Tuesday, October 12, 2010
Houses and holes
This blogger sees economies in three categories. There are pre-modern economies which produce largely commodity output. There are modern economies which produce knowledge and manufacturing output. And there are post-modern economies that produce nothing but huge numbers of transactions around assets and business services (especially the financial variety).
Australia used to have a balance of all three. But as the above chart from the RBA clearly demonstrates, for the last thirty years we have undergone a transformation. We have swapped the modern dimension of our economy - making things - for a post-modern one - selling each other houses. We have, as it were, deindustrialised.
There have been benefits of course, not the least being increased productivity. And let's face it, we were never going to be able to compete with emerging nations labour costs so losing the low value-add stuff makes sense.
But clearly, if this process is not arrested, before long we'll have no modern economy to speak of.
This is the historical context in which we find ourselves confronting a chronically high currency that is exacerbating the trend. And already the effect it is having on our modern economy is very clear. Another RBA chart does the talking:
The rubber is hitting the road in our mix of exports. The dominance of resources is an obvious and a spectacular windfall. But the other parts of our modern economy, in manufacturing and services, are in clear recession as the high dollar bites into their competitiveness.
Despite this, there is very little critical commentary around the issue in the public domain. Operating within its neo-liberal paradigm, the RBA seems satisfied to let the strong dollar squeeze the tradable goods sectors and shift capital and labour towards the resources sector. Despite the Henry Review recommendations, Treasury also seems ok with it. The Treasurer is happy because this helps keep pressure off interest rates, as does cheaper imports and taking the froth off commodity prices. Most commentators seem to agree (with some exceptions).
This blogger, however, can't help wondering why this slavish adherence to such an idea persists. Implicit in this world view is the notion that markets know what they're doing. That they are allocating capital in the most efficient way possible and that we're all benefiting from this wisdom.
But as the GFC showed, unfettered markets do no such thing. Rather, they build a head of steam around an investment narrative, which seizes the imaginations of investors and speculators worldwide. They play the boom any way they can. Often executing strategies as simple as the carry trade, borrowing offshore at zero rates and investing in Australian fixed interest products for a decent return. In other words markets overshoot, often dramatically, for long periods and to no useful purpose.
Australia currently has a bullish narrative around resources business investment. According to the Treasurer, the strongest since 1850. Nonetheless, there is also some portion, a substantial portion, of the dollar's rise that can attributed to nothing more than speculators buying it because it's rising.
The recent BIS Triennial Survey of Foreign Exchange and Derivative Market Activity shows that the Australian dollar has risen from 3% of daily global turnover in 1998 to 7.6% in 2010. The daily turnover is now above $192 billion, up 9% from 2007 and 80% from 2004. In other words we turn over roughly the equivalent of our total GDP every 6 days.
It's impossible to precisely determine how much of this turnover serves a useful purpose. The BIS reckons 17% of global foreign exchange turnover is related to underlying commercial or government activity. If applied to the Australian foreign exchange market that leaves a huge slice for speculators, even allowing a large margin for error.
In passively accepting the dollar's rise we are, in fact, exchanging our tradable goods sector for a range of flaky international speculators that will drop us the moment there's a hiccup in China.