Australia's Economy Is BROKEN (And Nobody Wants to Admit It)

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[00:00:18]>> Good morning, Michael and John. It's great to have you uh with us. um some very consequential articles featured in the Finn Review um over the past few days. The one that struck me was um former ACCU boss Bill Kelty.

[00:00:38]And for those of you who old enough to remember, he was a critical part of the Bob Hall Keading reforms in the 80s and the '9s.

[00:00:49]And Bill Kelty's given an interview to the Finn Review decrying the state of economic management in Australia, saying it was incomprehensible that real wages could be amongst the lowest in the OECD when commodity prices were so high, export volumes were so high. and he specifically called out high spending, high taxes and what he said was a disdain for the use of public funds. I thought this was an extraordinary um intervention coming from a lifelong Labor supporter such as Bill Kelty who's held in very very high regard. It's not as if these were comments coming from Pauline Hansen or Morris Newman or Jeff Wilson. This is Bill Kelty who's uh Labor royalty.

[00:01:45]Um John, let's start with you. What what did you make of that article in that intervention which is a very high-profile intervention in my opinion?

[00:01:57]>> Yeah, he should be on the view, shouldn't he? Because he's been he re reiterated what we've been saying for years on this program. Um I think it's interesting he's also said as a he's on the board of a a private company which is in payroll or cash services and he was lamenting uh the uh government support or intervention in that part of the market.

[00:02:19]So I think it stirred him up but his comments are absolutely correct. We've been saying it Australia has abundant resources. We have some of the largest resources across iron ore, LNG, gas, coal, uh, uranium, manganese, copper.

[00:02:36]Um, the unfair advantage to our north of three and a half billion people in economies which are growing faster than anywhere else in the world. We have what they need and we haven't been able to convert our natural advantage into wealth and then turn it into a distri distributed wealth across the economy.

[00:02:55]So we lift up everybody. Uh and he's pointed out as the OECD has uh that our wages growth in the last decade is one of the the slowest and lowest in the western world. Uh and I think it reflects bad planning, bad economic management, uh excessive expenditure in the budget. Everything he says we've been saying and um it's good that someone like him has said it and supports what we've been saying. whether it changes anything and it it is before and and Michael's in Adelaide. So, you know, there's there's a Labour conference in Adelaide, so good times for them. But I think it was very pointed that he threw it into the debate right before the Labor Conference. And I suspect they'll ignore what he said.

[00:03:39]Yeah, Michael, the next one's for you, and it's kind of along the same lines.

[00:03:44]Um, the Finn Review also carried another front page article quoting the former uh governor of the Reserve Bank, Philip Low, who I think now has a leadership role on the ASX and he warned that fundamental policy change is needed to encourage business investment. He quoted an astonishing statistic. He said Australia is heading for its weakest decade of living standard growth since the 1910s. That's more than a 100red years. GDP per per person has risen by just 4% this decade. Uh as I said putting the 2020s on track to the to be the weakest period um for a 100red years. Uh there's a common theme there, isn't there?

[00:04:40]Yeah. Uh, look, I think the problem's well known. Is the cause of the problem well known? And are the solutions well known? No. Um, because like both labor and you know, business people are calling for the same challenges. And we've talked a lot about this here. And we've also talked a bit about uh you know the Japanese economy and and I've been quite not fixated but very very interested in how Japan's economy moved from 1987 to now and how their population demographics migration and all of it. And I've thought for a long time that their situation and in some ways Russia's as well excluding the the war um have been a picture into the future for the West and how to deal with things and we can sort of live through their experiments if that makes sense.

[00:05:29]Um so I think calling out the problem is great. The biggest challenge I always have on the Labour side is often they're very good at calling out the problem because they want to propose a solution and the key thing is will that solution fix it? you know, so they've been banging on about the housing crisis and putting, you know, a multi-billion dollar property trust together to build 700 houses, right? So then they've implemented um, you know, these capital gains tax changes and rents have skyrocketed. So it's not whether we're calling out problems, which we are as well, it's what are the solutions. Um, and that that's a far more interesting, nuanced, and often ignored part of the whole dialogue. And um from my perspective, a lot of these uh problems are actually the solutions of the past have caused today's problems if that makes sense. And u we've been doing a lot of thinking about that. But um that's where I'm sort of landing in that we've cornered ourselves with regulation in lots of areas. And being the brave person to say we should get rid of this or remove that, they're the first person to be shot.

