Preparing a fall guy early

3rd April, 2021

Governments of both persuasions and at all levels are as quick to claim credit when the books look good as they are to find external causes when they turn red; it is an essential part of the art of politics and has been practiced from time immemorial.

Luckily for Government, in-depth economic analysis is about as popular as a round-the-barbeque conversation as Brussel sprouts would be being cooked on top. Only economic and political tragics care for the details, so as long as the numbers look good Government reaps the benefits irrespective of the reasons why.

There has never been a better time to demonstrate this principle than right now, because there has never been a greater contrast in the economic and fiscal outcomes around Australia as a result of a single issue like COVID.

During COVID the financial pain was missed by one state Government while the others and the Commonwealth suffered.

And the reason for this is simple. The world’s response to COVID included even more stimulus spending than normal, especially for major infrastructure projects and to boost the housing industry. Trillions of borrowed dollars continue to be poured into these areas, not just in the huge economies of the US and China but everywhere including Australia.

The spending is so free that much of the world can’t find enough skilled labour to deliver the projects, so timeframes and costs are blowing out even further.

In Australia COVID spending means the Commonwealth Government was heading for a $200 billion budget deficit and national debt approaching a trillion dollars, although there have since been some modest savings identified.

State deficits around the country have skyrocketed, with Queensland ($13 billion), NSW ($16 billion) and Victoria ($23 billion) leading the race to the red. All three are expected to roughly double their state debts over the next four years, to $50 billion, $100 billion and $150 billion respectively.

So was the fact that Western Australia is expecting multi-billion dollar budget surpluses and no significant change to debt when the rest are drowning in debt and deficit down to good planning or good luck? Or perhaps some of both? 

Certainly on one hand keeping COVID out allowed WA to keep producing and exporting. On the other the massive world stimulus spending on infrastructure was always going to require a lot of steel.  

China produces half of the world’s steel, with the next 50 or so countries producing the other half. China usually gets 60% of its iron ore from Australia, almost all from WA. With our largest competitor Brazil in a COVID and dam burst supply crisis, it has never been a better time to be a WA iron ore miner.

This demand has once again driven iron ore prices up to boom levels. The last boom was from around 2004 to 2014, providing ten years of plenty. The current one started in February 2019, but it wasn’t until COVID bit in 2020 that the prices for iron ore matched the incredible heights of the last boom. Today it is over US$160 a tonne.

Recently global ratings agency Standard and Poor’s lifted their predictions on iron ore prices from US$100 to US$130 for the rest of 2021, and from US$80 to US$100 in 2022. The state budget was based on prices of US$96.60 this financial year and US$64 from then on.

 If S&P are right that will mean another $3 billion a year in additional royalty income above and beyond the budget each year that the price stays up.

As a result, WA will still be fiscally flying while the other states are crashing, based entirely on iron ore royalties. In fact, the increase in iron ore royalties will end up paying for the State Government’s entire COVID response with plenty of cash to spare. 

The McGowan Government is effectively making a profit out of COVID.  

That is not to say it should be criticised for doing so; part of doing business is to take advantage when circumstances allow. However it needs to be recognised and acknowledged.

But it cannot be said that the Government planned and delivered this economic windfall, and therefore the downside risk comes when the world gets COVID under control and the stimulus spending slows or stops.

When iron ore goes back to its normal price, perhaps in a year or two, the pressure will go back on to the State to manage a much tighter budget.

Perhaps the Government recognises this, because you can already see it shifting its focus.

Last year the Premier had Clive Palmer to paint as the source of all evil while he was taking credit for the economic good times.

This year, especially post-election, a new economic strategy and a new state enemy will be required politically. And the Premier has wasted no time in identifying those rotten eastern staters as presenting a clear and present danger to this state’s GST receipts.

This is despite the fact that the Commonwealth has never suggested any change to the current floor it put in place when Scott Morrison was the Treasurer, and that it has come out supporting the current system to remain.

But when the iron ore price returns to normal and the free money disappears, the Government is going to need to identify a new external cause for the pain. It would be easiest to roll out the one you prepared earlier.