Economic adjustments loom as magic pudding disappears
But Woodside's decision to shelve the Browse liquefied natural gas project last week has ended the mining boom and we must now find new ways to develop investment if we are to grow. To do so, we must become more competitive, and we will, one way or another. There are two models to achieve it.
When an economy's standard of living surpasses its productive capacity, it tends to run large current account deficits as it borrows overseas and invests in unproductive stuff like property to support its inflated living standards. But this eventually runs out of gas when that nation's external position deteriorates enough to spook markets about the risk of not being repaid - such as what happened to Britain in the global financial crisis.
At this point a country has limited choices. It can continue to borrow via the public sector, as Britain has done, to support growth, as well as drop interest rates very low to ease the repayment burden on the private sector. This also devalues the currency, which makes the nation even more competitive.
The lower currency might spark inflation, which also serves to devalue the debts that are burdening public and private sectors and the real price of labour. Britain has also done this and wage growth since the GFC has been modest and below inflation.
Britain was succeeding in growing through external demand until Europe descended into crisis.
Which brings us to our second model. Europe's fringe states are being forced to pursue an exclusively internal devaluation. The big differences to the British approach are that government spending is cut, not expanded, and because of the common currency, there is no boost to competitiveness via a falling external price.
In Greece, for example, this has meant that wages are taking the brunt of the price adjustment, which has worked well to boost the external demand for its goods but has also meant that unemployment is through the roof.
In this scenario, growth is also so low that real debt burdens increase despite cutting spending.
Australia is better placed because it has a built-in increase of exports under construction already in the LNG boom. Some might argue that the same is going to happen in volumes for the bulk commodities, but they are wrong. The expansion in iron ore and coal is in trouble, with supply set to leapfrog demand later this year and then leave it far behind.The LNG boom will substitute for this deflating boom, not build on it.
That presents a pricing problem. We have enjoyed the high wage and income growth rates of the mining boom largely because China paid more for our goods, not because we earned it with better efficiency. As that income falls, so will capacity for wage growth and, if the falls are large enough, the nation will need to deflate to repair its competitiveness and boost investment.
Frequently Asked Questions about this Article…
Woodside shelving the Browse liquefied natural gas (LNG) project is portrayed in the article as marking the end of the mining boom. The piece argues this shift means Australia must find new ways to attract investment and boost competitiveness rather than relying on past mining-driven income growth.
The article explains that when living standards exceed productive capacity, a country runs large current account deficits and borrows from overseas. That external position can deteriorate and spook markets. For investors, this matters because the adjustment path (borrowing via the public sector, currency moves, inflation or internal cuts) affects interest rates, currency values, inflation and demand for different sectors.
The article describes two models: one like Britain’s, which expands public borrowing, cuts interest rates and allows the currency to fall (boosting external demand and devaluing debt), and the other like parts of Europe, which pursue internal devaluation by cutting government spending and squeezing wages. The first relies on currency depreciation and higher external demand; the second forces price and wage falls domestically, often with higher unemployment.
According to the article, a lower currency makes exports cheaper and can boost external demand. If that sparks some inflation, it also reduces the real burden of public and private debt and lowers the real price of labour, which can help restore competitiveness — though it may also lead to modest wage growth as seen in Britain after the global financial crisis.
Internal devaluation, as described in the article, means restoring competitiveness by cutting government spending and pushing down wages because a common currency prevents external price adjustment. In examples like Greece, this has boosted external demand for goods but driven unemployment very high, so it carries significant labour-market and social risks.
The article argues Australia is relatively better placed because there is already a built-in increase in exports under construction from the LNG boom. However, it cautions that LNG will substitute for the deflating bulk-commodities boom rather than build on it, and that iron ore and coal expansions face supply/demand problems.
The article notes that the high wage and income growth seen during the mining boom largely reflected higher prices paid by China rather than productivity gains. As those incomes fall, the capacity for wage growth will decline. If the falls are large enough, the nation may need to 'deflate' (lower prices or wages) to restore competitiveness and stimulate investment.
Based on the article, investors should monitor government policy choices (whether authorities opt for public borrowing and currency adjustment or tighter spending and wage compression), currency and inflation trends, developments in LNG export projects, and supply/demand dynamics in iron ore and coal. These factors will influence sectors, wage growth and the broader investment outlook.
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