Such are the well-documented achievements of the Australian economy in recent years. Yet over that time our economy has contained a time bomb that belies the complacency that has set in among the population and investors. This is the rarely-spoken-about pile of foreign debt that is the result of 40 years of uninterrupted deficits on the current account, which records a country’s trade in goods and services and its income flows with the rest of the world.

A current-account deficit can be viewed as a country’s savings shortfall that is funded by foreigners through the capital account, the other side of the balance of payments. (The current and capital accounts must add up to zero.) Current-account deficits are not bad per se if they are bankroll investment opportunities that will earn the foreign exchange that helps repay foreign capital. Until these borrowed foreign savings are paid back, they sit among a country’s liabilities as foreign debt.

There is a risk that, at some point, global investors would baulk at adding to Australia’s foreign debt, which stood at $852.8 billion on a net basis (after allowing for foreign loans owed to Australians) on 31 December 2013. This is equal to a record 55.5% of GDP, a high ratio by international standards. Net foreign debt exceeded Australia’s so-called net international investment liability position of $829.8 billion on that day. Our net foreign equity assets of $23.1 billion on that day explain the difference. (The December quarter marked the first time that an asset position was recorded on net foreign equity.)

These debt numbers show that at any time, Australia could face an economic crisis if foreigners became less willing to sending their savings. This is especially so as about 81% of our gross foreign debt of $1.63 trillion is held by private investors, while about 21% of this gross debt has a maturity of less than 90 days. That almost means about $340 billion of our gross debt needs to be renegotiated at acceptable rates every three months for Australia’s economy to run smoothly. What is happening to the most tormented of emerging countries and their currencies could easily be Australia’s fate. Many of these nations have lower foreign-debt ratios than Australia[2] and a falling currency only adds to a country’s foreign debt in local-currency terms.

Happily, the chances of a crisis erupting in Australia centred on its foreign-debt burden are now fading. Six liquefied-natural-gas projects (built at a cost of about $200 billion) are set to earn enough export income over the coming two decades to soon tip Australia’s current account into surplus, according to some forecasters. The optimistic predictions, if correct, herald profound benefits for Australia.

Australian indifference to its foreign debt (as distinct from the angst over small levels of government debt) is justified to some extent. There have been no signs that a crisis in investor confidence is brewing over the issue. Our stable and largely corruption-free politics, strong civil and legal institutions, relatively high interest rates and many investment opportunities seem to soothe any concerns foreign investors might have about Australia’s creditworthiness. But there was no forewarning of the current-account and foreign-debt crises of the mid-1980s that sent the Australian dollar below 50 US cents for the first time and prompted rating agencies to cut our credit rating. Net foreign debt was only about 30% of GDP when then-Treasurer Paul Keating in May 1986 warned that Australia was becoming a “third-rate economy, a banana republic”, though admittedly inflation at 9% and a federal deficit at close to 7% of GDP were higher then. No one can rule out a replay of the crisis of the 1980s, for net foreign debt above 30% of GDP is regarded as worrying. Foreign investors are fickle and no country can borrow endlessly.

Matching iron ore

If Australia does soon generate a current-account surplus over a calendar year, it would be the first since 1973 – the previous era when we enjoyed a boom in the terms of trade. (On a quarterly basis, the last surplus was recorded in the June quarter of 1975.) Just think, not even during the recent China-inspired export bonanza could Australia generate a current-account excess. Record commodity prices recently helped Australia notch trade surpluses from the June quarter of 2010 through to the December quarter of 2012 and again in the December quarter of 2013. But they were not large enough to overcome the deficit in income flows on the current account, which is where the interest payments on foreign debt are recorded. This huge income deficit basically means that past current-account deficits are the biggest cause of today’s deficits. The current-account deficit for the December quarter of $10.1 billion comprised an income deficit of $9.9 billion and a trade surplus of $247 million. Income flows include dividends, rents, interest payments and remittances.

Morgan Stanley Research and the Commonwealth Bank of Australia are two financial institutions that think Australia will be living within its means in no time, thanks largely to LNG exports reaching $46 billion a year by 2017 from $16 billion last year, by Morgan Stanley’s reckoning.

