Recession? What recession!? The Australian economy expanded by 1.1% in the March quarter, according to figures released by the Australian Bureau of Statistics yesterday. That’s an annualised pace of 3.5%. That’s not only ‘above trend’ as the boring economists say. That, my friend, looks an awful lot like the developed world’s fastest growing economy.
This looks like great news for the economy. But things aren’t always what they seem, dear reader! Personally, it’s potentially embarrassing for me since I will publish a special three-part series this weekend that proves (I believe) why Australia has a serious structural problem, and why recession is inevitable. It’s actually the transcript of an interview I recently did with DR Associate Publisher Callum Newman about the 10th anniversary of the DR Australia project.
But about the data. How do you reconcile yesterday’s ABS figure with a bearish forecast for investors? It’s easy, actually. You just have to look at the data. Most of the growth was driven by one commodity (iron ore) in one sector (mining). Mining, in fact, accounted for 80% of the growth in the March quarter.
Source: Reserve Bank of Australia
How could that happen when the chart above shows that the iron ore price has fallen steadily in 2014 (and since 2011)? Well, you can reason it out. If your unit price is falling, you have to shift more units to increase sales. Export volumes were up 4.8% in the quarter.
It’s not reflected in the March data, but Port Headland shipped a record 36.1 million tonnes of iron ore in May. BHP plans to ramp up production by 40% alone in the next quarter, from 49 million tonnes to 69 million tonnes. The other big producers — Rio Tinto, Fortescue, and Atlas Iron, have similar plans. The ‘production phase’ of the resources boom is what you saw kick into gear in the March quarter.
But two important points. The Terms of Trade are falling. They’re down 3.9% from this time last year. And if you believe in a world of mean reversion, the chart below will tell you that the price Australia gets for its key commodities has peaked. ‘National income’ is now growing slower than production.
Source: Reserve Bank of Australia
But that’s not even the most important point. The most important is that the macro-economic benefits of the production phase of the resource boom are much more narrowly distributed than during the investment boom phase (phase two). You don’t get a jobs boom. You don’t get a building boom. But you do get a production boom for the big iron ore companies.
If you prefer to put things in terms of pedantic Latin phrases, try this one: cui bono? Who benefits? The first phase of the resource boom — the huge spike in commodity prices created by a surge in demand while capacity was limited — benefitted shareholders of BHP and Rio Tinto. Earnings for those companies rose dramatically.
The second phase was positive for employment, wage growth, and consumption, especially in Western Australia. You need a lot of geologists, truck drivers, and miners to dig up all that iron ore. For example, BM Geological Services, a Perth-based company, had 25 staff at the height of the mining boom, according to Jonathan Barrett in today’s Australian Financial Review. It now has seven.
You can’t expect consumer spending to give the economy a little pick-me-up when people are losing jobs by their droves in the manufacturing and mining services sector. Now that the capex boom is over (see yesterday’s Daily Reckoning) the mining sector will actually begin to drag on the economy with rising unemployment.
It’s not my mission to rain on what looks like a sunny parade. Everybody loves a parade. But yesterday’s data show that Australia is becoming a two-trick pony. The high dollar is killing tourism and manufacturing. The only industries prospering are mining and finance, and they don’t create large employment booms that can flow through to the rest of the Australian economy. Check out the table below, taken from the ABS report.
Source: Australian Bureau of Statistics
The sectors highlighted in yellow grew by more than 2% from the December quarter of last year to the March quarter of this year. You can see that mining, construction, financial services, and real estate services are booming. This is exactly what you’d expect when you couple increased export volumes with interest rates left at 2.5% for ten RBA meetings in a row.
Cui bono? Who is getting richer in this Australia? It’s the banks and the miners. Everyone else is getting left behind. That’s why economists call this kind of one-commodity boom a curse more than blessing. It also leaves Australia’s economy at a fork in the road. It can go the way of Saudi Arabia or Sierra Leone.
Why those two? Well, the Economist Intelligence Unit recently released its projections for economies expected to grow the fastest in 2014. The top five are Mongolia (15.3%), Sierra Leone (11.2%), Turkmenistan (9.2%), Bhutan and Libya (tied at 8.8%), and Iraq, Laos and East Timor (tied at 8.5%). All of those countries are following the same basic resource-led growth model, and mostly shipping one commodity (iron ore or oil and gas) to one main customer.
Does that sound familiar? Saudi Arabia was able to do it. It turned itself from a tribal desert nation stuck in the 12th century to a petro political powerhouse by selling oil to America. It made the leap from the pre-Modern to the Modern world by turning massive oil profits into a richer, more diversified economy.
Then there’s Sierra Leone. It’s an African country rich in diamonds and rutile (the ore for titanium). Its GDP is less than $10 billion on a purchasing power parity basis. There isn’t a lot of value add in its raw commodity exports. And it’s dependent on a handful of commodities for economic growth. That is a tough way to create a wealthier society.
Australia has iron ore and housing. And I’m not suggesting the economy here is as fragile as Sierra Leone’s. But I am saying that the GDP figures tell a much different story once you do a little digging. Houses and mines are the main strength right now. Nearly everything else looks weak.
What should an investor do then? Well, I was asked this question recently by a younger DR reader starting out in life. Let’s call him Kane. He took a degree in finance. He learned the mortgage broking business. Now he’s trying to break into banking, which admittedly looks like a good move given how powerful, privileged, and protected that industry he is. What should he do? Here’s what I answered:
‘Don’t be too impatient. It can take years to master any given skill or profession. If you know it’s what you want to do with your life, stick at it. Get better at it every day. Don’t expect your results all at once. The only thing you can ever control in life is the quality of the effort you make.
‘You might find out rather quickly that you don’t care about the work but you like the money. Everyone likes the money, or the things the money lets you do when you’re not working. But work is what you do with most of your waking hours. If you’re just trading time for money, ask yourself how long you want to make that trade.
‘It’s not easy, but if you can find work that’s meaningful to you, you’ll be much happier. And that’s a kind of wealth money can’t buy. Your work should be fulfilling. It should be valuable in some way to other people, whether you bake bread or balance the books at an accounting firm.
‘Don’t be afraid to change if your heart isn’t in it. But don’t be put off by the fact that sometimes you have to work awhile before you have anything to show for it. And if you can’t find work that you want to do in Melbourne or in Australia, don’t be afraid to pack up and head for greener, or newer pastures. It’s a big world. Stretch your legs.’
There are plenty of Irish who’ve stretched their legs. I run into them all the time in St Kilda. They left Ireland when the property bubble burst and there were no other jobs in the economy. They’ve come here for the mining boom, the sun, and the construction jobs. What will happen in a bust? More on that and, as promised, on the psychology of belief, tomorrow. Until then!
for The Daily Reckoning Australia