Australia: Is this the end of the natural resources boom?

Today’s commentary

In yesterday’s commentary, I wrote that China was attempting to rebalance its economy, which ultimately means a slowdown in its use of commodities. This has hit the commodities currencies particularly hard, with the Australian Dollar down over 16% and the South African Rand down by over 18%. Commodity producers are going to be the biggest losers from a Chinese rebalancing. And the question then is what happens to their economies.

Take Australia for example. It is intimately tied into the Chinese (and Indian) investment-led growth paradigm through the commodities market. The Australian economy is in the 23rd consecutive year without a recession. There was no recession during the Internet bubble or the housing bubble. The rise of China and the commodities boom has been that helpful in creating economic resiliency. But as commodities demand and prices have come down, the Australian economy has begun to weaken.

In Q3 2013, Australia’s economy was up 0.6% q-o-q and 2.3% year-on-year. That is still heady growth compared to what is happening in Europe. But it is down significantly from 4%+ growth in quarters in 2012. This is directly related to the mining sector’s downturn. Investment in the sector will be weak. And investment in non-mining sectors will have to be weak as well because of low business confidence, tight credit and a falling currency.

On the jobs front, 2013 saw the lowest number of jobs added in seventeen years at 54,600. Most of these jobs were part-time positions. This has brought labor market participation down to a seven-year low of 64.6% as job seekers leave the labor market. The most recent jobs data showed employment declining by 22,600 in December, much worse than the forecast for an increase of 10,000.

This has the government in a bind. If you recall, ex-PM Julia Gillard was telling us in 2012 that she planned to eliminate the budget deficit altogether and move to a budget surplus – something very ill-advised. A surplus would imply an overheating bubble like domestic economy as the private sector dissaves due to the mining boom. But the mining boom has come unstuck and government finances with it. The government’s new finance minister is forecasting a AUD $47 billion deficit for fiscal year 2014, which is 50% higher than the Treasury’s pre-election August projection of AUD$30.1 billion. This puts Australia bang on a deficit of  3.0% of GDP, the demarcation line for eurozone deficit sinners.

The Australian Treasurer is therefore saying that deficits could last a decade and has been forced to make pledges to move to an austerity lite kind of fiscal stance. That is pro-cyclical fiscal policy that is going to make the downtick in growth worse. 2014-15 growth has already been downgraded to 2.5% from 3.0%.

The economic weakness has the Australian Dollar at three-year lows. After the jobs data was released last week, the AUD fell as low as USD $0.8794, a level last seen in August 2010. That is down from a peak of USD$1.10 in 2011. Right now AUDUSD is even lower, at USD$0.8782. Is the Australian Dollar oversold? Yes. But it has been much lower to the USD and just because the technicals say ovesrold, doesn’t mean it won’t go lower. The South African Rand has been the most oversold currency for months now – the most oversold in 11 years –  and it will continue to be sold.

Marc Chandler says the Reserve Bank of Australia is going to start cutting rates, given the lack of inflation surprises. This makes Australian fixed income assets less attractive and will contribute to continued bearishness for the currency. Rates are already at a record low 2.5%. But note that domestic inflation is already more than 3% with services, healthcare and education rising rapidly. The jury is out on whether the RBA will cut.

Meanwhile, house prices remain elevated, pricing first-time buyers out of the market. I believe 2014 will be a tough year for the Australian property market and for the banks funding that market because of the loss of job growth and the steep overvaluation of housing. What’s more, the expenditure cuts that Joe Hockey, the Australian Treasurer plans to make are going to be harmful to growth. The last time we saw expenditure cuts in Australia in 1986 and 1987 by the Hawke-Keating government, the economy eventually succumbed to recession in 1989 – and that made the deficit problem worse – not better. Moreover, Australia also had to deal with fifteen-odd years of high unemployment before the commodities boom turned that around. This even after the nominal effective exchange rate in Australia decreased nearly 20% during the deficit cutting period of 1985-86.

My conclusion: Australia is headed for trouble. China’s investment-led boom is over and the commodities boom with it. Australia is going to feel some serious pain in the coming months and years. Pro-cyclical fiscal policy will make the situation considerably worse.