Saturday, January 29, 2011

It's about China, and steel

You wanna make guesses about what will happen to the economy this year? Here's a tip: forget the floods and take more notice of China.

Australia's business economists have already got the message that China dominates the rest of the world's effects on us, whereas their mates in the money markets are slower on the uptake, retaining their obsession with all things American.

China matters, first, because, with a population of 1.35 billion, it's the most populous country in the world. That gives it 20 per cent of the world's population, making it 11 times larger than Japan.

The second reason China matters is because its economy has been growing so rapidly for so long: an average rate of 10 per cent a year for three decades, meaning it's been doubling every eight years.

This means that, since 1980, it's gone from being the 12th-largest economy in the world to the second-largest. This is measured using "purchasing power parity" - that is, taking account of the fact that one US dollar buys far more in China than it does in the US.

So China's economy has moved from being 9 per cent of the size of America's to about 60 per cent in 2009. The International Monetary Fund is expecting it to reach 90 per cent in 2015. If so, it won't be long before China's the biggest economy.

Of course, this still leaves the average Chinese a lot poorer than the average American. Income per person in China has reached only 18 per cent of American incomes - suggesting the Chinese have scope for a lot more growth yet (provided the world has enough idle resources to make it possible).

When you combine China's huge population with its rapid economic growth you find this growth accounted for a quarter of all the growth in the world economy during the noughties. Get that. America's share of world growth would have been very much smaller.

The third reason China matters so much to us: its economy is in our part of the world and is such a good fit with ours. China needs to buy what we've got to sell, and vice versa.

According to figures from the Department of Foreign Affairs and Trade, last financial year China became both our largest export market and our largest trading partner. Our two-way trade in goods and services grew by more than 18 per cent to $90 billion.

China has been our biggest market for exports of goods for some time but last year it overtook the United States to become our largest market for services as well.

Over the course of the noughties China's share of our two-way trade increased from 5 per cent to almost 18 per cent. Its ascension means Japan is now our second-largest export market. And get this: our third-largest is India.

Our top three imports in 2009-10 were travel ($19 billion), passenger vehicles ($15 billion) and petroleum ($15 billion). But to get back to the point, our top three exports were coal ($36 billion), iron ore ($35 billion) and education ($19 billion).

Why's that the point? Because coal and iron ore are the main things we sell China. Iron ore and coking coal are the main components of steel - and, as part of their economic development, the Chinese are producing huge quantities of steel.

So the well-versed economy watcher needs to know more than a bit about China's steel industry. Its story was summarised by James Holloway, Ivan Roberts and Anthony Rush in an article in the latest Reserve Bank Bulletin.

China is now the world's largest producer and consumer of steel. Ten years ago it accounted for 15 per cent of global steel production; today its share is 45 per cent.

Just how much of a country's gross domestic product is devoted to steel is determined by its stage of economic development. Undeveloped countries don't use much steel and advanced countries aren't very "steel-intensive" because much of their economic infrastructure has been built and most of their growth is coming from expanding services.

In between, however, countries are rapidly industrialising and urbanising. And that's where China is. Remembering its average rate of growth in GDP of 10 per cent a year for the past three decades, its steel production grew at average annual rates of 7 per cent in the 1980s, 10 per cent in the '90s and almost 20 per cent in the noughties.

The Chinese steel industry is highly decentralised, with plants scattered throughout the country and with a small number of large, advanced, state-owned steel makers and a large number of small and medium-sized private firms. The Chinese government's policy is to consolidate the industry, to improve economies of scale and reduce the use of high-polluting facilities.

The industry mainly produces steel directly from iron ore and coking coal using the blast furnace and basic oxygen converter method. This means that, on average, each tonne of steel produced requires about 1.7 tonnes of ore and 0.5 tonnes of coking coal.

China has its own extensive reserves of iron ore, but their ore content averages only about 33 per cent, compared with 62 per cent in Australia and about 65 per cent in Brazil and India, making local ore more expensive. So now more than half the ore used is imported.

Until recently China was self-sufficient in coking coal. But many of its deposits are relatively inaccessible and thus costly to mine. And many of its mines are unsafe. So since 2009 there's been a surge in demand for our coal.

More than half China's annual steel production is used for investment in buildings, structures and machinery. (Total public and private investment spending's share of GDP is a remarkably high 45 per cent - a sign China's in the industrialisation phase of development.)

At least a quarter of steel production is used for manufacturing cars, home appliances and much else. A lot of these would be consumed locally but most are probably exported.

The authors conclude that China's steel-intensive industrialisation phase - and hence its strong demand for our iron ore and coking coal - is likely to continue "over the next decade or so".

One conclusion from this is that the floods' biggest effect on our economy is likely to be the temporary disruption to the Queensland mines' production and export of coal.

Think of China, think of steel; think of Chinese steel, think of Australia making big bucks