Relative optimism

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Today I’m going to take issue with a couple of my fellow bloggers. I’m going to be optimistic, in a real sort of way.

I write often on Dutch Disease, which is a very real problem and, in my view, poses a serious threat to our prosperity in the long term. This, however, can sometimes mask just how spectacularly grateful I am for the existence of the mining boom. In my view, without it, we would be far, far up the creek. Let me explain.

There are two adjustments taking place in the Australian economy at once. They interact and change each other, but each would absolutely be transpiring regardless of the existence of the other. Those two things are the mining boom displacing other industries and, secondly, a long term shift away from the dead Western economic model of the past thirty years of ‘borrow and consume’.

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It’s the second point that is most often missed, by just about everyone, not least because that adjustment is being disguised by the other adjustment, the mining boom. To illustrate my point, let’s do a counter-factual.

Imagine there is no mining boom; that commodity prices are sitting somewhere just above historic averages. Australia’s terms of trade are strong but nothing like where they currently sit. What do you think would be happening to our debt complex?

It’s pretty straight forward. Following the GFC, the world has changed to a focus on debt consolidation. In Australia, the big fiscal stimulus of the GFC would have by now given way to little rebound in government revenues. With its guarantees of bank debt, and ongoing role as implied guarantor, the government would still be forced to aim for surplus. I think it very doubtful it would achieve it but would still try, under pressure from ratings agencies. The result would be big cuts in spending to various forms of middle class welfare and probably big job losses in the public sector at both state and federal levels.

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This would exacerbate the correction in housing that would have started earlier and be accelerating more sharply. Consumer caution would be much more advanced, along with saving, and retail would be getting thumped. There would be rolling waves of cost cutting across the services economy and much higher unemployment. There would be broad wage level stagnation and probably deflation. The banks would be under enormous pressure from rating agency downgrades aimed at their offshore liabilities and deflating assets. Whether more bailout measures would be required is a moot point.

Australia’s current account deficit would be forced to correct not through a rise in exports but a fall in imports, as well as through a squeeze on the capital account – that is, less borrowing.

All of these things would be happening without the mining boom. And would continue until our spending matched our productive capacity, at least to the satisfaction of global markets. The process would be helped by low interest rates and a low dollar.

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So, Australia would be in a situation not dissimilar to the UK. This is not a radical thought. Our inability to continue to borrow offshore has broadly been acknowledged by the RBA and Treasury, which has basically called time on Australia’s old externally funded ‘borrow and consume’ model. Would they still have done this without a commodities boom? As the recent Moody’s bank downgrade has shown, they would have had no choice.

So, what’s my point here? There are three. First, my fellow blogger, Unconventional Economist, today berates The Economist for representing Australia as the new California Golden State. His argument is that Australian prosperity is being goosed by immigration and on the real measure of increasing wealth, GDP per capita, we’ve flatlined since 2007. He is absolutely right. My response is, however, that in a world where hugely indebted Western nations are being smashed by forced austerity, our position of stalled prosperity is outright spectacular.

My second point is for Leigh Harkness who today argues that the huge rise in the exchange rate has effectively killed the commodities boom and some other exchange regime would make us much richer. Again, I agree, having campaigned ceaselessly for big resources taxes and an SWF to help manage the exchange rate. However, I’ll say again, that the rise in Australian commodity prices has so far outstripped the rise in the currency. We are also enjoying a huge capex boom into sustainable production. Sure, when the bubble pops some of that will end up as overcapacity but not all. And much of that expansion is being funded by huge retained earnings in the mining firms, not debt.

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My final point is to address a meme that has developed around my many Dutch Disease posts. Some comments argue that the mining boom is forcing austerity onto Australia’s services economy. I have argued this myself. Again, it is true. But let’s not kid ourselves, that austerity would have been coming anyway. And without the mining boom, it would have been much, much worse.

Fact is, the Australian economy has so far managed to adjust away from it’s debt addiction via disleveraging not deleveraging thanks to mining. We should all take a ganders at the US and UK be very grateful for that.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.