The mining boom is over

There is something of a revolution brewing in Australian economic thinking just now. It began several months ago when the RBA suddenly stopped talking about inflation and started considering stimulus. The change of heart is that the minnig boom is not delivering the kind of inflationary blowoff growth that everyone outside of MB and the Melbourne Institute expected.

And today, from Victoria University’s Centre for Strategic Economic Studies, comes a paper by Peter Sheehan and the father of Australian Dutch disease diagnoses, Bob Gregory, who contend that the benefits of the mining boom, such as they are, will now decline. Futureboom has become Pastboom in the blink of an eye.

The resources boom has had a major stimulatory impact on the Australian economy, as a result of the net impact of four factors which are all of major significance in their own right:

1.Higher domestic real incomes. For example, real compensation per employee hour grew by 2.1% per annum over this period, by comparison with 1.3% over 1979‐2002, and by mid 2011 was 10.5% above the previous trend. Real per capita household disposable income grew by 2.8% per annum over 2002‐11, by comparison with 1.0% over 1979‐2002, to be 17.6% above the earlier trend level by mid 2011.

2.Higher asset values. Strong growth in the value of resource shares and other assets, driving a 44% growth or an increase of $93,000 per capita in the real value of financial and housing assets held by Australian households over the five years from the first quarter of 2003 to the end of 2007.

3.The local content of rising resource investment. A continued rise in both resources investment and other investment as a share of GDP, from 21% in 2001‐02 to nearly 28.1% in 2010‐11, with a reasonably high local content of resource investment on most projects, provided a major stimulus to activity.

4.Competitive pressure on trade‐exposed industries. Intense competitive pressure on trade‐ exposed non‐resource companies from a combination of appreciation of the $A and enhanced competitive from China and other developing countries, resulting in an sharp reduction in the net trade balance on goods and services of 13 percentage points of domestic final demand between mid 2001 and mid 2008.

While the net impact of these factors has undoubtedly been strongly positive for most of the period since 2003, there are good reasons, on the assumption of fixed exchange rates going forward, for thinking that the net stimulatory impact of the resources boom has come to an end. These reasons relate to the changing time path of each of the four impacts noted above.

  • While the further path of commodity prices is uncertain, unless the exchange rate rises further the impetus to growth in real domestic incomes from this source will not continue. Since peaking in late July at 79, the trade‐weighted $A index has traded broadly in a 72‐76 band over the last three months. Assuming that the exchange rate is fixed at broadly currently 2011 levels, further real income growth from this source will not continue after the lagged effects have passed through.
  • The remarkable growth in real per capita household assets prices over 1995 to 2007, which was boosted to 8% per annum growth in the first five years of the resources boom, seems to have ended. Real per capita assets have trended downward a little over the year to the June quarter 2011, and this seems likely to have continued for the next two quarters at least.
  • Resources investment is likely to continue to increase as a share of GDP for up to two years yet, because of a dramatic increase in large LNG projects. But the combination of the high $A and of the shift to large, offshore and heavily foreign‐owned LNG projects means that the local content of resources investment will fall sharply, and this will substantially offset the impact of rising investment on the domestic economy.

With the exchange rate assumed to stay high, the competitive pressure on Australian trade exposed firms will continue, and indeed accentuate in key sectors such as manufacturing, tourism and education, as both producers and suppliers adjust to expectations of high exchange rates for the medium term.

Music to my ears. And they go on:

In short, on the assumption of fixed exchange rates, the stimulus from the three expansionary factors has or will shortly come to an end, while the pressure on trade‐exposed firms remains and in some respects is intensifying.

