Australia is no longer the miracle economy, and seems to be heading almost heedless into very difficult times. The Reserve Bank may feel constrained to help relieve the pain by cutting interest rates further, but going too far in this direction will just increase the disequilibrium caused by the major difference in costs of doing business in Australia compared to doing business elsewhere.
Most public discussion has focused on the high value of the Australian dollar, which seems finally to be falling. But domestic costs have also been rising faster than cost increases in both competitor and customer nations. This has inflicted double-barrelled, double-digit cost disequilibrium on Australian businesses.
Assuming it continues, the fall in the Australian dollar will not solve the problem of competitiveness, because what is needed is a reduction in costs measured in foreign currency, which requires future increases in domestic costs to be severely restrained. Further cuts in interest rates will encourage cost increases, not restrain them. This is the major dilemma facing the Reserve Bank.
A falling exchange rate combined with restraint of costs happened at a time of deep depression in the 1930s and to a lesser extent during the "Banana Republic" crisis of the 1980s. The feature of both episodes was careful and believable explanations by government of the sacrifices needed to minimise the costs of recovering competitiveness.
The current government has, in strong contrast, steered Australia into a situation of great economic disequilibrium whose main manifestation is loss of competitiveness of Australian businesses.
Constant description of Australia as having the "strongest economy in the developed world" allied with grandiose plans to "reform" various aspects of this "miracle economy" by spending taxpayers' money has provided no preparation for the sacrifices that will be necessary to restore Australia's economic competitiveness.
The budget has fallen apart and has been shown to be in far worse shape than Treasury or the government -- which have been engaged in an orgy of mutual backslapping about the economy -- believed until recently.
The cost disequilibrium can be illustrated most clearly by the cancellation or postponement of many large mining projects. But the health of many other industries is worse.
Ford closing its Australian operations, farmers bulldozing fruit trees, major declines of exports of wine and processed foods, tourist departures greatly outpacing tourist arrivals, the plight of small business generally and the difficulty new graduates face in finding jobs all tell a story that has recently been documented more formally by professor Ross Garnaut.
The short explanation is that the global financial crisis has finally come to Australia.
The GFC has meant that virtually all developed nations are operating with near-zero interest rates and engaging in "quantitative easing" (a euphemism for printing money). This approach is, in my view, a mistake, but this will only be proven by the judgment of history. Meanwhile, it has created the high dollar that is one of the "barrels" of Australia's economic disequilibrium.
The various innovations to global monetary policy will all eventually create goods and services inflation, as they are already fuelling asset inflation, especially share price inflation.
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