Australia, known as the lucky country for its resource abundance and temperate climate, is about to find out how long its latest BHP Billiton Ltd. (BHP), the world’s biggest miner, last week mothballed projects valued at more than A$50 billion ($52 billion) by Credit Suisse Group AG and Deutsche Bank AG. At the same time, Australia’s resources minister called the end of a bull run in commodity prices, and the central bank chief predicted the cresting of the investment wave within two years.
The deceleration of the industry that helped secure 21 recession-free years heightens focus on the views of a minority seeing economic contraction in a nation where consumers took on more debt than Americans at the height of the mortgage bubble. While Bloomberg News surveys indicate growth exceeding 3 percent in 2013 and 2014, Deutsche Bank sees the danger of a recession.
“There is a view around Australia that says this is a different economy,” said Adam Boyton, chief economist for Australia at Deutsche Bank in Sydney, who previously worked at the nation’s Treasury. “My point is: was it skill or luck that drove iron ore and coking-coal prices higher from the Australian perspective,” he said. “It was more luck than skill.”
The windfall Australia gets from exports, called the terms of trade, will slump 15 percent in the final three months of 2012 from a year before, a magnitude that presaged a recession in three of the five times it’s happened in the past half century, according to Boyton. The central bank estimates the terms of trade reached a 140-year high last year.
Rate Cut
Such a drop would send growth lower and spur the central bank to cut interest rates, he said. Deutsche Bank has underestimated Australia’s annual gross domestic product in four of the past six quarters.
Others have been warning for months that the fastest- growing major developed economy is vulnerable to a collapse, bucking a majority view that Australia’s pipeline of resources projects, low unemployment, sustained wage gains and limited government debt give it the underpinnings for continued success.
The burst-bubble argument centers on Australia’s dependence on China. A quarter of its exports, or about 5 percent of GDP, goes to the world’s second-largest economy, and 60 percent of those shipments are a single commodity — iron ore. The end of a Chinese residential-construction surge will sate demand for that product, says Andy Xie, a former Morgan Stanley (MS) chief Asia- Pacific economist.
China Impact
“China’s iron-ore imports are going to slow down dramatically,” Xie, a former World Bank economist who researched globalization and bubbles, said in an interview from Hong Kong. “It’s not just because of the economic downturn; it’s because construction of property and infrastructure has peaked” in Australia’s No. 1 customer, he said.
Premier Wen Jiabao in March cut the government’s growth target for China to 7.5 percent for this year, the lowest since 2004, as policy makers there seek to reduce the role of large- scale fixed-asset investment in favor of greater consumer demand. China also has applied limited stimulus relative to 2008-09, as officials rein in property market speculation.
“I don’t think there’s ever been a miracle economy that ultimately lived up to its billing,” said Dylan Grice, global strategist at Societe Generale SA (GLE) in London, who cited the Japanese experience of the 1980s, Thailand before the 1997-1998 Asian financial crisis and Ireland’s “Emerald Tiger” period last decade. “This year’s miracle is next year’s disaster.”
Weaker Construction
A government report today showed the value of construction work fell 0.2 percent in the second quarter from the January- March period, compared with the median estimate for a 0.5 percent gain in a Bloomberg News survey of economists.
Grice predicts the Aussie, one of the biggest beneficiaries of the economy’s outperformance, will collapse to 60 to 70 U.S. cents, and Xie sees a slide to about 70 cents, with neither putting a time frame on their calls. The currency bought $1.0378 at 4:33 p.m. in Sydney today, and has averaged $1.02 in the past two years — up from 72 U.S. cents for the prior decade.
Foreign-exchange markets don’t reflect Grice and Xie’s predictions. The currency, which historically has weakened as domestic economic prospects decline, has gained 1.4 percent this quarter. Currency forwards today showed a 1 percent chance of a 30 percent drop in the Australian dollar in the next 12 months, according to data compiled by Bloomberg. The probability of a 10 percent drop in the Aussie was 50.6 percent.
Currency’s Strength
The Aussie is up for the year so far against the dollar even after commodity prices cooled. That divergence may be unsustainable, according to John Quiggin, a professor at the University of Queensland’s School of Economics in Brisbane.