This conclusion has important implications for macroeconomic policy in Australia. The settings of such policy have been restrictive for some time, mildly so for monetary policy, as acknowledged by the Reserve Bank, and severely so for fiscal policy, as outlined by the Australian Treasury. The Australian Government is overseeing the most rapid process of fiscal consolidation for over 40 years. In the context of a perceived powerful continuing stimulus from the resources boom and in pursuit of a balanced budget by 2012‐13, the Government proposes to take $50 billion or 3.6% of GDP out of the economy (on an underlying cash basis) over 2011‐12 and 2012‐13 (see Table 5). Neither of these concerns is currently relevant to Australia’s economic situation. Partly reflecting the considerations outlined above and ongoing issues in the EU and USA, the outlook for the Australian economy is now much weaker than that presented in May in the 2011‐12 Budget Papers, in spite of the continuing resources boom. Real GDP has grown by 1.9% per annum over the last three years, and GDP growth for 2011‐12 in now likely to be closer to that figure than to the 4% forecast in the Budget Papers, while employment growth will fall well short of the 1.75% forecast.

It should be noted that Australia’s fiscal position is very strong, with Australian Government net debt at only 6.1% of GDP at the end of 2010‐11. It will be strengthened further over the next decade, even under the current taxation regime, as tax revenue from higher resource prices and from projects currently under construction begins to be received. Such revenue is currently being delayed by capital losses incurred in the global financial crisis and by depreciation allowances being generated by high levels of capital investment. The scale of both the investment and of the depreciation allowances being generated is massive, but tax revenues from the resources sector will rise strongly when these allowances are used up.

It is no longer appropriate in current circumstances for the Australian Government to pursue a budget surplus in 2012‐13. It should move away from this target and adopt a much less restrictive fiscal policy, more supportive of economic growth.

Here is where I start to get a little hazy. This paper is great reading but at no point does it mention the words “private debt”. I’d like to see an easing in fiscal policy. Who wouldn’t? Maybe some new infrastructure would be nice. But what about the private debt mountain that the Federal Budget backstops? Australian bank CDS are flying wild and free and there is a real chance that Europe will keep wholesale debt rollover too expensive for the banks  next year. Keep your powder dry for the wholesale guarantee, I say. Back to the piece:

Monetary policy has been ‘mildly restrictive’, in the words of the Reserve Bank, being directed to offset the presumed net (incremental) expansionary impact of the resources boom and by concern about inflation running above the target band. In our view both of these concerns are no longer relevant, the first for the reasons outlined above and the second because it is clear that there is now no inflationary problem in Australia that needs to be addressed by a restrictive monetary policy. On 1 November 2011 the Bank recognised that the economy was slowing and the threat of inflation was easing, and cut interest rates accordingly, moving to a more neutral stance.

Over the three years to the June quarter of 2011, five sub‐groups, out of a total of 90 in the CPI and accounting for about 12% of the index, have provided 40% the growth in the CPI and 44% of the growth over the past year. The five groups are lamb and mutton, fruit, vegetables, utilities and tobacco. These five groups in total rose have risen by 11.9% per annum over the past three years, while the rest of the CPI rose by 1.8%; over the past year the five groups rose by 16.7% and the rest of the index by 2.2% (see Table 6). Thus excluding these items, inflation has been well within the Reserve Bank’s target range of 2‐3% on average over the cycle. It is difficult to extend this analysis to the September quarter data, as a new CPI series was introduced in that quarter and the full data have not yet been released. But these trends appear to have broadly continued – utility charges rose by 7.2% for the month and tobacco prices by 1.8%, but the food items fell back a little.

There is no reason for thinking that the rapid growth in prices for these items can be significantly influenced by monetary policy. Prices for the food items reflect seasonal conditions affecting supply, while increases in tobacco prices are driven by regular increases in tax rates. The reasons for the rapid growth of utility charges (11.5% per annum over three years) are far from clear, but it is unlikely that price changes for this group would be greatly affected by a restrictive monetary policy. The move on 1 November 2011 to a more neutral stance may prove to be the first in a series of adjustments of monetary policy.

This CPI cherry picking doesn’t serve the argument well. The CPI is the sum of its parts so you can always deflate something to offset inflation elsewhere.

But I agree with the cut rates argument, though again, because there is no mention of private debt, I’m kind of wondering what the authors have in mind vis-a-vis easing. Theirs is an argument for structural easing to boost growth post mining boom. That could be achieved by cutting rates and lowering the dollar, which will boost the earnings of the external sector and growth. But it will also be hijacked by the banks and turned into another round of asset speculation quicker than you can say “here’s a loan, mate”. So, if you’re going to cut rates responsibly, then you’re also going to have to intervene with the banks. Why not use the new macroprudential rules available at APRA to contain mortgage lending?

