ECONOMIC AFFAIRS: by Colin TeeseNews Weekly
Currency, manufacturing and trade policy
, May 11, 2013
Issues revolving around currency, manufacturing and trade are central to economic policy. They are also interconnected, and impact economically and strategically on national welfare.
Governments have a responsibility to ensure that economic policy serves national ends, without concession to economic fads or narrow political objectives.
Some 35 years ago in both the US and Australia, political differences could be narrowly defined, including in economic policy. Wide areas of common ground existed between the major parties. The pursuit of full employment was one such area. More broadly, it was readily conceded that, in a well-functioning capitalist economy, there should be a legitimate role for government.
Today political differences about many of these considerations risk dividing us to the point that threatens the governability of our nation. A more sophisticated approach to political debate, especially about economic policy, is sadly lacking.
Before considering what might be done about all this, let us first examine what actually is happening.
Australia’s car industry is again in the news. As always, the debate turns on what matters least — the amount of assistance the industry receives. Given the size of our economy, and the fact that car manufacturing and the industries it supports deliver 200,000 well-paid jobs, the amount we feed into the car industry is quite small.
The industry has many powerful enemies. The Australian Productivity Commission, which should know better, is on record as saying it does not care how much the government spends supporting the industry, so long as it is misdirected and fails.
It seems likely that the commission will have its way and we will see this important industry snuffed out.
Those who will rejoice in its passing won’t talk about the 200,000 lost jobs. Nor will they attempt to sweep that loss aside by recourse to the now discredited mantra of orthodox economic opinion — that all the displaced workers would be absorbed into equally rewarding jobs in other industries.
Thirty years after what some like to call the Hawke/Keating “reforms”, that claim has become embedded in the mists of misunderstanding. Car industry unemployment will serve as a grim reminder to governments and oppositions alike of the folly of misplaced consensus around flawed economics.
One of the spokesmen for car manufacturers laid the blame squarely on the overvalued Australian dollar. He’s right; no industry can remain competitive when the nation’s currency is 25 per cent overvalued. Efficiency and productivity gains will never be enough to overcome such a disadvantage.
Our car industry faces another self-inflicted disadvantage. Foreign-owned manufacturers, as a part of their international business policies, require their Australian subsidiaries to continue building larger cars for which demand is dwindling.
But car manufacturing is not the only industry affected. The high Australian dollar is eating into the competitiveness of all of our industries — manufacturing, farming and mining. The former two are especially hard hit. An overvalued currency has hurt them in export markets, but has handed import competition a windfall competitive advantage in their home market.
Farmers have been especially badly hit. They can no longer find outlets for their production domestically, because the local food-processing industries — a vitally important market for farmers — are also under pressure from the overvalued currency and must source cheaper produce from offshore or go out of business. Is it any wonder Australia is becoming a net importer of food products?
In export markets, an overvalued currency means our car-makers and the farm sector are placed at a competitive disadvantage both at home and abroad.
At the same time, our miners are also suffering as they wrestle with a serious downturn in Chinese demand, while our biggest competitor in the Chinese iron ore market, Brazil, is making things worse for us. By busily manipulating its exchange rate Brazil consolidates a competitive advantage over us. Our exporters must match Brazil prices or lose market share.
Not unreasonably, our mining companies are complaining. Strangely, though, they don’t complain about Australia’s exchange rate — they blame our wage levels and want to bring in cheap foreign workers.
But wages are surely not the problem. Labor accounts for a relatively small part of their total costs. Their problem is that the system of floating exchange rates isn’t working as intended. As a result, a seriously overvalued Australian dollar is eating into their profits.
Consider the following. World minerals prices are denominated in US dollars. Our mining companies negotiate contracts with their customers around these prices — either in US dollars or in Australian dollars. Under present exchange rate relativities, returns from export transactions, once they are translated into Australian dollars, will be lower.