Morgan Stanley said that Australia is poised to overtake Qatar as the world’s largest LNG exporter by 2017 when energy exports (LNG plus steaming coal) will reap as much as iron-ore exports. “The ramp-up would be enough to see Australia record a current account surplus in 2015” (on a quarterly basis), Morgan Stanley said in December. “It is difficult to overestimate the long-term structural importance of this industry to Australia.”[3]

The Commonwealth Bank was no less emphatic in February when it forecast Australia to generate small current-account surpluses within five years. It calculates that higher export earnings and fewer capital imports to finance resource-related projects will boost the trade surplus. At the same time, increased earnings from Australian-owned foreign assets and low global interest rates will trim our income deficit. “Trade surpluses and smaller income deficits equal current-account surplus,” the Commonwealth said.[4]

While National Australia Bank expects the current-account surplus to reach 2% of GDP by 2017, not every economist is as optimistic, mainly because the income deficit will be so hard to narrow.[5] A current-account surplus is no cure-all anyway. Other problems can hobble economies or destroy investor confidence even for countries with current-account surpluses. So Australia could have an economic crisis triggered by some other malady or imbalance, such as, say, high household debt. A current-account surplus can sometimes signal that a country’s economy is struggling – many of the European countries in crisis are recording these surpluses now because imports have collapsed along with their economies.

But even talk of looming current-account surpluses has favourable outcomes for Australia. If these surpluses come to fruition the upshots are just more immense. A current-account surplus will make a high dollar the norm. Thus our living standards will rise, inflation pressures will ease, repaying foreign debt will be cheaper in Australian dollars and importing businesses will thrive at the expense of domestic ones. Interest rates will drop as the risk premium at which Australian bonds are sold over global benchmark (US Treasury) bonds tightens. So the economic outlook will be one more tilted towards growth and full employment (and housing and other bubbles). The chance of a crisis of confidence among global investors will recede, if they think Australia’s foreign-debt situation is less precarious.

One victim of a current-account surplus, though, could be the ability to garner widespread political support for the reforms that free-market advocates, business and aligned think tanks are seeking. After all, it typically takes a crisis to gain the public’s backing for measures that will hurt them in the short run. Concerns that Keating’s banana-republic comments would come true allowed the Bob Hawke-led ALP government within the same parliamentary term to announce steps to curb the federal fiscal deficit that would amount to $24 billion in today’s dollars, in an effort to boost national savings.[6] The recession of 1990-91 that Keating said “we had to have” was about the government tightening monetary policy to lower the current-account deficit by reducing demand for imports. Enough voters accepted the rationale for such drastic actions to re-elect ALP governments through this period. The political debate is largely limited to tackling Australia’s federal deficit, even though a crisis over foreign debt would be the quickest way to saddle taxpayers with astronomical debts. Financial corporations owe 53%, or $864.9 billion, of our gross debt and Canberra would need to back much of these borrowings in a crisis.

It’s a mystery why in the 1990s forex traders turned their attention to capital shifts rather than income flows and trade when setting the Australian dollar. Perhaps it was because the political fight narrowed to blackening only government deficits and debt. Current-account surpluses are sure to gain their attention and approval, though.

Nothing, of course, is guaranteed when it comes to the dollars tracked both ways through the current account. They are so large in both directions and so vulnerable to international political and economic events that forecasts easily go awry. The LNG export sales are written into long-term contracts that link LNG prices to oil, so these earnings are variable too. Even if current-account surpluses do eventuate, they will only trim rather than slash Australia’s pile of foreign debt. Australians could quickly boost their appetite for imports and live once again on foreign savings. After all, that has been the aftermath of each past export boom. But, hey, we’ll be right. No doubt when LNG exports are due to peter out, something else will be extracted from the ground to justify smug views of Australia’s economy.

Information on Australia’s balance of payments comes from the Australian Bureau of Statistics’ publication 5302.0, “December quarter 2013. Balance of payments and international investment position.” Released 4 March 2014. Other financial information comes from Bloomberg unless stated otherwise.

by Michael Collins, Investment Commentator at Fidelity