13 June 2023
Huge Chinese economic slowdown will be bad for Australia
Nobody believes Chinese official growth statistics, but certain observations cannot be hidden:
There is a Chinese housing collapse with large construction businesses either broke or struggling to survive and with millions of contracted apartments unfinished or in many cases not commenced despite part payments. Many Chinese buyers are reported to have ceased making payments. Much new building is in cities with insufficient industry to sustain employment for the intended population.
Local governments, whose income is largely generated by sale of land to developers, are experiencing extreme financial traumas.
Construction projects are slowing and with it the demand for Australian iron ore and coal to make steel. Our iron ore price has fallen sharply, and hence tax revenue will reduce sharply.
There are estimates of 20 percent youth unemployment in Chinese cities. Many recent university graduates cannot gain employment. The Chinese population has begun to decline in number and increase in age. We can look at the example of the negative impact of similar trends which began in Japan a generation earlier. One effect was that the overheated Japanese stock market of the 1980s stagnated for the next 30 years and wealth was destroyed in the collapse of the property market.
The proportion of US Asian imports from China has fallen relative to other countries in the region and there has been an overall reduction in shipping and use of shipping containers between the US and Asia. Both the US and Chinese economies have weakened.
President Xi’s challenges lie at home not in Taiwan—an invasion of which would multiply China’s economic troubles. Aside from that, an invasion of Taiwan faces huge difficulties.
In World War 2 the Americans had to decide between the alternatives of capturing Okinawa or Taiwan, then known as Formosa, as a final prelude to invading the Japanese home islands. One of these was needed to provide a forward base for allied forces including airfields and fleet support anchorages to support the planned invasion of Japan. Despite the vast forces at the ready by 1945, they concluded that Formosa was beyond their capacity and mounted a massive air, sea and land force operation to capture Okinawa including the largest concentration of aircraft carriers in history supported by other warships of every type plus a vast number of transports. The British fleet freed by Germany’s surrender also joined the operation. The sea, air and land battle was enormously costly. Shortly after, the USA successfully tested the atomic bomb, and used it on Hiroshima and Nagasaki whereupon Japan surrendered. We can be certain that the Chinese military have studied the battle for Okinawa, taken note of the massive forces involved and the reasons why the Americans concluded that seeking to conquer Formosa/Taiwan presented insurmountable difficulties. I expect that President Xi will continue to berate and threaten Taiwan but remain too wise to actually invade.
The US dollar will retain its preeminent position in the global economy
Attempts by the BRICS countries—Brazil, Russia, India, China and South Africa—to attract support for a rival currency to dethrone the position of ‘King Dollar’ in international trade are facing insurmountable difficulties. According to the Society for Worldwide Interbank Financial Transactions, the dollar is used for 42 percent of currency transactions and the Euro 32 percent; but the Euro has much less use outside of Europe and part of North Africa. The Chinese yuan has only 2 percent use outside of its domestic economy. The leading BRICS countries, China and India are not likely to ever agree to a location for a BRICS central bank in the other’s country. The BRICS countries cannot magic up an alternative international currency to rival the dollar.
I recall many years ago visiting Turkey. The merchants in Istanbul’s Grand Bazaar were most anxious to haggle in US dollars or Euros. When bargaining the purchase of a leather coat the ever so polite merchant became much more engaged after he had confirmed that we were willing to transact in dollars. Nobody was interested in hoarding the Turkish currency which was subject to astronomical inflation. Turkey has negligible public services and welfare is dependent on extended family support, and functions on a cash economy of dollars and to a lesser extent euros. Central government revenue is based on fuel tax easily measured at the refinery and visa charges. I observed that the myriad of small businesses operated strictly on a cash basis, mainly in dollars and euros. Items such as cash registers and EFTPOS terminals appeared to be non-existent. Staff were employed on a commission basis. A purchase was taken to the counter to be wrapped and a ticket with the sales person’s name was attached for the owner to note their commission. No wage records, no sales records, no payroll tax, income tax or sales tax records. A great deal of the world similarly functions in cash economies.
Australia’s home building crisis
A large number of builders have entered bankruptcy. The primary reason is the impact of inflation on the price of building materials and labor on building costs set against fixed price building contracts. Many personal tragedies are involved among builders and those with partially built homes.
A nationwide shortage of housing is being swamped with stepped up immigration, a shortage of tradespeople and vast amounts of regulatory state and local government red tape slowing building approvals. Everybody agrees that greater building density is required in inner city areas but not in their particular suburb.
