Combet’s timely rebuke of dollar denial

Industries waiting for the dollar to drop are living dangerously. Greg Combet is right that business models have to change – and not just in manufacturing.

Greg Combet might have been directing his message to the manufacturing sector when he warned the economy would have to adjust to the reality of a higher Australian dollar but the impact of a currency that has experienced what could be a semi-permanent structural adjustment goes well beyond manufacturing.

It is one of the obvious out-workings of the global financial crisis that the Australian dollar hasn’t behaved as it traditionally has. If it had followed its historical pattern, when commodity prices and the terms of trade slumped dramatically last year it should have fallen quite significantly.

Indeed it has been taken for granted, by manufacturers, miners and policymakers, in the past that in the post-float history of the dollar the currency would act as an automatic stabiliser and a balancer of activity within the economy.

The fall in commodity prices last year should have produced relief for the struggling manufacturing sector, indeed any trade-exposed sector of the economy. It should also have softened the impact of the tumbling commodity prices on Australian miners, given that all the major commodities are priced in US dollars.

There is no mystery as to why the currency is behaving "abnormally".

With the US, Europe and more recently Japan pursuing monetary policies that involve ultra-low official interest rates and very active printing presses there aren’t that many safe, first-world economies offering positive real rates of return.

Australia is also seen as a safe, albeit indirect, way to gain exposure to China and there are a lot of international fund managers with mandates to hold exposures to the Asian economies and China in particular.

Combet, the Minister for Industry and Innovation, said in an interview with The Australian that the government’s view was that the high Australian dollar was going to be around for "a considerable time".

That has to be the working assumption for Australian businesses. The debt and deficit-centred structural challenges in Europe, the US and Japan are so substantial that there are no obvious short term, or even medium term, fixes. They will be running unconventional and very loose monetary policies for a long time.

For manufacturers and exporters that means there isn’t any point in hoping and waiting for relief. Combet is right when he says business models have to change.

For the miners, the persistently high dollar has been a major factor in the cost inflation which has seen very large and damaging blowouts in the cost of new projects, most obviously in the export LNG sector, while undermining their returns.

All the major miners are engaged in a sector-wide assault on their inflated costs, but the benefits from that effort are going to be muffled by the strength of the dollar.

Miners, too – particularly the more diversified miners like BHP Billiton – might have to rethink their business models and strategies. The big miners generally stopped hedging currency risk a long time ago, comforted by the correlation between the dollar and commodity prices.

A lot of historical correlations that supported diversification have, however, broken down since the GFC and miners, with very lengthy lead times for their investments and decision frameworks that can look a decade or more into the future, are going to have to consider whether that is an aberration, albeit a quite lengthy one, or a permanent change.

There is no significant policy response available to counter the impact of the strong dollar. The Reserve Bank doesn’t have the firepower, or the inclination, to try to manage the currency and the gradual lowering of Australian interest rates has had no discernible impact.

The only logical response by business is, at the firm level, to focus on micro-level improvements to lift their productivity while governments need to do what they can (and they could do a lot) to reduce the various layers of burden, red and green tape and costs they impose on businesses large and small.

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