2008-03-04

Advantage Australia?

From the department of slightly:
Commodity exports from Australia, the world's biggest shipper of coal, iron ore and wool, are forecast to gain to a record for a fifth straight year driven by demand for steelmaking raw materials led by China.

Sales may reach A$189.1 billion ($178 billion) in the year ending June 30, 2009, the Canberra-based Australian Bureau of Agricultural and Resource Economics said today in a statement. That compares with a revised A$145.6 billion this fiscal year.

Prices for the nation's top five commodity exports, iron ore, coking and thermal coals, gold and crude oil have risen to records this year, benefiting producers including BHP Billiton Ltd. Robust economic growth is expected in China this year along with strong demand for Australia's resources, the bureau said in a report.

``China is far and away the biggest underlying force'' driving sales, Peter Arden, an analyst at Ord Minnett Ltd., an affiliate of JPMorgan Chase & Co., said by phone from Melbourne. ``The outlook is very, very rosy.''
This is obviously good news, not just because it is "good" that people overseas want our commodities, but because it will help to reverse one of Australia's economic imbalances - the current account deficit. This will, however, be a case of "I'll believe it when I see it" because the current account deficit is one of Australia's most intractable economic problems.

Australia's economy, like all modern economies, buys goods from overseas. It also sells goods overseas as well. The problem is, however, that Australia buys more than it sells. So where does it get the money to buy overseas goods? It borrows it from overseas lenders. In the September quarter last year, Australia borrowed a total of US$49.9 billion. This is called a current account deficit, and that figure represents some 5.4% of GDP. Australia has been borrowing money from overseas for a long time, and the amount of money Australia owes to overseas lenders is now around 53.5% of GDP - over US$610 billion.

Now I'm a great believer in balance when it comes to economics. A deficit is not "bad" but continual deficits are "bad". Similarly, a surplus is not "good" but continual surpluses are, in fact, just as "bad" as continual deficits. The idea is to get things in balance.

In order to reverse Australia's net debt and reduce it to zero, the current account must, at the very least, be reduced to zero as well. In short, this means that Australia needs to export more and import less, to save more and borrow less, to produce more and to consume less.

Since Australia's economy is heavily dependent upon commodities (like coal, iron, gold, copper, etc) as well as agriculture (like wheat and rice), the current commodities boom and increase in grain prices will act to increase the price of the goods we sell. This will, in turn, act to reduce Australia's current account deficit.

One of the more fortunate results of a conservative government that wasn't influenced by voodoo economics is that Australia's public debt (the amount of money all of Australia's governments owe) has basically been erased. Eleven years of fiscal prudence by Howard and Costello has meant that the government can now actually afford to do things like cut taxes and/or increase spending. This is where Australia and America differ.

Nevertheless, there are some weaknesses in Australia's economy.

The first is that inflation is increasing. It is expected that the Reserve Bank of Australia will raise rates to 7.25% today. Australia's economy, unlike America, is still showing signs of strength so our central bank is right to increase rates. Moreover, this increase in rates will do exactly what is needed to reverse the current account deficit - it will curb domestic spending, making us less likely to consume and more likely to save. If things work out okay (and they probably won't), this decrease in domestic spending will be balanced out by the increase in overseas exports mentioned in the news report quoted above.

The second is that, while Australia does not have the same subprime mess that the US has, our housing market is still significantly overvalued - perhaps more so than the US market ever was. I am astounded that housing prices here in Australia have remained stratospheric while they have been crashing in America for over 12 months now. Today's interest rate rise will, at the very least, deflate the bubble slightly. Hopefully it will pop it, and an Australian economic downturn is a possibility.

The third is that it is China and Japan that are buying all the commodities we produce... and both Japan and China turn those commodities into goods that are then sold to America. With the American dollar now low and its economy in recession (face it, it is), it is only a matter of time before Chinese and Japanese industry is affected by America's recession... which will, in turn, reduce the need for Australian commodities. It is this last point which is important because it assumes that the commodities boom will eventually end, leaving Australian mines and mine workers with less work and money.

Regardless of what happens - whether the commodities boom pops earlier or later - the right thing to do is to discourage domestic spending and to reduce the current account deficit accordingly. This will result in, hopefully, higher interest rates over the medium term. Over the long term, however, it will be dependent upon tighter monetary policy which targets inflation at a lower rate - something which has yet to become policy anywhere, mainly because it is my proposal for Absolute Price Stability.

In short, Australia is probably more likely to weather the brewing economic storm than America, but still has some serious shortcomings that need to be addressed sooner rather than later. The current account deficit is the key - reduce that and you will reduce a whole range of economic problems. Increasing interest rates and cooling the economy down is exactly what is needed at this point, even with a global recession heading our way.

2 comments:

Reuben Kincaid said...

In 1994 they increased official rates by a full percentage point.

I reckon if the RBA had the guts, it would increase it by at least one half. That will shock most people into not spending and hopefully slow things down.

So, if only 1/3 of Australians have a mortgage, how does using interest rates have a dampening affect.

A lot of talk on the radio is suggesting that the Interest Rate tool is like trying to drive a car with 1 wheel powering it.

It's funny though, when interest rates were being dropped a number of years ago, there was no talk at the time of it being a useless tool in driving the economy.

One Salient Oversight said...

So, if only 1/3 of Australians have a mortgage, how does using interest rates have a dampening affect.

Interest rates affect more than mortgages. The reason why there is so much focus upon mortgages is because it is an emotional subject and because so many people have them.

By raising interest rates, the reserve bank is essentially removing money from the economy. It is a way of controlling the money supply to ensure that inflation doesn't get out of control.

So money is certainly being taken away from mortgagees, but it is also being taken away from credit card holders and anyone who wishes to borrow money.

Increased interest rates also give more incentives to save. Go to your local bank and you'll see cash management accounts and term deposits increase their rates, rewarding people who save money they could have spent.

Inflation is essentially money being devalued. By raising rates, the reserve bank ensures that money retains its value, which will be felt in lower inflation.

Much of Australia's economic growth since 1996 has been driven by intelligent fiscal policy by the federal government, along with a clearly mandated responsibility on behalf of the reserve bank to control inflation. Nothing has changed since then except that the government has changed.