Does Australia have a plan B?

In a recent interview on the ABC’s Insiders, Treasurer Wayne Swan again stated that “the strength of the Australian economy stands in very stark contrast to that of other developed economies”, and that “the effectiveness of our stimulus, both fiscal and monetary, is on show for all to see here in Washington two years on”.

But who is Swan kidding? Australia is fortunate to benefit from Asia’s boom, particularly China, which has boosted our mining exports.

Australia also experiences many of the problematic trends evident in many Western nations. With average interest rates in Australia averaging 5.3% between 2000 and 2010, after being 11.4% during 1985-1995, Australia’s household debt to income ratio rose  from about 50 per cent in the early 1990s to be over 150% of GDP by the end of 2009. Australia’s household to income ratio is today similar to the US, New Zealand, UK, Sweden and Spain, although much lower than the Netherlands at well over 200 per cent.

Without a mining boom, Australia would be just as vulnerable as many other Western economies, albeit with a lower public debt level than most. In the case of the US, while financial services profits grew by 600 per cent from 1980 to 2009, profits for everyone else only doubled. This period was accompanied by wages stagnating with living standards expanding via increasing debt (both private and public).

All Western societies are struggling for the answers against tougher competition from China and other developing nations after decades of promoting freer trade.

With Australia’s increasing reliance upon consumption and debt, what did Labor do in 2009 when experiencing lower private sector activity from the GFC? It adopted more measures to reignite Australia’s housing bubble after prices started to fall in early 2009 by tripling the first home buyers grant to $21,000 for new houses and doubling it to $14,000 for existing homes.

During a time of falling interest rates, house prices soared 20 per cent in the 12 months between March 2009 and March 2010, the fastest ever recorded increase in Australian history. Labor decided it had no alternative, despite the Senate Select Committee on Housing Affordability reporting that “the average house price in the capital cities is now equivalent to over seven years of average earnings; up from three in the 1950s to the early 1980s”.

Even more amusing was Swan’s response about the recent high value of the $A when he noted that many Australians travelling in the US were really “enjoying their visits”, and that this reflected “the underlying strength of the Australian economy” and “the confidence of the investment community”.

While a high dollar may help contain inflation and keep pressure off interest rates, Swan eventually admitted that a high dollar would negatively impact on Australian manufacturing and tourism, things are not that great for Australia.

As Alan Kohler noted in October 2009 (Business Spectator October 27, 2009), a “strong Australian dollar is a disaster for Australian manufacturing”. In the same article, Treasury Secretary Ken Henry expressed concern about the structural changes that will be forced on the Australian economy by a sustained terms-of-trade boom which may mean that the resources sector will command more capital and labour. Henry noted that, “as the factors of production are reallocated, the pattern of growth will be characteristic of what is often referred to as a ‘two speed economy’; and real wages growth and labour productivity growth will be weak – possibly even negative”.

Notwithstanding the problems caused by a high dollar and a growing reliance upon mining, does Labor have an alternative strategy should events deteriorate in economic terms?

With the US Federal Reserve likely to undertake “quantitative easing” (printing money) as a move to deliberately devalue the dollar and make its exports cheaper, momentum is building towards greater trade tensions.

It will not matter what Australian investors want in terms of benefits from a booming China and its demand for Australian resources.

Nor may it matter what China has to say. Recently the Chinese have complained that their large portfolio of US Treasury bonds will lose value if the US dollar declines, while China’s Premier Wen Jiabao argued that a 20 per cent rise in the yuan would cost an unacceptable number of Chinese jobs.

So as Swan raves on about how well Australia is going, other nations are adopting measures in an effort to preserve their economic competitiveness, although to what extent they succeed remains to be seen.

The US is likely to act more aggressively in economic terms in coming years. After all, its unemployment levels are still 9.6 per cent, although the real figure could be over 20 per cent.

In response to a lower US dollar, Korea has instituted capital controls, Chile and Brazil have begun direct purchases of US dollars, and Japan and Switzerland have begun their own new rounds of quantitative easing. Brazil recently also doubled the tax on foreigners’ purchase of local bonds to make it more difficult for outside investors to buy assets denominated in reals, which pushes up its exchange rate.

While the European Union has been less aggressive than the US thus far, the head of the Centre for European Policy Studies Daniel Gros has declared China’s bid to have a lower yuan and support euro-zone debt to be “economic nonsense”. Gros suggests that euro-zone governments, and the US and China, introduce legislation to ban the sale of sovereign debt to countries like China, “which don’t allow foreign investors to purchase their bonds”. Paul De Grauwe, a professor of economics at the University of Leuven in Belgium, also suggests that the European Central Bank buy “large quantities of non-European government bonds to push up the value of foreign currencies”.

If a trade war breaks out, Australia’s economic well-being will be at risk given its high reliance on the resources sector. Along with much lower share prices, falling confidence may slow housing purchases (possibly ending the housing bubble.

While Australia may have more policy flexibility than many other developed nations given its relatively low public debt and higher interest rates, a plan B is needed just in case other more powerful nations do what it takes to preserve their own national interests in coming decades.

But perhaps I am asking too much. Linking all of the issues together to find an alternative policy mix may just be too hard for our political parties, despite this being a time when they should be considering alternative policies just in case everything falls apart. Perhaps it is all too hard for all of us with the relative peace and prosperity of Western societies in recent decades a mere blimp of history as we return to much tougher economic times. Time will tell.