Is time running out for the “lucky country”? I’ve long been quite sceptical of the plaudits routinely heaped on Australia and, for some of the same reasons, Sweden for superior economic performance.
Unlike Britain, it is sometimes said, these are advanced economies which have managed to get their public policy agenda broadly right, and as a consequence now reap the rewards. Both economies sailed through the credit crunch pretty much unscathed, unemployment is at or close to an all-time low, and unlike so many other “rich” nations, public debt is under control.
But while inspired policymaking has no doubt played its part, much more important is that both Australia, and to a lesser extent Sweden, are rich in natural resources. Sweden also has an abundance of relatively cheap hydro-electric power.
The blessings of nature, not the brilliance of policymakers, offer the better explanation of why these countries have done so well. This is especially the case with Australia, which displays some of the same illnesses that have afflicted Europe and America, with an overvalued housing market, a bloated banking sector, high levels of household debt, and a burgeoning current account deficit. Despite massive raw material exports, Australians live well beyond their means.
All this makes news of fresh job losses and mine closures at Xstrata and BHP Billiton of more than just passing interest. Just as Glencore’s Ivan Glasenberg goes for broke by increasing his takeover bid for Xstrata , many mining finance houses seem to be signalling the top of the cycle by cutting back on high cost production and deferring tens of billions of dollars worth of planned investment.
Is this just a temporary setback, or should Australia and other big producers be preparing for the end of the current “super-cycle”? One of those who, with qualifications, takes the latter view is Harry Colvin of Longview Economics. Indeed, he goes further to suggest that deflation of the iron ore price bubble will probably trigger the end of Australia’s mining boom, and with it, perhaps, the Aussie dollar’s new found status as the Swiss franc of the southern hemisphere.
Iron ore has been one of the biggest of the major asset price bubbles of recent decades, having risen 12-fold in the past 10 years alone. As Mr Colvin points out, this makes it a bigger ascent in real terms than either gold and silver in the 1970s, the Nikkei (Osaka: ^N225 - news) in the 1980s or indeed the Nasdaq (Nasdaq: ^NDX - news) in the 1990s. These high prices have brought unparalleled prosperity to Australia.
They have also contributed to economic success in Sweden, which has some of the highest grade iron ore deposits in the world making the country a battleground for the Allies and the Third Reich during the Second World War.
The very long-term trend for commodity prices has, in real terms at least, been relentlessly down. Improvements in technology, greater efficiency in production and use, and the discovery of bountiful new reserves have broadly kept supply well in excess of demand.
However, from time to time, this trend is interrupted by a “super-cycle” where prices diverge, often for a period of many years or even decades. These episodes tend to coincide with above average growth in world output and/or major phases of industrialisation and urbanisation, when demand for metals and other key components in infrastructure development is high.
A recent paper by Bilge Erten and Jose Antonio Ocampo for the United Nations has identified four such cycles in the modern age, each lasting between 30 and 40 years, and containing many smaller cycles within them. The first such cycle peaks during the main phase of American industrialisation, and the second, the post-war reconstruction in Europe and Japan. So far, so logical.
The third such cycle, lasting from 1971 to 1999 and consisting of a very feeble up phase of only a few years and a prolonged down phase, is less easily explained, and was perhaps more the result of an anomaly the Arab oil embargo than anything else.
The fourth, and current, super-cycle, conforms to type; it’s driven almost entirely by Chinese and other emerging market industrialisation.
In his seminal study of business cycles, the Austro-Hungarian economist, Joseph Schumpeter, explained these long or Kondratieff cycles as the natural result of particularly high periods of technological innovation. This seems plausible, even though the latest phase of innovation is of course mainly about communications, little if any of which originated in China.
Modern communications has none the less reduced Western advantage in many commodity industries to virtually zero. The major beneficiary has so far been China, where dissemination of Western technology and globalisation of trade has driven a remarkable economic transformation.
Western economies have in a sense shot themselves in the foot. Their own innovation has made them relatively less competitive and therefore less well off than they used to be. One of the manifestations of this shift is that we have to pay a lot more for our commodities be it food, oil or metals than we used to. Speculation, Western money printing and ultra low interest rates have turbo-charged the bubble.
But even assuming that China avoids the much feared hard landing, there is good reason for believing the present super-cycle may already have peaked. The iron ore price has fallen nearly 40pc in the past year alone.
As in 2008-09, the fall may be a blip, but equally, it may a presage a much-needed shift in the composition of Chinese economic growth away from commodity intensive investment and capital accumulation to consumption. China’s investment and export orientated model is proving just as unsustainable as the West’s consumption driven approach to growth. China knows it must change if it is to keep growing. There’s no relief to be had from once buoyant Western export markets.
And unfortunately for the big iron ore and coal miners, producing cappuccinos takes a lot less steel than building a new airport, high speed railway or skyscraper. China’s investment rate looks set to fall just as a wealth of new mining capacity, incentivised by high prices, comes on stream.
Any retreat in the commodities cycle is likely to be quite granular in its make-up. Chinese adoption of a more consumption-orientated growth model will only add to the pressures on food and oil prices. This in turn will limit the scope for consumption growth in the West, which unfortunately isn’t going to benefit much from declining metal prices. Still, every cloud has its silver lining. At least Australia may once more become a little more affordable to us pommies.