Tuesday, March 05, 2013

Uncertainties over the Australian economy

It's been a little while since I talked about the Australian economy here. I have been interested, but my focus here as been elsewhere.

I am finding it very difficult to interpret at the moment. It has tracked broadly as expected. The mining boom was choked off to a degree by rising costs and increasing market uncertainties. Other parts of the economy have been slow to take up the slack. The Australian dollar has remained high. All this was relatively easy to see without too much reliance on the tea leaves. But I'm not quite sure where it's going now.

One of the really big question marks in my mind is the Australian dollar. The world is awash with money. This is keeping the dollar up. However, this can't continue. The quantitative easing must end, official interest rates move up. As that happens, the value of the dollar is likely to fall. But when?

My feeling is that its going to happen sooner than presently expected. The Aussie is already of the boil, dropping back towards parity with the US dollar despite the sea of global cash. Assuming no catastrophic events, I'm inclined to think that quantitative easing is nearing its end. Who knows, of course. But its interesting.


Winton Bates said...

My tea leaves suggest that as the US economy picks up we will see the inflation rate rise in that country. That will bring quantitative easing to an end but probably not before there is a substantial increase in the US price level.

On that basis, I would expect relative price level movements to favour a high Aussie. Improvement in the world economy would also be relatively favourable for commodity exporters and for further investment in mining. All that suggests to me that the Aussie could remain relatively high.

Jim Belshaw said...

Hi Winton. Fair points, but you are leaving out interest rates At the moment, Aussie bonds are the only AAA security offering a return above the rate of inflation. Real returns are negative elsewhere. As soon as real returns start to appear elsewhere, the investment funds driving our currency up will switch.

I'm not sure about commodity price levels as a countervailing force. I have argued that the new projects coming on will be of such scale relative to demand as to force price drops. We are already starting to see this.

Winton Bates said...

I expect our interest rates will have to rise too, in order to avoid importing inflation.

The alternative is that the inflation rate could rise in Australia. That would result in a decline in the nominal exchange rate, but the real exchange rate would remain relatively high. The manufacturing sector would remain under pressure in that scenario.

Of course, at some stage, China's growth will falter. If that happens in the next few years, my tea leaves are leading me astray.

Jim Belshaw said...

Even if China's growth remains high, and I think that it will come down because of imbalances in the Chinese economy, I think that the price received for our mining exports will fall. We have seen this already.

I had assumed that Australian interest rates would rise. It's relative movements adjusted for exchange risk that, I think, hold the key.

Winton Bates said...

This discussion has interesting implications for the size of the structural deficit faced by the federal government.

If the government agrees with your view we should end up with more prudent fiscal management than if they agree with my view that there are strong grounds for optimism that Australia will continue to attract high levels of foreign investment over the next few years.

Even though I am optimistic about Australia's economic growth prospects, that doesn't mean I am about to incur a heap of debt that my grandchildren will have to repay. I just hope Wayne Swan can also refrain from incurring a heap of debt that they will have to repay.

Jim Belshaw said...

Did you see the coverage on the structural deficit in yesterday's Financial Review, Winton?

I don't think that Government debt levels in Australia. In fact, if I had been the Government and not worried about the debt obsession, I would have borrowed a reasonably significant amount a while back in long term Australian dollar denominated securities. That would lock in a low interest rate by historical standards while increasing the depth of the bond marketplace. Theoretically at least, and ignoring liquidity effects, I could then have parked the cash in the marketplace and taken a small profit on interest differentials.

Australian Governments have been somewhat lax in fiscal terms. The decision to commit spending based on theoretical revenue estimates in the case of carbon and mining was just plain dumb. With tighter fiscal controls, we could then have used the borrowed money on infrastructure. Assuming, of course, that Governments still know how to do this. With normal lags, that would have increased investment at just the time the mining boom was coming off.