Stephen Bartholomeusz of BS wrote late yesterday that:
While it will be overshadowed by Julia Gillard’s nomination of the date for the next federal election, her comments on the Australian dollar occupied a meaningful slab of her address to the National Press Club today, indicating that the continuing strength of the currency is a front-of-mind issue in Canberra.
The prime minister, noting that the dollar had appreciated by about 60 per cent in the past three years, said the dollar lay at the intersection of her concerns about economic diversity and competitiveness.
The dollar has, of course, held up despite a terms of trade that has been falling for more than a year and lower interest rates, damaging both the trade-exposed non-resource sectors of the economy as well as the resources sector, where the underlying commodities are priced in US dollars. As Gillard said, that defies economic orthodoxy (and the history of correlations between the value of the dollar and commodity prices).
While the resources investment boom is likely to peak within the next 12 months – which will cause a significant fall-off in jobs and activity associated with the construction of mines and LNG projects – there is no certainty that the dollar will weaken. Its strength has more to do with global financial flows, some of them purely speculative, and international relativities than the economic fundamentals of this economy.
Given that neither the government nor the Reserve Bank has the levers or capacity to shift the dollar and that the working assumption has to be that the dollar will remain persistently strong the government, as the PM acknowledged, has to have a plan that can respond to a continuing strong dollar.
I’m not going to argue that Australia does not have a competitiveness problem. It does. But the best way to look at it is via the prism of the real exchange rate. That is, the inflation of costs versus competitors that incorporates all inputs plus the exchange rate. Here is the Australian real effective exchange rate versus the major economies (Oz is white, US is yellow, Germany is green and Japan is purple):
Yes, that is called getting less competitive. And some will argue, as does Bartho, that the commodoties boom makes this OK. But let’s look at Australia versus other commodity producers (Aus is white, Chile is purple, Norway is top red, Brazil is bottom red, South Africa is green) :
Australia is the only country that has let the boom blast its real effective exchange rate beyond historical ranges. And how!
Now, to correct this, Bartho is right, we need a debate about productivity. But to think you’re going to correct an imbalance of this magnitude by internal deflation is the equivalent of a job application at the Bundesbank. Such an approach comes with risks. As the European experience shows, deflation via squashed wages can be a recipe for an unemployment and asset deflation feedback loop. That’s a dangerous path to start down when your assets are so inflated already.
The debate we need to have is about how to address the currency. Warwick McKibbin has suggested targeted printing of dollars for portfolio flows. Henry Thornton has suggested a Tobin tax on incoming hot money flows and the IMF endorses such measures. These are not the mutterings of fringe lunatics.
That our political classes have insufficient imagination to address this problem is no excuse for the media to join them.