If you don’t, you are asking for the kind of debt-growth trouble that the world is very happy to punish just now. But if you do, we could have a thriving and diverse external sector and I could enjoy some economic sunshine for the first time in ages.

AER_No_1

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the fouding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

Comments

  1. Mining boom over? Did it begin (in the context of huge flow-on to the rest of the economy)? The first boom coincided with the biggest and broadest boom in private sector credit in history – surely much more stimulatory than something that only employs 2% of the labour force and returns a great deal of it’s earnings to foreign shareholders rather than back to the broader domestic economy. We have seen mining boom mk2 roar away to new pardigms – yet the economy has been fairly tepid. What’s missing? Credit boom mk2 is what’s missing. Take away booming credit growth and we get a more realistic picture of mining’s effect on the overall economy – small. Not completely insignificant – but small.

    • “This paper is great reading but at no point does it mention the words “private debt”.”

      This is what is going to come back and haunt the Govt just like it did US and Europe. Its way to high and going to be that way for a while. Wait till houses start losing their value and a rapid pace. What will speed all of the doom and gloom up for Australia is a hard landing by China.

          • My problem with this kind of argument is that if it were to be the end of mining boom, a result of global economic decline, the same decline that ended the boom must also impact the above sectors – even with AUD at .9?

          • > tourism
            possibly but there’s a lot of competition there and our service side is really poor

            > education
            if it comes with a permanent resident visa attached

            > manufactures
            where will the capital come from to revive it? This is really a hard one. I’ve been trying to commercialise a rather niche market product and the only reason that I can build a prototype funded by my regular salary is that I came across an older bloke who is a brilliant engineer with a well equipped workshop who enjoys the challenge more than money, really a dying breed. I spoke to a few people before and they all pointed me in the direction of China. BTW, C. Joye once wrote that you used to be a skiing instructor so you may like the product 🙂

            > agriculture
            yes

            You forgot to mention Metricon apartments. H. Triguboff once said that his business of selling them to the Chinese is as important as mining.

          • H&H
            I don’t know about 0.9 Prior to the ‘boom’ in out TOT I used look at the economy and consider if we cut out all the spec money coming here for the high interest rates increasing currency etc, cut out the foreign ‘investment’ buying up every industry and mine, and set the economy so we were no longer running a CAD, A$=USD0.4 looked about right.

            With the current changes going on in China which will dramatically increase the price of goods from there, there would be one hell of a lot of manufacturing possible.

            Of course this would have to be accompanied by one hell of a lot of saving (high RAT rates)to provide the capital necessary.

            Again, the answer lies 50 years back in time so this is sort of idle speculation.

  2. I agree about the boom. It is finished. But I’m not so sure I agree with the authors about the currency. The high AUD is a product of four inter-related forces:

    Firm monetary policy in Australia
    Very firm fiscal policy
    Stellar terms-of-trade
    Portfolio allocation by global capital markets

    Given this is the case, I wonder why the authors of the report assume that the exchange rate will be stable. There is no precedent for this. The AUD fluctuates and will continue to do so.

    What is likely to happen?

    Monetary policy will continue to be eased
    Fiscal policy will remain tight, but relatively less so than has been the case
    The terms-of-trade will return to earth
    Global portfolio flows will probably favour repatriation to the US

    If things evolve this way, then the AUD will certainly fall. This is already happening and can become very pronounced very quickly.

    So, if the assumption of a constant exchange rate is discarded, and if monetary policy is being eased, why would you relax fiscal policy too? you would only do this if we faced a deep shock.

    My own supposition is that if households believe the public sector is going to return to deficit, then households will tend to try to increase their own savings, which would come at the expense of demand and jobs.

    There is a premium on stability and security in the current environment, and the single best thing the Government can do is demonstrate it has the nerve to keep its finances under control, just in case the international situation severely deteriorates.

