China hit as ‘dumb’ trade war backfires

China’s trade aggression has been dubbed as ‘smart politics’ but ‘dumb economics’, with Australian tax payers set to benefit.

Chinese trade aggression will provide a multi-billion dollar boost to the government’s budget bottom line, as the threat of trade sanctions against Australian exports helps drive the iron ore price to seven-year highs and enrich government coffers.

Deloitte Access Economics partner Chris Richardson branded China’s trade aggression as “smart politics” but “dumb economics”, and that its trade war “had delivered (Australian) taxpayers a handy – and hefty – windfall”.

Mr Richardson said the “fear factor” of possible Chinese trade action on our biggest commodity export had contributed to a $US18 a tonne surge in the iron ore price in this month alone, which had pushed our biggest export commodity to a seven-year high of approaching $US160/tonne.

Booming mining profits have boosted the government’s tax take, setting up this week’s mid-year economic and fiscal outlook to reveal what Mr Richardson estimated would be a $3bn improvement budget bottom line for 2020-21.

“The bottom line is that China’s trade war with Australia is making us money rather than losing it. To be clear, we’ve lost money on everything from lobsters to wine. But we’ve more than made that up in overall terms thanks to iron ore – and the taxman will be a considerable beneficiary of that.”

Mr Richardson said MYEFO would show the surprisingly strong economic rebound would lead to the government spending less and earning more in taxes than was estimated in the October 6 budget.

Josh Frydenberg has already revealed there were 2.1 million fewer than expected workers on JobKeeper in October than in September – a major saving which CBA has estimated will be worth $5bn in the December quarter alone.

More people in work, highly profitable miners and few new policy measures account for the conservative estimate of a $3bn improved bottom line for 2020-21, Mr Richardson said.

“That outperformance versus the official forecasts may lift to more than $15bn by 2023-24,” he said.

The veteran economist also estimated that the significantly faster rebound than anticipated in the October 6 budget would leave the economy $33bn larger in nominal terms in 2020-21 – and $106bn bigger by 2023-24.

UBS analyst Glyn Lawcock said while the geopolitical threats around Australian iron ore exports was a potential factor driving the commodity price higher, restricted global supply and strong demand out of China as it rebounded strongly from the pandemic explained the vast majority of the price rally in recent weeks and months.

“The political angle is just another input,” Mr Lawcock said.

The threat of politically motivated sanctions on Australian imports into China comes as the global supply of iron ore faces some major disruptions. Bad weather in Australia and Brazil – the other major iron ore producer – has tightened the market, while a major Brazilian mining tragedy in early 2019 continues to reverberate through that country’s iron ore sector.

The country has failed to contain the pandemic, which has also weighed on production.

Meanwhile, low interest rates have tended to favour speculation in commodity prices, and the weaker greenback has made US-dollar denominated resources more attractive.

Australia supplies 60 per cent of China’s iron ore imports, and analysts, including Mr Lawcock, say Chinese tariffs on the bulk commodity are remote as our biggest trading partner would not be able to find alternative supplies.

Mr Lawcock said already this year China had more than doubled its iron ore imports from high-cost producers in places such as Russia, Iran, Iraq and India.

Nonetheless, “as the temperature has risen, markets are worried that ‘something’ may happen”, Mr Richardson said.

“The geopolitical risk premium now being priced into world iron ore markets is a spark that is falling on some very dry tinder – no wonder that the flames have risen as fast as they have,” he said.

“And those higher prices are hitting Chinese steel mills, construction businesses and the wider Chinese public increasingly hard. In turn, that says that to date this trade war is coming at a rather higher cost to China than perhaps it had initially expected.”

Mr Richardson said there were “obvious victims in the current war, including those Australian businesses and their workers who sell wine, barley, beef, lamb, timber, cotton or thermal coal to China”. But “in those markets where Australia is losing money, these net losses look set to be less than a quarter of a per cent of national income,” he said.