Hollowing out

See the latest Australian dollar analysis here:

Macro Afternoon

Washington Consensus and Dutch Disease – yesterday saw an interesting convergence of these two ideas which are vitally important to the debate, or lack thereof about the structure of the Australian economy and the changes being wrought by mining and the high Australian dollar.

Briefly, the Washington Consensus was the set of “rules” which replaced the Bretton Woods philosophy with the rise to power of Margaret Thatcher and Ronald Reagan as they set the ground work which managed global capitalism along laissez faire lines  from around 1980 to the GFC. It was synonymous with belief in both free and efficient markets, deregulation, privatization, inflation targeting and floating exchange rates.

Speaking at George Washington University April 4th the International Monetary Fund’s Managing Director, Dominique Strauss-Kahn  delivered a eulogy for the Washington Consensus and its laissez fair attitudes that led us to the Global Financial Crisis. Specifically he said:

Before the crisis, we thought we knew how to manage economies pretty well. This “Washington Consensus” had a number of basic mantras. Simple rules for monetary and fiscal policy would guarantee stability. Deregulation and privatization would unleash growth and prosperity. Financial markets would channel resources to the most productive areas and police themselves effectively. And the rising tide of globalization would lift all boats.

This all came crashing down with the crisis. The Washington Consensus is now behind us. The task before us is to rebuild the foundations of stability, to make them stand the test of time, and to make the next phase of globalization work for all. This rebuilding has three core areas—a new approach to economic policies, a new approach to social cohesion, and a new approach to cooperation and multilateralism.

The importance of this speech should not be underestimated as the IMF has for decades been a proponent of the very free market  ideology Strass-Kahn seems now to be disavowing.

It goes against the financial markets professional in me, but these days I too distrust the notion that markets will channel resources to the “optimal” outcome. In recent days, that has seen me writing against the moves in the AUD/USD exchange rate and the structural changes that are being wrought in the Australian economy with little, if any, debate. I’m not averse to making money by trading these moves but we should still have a broader macro debate on what’s going on in the economy.

That debate needs to take up the baton offered yesterday with the release of the latest World Trade Organisation’s (WTO) Trade Policy Review for Australia. The WTO is now clearly concerned about a hollowing out of sectors in the economy outside of mining:

In 2008/09,the exchange rate of the Australian dollar against the U.S. dollar depreciated sharply, thus boosting exports and reducing imports, but since then it has been appreciating and negatively affecting Australia’s export competitiveness.

But it’s more than that. While Australia has been insulated from global turmoil by a “virtual doubling of China’s share of total exports” there are risks to this changing structure of the economy. According to the WTO:

Australia’s growing dependence on mining may amplify the business cycle, as the economy will become more vulnerable to swings in its highly favourable terms of trade. A major economic challenge confronting Australia, with potential trade policy implications, is to formulate appropriate macroeconomic and structural policies to facilitate rather than impede adjustment to the effects of its greatly improved terms of trade owing to the mining boom and the associated appreciation of the Australian dollar. The latter is likely to reduce the competitiveness of import-competing activities and non-mining exports, unless productivity in these activities can be improved. This will have far-reaching implications for the pattern of growth and structure of the economy by necessitating a reallocation of domestic resources. Significant structural adjustment by the non-mining economy will be required.

There we have it. If Australia doesn’t have Dutch Disease it soon will have.

Crucially, the WTO goes further, warning Canberra about policy and a lack of appetite to deal with the issues facing the Australilan economy:

Although Australia is still considered one of the most competitive economies in the world, it has experienced a marked decline in multi-factor productivity growth owing mainly to special developments in agriculture, mining, electricity, gas, and water…soaring export prices and low unemployment seem to have reduced the appetite for further structural reforms, which appear to have slowed or failed to deliver during the review period, thereby possibly affecting the prospects for achieving sustained growth in the future.

I don’t at all disagree. Our competitiveness in everything but mining is under assault. But it seems to me that it’s pretty laughable to discuss boosting productivity in an effort to overcome a currency disadvantage that is as large and fast growing as the rampant Aussie.

The Aussie sits around 1.0450 as I write and the path of least resistance remains up in the short term while the USD remains weak driving the leveraged bet that is commodities and the Aussie. We truly could be seeing an unstoppable march of the AUD driving toward 1.10 and even beyond. Certainly in the current global economy there is little reason to sell Aussie yet when you look at our 5 drivers: global growth and commodities; interest rates; investor sentiment, technical indicators and, crucially, weakness in the $US. So the kinds of changes being wrought in the economy will continue, productivity boost or not.

