Showing posts with label foreign exchange. Show all posts
Showing posts with label foreign exchange. Show all posts

Saturday, February 13, 2021

Why we're stuck with low interest rates for a long time

When it comes to interest rates, we’re living in the strangest of times, with rates lower than ever.

Savers are getting next to no reward for lending their money. Does this make sense? Not really. But we’re moving through uncharted waters and aren’t sure how we’ll get out of them, nor what happens next.

When Reserve Bank governor Dr Philip Lowe appeared before Parliament’s economics committee last Friday, he was asked whether we get the interest rates the world forces on us, or whether our authorities are free to set the rates they want.

Lowe’s answer was “we have the freedom, but we don’t”. Huh? “It’s complicated,” he explained.

Sure is. What he could have said is that we have some freedom, but not much. Were we to set our interest rates at a very different level to those in the rest of the world, there’d be a price for us to pay.

His own explanation was as clear as mud: we don’t have freedom in a structural sense, but we still have freedom in a cyclical sense.

Let me have a go. Remember that, as part of the process of globalisation over the past 40 years, the rich countries’ national financial markets are now so closely integrated with each other that each country exists in what’s pretty much a single global market, producing a single long-term real interest rate.

Purely by virtue of its big share of the global market, the things an economy as big as the US does can influence the level of the global interest rate. But nothing a middle-size economy like ours does is big enough to move the world rate. We are, as economists say, a “price taker”. We’re free only to take it or leave it.

The market price of something (including the price of borrowing money – the rate of interest) is set by the interaction of demand and supply: how much of it the buyers want to buy, relative to how much the sellers want to sell.

Lowe explained that the reason the “world equilibrium interest rate” has fallen so close to zero since the global financial crisis of 2008 is that, around the world, there’s been an increased desire by people to save, but a reduced desire to invest. That is, savers want to lend a lot more money than investors want to borrow, so interest rates have fallen sharply.

I think by now most economists accept this as the best explanation for the amazing low to which interest rates have fallen. It’s what Lowe means by “structural”. Just why saving is so much greater and investment so much smaller are questions economists are still debating.

Note that this explanation laughs at the standard view in neo-classical economics that saving increases when interest rates are higher, while investment increases when interest rates are lower.

Nor does it fit with the view that the “natural” rate of interest should reflect the rate of business profitability. Although the profits of some businesses have been hard hit by the pandemic, before it arrived – and even since, for most businesses – profitability has been high.

An alternative, minority view – pushed by economists at the Bank for International Settlements in Basel, the central bankers’ central bank – is that world interest rates have fallen so low because of the Americans’ excessive use of “quantitative easing” (central banks buying second-hand bonds and paying for them with money they’ve just created) after the global financial crisis and then, once the US economy had recovered, their failure to sell those bonds back to the market and so push interest rates back up.

An economy where households are saving too much of their incomes, and businesses don’t want to invest in expansion, is an economy that’s growing too slowly and not creating many new jobs. The solution, Lowe said, was to give people confidence to spend (and so get their rate of saving down) and give firms the confidence to invest.

How is he doing this? By cutting the official interest rate as close to zero as possible, and using quantitative easing to lower longer-term government and private sector interest rates. Really? Sounds to me like hoping to recover from a hangover by having another drink.

But back to the point. If interest rates ought to be higher to give savers a decent reward on the money they lend, why can’t our central bank set our interest rates higher than those being paid in other parts of the world?

Well, it can. We do retain that freedom. But because our financial markets are just part of the global market, what that would do is push up our exchange rate.

Why? Because financial institutions around the world would shift money into Australian dollars so as to get into our market and take advantage of our higher interest rates. When the demand for “the Aussie” exceeds the supply, the price goes up.

Such a rise in our currency’s rate of exchange against other currencies would reduce the international price competitiveness of our export and import-competing industries, thus reducing our economy’s growth and job opportunities.

That’s the price we’d pay for stepping out of line.

Lowe told the committee that the two main factors that drive the value of our dollar are world commodity prices and relative interest rates – that is, the level of our interest rates relative to other countries’ rates.

The prices we receive for the commodities we export (particularly iron ore) are up but, he said, the Aussie hadn’t appreciated (risen) by as much as you’d expect from past relationships. Why not? Because our lower official interest rates and quantitative easing have narrowed the interest rate “differential” between our rates and the rest of the world.