[00:06:32]>> Yeah. Well, obviously people are noticing because uh there has to be some explanation for the surge in [sighs] uh support for a uh I guess you could describe her as a maverick uh uh Pauline Hansen. Uh it's it's quite extraordinary, but it's also been noticed by investors on the stock market. Have a look at these listen to these numbers because I I pulled them up this morning and they're staggering. Um, so the ASX uh is just marking time this year. The the US S&P 500 is up 18% yearonear.

[00:07:14]NASDAQ is up 24% yearonear. You referenced Japan as a a kind of a um uh you know something that might be showing uh you know the the path to the future.

[00:07:30]Japan is up 60% year on year despite having no resources and and being totally reliant on imports. Even Britain with its political uh toxicity is up 18% year on year. And you know what Australia is up year on year? 1%. We're up 1% year on year. and we're on a PE of 18, meaning we're not even cheap. Um, so John, what's your comment there? I mean, I know we've spoken about this multiple times, but uh this has got to be an indictment from global investors that Australia is just not producing the goods in so many different ways.

[00:08:21]Well, it just shows you the flaw and the argument of weight of money because the one thing Australia does do is create immense capital through savings and superanuation.

[00:08:31]You know, $4.5 trillion which is what $1.7 times the Australian economy. Um so you can't say it's the way the money is not supportive. Uh the the capital we've produced for superanuation can't find a home in Australia because there's nothing happening. Um I was just looking at the stock market today and we should always relate this back to investing. Uh your observation of 1% today the stock market is up about half a percent. But if you if you looked at it the leading stocks which represent 50 odd% of the market are all up one and the rest of the market's doing nothing. So you can work out where the half a percent's coming from. It's just mathematics. And very much the destiny of the stock market is determined by you know about 10 or 12 stocks in terms of the index not the destiny of making money in the stock market the destiny of the index.

[00:09:20]And this is the disconnect that the index is not reflective of the Australian economy um with such a large weight to financials. Um now it's interesting in the last two months in America I know you went for the one year the last two months the IT sector has pulled back but is being replaced by the financial sector. So we've had a financial sector rally of about 10% as the IT sector has pulled back about 8%.

[00:09:45]So that's a short-term move inside the longerterm move which you showed but it shows bigger diversity in the American stock market and I think that diversity apart from something like Korea which we know is not not uh doesn't have diversity but Japan and some of the European markets just have a a better spread of opportunity to invest in Australia. We've destroyed our stock market. We've had this last a fair attitude that we could take good companies off the stock market. They've disappeared over the last 30 40 years.

[00:10:14]Um we're left with four or five big banks. Uh and we've got three or four big resource companies uh pretty much doing the same thing. You know, I know McQuary is an outlier in banking. Um and but the resource sector is pretty much doing the same thing. Drilling the same resources and selling it to the same markets. It's pretty poor. Uh how do we break it? I guess everyone's saying, "Well, that's the observation, John.

[00:10:37]What are you going to do about it?"

[00:10:39]Well, I think it it's going to take a long time because we have to reintroduce entrepreneurs to this country. We have a whole lot of companies which are long-term established and we have custodians in management who just come in for their 5year stint and make a fortune and leave. They have no vision.

[00:10:53]They didn't build a company. And that's what's missing in the Australian stock market. We don't have large entrepreneurial uh startups which are going into the market to meet the opportunity in the Asian market. So how do we fix it? We have to drive capital into ingenuity into innovation.

[00:11:12]See the opportunity and say okay it's great that we got resources. It's great that we got energy. It's great that we got a strong financial system. And I know Michael's going to talk about private credit shortly, but it's great that we've got a a strong system, but what else can we do in this sector? And um we're not thinking and we're not supporting entrepreneurs. So we are stuck.

[00:11:32]>> Yeah. Michael John uh spoke about private credit. What's I know you keep a a close eye on what's occurring. What what is occurring in private credit markets and is it concerning you?

