Scoops Lane
Thursday, 6th March, 2014
Melbourne, Australia
By Dan Denning

If you wish to be pedantically exact about it, those retrospectively blessed dozen years lasted from the chilly, fevered Central European night of November 9th, 1989 to the bright morning on the Eastern Seaboard of America of September 11th, 2001. One event symbolised the lifted threat of worldwide nuclear holocaust, something which had been hanging over humanity for nearly forty years, and so ended an age of idiocy. The other ushered in a new one.

Iain Banks, Transition

  • China’s transition
  • A security ladder
  • Boats that don’t float
  • Your concerns about Australian national security

China’s transition

If you learned just one lesson in the last week it might be this: the decline of American power and influence in the world makes armed conflict between nations more likely, not less. The second golden age of globalisation is over.  As a cash strapped America loses its ability (and will) to project force around the world, the incentives to take what you want from weaker neighbours increase. Conquest takes the place of trade.

That, anyway, is one lesson you could take away from Russia’s invasion of Crimea. But since China’s annual National People’s Congress began this week, everyone wants to know what growth rate the Communist Party of China (CPC) is targeting for the world’s second largest economy. Australia has a lot riding on what China’s communists decide the growth rate should be.

Chinese Premier Li Keqiang did not disappoint. He said the central planners would target 7.5% annual growth. For most of the world, that would be a phenomenal growth rate. But China’s average annual growth rate, especially since it entered the World Trade Organisation in 2001, has been around 9.9%. The rapid growth from a low base is slowing.

But for Australian investors, the real question is whether China is fair dinkum about rebalancing its growth model away from fixed asset investment and towards consumption. If China plans on building fewer bridges, factories, and housing developments, it’s going to affect Australian exports (and national income via the terms of trade). Remember, 36% of Australian exports go to China. Last year alone that amounted to $94.5 billion in exports, of which $52.8 billion was iron ore and $9.1 billion coal.

The National Development and Reform Commission, the agency that makes China’s detailed five year economic master plans, has reportedly told the Party Congress that it will target a fixed asset investment growth rate of 17.5% for next year. That would be the slowest growth rate in twelve years, according to the Guardian.

Is it a meaningful reduction? In practical terms, Premier Li said it would mean cutting Chinese steel capacity by 27 million tonnes next year. It’s been a long standing goal of the CPC to eliminate inefficient and polluting steel production. But to put that in perspective, China has the capacity to produce around one billion tonnes of steel a year. When you look at that way, it does not appear that China is planning a major shift in its strategy of urbanisation in 2014.

All of this is very good news for Kris Sayce and his two investment analysts Jason Stevenson and Tim Dohrmann. For small cap punters, Kris reckons the market will march higher and not be derailed by a change in Chinese strategy. And for iron ore and coal companies, the bull beats on.

The other side of the trade is that China isn’t really committed to structural reform and slower credit growth. It can’t be because slower credit growth would be a disaster for the Chinese financial system. And in China the link between the financial system and the real economy, via shadow banking, is much stronger than, say, in America.

Stay tuned for more from the National Party Congress. It lasts through next week. Will China have anything to say about Russsia’s invasion of Crimea? And will it have anything to say about how much gold the People’s Bank of China now has in reserve? Hmmm.

A security ladder

You can do exactly nothing about geopolitical trends. That’s one of the conclusions I reached in my most recent edition of The Denning Report. It doesn’t mean you shouldn’t try and understand them. You’re always better off at least thinking about what’s going on, even if you can’t know for sure. But whether Russian President Vladimir Putin plans to invade the rest of Ukraine or is happy just rattling a few European and American cages…that’s something neither you nor I have any control over.

What you do have control over is what you do with your money. Nick Hubble has been banging this drum since last year. That’s when he first unveiled his idea of building a ‘security ladder.’ It’s an investment strategy that pays you a predictable annual income over time.

Speaking for myself, I am always highly sceptical of strategies that claim a guaranteed, safe, and regular income without taking risk. There is no such investment strategy in the world, unless you count working for the public service. But I’ve seen the details of the idea. It’s real. Nick put a lot of work into it. It takes some money to make it work. But for anyone approaching retirement age who’s not interested in leaving large amounts of capital at risk in the stock market, the strategy is worth consideration.

Boats that don’t float

While I’m on the subject of national security, I’ve posted some of your replies to my question last week. I asked you what industries you thought were important to national security and deserved protection from the government. I obviously touched a nerve because there were many more replies than I can publish.

One reply I did not, get, however, was shipbuilding. It’s a noticeable omission given that Australia is in the process of deciding whether it will build more Collins-class diesel electric submarines as the existing fleet of six approach the end of their operational life. In point of fact, the Navy appears to have trouble putting more than two boats to sea at any one time.
 
The ability to design and build capital ships for the Navy is certainly a major national security decision. Australia could purchase foreign designed and foreign built boats if it wanted. But the local shipbuilding industry in Adelaide would die on the vine. Is warship design and manufacture an industry Australia wants to retain?

Yesterday’s Australian reports that Australian Navy chief Ray Griggs is already frustrated with faulty patrol boats used in the operation to interdict people smugglers from Indonesia. Half the fleet of patrol boats – six of them to be exact – are at port in Darwin awaiting repairs. Griggs said, ‘What we’ve seen is a re-emergence of cracking around the engine room which we believe to be design issues in the Armidale class. It is one that we have been working to resolve that is taking longer than I would like to resolve.

Resolving the problem would probably be a lot less urgent if Australia’s neighbours in the Pacific weren’t all engaged in a substantial military build-up. As I covered in my recent report, China is building coastal patrol ships that are as big as Second World War era destroyers, and capable of transporting large, troop-carrying, helicopters.

