AUSTRALIA is now entering an income recession

Our China crisis | The Australian

AUSTRALIA is now entering an income recession. Our stellar export market is crashing.
The sector that has driven the early 21st-century burst of Australian prosperity is now sacking workers, scaling back scheduled expansion and cutting production.

The China-driven resources boom that was supposed to go on for decades has come to a screeching Road Runner halt, replaced by the shock of an Australian mining bust.

Reserve Bank governor Glenn Stevens this week suggested that the striking economic fact of the past few months was not the expected downturn in the US. It was that "China's economy has slowed much more quickly than anyone had forecast".

China reports many of its key indicators in ways that obscure what has actually happened most recently. Stevens said the Reserve Bank's analysis indicated that Chinese industrial production went backwards over the four months to October. He was "not sure that many economic forecasters have fully appreciated this yet". "There is every chance that the rate of growth of China's (gross domestic product) is currently noticeably below the 8 per cent pace that is embodied in various forecasts for 2009," he said.

Stevens did not spell out what "noticeably below" meant but the word is that this could be as low as 4 per cent. That's a very big deal for a mega-economy that, until only months ago, was supposed to be marching ahead at a double-digit pace but which already had been clubbed by a home-grown property bust.

"China is in for a very rough year," agrees one of Australia's foremost China economy experts, Ross Garnaut. "The slump in Chinese demand for industrial raw materials will be much greater than the slump in overall Chinese economic growth. And that means a very big impact on not only the prices of our exports but also investments in the resources sector," he says.

A day after Stevens's warning, Anglo-Australian mega-miner Rio Tinto announced it would slash its 97,000-strong global workforce by 14,000 and chop capital spending by $7.6 billion in 2009. "No one had anticipated the severity of the slowdown of China's growth in the fourth quarter," said Rio Tinto chief executive Tom Albanese. A day later, official Chinese trade figures reported sharp falls in exports as well as imports last month.

This China crash challenges the national conceit that, while the global financial crisis is producing the deepest worldwide economic downturn since the 1930s, Australia will be spared the worst of it. Sure our banks are holding up, in part because Australia's resources boom meant they didn't have to get exotic to turn big profits over the past half decade. But now our blessed strength in mineral resources is turning into a Lucky Country curse. For Australia, the transmission of the US-sourced global financial crisis is being amplified via China through a sharp fall in commodity export prices, the exchange rate and national income.

"We have gone from the phase where China was protecting us to the phase where China is dragging us down," says Access Economics director Chris Richardson.

In time, Australia's China crash will force some needed national soul searching. What is Australia left with after half a decade of the mother of all commodity export booms? How much of this temporary bonanza have we invested in the future? How much have we put aside for a rainy day? What should we do if the China growth machine picks up again? What if it doesn't?

The answers won't be pretty. In the meantime, two successive quarters of declining output of goods and services won't be the worst of it. "We do forecast a recession for Australia," Richardson says.

"It is now inevitable."

But the more telling measure will be the income recession generated from this subdued physical output, including exports. It has been income from the commodity price boom that has made Australia feel rich by pumping up tax revenue, tax cuts, corporate profits, share prices and company dividends. The nominal or money value of Australia's gross domestic product advanced 10.4 per cent in the year to the September quarter, buoyed by the bonanza of iron ore and coal contracts that Rio Tinto and BHP Billiton screwed out of the Chinese and the Japanese earlier this year.

That show is over. Richardson now forecasts that nominal GDP will fall 0.8 per cent in the year to the 2009 September quarter. That would be a deeper income slump than the Keating recession, when nominal GDP bottomed at minus 0.2 per cent growth in the year to the 1991 June quarter.

In turn, that tees off predicted falls in Australia's terms of trade, the ratio of export prices to import prices. During the boom, this measure of national income increased by 70per cent or so. Making the 2005-06 reading equal to 100, Richardson suggests the terms of trade will peak at 122 in the present quarter. It will then slide to 79 in the last quarter of 2009. That would take it back to 2003 levels, when the boom was just starting to simmer.

So when we stand back, what has happened? What happened is that we got intoxicated by the notion that a commodity price super-cycle would allow Australia to ride on the back of hundred of millions of Chinese peasants as they moved from the rice paddies to factories fed by Australian coal and iron ore. We thought this would make us easily rich.

Garnaut last night was in Abidjan, the capital of Africa's Ivory Coast. The former ambassador to Beijing is also chairman of gold miner Lihir. He sees what's happening in China as a "serious dip" but that the huge budget stimulus announced by Beijing will start to take effect in the second half of 2009.

He adds that the likely "very deep" recession in the US may cut back global mining capacity enough to produce another temporary commodity price spike when Chinese demand does recover. But apart from this, he suggests commodity prices will not return to their recent giddy heights. China will not pay as much as it does under present contracts for Australia's iron ore andcoal.

Richardson reckons Australia's terms of trade will recover from 2010 to about 85. That would mean we get to keep only about one third of the previous price bonanza from the China boom. Export volumes will pick up, but not by as much as we previously thought.

Yet, as Garnaut points out, that would still leave Australia's commodity export prices well above their average in the last quarter of the 20th century. That's still a big opportunity if we're prepared to properly grasp it. Or, as Garnaut says: "We need to make sure we don't splash it against the wall again."