About 13 per cent of Australia’s economy is a gift from China. It wouldn’t exist without China guzzling resources and spewing out dirt-cheap consumer goods, the combined effect of which has been to make Australia’s exports a lot pricier than its imports over the past decade.
In economists’ lingo, Australia’s “terms of trade” have exploded.
The terms of trade – the average price of coal, iron ore, natural gas and other commodities exported by Australia divided by the average price of cars, medicine, telecommunications parts and other goods and services it imports – are about two-thirds higher now than the previous 100-year average.
The good times may now be coming to an end — unless India can deliver.
A shipload of Australian iron ore can still buy about 22,000 flat-screen TVs, compared with 2,200 just five years ago, but the gap between exorbitant commodity prices and ridiculously cheap consumer goods is beginning to narrow. “Australia’s terms of trade have peaked,” the Reserve Bank of Australia said in its April 3 monetary policy statement.
The big bet in currency markets is that Australia’s exports will progressively command less of a premium. Gerard Minack, a Morgan Stanley strategist, is forecasting a 4.5 per cent annual decline in Australia’s terms of trade through 2016.
A tired argument against the end of Australia’s resource boom is that per capita use of steel, aluminum, copper and other industrial metals in fast-growing countries like China and India is still low. In 2010, China’s per capita steel consumption was 15 per cent less than Japan’s. South Koreans consume twice as much steel in a year, on average, as the Chinese; Indians use about one-eighth as much of the metal as the Chinese. Surely, demand will continue to grow until consumption volumes have caught up with developed countries? Yes, in the long run. But developing-country demand is not a rubber band: it’s not that it will keep expanding irrespective of how expensive such consumption becomes.
“For commodity consumption to increase globally, prices need to come down,” Citigroup analyst Heath Jansen and his colleagues noted in a recent report titled “Super Cycle Sunset”.
Sensing that the terms-of-trade bounty won’t last forever, as it indeed never has in Australia’s history, the rational response of Australians has been to bank China’s gift cheque, and not splurge it on a second vacation home or a new BMW.
Are Australian households being too pessimistic? There’s, of course, the big question of whether India will take China’s place at the table, now that it has reached a per capita income level at which steel demand for autos and homes can grow exponentially. But the trouble with India is that the economy’s capacity to sustain economic growth above eight per cent for even three straight years is hampered by various supply-side bottlenecks, which make such growth inflationary.
Clearing up the clogged arteries of the Indian economy will require massive investments in large infrastructure projects, which are not getting off the ground because of the government’s own weak, debt-ridden balance sheet and a considerable slowdown in bureaucratic decision-making amidst a barrage of corruption scandals. The next commodities boom in Australia may indeed be fuelled by India’s hunger for raw materials, but that may happen only in the next decade.
Another way in which India can sustain Australia’s terms-of-trade advantage is by helping keep a lid on prices of manufactured goods Australia imports.
The end of cheap China looms. The world’s second-biggest economy is running out of workers. It will eventually allow faster wage increases and quicker currency appreciation, vacating its dominance over swathes of low-end manufacturing and assembly operations. Some of these businesses will relocate to Vietnam, Bangladesh and even Africa. But the single largest source of relatively inexpensive workforce is still India, whose dysfunctional politics is coming in the way of the country emerging as an industrial powerhouse. By allowing a plan to create Shenzhen-style manufacturing hubs to degenerate into a land grab, India has shown that it is not yet ready to be the factory of the world.
While Australian households have for several years now been preparing for life after the end of the current commodities boom, it’s only now that miners and equity investors are waking up to the possibility. Investment in natural resource extraction in Australia is growing even now and may not stop before reaching an unprecedented six per cent of GDP, according to the central bank.
Asian stock markets saw a nervous sell-off on March 20, after mining company BHP Billiton said that China’s steel demand had “flattened”.
Contrast the jumpy behaviour of investors with the prudent foresight of the average Australian. For four years now, there has been little change in Australia’s household debt as a ratio of its income, Mr Minack of Morgan Stanley notes.
There could be several reasons for that. The global financial crisis may be making workers cautious about spending, especially on housing. Confidence may have also ebbed because of a “resource curse” effect: the mining boom has led to a strong Aussie dollar, which has made tourist destinations like Gold Coast more expensive for foreigners. The rout of the Labor Party in last month’s Queensland provincial elections reflects some of the angst against the hollowing out of non-mining businesses.
But it could also be that the average Australian has more faith than economists in repeated promises by the leadership in Beijing that the Chinese economic model is going to be re-tooled, and that export- and investment-led growth will give way to a more domestic consumption-oriented and less resource-intensive economy. The oversupply situation in China’s residential real estate is scary. To bring demand and supply back in balance, the present leadership in China won’t let up on its resolve to drive down property prices. That, of course, does not augur well for commodities demand. It might also be that Australian households have highly rational expectations about India’s unpreparedness to take the baton from China and run.
Unless India can quickly get its act together, Australia’s boom is on its last legs. Households in Australia saw the inevitable end some time ago. It’s time for mining companies and investors to smell the coffee.
The writer is a Singapore-based financial journalist.
This is the first of a monthly column he will write for Business Standard. These views are his own