As China Slows, Australia Feels the Pain
The last time Australia was mired in recession, Boris Yeltsin had yet to stand on a tank in Moscow, and the Clinton era hadn’t begun. In 1991, Australian trade with China was a modest A$3.6 billion (about the same in U.S. dollars). In the preceding decade unemployment had averaged 7.8 percent, as Australia struggled to develop tourism and other services to diversify growth.
The urbanization of hundreds of millions of people in China changed that: Demand in the world’s most populous nation for Australian iron ore and coal spurred a more than 33-fold increase in trade between the two countries to a recent A$121 billion. The Australian jobless rate is down to 5.1 percent.
This prosperity is now threatened. Chinese Premier Wen Jiabao in March reduced his government’s growth target to 7.5 percent for this year, the lowest since 2004, as policymakers seek to reduce the role of large-scale investments in favor of stimulating greater consumer demand. On Sept. 9, President Hu Jintao told an Asia Pacific Economic Cooperation forum in Vladivostok, Russia, that China’s “economic growth is facing notable downward pressure” due to a slowdown in exports. The price of iron ore, Australia’s most lucrative export, has tumbled 25 percent since June 30.
Saul Eslake, chief economist at Bank of America’s Merrill Lynch division in Melbourne, says that while he expects China to keep growing, a severe downturn—growth of under 6 percent for a year or more—would hurt. “If China were to have a hard landing, then Australia would arguably be more exposed than any other country in the Western world,” says Eslake. China buys about 28 percent of Australian exports directly and “indirectly sets the price that countries that take another 30 percent or so of our exports pay.”
BHP Billiton’s decision last month to delay an estimated $33 billion expansion of the Olympic Dam mine in South Australia has sparked suggestions that the resources boom is over. On Sept. 4, Fortescue Metals Group, Australia’s biggest iron ore producer after Rio Tinto and BHP, cut its full-year capital spending forecast by 26 percent, to $4.6 billion. The shelved mining projects are a blow to Prime Minister Julia Gillard, who has called mining “our economy’s strong right arm.” Already, falling prices for iron ore and coking coal have eroded the nation’s terms of trade, a measure of the windfall gains from exports that reached a 140-year high last year.
“If you looked three months ago at commodity forecasts, nobody picked this,” says Mike Young, managing director of BC Iron, which is developing an iron ore project with Fortescue. “I call it a perfect storm. You’ve got the leadership change going on over in China—decisions are on hold. You’ve got elections in America. Europe? Still Europe. You’ve got mills de-stocking because of the slowdown in China.”
Amplifying these woes is the strength of the Australian dollar. Historically, the currency has lost value quickly in a downturn, which restored competitiveness in fairly short order. Yet the Aussie dollar is up for the year even as Australia’s No. 1 customer, China, sees a deepening slowdown. “The Australian dollar is behaving more like a fixed exchange rate,” says George Tharenou, an economist for UBS in Sydney. The currency looks better than most alternatives. Its 10-year government bonds yield more than 3 percent, compared with well under 2 percent for 10-year bonds in the U.S., Germany, and Britain. Investors fleeing the euro have piled into Australian bonds. Even Switzerland’s central bank is buying Australian dollars. As further quantitative easing looks likely in the U.S. and the euro zone, the result will be even lower interest rates in those areas. That would accelerate the flight to the Australian dollar, further hobbling competitiveness.
Brian Redican, a senior economist in Sydney at Macquarie Group, an investment bank, still predicts the currency will respond in traditional fashion should the fall in iron-ore prices prove long lasting. For now, he says, investors expect iron-ore prices to recover along with China. If that prediction is wrong, there will be what he calls a “Wile E. Coyote moment” for the Australian dollar: The coyote gets tricked by the Road Runner into running straight off a cliff. “Initially at least, he doesn’t fall,” Redican says. “But then he looks down and realizes that there is nothing supporting him.”
Intensifying the pressure is the government’s pledge to post its first budget surplus in five years. That will require spending cuts that in the short term will be a drag on growth, leaving the central bank as the last option to stimulate the economy. Yet Reserve Bank of Australia Governor Glenn Stevens has held the benchmark interest rate at 3.5 percent, the highest level among major developed nations. He wants to keep inflation contained and make sure no spike occurs in already high home prices. Seven of the world’s 25 most expensive cities are in Australia, according to ECA International’s Cost of Living Survey.
The deceleration of the mining industry heightens concern in a nation where consumers are heavily in debt. Consumer borrowing stood at 150 percent of disposable income in the first quarter, says the central bank. That’s higher than the 133 percent Americans accumulated at the peak of the subprime mortgage boom, according to the Federal Reserve Bank of San Francisco.
The median forecast for Australian growth is 3.6 percent this year. No one is predicting recession, but no one predicted the plunge in iron-ore prices, either. The windfall Australia gets from exports will slump 15 percent in the final three months of 2012 from a year ago, according to Adam Boyton, chief economist in Sydney at Deutsche Bank. A trade drop of that size has preceded a recession three of the five times it happened in the past half century.