Over the weekend, AFRTV gave us a forecast of a return to parity for the Australian dollar from Wespac’s Robert Rennie:
Regular readers will know I don’t expect any such thing. There are many reasons for why but I’ll confine my comments largely to Rennie’s arguments.
The first is that although LNG will raise our export volumes, as well as support GDP, roughly 90% of those earnings are foreign-owned and will flow back out again, largely neutralising positive trade flows in the capital account.
Second, although sentiment towards the dollar may be positively affected by LNG exports, there will be major counter-weights to that sentiment in the Chinese rebalancing process and Australia’s falling terms of trade. The Westpac team recognises that process but sees it happening very slowly with 7-8% GDP and $100+ iron ore forecasts out to 2018. I see both as very aggressive. We saw an example of how weakening sentiment can de-rate Australia just last week.
The third reason is that LNG may support headline GDP but in Australia’s current account account deficit growth model – and it is a “model” – unless the trade surplus-led growth isn’t levered up and blown on housing and subsequent consumption then there’ll be a deficit of domestic activity that results in rising unemployment. That, in turn, will drive down interest rates and pull down the dollar.
You may think that that’s OK but house prices don’t have much further to run with both the RBA and Moody’s warning on household leverage.
There are ways out, of course. As I’ve written extensively, high-caliber government investment and a productivity revolution could help create income growth that is not reliant on further leverage. But neither appears to be in the offing.
From the perspective of my analytical framework, economists that predict current account surpluses or high dollar trade account led growth, are missing the crucial second step in how Australian economic activity is actually created.
