The China-fuelled resources boom is at risk

China has been good to Gina Rinehart. The commodities boom fuelled by demand from the world’s second biggest economy has elevated the Australian iron ore heiress to the top of the country’s rich list with an estimated $10bn fortune.

That may not be the end of it. Research from Citigroup suggests that her private ownership of three of the world’s top 10 undeveloped mining projects, all based in Australia, could catapult her into the world’s superleague alongside the likes of Carlos Slim and Bill Gates.

Dubbed the iron lady of the Pilbara, Ms Rinehart has worked hard to rejuvenate the debt-laden mining business left to her two decades ago by her father Lang Hancock, a 20th century pioneer who made one of history’s great resource finds when he discovered great canyons of iron ore in Western Australia’s remote outback.

On top of a perpetual royalty now worth more than A$100m annually paid by Rio Tinto, the London-based miner, on its Western Australian iron ore sales, Ms Rinehart’s private vehicle Hancock Prospecting owns a half share alongside Rio Tinto in Hope Downs, another iron ore operation producing 30m tonnes a year. Based on an iron price of A$170 ($---) a tonne, and production costs of A$40 a tonne, Ms Rinehart and Rio are splitting profits of close to A$4bn a year from this one operation alone.

Famously reclusive – some say secretive – Ms Rinehart embodies the wealth pouring into Australia where booms and busts have featured since the country’s 1850s gold rush. But the bonanza this time is so great that it has pushed Australia’s terms of trade – a ratio of export prices to import prices – to record highs, and led to a stampede of investment in the iron ore, coal and natural gas sectors.

But the breakneck expansion, and a surge in the Australian dollar, a global proxy for the commodities boom, has forced painful structural change on the non-mining parts of Australia and led to a fierce debate about the “dark side” of the boom.

Just ask manufacturers trying to export and those industries trying to compete with imports made cheap by the dollar, which last month reached a near three-decade high of $1.10.

The dark aspects of the boom have also the set the torch to Australia’s tottering Labor government, which clings to power with the backing of Greens and maverick independent lawmakers that give it a single extra vote in the country’s lower house parliament. Having botched the introduction of a mining super tax under former Labor leader Kevin Rudd, which was replaced by a heavily watered down impost that is yet to pass into law, the Australian government appears to have lost a once in a generation opportunity to capture a greater share of the boom need to realign its economy into the new age.

All calls for some of the mining boom’s spoils to be protected in an evergreen sovereign wealth fund, similar to Norway and Chile, have fallen on Canberra’s tin ear to the dismay of the country’s central bank and senior businessmen.

The boom has also exposed the mixed blessing of Australia’s China addiction. The Asian powerhouse’s rampant demand for iron ore has made it Australia’s dominant trading partner, accounting for 26 per cent of all exports.

But in the words of Saul Eslake, economist at the Grattan Institute, a Melbourne-based think tank, no other nation in the developed world is at greater risk from a China slowdown than Australia.

Spurred by China, Australia may be entering a particularly dangerous resources trap known as Dutch disease, the idea that a surging exchange rate propelled by a commodities boom causes long-standing destruction to other parts of the economy that are eventually hollowed out and collapse.

Evidence of that affliction was on display this week when Australia’s steel export industry was officially laid to rest

[Ed Note – It was the last steel exporter operating in Australia, so fair to say Australia’s steel export industry has died]

when BlueScope, the country’s biggest steelmaker, shut one of only three surviving blast furnaces.

Following retrenchments in the food, travel and retail sectors, the headlines screamed Australian manufacturing had entered a crisis.

On top of the high dollar, BlueScope buckled under the weight of big increases in raw material costs, ironically the iron ore and coal that the country ships to fast-growing Asian markets, and steel imports made cheaper by virtue of the nation’s elevated currency.

Unions made a patriotic call for a “Buy Australian” campaign and accused Beijing of artificially restraining the renminbi to artificially boost its exports into Australia.

Reports that Ms Rinehart had overlooked local steel and sourced railway tracks for one of her large projects from China drew criticism. Wayne Swan, Federal treasurer, pointed out that Australia’s miners had plenty of opportunity to buy more Australian goods – including domestically made steel.

By design or not, Ms Rinehart launched herself on Australia’s political stage last year when she climbed on to the back of a flat-bed truck to address a rally over Mr Rudd’s mining tax hike.

Megaphone in hand, Ms Rinehart shouted herself hoarse at an “axe the tax” rally. “What are we going to tell those jittery Labor MPs in marginal seats?” she threatened. “The reason I am … screaming up and down about this, even in the city streets, is because I feel so strongly about it. I feel strongly about it for our future.”