So, although rising commodity prices have caused our exchange rate to go higher, our quantitative easing has nevertheless caused the dollar to be “lower than it otherwise would be”. Ah. That’s the game he’s playing.


Saturday, June 27, 2020

We should get a fair share of foreign investors' profits

Australia has been a recipient of foreign investment in almost every year since the arrival of the First Fleet in 1788. Yet for much of that time the idea of foreigners being allowed to own so much of our businesses, mines, farms and land is one many ordinary Australians have found hard to accept.

For older Australians, the thought of “selling off the farm” to foreigners makes them distinctly uncomfortable. Why can’t we do it ourselves and own it ourselves?

The short answer is, we could. But had we chosen that path we wouldn’t be nearly as prosperous today as we are. As the Productivity Commission reminds us in a paper published this week, you need money to set up a business, let alone a whole industry.

That money has to be saved by spending less than all your income on consumption. And had we been relying solely on our own saving, we’d have been able to develop much less of this vast continent than we have done. So, from the days when we were a British colony and had no say in the matter, we’ve invited foreigners to bring their savings to Australia and join us in exploiting the golden soil and other of nature’s gifts with which our land abounds.

Total foreign direct investment – that is, where the foreigner owns enough of the shares in a company to have some control over its management – is now worth about $1 trillion. The largest sources of direct investment are, in order, the United States, Japan and Britain. In recent years, of course, most of the action – and the angst – comes from China.

The less poetic way to put it is that Australia has been a “net importer of capital” for more than two centuries. It’s thus not so surprising that, despite whatever reservations ordinary Australians may have, the dominant view among our politicians, business people and economists has been that we must keep doing whatever it takes to attract the foreign investment we need to keep the economy expanding strongly.

For many years it was felt that we always run a deficit on our balance of trade in goods and services with the rest of the world, so we always need to attract sufficient net inflow of foreign capital to be sure of financing that trade deficit – as well as covering all the regular payments of dividends and interest we need to make to the foreigners who have invested in local businesses or have lent us money.

This mentality made sense in the days when we had a “fixed exchange rate” – when the government, via the Reserve Bank, set the value of our country’s currency relative to other countries’ currencies – particularly the British pound and, later, the US dollar – and changed that value only very rarely in situations where it couldn’t be maintained.

The point is that when you choose to fix the price of your currency, you do have to worry about getting sufficient net inflow of foreign capital to cover the deficit on the “current account” of the “balance of payments”. Should you fail to attract sufficient inflow, you’re forced into the ignominy of cutting the price you’ve fixed.

Now, this problem went away a long time ago. In 1983, after we’d been having a lot of trouble keeping our exchange rate fixed and our balance of payments in balance, we decided to join most of the other advanced economies in allowing the value (or price) of our currency to float up and down according to the strength of the rest of the world’s demand for the Australian dollar (the Aussie, as it’s called in the foreign exchange market) relative to the supply of it.

From that day, the two sides of our balance of payments – the current account and the capital account – were in balance, the deficit on one matched exactly by the surplus on the other, at all times. How? Because the price of the Aussie adjusted continuously to ensure they were.

The “balance of payments constraint”, which had worried the managers of our economy for so long, just evaporated. But here’s the point: the attitude that we must always be doing as much as we can to attract as much foreign investment as possible continued unabated.

There’s this notion that, in the now highly competitive, globalised financial markets, if poor little Australia doesn’t try really, really hard, we’ll miss out.

This, of course, is the reasoning behind the unending push by big business for us to cut the rate of our company tax. Our system of “dividend imputation” means Australian shareholders have nothing to gain from a lower company tax rate. The only beneficiaries would be foreign shareholders because they aren’t eligible for “franking credits”.

We’re asked to believe that how well the level of the nominal rate of our company tax compares with other countries’ rates is the main factor determining whether we get all the foreign investment we need. Not even how the tax breaks we offer compare matters much, apparently.

I don’t believe it. It’s a try-on. As the Productivity Commission’s paper reminds us: “Foreigners invest in Australia because of our fast-growing and well-educated population, rich natural resource base, and stable cultural and legal environment.”

Just so. Mining companies flock to Australia because we have the high-quality, easily-won minerals and energy they need. The idea that global companies such as Google or Amazon would give Australia a miss because our company tax rate’s too high is laughable. Especially when they’re so adept at minimising the tax they pay in advanced countries.

