China sneezes, Australia calls an ambulance

To state the bleeding obvious, Australia’s economic fortunes are linked to the Chinese economy.

China is Australia’s largest export destination, with its export share having grown from around 5% in 2000 to 22% in 2009 (see below IMF chart):

And according to GMO, China alone accounts for nearly half of the world’s consumption of Australia’s two largest exports – iron ore and coal (see below chart).

The strong growth of the Chinese economy has sent iron ore and coal prices (amongst other commodity prices) soaring:

Which has sent Australia’s terms-of-trade (ToT) to its highest level for at least 60 years:

In fact, no other commodity exporter has benefited as much from the China boom as Australia:

The surge in Australia’s ToT has significantly raised national income, increased the Government’s tax take, and sent the Australian dollar above the US dollar. It has also led to a significant increase in mining investment, as mining companies look to build supply capacity (see below Australian Treasury chart). This investment, in turn, has also significantly boosted Australia’s GDP.

The importance of the China-led commodities boom on Australia’s GDP was recently summarised by the RBA Governor, Glenn Stevens:

As a result of the mining boom, Australia’s terms of trade have risen sharply, to be about 65% above the twentieth century average level, and about 85% above the level that would be expected had the downward trend observed over the twentieth century continued…

With the terms of trade at their current level, Australia’s nominal gross domestic product (GDP) is about 13% higher, all other things equal, than it would have been had the terms of trade been at their 100-year average level,” Stevens said.

And according to the Australian Treasury:

The terms of trade, and so mining activity, are expected to remain at historically high levels for an extended period…

Driven by the mining sector, new business investment is expected to attain 50-year highs as a share of GDP. This investment boom will be underpinned by a massive pipeline of resources projects planned for the next five years and beyond. The capital expenditure survey of the ABS suggests planned mining investment will reach a record $76 billion in 2011-12 (ABS 2010e). ABARES estimates that this high level of investment is set to continue, with an estimated pipeline of resource investment of over $380 billion (ABARES 2010).

The Treasury sees no end in sight for China’s strong growth and voracious appetite for Australian resources. Whereas China’s economy accounted for less than 5% of world GDP in 1990 and around 13% currently, by 2030 Treasury forecasts that China will account for just under a quarter of the world’s GDP (see below chart).

What could possibly go wrong?

While I acknowledge that China’s (and to a lesser extend India’s) industrialisation may hold commodity prices above their long-run average levels, prices will likely exhibit high levels of volatility.

Certainly, the past 200 years of commodity pricing confirms this view, with every price boom followed by a sharp contraction (see below chart).

And there are now early signs that China’s economy is slowing. On 13 May, UBS Global Economics Research released a report with two charts showing sharp falls in construction activity, steel consumption and electricity usage.

Here’s the first UBS chart:

And the second:

And here’s UBS’ summary explanation of the data:

Two days ago China released official nationwide property construction and sales data for April, as well as figures for sectors like steel and autos … and on a seasonally-adjusted basis many of the latest numbers look downright frightening.

You can see what we mean in the above chart. Total floorspace under construction (whether measured for overall building  construction or just for “commodity” buildings) peaked outright in January and has fallen sharply in the past two months. So have auto sales, which are now nearly 20% off November highs. Property sales peaked in November in volume terms and are declining sequentially since the beginning of the year. And after rising steadily for the last three quarters domestic steel consumption is now flat.

UBS’ research appears to be supported by the below chart from Capital Economics (via FTAlphaville) which shows China’s commodity import volumes falling in the face of rising prices:

According to Capital Economics:

There are already warning signs in the recent data. For example, China’s demand for imported commodities has weakened sharply. The value of China’s imports is still growing rapidly, but this is a reflection of higher global prices. Focusing instead on the volume data, China’s imports of many key commodities are actually falling outright. Chart 1 shows the April data, released on Tuesday, but the year-to-date numbers tell a similar story.

Finally, Business Spectator’s Karen Maley on Friday also reported on recent analysis that China’s economy is slowing:

Are fears about a looming slow-down in the Chinese economy about to overshadow worries about rising inflation?

That’s certainly the view of Jim O’Neill, the chairman of Goldman Sachs Asset Management, who believes that “the Chinese economy is probably slowing down more than people realise”…

China’s industrial output growth eased much more than expected in April, causing some analysts to worry that a slow-down in the world’s second-biggest economy is already underway. Other symptoms of slowing growth include weaker exports, a slump in residential property sales, and slowing car sales.

