Paul Bloxham, Chief Economist at HSBC, has a habit of hanging his hat on outlandishly bullish calls. One recalls his supposition last year that is was “impossible” for house prices to fall as one example.
Today he braves another bullish cliche with a new note declaring that this mining boom is different:
Australia has a long history of mining booms. These have often been followed by busts. But this one should be different. Why? Simply put, any irrational exuberance in mining has not spilled over into the broader economy this time around, as it had previously. The floating AUD has been the key part of this story. Rising commodity prices were matched by a large AUD rise, rather than rampant inflation as happened before. The AUD has held back other sectors of the economy and contained inflation. When the mining story fades, which is not yet, there will be room for other sectors to pick up and growth to rebalance.
Contrary to the inflammatory title, this note is actually quite interesting and useful. It reminds us that this boom has been handled differently to those of the past, principally via exchange rate appreciation, and that our terms of trade are unlikely to slump to previous lows, which is also a reasonable contention.
If the terms of trade falls seen to date are as far as this correction has to run, I agree that the risk of recession is limited. Bloxham’s reasons for this are worth digging into:
First, Australia’s post-war recessions were all also coincident with global recessions, with the falling terms of trade a result rather than the cause. So it is not the commodity price fall, per se, that drove the recession, but rather the global recession. The mid-1970s global recession was due to the OPEC I oil shock; the early 1980s saw OPEC II and Volker disinflation; and, the early 1990s saw a widespread credit boom and bust, with Australia also experiencing this large asset price cycle. Australia did not experience the early 2000s tech wreck and did not have a technical recession in 2009, despite a sharp fall in the terms of trade (-21% in four quarters). To forecast an Australian recession, recent history would suggest it would be necessary to be forecasting a global one.
Second, inflation has remained contained. Previous mining booms led to widespread rising inflation. Rising commodity prices boosted incomes which saw greater spending and too much demand chasing too few goods. This time around much more of that demand has leaked offshore. The significant AUD appreciation has done what it ought to, with much of the excess demand met by imports, made cheaper by the AUD appreciation. Inflation has generally been low and wages have remained contained in all but the mining sector, so that price pressures have not spread across the economy.
During other mining booms in Australia’s history, the economy has adjusted to higher commodity prices and incomes with a large rise in inflation. In Australia’s first gold rush, in the 1850s, economy-wide wages rose by 250% between 1850 and 1853. High returns from gold prospecting drew workers away from other industries. For example, shepherd’s wages doubled, causing great difficult for the wool industry. During the late 1960s and late 1970s mining booms, inflation ran at double digit rates, as the centralised wage system meant mining sector largesse spread across the economy. As Chart 1 shows, the rising terms of trade directly boosted nominal GDP and inflation in these episodes.
Unlike during previous mining booms, irrational exuberance in the mining sector has not spilled over into the broader economy this time around, as it had previously.
Third, foreign involvement in the mining industry is much higher this time around which should cushion the effect on the local economy. Four-fifths of the industry is foreign owned and the imported content of the investment is much higher than in previous booms. This has curtailed the expansionary impact of the run-up on investment capacity and local profits, and should cushion it on the way down.
Finally, the financial system is also not overly leveraged into the mining story, as it has been on some occasions in the past. Having escaped the global financial crisis reasonably unscathed, Australia’s banking system is also in pretty good shape such that conventional monetary policy still works.
The only major point I disagree with here is that the mining boom has not, in some very serious way, dripped into the broader economy. The boom unquestionably prevented incomes from falling in conjunction with asset prices, as Glenn Stevens has stated several times, and that prevented a major asset bust from transpiring in the economy. Those asset prices remain very high, so does the household leverage that supports them, and there is absolutely no way that credit and asset price growth can simply pick up any substantial slack left behind by a mining bust. So, Bloxham is assuming a quite low level mining retrenchment, certainly not much worse than things are now, and not really a mining “bust” at all. In short, there’s a bit of straw manning going on here.
But that is not my major point of objection. I do not fear a short term drop in the terms of trade. We do have the fiscal and monetary fire power to negotiate such.
But that is not what the Chinese are telling us is going on.
Senior Chinese officials continue to argue that are they are entering a new phase for their economy, a structural adjustment, that will discontinue the big fixed asset investment drivers of yesteryear in favour of consumption. This will take years to pull off of course and prove quite difficult but the Chinese do appear to be committed to it.
The risk is then, as Michael Pettis has argued, that to achieve this, Chinese officials must end the financial repression of households which is part and parcel with investment-led growth. You cannot, in short, have it both ways. Either you pursue debt-driven and commercially questionable infrastructure builds, which require low interest rates to survive and prevent bad loans from spreading into and paralysing the banking system, or you pursue consumption friendly policies, driven by higher interest rates which deliver Chinese households higher rates of return on their enormous savings.
If this is the case, and I agree that it is inevitable over time, then the structural adjustment will cause commodity prices to fall much further over the next several years.
That virtually guarantees a low growth future for Australia in which recessions are a distinct possibility as we face three simultaneous challenges: falling income, falling asset prices and a hollowed out non-resources tradeables sector. It is sobering to think that all of this could happen with the terms of trade still at historically high levels.
Bloxham gives this possibility only very short shrift:
Of course, some risks remain.
China presents the main risk. Our central case holds that China’s growth cycle is currently bottoming out, with growth forecast to pick up to 8.4% next year. This is expected to support demand for commodities and prevent prices from falling too much further.
Well, of course, if the principle customer for our commodities keeps buying we’ll be fine. But the leaders of this customer keep telling us that is not what they’re about. If they stick to their commitment, then this boom will end just like all of those before it.
120925 Australian Economics Comment – This Mining Boom is Different (1)
