Western Australia may be half a world away from the epicentre of the fallout from the collapse of the sub-prime mortgage market in the US, but that does not mean the US housing market’s woes will not eventually turn up in the prices of key commodities important to this state.
You need to join plenty of dots to get from falling house prices in the US to: a sharp slowing in private consumption; a significant decline in US demand for Chinese manufactures; and falling demand from China for WA’s iron ore and nickel. Nevertheless, such a scenario cannot be dismissed as a way-out-there risk that should be assigned only a negligible probability.
Despite equity markets’ optimism, global debt markets remain disjointed pending the identification and bringing to account of losses incurred.
Despite the increase from unrealistically low levels in US corporate bond risk premiums, the general level of longer-term interest rates in the US remains low by historical standards. So does actual inflation, despite upside risks, not least of which is from a US oil price near US$90 a barrel.
And the US bond market is to the global bond market what Wall Street is to the rest of the world’s stock markets – the benchmark from which longer-term interest rates are priced wherever markets, rather than governments, determine bond yields.
As long as US bond yields remain low and stable, WA’s capital-intensive economy would have to suffer a big shock on the demand side of the equation to fall out of bed.
And apart from iron ore, the biggest shock to WA would be if falling oil prices were to backfill to LNG prices, just as that industry has designs on iron ore’s status as the state’s chief export commodity.
But it couldn’t happen, could it? Just for starters, actual and prospective supply constraints in the Middle East are not going to go away in the foreseeable future.
Probably not, but you only have to go back to 2001 to get back to a sub-$20 oil price in the face of a mild recession in the US. And while that was also in the wake of 9/11, apart from the 1991 Gulf war, the oil price struggled to get above $25 during the past decade, even dipping as low as $12 in mid-1998.
An oil price below $25 a barrel probably is now history, but a steep decline in the oil price (for instance if recession in the US sliced a few percentage points off China’s growth), would surely put big dents in the viability of the great LNG projects slated for development in WA in the next few years; not to mention the federal and state government coffers.
•Alan Langford is the chief economist at HBOS Australia.
