Lowe's soother for a hard-to-swallow dollar

Philip Lowe has produced a dispassionate and somewhat encouraging assessment of the state of the economy as it transitions towards a post-investment boom environment, with the Reserve Bank deputy governor seeing streaks of silver within some of the gloomier post-financial-crisis clouds.

The most "disruptive and sometimes painful" of the changes that have occurred for business, including resource groups, in that period has been the continued strength of the Australian dollar, both in response to the strong commodity prices for most of that period, until relatively recently, and the weakness of most of the rest of the developed world.

As discussed here recently (Dollar drags CSR over broken glass, March 11), it has taken quite some time for Australian companies to accept that they have to plan on the dollar remaining at elevated levels for the foreseeable future and adjust their business models accordingly.

Lowe said today that the Reserve Bank’s extensive discussions with business confirmed that they were adjusting to the high value of the dollar and that where previously his sense was that many businesses were simply hoping the strength of the currency was a temporary development he now had quite a different sense.

"Nowadays there is a greater recognition that the high exchange rate is likely to be quite persistent and firms, including in the manufacturing sector, are adjusting to this. Many are looking to improve their internal processes and address inefficiencies. They are focusing on products where value added is highest and where the quality of the workforce is a strategic advantage. We hear from businesses right across the country that they are looking for improvements and that many are finding them," he said.

"This adjustment in business processes and models is often painful. But the fact that it is occurring is one reason why the Reserve Bank has been tentatively optimistic for some time that productivity growth would pick up from the low rates experienced over much of the previous decade.

"We are now seeing some tentative evidence of this in the aggregate productivity data," he said, adding that productivity growth in 2012 was better than it had been for quite some time and that while there was no certainty this would continue the structural changes occurring meant there were reasonable prospects for a sustained lift in productivity growth.

I’ve previously likened the impact of a dollar above parity to the impact of the demolition of the tariff walls in the 1970s and 1980s, which had a very traumatic impact on manufacturing industry and dramatically re-shaped the sector but produced a far more rational, efficient and competitive reallocation of capital and resources.

Lowe says there is some evidence that, while overall there has been little growth in either aggregate output or exports from the manufacturing sector, some parts of the industry are doing quite well and that many of them are in areas like specialised mining-related equipment and machinery, where Australia has a comparative advantage and where the value added is high.

Apart from playing a role in forcing trade-exposed industries to restructure and to improve their competitiveness the dollar has, of course, helped to keep a lid on inflation despite the record levels of resources-related investment and allowed/forced the Reserve Bank to lower interest rates. As the investment boom peaks (at a lower level than once anticipated) and trends down that ought to help take some of the pressure off costs and access to capital for the rest of the economy.

The other big shift in the economy that Lowe referred to in the period since the GFC has been the behaviour of households, which were net dis-savers in the lead-up to the crisis but which are now saving more than 10 per cent of their disposable income. Lowe cites that shift as the other broad factor that has helped maintain domestic balance during a "once-in-a-century" investment boom.

That new-found conservatism, he said, represents about an extra $90 billion a year that is saved rather than spent. As he noted, that hasn’t been good news for retailers or other businesses (banks, for instance) that had business models geared to the pre-crisis environment but had consumers kept spending at pre-GFC levels it was likely there would have been significant over-heating, he said.

It has been apparent from the recent round of retailer results that their own responses to the retail recession and the first visible impacts of the equal record low level of official interest rates is starting to have mildly positive effects, albeit off depressed bases. Retailers, too, have been forced to make structural adjustments to their models although they are a sector that has actually benefitted from the strong dollar.

"So, somewhat ironically," Lowe said, "two of the factors that have created difficult challenges for many businesses over recent years – the high exchange rate and increased household savings – are the very same factors that have been critical to Australia’s good macro-economic performance.

"Importantly, these factors have helped Australia to digest a huge investment boom without generating structural imbalances in the economy. At the same time these factors have prompted significant structural change which, while difficult, is critical to achieving higher overall productivity and higher living standards," he said.

A factor in Australia’s good fortune in avoiding any significant impacts from the GFC, of course – and the over-riding factor in the strength of the dollar – has been the new and growing economic reality that the Australian economy and currency are now driven largely by the circumstances of our region rather than by distant events in Europe and the US.

The GFC was a trans-Atlantic crisis with only modest impact on China and the other developing economies in the Asia Pacific region. The dollar’s strength post-crisis reflects the new global economic relativities and Australia’s fortunate – indeed lucky – place within them.