The Reserve Bank of Australia is the householder doing a nervous little burn-off in the backyard on a hot day while, in the distance, a neighbour’s house goes up in flames.
Russia’s central bank raised interest rates from 10.5 to 17 per cent at 1am yesterday in an attempt stop the collapse of the rouble. It didn’t work, and in fact it was like hosing the flames with petrol, sparking an even greater stampede out of the rouble.
Russia is staring economic disaster and default in the face, as it did in 1998.
Meanwhile in Australia the RBA issued its minutes for the December 2 meeting yesterday and again said the dollar should fall -- needs to fall, in fact, for Australia to achieve a “balanced recovery”. Be careful what you wish for.
The Australian dollar certainly will fall next year, but not in response to Reserve Bank ‘jawboning’. It’s because the commodity cycle has decisively turned, which is, in part, the same thing that is causing Russia to go up in flames.
For Russia it is the collapse in the oil price, on top of sanctions in response to its President’s actions in Ukraine; for Australia it’s iron ore and coal.
For all of the commodities the issue is much the same: the price boom has resulted in a supply response, which produced a glut at the same time as demand fell. Therefore prices fell -- it’s called the commodity cycle.
Australia’s commodity prices, as measured by the RBA commodity index, have fallen 44 per cent in US dollars and 31 per cent in Australian dollars. Bulk commodities -- iron ore and coal -- make up 56 per cent of that basket, which is their percentage of our exports.
The oil price collapse is so far neutral for Australia. We are a net importer of oil, so petrol prices have dropped and consumer spending should be boosted, but LNG represents 7 per cent of our exports and coal 23 per cent and the oil price tends to lead those other energy commodities.
Russia’s crisis has two causes: the export commodity price collapse and the fact that its economy has evolved into what the Financial Times calls “a corrupt version of state capitalism”, with its President Vladimir Putin pursuing “illusory geopolitical goals”.
Australia has the first of those but thankfully not the second. However we do seem to be going through a period of more than usually messy politics.
Apparently Russia now needs oil at $US120 a barrel to balance its budget thanks to colossal military spending, plus corruption, which is where the commodity cycle meets Russia’s dysfunctional political system.
If it were just down to iron ore (which it’s not) Australia would need an iron ore price of about $US200 a tonne to balance its budget. It’s currently $US68.
According to the Treasury, a $10 per tonne fall in the iron ore price leads to a 2 per cent fall in the terms of trade. According to UBS, that leads to a 0.5 per cent reduction in nominal GDP, one year ahead, and that, in turn, costs the budget $3 billion a year.
Therefore to balance the budget on iron ore alone, the Australian government would need the price to go up by $US130 a tonne.
That’s not going to happen. Nor is the oil price going to go up in hurry, taking with it coal and LNG.
So what IS going to happen to save Australia’s budget, and prevent the economy sliding into a recession next year? Without a sudden recovery in commodity prices, only two things can do it – Parliament getting its act together or a currency depreciation, or preferably both.
And the lesson from Russia is that the latter can get away from you unless the former happens too.
As things stand, without the “balanced recovery” that the RBA says requires a fall in the exchange rate, the Federal budget will never balance.
Distant forecasts of a surplus in this week’s MYEFO statement are based on nominal GDP to bouncing back to 5.25 per cent (from 1.5 per cent) within two years.
This will simply not happen unless the currency falls.
When the commodity cycle turns, the living standards of a commodity exporter must also fall. This can either be achieved through lower real wages, government spending cuts, tax increases or a currency devaluation. They all have the same effect.
The first is almost impossible and numbers two and three are very difficult at any time, but especially when the country’s politics are mess. That’s why everyone goes for the devaluation -- it’s a cut in living standards that doesn’t get blamed on anyone.
But it’s also dangerous, as Russia has shown -- again -- and as both Russia and Australia found out in 1986. In a sense you’re putting the country’s future in the hands of currency traders who are unpredictable and self-interested.
It really is like putting your faith in controlling a fire.