One of the world's leading hedge fund managers has warned that economies dependent on China for income, including Australia, are headed for recession, and central banks will not be able to able to come to the rescue because they have exhausted the arsenal of policy weapons.
Crispin Odey, who is the founder of London-based Odey Asset Management, has taken a number of short positions on Australia since adopting a bearish view of China's growth outlook.
He is short stocks Genworth Mortgage Insurance Australia (GMA, Financial) and Fortescue Metals Group (FMG, Financial), indicating that he expects the share prices to fall, and he believes the Australian dollar is headed for further losses. He said Australia's banks could have a "bad time time ahead of them."
"China is everything to Australia in lots of ways," Odey told The Australian Financial Review.
The world's second-largest economy was eroding its competitiveness, and its capital accounts were vulnerable to outflows as Chinese policy becomes more accommodative. "We've got a very old-fashioned recession, which is spreading across the world."
First impact already evident
The first impact was the hit to income, followed by the decline in capital expenditure and rising unemployment. All three trends are already evident and have prompted the Reserve Bank of Australia to cut interest rates to a record low 2.25 percent this year. Australian banks faced a tough time ahead, too, because of indications bad debt risks would rise.
"The only thing you can do in those countries as you're seeing in Australia is you're cutting interest rates," Odey observed.
"Frankly, it's a demand problem."
This is complicated by the prevalence of quantitative easing (QE), or large monetary stimulus, elsewhere in the world which has pushed share prices to record highs in spite of worsening economic conditions in many economies outside of the United States. The competing forces of QE and the threat of recession could set up a crash as "we're in the midst of a wonderful bubble."
Odey is one of several high-profile hedge fund managers to bet on Australia running out of luck.
Jim Chanos (Trades, Portfolio), one of of the world's largest short-sellers and a prominent China bear, has shorted shares Fortescue Metals and several local other iron ore and coal miners, a position he confirmed last year.
George Soros (Trades, Portfolio)' Soros Funds Management is also understood to have considered betting on a downturn by shorting mining services companies while in April 2010 Jeremy Grantham (Trades, Portfolio) of GMO branded Australia's property market a bubble, sparking interest in shorting Australia's banks that has remained ever since.
Big calls
Odey is best known for his big macroeconomic calls, including foreseeing the 2008 global credit crisis; piling into insurers in the wake of the September 2001 attacks; and picking the recent oil price rout. He famously paid himself £28 million in 2008 after shorting credit crisis casualties, including British lender Bradford & Bingley. Odey's fund returned 54.8 percent that year.
"The market's reaction to all of this is leave it to the professionals, leave it to those great guys, the central bankers, because they saved the day in 2009," he said. "These guys are kind of relying on central banks pulling a rabbit out of a hat."
The risk is that this time, monetary policy may be ineffective: "We need the crisis to reformulate policy. Central banks are not all singing and all dancing; they cannot basically avoid the natural consequences of what we are doing."
An inadequate supply-side response to the plunge in commodity prices as the resources industry declines to reduce production was in effect stimulating supply into falling demand.
"The trouble is today the players, whether they are the miners or the oil companies or the Saudis or anybody else, they are not doing the right things. This is the first time in my career where economics 101 doesn't work at all."
But it was also true that the world has not had a major recession for 25 years and thanks to frequent interventions, "there is a sensation we don't have a business cycle." Stocks are enjoying a six-year bull market, but he also hinted at liquidity issues bubbling under the surface.
"I just think that you and I have got grandstand seats here [to an imminent market shock] and my point is having found myself in the second quarter of last year selling a lot of equities and starting to go short, I found out just how illiquid it all was. You never actually see it until people try and get out of these things."
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