Monday, October 18, 2010

Enemy mine (updated)



Any regular reader of this blog will know two things for certain. The first is that it is intensely concerned about the effects of Dutch Disease. The second is that it finds Ross Gittins's smug baby-boomer prattle intensely annoying. So, when you put those two things together, spleen hits the screen.

From Gittins today:

Our high dollar - which could easily go higher - is imposing considerable pain on our farmers, manufacturers, tourist operators and education providers. The pain will intensify over time, but guess what? The econocrats think it's a good thing.

The pollies don't mind either, because the punters think parity with the US dollar is Christmas come early.

Remember, too, that about three-quarters of Australian industry is non-tradeable - it neither exports nor competes against imports. So it is not directly affected, except to the extent that it uses (the now cheaper) imported components and capital equipment.

A higher exchange rate is anti-inflationary and thus does a similar job to a rise in interest rates. It lowers the price of imported goods and services, which reduces consumer prices directly (though, these days, the process is quite attenuated, with foreign suppliers and importers tending to absorb rather than pass on the short-term ups and downs in the exchange rate).

As well, a higher dollar helps to ease inflation pressure by redirecting some domestic demand into imports (for instance, it makes locals more inclined to holiday abroad than at home) and by dampening production of exports (such as accommodation for foreign tourists or education for foreign students).

So, to some extent, a higher exchange rate is a substitute for further rises in the official interest rate. But I wouldn't take this to mean a further rise in rates this year is now unlikely. At best it could mean a rise in early December rather than Melbourne Cup Day.

This blog doesn't dispute any of this. The dollar should rise during such a boom and it does do all the things outlined. However, the question Gittins fails to ask is how much should it rise? As addressed in the post Houses and Holes, the vast majority of the dollar's rise is nothing more than speculation. The Bank of International Settlements estimates just 17% of currency flows are based around actual commercial and government transactions.

In the case of the Aussie, that would mean that of the $190 billion daily turnover, only $32 billion is based on transactions of real value. Does this sound like a revaluation based upon fundamental value or some outsized bet in a monster casino?

Back to the article:
I'm trying to get from the immediate cyclical issue to the longer-term structural one. Sooner or later, coal and iron ore prices will fall back from their present dizzy heights, though they're likely to stay well above their long-term average.

The second element of this boom - the thing that distinguishes it from previous commodity booms, giving it a medium-term, structural element - is the unprecedented boom in mining investment that's about to get started, coming on top of a level of business investment spending during the downturn that was already remarkably high.

Even if some of these projects are abandoned and some are delayed, we're still talking about a huge expansion in our mining sector that constitutes a historic change in Australia's industry structure, affecting the oil and mining industry, the mining services industry and - for a decade or more - the engineering construction industry.

This will require a huge application of resources: labour and financial and physical capital. But because it comes at a time when we're already at full employment then, to the extent we're not adding to our supply of skilled labour via immigration, this will require a reallocation of resources within Australia.

Labour and capital will need to move from non-mining industries to the mining sector and from the non-mining states to the mining states.

The textbook, closed-economy way for this to happen is for the mining sector to bid up wages and other ''factor'' prices until it gets what it needs and can still afford. But in an open economy, the textbook promises the process of reallocation will be assisted by a high exchange rate, which will cause the non-mining tradeables sector to contract, thus releasing labour and other resources to shift to the mining sector.

Now do you see the other reason the econocrats want a high dollar? It is a key part of the market mechanism by which the industrial restructuring of our economy will be brought about without it exploding.

All very neat and tidy but let's have a look at the data shall we. The first graph (above) is the top 9 employing sectors plus mining. It is clear that mining is a paltry employer, on a par with arts.

Moreover, if we look at the same figures by the percentage growth across sectors it gets worse:



Mining hasn't budged since 1984. The two other sectors that look mining-related and have Gittins excited are Professional Services and Construction. Let's break them down. First, the Professional Services category (which includes engineers):



Solid growth, sure, but it also looks like we're radically restructuring the economy toward bookkeeping. How about construction?



There is some evidence here of mining-related growth, with construction one of the highest employment growth sectors. But the breakdown is interesting and looks as much governed by general building and the rise of the sub-contractor. Cutting back a bit of stimulus could do wonders here.

Finally, it seems to this blogger that it is ridiculous to restructure your economy toward these sectors because, for heavens sake, they only make things once. Once you've built stuff, or the income prompting you to build dries up, it's game over.

The three sectors that do keep on giving (in output terms) look sick. Manufacturing is in terminal decline. Tourism is rolling over and education is flat.

The point of this is not to argue that mining-related investment is not high. It is. What this blog is illustrating is that with one afternoon's research you can get a reasonably granular sense (you can go deeper) of where demand for labour is growing. A bit of sensible government skills generation and tinkering with spending solves most of the issues without shutting down every export sector we have outside mining.

But of course, that approach doesn't come with ideological purity.

Update
Late yesterday the SMH quoted the Treasurer saying he:
..dismissed calls to artificially lower the Australian dollar, [because] such moves would be ‘‘dangerous’’ for the economy ... In a ministerial statement on Monday, Mr Swan said he understood that a high dollar would have an impact on trade-exposed industries such as tourism, manufacturing, agriculture and education.

But he said the opposition’s suggestions to lower the value of the dollar would lead to higher inflation and higher interest rates, ‘‘and with a collapse of confidence in the management of the Australian economy’’.

‘‘This would hurt our manufacturing, agricultural and tourism industries, as well as homeowners right around country,’’ he told parliament, saying such suggestions were ‘‘dangerous’’.

‘‘Because it risks fracturing the long-held bi-partisan consensus on the floating exchange rate,’’ he said. ‘‘The floating of the dollar was one of the big changes which made our 20-year record expansion possible.’’

He said it helped Australia manage both ‘‘positive and negative shocks’’.

‘‘Any action to artificially lower the value of our currency would also encourage retaliation from our trading partners, not something that’s in the interests of our export industries,’’ he said.

Sigh. It's not, of course, artificially inflated by global markets whose only remaining strategy is front-running the Fed. Back to the article:
He also dismissed the opposition suggestion that the government’s fiscal policy was feeding the rise in the dollar.

‘‘If this logic were true, with larger fiscal deficits in the US, we would see the US dollar appreciating against the Australian dollar, not depreciating,’’ he said. ‘‘The fact is Australia has one of the strongest fiscal positions in the developed world.’’

Clearly this is just rhetoric. But one has to ask, if there is no imbalance emerging from the high currency then why did the Treasurer trash his QLD mate's Prime Ministership by attempting to implement a resource rent tax that redistributed mining revenue to other parts of the economy?

4 comments:

The Lorax said...

Ross Gittins Pwned.

Luke said...

Good article.

Don't forget that most of the "professional" resource sector staff are international. The majority are from the UK & US. Things dry up here and there are plenty of opportunities overseas.

Whereas the construction is much more of a TAFE-educated (if at all) Aussie bloke. Not many industries he can transition to.

"Sensible government skills generation" is long overdue

Bear Feller said...

I was intrigued to see in your Professional Services chart that there was a spike in vets just when management consulting positions dropped. Either the data needs smoothing or it suggests that laid-off McKinsey workers went straight to animal husbandry - a far nobler profession. I hope it was so as it gives me hope for the future. We need better animal care in the new normal.

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