24/01/2012 - 08:54

Analysis: When cheap is too cheap

24/01/2012 - 08:54

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Everyone loves a bargain. But, there comes a time when cheap is too cheap, as the world is discovering with falling prices destabilising industries, and entire economies.

Four examples illustrate the destructive power of falling prices:

  • Australia’s manufacturing sector, especially car making, is being decimated by imports made cheaper by the rising value of the Australian dollar.
  • Traditional retailers are feeling the same pressure, with the damage doubled thanks to internet shopping.
  • Super-lower interest rates (zero in some cases) are killing the finance industry in the U.S. and Europe, causing widespread job losses, and leading to risky investing of the sort which triggered the global financial crisis.
  • Pollution free power sources, such as wind and solar, are being dumped in the U.S. in favour of cheap natural gas unleashed from vast beds of shale rock once regarded as too hard to tap. Australia is next in line for the gas revolution.

Looked at separately and a casual observer might be inclined to argue that each event contains a core of positive news.

-          Low car prices make it easier to buy the vehicle of your dreams.

-          Internet shopping delivers globally competitive prices (and choice).

-          Cheap money makes it easier to service debts, and

-          Cut-price natural gas means electricity prices have crashed in the U.S., restoring that country’s competitiveness.

Now, look a bit closer and see what happens when a financial equation is altered by cheap money (or very low interest rates).

Toyota’s decision to sack 350 workers at its Altona plant in Melbourne is the tip of an iceberg with thousands more jobs scheduled go, a process which will either force government to offer ever-greater subsidies, or wear the pain of rising unemployment.

In a resource-exporting state such as WA this might not seem such a big deal, a mistaken view because it fails to recognise the long-term damage being done – either by the closure of factories and lost jobs, or the artificial life-support offered by government, a cost carried by all taxpayers.

Internet shopping is a well-reported phenomenon which is benefitting local buyers, but biting deeply into shopkeepers who lack an internet offering, and shopping centre owners who are starting to feel the cost of empty outlets, a situation which can only get worse.

Cheap money, contrary to every instinct, can be damaging to the health of a bank, its staff, and borrowers. Banks in Europe and the U.S. are finding it hard to earn a profit as the gap between their borrowing and lending cost is so low it barely covers costs.

That is leading to mass sackings of bank staff, while customers who can get a low-interest loan are using it to chase higher interest elsewhere in what is called the “carry trade” – Greek debt, anyone?

Falling electricity prices, which Australians would love, are perhaps the best example of an unintended consequence.

In the U.S., a glut of natural gas has slashed the price of that commodity by 80 per cent over the past five years. Gas which once cost more than $US13 per million British Thermal Units now costs less than $US3/mbtu – and it is not an overnight phenomenon because the shale-gas revolution has just started.

Low gas prices have, in turn, cut electricity prices by 50 per cent, causing one U.S. electricity producer to abandon plans to expand two nuclear power plants, and caused the cancellation of new coal-fired power stations, decisions which environmentalists will applaud.

But, the same damaging effect of cut-price competition is being felt by wind-power developers with the NextEra Energy last week shelving plans for a new wind farm because it too cannot compete with gas.

Australia is travelling exactly the same road as the U.S. when it comes to shale gas, only 10-years behind.

The gap will start to close over the next 12-to-24 months as multiple shale-gas exploration programs reach critical points in their evolution, starting with Beach Energy which is in the process of testing its Encounter No.1 shale-gas discovery in South Australia’s Cooper Basin.

With Australia having geological similarities to the U.S. there is every likelihood that shale gas will become as big a factor here as it is there, presenting a unique challenge for coal-fired power, and the renewable power sources which the Australian Government hopes to attract.

Perhaps there really is a time when cheap is too cheap.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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