economics
17 Jan 2012
What Credit Ratings Don't Tell Us
Bill Shorten might be using the downgrading of European economies as an opportunity to crow about Australia's prosperity - but being rich and having a sound economy are not the same thing, writes Ian McAuley
When Standard and Poor’s cut France’s AAA sovereign credit rating and downgraded the ratings of eight other European countries, Bill Shorten couldn’t resist an undignified outbreak of Schadenfreude:
"S&P’s decision overnight to strip France of the exclusive, top-tier AAA credit rating confirms once again the stark contrast between Australia’s rock solid economic fundamentals and the fiscal challenges facing Europe and other parts of the world" he said in a statement last Saturday.
Shorten must be one of the few people who still take these ratings seriously. After all, S&P was one of three agencies that was still giving Lehman Brothers a strong rating just days before it declared bankruptcy in September 2008. As if to confirm the irrelevance of ratings agencies, France’s cost of borrowing has actually fallen in the days since its downgrade.
His main error, however, is to confuse a credit rating with an assessment of Australia’s "economic fundamentals".
A credit rating, even if accurate, is simply an assessment of a government’s capacity to repay its debt; it says little about a country’s underlying economic strength. It would be amazing if Australia, with its huge mineral reserves and low government debt, did not have a high credit rating.
It happens that countries with strong economies, such as the northern European countries, are also those with AAA credit ratings. But most oil-exporting countries, many of which have very weak economic structures, also have reasonably strong credit ratings. Being rich and having a sound economy are not the same thing.
Europe’s main problems are an immediate fiscal crisis which could drag the region into a prolonged recession, but most European countries have far more economic depth than Australia.
France is a world leader in high value-added industry, in aerospace, pharmaceuticals, telecommunications, defence equipment and civil engineering. It may have high government debt — about 80 per cent of GDP — but much of that debt has gone to fund productive infrastructure, such as its high speed rail network and urban metro systems. By contrast we struggle to keep our car industry alive and have a third world rail network. We may have low public debt, but on the other side of the national balance sheet we don’t have much in the way of public assets.
When the mineral boom eventually ends, Europe’s troubles of 2012 will be no more than a memory. Most European countries will still have reasonably strong and diversified economies. By contrast, unless we modernise our economy, we could slip into a condition far worse than a recession. Nauru provides an extreme example of what happens once a commodity-based economy loses its export base.
Australia’s economic weaknesses are not of this government’s making. It was the Howard government which squandered the benefits of earlier economic reforms and allowed our public revenues to be diverted from national investment in education, infrastructure and environmental protection, and re-directed to middle-class welfare and tax breaks for the well-off. They left us without debt on the fiscal balance sheet, but they left us with a huge liability to replace and repair our worn and crumbling infrastructure. Those are liabilities which staff of the ratings agencies don’t see.
So far, however, both the Rudd government and the Gillard Government have continued with the Howard-Costello policy, with a little tinkering at the margins, most notably in relation to labour relations. It is yet to tackle the hard task of re-building our economic strength to ensure that our prosperity can endure once the mineral boom has ended.
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Posted Tuesday, 17 January 12 at 10:47AM
thank you Ian, your analysis keeps me at NM, i wish you would make more regular contributions though, so that there’s more of it!
i am surprised you did not mention the fact that while our public debt is low, our private is debt is very high. most of our banks, and major corporations for that matter, are very heavily indebted overseas. furthermore, the four big banks are so dominant, that in the event of a collapse, we would have little choice but to bail them out. our problems are not the same as europe’s, but there is plenty of room for concern.
Posted Tuesday, 17 January 12 at 5:20PM
This was a very interesting read Ian, thanks!
It is one thing to be wealthy/financially secure, to have a good credit rating, to have low public debt - but its more important to address WHO has this wealth, who controls and benefits from it, who would/will absorb the costs of private debt once it inevitably catches up with us (of course this will be the taxpayer who at the time recieved no benefit from the company!, the diversity of who owns/operates our resources, infrastructure etc.
This is by no means a topic within my personal strengths areas - but hasn’t Australia’s economy and wealthiest people always ridden on the back on something or other - whether sheep, wheat or mining?
Why is so much effort made by our so-called “leaders” to support and encourage mining and economic strength of our very small number of wealthy business owners and yet does little for example for people making tomato sauce, growing pears or any farming or manufacturing industry for that matter?
Isn’t our farming and manufacturing our “safeguards”? Yet we are quickly losing these - all to the benefit/detriment of WHO? It is like there is some undercurrent hellbent on the destruction of manufacturing and small scale farming…but as I said…all this is something I dont really understand as what our government DOES do, seems irrational in the long term to me!!
Maybe someone can explain it to me!
Posted Wednesday, 18 January 12 at 2:30PM
Ian - spot-on article, as your articles usually are.
They make sense.
Australia really worries me. The direction we seem to take is to ‘milk’ (exploit) everything, instead of building strong foundations for future generations.
When I cast my thoughts quickly around the globe, I can only say that the countries with strong human resources, well trained, well schooled, well skilled, and with a high work ethic - are also the ones that are doing economically well. Add to that sound infrastructure and a quality producing manufacturing industry and the country has it made.
We rely on what we can dig up and export, and in terms of labour what we can import on the cheap. Yet we have talent from within.
We have sold our icons, privatized our public assets, and are now selling our bread and butter (agricultural land) to foreigners.
There was a good article by Leon Gettler in the Business Spectator today (on what we can learn from Germany). It fits in with Ian’s column.
When I think of Australia, then I remember a joke from way back:
Someone is asking God why some countries have so little and Australia has so much in terms of natural resources. And God answers:
I may have blessed Australia with natural resources but look at the people I put there.
Well, it’s not all the people. We are not even a democracy anymore. Just a plutocracy. It is just the people who happen to lead us.
As an aside to Bill Shorten: maybe he does not believe in ratings, but it certainly suits him politically to make a song and dance about it when Australia’s ratings are high.
Posted Wednesday, 18 January 12 at 3:27PM
Oh, I think I can predict that the Coalition will take them very seriously if Australia lose AAA, just as much as they’re feigning not to be taking them seriously now. “Its all good news, nothing to see here, move along” - would be their current position on credit ratings, would shift to “Appalling financial mismanagement by the Australian Labor party has resulted in the loss of this most important rating” …
Posted Sunday, 22 January 12 at 6:31PM
Nice article Ian. S&P also gave plenty of those subprime-heavy CDOs AAAs — there are a few Aussie Local Governments (and plenty of super funds) who are suing them for that. And then there is their behind-the-scenes role in the explosion in trading in over-the-counter derivatives, mostly credit default swaps. Now there’s a candidate for the other shoe (yet to drop).
Take care engaging with fightmamma, the handle is literally true — she kickboxes competitively when she is not busy being a single Mum.