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Finally, a boom unlikely to bust painfully

At first blush it seems almost too good to be true: an economy cruising along with reasonable growth, virtually no inflation and the prospect of lower interest rates.

That's the picture from 20,000 feet, from the safety zone of the ivory tower. At ground level, however, a vastly different vision emerges with starkly contrasting growth rates between the states and between regions and manufacturing and service industries squeezed by the rapid expansion of the resources sector via a rampaging local currency.

In a federation such as ours, however, that's the way it has to be. Monetary policy is a blunt tool that does not discriminate between states, regions or industry and the Reserve Bank, independent from government since 1996, has steadfastly maintained its goal of keeping inflation, and with it national economic growth, under control.

This is the first time in modern history that Australia has not squandered the spoils of a resources boom by allowing inflation to run rampant. The difference this time is our currency. Every other boom in the past century - in the 1920s, the rural boom in the 1950s and the minerals booms of the 1970s - all occurred at a time when the exchange rate was fixed or managed.

The temptation in each case, with the rural lobby leading the charge via its disproportionate representation in the Parliament, was to maintain the exchange rate at an artificially low level and keep interest rates lower than required.

The end result: rampant inflation, runaway unemployment and recessions more severe and longer than they should have been.

Like everything in economics, and life for that matter, there is always a trade-off, a price to pay. Previous booms felt exactly like that. Prosperity coursed through the nation. But the hangover after the party, often years down the track, exacted a heavy toll.

This time around, unless you live in parts of Queensland or Western Australia, the good times just don't seem to be rolling at all. This time, the pain of an economy readjusting and restructuring itself to make way for an enlarged resources sector is causing pain at a time when the party previously was in full swing.

Often referred to as Dutch Disease - a term coined by The Economist magazine in 1977 to explain the shifts under way in the Netherlands after the discovery of natural gas fields - the phenomenon in fact was first identified by an Australian, Professor Bob Gregory, of the Australian National University, a decade earlier.

The Gregory Thesis sought to explain how a minerals boom would squeeze out other parts of the economy, particularly manufacturing, via a stronger currency. During the 1970s, your columnist studied it at length to determine the effects of a boom on the Australian rural sector.

For all the complaints about the strength of the Australian dollar this year, this week's inflation figures - both the Consumer Price Index and the Producer Price Index - graphically illustrated some of the benefits of having a strong dollar right now.

Imported consumer goods and componentry for manufacturers are much cheaper now than at any time in recent history. In the three months to the end of March, prices fell by 1.5 per cent while the price of domestically produced goods and services jumped 3.6 per cent.

Whether or not next week's interest rate cut takes the wind out the Aussie dollar remains to be seen. But it is likely to have little impact given as almost everyone expects a cut, that already has been priced into the value of the local currency.

Other factors are at work boosting the Australian dollar right now and most of them are related to Europe. Spanish bond yields have blown out again, with fears of another looming debt crisis, the Dutch government has collapsed while in France, a power shift appears inevitable with a swing towards the Socialist party.

Once again, global investors are seeking safe havens. The yield on 10-year US Treasuries dropped to 1.96 per cent yesterday as demand surged for American government-issued bonds.

Until three years ago, Australia was considered a risky and volatile economy, primary because of our reliance on commodity exports and hence volatile commodity prices. The boom has changed all that.

Global investors have sought out Australian dollar-denominated assets, not simply because it is a proxy to an investment in resources and the strength of China, but because Australia suddenly has assumed the mantle of safe haven.

Low government debt, the strongest economic growth of any of the developed economies, the prospect of improved growth next year and a federal government determined to wind back the budget deficit, no matter what, has seen Australian government-issued bonds in hot demand.

There is an inverse relationship between the price of these bonds and the yield they deliver. Strong demand has sent the yields plummeting to their lowest levels in more than 60 years.

The yield on a 10-year bond is now 3.648 per cent. While historically low, that is a huge premium to the yield on US government bonds. Remember too that Australia is rated AAA while America is rated only AA, adding to our appeal.

It is also worth noting that the US Federal Reserve has been forcing American rates lower and pumping money into the system through huge purchases of US government bonds. That has not happened here. There is no manipulation.

Coupled with the vast amounts of investment flowing into the country for mine expansions and development, it would appear our dollar will be stronger for longer.

7 comments so far

  • This time it's different - usually followed by a crash?

    Date and time
    April 26, 2012, 12:21PM
    • Logical enough; by averting a boom we avoid a bust.
      Of course, some of our industries must languish, while foreigners bid up the dollar and buy a lot of our minerals. But we have to buy something from them - basically, either their manufactured goods or tourist services- or else, the foreign customers simply will not have the currency to buy our minerals. It follows the whole point of exporting things is to buy more imported goods and services.

      Date and time
      April 26, 2012, 12:56PM
      • Outsider,

        Or we could invest in them, like they are investing in our country.

        Or we use the money to pay down some of the huge net foreign debts, almost 800 Billion dollars, which net not gross foreign debt, that Australia has racked up most through our big Australian banks borrowing foreign money to finance a housing bubble over the last twenty years. Australia has about a 1.4Billion dollars Gross Foreign Debt and we have about $600 Billion dollars invested overseas. As we have found out in Greece, when the foreign investors want their money you had better be able to pay.

        Pay the Piper
        Date and time
        April 27, 2012, 7:38AM
    • Boom and no bust? Yep. OK....before uncorkin' the bubbly, who's gonna pay for that?

      Let's just check spot oil today:
      Tapis USD128
      Brent USD119
      WTI USD104

      Yep. Someone's gonna pay alright.

      Anything for a price
      Slumdog millionaire
      Date and time
      April 26, 2012, 5:25PM
      • We are not too far away from following the US & Europe into a sustained and difficult period, even though we have such good prospects in the resources sector. The reason is the elephant in the room. ITS THE INTERNET!... the fastest, largest Industrial Revolution in Human History. It is a wrecking ball smashing small business to pieces. It reminds me of the Life Of Brian sketch where its a given that the Romans supply peace, wine, roads, education,water etc but what have the Romans ever done for us? I say to people Its the Internet killing newspapers, magazines, paper directories, free to air TV, bricks & mortar retailers & on & on... they go.. Yeah but Its not causing the world wide recession you idiot. I say that list is the tip of the iceberg. The Internet is whiteanting the world economy & it will take many years for a new paradigm to emerge. In the meantime The Internet is lurching into exponential growth & steamrollering over small businesses which are predicated upon an old way of doing business. Australia is going into an Internet induced makeover where the vast majority of its citizens are going to be left with a very different economic landscape to ply their trade in.

        Date and time
        April 26, 2012, 5:33PM
        • Strange, the last resources boom was in late 1970s, then the Aud = 1.25 Usd, interest rate typically 12%. How can it be said exchange rate was at an artificially low level and interest rates lower than required?!

          Date and time
          April 26, 2012, 6:22PM
          • The Elephant in the room is climatic/weather extremes. Rain has impacted on some of our miners. China has suffered from weather extremes previously and now they have those massive dams. The anti CO2 tax may have to review their position, however action will take years to bear fruit, pity action was not commenced years ago

            Abel Adamski
            Date and time
            April 27, 2012, 12:40AM

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