Conversely there are vast numbers of spare bedrooms across our major population centres. Incentives favoring downsizing are swamped by selling costs of existing homes and stamp duty on new home purchase. Not a lot of older people are willing to lose substantial sums in transaction costs of agent’s commission, advertising, stamp duty and conveyancing to move to smaller dwellings. As a rough rule of thumb, transaction costs eat up about 10 percent of the average value of a house being sold and the replacement dwelling being acquired.
Building products companies are substantially impacted by the reduction in timely home completions.
Just how the expected huge number of immigrants anticipated over the next two years are going to be housed is a mystery.
Costs of energy transformation are proving vastly higher than hoped for
It is not as simple as harnessing solar power. The cost of establishing large solar farms on remote land not required for agriculture and transmitting that power to areas of major usage are enormous. Nor are farmers keen to have huge electricity pylons spread through their paddocks nor do environmentalists look kindly on swathes of forest being bulldozed to make way for transmission lines. Lost in much of the emotive debate over green energy are the costs of the huge infrastructure build required, including building sufficient storage/firming capacity. Industries dependent upon high energy inputs from both gas and electricity are very vulnerable. Promises of lower household energy bills are proving to be political fantasy. Ultimately jobs are at risk.
Reserve Bank of Australia had to lift interest rates
When governments cannot adequately restrict their spending and carry out expansionary wages policies, inflation is the result. Higher energy costs due to reducing coal fired generation before there are sufficient renewable power sources are also inflationary. In the absence of political will to control spending i.e. fiscal policy, the Reserve Bank is forced to use monetary policy to stop inflation from exploding. It does this by forcing up interest rates to reduce economic demand and by selling down its stock of government securities as well as not rolling over securities as they mature thereby sucking money out of the financial system. This is referred to as quantitative tightening. We now have increasing interest rates and quantitative tightening with which the Reserve Bank is hoping to fulfill its statutory obligation to contain inflation which currently is well above the target range.
Question: Why control inflation?
Answer: because left unchecked inflation ravages industries and destroys jobs.
Money basics: Personal opportunity cost.
Opportunity cost is the value of the best foregone opportunity.
Consider a high-income earner with a marginal tax plus Medicare rate of 47 percent who has a home mortgage rate of 6 percent has the opportunity of reducing their home loan or subscribing to an investment opportunity. To achieve the same benefit as reducing their home loan they need to earn a safe 11.32 percent pre tax to end up with 6 percent in hand. That 11.32 percent is their opportunity cost.
A person or a couple with a lower marginal tax rate has a lower break-even point. The opportunity cost for this individual/couple is lower.
A self-employed health professional has the opportunity of making tax deductible superannuation contributions for themselves and their partner of say $25,000 each and their superannuation balances are each well below pension account limits. They also fall below superannuation surcharge limits. Their contribution tax is 15 percent payable from their superannuation account. What is their net benefit? They also have modest non-tax-deductible home loan with interest costing 6 percent per annum.
Their choice is whether to contribute the super and claim the tax deduction or choose to elect to receive maximum after- tax income taxed at 47 percent including Medicare levy of 2 percent and accelerate home mortgage repayment. Each marginal dollar will produce $0.53 after income tax. If instead it is paid into superannuation each dollar produces net $0.85. $0.85 is appreciably greater than $0.53. However other factors may be relevant such as a need to reduce their mortgage to enable a trade up to a larger home to accommodate a growing family.
If the individual’s income was much larger and their superannuation contribution was wholly or partially subject to the superannuation surcharge the net amount of superannuation benefit may be as low as 70 cents per marginally taxed dollar. Or in some cases with sound tax planning one partner’s superannuation contribution is subject to surcharge and the other is not. Their average net superannuation benefit is then 77.5 cents per dollar of tax-deductible contribution.
Strategies for the times: Australia facing slowing economy—possibly amounting to a recession
Those who have home mortgages and have the capacity to liquidate other assets to reduce it should do so.
Do not assume that the interest rate cycle will begin to ease in the near future. The RBA has to reduce inflation and this will take time; longer if government policies keep adding to inflation. Hence now is the smart time to tighten household budgets.