    Before fiscal policy is eased, we should wait and see what actually happens to the external account and the AUD. As experience shows, it is very easy to relax fiscal settings, but it takes a long time to reverse them. More than usual, restraint and caution are required.

  3. It is no longer appropriate in current circumstances for the Australian Government to pursue a budget surplus in 2012‐13.

    thank you, thank you very much (for “no longer appropriate” substitute “crazy”, it then reads even better).

    This paper is great reading but at no point does it mention the words “private debt”.

    Since none of their names is Steve Keen why would you expect them be concerned about private debt? 🙂

    So, if you’re going to cut rates responsibly, then you’re also going to have to intervene with the banks.

    You could also intervene with the tax treatment of housing speculation but hell will freeze over first.

  4. The boom may be over for now, but it wouldn’t be a great surprise to see it resumed in two or three years’ time.

  5. Hallelujah!

    The end to the acrimony directed to the resources sector, focus can now shift to banks or private debt or foreign borrowings or the impending end of social democracy…resources have served this country well, always have throughout our history and more recently cushioned our small economy from the full effects of the GFC.

    Resources companies can now simply get on with what they do best: responding to present and future demand as required, developing world class mining infrastructure and extraction technology – business as usual. Life goes on!

    Rather liberating I think.

      • I think that needs more consideration than a knee-jerk johnno Capital investment allowances and depreciation considerations probably mean that the no income tax stems from very high capital requirements upfront. As the paper says the tax is coming so Fortescue will not continue to pay no tax.

        • The tax is coming. Great. The tax payer, legally, has had to foot the bill for the last 7 years while the company and owners have benefit quite handsomely. I have no problems with this. I do however have a problem when Twiggy bangs on about how hard done by his company will be all the while paying no tax for 7 years and enjoying the results.

  6. You probably should change “Paul Sheehan” to “Peter Sheehan” in paragraph 2, lest people think that the SMH columnist has taken to writing economic papers…

  7. “….This paper is great reading but at no point does it mention the words “private debt”…..”

    Or “house price bubble” – which is nothing whatsoever to do with the “resource boom”.

    • In relation to 8% growth per annum 2002-07 in household real per capita assets:

      “This increase in real asset prices driven by the resources boom has also come to an end.” Strange, I was convinced it was driven by a credit boom leading to the housing price bubble you mention. Not the authors of the report, can’t see beyond mining…

    • > Or “house price bubble” – which is nothing whatsoever to do with the “resource boom”.

      Since the two coincided many people started believing that our economy is indestructible due to mining meaning that it was safe to load up with more and more debt. A while ago I quizzed my educated friends if they knew how much mining was contributing to GDP and employment and the responses that they were giving were close to an order of magnitude higher than the actual figures. I expect that when we hear an “official” announcement that the mining boom is over it will play in reverse and destroy whatever confidence is left out there.

        • The reasons for all the housing bubbles have been the same everywhere, restricted land supply, usually regulatory by nature, and pumped up demand by relaxed credit. The mining boom saved our bubble from crashing and made it even bigger.

          • > Given the causes you believe
            > are responsible for the housing
            > bubble, can you explain how
            > mining made it even bigger?

            Only on the credit side. When mining bounced back after the onset of the GFC it helped our government and banks sourcing reasonably cheap O/S capital to prop up the housing market. Remember the FHOB?

    • “The remarkable growth in real per capita household assets prices over 1995 to 2007, which was boosted to 8% per annum growth ”

      I read that as code for ‘housing’.

      And that growth started before the mining boom.

  8. Wait so this is happening without China’s property bubble busting (yet). What happens to our mining when construction slows down in China.

    • To be fair to the report authors, they essentially assert that the peak of the boom has been reached, that major stimulatory effects of the boom unlikely to be continued at similar rate, that from here on whilst there will continue to be positive effects from resources sector activity, these ‘positives’ are likely to decrease in magnitude over time.

      The Mining Boom is Over is HnH’s literary licence writ large.