“It’s not surprising at all that commodities prices are coming under pressure,” O’Neill said. “The surprise is that they rose so much earlier in the year”…

Wang Jian, a researcher with China’s top planning agency, the National Development and Reform Commission… said that fixed-asset investment, which has been powering China’s economic growth, would soon run out of steam, because spending on new projects had fallen.

Australia on notice:

While it’s possible that this commodities cycle will continue unabated for an extended period, the weight of 200 years of history is against it.

If a sharp contraction of the Chinese economy doesn’t send commodity prices falling, it’s likely a flood of new supply from competing commodity producers will force prices lower.

The worst case scenario for Australia is a structural slowing in the Chinese economy even as rising supply comes on stream from the massive mining investment currently underway in Australia, Brazil and other commodity producing nations. If this occurs, then the assumed demand volumes that underpin all of those new mines won’t materialise. And even if we are shipping more that will not be enough to offset large price falls. All of the positive effects on employment, incomes, growth and the Government’s fiscal position received by Australia over the past decade would unwind.

As the UBS charts show, there are significant risks in China’s dependence on fixed-asset investment, its shift to a consumption growth model, and its politics.

A slowdown of the Chinese economy is, in my view, the biggest risk to Australia’s ‘miracle’ economy. Hence, authorities should at least entertain the possibility that commodity prices could fall abruptly and plan accordingly. China is not a one-sided bet. There are are grave risks.

[email protected]

Leith van Onselen


  1. Alex Heyworth

    A lot depends on the Chinese government’s response to the latest economic data. It is extremely unlikely that they will not react in some way. The question is, how much room do they have to manoeuver? I would like to see some good analysis on this issue – no doubt it will be forthcoming shortly.

  2. @Alex Hayworth
    “A lot depends on the Chinese government’s response to the latest economic data. It is extremely unlikely that they will not react in some way. The question is, how much room do they have to manoeuver?”

    I dont believe they are going to be able to do much. Last time in 2008 they didnt have an inflation problem this time they got a major inflation problem. If goods, food and gas continue to rise it will cause a massive hysteria of social unrest. I read something yesterday where there is alot of it already going on but the Chinese govt isnt letting the stories about it get out. If China pops then Australia, Brazil, Canada are royally SCREWED.

    I seriously dont think China or Australia are in for a soft landing. It might start out like that but will eventually crash like everyone else.

    • H and H,

      How do you figure that? Wouldnt all that money that the Chinese have printed be a major factor in their inflation. The Chinese have been running the printing press as well. I would think commodities going down would bring down a bit. It is a good point. Might be a good subject for an article.

  3. While it may take an extended period to move toward greater consumption by Chinese may become a boon for our troubled tourism, wine and dairy industries.

    Leith, was that 13% per annum growth being contributed by ToT at +85%? Meaning non-mining sector is negative 10% roughly?

  4. China’s economy is in the same cleft stick that Britain’s is, only it is in that cleft stick much earlier in its stage of “development”.

    The process of development from third world to first, requires urban land prices to be kept low in spite of the rapid urbanisation of the economy. Every city in the developed world, achieved this through “sprawl” and automobility.

    We have seen first world nations drag their economies backwards by imposing prescriptive urban planning, Britain being the most glaring example (one that we should have all learnt from long ago). But if a developing nation refuses to allow its people “freedom to build” and total freedom of movement, (for whatever reason), their economic growth will implode. Has everyone forgotten the Asian crisis of the 1980’s? China is going to do this long before it gets as developed as Japan or Korea did. Urban land markets actually had a central role in those earlier crises too.

    Alain Bertaud’s paper “Land Markets, Government Interventions, and Housing Affordability” is the best work I know of so far, that examines how the Chinese are mismanaging their urban land supply, and rampant corruption is forcing the costs up astronomically. India has a similar problem – in fact, I would say that these issues are one of the main obstacles to progress in most developing nations.

  5. The trouble with the long run commodities chart is that it is a line without explanation …even when you go to Macleans there is no explanation given. Personally I prefer to know how the charts I am looking at are constructed.

    With that in mind here is an RBA study:

    I think w.r.t. base metals, iron and coal this tells a more positive story and the narrative links price movements to industrial demand. …which doesn’t negate your argument, i.e. if China sneezes we WILL need an ambulance, just that this study provides more solid grounding than the Macleans chart, i.e. prices don’t fall because of gravity they fall for a reason.