We should take a more hard-nosed, business-like attitude towards foreign investors such as the miners, which make huge profits but employ very few workers. When state governments fall over themselves building infrastructure for them and offering royalty holidays and other inducements, it matters greatly how much company tax they pay before they ship their profits back home.

Monday, August 27, 2018

Weakening dollar looks a lot worse than it is

Oh dear. While the pollies have been playing their games, the dollar has been falling and there’s even talk in the market of it going below US70¢. Is this a worry? Short answer: naah.

At the local close on Friday the Aussie was at US72.8¢. That’s down from a recent peak in January of almost US81¢. Is that a bad thing?

Depends who you ask. You can find plenty of people who’ll tell you a low dollar is bad and a high dollar is good. But most manufacturers, farmers and miners will tell you the opposite. The lower the better, they say.

Truth is, a fall in the dollar has some advantages and some disadvantages; a rise in the dollar has the opposite set.

A lower dollar has the disadvantage of making imported goods – and overseas holidays – more expensive. It will add to inflation. But it has the advantage of making our export and import-competing industries more internationally competitive on price.

An Australian item priced in Aussie dollars will be cheaper for foreigners to buy; an Australian item priced in US dollars will now bring more Aussie dollars to an Australian exporter. And overseas-produced goods and services will be more pricey relative to locally produced.

Since our inflation rate is unusually low, and our economy should be growing faster, that doesn’t sound like a bad deal to me.

But that’s just the first part of the story. Because a fall sounds bad and a rise sounds good, many people assume a falling dollar must be happening because we’ve stuffed up.

As we’ve seen, wrong on the first count. And most likely wrong on the second. The exchange rate is a relative price – the value of our currency relative to the value of another country’s currency. In this instance, the Yankee dollar.

Any change in that rate of exchange could be explained by happenings on either side of the Pacific – or a bit of both.

At present, however, all the action’s on the American side. The US economy is growing strongly, with President Trump stimulating an economy already close to full employment by cutting company and personal taxes.

So higher inflation is a significant risk. The US Federal Reserve has already raised the US official interest rate from about zero to about 2 per cent (significantly, higher than our 1.5 per cent), and may well raise it further if it gets more concerned about inflation.

A strongly growing economy, with rising interest rates attracting more capital inflow, is an economy with an appreciating currency. In recent times the greenback has been rising in value not just against the Aussie but almost all currencies.

A fact too few people realise is that, though the Aussie has fallen against the greenback (and the currencies of a few developing countries that shadow the greenback), it hasn’t changed much against most other currencies.

We don’t realise that because we’ve long had the bad habit of regarding the Aussie’s value against the greenback as the exchange rate rather than just one of many.

Economists, however – and particularly those at the Reserve Bank – know not to take such short-cuts. They focus on our “effective” exchange rate – the rate against a basket of our trading partners’ currencies, with each country’s currency weighted according to its share of our two-way trade (exports plus imports).

This is the trade-weighted index, or TWI (pronounced “twy”). Since our trade with the US is less than most people assume, the US dollar’s direct weight in the basket is just a bit over 10 per cent.

So whereas since January the Aussie has fallen by almost 10 per cent against the greenback, it’s fall against the TWI has been a more modest 4.4 per cent.

Which is why the country’s economic managers are neither greatly worried nor greatly excited by the dollar’s movements in recent times.

They see the TWI as simply as being around the bottom of the band in which it’s been moving for the past few years. No biggie.

For someone planning an overseas holiday, it’s not good news if you’re off to the States. But doesn’t make much difference if you’re going to Britain, Europe, N’Zillund or Bali.

But could the Aussie fall a lot further against the greenback? It could, and that’s what economic theory would lead you to expect. But I don’t recommend making currency bets on the basis of economic theory.

As a Reserve Bank assistant governor admitted recently, if she knew how to forecast the exchange rate with any accuracy she wouldn’t be here, she’d be on her private island.

Even so, should the dollar end up falling below US70¢ in coming months, I can’t see the Reserve getting too worried. As I say, a bit more inflation would do little harm and a boost to our export industries would be handy.

Monday, February 26, 2018

Not even the IMF is worried by our huge foreign debt

In its latest report on Australia, the International Monetary Fund says it isn't worried by our net foreign debt, now just a squeak short of $1 trillion. Just as well, since none of us ever worries about it either.

Still, it's nice to have the fund's judgment that "the external position of Australia in 2017 was assessed to be broadly consistent with medium-term fundamentals and desirable policies".