    • It should do….but it won’t. Any move by the govt to back away from the delivery of a surplus will be seized upon by the MSM and the opposition. Hockey has consistently been asserting this govt….like any labor govt….cannot deliver a surplus. Delivering a surplus has now become synonymous with fiscal responsibility and sound management.
      The govt has been making some suggestions around the edges of the idea they might not achieve a surplus…..but obviously the feedback from the focus groups is not encouraging….so invariably the worlds greatest treasurer then re affirms the commitment to surplus.
      So expect short-term, focus group driven politics to win out yet again.

    • Why?

      In my opinion the boom mark II has/had barely taken off – if global conditions were not such – this paper would not have been written.

      With billions in projected infrastructure spend – the major bulk of which has not started yet – claims of benefits not flowing directly into the economy are premature. In addition, if/had global commodity prices hold up and demand as forecast proves/proved correct I guarantee you – this boom would be all that Treasury/RBA had hoped for, and more. We are still experiencing record ToT, albeit likely to moderate into the future due to current global difficulties – if China muddles through all will not be over.

      No need to apologise for anything. The boom has been overwhelmingly beneficial.

      • 3d1k, I’m definitely not against the boom, far from it. I’ve done very very well on my resource stocks. I research resources for investment, but I never believed what the RBA/Treasury said. They never look at risks IMO. They don’t recognise sovereign risk, and as they have to spin everything is always ok until it’s not; I don’t trust them. I’ve been to China as well so I’m more cautious. Also, if I believe what junior mining MD’s tell me things in Australia are changing. The government does not listen to anyone other than the majors so there is a big gap in their views IMO. Also there is a lot of environmental conditions that can blow us up….no one seems the see that as a risk.

        I’m definitely against the failure of government to at least try to support industry with better policies to get a better balance to our economy. I could write a lot more on this, but there it is.

        I should have clarified my comment.

        • +1 Well said.

          I am a little more forgiving of Treasury/RBA – they were offered the boom on a platter when little else held any prospect for massive growth, at a time when many other economies were facing real challenges including the collapse of domestic property markets and rising (+ entrenched) unemployment. I have always thought we had little option other than to go with it.

          The demographic change in Chindia argument is not without some merit in reference to long-term commodity demand. Any modelling reliance on commodities at record pricing a little foolhardy. Nonetheless to date the resources boom as delivered record ToT and put us in an enviable position. It is human nature to be optimistic, if again a little foolhardy not to fully recognise and acknowledge the risks. On paper and largely in reality it looked good, really good and so it has been.

          I would agree with your assessment of government (and bureaucracy) attention to the voices of the juniors is often lacking, not too sure what environment conditions you refer to.

          The prime difficulty the boom has presented for Australia thus far has been the appreciation of the currency – but again as I have said many times this has been both a positive and a negative.

          Cheers.

      • That’s my understanding. From the data it looks as if the boom hasn’t yet started. I’m still backing long term interest rates to rise.

        Costs were mentioned, but most of that is still spent in Australia even if imported labour is used.

        I know that many expect China to slow rapidly, but the chance of growth is just as high.

      • i disagree it has been beneficial to the very few (and i am certainly one of them). however, the majority do not understand asset bubbles particularly when they are in the middle of one. and make no mistake over 200 year cycle we are in one hell of a commodity bubble, the housing and credit bubble goes without saying. china muddling through is distinct possibility as anomalies exist naturally in all systems, but i am not convinced china is the anomaly that can deflate painlessly. who cares about sorry, all that matters is navigating through the next lost decade with as much capital preserved as possible.

  9. Isn’t the assumption of a fixed exchange rate fundamentally wrong?

    Doesn’t this make all of this paper waffle?

    Or is the effect of exchange rate minimal? If so, how?

    • No, the effect of exchange rate is not minimal, and the assumption of a fixed exchange rate is, by definition, wrong. However, the point is it is no more wrong than any other (reasonable) assumption you might make about the exchange rate. Obviously the $A is unlikely to hit either $US0.40 or $US1.60 any time soon. The closer you get in to the current exchange rate from those extremes, the more likely you are approaching something like the right answer. Of course, this assumption is only about one exchange rate. If you were going to delve into that question, you would have to explore the implications of different exchange rates with the currencies of all our major trading partners. To avoid this complexity (which would not necessarily improve the accuracy of the resultant analysis, and may well make it worse), it is common to simply assume current exchange rates.

