Australia Has Much to Teach Us

05/02/2011 1:58 pm EST

Focus: STOCKS

Josh Peters

Editor, Morningstar DividendInvestor

Beyond commodity riches, the country benefits from tax and pension rules that reward savings and dividends, writes Josh Peters of Morningstar DividendInvestor .

Australia has a lot to teach Americans—both investors and companies—about the way the stock market is supposed to work.

Australia isn’t just on the other side of the world. When it comes to the way investors interact with the financial markets, Australia might as well be on a different planet.

Nothing during my recent trip made a bigger impression on me than the dividend yield of the Australian stock market: 4.25% as of late March. Seems like a place worth getting to know.

A high yield cannot turn a bad business into a good stock, and the same logic applies to countries. If Australia had a big structural trade deficit, skyrocketing government debt, utterly incoherent political leadership, persistently high unemployment, nonsensical regulation of its banking system, and a monetary policy that a third grader would laugh at, a fat yield alone probably wouldn’t be enough to get me interested.

But if the problems listed above sound familiar, it’s because they apply to the United States, not Australia.

Australia, like America, is blessed with an abundance of natural resources. Unlike America, though, only about 22 million people share directly or indirectly in this wealth, while our 310 million-plus souls are forced to import half of our most important resource (oil).

Australian unemployment, which peaked at only 5.8% during the global recession, has already retreated to 4.9%. These facts alone might seem like a sufficient prescription for prosperity, but as a nation, Australia has handled its blessings with prudence and restraint.

Measured relative to gross domestic product, total government borrowings are a fraction of US levels. [Debt-to-GDP was at 22% of GDP for 2010, versus 59% for the US, according to the CIA World Factbook—Editor.]

Land of Real Interest
Even as America robs its savers with negative interest rates after inflation, a one-year, government-backed term deposit in an Australian bank pays 6%—and inflation is running at only 3%.

No economy is without problems, and Australia’s proximity to resource-hungry emerging economies in Asia is regarded rather nervously. (What if China cracks?) Everyone I asked thought the Australian dollar, which now costs $1.05, is overvalued. Maybe they’re right; historically, the long-term exchange rate has tended toward the $0.75 to $0.85 range.

Then again, maybe it takes an outsider’s perspective to see just how good the Australians have it—particularly when compared with their profligate cousins in the US and parts of Europe.

Economic cycles in Australia are bound to track commodity prices, and mean reversion may catch up with the Australian dollar and everything that changes hands with it.

Yet the country’s long-term prosperity strikes me as the product of not just luck, but also thoughtful economic policies—the benefits (or rather, the absence of burdens) of which ought to outlast the current commodity boom.

Perhaps the starkest difference between US economic policy and that of Australia is the pension system. The idea of private investment accounts to replace Social Security has been floated in the US before, with all the popularity of the proverbial lead balloon.

NEXT: A Working Pension System

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A Working Pension System
I don’t know whether it would work here, but Australia did it decades ago with a system called superannuation.

Every employer must contribute a certain percentage of employee wages (currently 9%) to a private, portable, tax-advantaged retirement account that belongs to the employee. Employees generally have a wide choice of options for investing these savings, including self-directed accounts if they like, and they may add some contributions of their own.

A state-funded pension similar to our Social Security system is also in place, but unlike ours, it is means-tested with fairly low cutoffs—and therefore presents few long-term demographic problems.

What kind of a stock market would you expect if most people had sole responsibility for funding their retirement through investment accounts? You’d probably look for a lot more interest in dividends and a lot less tolerance when they’re obviously missing. Yet the Australians’ ardor for dividends doesn’t stop there.

Dividends Taxed Lightly
In the US, as in most of the world, corporate profits are said to be taxed twice—first at the corporate level, then again when they are distributed (either through dividends or capital appreciation) to shareholders.

Not so in Australia, where an imputation system called franking attaches a lucrative tax credit to most of the dividends paid to Australian investors.

Companies receive franking credits based on the domestic profits on which they have paid a 30% corporate income tax, which they cannot use for themselves but can pass along to shareholders along with dividend payments. A dollar of fully franked dividend income arrives with a tax credit worth 30 cents, which offsets the income tax the investor will owe.

In fact, an investor in Australia’s lowest tax bracket (15%) would actually get a 15-cent refund from the government, while one in the highest bracket (45%) would owe just 15 cents of additional tax.

This system gives Australian investors another big reason to demand dividends from their companies—and the companies the means to deliver that much more after-tax value to their investors.

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