On one account the Australian dollar is falling. It hit new lows again yesterday. But this was only on one account: that of the mighty US dollar. The Australian dollar is more than holding its own against the euro, the pound sterling, the New Zealand dollar and the yen – the currencies of our other major trading partners. However, a lot of world trade is done in US dollars so the currency change will have a more profound effect in Australia than the bilateral US-Australia trade relationship would otherwise warrant.
What should Australian policymakers do in the face of the weakness of our dollar against that of the US? For a start, they should not panic. Australia’s is a floating currency. It means that the price of imports will go up. When that happens demand for imports will fall somewhat. Further, the value of Australia’s exports will rise. These two effects should help our balance of trade. However, if Australian goods are priced in US dollars, demand for them will contract. In any event, a free-floating currency will self-correct in time – provided the fundamentals are good.
That proviso is very significant for Australia. Australia is vulnerable on several fronts but has a very good report card on two other fronts (inflation, govt spending).
First to the vulnerabilities. Australia has long been a large importer of capital. Indeed, without it our imbalance of trade would become unsustainable. Australia will only continue to attract capital in the amounts need if returns are seen to be a good prospect. If the dollar is falling and returns are paid in Australian dollars (which is what happens with capital investment), then investors feel they will get less return and will tend not to invest. One way around this is to increase interest rates to continue to attract capital. That will help (though not for equity investors), but the help comes at a price. Local investment is made more difficult if interest rates go up. We have seen in the past how a cycle of economic growth has been wreaked by Governments panicking and raising interest rates. Australia has usually had a trade imbalance. That makes international capital even more wary.
Of more significance is the perception and partial reality that Australia is an old economy. The Olympics may go some way to changing that perception, but government policy is more significant. The Government’s digital television decision which stultifies innovation and foreign investment in telecommunications is catastrophic. Labor has been complicit in this folly. Regulation to appease mates is a surefire way to tell the international economy that we are and “”old economy” looking backward not a innovative one looking forward. The Government’s appalling record in university funding sends a message that we are not interested in the foundations of the “”new economy” – education, research and science. Without the educational infrastructure entrepreneurialship has nothing to build on. Perhaps, alas, the Olympics will reinforce the message that Australia is not interested in research and education preferring to blow government money on sport.
The Senate’s recalcitrance on selling the rest of Telstra and labor-market reforms are also telling against Australia.
On the good side we have had some good work by the Government on fiscal discipline, albeit eroded somewhat last Budget because of electoral fears. This in turn has helped control inflation. It is likely the GST will only have a temporary one-off effect on inflation. Otherwise the GST will be beneficial. It will force small business to computerise, improve record-keeping and ultimately make it more efficient.
The plummeting of the dollar against he US dollar should be seen as an opportunity for economic and societal assessment. The Games have been marvellous, but Australia must match sporting prowess with greater capacity to innovate if people’s lives are to be improved.
At present Prime Minister John Howard and Treasurer Peter Costello are only partly right when they say the fundamentals are good. They should look again at some of their own backward-looking policies in addition to blaming the Senate and congratulating themselves on earlier good work.