Australia Has a Nuclear Option in Its China Diplomacy

(Bloomberg Opinion) — After years of slow deterioration, diplomatic relations between China and Australia have taken a sharp turn for the worse. The disputes range from pressure on journalists, to spying allegations, to an investigation of Australia’s wine exports. Beijing holds most of the cards, but Australia does have one doomsday weapon at its disposal. It’s better not used.

The conflict echoes China’s widening disputes with other countries. Two journalists working for Australian Broadcasting Corp. and the Australian Financial Review newspaper fled China this week, after a third Australian working for state-run China Global Television Network was detained. For their part, Australia’s intelligence services have interviewed at least one Chinese journalist in a probe of alleged covert foreign influence of a state legislator, according to reports in Xinhua news agency and the Sydney Morning Herald. 

Recent years have been a minefield of clashes over Australia’s foreign-influence laws, China’s human rights record and response to Covid-19, and even competitive swimming.

These diplomatic disagreements are spilling into the economic arena. Having slapped tariffs as high as 80.5% on Australian barley exports in May over alleged dumping, China has now started an equally improbable investigation of the wine industry. Canberra last month prevented China Mengniu Dairy Co. from buying local milk, juice and beer producer Lion from its Japanese owner Kirin Holdings Co. for reasons that aren’t really clear. 

Through all this, the bedrock of their trading relationship has been surprisingly solid. China’s imports from Australia are up 75% year-to-date on the same period of 2016, the last time there was a meeting between the country’s leaders.

The core of this is a product that’s absolutely central to Beijing’s ability to direct the Chinese economy: iron ore. The 700 million metric tons China imported from Australia over the last 12 months is more than double the levels that prevailed when relations were stronger in the early 2010s. That’s a source of surprising vulnerability for China — but like any nuclear option, it’s a weapon that Australia would be wise not to use.

As we’ve written in the past, pushing the button on giant engineering and real estate projects is to China what cutting interest rates is to other countries. Private sector-dominated manufacturing and retail sectors are still reeling from the impact of the coronavirus, with fixed-asset investment down on levels that were already subdued last year. State-dominated construction and engineering sectors such as power generation and real estate are where all the growth is. Keeping the economy ticking over through 2020 is going to involve adding further to that teetering pile.

This economic machine runs on steel — and Australia has a crucial role there. Its mines provide about two-thirds of China’s iron ore imports, as well as a significant chunk of the coking coal used to turn that ore into usable metal. Were Canberra ever to attempt to turn that supply chain into a weapon in the diplomatic spat between the two countries — by imposing spurious paperwork, for instance, as Chinese customs officials applied to Australian coal last year, according to some reports — it would be aiming at the heart of Beijing’s economic management.

China’s addiction to industrial stimulus and Australia’s desire to work as its dealer are unhealthy dynamics for both economies. Still, it’s notable that their current fight has focused on agricultural and food produce, which attracts a lot of attention but ultimately counts for relatively few dollars. That’s probably because touching heavy industry would represent a doomsday weapon that would be quite as damaging to an export-dependent Australia as it is to an import-hungry China.

Australia has spent decades building up a reputation as a reliable supplier of raw materials to the rest of the world. As the U.S. learned the hard way, consumers of commodities have alternatives if they don’t trust their trading partners. American attempts to use soybeans as a weapon of trade diplomacy in the 1970s encouraged Japan to foster a rival export industry in Brazil. Similarly, a consortium of Chinese companies in June signed a deal to develop the Simandou iron ore project in Guinea, a country that might be more reliably compliant than Australia if relations with Canberra sour further.

Economists and historians have often argued that war is impossible between deeply integrated capitalist economies because of the countervailing forces encouraging commerce. The expectation of future trade is “essential for peace by trade to work,” said Erich Weede, a professor at the University of Bonn. 

Amid the rapid decline of diplomatic relations between Australia and China, the ongoing strength of imports and exports should be a source of hope. Trade with a foreign country leaves you exposed and dependent upon trust, but that’s an attribute that both countries need to restore at the moment, not flee from. When the dust stirred up by the wolf warriors and trade war-mongers dies down, China and Australia — and the U.S. — have far more to gain from working together than from threatening each other.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

David Fickling is a Bloomberg Opinion columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

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