Australia is thriving on a super economic cycle, created by the ongoing resources boom. As a result we cannot rely on the cyclical experience of previous decades to determine what may develop. 
 
Story Adrian Thirsk 
 
As the global economy approached the new millennium, its most powerful central banker was toying with an elusive possibility. Better known to mass media consumers for his 1996 warning against irrational exuberance on sharemarkets, the then US Federal Reserve chairman, Dr Alan Greenspan, was also coming to grips with an economic postulate dubbed the new paradigm. It was reasoned that surging productivity, strong economic growth and low inflation were the result of a technological revolution. Like the nation-changing advent of the railway during the 1800s, the semiconductor and the internet were rolling out a fast track to the economic future. It was time to junk old models of the economy which, inter alia, allowed for the cyclical reemergence of inflation pressures. Or was it? 
 
In Australia, there was a thought in some quarters along the lines: “The business cycle is dead. Long live the business cycle!” Then along came the tech wreck of 2000. Silicon Valley start-up companies trading on astronomical multiples of putative future sales were transformed in the twinkling of an eye from the next best thing to risky investments. The implosion shunted the world’s biggest economy into reverse gear, and forced a sober reappraisal of the virtuesof the so-called new economy. Fortunately for Australia, its old economy was very light on technology companies. 
 
For the bulk of the period since then, those old economy stalwarts – the big mining houses – have been locomotives of activity and wealth creation in Australia. Responding to synchronised global economic growth, which has been supercharged by a red hot Chinese economy, Australia’s resources sector has built up a head of steam unparalleled since the nation rode the sheep’s back to prosperity a century ago. 
 
SCALE OF EXPANSION 
The scale of the expansion in the minerals industry leaps off the pages of tables showing the volumes and value of production, exports, exploration and investment. In 2003-04, the value of Australia’s mineral exports was $53.5 billion. The latest estimate from the Australian Bureau of Agricultural and Resource Economics (ABARE) for 2006-07 is $107.4 billion. And that’s forecast to rise to more than $116 billion in 2007-08. Among the individual commodities, iron ore exports are set to jump from 2003-04’s $5.3 billion to $18.7 billion this financial year. The value of gold shipments will have doubled to $10.6 billion. And Australia’s top earner, coal (metallurgical and thermal combined), will have fired up from $11 billion to $23.2 billion. 
 
It’s little wonder that spending on minerals and energy exploration in Australia is the 
 
strongest it’s been in real terms since 1982- 83. ABARE also says investment in new capital across the mining industry is running at well over double the average annual expenditure for the past 25 years. And, based on surveys of industry intentions, investment spending is forecast to surge to more than $30 billion this financial year. 
 
So right now, the Australian resources industry is hitting the sweet spot. Global demand and an undersupplied market mean local producers can ramp up volumes and, in the main, still legitimately hope for prices to keep rising. ABARE chief commodity analyst Terry Sheales provides a caveat. “In the longer term, prices will come down as more supply comes on stream. The rate at which they come down and when this happens remains to be seen,” he says. 
 
At the moment, though, the question of when continues to be pushed further out into the future. In publishing its last ever Minerals Monitor earlier this year, Access Economics observed that output growth among the big importers of the bulk commodities (not just China, but also the likes of Japan and India) was still on the rise. 
 
“That suggests industrial commodity demand is also still accelerating, not slowing down. In turn, that yet again means a goodly dose of stronger-forlonger is hitting the commodity forecasts of analysts,” reports the Monitor. And it’s this line of thinking which invites the references to a super cycle although it’s not a label with which Sheales is comfortable. “It’s one of these words that suggest we’re in a period that sounds like this might continue on forever. It’s a pretty fair bet it won’t.” 
 
STRUCTURAL CHANGE 
Fronting a parliamentary committee hearing on the Gold Coast in August, the Reserve Bank governor, Glenn Stevens, said: “The emergence of potentially very large economies like China and India, at such a rapid pace and with such consistency, is unlike anything we have lived through before. We cannot be confident, therefore, that the cyclical experience of the past few decades is necessarily a reliable guide to how things will develop.” 
 
Access Economics director Dr Chris Richardson says the lift in demand for a number of minerals is permanent. “It is a super cycle in demand,” he says, with a number of countries besides China and India effectively undergoing their own industrial revolutions. 
 
At nabCapital, chief economist Rob Henderson has few concerns that the Australian economy might be too dependent on the resources sector. “If this was a short-term commodities cycle, then perhaps you could over-invest in it. But if you believe, as we do, that it’s a longer term structural change, then Australia would do well to plough more resources into the commodities sector in order to supply that demand which looks like being there for a decade plus ahead,” he says. 
 
In the past, Federal Treasury secretary Ken Henry has played down concerns about the re-allocation of capital and labour from the southern states to the resource boom states of Western Australia and Queensland, seeing it simply as economic efficiency. The Commonwealth Bank’s commodity strategist David Moore is likeminded. 
 
“The mining sector is a sector that is experiencing strong growth and returns at the moment. There’s reason to believe that the sector is likely to remain strong for a number of years to come yet. It does mean that that sector may well attract labour and other resources. But that’s part of the growth process,” says Moore. 
 
The notion that Australia is overly dependent on the resources sector at the moment is also dismissed by Westpac’s global head of economics Bill Evans. “The income growth that the resources sector creates helps stimulate other parts of the economy.” That includes an impact on the services sector, as the spreading wealth increases incomes and employment. “When incomes grow, services demand picks up. 
 
And that’s what we’re seeing. So sectors like retail, health, education; they’re all contributing to growth. So I don’t think you can have too much of a good thing.” Richardson observes that the benefits are being delivered to Australia on a platter  
 
“The lift in the commodity prices over the last three and a half years is handing us about an extra $75 billion a year for doing what we’re already doing. It’s like the world giving us a pay rise.” 
 
