Is Swan undermining the MRRT?

I wonder if the governor of the People's Bank of China, Zhou Xiaochuan, reads the Wall Street Journal Asian edition over a steaming bowl of congee each morning at breakfast.

If so, there may have been congee on the carpet last Thursday when he got to a jointly-penned opinion piece written by Treasury Secretary Timothy Geithner, Singaporean Finance Minister Tharman Shanmugaratnam, and none other than the boy from Oz, Treasurer Wayne Swan.

The three wrote: "…we need a new framework for cooperation to allow exchange rates to reflect economic fundamentals and support needed structural reforms. Currency issues were once left to the United States, Europe and Japan, but that will no longer work in the new world economy … the emerging economies need to allow their exchange rates to reflect the substantial growth they have achieved in their economies over the last decade and to respond more flexibly to underlying market forces."

Though the piece did not name China explicitly, it was clearly a pointed message that Zhou and his central banking compatriots should listen to the Americans (and their South East Asian hangers on) and allow the yuan to rise.

Such public pressure, delivered during the Seoul G20 summit at which Prime Minister Gillard declared, for obvious strategic reasons, that the US and Australia "are great mates" would no doubt have angered Beijing.

Most of the developed world is keen to see the yuan rise, and there had been some hope that the Seoul summit would come out with a stern rebuke for countries such as China causing 'global imbalances' through competitive currency devaluation.

No such communiqu could be agreed on – instead, an anaemic statement was released resolving to talk about 'indicators of global imbalances' again in early 2011. Even then, if those discussions mean anything they'll have to add the current US quantitative easing program to their list of currency and market distortions.

The problem for Wayne Swan, and our own central bankers, is that there is much uncertainty about what redressing global imbalances would do to our greatest cash cow – the China-led minerals boom that has saved Australia's hide since the GFC. In the OECD's latest Economic Survey of Australia, released yesterday, there was a warning that MRRT revenues should not be included in budget spending – it noted that "should [commodity] prices fall faster than expected, this policy could lead to a structural deterioration of the budget".

While rattling the sabre with Uncle Sam on the world stage might make Swan feel pretty tall, there's a risk that a rising yuan could damage our biggest money spinners – coal and iron ore exports – impacting on GDP growth, employment and, of course, the boon in revenue the Gillard government expects from the mineral resources rent tax (MRRT).

The Australian iron ore and coal being rushed to China has long been explained in terms of the boom in construction and infrastructure investment. But a new discussion paper from the RBA suggests that we may have been too focused on the wrong parameters in understanding minerals demand in China.

In the paper, 'Sources of Chinese Demand for Resource Commodities', RBA researchers Ivan Roberts and Anthony Rush argue that the iron and coal being sucked up by China is at least as much driven by its manufacturing sector as by infrastructure and construction projects. Put simply, China makes metal things and then exports them.

The pair write: "… over the past decade or so, the manufacturing sector (which accounts for most of China's exports) has been more important than construction as a direct consumer of resources and intermediate metal products"

They further note that "…if China's manufacturing export industry is an important driver of resource demand, then China's demand for resource commodities may be more vulnerable to external developments".

From Australia's perspective, key among those 'external developments' is the rise in the yuan that Swan and friends clamoured for last week.

While the RBA discussion paper is careful to point out that there is still strong disagreement between economists over what is driving China's commodity consumption, the important point for Wayne Swan and his Treasury boffins is that a rising yuan could be a double blow to our resource exports to China.

If China's exports were crimped by a higher yuan, not only would our biggest customer have less foreign exchange to spend on commodities, but it would need less of our resources feeding into the manufacturing industries as well.

That would appear to create some tension between Australia's desire to see the yuan rise to make our own exports more competitive, and the desire to keep China pumping out cheap exports to create the trade surplus it uses to buy our resources.

So if Swan gets what he called for in the Wall Street Journal last week, history may judge him harshly. Robert Menzies earned the epithet 'Pig Iron Bob' for encouraging iron ore exports to Japan before World War II, which the unions feared would return as bombs. So what will Swan be called 20 years hence if a China manufacturing slow-down hits Australia? 'Geithner's Goose' might just do the job.