    Also the RBA work give lie to the concept of a long run price, in base metals at least. When the punditry talks about long run they usually refer to the period post 1970, which is not long run, and corresponds to depressed prices. Historically the prices we see now are not unusual.

    • “Historically the prices we see now are not unusual.” This RBA chart showing Australia’s ToT since the 1890s begs to differ.

      That said, I agree with the thrust of your argument that commodity prices will continue to be supported as long as Chindia industrialise. Certainly Jeremy Grantham of GMO has expressed similar sentiments in his latest quarterly letter. But the road ahead will likely be rocky with mini commodity price busts along the way. I don’t think Treasury/RBA have fully acknowledged these risks.

      • Your RBA chart falls into the same category as the Macleans chart: lines without explanation. Do you have an RBA link for a discussion of it?

        Among other things I am focusing specifically on minerals/metals — because of the china story — and real prices. A ToT chart doesn’t tell you anything about the actual real prices of these commodities, it tells you about prices of all exports, incl. wool, wheat and so on, relative to prices of all imports, incl. iPods, $10 T shirts from K mart.

        So I don’t agree at all that the RBA chart begs to differ. It is apples and oranges.

  6. I was in China mid 2010 and what amazed me at the time were the vast amount of empty buildings, I passed hundreds of multi tower construction sites just planted in the country side. If China is stockpiling resources and they are loaded with surplus money my thought is that they are relying on one certainty with the west “GREED”. They will suck us all in to building massive new sources of minerals and then “STOP”….wait a while, and clean up the mess cheaply. They are patient and long term…we are impatient and short term.???

    • They’re not loaded with surplus money, they are loaded with US treasury bonds. There is a difference. They also have probably the world’s biggest ever property bubble – did you get the connection with all the empty buildings you saw? Why does everyone forget the previous Asian tiger economies going into crisis? China is this all over again, only bigger.

      Japan is now on a comeback, because their land prices have dropped back to levels at which the costs imposed on the productive sector, now allow it to compete again.

  7. some friends of mine in production businesses say that its rather risky having only 1 major customer. If they walk or stop spending and you’re out on a limb with debe then you’re screwed.

    these guys aren’t economists their just medium business owners.

  8. OK. So China is using a lot of iron ore and coal. Iron ore is used to make steel. Coal is used to make steel and for electricity.
    What is China doing with all the steel? Is it going into useless tower buildings? or is it going into toasters and cutlery being sold throughout the world?
    I suggest that the first should be of great concern to Australia’s miners, the second would be a great comfort.

    • Alex Heyworth

      Some of both, plus lots of infrastructure (railways, bridges, power stations, factories, warehouses, ships, trains, cars etc etc).

    • Its going into “useless tower buildings”.

      There is a direct correlation between China’s iron ore and coal imports and the fixed asset investment boom of 2009. Remember, this was a time when global trade (and China’s exports) was collapsing, yet China’s imports of iron ore, coal and copper spiked.

      Macro Man has the smoking gun, in his famous set of charts from June 2009.

      • Alex Heyworth

        It’s definitely going mainly into building of one sort or another, plus stockpiling (which I forgot to mention). Clearly lots, though not all, is going into real estate construction. How long those empty tower buildings remain empty is the real question. Some of them for a long time, I suspect. Others may fill up quite quickly. Remember those photos of a deserted city that were circulating a few months ago? It’s filled up now.

        The bottom line is that the Chinese economy is certain to experience considerable misdirected investment with the current easy money availability there. At the moment, the area with excessive investment seems to be residential construction.

        I’d still rather see investment misdirected to empty towers that will eventually fill up than to towers of derivatives reaching up to the sky, though.

      • A new coal fired power station every week; 100,000’s km’s new paved road, ports, harbours, tunnels to Tibet…so much more. If we remain ‘stuck’ on the premise that China is only building ‘housing’ we are dead wrong. This is a nation giving it its best shot to lift itself from semi-third world to modern. If only we could harness the same energy…and where almost there…

        Chinese infrastructure development 2000-1000, propaganda yes, but guess what, it’s happened.
        Other stuff, possibly also propaganda. This is a country endeavouring to move into the modern world, its way.

        As all know, we are tied to China. China (India?) all we have – not one contributor to this site has suggested anything other. Again, ideas please. I realise there are none. So what the hell, go for it, hope for the success of the Chinese economic vision. Then work like hell to build-in mechanisms to ensure our own relevance.

        My money’s on the resource extraction/agricultral model initially; when resources are exhausted, the “food-bowl”. Serious folks, we ain’t doin nothin’ special here. If we don’t, someone else may. The way of the world. The Lucky Country.

