Leading economist Saul Eslake believes the current commodity cycle hasn’t reached its floor yet. He’s expecting further price falls in both iron ore and coal over the next two years.
For any of you with a pulse on the Aussie economy, that won’t surprise you. It’s not a particularly new train of thought. Most economists already take a bearish position on commodity prices. But Eslake is predicting something few others are talking about.
Not only does he think this cycle will get worse, but he reckons it’ll be the last one.
When you look at the facts at hand, it’s hard arguing against this point of view. China’s rampant growth was a once in a lifetime opportunity. The kind of golden period that dragged global growth by the scruff of the neck for decades. But as China’s economy slows, the future becomes less certain for major exporters.
Commodity cycles are a blessing for exporters, like Australia, that have resources to sell. Yet, we often take them for granted. We tend to believe that things that appear solid will stay that way forever. But every now and then, we get a reminder that reality is far different.
Australia received its wakeup call back in 2012. That was the point at which iron ore prices began plummeting. From a high of US$190 a tonne, the decline has been nothing short of spectacular. Iron now sells for a third of that on a good day.
In 2012 many of us realised things are more fleeting than they appear. We enjoyed the fruits of this cycle since the beginning of this century. Average household wealth rose. Asset prices were on a tear. We milked the boom for all it was worth.
We owe most of our prosperity today to China. Its boom was a marriage made in heaven. But if everything prior to 2013 was a perfect union, what came next was a difficult divorce.
The diminishing returns of high growth
China’s GDP growth still amounted to 6.9% in the year to September. By global standards, that’s impressive. Especially in the context of China’s sheer size.
At the same time, the developed world is happy just hitting anything above 2%. From that perspective, the panic over China seems irrational. Yet it’s anything but. At least not for commodity exporters like Australia.
High growth is high growth, however you look at it. That’s true. But we should be wary of anyone spruiking Chinese growth of 6.5% as a positive trend. It’s good, but not good enough.
China’s transition to a consumer economy makes slower growth inevitable. Even if consumption made up the shortfall, it wouldn’t be enough to maintain 7% growth. Let’s say China did manage it — it’d still be the wrong kind of growth for Australia. We need rampant construction in China, not consumer spending.
At present, China has little need to build cities from the ground up. Which means they have less need for steel in general.
China’s output fell 2.1% year on year in the first nine months to 2015. The industry lost $3.9 billion in the first eight months of the year. But it hasn’t reached a floor yet. Recent forecasts put Chinese steel production falling by another 20%. Despite the fact that it’s already at six year lows.
But there’s always the next commodity cycle to look forward to. Right? Well, not quite.
Eslake is right about one thing in particular. There’s no other country on earth that can replicate the kind of growth we’ve seen in China. Not even India.
You often hear people talk up other emerging markets like Indonesia. But none of these EM’s have the potential of China 40 years ago. Or even the China at the turn of this century for that matter. Here’s Eslake speaking on this:
‘The countries that are still to develop are much smaller than China and India are. They are not, in most cases, starting from as far back on the development curve as China was in 1979 or India was in 1991, and most of them are much more self-sufficient in commodities than China or India ever were.
‘So it could well be, in my view, that the commodities boom Australia has just experienced in the last 12 or so years is the last of its kind in human history unless unforeseen technological developments ordain otherwise’.
He’s right, of course. A lot of these emerging markets are rising because they have commodities. They’re sellers, not buyers. All of which matters little to Australia. We’re looking for markets to sell to. Unfortunately the list is thinning. The only viable candidates, China and India, won’t be as reliable going forward.
That’s the law of diminishing returns. Growth still looks high comparatively, but it goes less every year. Brazil is another example of this. It could be a strong export market for resources, were it not for the fact that it sells iron ore by the boat load.
The end of the commodity cycle is a black day for Australia
If we take Eslake’s argument at face value, it spells trouble for Australia. It means we have to look elsewhere to maintain the living standards we’ve come to enjoy. And that we need to take a strategic, 20–30 year approach. If commodity demand never recovers, our national prosperity will decline too.
Diversifying the economy is an alternative. And it’s an important part of this process going forward. The service sector will need to take up the slack. But of course all that’s easier said than done.
Eslake’s advice on this is no different than what most economists offer. He notes (emphasis mine):
‘Australia needs to broaden and deepen its economic development with Asia if it’s to prosper from the next phase of Asian economic and social development. That means we need to increase our exports of agricultural commodities and services as well as maintain or improve our market share in minerals and energy commodities.
‘The free trade agreements that Australia has signed with some Asian economies will be helpful in that regard but they are not magic bullets’.
Yet even if everything goes to plan, there’s no guarantee of anything. We should remain a first world nation, but one that’s increasingly worse off. Household debt will keep growing, as families feel the pinch of less purchasing power.
As for Asia, our pivot to the mainland is already well under way. From free trade agreements to regional development initiatives, our future path is set. We’re members of the Asian Infrastructure Investment Bank. We’ve just signed off on the Trans-Pacific Partnership. We have free trade deals with the likes of China and Japan.
There are plenty of other opportunities in expanding our relationships with the rest of the continent. If we want to maintain living standards, we must figure out a way of selling them value, not resources. We’ll always be a commodity exporter at some level. But our reliance on it must change.
What’s more, we need a service sector that understands the new century we’re living in. One that knows Asia, and its tendencies, inside out.
The only concern is that our reliance on commodities has left us shorthanded. For the better part of 15 years, we’ve known nothing else but mining. And we didn’t take the opportunity to prepare for what came after it. How we manage this will determine the rate at which our living standards fall. But make no mistake, they will fall.
If Eslake is right, and the commodity cycle is never coming back, then Australia can’t hope for much more than mediocrity.
Contributor, Markets and Money
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