In terms of what might bring the commodities boom to a shuddering halt, the Chinese economy appears to be the commonly acknowledged key. China is far and away Australia’s biggest customer for iron ore and is only just behind Japan as a recipient of Australian copper shipments. So what could upset the apple cart or the iron ore trains? Westpac’s Evans says the big issue is how resilient China and Asia will be to a downturn in the US. “But I think what we have to bear in mind is that the US started to slow down in the first quarter of last year. 
 
The US has slowed from a 3.5-to-4 per cent pace to a 2 per cent pace over that period and yet we’ve seen Chinese growth actually accelerating to 11-12 per cent.” Evans says that’s been an early test of how resilient Asia can be to a slowdown in the US. “Now obviously if we go into the next phase of an actual recession in the US associated with the sub-prime (mortgage market problems), then clearly that will have an impact on the world economy. But I don’t see a recession in prospect.” 
 
INTERNATIONAL TRADE 
CBA’s Moore believes the global economy is benefiting like never before from international trade, with the barriers to trade substantially lowered in the past decade. He finds it difficult to envisage a downturn that would be sudden enough to be dislocating. “International growth has got some fairly solid support at the moment. That doesn’t mean that something can’t cause it to turn around.” In the meantime, he also applauds the record of central banks in controlling price pressures. “Major central banks have implemented monetary policy in a way that’s really kept inflation at bay. And that’s a positive for the international economy.” 
 
The slaying of the inflation dragon was one of the heraldic feats of those old new paradigm days. One outcome has been a goodly dose of lower-for-longer where global and Australian interest rates have been concerned. And while some might argue that that’s been the vat of mead at the castle feast, it’s difficult to fault the logic that says the time to borrow is when borrowing costs are low. Around $900 billion in outstanding housing loan balances suggests Australian home buyers think it’s been the right time. At the big end of town, the US$800 billion in leveraged buyouts consummated globally during 2006 indicates the major private equity funds also thought so. 
 
Governments in Australia have operated according to a different imperative, however. On 21 April 2006, Treasurer Peter Costello triumphantly declared the Commonwealth was debt-free. The benefit, he reminds us, is an annual saving of $8 billion in interest payments which no longer have to be made on the $96 billion debt paid down since 1996. State governments, too, were embracing fiscal rectitude over the same period, chastened by their credit rating downgrades in the early 1990s. 
 
INFRASTRUCTURE INVESTMENT 
But Evans is among those who think that governments should have been investing more in infrastructure – even running deficits to do so while interest rates were low – instead of maintaining what were effectively undergeared, lazy balance sheets. “I completely agree with that. I think if you look at the level of infrastructure investment as a proportion of GDP it’s fallen significantly since 20, 30 years ago,” he says. “There are lots of areas, particularly in health, education and transport that aren’t really commercial propositions for the private sector. And as a result, the investment hasn’t been happening.” 
 
Water and electricity are other major areas where renewal and expansion have been deficient. Evans blames the Australian federal system whereby the Commonwealth raises most of the revenue, but the states have the bulk of the infrastructure responsibility. It’s a political architecture which heightens the risk that windfall receipts generated by the commodities boom find their way into income tax cuts rather than infrastructure spending. And that’s also the complaint of Richardson, who observes that there’s a pattern at government level that “policy making is great in adversity, but terrible in prosperity”. 
 
He says state governments could have used the stamp duties from the recent house price boom on infrastructure, but frittered them away on recurrent spending instead. But it would appear that in the past couple of years, state governments have been looking to make up for lost time, embarking on big borrowing programs to fund infrastructure development. The problem is that they’re now competing for resources and labour with a booming private sector. 
 
“Men and materials are costing a fortune,” says Richardson. “They’re spending at the top of the cycle, paying absolutely top dollar.” Evans says they might not be able to spend all the money earmarked. “We are seeing the state governments coming a bit late to the party in terms of infrastructure investment.” But the budget commitments are being made nonetheless. It’s to be hoped that they won’t be coinciding with a left field event which precipitates the next sharp economic downturn. 
 
Such an event would be very much an X factor. As Access Economics’ Richardson points out, the Australian economy is very sound. “To get a recession you need not just the bad luck of a commodity boom going bust, but you would need bad policy. You’d need the Reserve Bank to not recognise for a while that interest rates needed to come down. And you would probably need a federal government that was dumb enough, as funds suddenly disappeared underneath it ... to try to hang onto a surplus.” 
 
LEAST PREPARED  
If such a downturn were to occur, however, it’s the household sector which is least prepared for the not-so-super side of an economic cycle. It’s 16 years since Australia’s last recession and unemployment is at its lowest in three decades. That means there are a lot of people who have bought their first home and/or run up big consumer debts without having subsequently lived through economic hard times. nabCapital’s Henderson suggests the lack of such experience might, at the margin, encourage riskier behaviour. “There are many people in the workforce today that weren’t in the workforce when the last recession happened, which probably makes them more prone to sign up for higher levels of debt, without any expectation that there’s a possibility that they might lose their job during that period.” 
 
Evans says that not having been through a recession, they’re not planning for the downside if one were to occur. “The corporate sector still remembers the late 80s recession. They really haven’t geared up their balance sheets to the extent that we were used to in the 80s since then.” He says the corporate sector is, therefore, well prepared for any downturn. “It’s the household sector where the risks would be. But the corporate sector would pay via lower sales as their customers ran into some trouble.” 
 
In the meantime, the smokestacks of China continue to belch economic activity. And in Australia, that might well give rise to a thought along the lines; “The commodities cycle is red. Long live the commodities cycle!”