The fact is, the currency is caught in the back wash from the world’s two largest economies actively managing their currencies lower. By doing so, they have abandoned the Washington Consensus. Yet, we’re still hanging on to the same old doctrine, despite the artificiality of the circumstance. We need a debate on the currency now.

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  1. it seems to me that it’s pretty laughable to discuss boosting productivity in an effort to overcome a currency disadvantage that is as large and fast growing as the rampant Aussie.

    My thoughts exactly. I’ve boosted my productivity by not paying salaries. Many have helpfully suggested that I should be “hedging”. How exactly do you hedge against a structural change to a rocks-only economy? Answer: You don’t, you just go out of business.

  2. Very well said DFM.

    All this talk about carbon taxes etc is drowning out the real discussion about the threats to our economy: the dollar.

    • I agree. Truth is Australia has always relied on the fortunes of our natural commodities – wheat, sheep, coal, minerals and never really engaged in considered meaningful discussion as to the country’s economic development and future. By a wing and a prayer you might. Oh, we have the occasional ‘clever country’ inanity and repeated exhortations to ‘specialise’…never quite seem to get off the ground.

      But government is busy. Busy planning expenditure from the windfalls of mining whilst attempting to tax the industry to the limit, imposing a unique carbon tax with questionable long term environmental benefits, committing billions to the NBN (already contractors saying costs may blow-out by 50%) – a bargain $80-$100billion! – delivery up to ten years into the future (confident technology will not change exponentially?), standing by, like successive governments, as the manufacturing base declines, possibly terminally, busy re-designing cigarette packets, shielding esteemed leader from destructive white-anting. The exchange rate is excellent – perfect for my next overseas jaunt. The Australian Way.

  3. This is where smart fiscal policy could be exercised, companies that are cashed up and Australian owned are given tax breaks to use the strong dollar to purchase distressed overseas assets. Hopefully these distressed assets can be made to turn a profit that then flows to Australian shareholders. The problem is finding the Australian companies.
    This is similar to what the Jap’s have done and what the Swiss are doing now.

    • Excellent suggestion! The federal government should also be investing overseas to build up a sovereign wealth fund. Even if they did this with deficit financing (ie just created the necessary $A) this would help keep the $A down and provide a hedge against future corrections.

    • Let’s hope these companies do a better job selecting foreign enterprises than the Banks did. Someone on this blog mentioned the glaring inadequacies of Australian management when stepping into the global sphere.

    • That’s under the assumption that the Australian executive management class is capable of adding value to any distressed asset they acquire.

      Our executives tend to fail whenever they attempt overseas expansion.

      Our business leaders don’t innovate, they don’t add value, they are mediocre. All they can be described as are M&A bureaucrats that push most sectors in Australia into duopolies, where they can then price gauge consumers.

      They then lobby hard to protect these duopolies.

  4. Don’t think both US and China are managing currencies lower. Today’s yuan fix was a record high against the dollar. Are you proposing a return to a managed Aussie dollar? Bit of a disaster for funding the current account deficit, wouldn’t you think?

    “POBC fixed the yuan’s mid-point versus the dollar at a
    record high of 6.5456 on Thursday, the fourth straight trading day that the fixing was set at a record high and up from Wednesday’s historical high of 6.5496. — Reuters”

  5. If devaluation equals prosperity, why not go all the way?

    We could be like the starving billionaires in Zimbabwe!

  6. JMD does selling off our assets to pay for imports really lead to prosperity in the long term?

  7. Ah..JMD maybe you were alluding to teh idea of printing up a few dollars and handing them about?

  8. In defense of the notion of “markets”, they are anything but “free”, really. Their current character is mainly from massive the massive, massive distortion that comes from the govts, in effect, setting the price of money. Not to mention the many other regular, large distortions that govts cause on “markets”.

    What has failed, really, with the GFC is massive govt directed and distorted marketism, not free-market capitalism.

    Hence, what govts are now, really, doing is massively intervening on massive distortive interventions that began as far as post WW2, and even the early 1900s, which they were responsible for.

    Therefore, it’s really a movement from Crony Capitalism to Statism, that we are now looking at.

    And I can say all this without necessarily being a free-market fanboy – it was never really given a chance anyway.

    …watch for more and more govt encroachment into every phase of life, as “free capitalism” is declared a failure (even though it was never tried). It really is stinking more and more of Elitism, isn’t it?


  9. Flawse I reckon we need to buy chinese companies to get our own land back, and they are not going to sell. The Swiss seemed to be pretty good given the size of Nestle Xstrata etc

  10. Might be a bit late to ask this question here but: the high AUD does help in some way with dealing with increase in oil price. if AUD was 80cents and petrol was $2+ a liter would that damage us more than risks of high AUD?