But her outcry also attracted critics, including Jim McGinty, a Labor former attorney-general of Western Australia. “All I could think of was Gordon Gekko shouting ‘greed is good’,” he told the Sydney Morning Herald. “Gina was basically saying ‘I don’t want to pay my fair share of tax, I want to enjoy what I inherited from daddy’.”

The battle waged by the amply funded mining lobby had its scalp weeks later when Mr Rudd’s was dethroned and Julia Gillard shot to power.

Fifteen months into her reign and the mining industry operating in Australia has never enjoyed greater health.

Rio Tinto this month reported record interim results, with profits from its Australian iron ore operations up by half to $6bn or 78 per cent of the group’s total net profit.

BHP, Australia’s global champion, on Wednesday reported the country’s biggest ever annual post-tax profit of nearly US$24bn, 84 per cent higher than the previous year.

In spite of warnings that even the threat of the old mining tax as well as the new impost would drive business elsewhere, the industry is embarking on an unprecedented investment spree.

More than 90 projects are under way in Australia’s mining industry worth A$174bn, or 13 per cent of nominal gross domestic product. That figure rises to A$832bn, or 60 per cent of GDP, when potential projects under consideration are included.

That rate of investment is supported by the windfall profits generated by Rio and BHP, and individuals such as Ms Rinehart and Andrew Forrest, founder of Fortescue Metals, a group owning vast deposits of iron ore in the Pilbara that from first production a few years ago is now the world’s fourth biggest exporter of the commodity.

Such profits and investment have inflamed an already divisive debate about Australia’s lop-sided economy.

Paul Howes, national secretary of the Australian Workers Union, the nation’s oldest union representing 135,000 blue collar workers, summed up the mood when he attacked “greedy miners” for not investing in local communities.

“These are the same miners that bitch and moan every time they have to pay a different tax,” he said on Australian television.

The more measured response from Graham Kraehe, BlueScope chairman and a Reserve Bank of Australia board member, was that a well-designed mining tax with greater industry consultation would win support from both ordinary Australians and the mining industry.

Funds from such a tax could be used to help transition manufacturing and tourism into the new economy, he said as his company axed 1,000 workers.

Australia’s monetary authorities are also in a bind as they set policy for what Mr Swan describes as the country’s “patchwork” economy. The Reserve Bank has lifted rates seven times in two years to 4.75 per cent, the highest in the developed world. It has done so to dampen inflationary pressures fuelled by the resources boom, but its action has led to a surge in mortgage costs and a slide in house prices. That in turn has damaged confidence and prompted jittery Australian consumers to save more and spend less.

Paul Bloxham, Sydney-based economist with HSBC, is not convinced Australia is suffering from Dutch disease although he says there are structural forces at work that are hollowing out parts of the non-mining parts of the economy.

But he lists a range of problems associated with the resources boom.

“Another ‘curse’ of having natural resources is that it can put a country at the whim of often very volatile international commodity markets,” he says. “Resource wealth can also lead to policy complacency, as do many other unearned windfalls. This can manifest in a stymied reform agenda,” he adds.

To back up that point, Australia regularly features at the low end of international rankings for competitiveness, productivity and innovation.

Paul Cleary, journalist and author of a recently published book “Too Much Luck”, says Australia has relied too heavily on the “dumb luck” created by successive resource booms.

“It’s a lazy way of making a living and generating export income,” he says. “Ten years ago, the economy was more diverse, there were better towns and education.”

“There is this unbridled stampede into the resources sector. It only represents 10 per cent of the economy but it sucks up 70 per cent of capital expenditure.”

He says it is incumbent on the Australian government to better manage the boom by moderating the rate of investment.

“In Australia, there is a really big lie underpinning our economy and that is that we have infinite amounts of resources. We don’t,” he said.

He cites Geosciences Australia, a government research group. It forecast the life expectancy of the country’s known iron ore reserves has fallen from 100 to 70 years since 1998, while black coal is down from 180 to 100 years. Those figures do not take into account undiscovered deposits but neither do they fully factor in the rampant rate of expansion currently under way.

Australian governments must also address structural issues, including the addiction of state governments to the “royalties” earned from the mining industry. “They spend it likes there’s no tomorrow,” Mr Cleary says. “They have a development bias and they downplay the risks of the projects.”

With the commodities boom continuing in spite of debt concerns in Europe and the US that has sparked a fresh round of financial turmoil, Australia’s dumb luck does not appear to be coming to an end anytime soon.

Ideally situated to service fast-growing Asia, Australia will one day hit the bottom of the quarry. By then, the fabulous windfalls may have squandered.

As one Perth-based mining executive says: “I get a sense we are at a critical point. What is the country getting for these massive revenues and who is getting it? That is becoming a very sensitive political debate.”

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