Although I wrote recently on Australia avoiding the ‘resource curse’ this video from the FT suggests otherwise and that the Aussie Dollar in 2019 is going to be volatile. The slowing down of the Chinese economy accompanied by a trade dispute with the US has meant lower demand for the Aussie Dollar. Imports of commodities, especially iron-ore, have slowed as China recorded significant reduction in exports and imports in December last year – see graph below:
A lot will depend in the US Fed and its interest rate stance and whether with weaker inflationary pressure and a slowing economy there could be a drop in rates which would help the Aussie Dollar. The cother concern is the exposure that commercial banks have in the mortgage market. Housing has long been a favoured investment option in Australia and with the housing market slowing banks could be left exposed with defaults on mortgages. So is it time to dump the Aussie Dollar?
Falling exchange rate – causes and effects.
I have mentioned the ‘resource curse’ in many postings since starting this blog. It affects economies like in sub-Sahara Africa and Australia which have a lot of natural resources – energy and minerals. The curse comes in two forms:
- With high revenues from the sale of a resource, governments try and seek to control the assets and use the money to maintain a political monopoly.
- This is where you find that from the sale of your important natural resource there is greater demand for your currency which in turn pushes up its value. This makes other exports less competitive so that when the natural resource runs out the economy has no other good/service to fall back on.
The Australian economy did well at the height of the commodity boom in 2013 with iron ore, copper etc earning companies and the economy significant amounts of money. Investment in this area amounted to 9% of GDP in the same year with new mines, gas fields and infrastructure to cope with the increasing demand. But the collapse in commodity prices didn’t have the effect that suggest the resource curse. Countries like Venezuela – oil, Chile – copper, Nigeria – oil etc. have gone through turbulent times as commodity prices fall. Australia though has come through this period quite well for the following reasons:
- falling investment in the mining sector has allowed the central bank to lower interest rates allowing other sectors, previously shut out, cheaper access to investment funds
- the falling exchange rate – AUS$ lost 40% in value against US$ between 2011 – 2015 – made other elastic exports more competitive and this was particularly apparent in the tourism, education and construction sectors.
- Tourism – spending by tourists increased by 43% from 2012 and amounted to AUS$21bn in the year ending March 2018.
- Education – overseas student numbers increased from 300,000 in 2013 to 540,000 in 2018. Each year they contribute AUS$40bn.
- Construction – firms have completed projects worth AUS$29bn in the 4th quarter of 2017 which compares with AUS$20bn in the 1st quarter of 2012. The Foreign Investment Board approved AUS$72bn worth of residential-property purchases in 2016, up from AUS$20bn in 2011.
Australia GDP Annual Growth Rate – 2010-2018
Source: Trading Economics
So despite the end of the resources boom the Australian economy’s GDP per annum hasn’t fallen below 2.4% – see GDP graph. Furthermore, Australia ranks as the 14th largest economy on the globe but ranks 7th regarding the volume of foreign investment and this ranking has risen despite the end of the resources boom. Prudent fiscal measures and a sound monetary policy have also played their part in a resilient Aussie economy.
Below is a video from the FT that I showed my A2 class this morning. The significance of it is the Australian dollar and how its value is strongly linked to iron ore prices. Recent growth in China has exceeded expectations and this has led to a rebound in commodity prices especially iron ore. The belief is the AUS$ is higher than the equilibrium level suggests and that this rate will not be sustainable. There are two reasons for this:
- Commodity prices have accelerated which has led to more demand for AUS$ which might not be sustained.
- Higher relative interest rates has made the AUS$ strong as ‘hot money’ has been attracted in the country. The Reserve Bank of Australia (central bank) has recently cut the cash rate (interest rates) to 1.75% and there is talk of a further cut this year.
Here is graph from the recent Westpac Bank Economic Overview. It shows how closely correlated the New Zealand and Australian economies are with regard to the % of GDP from the quake related reconstruction in New Zealand and the iron ore boom in Australia.
The Canterbury rebuild will peak around late 2016 and into 2017 although growth after this point will be fairly subdued. The falling exchange rate and lower interest rates will act as a buffer but the dwindling rebuild with become a drag on GDP in New Zealand.
Australia has also experienced a slow down with a reduction in mining construction amid falling iron ore prices. To stimulate growth the Reserve Bank of Australia has cut the cash rate from 4.75% to 2.0% and the Australian dollar has fallen about 30%. However high unemployment and low business and consumer confidence have been prevalent in the economy and growth prospects are very modest for the next few years. This is similar to what New Zealand can expect.
