Once a Jolly Strong Buck Dampened an Economy
Published in The Weekend Australian on 28.09.13
AUSTRALIA'S rebounding dollar is threatening the transition from the peak of the mining boom to a more diversified economy capable of taking advantage of the opportunities offered by the Asian Century. It also helps explain why the federal government has foreshadowed deferring the mid-year economic and fiscal outlook until January as the high dollar further weakens government revenues.
If a high Aussie dollar is bad for the economy and jobs growth, what can be done about it? To answer, we need to know why the dollar has again been rising.
In international foreign exchange markets, the Aussie dollar is considered to be a commodity currency: when mineral prices are high, Australia's dollar is high. And so it was during the heady years of the mining boom. But as the global economy struggled to recover from the recession of 2008-10, and as China began diversifying its economic growth to rely less on manufactured exports and more on domestic consumer spending, mineral prices began falling from their stellar peaks.
Yet the Aussie dollar didn't fall with them and our exporting and import-competing industries - especially manufacturing and enrolments of foreign students at our universities - began copping a hammering.
Long-term foreign currency continued pouring into Australia, buying Australian dollars for use here, as the minerals and gas construction boom drove investment to 50-year highs.
Not only were foreign companies buying Australian dollars on the short-term money market, so were overseas central banks. Australia's economy was rated AAA by all three international ratings agencies and our currency was increasingly being regarded as a haven. On offer was an attractive interest rate by international standards and a low risk of a capital loss from our dollar depreciating. Though low by Australian historical standards, the Reserve Bank's cash rate was well above those of central banks in the US, Japan and Europe.
Those foreign central banks had slashed their interest rates to negligible levels to stimulate their economies during and following the Great Recession. When their economies failed to respond to near-zero interest rates, their central banks engaged in quantitative easing - akin to printing money.
Realising that short-term money-market investors had assessed they were on a safe one-way bet by buying Aussie dollars - earning a higher interest rate than elsewhere while facing no real risk of a capital loss from the currency depreciating - as minister for trade and competitiveness I began writing in these pages that a falling Australian dollar would be good for Australia's international competitiveness. Prime minister Julia Gillard later made similar comments and Ross Garnaut led a public discussion on the cost of a high dollar.
At about the same time, independently, the Reserve Bank observed publicly that the high dollar was adversely affecting Australia's international competitiveness and further lowered its cash rate. The currency began falling from $US1.03 in early May to below US90c four months later. No longer was buying Aussie dollars a one-way, safe bet. The discussion in the financial press was about how low the Aussie dollar might go.
But on September 18 the US Federal Reserve surprised financial markets by announcing it would not be tapering down its quantitative easing, instead maintaining it at $US85 billion per month. The ongoing abundance of US dollars being placed on international money markets will keep the greenback low against other currencies, including ours.
Australia needs businesses in tourism, agriculture, food processing, higher education and financial services to fill the hole being left by mining investment phasing down. At an exchange rate in the mid-US90c range, Australian exporters and businesses competing against imports will struggle to be competitive in the Asian Century. If they are not competitive, unemployment will continue to rise and living standards will begin to fall. And the federal government's fiscal position will continue to deteriorate with further downward revisions to revenue.
Shortly before the 2013-14 budget was brought down, the Australian dollar was buying $US1.03 and this became the assumed exchange rate in preparing government revenue projections. In the May budget the squeeze on company profits from the high Aussie dollar, low inflation and low wages growth from a weakening jobs market forced a further downgrade of government revenue forecasts. More revenue downgrades were made in the government's economic statement released ahead of the federal election campaign.
In opposition, the Coalition repeatedly claimed the Labor government didn't have a revenue problem, it had a spending problem. Yet the Barnett government has just suffered a ratings downgrade from weakening revenues. The delayed federal mid-year fiscal outlook may contain even further revenue writedowns.
At 2.5 per cent, the Reserve Bank cash rate is the lowest on record, but it is still well above corresponding interest rates in the US and Japan. A cautious Reserve Bank won't want to create a housing bubble. Measures such as different prudential requirements for mortgage lending than for other forms of credit might be worthy of consideration. But maintaining the cash rate at 2.5 per cent is unlikely to be compatible with a competitive Australian economy in the Asian Century and the sort of jobs growth needed to prevent unemployment rising further.