[00:11:46]>> Yeah. And and we've got to go into the detail a little bit here because private credit isn't private credit. Um but broadly speaking, it it's funny. I was sitting in front of the computer a month and a bit ago and I was about to do a little LinkedIn post and basically so I think we're in the beginnings of a you know mini GFC and private credit and I went uh no I just won't post it um because you know I was just just sort of thinking and you often you write things and delete them or um but the reality is that we go back a step why do we have this big private credit market we have this big private credit market and it is massive it's gone from I think 35 billion to um I think it was the 350 billion in Australia alone and in the US, it's, you know, I think something like a $3.2 trillion credit pool now.

[00:12:31]And I think we've got to sort of go, well, why does that exist? It exists because, uh, we pulled banks out of the types of sectors they used to be in. So, we pulled banks through, uh, regulatory reform post the GFC. We pulled all banks globally out of um, this sort of uh, construction lending, land holding lending, um, bridging lending, and um, small business lending, right? We pulled them all out of that. and the capital just simply went into less structured arrangements which are private credit that you have smaller credit teams, you have less infrastructure and resources managing the same sorts of debts. Now in the US, private credit is a broad catch all for anything the bank's not doing.

[00:13:09]Private credit in Australia is for the most part linked to property assets. Um, so we're seeing uh, you know, gated funds and so funds being closed to redemptions in the US because investors are getting wind of potential risks being higher than they thought they were or chance of loss being higher than they thought they were and they're drawing all the money out. And that drawing the money out when you're invested in an illquid position forces the fund to close redemptions. You know, they can't force the borrower to repay early. So, they just have to stop redemptions. And it's very much a private credit like a lot of things in markets is a self-fulfilling prophecy. If you think there's a problem, you'll make a problem by taking the money out. Um, and if you don't have the capacity to complete an a project and they can't refinance somewhere else, you get a credit freeze, which is exactly what happened with the GFC. Um, so what we're seeing is uh that's the background. We head to Australia. Um, asex been concerned for some time that there's no real standard as to what you disclose and auditors having had their own issues are also concerned around there being a lack of standard as to what is an impaired credit position, what is not, what is the unit price of a loan. Is it accurate? Is it not? Um, and picking that through and trying to answer it, um, very much creates the big problems that they hope to solve. It creates nervousness. It erodess confidence.

[00:14:32]confidence means lost confidence means redemptions. Redemptions mean freezing which means you know uh not being able to advance further capital to to projects. Um so it's nicely put as a mess and as has always been our sort of view around private credit. It's a high yielding asset class but you have to really know exactly what you're investing in. Um and if you're not getting clear answers from the manager you're working with you shouldn't do it.

[00:14:58]I'm reminded, Michael, you you might be a little bit young for this, but John is my age, so he would remember. One of my first jobs at Westpak Financial Services was uh being involved in the closure of a series of property trusts because there was a run on redemptions. And I remember our CEO David Morgan going to Bob Hawk and Paul Keading and asking for the government to put a moratorum on redemptions so that we could uh manage over a period of years the um you know the the redemption process and uh you know property trusts were frozen for I don't know I can't remember 3 four years while that process. So we've seen it all before.

[00:15:45]I'll give you a more recent example. Um you know when the government during the GFC uh you know the government moved to guarantee the banks you know we introduced the deposit guarantee no such guarantee was offered to mortgage funds.

[00:15:57]So what happened um every man in their dog with immediately redeemed from mortgage funds they all became frozen.

[00:16:02]Mortgage funds are now mud as far as talking to any investors. But I mean they've been around for decades. They've grown. They're now called private credit instead of mortgage funds. Um and the same thing happens. you you basically kill them through redemptions.

[00:16:15]Ultimately, what happened to um I think one of the largest land um malls or um uh what would you call it like a a Westfield equivalent was that they were simply unable to roll over their loan.

[00:16:26]Their loan was maturing. They went under. There was nothing fundamentally wrong with the business. It was just purely that the private credit providers or the mortgage funds as they were called then had redemptions, had to meet them. Also had a a term loan ext um you know completion. And a lot of this is a I'm not going to say it's fiction, but it all very much is just whatever's written down. I mean, like you sort of this is the problem that auditors and and asset have with unit prices. Is a borrower in default? Well, if they're paying their interest, but their loan expires, well, then technically need to pay it back. Well, how do they pay it back? Sell the property or refinance?

[00:16:58]What if they can't because there's no one else to lend to? But they're otherwise paying their interest. What's the unit price? Is it a dollar? There's nothing wrong with the asset, but the loan's expired. the fictitious loan maturity date has completed.

