ECONOMICS: by Patrick J. ByrneNews Weekly
Should the Australian dollar fall below US 40 cents . . .
, April 15, 2006
Chronic policy neglect by Australian governments could see our dollar plummet in value, writes Pat Byrne
.Sometime later this year, Australia's net foreign debt is set to pass the A$500 billion mark, equivalent to over 60 per cent of this country's annual output (gross domestic product). The foreign debt is now growing faster than economic growth, meaning that we have a diminished capacity to wind back the debt without considerable economic pain.
A number of leading economic commentators have expressed grave concern at the eventual consequence of Australia's addiction to foreign borrowing for housing and consumption. Director of Access Economics, Chris Richardson, last year admitted: "OK, it's panic-button time. ... It will take longer than markets realise to rein in a current account deficit in the 'banana republic' range. ... We repeat, neither official forecasters nor the money market are yet scared by this scenario. But we are." (Brisbane Courier-Mail
, January 24, 2005).High-risk
Economic theory has it that, as a country's foreign debt rises, it becomes a high-risk investment. This reduces the willingness of international financial institutions to lend, causing a decline in the demand for the currency and therefore the value of the currency to fall.
A currency devaluation means that imports become more expensive and decline, while exports become cheaper on world markets, boosting domestic industry and exports. Over time, the decline of imports and expansion of exports generate a trade surplus that allows for the reduction in the foreign debt.
This theory describes what is supposed to be a self-correcting mechanism for countries with big foreign debts. Unfortunately, the opposite has happened in Australia. A conjunction of economic circumstances has conspired to keep foreigners lending to Australia and to keep the Australian dollar high in value, thus encouraging imports and holding back exports, and so driving the foreign debt even higher.
How has this happened? Are those circumstances set to change? After all, virtually all economic commentators agree that this situation cannot continue indefinitely, and that eventually there will have to be a "correction".First
, Australia's exchange rate fluctuates in direct relation to commodity prices. The world has seen record mineral prices in recent years, owing to shortages caused by the rapid expansion of China and India. The high prices for mineral exports have caused the value of the Australian dollar to rise.
However, those mineral shortages are rapidly being overcome. Worldwide, marginal producers are coming into production to cash in on the commodities boom, while there has been an "invasion" of mining companies into minerals-rich Mongolia and southern Russia. Within two years, these regions are expected to be supplying a range of mineral commodities to China and India, causing a downward pressure on prices. In turn, the decline in prices will cause a downward shift in the Australian dollar.Second
, to keep attracting foreign lending, Australian interest rates have had to be two per cent higher than those of the US. This differential was maintained for a time, while the US kept interest rates low to boost investment and spending as a countermeasure to the 2001 recession. However, US interest rates have been rising, and, with Australian interest rates now roughly equal to those in the US, investors are preferring to invest in the US rather than Australia, causing the Australia dollar to fall.Third
, foreign lenders have not only been willing to lend to Australia when we offer higher interest rate returns than the US, but they have been able to lend huge amounts. To counter the world recession, Japan acted as a giant global liquidity pump, lending vast sums at near zero per cent interest. As a result, for the past four years, the world financial markets have been awash with cheap capital.
As Barry Hughes, economic consultant to Credit Suisse, has pointed out, Australia has been a huge beneficiary of these cheap funds. In fact, last year, Australia was the fourth largest recipient of global capital flows. (Australian Financial Review
, March 13, 2006).
This is set to change dramatically. The governor of the Bank of Japan, Toshihiko Fukui, has given notice that Japan is about to turn off the cheap liquidity pump. This means that foreign lenders will no longer be able to borrow cheap in Japan to lend to Australia, to keep financing our foreign debt. Again, this will force down our dollar.Fourth
, Australian agricultural exports are likely to come under pressure because of the likely impact of Argentine and Brazilian agricultural export policies, according to a research report by the Australian Farm Institute. These countries are gearing up for a major expansion of their rural industries, such as the beef industry, to sell into what are Australia's traditional export markets. China is also becoming a major food exporter. This will harm our trade balance.Fifth
, Australia is about to go from importing only 22 per cent of its oil needs, to importing 50 per cent by 2030, according to the Australian Bureau of Agriculture and Resource Economics (ABARE). Future oil imports will substantially increase our foreign debt, particularly as the value of the Australian dollar falls, making oil more expensive.Sixth
, around 2010, the baby-boomers will begin retiring in big numbers around the world. This means countries like Japan and Germany, that have been investing their big retirement savings funds overseas, will no longer be looking to invest in places like the US stock and bond market, and in Australia. In fact, they will be looking to cash in their investments so as to fund their ageing retirees. This will further restrict the ability of foreign lenders to fund our foreign debt.
Australia's retiring baby-boomers will probably force the Federal Government to incur deficit budgets, as the huge number of retirees puts mounting pressure on the health and social security budgets.
This means the Federal Government could go into permanent budget deficit, forcing it to borrow domestically and overseas.
The combination of these short- to medium-term changes in the international and domestic economies is likely to mean that the international financial markets will curb their funding to Australia, while our worsening trade balance will be accelerating the growth of our foreign debt. That will spell crunch time for Australia.
The first likely effect will be a fall in the Australian dollar. Its long-term trend line since the late 1970s shows a downward decline, with each low point being significantly lower that the previous low. The trend suggests that this time the Australia dollar could fall well below US40¢.
As indicated above, economic theory suggests that a large fall in the value of the Australian dollar should greatly boost exports by making manufactures and commodity exports cheaper on world markets. Theory assumes that companies only have to gear up production to ride the export boom.
However, the structural problem facing Australia is that large parts of its manufacturing industry have shut down or moved offshore into low-wage Asian countries. Many manufacturing companies that once would have benefited from a low Australia dollar are no longer present in Australia.
A further problem is that even if the Australian dollar halves in value, it still won't make many local industries competitive with China, where wage rates are one-fifteenth of Australian wages. Unlike Japan and Germany, that geared their industries to lead the world in high-tech industries and machine-tool production, Australia has chosen, by policy default, to have its manufacturing sector compete with low-wage countries. But competing with low-wage countries is a mug's game.Raise costs
Rural industries will, on the one hand, benefit from their exports being cheaper. On the other hand, they heavily depend on imported machinery, fuel, fertilisers, chemicals and other imported inputs. A falling dollar will raise the cost of these imports, while Brazil and Argentina are getting ready to challenge Australia in many of its traditional markets.
Minerals will benefit. But, as the dollar is expected to fall, so is the expected price of commodities likely to fall, as supply increases to meet world demand.
The second effect will be that, in order to continue attracting "hot capital" from world markets, Australian interest rates will have to rise. If we also have to compete with the US over shrinking world liquidity, interest rates could go even higher.
The third effect could well be a further, unsustainable blow-out of the foreign debt, owing to the deep structural problems in the economy. Imports are set to rise, particularly oil. Exports are set to come under pressure as commodity prices decline. Domestic manufacturing is unlikely to fill the gap as so much of it has gone. Agriculture is facing new competition on world markets.
If this occurs at the same time as Australia's access to cheap credit is drying up, then Australia is going to face an unfortunate conjunction of events.
At that point, the idea that the foreign debt "doesn't matter" will be put to rest. It does matter!
Then Australian governments will be scrambling to find ways and means to bring down the foreign debt and, for the first time in many years, again take an active role in industry policy. (Industry policy for the past 20 years has been one of having "no policy").
Policies such as the rapid development of a domestic ethanol industry, to replace oil imports, will become very, very necessary, and become very, very attractive to governments. Then the fashionable globalism policies of the past two decades could well prove as ethereal as last year's fashions.