March 29th 2014

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Articles from this issue:

CANBERRA OBSERVED: Clive Palmer, the would-be powerbroker

SOUTH AUSTRALIAN STATE ELECTION: Independent MP puts Labor back in power

TASMANIAN STATE ELECTION: Massive swing to Liberals, major shock for Labor

EDITORIAL: SA, Tasmanian elections confirm Labor's decline

ECONOMIC AGENDA: Fixing the distorted high Australian dollar

HUMAN RIGHTS: Restoring human rights protection to children

AUSTRALIAN HISTORY: New perspectives on the 1955 Labor split

NEW ZEALAND: Export boom sees NZ's economy forge ahead

UKRAINE CRISIS: Ukrainian church leaders urge Putin to back down

UNITED STATES: Justice Dept drags its feet over sex-trafficking website

OPINION: Repeal, don't amend, laws that threaten free speech


TELEVISION: Rival depictions of a modern-day Sherlock Holmes

BOOK REVIEW The generals who started the war on the family

BOOK REVIEW Australia's first major victory in the Great War

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Fixing the distorted high Australian dollar

by Patrick J. Byrne

News Weekly, March 29, 2014

The white-anting of Australian industries has been caused partly by the abnormally high exchange-value of the Australian dollar in terms of other currencies. The dollar’s value has been driven upwards by the resources boom and high interest rates.

Ask any farmer, car industry executive or any owner of a manufacturing business across the country: what does a high Australian dollar mean for you?

They will tell you that a high dollar makes their export products dearer and less competitive on world markets, while in the home market it cuts the cost of imports thereby making Australian products less competitive.

A high dollar punishes domestic industries and rewards importers.

Paul Keating and Bob Hawke “floated” the Australian dollar in 1983. This allows the dollar to fluctuate on a daily basis according to the demand for, and the supply of, Australian dollars on the foreign exchange market.

A floating exchange rate can act like a shock-absorber in a time of economic crisis. Many have argued that the free-floating dollar helped insulate Australia from the series of international financial crises that have occurred with increasing magnitude since the mid-1980s.

There is a point to this argument. However, it reveals only part of the picture; it tells only part of the story.

So long as there are underlying structural problems in the economy, Australia cannot use a floating exchange rate to its advantage. These structural problems are forcing up the value of the Australian dollar (AUD) well above what its value would otherwise be under normal demand-and-supply conditions.

Australia suffers from what is known as the “Dutch disease” and also from high interest rates compared to those of other major developed economies. Together, these two factors conspire in a number of ways to push up the AUD, which white-ants and destroys Australian industries.

At the same time, governments have failed to provide means to channel investment from the superannuation funds into domestic investment.

1) The Dutch disease. The term was coined in 1977 by The Economist magazine to describe the industrial decline of the Netherlands after the discovery of large reserves of natural gas.

The classic economic model describing the Dutch disease was developed in 1982 by Australia’s W. Max Corden, now emeritus professor of international economics at Melbourne University, and J. Peter Neary, former president of the European Economics Association.

The phenomenon occurs when an increase in revenues from natural resources makes a nation’s currency stronger compared to that of other nations (i.e., a significantly higher exchange rate), resulting in the nation’s other exports becoming dearer for other countries to buy, and making the manufacturing and agricultural industries less competitive on the export market and in the domestic market.

Former U.S. Federal Reserve board chairman, Alan Greenspan, could well have been thinking of Australia when he asked in his book The Age of Turbulence: Adventures in a New World (2007): “How is it possible that a super-abundance of natural resources — oil, gas, copper, iron ore — would not significantly add to a nation’s production and wealth?”

He said: “Paradoxically, most analysts conclude that, particularly in developing countries, natural resource bonanzas tend to reduce rather than enhance living standards.…

“[The] Dutch disease strikes when foreign demand for an export drives up the exchange value of the exporting country’s currency.”[1]

Solutions: There are two basic ways to reduce the adverse symptoms of the Dutch disease.

One approach is to “sterilise” the revenues from a resources boom. This is achieved by saving a sizable proportion of the revenues from the boom in special offshore accounts. This takes away upward pressures on the currency.

Other countries have achieved this by setting up sovereign wealth funds (SWFs). Norway has put some of its oil revenue into a government pension fund. Russia has created a Stabilisation Fund. Kuwait has a Future Generations Fund. In Canada, the province of Alberta has the Alberta Heritage Savings Trust Fund.

Another way to reduce the effect of the Dutch disease is to reduce domestic demand for imported goods by increasing domestic savings, either by the government running large budget surpluses or by encouraging households to save rather than spend.

Running budget surpluses will be difficult for Australia in the foreseeable future. Because of the white-anting of the nation’s big industries, a hefty increase in welfare expenditure will be needed to pay for the resulting jobless, and major public (and private) investment will be needed to restore output and employment.

Also, while Australians have substantial savings in superannuation, this is greatly offset by average household debt being some 150 per cent of household income.

The typical response of Treasury mandarins and economic policy-makers to job losses as industries shut down is to claim that those losing their jobs from places like Holden, Ford, Toyota and the smelting industries are bound to find new jobs in the mining industry.

