Why Australia will survive the commodity slump

The 90 per cent of Australia's economy not based on mining will be glad to see a wealth transfer to households and local business.

It’s not a well-known fact, but a slump in commodity prices has never caused a recession in Australia. With that in mind, we shouldn’t be overly concerned by investment bank analysts who run around saying just this -- they are very wrong. Indeed, amid all the wailing and gnashing of teeth, it strikes me that the commodity drop may even be beneficial.

I realise this point may seem counterintuitive, and may even be met with howls of outrage -- commodities account for about 73 per cent of our exports. Yet the point is, a drop in commodity prices isn’t all bad. No doubt profits for ‘our’ commodity exporters will plummet -- sharply maybe -- yet it’s often forgotten that our commodity exporters aren’t really true blue Aussies. Our largest are majority foreign owned, and it’s these foreign investors who lay claim to the vast proportion of the profits produced (80-100 per cent). That’s not to say that foreign investment is bad or that we should nationalise everything. No siree. But let’s not pretend it’s the end of the world when commodity prices do fall.

For a start, and to the extent price falls are sustained, they’re falling for all the right reasons. We’re not talking about a slump in aggregate demand here -- a malign commodity price slump. We’re talking about a solid global expansion (for China, the largest in its history: see Woe and despair, but China's not broken, October 24) in which the volume of commodities consumed has never been higher.  The US dollar for its part, a key driver of the current commodity price rout, is surging because employment growth is the strongest in about 15 years. The economy itself is posting the strongest growth in over a decade; 4 per cent over the last couple of quarters. And commodity prices are slumping!

Confronted by this global lift in aggregate demand, falling input costs can’t be regarded as a bad thing. Commodity extractors, to the extent that profits don’t go overseas, account for only 10 per cent of the Aussie economy. And while they may not like it when prices fall, those which make up that other 90 per cent do.

Think of the upside. I can’t help but note that petrol prices have come off quite a bit. Indeed the Australian dollar price of crude has slumped to its lowest level in four years -- TAPIS is at $72.20 -- petrol is at $1.30c per litre and if anything there is pressure for that to fall further. On current indications there is no reason why petrol shouldn’t be below $1.20 per litre. That’s what the oil price would suggest anyway. Households, the transport sector, we all benefit from that, and other sectors of the economy (that leftover 90 per cent we never talk about) will benefit from the increased income consumers have to spend elsewhere.  At the very least, consumers have more money to spend on retail or entertainment -- services -- and that’s an impact that permeates through the economy.

This fact highlights an important point. When it comes to the apparent policy goal to rebalance the economy, this is much more likely to occur with input costs (read commodity prices) falling.  In addition to retailers and the services sector, it’s also going to help the construction sector quite a lot if the price of fuel, steel, iron ore, copper etc continue to weaken -- and continue to fall at a faster pace than the Australian dollar.

Similarly the boost to global growth that will come from falling commodity prices will do more to lift animal spirits, and thus investment in the non-mining business sector, than an iron ore price at $140. Certainly the commodity price slump may lead to job losses in that sector. Yet given the mining sector only accounts for around 2 per cent of the labour force, job losses there will be easily offset by the lift to jobs growth elsewhere. That we see from cheaper input costs for the remaining 90 per cent of the economy, and the associated lift in profits demand etc. It's a virtuous cycle.  

That’s not to forget the disinflationary forces unleashed from falling commodity prices -- central banks don’t need much of an excuse to cut rates and print money and low inflation outcome will ensures this will last for some time yet. 

Really when we talk about a commodity price fall, all we are talking about is a transfer of wealth from foreign owned commodity producing companies, to true blue Aussie businesses and households. Is that such a bad thing? The country would face a far worse scenario if commodity prices hadn’t fallen (and the Australian dollar had).  

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