What will happen to the Aussie economy in a war with China?

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Since war with China is so de rigueur, with ABC running a four-expert special on what it would look like for Australia, much of which is pretty naive, I thought I’d add some more realistic analysis of the economic outcomes.

You can read the ABC material at your leisure but, basically, it suggests that Australia has a choice in the matter, which is wrong.

There are three main reasons why we would have no choice:

  • We are already a US client state, not a free state with the capacity to defend itself.
  • The Australian people (and therefore politics) wouldn’t stand for anything other than being involved.
  • It would be a war of values. Chinese totalitarianism versus liberal imperialism and Australia has no choice in that context.
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So, we would be involved. The question is how.

The direct military contribution would be minor but more significant in terms of intelligence and symbolism. The largest contribution we would make is economic.

How so? Because in each scenario for a conflict around Taiwan – bombardment, blockade, or invasion – Australia would cut off all trade with China. And it would do the same in return.

This would include, iron ore, both coals, LNG, and softs. In return, all of that cheap China crap would disappear.

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What would be the economic fallout?

Recall that during the initial stages of the recent Chinese wolf warrior war on Australia, there were many stories of catastrophes coming to Australian exports. Nothing of the sort happened, as MB argued it would not.

Commodities are fungible and cuts in one place mean another opportunity elsewhere. The dirt will always ship out (the exception being iron ore which I will come to). The question is more at what price?

And here, the news gets a little less gloomy. As the Ukraine War nicely illustrated, times of war generally trigger much higher not lower commodity prices.

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Here is my best guess for what would happen to Australia’s key resources.

Iron ore and coking coal volumes would initially crash and so would the price. This would be a big blow to GDP straight up. But it would be offset in some measure by a rising price before very long. Chinese steel exports would largely collapse and be picked up in other jurisdictions such as Japan, Korea, and India. Demand in all three would likely surge beyond that as military buildouts ramped up.

Total iron ore volumes would still fall given China takes so much of it, but the net result would be good prices for perhaps half current volumes.

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Other hard commodities would be rerouted to other markets and prices would probably rise for all. An AUD at 30 cents is a pretty handy offset.

LNG is another story and quite a good one. Oil prices would skyrocket in any such conflict as a geopolitcal risk premium was built-in. This would hugely lift LNG revenues and the context of war would finally enable the total crushing of the gas cartels with huge export levies.

Suddenly, even east coast gas volumes would make us money, though it would also be hardest hit in volume terms.

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Arguably, the flip side, for imports, would be the much more difficult adjustment. This would be highly inflationary and require a mad scramble to substitute, as well as a build out of capacity at home.

This would be made worse by the blockade on Chinese goods encompassing the US and (at least parts of) Europe.

Some of the shortages would be offset by wartime austerity measures but the net result of changes in import/export prices is very likely to be inflationary, not least owing to an AUD at 30 cents, so that would sorely challenge the banks and household debt.

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This would be exacerbated by the seizure in global interbank markets as the blockade against China seized its monetary assets and it was cut out of SWIFT. Public guarantees and RBA money printing for the banks would be vital to preventing an interest-rate-led rout.

So a big recession is likely.

However, the budget would come through it all right as commodity prices remained good and new war levies were applied to LNG. Households would rally to the cause. Cheaper land and houses would lift booming competitiveness. US capital would flood in. A huge defence and industrial build-out would reduce unemployment swiftly, especially as mass immigration ceased (except American GIs).

Perhaps the most thorny issue would be the local Chinese diaspora. Australian authorities are very good at integrating with ‘at risk’ ethnic populations. But there are elements of mixed loyalty in the ethnic Chinese community and why wouldn’t Beijing activate them, directly or via coercion?

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This is why we should be preparing now as a nation by diversifying every feature of the above.

But the cowards of Canberra will simply say “nobody saw it coming”:

Australia’s top spy Mike Burgess was directly pressured by public servants, academics and business identities to “ease up” on ASIO’s foreign interference and espionage operations, despite judicial figures, journalists, veterans and diaspora communities being targeted in record numbers by foreign spies and agents.

In his fourth annual threat ­assessment speech on Tuesday night, the Australian Security Intelligence Organisation director-general revealed that, at a time of unprecedented espionage and foreign interference activity in Australia, there were “senior people in this country who believe (it) is no big deal”.

“Individuals in business, ­academia and the bureaucracy have told me ASIO should ease up its operational responses to avoid upsetting foreign regimes,” Mr Burgess said.

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Paid by China to think it is “no big deal” is more like it.

About the author
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 founding 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.