When the US dollar was valued above the Australian currency, the US dollar bought more Australian dollars and so improved returns for our miners. Today that position is reversed — more than one dollar US is required to buy one Australian dollar. To that extent, the Australian dollar returns are correspondingly less.
Put simply, if world prices are set in US dollars, the Australian dollar returns to our miners rise if the Australian dollar is valued at less than the US dollar, and fall if our dollar is valued above the US dollar, as it now is. The larger the difference, the greater the loss.
At the moment, the difference is extremely large. There is almost universal agreement that, at current relativities, the Australian dollar is overvalued against the US dollar by some 20 to 25 per cent.
How can this have happened? The Australian dollar, along with a great many other currencies, has been allowed to “float” since the mid-1980s — which means that, instead of the government setting a price for the currency, buying and selling pressures are allowed to determine its relative value at any given moment.
We are not the only country which has had to confront a rise in the relative value of its currency, making imports cheaper and exports dearer. Most exporting countries with floating currencies have been similarly afflicted.
Australia, unlike many others, has chosen to tolerate the rise in its currency. Most governments have intervened, in one way or another, to contain the rise in their currencies relative to the currencies of their trading partners. In this manner, they have sheltered their domestic industries from the harm an overvalued currency can cause.
And, make no mistake: our inaction is a matter of choice.
Before considering how we could or should act to protect our economy, it is appropriate to understand what caused the floating system to spin out of control. The short answer is the global financial crisis (GFC) — or, more accurately, the responses to it, most notably by the Federal Reserve Bank of the United States.
Faced with a private debt overhang which had paralysed its banks, threatened to send the economy into a tailspin and caused a frightening rise in unemployment, the Fed moved quickly with programs of “quantitative easing” — feeding money into the economy. The Fed also began setting its interest rates at ever-lower levels.
The effect of these policies was to drive official interest rates to almost zero — and, as a consequence, put downward pressure on the value of the US dollar. Effectively, the Fed devalued the US dollar.
Had those actions not been taken, the US economy would probably have sunk into a prolonged depression. But the consequences of this action were felt round the world. Among other things, the world of floating exchange rates was destabilised.
Australia’s currency was among those affected. In laymen’s terms, we characterised it as our dollar rising steadily against the US dollar. What really happened was that the US dollar fell sharply, while ours remained unchanged.
With the US dollar at rock bottom, we are locked into that position. Most of the other countries with floating currencies have responded by capping or forcing down the value of their currencies.
Tempting though it might be to blame our plight on the US, the fault lies with our government. The US was acting to protect its interest: we should have done the same.
Like it or not, we have placed our industries on the losing side of a “currency war” — which resembles the “tariff wars” of the 1930s. Then, tariffs were raised to protect domestic industries. The current tool for achieving a similar outcome is currency. It is the same “beggar thy neighbour” policy pursued by different means.
For the moment, our government chooses to run its own race and place the burden of adjustment on our domestic economy.
Can we and should we do something about it? The answer is “yes” to both questions.
Professor Ross Garnaut — who, ironically, was advisor to Labor’s Prime Minister Bob Hawke at the time Australia decided to float its dollar — has acknowledged the problem. Fortunately, Garnaut recognises that changing circumstances now justify a fresh approach.
He identifies interest rates as the problem — as did the US much earlier. The Reserve Bank of Australia (RBA) should cut deep into them. If the cut is deep enough, Garnaut argues, the value of our dollar should fall, as happened in the US.
Lower interest rates and a better dollar relationship would help our industries meet our competition. Lower interest rates would benefit heavily mortgaged homebuyers. An immediate and beneficial result could be a redirection spending away from finance into the job-creating parts of the real economy.
If that does not work, Garnaut further suggests, we should follow the example of Switzerland: cap the value of our dollar and print dollars to keep it down.
In following this strategy, all we would be doing is keeping in step with what the rest of the trading world is doing.
Colin Teese is a former deputy secretary of the Department of Trade.