The share market is unlikely to boom when many investors are being squeezed out of cash. It is best to maintain substantial cash/fixed interest allocation in SMSFs. Convert industry super fund strategies to conservative investment options. Do not believe the television advertisements touting historical returns. Returns are likely to be much lower than the historical numbers featured in the advertisements. We have well above 50 percent of assets in our family superannuation fund in cash and bank hybrid securities (classified as interest bearing securities). The bank bill swap rate which is a key component of the return on bank hybrids has followed the rising trend of interest rates. Cull share market portfolios and reduce or eliminate poor performed companies—but remember it is essential that individuals become familiar with accessing company financials and updated trading reports. Look up ASX stocks and access their financials. Seek help if they are unclear to you.
If you have a self-managed superannuation fund (SMSF) review the administration and advice costs. We utilize Campbell Thompson of Ord Minette as investment adviser and Heffron as administrator responsible for compliance. There are many other firms providing these services and while I am under no obligation nor incentive to recommend any, it is appropriate to disclose the services that we use for our family superannuation fund.
For those who have a home with a substantial mortgage and a residential rental property consider selling the rental property and reducing the home mortgage. Take advice as to realizable value of the rental property after selling costs and allow for the capital gains tax which will only apply to half of the net gain if the property has been owned for more than 12 months. Then calculate the savings on your home mortgage if the net realizable amount is fully applied to its reduction. Factor in expected increases in interest costs, particularly if you had a fixed mortgage commencing at the recent period of extremely low interest rates. Then sleep easier at night.
For those in professional practice or small business it is time to review all costs. Belt tightening is past due.
Synstrat Accounting is having client work prepared by accountants based in India.
Some accounting practices with staffing difficulties are having the preparation of accounts done in India (and possibly elsewhere) but presenting it to clients as though done in house, albeit that a partner has to sign off as tax agent. There may be a huge saving in staffing costs accruing to the partners without their clients realizing what is occurring! The Synstrat Group are known to have experienced significant staffing difficulties and are sourcing accounting support off shore. Their manager was reluctant to talk about it when asked. Good business practice requires that accounting practices using off-shore staffing must advise clients as a matter of proper disclosure. There are likely to be significant cost savings compared to Australian staffing costs. Industry talk is that various other accountants are also having work done off shore. Clients should ascertain where their accounts are being worked on. They should demand a statement of costs and passing on of savings.
Financial Success for Dentists
Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owning their own practices and for those aspiring to own practices. Among the topics included:
Understand key practice valuation criteria.
Learn how some dentists inadvertently reduce the value of their practice by $500,000
Avoid long term errors when purchasing your practice.
There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value.
I spent 33 years examining dental practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners.
A complete and comprehensive career guide for mature and aspiring dentists. Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school.
—Merv Saultry, Founder Dental Innovations Network
To Obtain a Copy:
Go to the Delany Foundation website at http://www.delanyfoundation.org.au
Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.
Email graham.george.middleton@gmail.com confirming that your donation has been made, as well as your name and mail address
A copy of the book will be mailed directly to you
All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome.
The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive.
Please Pass On
If you like these newsletters, please pass them on to colleagues. Past newsletters and articles in Australasian Dental magazine on business issues are at grahammiddleton.com. I can be contacted directly at graham.george.middleton@gmail.com
Independence And Disclosure
I am not a representative of any accounting practice, financial planning firm, business or marketing consultancy. I spent 33 years as a business and financial adviser to mainly dental, medical and veterinary specialist and general practitioners. Since I retired as a director of a financial services group, of which I had been a founder, on 30 June 2020, I am no longer licensed as an investment adviser. Readers should treat the above as general advice and take professional advice as required.
General Advice
The above is ‘general advice’ and individuals are urged to undertake considerable personal research of companies in which they are investing as well as demanding of their advisers that they tailor advice toward their best outcome after demonstrating an understanding of their position in detail. Be cautious about accepting advice unless you are certain that your adviser has a thorough knowledge of your situation. If in doubt the best decision is often to make no investment changes.
I sold my interest in a financial services and accounting group on 30 June 2020 and have no intention of starting another financial services business. I own, via my family superannuation fund and investment portfolio, some of the stocks mentioned in this newsletter. My website is now available at grahammiddleton.com.
Those who find my newsletters of value to them are asked to consider making a donation to the Delany Foundation, a registered charity which assists schools in Papua New Guinea, Ghana and Kenya. Delany Foundation c/- Holy Cross College, 517 Victoria Road Ryde NSW 2112.
Best wishes to all readers
Graham Middleton
