Oz Mines for Trouble

Australian hubris appears to have reached a new high. Now that property prices in the US, UK, Ireland, Spain etc, have collapsed, Australia has the highest property prices relative to income of all the OECD nations. And now it is exulting in a mining investment boom which contains the seeds of its own destruction.

Believing that urbanization in the developing world will continue to lead to exponential growth in demand for steel, copper, coal, gas and other commodities, Australia has embarked on what the Reserve Bank of Australia governor recently described as "the largest resources sector investment expansion in a century." Indeed that is probably correct as the mining sector plans to invest A$55 billion in fiscal year 2010/2011, an increase of 57 percent on last year, which itself was a record.

This is even powering spin-offs in the manufacturing sector, which otherwise has been suffering from the strength of an Australian dollar itself propelled by commodity prices gains.

Commentators exult that Australia’s terms of trade have improved a dramatic 30 percent. Admittedly that was after a slump in late 2008/09 but now amounts to an improvement over the past decade of more than 40 percent, a rise which equals that seen during the wool booms that once propelled feverish growth for the economy as a whole and for construction in particular.

But it’s hard for anyone with a sense of history and commodity cycles to believe that this mining boom will not be followed by a bust like its predecessor in the 1970s or the wool price busts of earlier decades. Of course the cry "this time it’s different" is again heard, based on assumptions that the extraordinarily rapid growth of Chinese and Indian demand will continue. But even the demand side of the equation may be misleading. There are several reasons to believe that China’s demand for basic materials will stabilize if not fall. One is that the rate of urbanization will slow as the population stabilizes and the numbers of young people – ie those most likely to migrate to the new cities – falls.

Secondly, it is well known that China has been massively over-investing in housing and infrastructure while consumption has lagged. This is likely to reverse over the next few years as the poor returns from much of the infrastructure spending become apparent and the government is forced, however reluctantly, to shift towards more rapid consumption growth to keep the overall economy growing. In turn that will mean more emphasis on services and light industry – and less for mineral intensive activities.

It may be that in India the opposite will occur and urbanization and infrastructure spending will rise. Ditto the likes of Indonesia, Vietnam and the Philippines. Nonetheless with population growth and urbanization slowing everywhere except Africa net global demand does not look to be in for another decade of the growth seen in recent years.

As for the supply side, the bulls seem to forget that the rising prices of recent years have been due not just to Chinese and other developing country demand but to the very low levels of investment in the preceding two decades. Australia is not alone in making up for this with a vengeance. Brazil in particular is expanding capacity and China is investing even in the most difficult parts of Africa such as Guinea, Liberia, Congo, Cameroon etc where mining opportunities exist for iron ore, bauxite, copper etc that offer both profit potential and promise, from a national interest perspective, to bring down the cost of raw material imports.

Few of these minerals are actually scarce, as Australia well knows, having almost unlimited quantities of iron ore. What are needed are railways and ports to get them to market. Those take time to build. But being built they are, all around the world – in many cases with cheap Chinese financing and construction by Chinese state enterprises.

Another of the Australian boom sectors is coal seam gas with three projects announced with a total of A$55 billion investment. But coal and shale seam gas is a global story and increases in shale gas and coal bed methane production are already undermining gas prices in the US. Big future rises are forecast for the US, Canada, China and elsewhere.

All this suggests that Australia could have another year or so of both mining investment- fuelled growth and healthy terms of trade. But the outlook beyond that is scary as supply grows faster than demand and commodity prices crumble. As it is, even with its extraordinary terms-of-trade gains, Australia is still recording a significant current account deficit.

Some of that is related to investment goods imports. But the current account is also the beneficiary of extraordinarily low interest rates on its large foreign currency denominated foreign debt much of it owed by a banking system over-exposed to the property sector. Foreign debt is some 60 percent of GDP and of that about 55 percent is in foreign currencies. The Australian "miracle" could vanish as quickly as the Celtic Tiger, Ireland, moved from growth exemplar to threat to the whole Euro system. Imagine what a combination of a 30 percent fall in Australia’s terms of trade combined with 6 percent interest rates on that debt could do.