The canary in the Australian economy

4000 people live in Nhulunbuy, a town in remote North-East Arnhem Land. Nearly 1600 of them rely on the local mining company Pacific Aluminium, a wholly-owned subsidiary of Rio Tinto, for employment. This month Rio Tinto head office will decide whether or not they will shut down a substantial part of its Nhulunbuy operations. After having axed now former CEO Tom Albanese last week, you get the feeling Rio is in a decisive mood.

For four decades Nhulunbuy's bauxite mine and alumina refinery have followed the fortunes of the Australian mining sector. Today, Rio states that poor market conditions, high fuel prices and the strong Australian dollar are making business conditions tough. That seems to be an understatement. Estimates vary – but reports suggest the refinery is losing over one million dollars a day. Mining bauxite is still profitable, turning it into alumina, less so.

It is enough to make the bean counters in London a little nervous. Their only hope is that the Northern Territory and Federal governments spend an estimated $900m on a pipeline to divert cheap domestic gas to Nhulunbuy and power the refinery. Pacific Aluminium has issued an ultimatum: if the government cannot bring gas to Nhulunbuy it will close the refinery leaving only its bauxite mining operations. Now, 1600 jobs hang in the balance.

If anyone was still wondering about the changing nature of the mining investment boom – it should look north. Pacific Aluminium is the canary in the Australian economy.

Indeed, Pacific Aluminium's troubles bring to light a core challenge for the Australian economy. The restructuring occurring in the mining sector is going to be hard on towns across Australia and it is likely to lead to a requirement for government support.

Reserve Bank Governor Glenn Stevens has talked recently of the potential challenges within the economy as it shifts from the mining investment boom to being driven by non-mining sectors of our economy. In the past 10 years we have successfully transitioned from growth being driven by private demand then government stimulus then mining investment. The next transition, he suggests, may not cause great instability.

Unfortunately, in present market conditions this transition is more likely to be one big come down.

Since 2005, a third of Australia's income growth has been driven by the mining sector – an area that accounts for only 10% of GDP. A slowing mining sector combined with an overvalued Australian dollar spells trouble for the economy. Unlike in the past, the Australian dollar does not seem to be following the fortunes of the mining sector. Instead Australia's AAA credit rating, our emphasis on fighting inflation and continued instability in the US and Europe means that the Australian dollar has become a reserve currency for investors across the world. This is pushing up its natural value. Therefore, as the mining sector slows down potential balancing sectors may, due to the dollar, be unable to fire back up.

Potential losers, such as Nhulunbuy, will emerge as Australia adapts to a new growth cycle. Helping transition Australian industries, cities, towns and individuals into the new cycle will require an innovative and structured approach from business and government. Programmatic confetti thrown at every panic caused by the transition is not the answer. There will be necessary interventions and unnecessary ones. Innovative policy choices will need to be considered especially when examining how to deal with the high Australian dollar. This may include mixing lower interest rates with new regulatory controls or considering different tax structures for foreign currency investors. Careful, measured cost-benefit analysis will be needed to ensure we are doing all we can with our limited resources. State and Federal Governments should be wary of both the status quo and rash political decisions. They cannot do everything. Nor can they do nothing.

In December the Northern Territory and Federal Governments announced support for a gas pipeline to Nhulunbuy. The town and region are still waiting for a decision on the refinery closure from Rio Tinto. Last week Tom Albanese lost his job largely for his role in the deal that resulted in Rio owning the Nhulunbuy mine and refinery. The canary is looking anxious.