From David Uren today:
Estimating the probable path of export prices has been the most vexed forecasting problem for Treasury over the past decade.
…Treasury has, since 2010, assumed that export prices would continue to dip, relative to import prices, at a rate of 1.3 per cent a year, enough to erode Australia’s returns by 20 per cent over a 15-year period.
In the mid-year budget update published just before Christmas, Treasury changed its methodology for preparing a projection on the terms of trade to reflect the three phases of the mining boom.
…Treasury estimated that the fall in prices during the “supply phase” would be a bit sharper than under its previous methodology, but the point at which prices would level out, which it expects to be from 2017-18, would be higher.
However, research by German economist Martin Stuermer from the University of Bonn shows that metals prices have a strong tendency to revert to their long-term average. He reaches back into distant history. His study of copper, oil, lead, tin and zinc prices since 1840 shows the China boom is not a new phenomenon.
“Industrialisation of the UK, the US and Japan had similar effects on mineral commodity prices,” he says.
These surges in demand typically elevated prices for between five and an absolute maximum of 15 years. Supply shocks, such as the oil embargoes following the formation of the OPEC cartel, have price effects lasting a maximum of five years. Over the last 200 years, the price trend for commodities is either flat or slightly negative.
I am one of those that thinks there is a difference in this cycle because of the many long term structural supply shortages that are developing in commodities. So although I expect the terms of trade to fall materially further, I also expect a higher base.
But that matters little with regard to handling the boom. Nobody knows where the ToT will settle and to bet on its breaking hundreds of years of trend is hardly prudent. As Stuermer concludes:
…”My results suggest that commodity exporters should take a counter-cyclical policy stand rather than increasing long-term public investment based on the assumption of a permanent price increase.”
That’s just common sense, that we ignored.
On that, Mr BRICs, former head of Goldman Sachs asset management Jim O’Neill chimes in at the AFR:
He pointed to concerns that slowing Chinese economic growth would hit commodity prices and expose vulnerabilities in economies reliant on commodity prices.
Mr O’Neill said the “new China” posed a risk to countries like Australia which were uncompetitive.
“Many commodity producers are losers unless – like Mexico – they are competitive and can produce a lot of things China did,” he said, calling Australia a “big loser”.
The one significant exception to my thinking on these matters is if China slows much more quickly and via crisis than most currently assume, which is far from impossible if its shadow banking system shakes out. In that event the kind of long term banking stagnation that has afflicted Japan could combine with China’s similarly poor demographics to cause enduring deflation and slower growth. That would mean our terms of trade would keep falling, further than I expect, and probably stay there.
