How the fight against deflation is killing us

Together, the desperate global inflation fight and China's reform efforts are preserving Australia as a big mining pit. And the Reserve Bank is largely helpless.

On Friday the Reserve Bank laid bare the bind that it’s in. No, it wasn’t the Statement on Monetary Policy, although as usual it was in there between the lines (The RBA's crystal ball is clear as mudNovember 8). It was assistant governor Guy Debelle’s speech in Washington.

“So we’ve had this interesting balancing act of telling foreigners, actually, things aren’t quite so good at the same time as trying to tell our domestic citizens, actually, they’re a helluva lot better than they think they are,” he said.

The RBA is getting increasingly frustrated about the strength of the Australian dollar. It has been trying to “jawbone” it down, while talking domestic demand up, but the people who matter aren’t listening – they are far more interested in what the Fed, the European Central Bank and the Chinese Communist Party are doing.

In essence the desperate fight against deflation in the United States, Europe and Japan as well as China’s incredible infrastructure spending, and now the expectation of reform there, are combining to keep Australia’s currency high.

The ECB’s surprise rate cut last week from 0.5 to 0.25 per cent revealed just how fearful they are of deflation in Europe. Likewise there is no sign yet of the Federal Reserve tapering quantitative easing, or of Japan ending Abenomics.

As a result, Australia’s currency is now the best performing in the western world. At a time when activity and employment need to shift towards non-mining industries, they are being hammered by the currency.

Meanwhile the Chinese leadership went into yesterday’s Third Plenary meeting with expectations of a new wave of reform running high, with predictions from Politburo members of “unprecedented” policy changes.

If that happens it will put further upward pressure on the Australian dollar, as a proxy for the Chinese economy.

And all the Reserve Bank can do about this is talk about the problem and cut interest rates, which is only inflating the property market.

The death of the Australian car industry is symbolic of what’s happening: basically the global fight against deflation and the Chinese Communist Party’s efforts to stay in power through stimulus spending and reform, will ensure that Australia remains primarily a resource-based economy – a quarry.

Successful non-mining export industries seem to be impossible in Australia without a significant decline in the currency because costs are too high and firms are uncompetitive. Mining and energy industries are competitive because labour is a low proportion of costs.

The car industry is dying despite a boom in car sales because it is fundamentally uncompetitive: high costs and the high dollar are leading to high imports and very low exports. The only countries buying our cars are those without car manufacturing industries of their own, and they don’t buy many.

This is happening throughout Australia’s non-mining industries. The interest rate cuts are doing nothing to stimulate demand or reduce the currency, and are only increasing the cost of land, which is making them even less competitive.

As Guy Debelle said in Washington last week, it’s called Dutch disease. We’re getting it.

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