Tuesday, May 24, 2011

Boom Boom Boom

Just in case you were wondering about the size of this boom, this graph from ex-RBA banker Ric Deverell, now global head of commodities research for Credit Suisse in London via Michael Stutchbury.

The real issue for the future is whether this investment boom will actually get to forecast or whether like previous booms it will fall over. Already this boom is the longest "sustained" boom for 140 years (which means on a 5 year moving average basis - on a normal basis the terms of trade have not yet reached the level of the post-war Korean War wool boom, which was in contrast to the current boom relatively fleeting.

Those such as myself focused on economic vulnerabilities have already been burnt by the return to boom. This makes the current boom different to any over the past 140 years. Still, having staked a claim that policy-makers need to think about the end of a boom (as well as dealing with the boom itself), I'm hardly going to change direction and get on board with the never-ending boom brigade.

The sustained investment boom points to a couple of things that need to considered by policy-makers. First the idea that Super-profits tax would stop investment was a complete fabrication and the government should have the guts to tax the mining sector harder. (Notwithstanding the fact that the Treasurer and the PM buggered things up by developing a ridiculously complicated tax that was easy for the mining industry to attack because it was very difficult to explain to the average punter).

The other factor is that this very investment boom, which is being replicated in other resource economies, will undoubtedly markedly increase supply. With China having pushed construction so hard over the past 2 years, it is unlikely that the rate of expansion can continue unabated.

This will mean that increasing supply will probably be met by at best flat demand in the short-term (the longer-term picture is more encouraging because China and India ARE likely to sustain demand at albeit lower prices). Increased supply and flat or declining demand will mean lower prices.

I don't blame the Western Australian government for increasing its royalties on iron ore fines to 7.5%, my only regret is that they didn't do it earlier and make it at least 10%.

Rather than a sustained rise in the terms of trade and the dollar, expect continuing variation even if at an average much higher than the 1980s and 1990s.

For a corrective to Treasury Secretary Martin Parkinson's assertion that the Aussie dollar "can be expected to move roughly in line with the terms of trade over the longer term" see this from AAP
[T]he Australian dollar is currently way out of line with what would be expected if there were a one-to-one relationship between it and the terms of trade.
At last measure, at the end of 2010, the terms of trade ratio was 87 per cent above the average for the decade following the floating of the Australian dollar in late 1983.
By the same yardstick, the Australian dollar's trade weighted average, calculated by the Reserve Bank of Australia (RBA), was up by only 26 per cent.
The Australian dollar has actually risen by a further two per cent since the end of 2010 but would still have to gain a further 45 per cent to have moved exactly in line with the terms of trade between the decade of 1984-1993 and now.
That would put it at about $US1.54, compared with around $US1.07 at the moment.
So it seems that the terms of trade matters, but only in the sense that it confirms the Australian dollar ought to be doing well in broad terms.
When the terms of trade head higher, the Aussie - as traders call it - tends to head higher as well.
But while turning points in both will probably line up on a chart, there is no reason to expect a 10 per cent rise (or fall) in one implies a 10 per cent rise (or fall) in the other.
In an interview on the ABC with Chris Uhlman after the Budget, Julia Gillard argued that she believed that Boom Mark II was going to last for quite some time.

HOST: Well, Prime Minister, what would happen if the price of commodities falls over the next couple of years?
PM: Well, Chris, we base the Budget on the best projections available to us from Treasury. We’ve made conservative assumptions about the price of commodities in this Budget, with the terms of trade slightly falling away during the duration of the four years that the Budget covers.
HOST: In the 2007 election, Kevin Rudd liked to say quite a lot, well, are you planning for the end of the mining boom? It was a question he was asking of the Howard government. Are you planning for the end of the mining boom?
PM: Well, certainly we believe that this mining boom, mining boom Mark II, will last for some period of time. This is a very special opportunity for our nation to make a difference, particularly to long-term disadvantage and getting more people into the workforce.

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