From punchbowl to prudence

In contrast, the exchange rate measures the value of one currency in terms of another.

The link between our terms of trade and the value of the $A comes through the balance of payments, both current and capital accounts. Other factors, such as global growth conditions, and not just commodity supply capacity for our major commodity exports, affect our balance of payments and demand for the $A.

Historically, weaker global growth, and increased global supply of our commodity exports, tended to result in falling terms of trade plus a lower $A. However, as long as Australia is perceived as a (relatively) well-managed economy, given emerging global 'currency wars', risk aversion and relatively disciplined monetary policy here could support the $A via strong net capital inflows.

Both falling terms of trade and a depreciating $A convey the same policy message.

Falling terms of trade mean the world is imposing cuts in our national income. Our recession in terms of real per capita net national disposable income has been running unbroken for 15 months now. Martin Ferguson noted we must grow our pie before we can distribute it. Our slices of pie, on average, are shrinking.

A depreciating $A is no 'free lunch' either. It can improve our international competitiveness. This requires export prices to fall in foreign currency terms (even if they rise in $A terms). Import prices must increase in $A terms. Local price effects of depreciation must not be allowed to flow on into higher wage and price inflation here. Real incomes must shaved, or at least grow less. Otherwise the competitive gains from depreciation won't last.

Falling terms of trade and a weaker $A are telling us it's well past time the policy switches are flipped more decisively from punchbowl to prudence and productivity.