  10. External Indebtedness – Australia in Bad Company

    Australia has one of the worst Net International Investment Positions in the developed world at -61% of GDP in 2009 according to the Bank of Japan. (1)

    Could we face action by “bond vigilantes” in the same way as Italy?

    Our position (2) is worse than:

    Country Year % of GDP
    United Kingdom 2009 -13.1
    United States 2009 -17
    South Korea 2009 -17.8
    Sweden 2010 -22.2
    Italy 2010 -24.3
    Slovenia 2010 -35.1
    Mexico 2010 -36.5
    Brazil 2009 -37.5
    Kazakhstan 2009 -38.1
    Turkey 2009 -44.9

    However we are in a better position than:

    Poland 2010 -63
    Slovakia 2010 -66.4
    Estonia 2010 -71.8
    Greece 2009 -83.1
    New Zealand 2009 -90.1
    Spain 2009 -93.6
    Ireland 2009 -97.8
    Portugal 2009 -108.5

    Is a position better than Poland and Slovakia but not as good as Kazakhstan and Turkey sustainable?

    Is a position of 4 times as much net international investment as a percentage of GDP as the US and UK sustainable? And for how long? And can we allow our current position to deteriorate further?

    In a world of “bond vigilantes” perhaps we need to examine our vulnerability. We have seen a number of myths exploded over the last few years:
    1. House prices don’t fall
    2. Banks don’t get bailed out,
    3. Bank debt to foreigners doesn’t matter of itself.
    3. Western developed countries are immune to sovereign debt concerns.

    While we have the benefit of being an issuer of our own currency (and can print and “quantitatively ease”) to our heart’s content, that doesn’t help where our debt is denominated in foreign currencies, or we want to borrow more money from foreigners (remember the “Belgian dentist?).

    We also have the benefit of low sovereign debt, but our states, while generally well rated, have large pension obligations under old defined benefits schemes many of which are indexed for inflation. The states can’t issue currency and therefore need to fund these pensions over time as our demographics (dependency ratio) deteriorate.

    The Federal Government has already had to guarantee some of our major banks borrowings from overseas which are needed because of the historically poor savings rate over the period from about 1995 to 2007.

    Remember that European and US banks are likely to have to raise hundreds of billions of dollars in additional capital over the next say 5 years, or sell assets to reduce balance sheets. In those circumstances, will those banks increase lending to Australian Banks or to Australian governments wishing to fund welfare such as health, education, unemployment and retirement benefits?

    Will international banks wishing to accept additional Australian exposure simply lend only to those major resource projects with undoubted export markets such as energy projects and not into general pools of funds in banks unless they are guaranteed by the Federal Government? Might foreign banks only fund their own major companies and their projects in Australia?

    Could we face a foreign debt capital strike? Or increased yield requirements?

    How can our policy makers address this position without causing a recession, higher unemployment, falling house prices and possibly a bank failure or two?

    Footnote
    1. See Table 5 on page 10 of http://www.boj.or.jp/en/research/brp/ron_2010/data/ron1009a.pdf
    http://www.boj.or.jp/en/research/brp/ron_2010/data/ron1009a.pdf
    2. See Wikipedia: Net international investment position
    http://en.wikipedia.org/wiki/Net_international_investment_position

    • “Remember that European and US banks are likely to have to raise hundreds of billions of dollars in additional capital over the next say 5 years, or sell assets to reduce balance sheets. In those circumstances, will those banks increase lending to Australian Banks or to Australian governments wishing to fund welfare such as health, education, unemployment and retirement benefits?”

      I am at least hopeful that our government will have learned from the Europeans and not go down the latter path. If they do, will the banks lend to them? Of course, if the interest rate is sufficiently attractive. Same for Australian banks, particularly with a government guarantee.

      You have to remember that this is what banks do. Sure, they have had a temporary set back but borrowing short and lending long is what banks are set up to do. Managing risk by spreading your loans around, charging higher interest where the risk seems higher etc is all part and parcel of it.

      After all, until very recently they were quite happy to lend to the Greeks.