Australia's negative "net international investment position" – consisting of our net foreign debt plus net foreign equity investment – has varied between 40 and 60 per cent of gross domestic product since 1988, it says. At the end of 2016, it was equivalent to 58 per cent.

That's high. So why's the fund so relaxed? Because, it says, both the level and the trajectory of our net international investment position are "sustainable".

It has calculated that a current account deficit between 2.5 and 3 per cent of GDP, which is larger than the deficit of 1.9 per cent it expects for 2017, would allow our total net foreign liabilities to be stabilised at about 55 per cent of GDP.

Note that, for some years now, our net foreign debt actually exceeds our total foreign liabilities (debt plus equity). That's because the value of our equity investments abroad (mainly foreign businesses owned by Australian multinationals and our super funds' holdings of foreign shares) now exceeds the value of foreigners' equity investments in Australia, to the tune of about $30 billion.

The fund derives much comfort from the knowledge that our foreign liabilities (both debt and equity) are largely denominated in Australia dollars, whereas our foreign assets (debt and equity) are denominated in foreign currencies.

Get it? In a globalised world of floating currencies and free capital flows between countries, the big risk for an economy heavily indebted to the rest of the world is a sudden loss of confidence by its foreign creditors, which would be manifest in a sudden drop in its exchange rate (as we experienced at the turn of the century, when the Aussie briefly fell below US50¢).

But when our foreign liabilities are expressed in Australian dollars, the depreciation doesn't increase their Australian-dollar value, whereas it does increase the Australian-dollar value of our foreign assets, leaving our net foreign liabilities reduced.

The broader conclusion is that an indebted country able to borrow abroad in its own currency has a lot less to worry about. And the fact that foreigners are willing to lend to us in our own currency is a sign of their confidence in our good economic management.

And, of course, a big drop in our dollar does improve the international price competitiveness of our export and import-competing industries.

Speaking of which, the fund estimates that, after the heights it reached in 2011 when prices for our coal and iron ore exports were at their peak, our "real effective exchange rate" (that is, the Aussie's average value against all our major trading partners' currencies, adjusted for the difference between our inflation rate and their's) depreciated by 17 per cent between 2012 and 2015.

Since then it's appreciated by about 5 per cent, up to September last year. The fund calculates that, by then, it was about 17 per cent above its 30-year average, leaving it between zero and 10 per cent higher than it probably should be, making it "somewhat overvalued".

The fund says our gross foreign liabilities (debt plus equity) break down into about a quarter as "foreign direct investment" (foreign control of Australian businesses, starting with our mining companies), about half as "portfolio investment" (mainly our banks' borrowings abroad, plus foreigners' holdings of Australian government bonds) and a quarter of odds and sods.

So the mining investment boom was mainly funded directly by the foreign mining companies themselves, including by ploughing back much of the huge profits they made while export prices were sky high.

But this was happening when, after the global financial crisis, our banks were increasing the stability of their funding by borrowing more from local depositors and less from overseas financial markets.

What most people don't know is that most of our net foreign debt is owed by our banks, though that's less true than it was, particularly because recent years have seen more central banks buying Australian government bonds from their original Aussie holders.

Though the central bankers like our higher interest rates, it's another indication that the rest of the world isn't too worried about our financial stability.

Saturday, April 8, 2017

Why we needn't worry about our massive foreign debt

When you consider how many people worry about the federal government's debt, it's surprising how rarely we hear about the nation's much bigger foreign debt. When it reached $1 trillion more than a year ago, no one noticed.

That's equivalent to 60 per cent of the nation's annual income (gross domestic product), whereas the federal net public debt is headed for less than a third of that – about $320 billion – by June.

Similarly, when you consider how much people worry about the future of the Chinese economy, American interest rates and all the rest, it's surprising how little interest we take in our "balance of payments" – a quarterly summary of all our economic transactions with the rest of the world.

Note, I'm not saying we should be worried about our foreign debt. We already do more worrying about the federal government's debt than we need to.

No, I'm just saying it's funny. Why do we worry about some things and not others?

Short answer: the politicians don't want to talk our "external sector" because it sounds bad. The economists don't want to talk about it because they know it isn't bad.

But since we're on the subject – and since Reserve Bank deputy governor Dr Guy Debelle gave a speech about it this week – let's see what's been happening while our attention's been elsewhere.

