? Probably managed devaluation of its currency. Competitively with Japan.
Where does this leave Australia, its industries and investors?
More than 40% of Australian exports go to China, and most of this is iron ore. Australia, and its governments, are massively exposed to events in China. There used to be a saying that if the US catches cold, then Australia gets the flu. Today, if China reduces Australian iron ore and coal imports, (volume and/or price) the Australian economy and its tax base will suffer enormous consequences. A heart attack, not the flu.
This is at a time when Australian industry has been damaged for a decade by the destruction its previous major comparative advantage (cheap and abundant energy). This destruction is a direct result of the Labour-Green government of 2007-13. Energy costs are unprecedented in Australia and are now a negative factor when companies determine whether or not to invest in new projects or continue with their present ones.
Recent examples including the scaling down of production of aluminium from its raw material in Gladstone, Queensland, and the likely closure of aluminium production by Alcoa at is Geelong, Victoria factory.
Australia will not process its raw materials any longer: raw commodities will be exported for processing. This is happening across all industries, including the recycling of plastics wastes.
The worlds' highest energy costs are being replicated in the LNG industry, to the point where there is uncertainty not only about high prices but also about domestic availability to industry.
This is leading to a downwards spiral where reduced energy consumption (industrial and household) generates further prices rises to accommodate fixed costs structures.
Energy costs impacts and China are likely to have profound impacts on Australia's industrial and tax bases in the near to medium term, and thence to its housing markets and banks. These impacts will include more company closures, less employment (skilled and unskilled), government fiscal problems, and increasing housing unaffordability at todays' price points. In short, no, low, or slow growth in an environment where the US and Germany will do well. Or even a contraction, depending on China. All of this suggests a markedly lower Australian dollar.
The tragedy is that Australian industry makes many world leading manufactures: its doesn't capture the brand value (yet) that the German brand captures, but it can. It can also compete (as Germany does) with high unit labour costs and a strong currency. The Australian Mittelstanden are the unsung heroes of the economy and its likely medium term saviour.
However, what will be required is a weaning of the whole country off China, and an end to the Australian complacency, including in Canberra. The country needs its "Margaret Thatcher moment" and it is likely to be painful. Whether the new government in Canberra is up to the policy challenge will be a recurring theme in 2014.
David Millhouse is an international entrepreneur with over 30 years in venture capital and private equity internationally. Based in Brisbane, Australia he is a specialist in venture financing and capitalisation, as well as the management of high growth companies, many of which proceed to IPO. He has conducted business in the UK, Germany, Switzerland, USA, Canada, Singapore, Hong Kong, Australia and New Zealand. A scientist by original profession, with an MBA and LLM from Bond University in Australia. He is a trustee of Bond University, Australia’s premier private University, and was formerly a trustee of the Queensland Art Gallery/Gallery of Modern Art. There are 30 years of publications and media on his professional activities and he has had a stellar career at CEO level since 1983.
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