The Abbott government missed a great opportunity to show some economic leadership last week -- leadership the country desperately needs. Instead, the House of Representatives Standing Committee on Economics continued to indulge a fanciful theory that has proven to be wrong: a theory that actually places Australia at greater risk of a severe recession in future years.
Specifically, the committee spent far too much time discussing the exchange rate on the underlying premise that currency strength was bad and that weakness is good.
Reserve Bank of Australia governor Glenn Stevens was directly asked about what it would take for the RBA to intervene in the currency market. The governor opted not to give details, but he noted it remained an option.
A weaker currency has been a keystone of economic policy only recently, pushed along by ‘growth girls and boys’ on the RBA board and at the Commonwealth Treasury. The argument is that a weaker currency (around 80 cents or so) is essential for our record expansion to continue.
In pursuing this goal, they've risked a lot. Rates are at a record low, and policy ammunition whittled away, seemingly for nothing since even the most ardent fans of this policy still maintain that the economy remains weak and fragile three years later. The key achievement has been a worsening in housing affordability due to a growing price boom. A large number of analysts are now alarmed by the prospects of this deflating at a time when inflation is already at the top of the band.
There has been no investigation of the merits of such a policy, no cost-benefit analysis. If one were conducted, the international evidence on benefits is pretty clear: it shows this working assumption to be wrong.
The experience of Japan stands out: over the last two years, the yen has depreciated by about 35 per cent against the US dollar. That’s a sizeable move. As in Australia, the hope was that this would lead to an export surge, a revival of the Japanese economy and hopefully a little bit of inflation on the side.
The Japanese government may have the boost to inflation that they wanted, with a little bit of help from a tax rate hike, but unfortunately the export-led surge is as yet proving elusive. As it stands now, the yen is at its weakest point since the GFC, yet exports are still about 3 per cent below pre-GFC levels. And while exports have recovered substantially since GFC lows -- up by 52 per cent -- the bulk of that occurred while the yen was 35 per cent higher in value and appreciating! The uplift since has been marginal: another 2 per cent or so in addition to that initial move, and even that may prove to be transitory, driven by a March quarter spike.
The UK experience should provide another valuable lesson to Australian policymakers. With the sterling just above decade lows against the US dollar, UK export growth averaged less than 0.5 per cent per quarter in the three years immediately after the GFC. Even in 2012 through to the first half of 2013, there was no sign of a lift to export growth from a weak exchange rate. Indeed, it’s really only during the last three quarters that export growth has surged back to rates last see pre-GFC. However -- and this is the important point -- this has been alongside a 13 per cent lift in sterling against the US dollar and a 9 per cent spike against the euro.
In the Australian context, export growth has been extraordinary. Average quarterly growth (annualised) has been over 5 per cent -- even with the currency at historically high levels -- which is nearly double the average prior. Quite obviously, a high exchange rate is not an impediment for export growth. The RBA governor even noted that strong export growth itself was one possible factor accounting for currency strength. So where is the problem?
The flipside is that if we do see a dollar slump, inflation is going to lift. The cost of imports will spike, fuel bills will surge, household wealth will fall, etc. Why would we want that?
The country deserves more than this, and the Abbott government needs to shows some leadership and redirect the economic discussion. It has an opportunity to help buttress the country against future recession.
As it stands, politicians on both sides, along with Treasury and the RBA, have needlessly increased the risk of a severe downturn for no good reason. Instead of mindlessly sanctioning what is clearly a flawed paradigm, the government should be asking bureaucrats why such policies have failed overseas and why are they risking financial stability, higher inflation -- and ultimately a weaker Australian economy.