From the National Australia Bank – The slowdown in China and weak bulk commodity markets has seen Australia’s trade deficit blow out again in recent months, hitting a record in April but remaining very high at a deficit of $2,750mn in May under pressure from Australia’s declining terms of trade from the softening in Chinese import demand (and higher export supply) for Australia’s major bulk resource commodities. Interesting to note the importance of China as an export destination
Both Australia and New Zealand face the worrying prospect of the impact of lower commodity prices. For Australia it is iron ore whilst across the Tasman it is the dairy industry. So how will each economy be affected by this?
The whole milk price has fallen from:
US$4999/tonne on 18th February 2014 to US$2270/tonne on the 16th December – a 54.6% decrease.
This downturn in prices will have a significant impact on the rural economy of NZ. The lower prices will not only reduce dairy farmers’ incomes, but there will be a knock on effect in other parts of the local economies as farmers and contractors will be less inclined to spend or invest in anything but necessities.
Short-term credit facilities will be able to help farmers with their costs but permanent lower returns would cause a rethink regarding production capacity and economies of scale.
Aussie Iron Ore
For Australian the iron ore prices have fallen from US$136 a tonne December 2013 to US$68 a tonne December 2014. This will have a major effect on their economy for the following reasons:
Iron ore represents 25.5% of exports from Australia
Iron ore producers are significant tax payers to the Australian Government. The drop in prices = AUS$18 billion loss of revenue
Lower prices mean less investment in capital – this sector has been a major part of the Aussie economy over the last few years
Who will take the biggest hit?
It is expected that Aussie will take the biggest hit mainly because of the tax revenue lost through lower iron ore prices. In NZ dairy farmers are not big tax payers and the NZ government are not expecting a big fall in tax revenue. Furthermore overall economic activity is largely unaffected as milk production is likely to continue in the short-term. However the falling unemployment rate in NZ and a rising level in its Trans Tasman neighbours suggests NZ is in a much better state to weather the storm. Other indicators below favour NZ. These include GDP growth and consumer confidence as well as having the ammunition of being able to cut interest rates further, a situation that Australia might find difficult.
Source: NZ Herald December 20, 2014
From the National Australian Bank – non-mining GDP growth is already running at around or slightly above trend at around 2.75%. This improvement accords with the message of sectoral business conditions in the NAB survey. In 2011, interest rate markets ignored the strength in mining and correctly priced off the weakness in the non-mining economy. Non-mining GDP growth is already running at around or slightly above trend at around 2.75%. This improvement accords with the message of sectoral business conditions in the NAB survey. In 2011, interest rate markets ignored the strength in mining and correctly priced off the weakness in the non-mining economy. While it’s much too early to make the reverse conclusion, especially given the pick up signalled is only very mild, it’s certainly a scenario worth monitoring as it would be a major surprise for Australian rate markets.
I was surprised to read in the NAB Australian Markets Weekly that for the past three years real income per person in Australia has been falling and is now back to levels that were evident in late 2008. The graph shows the level of real income per person with the recessionary periods marked in grey. From the last recession in 1991 up to the Global Financial Crisis in 2008 Australians have experienced a continued rise in the level of their real incomes. Nevertheless how can it be that with GDP growing at about 3% a year real levels of income have been falling?
1. Growth in aggregate real GDP has been boosted a great deal by the sharp growth in the population – Australia’s population grew 1.7% in 2013.
2. While Australia are seeing good growth in the “volumes” of GDP, particularly as some of the new mining capacity has been coming on stream, they are receiving lower prices for this output due to falling commodity prices.
As a nation, they are working harder for less income.
The graph from National Australia Bank below shows the components of Australian GDP March Quarter 2014. This is particularly useful when doing GDP Expenditure approach in Unit 5 of the A2 Cambridge course where you can breakdown the equation C+I+G+(X-M).
C = Private Consumption
I = Business Investment
G = Government Demand
(X-M) = Net Exports
Consumption is still the largest contributor to Australia’s GDP. Over the next couple of years GDP is expected to grow around 3% but key to meeting that target is a solid consumer sector. Household consumption growth in recent quarters has been solid, contributing 0.3 percentage points to growth in Q1 – only exports have contributed more to growth over the past year. However sustaining solid consumption growth in years ahead requires the labour market to improve and consumer confidence levels to recover from their recent lows.
Below is an interesting look at the components of GDP in Australia. Capital intensive and net exports are the mainstay of growth this year. However it wasn’t always like this and notice the changes in consumption that reflect the GFC and the role of net exports in the recovery. Remember the equation:
AD = C+I+G+(X-M)