[00:17:12]Well, then do I discount it? It's those gray areas, >> very gray area in valuations of uh private private credit funds and uh and private debt funds. Um John, just to bring it back to um kind of more recent market movements last night, you would have seen uh so we've had a the second quarter reporting starting in the US.

[00:17:39]The banks reported stellar results in the first week.

[00:17:44]This week it's the turn of the uh the hyperscalers and I think Google's results came out last night and we saw for the very first time negative cash flow because they are using so much of their capital to invest in uh new data centers. It's actually went backwards by $6 billion over the quarter. Very very unusual. Um, and I guess the jury's out on whether there is a realistic prospect of uh market related returns on this 3/4 of a trillion dollars that's going to be invested. Uh, the market is kind of in a wait and see period. Is do you see it that way or do or do you think it's just um you know uh suspending judgment and marking time and and being really sensible um with kind of uh slightly depressing the valuations that we saw earlier on in the year. Well, we've been talking about the cash flows of these big American corporates for quite a while. So, you can go back and look look at the views and we've been flagging this as an issue. Um it obviously comes into sight when you get your quarterly updates and I think we also had Tesla with negative cash flow last night but I don't think that's rare for them. Um look I think uh given what Michael said about private credit the worldwide uh magnification of issues which are developing and the American private credit market is very much corporate lending against cash flows and investing. Um it's probably not appropriate to raise capital on that basis to invest in long-term investments. uh sorry raise debt, it's probably more appropriate for that to be funded off the off the uh capital side.

[00:19:32]Now companies like Google have immense resources um and they do have excess cash. So it's not as if they're borrowing, they're just drawing down their cash. But it is interesting that it's negative. Uh and as you said, the question is what's the return? And no one knows. um given the multiples that some of these companies are trading at and you do what I call earnings yield and cash flow yields, they're not very big hurdles for them to improve their returns in terms of cash because the market gives them a very high rating and they don't that's therefore their hurdle to beat the the the ratio which is the um cash flow ratio cash flow yield is not that high. But when you see negative then it does send shock waves through.

[00:20:15]Now it's shortterm. It may may change in the next 6 months. So let's not get too caught up in it. But it is a warning shot which we've been reflecting. Um but there's other warning shots and we talked about AI last week and this development of Kimmy which has come out this week and there's revelations now that Open AI has led out a I don't know what you call it a bot.

[00:20:37]Let's call it something. It's not a virus but it's it let out a bot last week and it attacked a website. Um, and then if you read the Finn Review this morning, um, and this is Microsoft, uh, I guess, um, they're saying, well, that sort of thing has happened in America, it's almost like it was it was a deliberate strategy to release this AI upgrade, let it go into the market, let it attack a website, and then say, "Oh, that's what could happen if China was allowed to join the American AI sector at Frontier Solutions." And call it a false flag.

[00:21:13]>> It's called a false flag in a false flag in conspiracy circles.

[00:21:17]>> Well, that's what we Yeah. Was it deliberate? Was it intended to make a point or was it a true, you know, escape of an AI solution? I I I'm just sitting here and I'm not I I I'm an old guy watching all these developments. I'm just scratching my head. Um it's been a very big week in AI because we've got China catching up dramatically. We've got massive now we've got reports that American companies have gone to negative cash flow to try and stay at the frontier of AI. Um there are issues developing and we we're all exposed and Australia superanuation funds have piled a lot of money into the American equity market and as Paul said earlier it's performed very well so you can't knock it but is it sustainable and are we hitting road bumps and that's not even to speak about what's going on in in Iraq sorry Iran in the straight the oil price the inflation surges coming through the weakness in the bond market I mean this is a extreme extremely volatile situation on a whole lot of levels and um >> you know private credit as you talked about Michael negative cash flows high pees super profits from the financial system of America which are really oneoff and they're you know quite uh deliberately contrived to support excessive prices in the AI market. I mean, I just sit here and go, uh, this is a little bit hard, you know, and look, a year ago, we're all chasing yield and saying, look, if I get eight or nine% yield, what do I need to bother? Well, now even that yield's been contested because it comes with risk. Um and all of a sudden the Australian share market taking your point uh Paul earlier 1% capital gain let's say the the yield about 4% total return like that's half a percent below what the 10-year bond yields you know it's not an attractive outlook on a whole lot and a lot of uncertainty developing so I don't want to alarm everyone but you just watch this go on and >> to to extend that John the drivers of the GFC being the need for yield has not gone away you know the demographic shift of more and more people heading to retirement, baby boomers heading to retirement and and seeking income is one of the principal drivers of uh of of these um you know many of these outcomes. You know, we clamped down on what lenders are a able to do. So, they went off into other sectors and investors followed them. Um you know, why are these guys running negative um cash flows? Well, because from a shareholder perspective, when I can get debt so cheap, why would I give away equity and be diluted, right? So, um, so long as they're able to make the payments from their existing cash reserves, which of which they have plenty, um, you know, it seems to be a smart play. And again, they're just responding to markets seeking more yield than they are growth. Um, and I think, you know, we we'll close up in a second, but when we go to solutions here in Australia, none of these solutions are comfortable, right? So if we look at one of the single biggest things we've done that's detrimental to our economy in the long term is we've locked up a significant amount of personal talent of labor force talent into the government.

