Devaluation is here, but will it help?

A lower Australian dollar is supposed to boost our competitiveness, but weak wages growth and inflation around the world threaten to rob us of the benefits of a falling currency.

Friday’s October payrolls report seemed to entrench the rut that the American economy is in: unemployment is falling but wages aren’t rising. It means the US dollar will keep going up but inflation is not going with it.

It’s difficult to overstate the importance to Australia of what’s going on. In essence, low wages growth and inflation elsewhere in the world could rob Australians of the benefits of a falling currency.

There is no doubt that the Australian dollar is in decline, at least against the US dollar. The greenback fell slightly on Friday, but it recently went above a four-year high and seems to have decisively broken out of a 30-year downtrend.

So all things being equal, Australia’s currency is heading lower and its competitiveness higher, but if deflation takes hold in the rest of the world that will be blunted at best.

If Australian prices and costs are rising while those in the US and the rest of the world are not, then we will need all of a currency devaluation simply to maintain competitiveness. Significant reforms will be needed to improve it.

Without rising wages, America faces the full deflationary impact of a rising currency combined with falling energy prices and productivity improvements from automation.

The US economy has added more than 200,000 jobs in nine consecutive months now, the first time that’s happened since 1994-95, but the employment growth that’s occurring is not enough to move the dial on either wages or prices .

Despite that, the Federal Reserve will soon have little choice but to start raising interest rates as labour market slack continues to disappear. In Paris on Friday two Fed officials – the chair, Janet Yellen, and New York Fed president William Dudley, began preparing markets for a rate hike next year. Dudley was explicit about it; Yellen less so.

That will put even more upward pressure on the US dollar over the months ahead.

The issue facing Australia is this: if cheap energy and technology are reducing global costs and causing a new era of deflation, can we actually take advantage of a declining currency at all?

In fact, I suspect Australia cannot avoid what is called an “internal devaluation” – that is, a cut in real wages – at the same time as a currency devaluation.

It might be different if we were able to take full advantage of this country’s own cheap energy, but as The Australian reports this morning, the Business Council of Australia has produced a landmark energy paper that says Australia’s comparative advantage in energy is declining.

The report calls for urgent reforms to deliver cost-competitive energy to industries that had been built on the back of cheap energy in the first place. That advantage is rapidly disappearing.

And despite years of talk, Australia is simply not known for its technology and innovation and certainly does not have a comparative advantage in that.

The challenges for Australia from the shifts that are taking place in the world economy are immense. Improving infrastructure, as planned by the “infrastructure PM”, as well as various “infrastructure Premiers”, is a good start, but it won’t be enough.