If you're unsure of the difference between the two debts, it's simple. The federal net public debt is all the money owed by the federal government to people, less all the money people owe it (hence that little word "net").

According to Debelle, about 60 per cent of all bonds issued by the feds is owed to foreigners and 40 per cent to Australian banks and investors. About a quarter of all bonds issued by the state governments is held by foreigners.

In contrast, the nation's net foreign debt is all the money Australian businesses and governments (and any other Aussies) owe to foreigners, less what they owe us. (For every $1 we owe them, they owe us 52¢.)

But how did we rack up so much debt?

Long story. Let's start with the balance of payments, which is divided into two accounts. The "current" account shows the money we earn from all our exports of goods and services, less the money we pay for all our imports, giving our "balance on trade".

Our imports usually exceed our exports, giving us a trade deficit. This deficit has to be funded (paid for) either by borrowing from foreigners or by having them make "equity" (ownership) investments in Australian businesses or properties.

Of course, when we borrow from foreigners, we have to pay interest on our debts. And when foreigners own Australian businesses, they're entitled to receive dividends.

The interest and dividends we pay to foreigners, less the interest and dividends they pay us (actually, our superannuation funds and Australian multinationals), is the "net income deficit".

We've been running trade deficits for so long, and racking up so much net debt to foreigners, that the net income deficit each quarter is much bigger than our trade deficit.

But add the trade deficit and the net income deficit (plus some odds and ends) and you get the deficit on the current account of the balance of payments.

The money that comes in from various foreign lenders and investors to cover the current account deficit is shown in its opposite number, the "capital and financial account".

Because the price of our dollar (our exchange rate) is allowed to float up and down until the number of Aussie dollars being bought and sold is equal, the deficit on the current account is at all times exactly matched by a surplus on the capital account, representing our "net [financial] capital inflow" for the quarter.

It turns out that, in the years since the global financial crisis of 2008-09, the current account deficit has narrowed.

In the 14 years to then, it averaged 4.8 per cent of GDP. In the years since then it's averaged 3.5 per cent. And in calendar 2016 it was just 2.6 per cent.

Why has it narrowed? Well, Debelle explains it's mainly a reduction in the net income deficit component of the overall deficit, which is at its lowest as a percentage of GDP since the dollar was floated in 1983.

The rates of interest we're paying on our foreign debt are lower because Australian – and world – interest rates are a lot lower since the crisis. And our dividend payments to foreign owners of Australian companies fell as the fall in coal and iron ore prices hit mining company profits.

That's nice. But while ever we have any deficit on the current account, our foreign debt will grow, and it already exceeds $1 trillion. Isn't that a worry?

Not really. It's not growing faster than our economy (GDP) is growing, and thus our ability to afford the interest payments.

More to the point, the current account deficit is just the counterpart to all the foreign capital flowing into Australia and helping us develop our economy faster than we could without foreign help.

The proof that such a massive debt doesn't mean we're "living beyond our means" is, first, that the nation – households, businesses and governments combined – saves a high proportion of its income rather than spending it on consumption.

Everything the nation saves each year is used to fund new investment in houses, business structures and equipment, and infrastructure. This investment is further proof we're not living beyond our means.

In fact, the nation invests more each year than we save. Huh? Well, the extra funding is borrowed from foreigners.

You can call it the surplus on the capital account of the balance of payments, or the "net foreign capital inflow" or – get this – the current account deficit.

Wednesday, November 9, 2011

We may be two-speed, but we are all sharing dividends

Forgive my absence at such an anxious time but I've been away on holiday in Western Australia, walking bits of the Bibbulmun Track, which runs from Perth to Albany. The wildflowers were unbelievable. And so was the affluence in Perth, where the mining companies' skyscrapers are so tall they can be seen from Rottnest Island, 19 kilometres away.

How'd you like to be living in Perth, in the winners' circle where everything is on the up, not doing it tough in Sydney or Melbourne, on the wrong side of the two-speed economy?

Actually, things in Perth aren't as wonderful as it suits envious easterners to imagine. Know what they complain about in the West? The two-speed economy. Most of them think they're missing out. Some people may be raking it in, but not me. I'm not on some fabulous salary, just paying the exorbitant house prices the well-to-do have brought about.

Now where have I heard that before? What is it about Australians at present - on both sides of the continent - that makes them so convinced they're missing out and battling to get by?

