An Australian PM's Fatal Tussle with Big Mines

Australian Prime Minister Kevin Rudd faced off against the mining companies—and lost. In May, Rudd, a Labor Party PM, proposed a 40 percent tax on mining income to slow the industry's runaway growth in Australia, the world's largest exporter of coal and iron ore. Rudd also wanted tax cuts for non-mining companies in an effort to redistribute profits and rebalance growth in the economy. What he got was a bitter battle between the Australians who benefit from the mining boom and those who don't.

The resistance to the mining tax was so intense that Rudd had to step down as Prime Minister on June 24. His successor, Julia Gillard, who was Rudd's Deputy Prime Minister, now says she will negotiate with the mining companies—which include giants like BHP Billiton (BHP) and Xstrata—over any possible tax instead of locking horns with them.

While Gillard, the country's first female PM and a lawyer, has calmed the political scene temporarily with deft diplomacy, the underlying problem Rudd was trying to address remains. Chinese demand for metals and energy is pitting resource-rich Western Australia and companies like BHP Billiton and Xstrata, which have a combined $74 billion in revenue, against the rest of the country. Coal and metal sales to China have grown so fast that the mining sector has driven up demand for labor and funds to expand the mines further. As upward pressure on prices has increased, the central bank governor, Glenn Stevens, has raised interest rates six times in seven months.

The rate hikes have helped drive the Australian dollar up 21 percent since early 2009. The rise has not had a major effect on the miners' exports to China, which still hungers for raw materials. Yet for other exporters, like wheat farmer John Springbett, the dollar's rise hurts. "We're going broke by the minute," says Springbett, who ships 4,000 tons of grain a year to India, Indonesia, and the Middle East from his farm east of Perth. Springbett says when the Australian dollar rises above 70 cents (U.S.), it puts many farmers in the area at risk. (It's near 85 cents now.) "Last year most farmers would have made a loss," he says. "We don't want another one of those years. Otherwise there will be a lot of farms for sale." The government figures wheat exports dropped 21 percent in the 12 months through June 30.

The domestic economy is showing the strain, too. Workers now flock to higher-paid jobs in regions such as the Pilbara, the remote north of western Australia and source of one-third of the world's iron ore. Mining wages eclipsed the earnings of staff at Australian banks, brokers, and insurers by 35 percent in February, according to the Bureau of Statistics. Mining workers earn an average of $1,685 a week, well above the $1,250 average in the financial sector.

In the snowy mountain town of Tumbarumba, 310 miles southwest of Sydney, Hyne & Son, the Southern Hemisphere's largest softwood timber mill, is short of electricians, wood machinists, and clerical staff, the local shire council told Parliament in April. "It's very much a two-speed economy that's emerging," says Saul Eslake, an economist at the Melbourne-based Grattan Institute, a nonpartisan state-supported research group.

BHP and Xstrata have both warned that if the 40 percent tax goes through unaltered, they will probably divert investments to mines outside Australia. Some local economists like Eslake, though, say less mining investment may be beneficial, since it would cool off growth and let the central bank stop hiking rates. "From the viewpoint of the whole economy, the best thing that could happen is for one of the big [mining] projects to fall over," central bank Deputy Governor Ric Battellino said, according to a May 11 report in The Australian Financial Review, the business daily. The central bank would not comment.

Gillard must heal the split in the economy even as China's purchasing power expands. The wider trading band for the yuan means a stronger Chinese currency. That could translate into even more demand for Australian coal and iron ore—and strengthen the Australian dollar further. A boon for some, more hardship for others.

The bottom line: Australia's new Prime Minister must avoid alienating the mining sector while shoring up the rest of the economy.

Before it's here, it's on the Bloomberg Terminal.