Oct 1, 2010

Joe cut and pastes on commodity prices

Joe Hockey misses the point in his cut'n'paste effort today about our reliance on commodity prices. Australia has always ridden commodity booms. The real issue is the strength of the dollar.

The opposition's Treasury spokesman, Joe Hockey put pen to paper (or fingers to keyboard) and penned an attack on the federal budget for the op-d pages of The Australian this morning. Perhaps it should have been an item in that paper's Cut and Paste section (AKA Cut and Waste), because Joe's effort was strangely familiar -- in fact it was more or less the commentary on the 2014 budget from Access Economics that got some publicity on Tuesday. "The latest Budget Monitor report released from the highly respected independent forecaster Access Economics should send alarm bells ringing in the Treasurer's office. It warns that the federal budget is effectively held 'hostage to the fate of commodity prices…'" wrote the man who is two by-elections away from being in charge of the economy. Just to remind everyone -- including Joe, Chris 'look at me, look at me' Richardson and the more excitable members of the commentariat -- this is not new news. Australia has been "hostage" to commodity prices now for over a century. There was the gold boom and then depression of the 1890s, the influence of the slump in rural commodity prices in the 1920s which intensified the impact of the Great Depression, the 1950s wool boom and crash (but not the 1960s credit boom and crunch), the two oil booms of the 1970s and 80s, and the subsequent crunches (although the early 1990s crunch was also a replay of the one in the 1960s being driven by over-investment in property). But Joe seems not to recognise that, nor Access' dodgy forecasting record especially on the resources boom, its size and duration. The problem, according to Joe, is that Treasury is being too optimistic about long-term commodity prices because supply will surge to meet demand, leaving the Federal Government stranded because of its dependence on high commodity prices. "This is an argument I've long been touting," says Joe. "Despite some assertions to the contrary, Australia is not the sole source of these popular commodities. Countries such as Brazil and South Africa also have large deposits of coal and iron ore, and the surge in demand has prompted the governments of these nations to fast-track investment in the mining infrastructure required to extract them." Actually Joe, South Africa has little iron ore and there is presently a nasty fight involving a major producer and ArecelorMittal, the main steel maker, over prices. And because South Africa is underinvesting in logistics, its coal exports are falling. And besides, much of South Africa's coal exports consist of lower value thermal coal that's sold into Europe, which is closer than China. Indonesia and Australia are two of the closest and most economic exporters supplying China because the shipping costs are lower and the coal quality is higher. And Joe would have missed the move by the youth wing of the ANC this week to force onto the party's platform the policy of complete nationalisation of all mining in South Africa. That was supported by the trade unions. It won't succeed, yet, but it looks a lot more like a 'sovereign risk' than either version of Labor’s mining tax. Joe failed to mention Canada, another potential rival, but it's busily turning cartwheels and having conniptions over the BHP Billion's $US40 billion bid for PotashCorp, which is looking better by the week. If the Canadians knock that one back, gee, Joe, Australia looks even better, wouldn't you say? "There are also multiple threats to the demand for our resources," Joe goes on. "The introduction of the mining tax itself is one of these. At the 10th China International Steel & Raw Materials Conference, held this week, Shan Shanghua, the secretary general of the China Iron and Steel Association, warned that Chinese steelmakers 'will not be able to accept rising costs from the Australian iron ore mining tax as steel prices will see the ceiling and downstream users won't consume rising costs.'" That all sounds well and good, except the reference to the conference in China was to the discredited Mr Shan, head of the China Iron and Steel Association, who only represents 78 (most of them large) steel companies. What Joe doesn't tell is is that the same conference heard (as detailed in the Financial Times and others), quite surprising statements to the contrary from other producers and from Vale, the world's biggest iron ore miner and exporter. They expect demand to start recovering this quarter and continue into next year. Joe missed this one, as did Australian reporters covering the conference. It was a rather more important comment than the meanderings of Mr Shan. This not to say any of what Joe and what Access say can't happen. It may, and it may not. But it is not black and white. Australia is a resources-based economy, always has been, always will, from riding the sheep's back to driving big coal and iron ore and copper ore trucks. And when prices and demand turns down, the budget in the past had to take the brunt of the adjustment. That was because of the fixed exchange rate. The dollar floats these days, as many people still fail to understand, including Access, and, it would seem, the Man Who Would Be Treasurer. The downturn in demand and prices is transmitted very quickly through the falling value of the dollar, which is what happened from July 2008 to early 2009. It's not protection, but it is a cushion. If prices fall along with demand, mining companies will cut back, but the falling dollar eases the pain by increasing the returns, for a while, in Australian dollars. Reserve Bank deputy Governor, Ric Battellino explained this in a speech in Brisbane on election eve. "Evidence of the role played by the exchange rate in stabilising the economy can also be seen in recent years. The Australian dollar rose strongly between 2006 and 2008 as commodity prices rose, which helped to dissipate pressures that would otherwise have caused the economy to overheat. Conversely, the temporary, but sharp, fall in the exchange rate during the recent financial crisis helped cushion the economy on the downside. Given the consistent way in which the exchange rate has moved to insulate the economy from various external shocks, I would have to conclude that the decision to float the exchange rate in 1983 ranks among the most important economic reforms, if not the most important reform, of the past 30 years." There’s also a certain disingenuousness about a Coalition figure -- and a senior member of the Howard Cabinet -- complaining about a budget that is over-reliant on high commodities prices. The Coalition had a strong fiscal record in its first three terms, but the legacy of its final term was- - as Treasury itself has explained -- a structural budget deficit, fuelled by too much middle-class welfare that wasn't offset by savings elsewhere in the budget, and successive waves of permanent tax cuts fuelled by the Mining Boom Mark I. Those personal income tax cuts lifted the dependence of the federal budget on company tax, leaving the Commonwealth more exposed than ever to the vicissitudes of the commodities price cycle. That’s why the GFC had such a massive effect on tax revenue. For a Coalition figure to now paint that as Labor’s fault is rich indeed. Finally, Joe wrote this: "there is also an ever-present threat that the Chinese government could deliberately slow its growth. Inflation is a looming threat, with the nation's CPI growing by 3.5 per cent year on year -- a 22-month high -- just last month. Chinese policy-makers are well aware of the dangers this poses and stand ready to pull the interest rate trigger. This would ultimately slow down the country's growth and subsequently hose down the demand for Australian commodities." Joe, demand and prices have fallen, the quarterly iron ore contracts this quarter see a price fall of around 13%; coal prices will also be lower in some markets. But gold, copper, wheat, cotton and LNG prices are rising. It's swings and roundabouts. The rise in Chinese inflation is coming as a result of a drought and then the impact of the bad floods on food prices. Joe might have missed the survey of Chinese manufacturing released for September by HSBC on Wednesday, which showed a rise in the index to 52.9 from 51.9 in August and less than 50 in July. China isn't slowing Joe, it's coasting to a soft landing. Growth in Chinese house prices is slowing, as are Australia's. No bubbles there. The Asian Development Bank said this week growth in China this year will be 9.6% and 9.1% in 2011. That's less than the near 12% rate in the first quarter, but that means inflationary pressures will ease soon, once food supplies start returning to normal. But Joe missed the biggest concern for everyone including China, as we head towards 2011 (and beyond) and that's the problems in the US. He might have demonstrated he can actually think for himself if he'd asked just what the Reserve Bank, Treasury and the Federal Government think the pros and cons are of a prolonged period where the Australian dollar remains at parity with the US, or more as the US Federal Reserve spends more money to try and kick start a sluggish and indebted economy? And what happens if this coincides with an escalation of inflationary pressures in Australia? What's the policy response, especially on the budget? We can't cut rates if growth is accelerating and inflation is starting to rear its ugly head. And what happens if the strength of Aussie dollar starts causing businesses to close or cut back and unemployment to rise? If the Fed spends another $US trillion (and it is still a big if), what are the policy responses needed from Australia, because these are unchartered waters: we are growing quickly, as is China -- could this huge lift in US spending, which drives down the value of the US currency, and pushed the Aussie dollar well over parity, destabilise our growth, and therefore the budget? It's not an original query, but it's better than Joe's effort today, which merely rehashed "the cuts" as we say in newspapers, from the week's news stories.