According to a comment published this week from State run media, China’s military is merely stepping into its natural role as a guarantor of regional stability. Commenting on the 12% rise in China’s military spending to US$132 billion, Xinhua news agency reports:

As a responsible major stakeholder in regional peace and stability, China needs sufficient strength to prevent hot-headed players from mis-judgment and thus forestall conflict and war, so as to maintain a favourable environment for the socioeconomic development of all in the neighbourhood.’

Does this mean China seeks a blue water navy in order to convince ‘hot headed’ countries like Japan, South Korea, and the Philippines that they have no claims on the oil and gas rights in the South China Sea?

Australia’s political alliance with the United States has always been its greatest national security guarantee against trouble from the North. But if the US is unwilling or unable to defend its allies, that will make the Pacific a very interesting, and potentially dangerous, neighbourhood in the coming years.

Now on to your replies to my question last week. Thanks for writing in,

Regards,
Dan

Your concerns about Australian national security

From: Judith
Sent: Thursday, 27 February 2014 4:29 PM
Subject: Industries of national security

Water, food, energy, technology

From: Walter
Sent: Friday, 28 February 2014 4:28 PM

I still believe that we should have a list of strategic assets, industries and reserves. Our fuel reserve is only 60 days. Within one week of trucks stopping medicines and food would become short in supply. Tax loopholes have to be closed e.g. Apple made $6 billion in Australia and payed $36000 tax meaning a tax rate of less than 1%. I don’t think any Australian company would get away with that. We are punishing our own industry. Fuel, Medicine and Food should be stockpiled. A diverse range of industries supported so we have one Australian Made product in each major industrial group even if it is a small business producing a small amount. It keeps the country prepared for shock. No one can say what the exchange rate is going to be in 10 years or even if world events could conspire to prevent important products being imported.

From: Brendan
Sent: Friday, 28 February 2014 11:33 AM
Subject: Industries of national security

ELECTRICITY!  Try this little thought experiment. Imagine if all the electricity generators stopped today for some unexplained reason. Now consider how your life would be affected and what you and your family would need to do just to survive. As you come up with each new thought there it is again, the requirement for electricity.  As well as recognising that requirement you also see the alternative in order to survive.  You soon come to the conclusion that we have become ‘stranded’.  We cannot survive in our current lifestyle without electricity.

From: Tom
Sent: Thursday, 27 February 2014 5:59 PM
Subject: national security

Dan,

You are right we are not big enough to protect every key industry. I think food and energy are key industries and at the moment rising energy costs driven by wacky environment policy, high mining costs, failure to invest in the long term savings nuclear power could provide are eroding the profits of food producers (as well as many other industries). The costs we incur pandering to the evil green sector are having negative effects on the environment in many cases and contributing to a lower standard of living for all Australians.

Yours faithfully,

Tom

From: David & Joanna
Sent: Thursday, 27 February 2014 9:23 PM
Subject: national security

Hello Dan,

Keep up the great work you guys do….National Security? There are many levels to national security but the Aussies just seem to have blown it all away over the last few decades with privatisation.

As the years have gone by since the 80’s politicians have sold our souls & future to multinationals, all in the name of ‘self-interest.’

Whatever happened to securing our future? Everything government & corporates do is done on a short sighted premise. Gov’t squanders years of good work done by those years before them. All in the name of short term gain. (Bonuses & shareholder profits)

The public just seem to bend over & take all the crap that is served to them. I don’t believe it is worth voting for any of them because all we get is the same self-serving mismanagement with every government that is elected. Where is the public’s rage? All we seem to get is Government mismanagement and corporates pillaging the public with the help of their political lobby groups.   

National security? Aussies wouldn’t know it if it stared them in the face!

Yours unsecurely,

D&D subscriber

From: Vivian
Sent: Thursday, 27 February 2014 11:30 PM

Australia should stick to what it does best i.e. they are most famous for their beef, lamb and fruits.  Why don’t they just stick to it instead of tearing up all the fruit trees and importing fruits from other countries just because it’s cheaper?  Although it can be cheaper, do we know what they inject in them?  I strongly feel that Australia should concentrate on their agriculture and resources and leave the other industries to other countries who can manufacture them cheaper as no one is going to buy from us anyway if our prices are much higher.

From: Bryce
Sent: Friday, 28 February 2014 7:17 AM
Subject: National security

Hi guys,

Land + water = FOOD

Reciprocal land titles (i.e. if you want to buy land here in Australia, we have to be able to do so in their country). Should know how much of our country is foreign owned (should be simple since we have a central lands title office & computers) and be capped at $100M, lower target from current $250M.

Watch out for Brazilian Bank backed JBSwift who have bought up over 60% of our beef feedlots and abattoirs on eastern seaboard, not in the interest of local farmers anyway!

The duopoly of Coles & Woolworths (estimated 80%) are strangling suppliers for shareholders $$, cannot last.

I am getting paid $1.40/kg for 500kg beef cattle that I have raised over two years for $700. Less freight out $60, NLIS tag reading fee $4, MLA levy $5, less agents 5% commission $35, less yard dues $5) let alone shire rates, high wages & cost of living, fuel, power, land rates, interest at 7.7% (should have a rural bank that DOESNT get privatised, another issue)

As you can see I am a farmer trying to earn some cash-flow on a large asset & am getting 1980’s prices, sure I produce a commodity that people need, but import from the "globe" who do not have our principles in animal husbandry, using banned chemical, employee OH&S, and fertiliser use (we do not use raw human sewerage on vegetables).

Put succinctly, we cannot be a service providing economy without producing goods (GST). The service industry can serve each other, but must get focused on Trade Account Deficit, i.e. have to export something to import anything!

I have had my ramble. I hope you can understand where I am coming from.

Cheers,

Bryce