Yesterday we promised to try and figure out the Australian dollar's behaviour using the Grattan Institute's new report on the mining boom. Analyst Jim Minifie's work isn't a bad read because it has lots of pictures. His key points are that Australia can transition quite well into and out of a mining boom, but we've failed to make the most of our latest one.

First of all, it's the size of the boom you need to understand. Minifie calculated that the mining industry provides 'nearly a fifth of all production in Australia' and 'mining's direct share of GDP more than doubled in the past decade, to 11 per cent.' (Not all GDP is 'production'.)

This chart shows how, even in nominal terms, Australia's mining investment has dominated globally.

The question is where all that money came from. Much of it was from overseas, explaining the Aussie dollar's surge to $1.10 USD. And so, as the mining investment boom slows, that has implications for the currency, not just the economy.

So why does Minifie disagree with all the media shenanigans about the mining boom giving us resource curse? He points out that Australia is extremely good at handling the comings and goings of the commodity cycle. This chart shows how, despite having resources contributing to much of GDP (bottom axis), Australia's output and income volatility is low (y axes).

Noting that OECD countries tend to have lower volatility, this chart basically says that Australia has the stability of a developed nation despite a volatile resource industry. The best of both worlds.

To understand this stability, you've got to know what's been going on in the rest of the economy while all this mining boom business has been dominating. Three important things.

This chart shows how prices in non-tradeables have boomed many times more than in tradeables, which includes resources. In other words, what Aussies have to buy from here at home has become expensive at a much faster rate than what they export. Australians are 'price takers' when it comes to buying non-tradeables and selling tradeables. They've been slogged on the difference between the two.

That's why so many people feel like the mining boom has been a disaster for them personally. Not everyone got a job driving trucks, but everyone did have to put up with a soaring cost of living.

What Minifie focused on in the report was the failure of Australia to capitalise on the profits of the boom. Strangely enough, he considers disappointing tax revenue to be a measure of this failure. In our book, you starve the beast, not fund it.

But in a politician's world, the gap between revenue and spending doesn't matter so much. So, even if you've got a soaring mining boom on, there's no reason to worry about saving for a rainy day. That's why Australia's government debt has been soaring when it's supposed to be falling. For now, that's goosed GDP to the upside. At some point' we'll have to pay the debt back though.

The real revelation out of the Grattan Institute's report has nothing to do with mining and came from this chart:

Stuff mining, what on earth is going on in the professional, financial and admin services industry? It's 20% of our economy and growing rapidly.

What kind of economy runs on financial services? They're supposed to enable other parts of the economy to function, not become the economy itself.

If you're looking for a bubble or economic strife, it's not mining you have to worry about. It's financial services. A banking crisis could sink Australia's economy far more than a slowdown in mining.

Speaking of sinking, what do you get when you throw 28 cats into a bag and shake it? The European Union.

You just gotta love these guys and the spats they get into. The latest one is just brilliant. The Brits, proud of their austerity efforts (in terms of rhetoric anyway), have gone and annoyed the Spanish by having a successful economy. So the Spanish want to stick a border tax of 50 euro on crossing into Gibraltar.

If you can't tax your own flailing economy, tax somebody else's. The Spanish also want to close their airspace to anyone flying into the British outcrop. They already fired upon a British jet ski a few months ago in a border dispute.

It won't be long before the English hoist this onto their border posts as a reminder of what happened to the Spanish Armada the last time it tried to get in the way of the English at the battle of Trafalgar:

As always, politics trumps economics in Europe.

Regards,

Nick Hubble+
for The Daily Reckoning Australia