However, according to the Australian Bureau of Statistics,[2] mining employs only 275,000 workers. In comparison, manufacturing employs 944,000 and agriculture, fisheries and forestry 319,000 (although when downstream industries are included, agriculture employs over 17 per cent of the Australian labour force, according to the Australian Farm Institute).[3]

2) High interest rates: The second major pressure forcing up the AUD is Australia’s high interest rates.

Offering a high interest rate attracts foreign capital, forcing up the value of the AUD, as well as the cost of borrowing for domestic housing and business investment.

According to Reserve Bank of Australia (RBA) figures,[4] as of February this year, Australia’s official interest rates are (and have been for many years) well above those of other major developed economies and our major trading partners, e.g:

Australia: 2.5 per cent.

USA: 0.13 per cent.

Euro area: 0.25 per cent.

Japan: 0.10 per cent.

UK: 0.50 per cent.

Australia’s interest rates are deliberately kept at about 2 per cent above rates in the U.S. and other major countries in order to attract foreign capital, which Australia needs in order to keep rolling over the nation’s $853 billion net foreign debt.

Many foreign lenders will lend to Australia only on a short-term basis, so the borrowing for this debt has to be refinanced every six months to two years.

Australian banks hold much of the foreign debt. They borrow heavily offshore in part to pay for imports of goods we no longer produce here because of the high value of the Australian dollar which is destroying industries.

Australia’s high interest rate — combined with the Australia’s floating exchange rate and the fact that Australia is seen as a safe haven for foreign capital — has encouraged huge speculation on the AUD.

This speculation further drives up the value of the AUD. In fact, the trade in the AUD is many times the amount required to fund our international trade in goods and services.

The huge irony is that while Australia’s banks are borrowing offshore, the nation’s superannuation funds are bulging at the seams and can’t find enough investment opportunities in Australia.

Currently, they hold $1,600 billion in savings and much of this is invested offshore.

Here, then, is a huge mismatch between savings and investment.

Solution: Australia needs to mobilise its super funds to reduce its reliance on imported goods.

The Commonwealth government needs to change the superannuation investment rules and create a number of “conduits” from the nation’s massive savings pool (superannuation) into domestic investment.

The Coalition government has promised to create investment bonds to tap superannuation for infrastructure investment by public-private partnerships. That is a start.

However, much more is needed. Additional “capital conduits” are needed to channel super funds into infrastructure and industries.

After all, it’s somewhat strange that a country with such a huge bank of savings is now finding itself seriously short of investment opportunities, while at the same time high interest rates are helping drive up the AUD’s value and undermining industries, which in turn is causing joblessness and making the nation even more dependent on imports!

A number of economists have called for the AUD to be brought down in value. In February this year, even the International Monetary Fund said that the AUD was too high and should be brought down in value.[5]

There will be those who try to say that these policies violate the principle of a free-floating exchange rate.

Well, actually they don’t. These proposals, which are designed to address the Dutch disease, the mismatch between savings and investment and our over-reliance on imports, are aimed at fixing structural problems in the economy. The exchange rate could still be flexible.

What if these measures take too long to implement and take effect? What if they are too late in the day to halt the loss of big-employment industries such as the car industry?

Then it should be pointed out that many countries manage their exchange rates in a variety of ways, and Australia could learn from them in order to apply medium-term policies to manage down the dollar.

China and the East Asian economies have followed the long-time practice of Japan in managing down their exchange rates in order to boost exports, curb imports and then accumulate large foreign currency reserves. These reserves help them to defend their currencies in the face of repeated global financial meltdowns.

These countries periodically sell their currencies and manage down their exchange rate.

The U.S. has effectively managed down its exchange rate since the onset of the 2007/08 global financial crisis. The U.S. Federal Reserve’s “quantitative easing” program (that is, printing money) has flooded the global economy with U.S. dollars. This has increased supply of U.S. dollars and forced down the value of American dollar.

Germany provides a very different example. Germany has benefited enormously from the introduction of the European Union’s currency, the euro. This is because other members of the European Union effectively keep the value of the euro relatively low for Germany, providing German industry with a huge competitive advantage with other nations, both within the EU and abroad.

Conclusion. The high value of the AUD is the result of structural problems in the Australian economy, currency speculation and our over-dependence on imports that have to be financed in foreign currencies.

Australia is not using to its advantage the benefits that can come from a flexible exchange rate.

The optimum solution involves fixing the structural problems of the economy. Then Australia’s exchange rate should come down according to the laws of supply and demand in a floating exchange-rate regime that can still act as a shock-absorber when an economic crisis occurs.

The back-up solution is to use the methods employed by other nations to manage their exchange rates, to the point where Australia’s manufacturing and agricultural industries could compete on a genuinely level playing-field with their foreign competitors.

Patrick J. Byrne is national vice-president of the National Civic Council.


[1] Alan Greenspan, The Age of Turbulence: Adventures in a New World (Penguin Press, 2007).

Also see: Paul Cleary, “Mining boom could bust us”, The Age (Melbourne), November 11, 2007.

[2] Labour Force, Australia, Detailed, Quarterly, Table 04, 6291.0.55.003; Employed persons by Industry — Trend, Seasonally adjusted, Original.

[3] Australia’s Farm-Dependent Economy (Australian Farm Institute, 1995).

[4] International Official Interest Rates, F13, Reserve Bank of Australia, February 2014.

[5] Peter Martin, “IMF: Australian dollar should trade at ‘low US80¢’”, Sydney Morning Herald, February 12, 2014.

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