Trying to stem dollar's rise is asking for trouble

We’re sorry, this feature is currently unavailable. We’re working to restore it. Please try again later.

Advertisement

This was published 13 years ago

Trying to stem dollar's rise is asking for trouble

By IAN VERRENDER

Here we go again. As the Australian dollar prepares to punch through parity, the usual howls of protest about the damaging effects on our rural exports already have begun.

The worry, however, is that the misinformed howls are emanating from the alternative government and, given the tenuous political position of the Gillard government, from those who could soon be running the nation.

Yesterday Andrew Robb, the opposition finance spokesman, made the extraordinary claim that the rising dollar was a result of economic mismanagement and let fly that the government should take action to keep the dollar down.

It is a comment that defies logic. For in normal circumstances, a strong currency is a reflection of a nation's economic health. And the simple story behind our soaring currency is that our mineral exports are booming - in terms of volume and value - and our economy is powering ahead with unemployment and inflation in check.

But to understand his outburst, you need to realise that Robb cut his political teeth in the hurly burly world of rural politics. Clearly he hasn't forgotten his roots.

Each time Australia has enjoyed the fruits of a resources boom in the past half century, the rural lobby has mounted a campaign to hold the dollar at artificially low levels.

Each time it has been successful. And each time Australia has squandered the bounty that should have been delivered through that boom as an artificially weakened currency resulted in massive capital inflows, surging domestic demand and eventually, rampant inflation followed by the inevitable recession.

Often that was exacerbated by overly loose monetary policy and governments embarking on a spending spree to aid re-election.

On those occasions, however, the dollar was set by politicians, not the market. This time it will be much more difficult to cocoon our rural industries from the inevitable pain of a stronger currency caused by a booming resources sector.

A floating currency acts as a vital shock absorber for an economy like ours. When our trade performance is weak and export income slows, our currency falls - and falls rapidly - in a way that boosts our competitiveness.

Advertisement

Just look at the events of 2008. As the world plunged into recession and China stopped buying iron ore and coal imports, our currency quickly dropped to US60¢.

It is now hovering between US98¢ and US99¢. It is a reflection of the wealth flowing into the country, and acts as a natural brake to slow the very boom pushing the currency higher. Our exports are more expensive.

Unfortunately, that has a debilitating effect on other parts of the economy. Other exporters like farmers suffer, fewer tourists arrive and manufacturers find it tough competing against cheap imports.

But the alternative - to keep the dollar artificially constrained - would force the Reserve Bank to jack up interest rates enormously, far higher than now, to slow the economy.

Interestingly, as Robb bayed for a weaker dollar, Queensland independent Bob Katter called for lower interest rates. Put those two together in an export environment like this, and you would have an instant recipe for long-term economic disaster.

The idea that a boom in one part of the economy can hurt another is not new. It is often referred to as the Gregory thesis, after the work of a pioneering Australian National University economist and later member of the Reserve Bank board, Bob Gregory. He argued in the 1970s that a boom in the resources sector could squeeze out the manufacturing sector as consumers switched to cheaper imports using their stronger currency.

Rural exporters, meanwhile, would be disadvantaged as they received less from foreign sales when their returns were exchanged back into Australian dollars. Once again, he's watching his thesis neatly come to fruition.

Manipulating exchange rates, the way we once did, distorts investment decisions, causes dangerous imbalances and ultimately costs consumers and taxpayers.

That's what has happened in China. Its currency has been held artificially low for more than a decade. That has boosted its manufacturing base and exports. But China is more reliant on its export sector than it should be, which has crippled the US manufacturing base.

It is the reason behind a global currency war under way between China, the US, Japan and Europe that threatens to blow up into a diplomatic and trade dispute.

So how best to manage this boom of ours?

If rural producers or manufacturers feel they need to be compensated, it is far more efficient and transparent to hand out the cash directly rather than through a manipulated dollar.

But in this kind of environment, a tighter monetary policy - such as being run by the Reserve Bank - should be backed up by tight fiscal policy. That means not squandering the proceeds of a boom with tax cuts and handouts. So rule that one out.

Another way would be to slow down the boom, or at least the speed at which the proceeds are hitting our economy.

An ingenious method would be to introduce a resources rent tax, say at 40 per cent. The dollar and interest rates wouldn't need to rise as quickly, farmers and manufacturers would be happy and the money could be invested for future generations.

It's just a thought.

Most Viewed in Business

Loading