WITHIN two years, the Rudd Government will have a massive Keynesian insurance policy worth some $40 billion — equal to almost 4% of gross domestic product — available to "pump-prime" the economy if Australia gets caught by the subprime financial squeeze now affecting the US and European economies.
There can be no doubt that the money that accumulates as a result of the budget surpluses this year and next will be deployed to maximise the ALP's chances of winning the next federal election due in 2010.
This doesn't necessarily mean the money will be a giant electoral slush fund, as suggested by the shadow treasurer, Malcolm Turnbull. This is one occasion where there is no necessary conflict between good policies and good politics.
First, the money will only be available for infrastructure — without offsetting tax increases — if inflationary pressures ease.
Federal cabinet may reflect on the fact that if Rudd had not decided to match the then Howard government's promise of $31 billion in tax cuts over four years, or even postponed the first cut for a year, there would have been room for a $7 billion-a-year infrastructure program beginning in 2008-09 without adding to inflationary pressure.
Commodity market prices tend to overshoot in both directions. The history of commodity-price booms is that their collapse — both in timing and severity — usually takes both the players and the pundits by surprise.
If the terms of trade don't continue to increase strongly as forecast in the budget papers (4.5% in 2007-08 and 16% in 2008-09), the decline in domestic incomes will provide room for a significant increase in infrastructure spending without imposing additional inflationary pressures on the economy.
The infrastructure spending should be designed against the background of rising foreign debt, climate warming, peak oil and water shortages.
For Australia, interest rates and the environment are related. It is difficult to see how the strong world demand for commodities like coal and iron ore can be maintained at the same time as global carbon dioxide emissions are reduced sufficiently to avoid the risk of catastrophic global warming.
It is possible for China, India and other rapidly developing countries to maintain high growth rates and contain greenhouse emissions consistent with global targets, but only if they skip most of the energy and raw-material-intensive growth of the older industrialised countries.
The implications for Australia are obvious. Perceptions of the Australian dollar as a commodity currency will become a weakness rather than a strength unless Australia can take advantage of the looming food shortages associated with climate change. Based on the response to the water crisis in the Murray-Darling-Goulburn basin — which accounts for 60% of Australia's food production — and the senseless plans of the states to invest billions of dollars in desal plants where cheaper and more environmentally friendly options are available, Australia is unlikely to be in the position to make up on the swings (food crops) what is likely to be lost on the roundabout (minerals).
The stock of foreign debt is now approaching $700 billion or equal to about 60% of GDP. If (when) the commodity boom ends, foreigners are likely to demand an increased interest rate premium to cover exchange risk associated with large and rising foreign exchange risk of holding Australian dollars.
According to the budget papers, improvements in the terms of trade have added about $100 billion to the terms of trade in the four years since 2003-04. Continued…
