As we enter COVID apartheid with the NSW leper colony razor-wired off from the rest of Australia, and the nation is locked into a genuine two-quarter double-dip recession, you could be forgiven for thinking that things are about as bad they can get.
You’d be wrong.
Another shock is bearing down on Australia with an astonishing speed that is going multiply our economic problems many times over.
Throughout the pandemic, Australia has been protected economically by rocketing terms of trade. Chinese stimulus, trade war follies and COVID distortions have sent the price our commodity exports to the highest levels in history:
That has lifted nominal growth and flooded the nation with cash. Federal and state coffers have overflowed with a tsunami of income that has enabled both to spend without concern for the future as we managed the pandemic. It has contributed mightily to a runaway stock market driven by fantastical dividends. It has liquified business such that profits and wages have bounced hard off the lows.
All of that is about to violently reverse even as our pandemic response collapses into biological civil war.
What am I talking about, I hear you howl? Chinese steel output:
Steel production and commodity demand (iron ore and coking coal) are crashing in a manner that I have never seen outside of shocks such as the GFC. Prices will follow with equal ferocity in due course.
That’s half of Australia’s terms of trade that is about to crater.
This is going to have direct and obvious economic consequences over the next 18 months:
- nominal growth is going to be smashed;
- large segments of the stock market will come under sustained selling pressure;
- rebounding wages will be crushed;
- federal and state budget deficits will either blow out or make the economic impact a lot worse.
So, take what we see today in our collapsing pandemic management strategies and add a gigantic economic shock the likes of which we have not seen since 2015. What do you get?
First, monetary policy is going to have to step into the breach. The RBA will not be going ahead with taper. It will be printing its little butt off. If the US continues taper anyway (which is also doubtful), then the RBA may have to resume the TFF to stop the banks from lifting real mortgage interest rates. Indeed, the income stall may be so bad that it has to do so anyway.
Second, a booming WA (and less so QLD) is going to get smashed. Expect Perth property prices to stall out and fall.
Third, unemployment is going to rise and become more sticky. The spectacular rebound of the economy out of COVID round one is not going to be repeated. Whatever kind of rebound that we enjoy amid COVID apartheid is going to run headlong into a giant income suckhole that drowns any wages and consumption bounce before it can take hold.
Fourth, 2022 will leave Australia with only two economic cards to play. The first is house prices. They will be protected and boosted at all costs. If this necessitates negative interest rates then they will come. Do not doubt that this will be priority numero uno.
The second is a falling Australian dollar which will become integral to offsetting the external shock. But even this will not deliver enough of a boost to absorb all of the income drain, in part because as borders reopen around the world ours will remain more closed than many. And because Chinese tourists and students will never return even when borders are reopened.
This brings me to my fifth and final point. As we head towards a federal election which the Coalition appears odd-on to lose, the crashing commodity cycle takes on a whole new meaning. It’s been relatively easy for the Morrison government to resist Chinese economic coercion during a non-stop iron ore boom cycle. Bulk commodities have protected the Australian economy from the blandishments of Beijing and broader trade war losses and turned Australia into some kind of China anti-hero globally. The latest discussion and analysis in the US concludes that all Beijing’s bullying has achieved is to describe the limits of its own power.
But that calculus shifts radically as the commodity cycle turns deeply negative. As bulk commodity prices are routed, the wider trade war losses become much more obvious and important. It will take considerable will on the part of the Morrison government to persist with its resistance. Likewise, a new Albanese government will be under immense pressure to reverse any and every anti-China policy to restore non-mining Chinese exports. We can expect it to grovel in a way that makes all previous ALP China kowtowing appear like Herculean strength.
Never fear, the one thing Australian policymakers are good at is rendering short-term economic supports that make the long-term outlook much worse.
Another round of that madness is at hand.