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5 thoughts on “Joe cut and pastes on commodity prices

  1. John Bennetts

    Nice stuff, GD and BK.

    What else would we expect to come from a Treasurer-In-Waiting who rejects as unreliable sources such as Treasury in favour of Access Economics? It’s past time for the Opposition to put a few positive proposals on the table. For Joe and Co to continually come across as knockers invites a FTOTM cartoon on the subject… of knockers.

  2. David

    Treasurer in waiting and waiting and waiting and waiting and…where is he?


    “A bit rich” indeed!

    It still doesn’t stop Sloppy Joe bloviating his confected rage in parliament, nor his ludicrous claim that the Coalition will do the ‘hard yards’ whatever the f^%k that’s meant to mean.

    Mildly entertaining our Joe, but foreman material? He ain’t.

  4. Harvey Tarvydas

    Dr Harvey M Tarvydas

    Excellent and necessary GD and BK, thanks.
    What’s worse than young Joe’s careless ignorance on matters ‘treasury’ is the acceptance of it all by his boss given his university education. A young jolly Joe maybe could pull himself into line with a leader ship.
    While I only did (in secret) most of the part time students undergrad UWA economics course while studying medicine there in the 60’s I can see the foolish arrogance besetting Joe’s economics babble and from there cometh my support for your quality article, not from politics.

    Australia could be well served by seriously potent and individual economics thinking to change some seriously stymieing old cultural economics thinking that cloaks us because Australia has so so much to gain in the current world economics situation and its people deserve something special. Approximately one half of its politics isn’t even able to deliver the most ordinary economic planning for the Australian people’s wealth.

  5. Sean O Finn

    A great well written and factually based analysis. I love it keep it up.

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