The iron ore spike is now so huge that macro economic implications must be explored. The first point to make is that it is a “spike” not a recovery. It is being driven by a sudden steel shortage in China not some some new multi-year Chinese construction boom. It will run as long as it needs to to restore inventory equilibrium then collapse, not all the way back to where it was but I suspect to around $50 by mid year. Most likely it will then erode further through H2.
It is also being accompanied by a spike in its conjoined twin, coking coal, and between them they constitute roughly 40% of Australia’s terms of trade (ToT). Oil is also charging but that will work the other way on the ToT given we are still a net importer. Other commodities are not following at anywhere near the pace of these two, which is a giveaway vis how long the spike will last, so the terms of trade impacts are largely restricted to these three.
We could see a several quarter spike in the ToT of as much as 10% (it will be stretched out by the lagged contract system) which then reverse over subsequent quarters.
The numerical implications are:
- a short upwards shock to national income, and
- a short upwards shock to nominal growth.
However the practical implications are much less favourable:
- the income shock is distributed via three channels: mining shares and dividends, the Budget and wage growth;
- the first of these is at work already but is relatively minor given the wider under-performance of shares owing to the turn in the debt cycle for banks, with a small boost to confidence to enhance it;
- the second will have no practical impact given the tax windfall will not be spent but some positive impact on confidence as deficit estimates improve somewhat (only to reverse soon enough);
- the third impact will not happen given there will be no investment follow through, indeed the opposite is still happening and will continue.
The net impact is modest but helpful for a few quarters. Unfortunately it will also create its own hangover in that it will only delay further much needed post-mining boom reform and will sustain uneconomic iron ore and coke producers (enabling them to quickly deleverage) for longer, dragging the ongoing larger ToT crash even lower than prior.
