Economic Insider: Challenging times for the Australian economy as commodity prices fall
23 February 2015
- Multi-generational commodity price boom well and truly over, although …
- Falling $A offsetting some of the impact of lower prices, and in any case …
- The local currency denominated RBA index of commodity prices is still double what it was as recently as the middle of the 2000s - just before China’s investment in steel-intensive industrial infrastructure took off in a big way.
- Dwelling construction cycle offsetting the downturn in resources construction employment.
- Housing cycle still has some way to run, but it will top out by 2016, which is where the biggest challenge lies if commodity prices continue to fall.
- Households remain cautious in the face of uncertainty about job security as the unemployment rate grinds higher.
- Business confidence constrained by uncertainty about Europe and China, while political gridlock at home is not helping either.
RBA Index of $A Denominated Commodity Prices
Falling commodity prices (Figure 1) pose an enormous challenge to the Australian economy in 2015 and beyond. Not only directly, as the revenues of mining companies fall in line with lower prices, but also via even greater constraints on governments’ already limited capacity to fund infrastructure projects to fill the void left by the end of the once in a multi-generational resources boom.
The slide in commodity prices was already steep even before global oil prices started to fall sharply, but the severity of the problem went up a notch or two when benchmark crude prices fell from more the $US100 a barrel in August 2014, to less than $US50 by new year’s day 2015.
Australia is only a minor oil producer by global standards, but it is a major liquefied natural gas (LNG) exporter. And long-term LNG export contract prices are tied to benchmark oil prices, so unless the oil price recovers soon, the revenues of existing and nearly completed mega-LNG projects will fall. So too will Canberra’s tax revenues, while the next wave of LNG projects will at best be delayed.
Nevertheless, lower oil prices are good for households and a wide range of businesses, so there are winners as well as losers from the big drop in the oil price.
Just as there are winners (exporters) and losers (importers) from the steady depreciation in the Australian dollar since commodity prices peaked. But as an economy that has always relied heavily on exporting its wares to the rest of the world, the net benefits of a more competitive currency far outweigh the downsides.
The Australian dollar is a very small fish in a very big sea, so can and does often get buffeted by realignment of major currencies. Accordingly, there is no guarantee that it will fall further, or even that it will not rebound - as it did in 2009 after its precipitous fall during the GFC (Figure 2) - but the case for it to continue to fall, or at least stay at the lower level for a prolonged period, is quite a bit stronger than the risk of it rising back up towards parity with the US dollar.
Australian Dollar against US Dollar
Given the choice between a steep but temporary fall to around say 60 cents and a gentler but lasting drop to say around 70 cents, exporters will choose the more moderate and lasting depreciation any day.
And if the Australian dollar does stay competitive for a couple of years or more, there is a good chance that investment in the non-mining economy other than dwelling construction will make a solid contribution to growth in time.
Residential Building Approvals
Source: ABS catalogue 8731.0
Trend Labour Force Underutilisation Rates
Source: ABS catalogue 6202.0
If not for a sustained growth phase in dwelling construction (Figure 3), the impact of lower commodity prices on the labour market would have been much worse.
In fact, the labour market is quite a bit softer than an unemployment rate of around 6½ per cent implies. The underemployment rate is at a historical high and still rising, and when the numbers of unemployed and underemployed persons are grouped together and expressed as a proportion of the labour force, the resulting labour force underutilisation rate rose to a 15-year high of just a touch under 15 per cent late last year (Figure 4).
The soft labour market is doing nothing to underpin a rebound in consumer sentiment as households continue to nurse balance sheets damaged by the GFC. Household consumption’s share of GDP returned to its 50-year average late last year, but only after having plunged to a 37-year low in 2010 as the stings in the tail of the GFC bit deeply into households’ appetite to consume.
It is all but inconceivable that household consumption will again approach the share of economic output it tracked at in the 15 years or so to around the middle of the 2000s. And if it did, the RBA would have something to say about it, because while inflation is well contained at the moment, upside inflation risk would rise quickly if consumption growth were to accelerate markedly, particularly if the Australian dollar does continue to fall.
As the dwelling construction cycle tops out later this year, the RBA’s preferred scenario is for a recovery to what it calls “trend” growth in the economy to be fuelled by business investment, but evidence of a rebound is thin on the ground. It won’t come from either the mining or the energy sectors unless the iron ore, other mineral and the oil prices recover quite a bit of ground in the next year or so.
And the federal government’s much touted infrastructure-led recovery is held up by political gridlock that is not on the verge of being resolved.
Nevertheless, the importance of the production/export phase of the last resources boom is all too often downplayed too vigorously. Yes, the operational phase of a new mine employs a lot less people than the construction phase, but it lasts for the 20-30 year life of the mine, rather than the 2-3 years it takes to construct it. And there are a lot more mines that need to be maintained throughout a life that will earn billions of dollars in export revenues.
To the extent that the resources boom pushed the Australian dollar higher for longer, other export industries struggled to land their wares on world markets. Conversely, now that the currency is retreating, tourism and education services in particular will benefit from a lower Australian dollar, while the ageing population all but guarantees that the health and social assistance industry classification will remain the nation’s biggest employer for some time, if not permanently.
The change in the composition of growth in China’s economy away from steel intensive industrial infrastructure in favour of consumption will limit the extent of any recovery in the iron ore price - and may even send it lower - but Australia would only need to grab a modest market share of China’s burgeoning consumption - including especially high protein foods - for it to be a big deal in absolute terms for a country of 24 million people at the bottom of the world.
The benefits of trade liberalisation agreements Australia has recently forged with major Asian economies - including China itself - that are much closer to Australia than Europe or North America, will accrue gradually, rather than suddenly. But the sky – or more to the point our capacity to supply enough to meet literally hundreds of millions of new customers’ needs - is the limit when the agreements gain traction in the latter part of the 2010s.
In the meantime, if the Australian dollar does stay lower for longer, upside potential for the rural component of the RBA’s index of commodity prices (Figure 5) is more promising than the outlook for the index as a whole - fully one third of which is accounted for by iron ore.
RBA Index of $A Denominated Rural Commodity Prices
Alan Langford has been with Bankwest since 1989 and is responsible for the analysis of economic and financial market trends in the Australian and global economy.
The information contained in this publication is of a general nature and is not intended to be nor should it be considered as professional advice. You should not act on the basis of anything contained in this publication without first obtaining specific professional advice. To the extent permitted by law, Bankwest, a division of Commonwealth Bank of Australia ABN 48 123 123 124 AFSL/Australian credit licence 234945, its related bodies corporate, employees and contractors accepts no liability or responsibility to any persons for any loss which may be incurred or suffered as a result of acting on or refraining from acting as a result of anything contained in this publication. BWA-6124 230215 – GEN Australian Bureau of Statistics data used pursuant to the Creative Commons Attribution 2.5 Australia license (available online at: http://creativecommons.org/licenses/by/2.5/au/).
Chief Economist, Bankwest