    • It wouldn’t damage us more, but it would hurt more politically because the Bogans would squeal about their Falcodores costing a mint to run.

      A strong dollar is far more insidious because it hurts great companies like Cochlear and CSL, while rewarding Bogans with cheap plasmas, cheap overseas holidays and cheap petrol for their gas guzzlers.

      In short it rewards the lazy, and punishes the hard-working … and people wonder why Australia’s productivity growth is in the toilet.

    • 😀

      Nicely put Lorax.

      I shake my head everytime I look at the ASX50 and the ASX200 and only see CSL and COH respectively there. Banks, finance companies, resource, energy stocks.

      • Where the hell is our Apple, Sumsung or Nokia?

        (ok, maybe Nokia isn’t such a good example these days, but you know what I mean)

        • Won’t be coming anytime soon if the government goes through with slashing NHMRC funding by $400 million over the next 3 years… (that’s some 19% of funding by the way).

          Don’t worry about the brain drain starting again, we’ve got mining! /sarcasm

  11. Good question Dan and maybe it is ALL coming our way…between a rock and a hard place. Hope others with better current knowledge than I have might have a go at that one.

    • I noticed that. Do you guys (macrobus contributors) normally get published in MSM? If not, then congrats on getting noticed. Your traffic must be going through the roof.


  12. Here’s an alternate thesis – there’s not a helluva lot we can do wrt managing the strength of the dollar in the current or near-term.

    The US Fed with it’s Quantitative Easing v2 program (perhaps QE3 too?) is engaged in a race to the bottom in terms of devaluing the USD. China, Japan, are also heavy hitters when it comes to currency intervention.

    All 3 are major trading partners.

    We just don’t have deep enough pockets to compete in this game. Perhaps it’s a case of learn to stop worrying and love the AUD?

    My 2cents – China’s growth isn’t sustainable, Russia’s outbuilding us in terms of transporting what’s in their dirt to customers & far less hung up on who they’re selling to. Ultimately our growth will hit a wall, the dollar along with it.

  13. Deus Forex Machina

    Hey Guys…thanks…good to see a little bit of MSM picking up on what we are trying to achieve here at Macro…some good comments above and on the fairfax sites are food for thought…we may have started the debate but whatever the outcome I believe that economies are complex adaptive systems and I want, indeed we need, to seek to maintain as much biodeversity as possible…that means protecting productive businesses and industries survive and adapt.


  14. I guess in the short-medium term there is no choice for Australian manufacturers but to try and focus on markets where the currency relationship has been a little more stable than that with the USD.
    A tough thing to do, but not really a lot of options. I fail to see the benefit of trying to participate in a race to the bottom.

  15. Dan
    I have noticed this argument about the strength of the AUD vis-a-vis petrol prices bandied about quite a bit lately – Alan Kohler and Terry McCrann to name a couple. Whilst there are undoubtedly many reasons as to why the AUD has reached its recent highs, one of the significant reasons is a developing weakness in the USD, courtesy of Dr. Bernankes magical printing machine. This same factor is also at least partly responsible for the rise in the price of oil, and commodities in general. Therefore, it seems that there is a common factor at work, pushing up both the price of oil, and the value of the AUD. If that is so, then it follows, within the context of other influencing factors, that regained strength in the USD would see both a fall in the price of oil, coinciding with a weakening of the AUD. It seems to me, therefore, that it doesn’t necessarily follow that one can draw a direct line between yesteryears value of the AUD and todays price of oil (although I appreciate we have been down that road, but for very different reasons). If the AUD was back somewhere in the financial past, so, most likely would be the price of oil (with qualifications).
    Just a thought.

  16. It’s mid August now, and the hollowing out continues apace.

    I’m of the opinion that the only effective thing the government could do is tax mining properly (to slow it down), and quarantine much of the revenue in a long-term sovereign wealth fund.

    In any case, my industry (software) is clearly dying in Australia, and is dead in Adelaide. Australia is more expensive for software development than all larger developed nations; ergo the industry here is doomed except for local government work. I imagine this is true for many other industries.

    I’m off to the USA; even though they’re ‘printing’ like crazy, their inflation rate is about the same as ours, and cost-wise, they blow us out of the water. Their economy may be sick, but I’ll take ‘sick economy with jobs in my industry’ over ‘strong economy with only one sector’ any day.

    As ‘the Lorax’ said, if you’re running a business in an industry that doesn’t benefit from mining, in general, you can’t hedge.