[00:24:22]So we have one of the highest rates of employment in public service as a percentage of our overall labor force. I know a lot of these people my wife worked with them for a long time. I've still got lots of friends there. They're very very smart people. Their productive capacity is being sucked into government and taken away from the real economy.

[00:24:38]Now, it's not a popular thing to say we should cut public servants. It's not about cutting public servants. It's about taking the talent pool that we have in our country and and assigning it to productive tasks because almost nothing that's being done in government is productive for the economy from a growth perspective. But if we take such a large percentage of our workforce and suck it away into blithering reports on reports on reports and putting 11 billion aside to build 700 houses, then you're stuffed when you start looking for that productive capacity need in your economy. The entrepreneurs and people we need are actually employed in public service in if you ask me. There's some young talented people there that should be in the real economy.

[00:25:17]>> Yeah. But they're they're swamped by the No, but they're swamped by the political imperative to be reelected. And it's quite clear to me that the government and the cabinet, they dictate to the bureaucracy, this is what we want to do.

[00:25:33]Now you fiddle with your numbers to justify that direction. And you and it's being questioned now some of the reports and the backgrounding by Treasury and other departments to healthcare education to support initiatives coming out of the cabinet room and you don't have to read about two pages. No, this is just nonsense and it flows through the budget. You know we the budget is just the nonsense. You know we're talking this morning I give you a number. In the next 10 years, the Australian government will collect about $10 trillion in taxes and revenue. So when people talk about 10 years, let's get real. It's a massive amount of money the government gets. And then you get a minister coming out this morning saying, "Oh, we're going to allocate $20 billion more to the education system over the next 10 years." You go, "Well, that's nothing." You get $10 billion of re10 trillion dollars of revenue over 10 years, $20 billion allocation and they put it out there as if it's some sort of vote gathering. Oh, it's a lot of money, but it's it's extended over an excessive period, you know, and then some bure bureaucrat will be told, can you just write a report justifying what I've just said and saying it's fundable, you know?

[00:26:42]That's right.

[00:26:42]>> That's where we go back to where we started. Oh, sorry, sorry, John. If we go back to where we started, um, Paul, where you said, you know, there's this correspondence from these labor guys saying, "Hey, we've got a real problem with the economy." The problem is not identifying the problem. The problem is the solution. If the solution becomes coming out of this conference here in Australia, you know, in South Australia, wages growth is stalling because big business are robbing the poor and the only way we're going to fix that is some sort of god-awful labor control or some further, you know, pressure on business to to pay more to to fewer people, we're not going to fix anything. we're just going to drive more entrepreneurs and more business people offshore.

[00:27:18]>> But so to me, it's not identifying the problem. It's what are the real solutions.

[00:27:23]>> We're going to have to end it there, gentlemen. I'll just uh end with an observation. the um the highly regarded Loey Institute uh released its 2026 uh poll where they ask Australians about uh whether they're optimistic or pessimistic about prospects for the Australian economy over the next 5 years. And a recordbreaking 60% of Australians are pessimistic about prospects for the next 5 years. This is higher than at any time in the pulse history including during the pandemic and the GFC. So something is going wrong somewhere. Anyway, we'll have to leave it there. Gentlemen, thank you very much and we'll continue with our discussions next week. Cheerio.

[00:28:16]>> Thanks. Thanks everyone.