“If we didn’t have this huge export boom, we could reasonably expect that the dollar would be at something like 80 U.S. cents,” said Quiggin, author of books on the economy including “Great Expectations: Microeconomic Reform and Australia.”
Iron ore dropped to a 2 1/2-year low in August, and thermal coal at the Australian port of Newcastle, the benchmark price for Asia, fell 17 percent in the three months through June, the worst quarter since 2009, according to data provider IHS McCloskey. Prices for Australian raw-materials exports slid in July to the lowest since 2010, and the commodity price index has fallen 10.8 percent over the past year, the RBA said this month.
Shelved Projects
Along with BHP, Origin Energy Ltd. (ORG), the nation’s largest energy retailer, is reducing spending targets. A proposed expansion of Woodside Petroleum Ltd. (WPL)’s A$15 billion Pluto project in Western Australia is on hold after the company said Aug. 22 it failed to find enough gas to support a second phase.
“The boom in commodity prices is over — no one can deny it,” Resource Minister Martin Ferguson told reporters Aug. 23. The next day, Reserve Bank of Australia Governor Glenn Stevens told lawmakers “the peak of the resource investment boom as a share of gross domestic product, the highest such peak in at least a century, will occur within the next year or two.”
In July, Stevens gave a speech he called “The Lucky Country” promoting optimism and using the same title as a 1964 book by Donald Horne that was critical of Australia’s dependence on natural resources for prosperity while other industrial nations pursued technological innovations.
This month’s shelved mining projects were a blow to Prime Minister Julia Gillard, who in May had called mining “our economy’s strong right arm.”
Policy Responses
Policy makers have signaled confidence they have the tools to cope with any external turbulence, with Martin Parkinson, the Treasury’s top bureaucrat, on Aug. 16 citing “capacity across the arms of fiscal and monetary policy” and the RBA saying Aug. 10 Australia was “well placed” to respond to global shocks.
The central bank’s benchmark rate, at 3.5 percent, is the highest among major developed economies. Australia’s gross government debt, which the International Monetary Fund estimates at 24 percent of GDP compared with 107 percent for the U.S., also gives it scope for fiscal stimulus.
The ability to respond to any Chinese hard landing with policy stimulus distinguishes Australia from much of the rest of the global economy, said Saul Eslake, chief economist for the country at Bank of America Corp.’s Merrill Lynch division in Melbourne, who has analyzed the Australian economy as a financial economist for a quarter century.
Eslake predicts 3.5 percent growth for the economy this year, slowing to 3.1 percent in 2013. He plays down the danger of a buildup in household borrowing, saying that “although Australians appear to have a lot of debt, the distribution of debt is skewed towards people who can afford to service it.”
Last Recession
The Australian economy last contracted for two straight quarters — a textbook definition of a recession — in the first half of 1991 after the benchmark interest rate was raised to 18 percent to deflate a credit boom. In the fallout from the slump, the unemployment rate soared to a record 11.2 percent in December 1992, on a par with the euro area’s level in June.
Since then, the RBA’s preferred gauge of inflation has averaged near the middle of its 2 percent to 3 percent target range. Slower price gains allowed lower rates, contributing to Australians loading up on debt.
The country’s consumer borrowing stood at 149.7 percent of disposable income in the first quarter, compared with a record 156.3 percent in 2006, RBA data show. That’s higher than the 133 percent Americans accumulated at the peak of the U.S. subprime mortgage boom, according to the Federal Reserve Bank of San Francisco.
Living Expenses
Seven of the world’s 25 most-expensive cities are in Australia, led by Sydney and the capital Canberra, according to ECA International’s Worldwide Cost of Living Survey conducted in March.
John Muellbauer, a professor of economics at the University of Oxford in the U.K., flagged the risks the country faces at an RBA conference on Aug. 20-21 in Sydney.
“Dependence on exporting to China and more generally its reliance on a permanent improvement in its international terms of trade does point to a potential vulnerability in other economic fundamentals,” Muellbauer said in his prepared remarks. “If these fundamentals turned negative, the high levels of household debt in Australia could seriously constrain growth.”
Brian Redican, a senior economist in Sydney at Macquarie Group Ltd., the nation’s largest investment bank, said in a report this week that the nation’s Treasury uses a “rule of thumb” that a 5 percent fall in the terms of trade reduces nominal gross domestic product by 1 percent.
Source: Bloomberg