        • China isn’t just building housing (but that’s the biggest single source of investment) they’re building bridges, roads, airports and railways as well. The problem is, almost all of these “investments” are losing money and unable to generate enough income to repay loans. Imagine an entire country where every building project is a white elephant like Sydney’s cross-city tunnel?

          This investment is the problem not the solution to China’s imbalances. The solution is to increase domestic consumption and reduce reliance on investment and exports. Everyone agrees on this point, even the China-will-grow-forever crowd. The problem is, since 2009, China has been heading in precisely the opposite direction.

  9. I am surprised that you have not mentioned Kondratiev waves, given that you’ve taken a look at long-term commodities prices.

  10. The big issue for Australia is that it is an all your eggs in one basket strategy.

    It is bit like the scenario that afflicted the Netherlands in the 1970’s after a large resources boom – they discovered lots of gas of the coast. The Guilder became overvalued, poor investments were made using the inflow of cheap capital and other sectors of the Dutch economy were under-invested.

    When the boom ended it was economically painful as other sectors of the economy were ill equipped to take up the slack (lack of investment) and investments that seemed good turned sour.

  11. “prices don’t fall because of gravity they fall for a reason”

    You’ve been fooled by randomness… there doesn’t need to be a reason for anything. Needing a reason is just your belief that everything needs an explanation or there is an explanation for a move.

    A 10,000 sigma event is just-that… an event. If you are not robust, you are bust.

    Plain and simple.

    Rational explanations only explain noise (at least in the short-term).

    There were numerous articles/studies pre-GFC in US, Ireland etc why property prices CAN’T fall… it’s a bit like what we’re seeing in Oz.

    Not too different to idiotic explanations at 6:25pm every night: “Stocks fell due to profit-taking except when they fell due on Europe worries, China falling, or India farting”.

    How does anyone know why stocks fell… they just did.

    • Saying that there must be a reason for something to fall is not the same as saying it cannot fall. And there is a difference between there being a reason and knowing what the reason is.

      The point in my initial comment was that the RBA provided sound arguments about *100 year* price movements whereas the chart used in the article was just a line without any explanation.

      There was nothing random about the price of minerals over the last 100 years. When countries industrialized the supply/demand balance was tight and prices rose. In other times the balance was different.

      You sound like a day trader so 100 year events must seem hard to relate to.

      • Yes, I am a trader with an investment horizon of days to years (but no day-trading), depending on the asset class.

        I actually agree with you, “Rational explanations only explain noise (at least in the short-term”). The further in the past the event, the less noise there is.

        The point I’m making is the all the RBA has are plausible reasons… the actual one(s) are never really known… though I would agree that a 100 year graph has more weight with one exception…

        In the real world, there are instances of long term dependency (sometimes decades) due to numerous and largely unknown variables makes it very hard to work out the cause… so the ‘real’ reason is never really known. This is different to ‘hard’ sciences where lab experiments allow us to know and test variables.

        There are no lab experiments in socioeconomics.

        An example (made-up) may be a huge increase in crime in Australia in 20 years because of the baby-bonus.

        In this case an entire generation of crime has one start point (a 5 yr period of baby bonuses), but the analysis of the day (in 20 yrs) will put the blame on something else which has a high correlation to crime.

        I think you’ll prefer a 400 yr study in real estate prices.


        • Does any of that negate what I said in the original comment?

          You have actually focused on known unknowns and unknown unknowns, but as I said above, just because they are unknown doesn’t mean there are not reasons. Not knowing something doesn’t equate to it being random.

          Coming back to my original reason for commenting: a plot was shown in which the reader was essentially asked to take it on faith — even the source did not provide an explanation — and this happens a lot in the MSM. By way of comparison I commented on a similar long term commodities plot, but one in which some plausible explanation was given/offered. It is possible to rebut the explanation by finding data that contradicts the reasons put forward by the RBA. It is not possible to rebut lines drawn on plots that have no explanation. The RBA study leads to intelligent discussion, the other “study” leads to intellectual stagnation and blind acceptance.

          As for the hard sciences, people forget that you can’t do experiments with stars and planets. Astronomy is a hard science based on empirical observation. It progressed past the “take it on faith” basis in the middle ages.

          • You make a good point that without a supporting data/methodology it is difficult to have a debate.


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  12. Can china india get to western standards?? Is it even possible that 3 billion people can acheieve this with todays tech? i dont think so, not unless new nuclear tech is launched.