According to polling by Labor, 68 per cent of respondents believe average Australians aren't benefiting from the mining boom. Is that how you feel? If so, you haven't thought about it. As someone said, there are more things in heaven and earth than are dreamt of in your philosophy.

After such a long plane trip, I was half expecting WA to be like another country. And it's true they have things we don't: magnificent tall trees - jarrah, karri and marri - and strange animals such as quokkas. But step into the bush and it's very much part of Australia: gum trees everywhere, kangaroos and kookaburras.

It's the same story economically. They may have huge reserves of natural gas and iron ore that we don't, but their economy is really just a corner of the greater Australian economy. As the locals are the first to tell you, a lot of the money they make soon finds its way into the pockets of people Over East.

For a start, there are no customs barriers between the states, so there's a lot of trade between them. Step into a WA supermarket and you see they're selling just the same stuff ours do. Which means most of what they're selling was manufactured on the east coast.

Their big mining companies have been making huge profits for the best part of a decade. Nothing to do with you? Every east-coaster with superannuation has a fair bit of their savings invested in the shares of those big companies. So you've been getting your cut.

Your super's been looking a bit sick in recent years? That's mainly because of problems in the rest of the world. Whatever you've got, it'd be looking a lot sicker without the resources boom.

Those mining companies are subject to the federal government's 30 per cent tax on company profits. And the feds' company tax collections have been massive since the resources boom started in the early noughties.

Do you realise that under Howard and Rudd we had cuts in income tax eight years in a row? Where do you think the money came from to finance those cuts?

In the economy, everything's connected to everything else. So if you're conscious of only the direct connections you're missing a lot of the story. And no connection is more indirect - or mysterious - than the way the governments of NSW and Victoria have been benefiting from the good fortune of the WA and Queensland governments.

This arises from our longstanding commitment to the principle of ''horizontal fiscal equalisation'' - which holds that all Australians, no matter where they live, are entitled to the same quality of government services.

That ain't easy, particularly because most government services - education, hospitals, law and order, roads - are delivered by the states. The cost per person of delivering services varies with how big and decentralised the states are. But another factor is the states' varying capacities to raise revenue. These days, states gaining royalty payments from their big mining industry have considerable ''taxable capacity''.

To bring horizontal fiscal equalisation about, the Commonwealth Grants Commission does many intricate calculations which determine how the $48 billion-a-year proceeds from the feds' goods and services tax are divided among the states. The commission works out the average amount of GST paid per person throughout Australia, then decides whether each state requires more or less than that, per person, to be able to deliver services of equal standard.

This equalisation process was introduced in the early 1930s to mollify the restive West Australians. Until just a few years ago, it meant Victoria and NSW got a lot less than the national average, while South Australia and Tasmania got a lot more than average and Queensland and WA got a bit more.

In 2004-05, NSW got just 83 per cent of the national average GST paid per person, while Victoria got 84 per cent. WA got 104 per cent and Queensland got 107 per cent (with SA getting 123 per cent and Tasmania 171 per cent).

But the huge increase in the resource states' taxable capacity thanks to booming mining royalties has changed all that. This financial year NSW's cut has risen to 96 per cent and Victoria's to 90 per cent, whereas Queensland's cut has fallen to 93 per cent and WA's to - get this - 72 per cent.

It works out that, in effect, Queensland's benefit from its mining royalties this year will be reduced by $1.2 billion and WA's by $2.5 billion. Of their combined loss of $3.7 billion, NSW gains $1.3 billion and Victoria $1.8 billion.

Still think you're getting nothing from the boom?


Saturday, October 15, 2011

Understanding the Aussie dollar

Economic theory tells us the level of the exchange rate is an important factor in the health of the economy. Unfortunately, there's nothing in economic theory that can explain the Aussie dollar's strange behaviour in recent weeks. It's hard to know whether to cheer or boo.

We do know the Aussie has a strong and longstanding tendency to move in line with the prices we're getting for our commodity exports so, since during the past few years the prices of coal and iron ore have moved to record highs, it hasn't been surprising to see the Aussie rising to heights not seen since before it was floated in 1983.

It hit a peak of 110 US cents in early August, but seemed to settle at about 105 US cents. But in late September, during a bout of considerable anxiety on world markets about the state of the North Atlantic economies, it fell below parity, eventually getting down as low as 95 US cents.

But then this week it began going back up, reaching comfortably above parity, jumping 3 US cents in just 12 hours on Wednesday.

It's possible we've reverted to an earlier pattern where, when the global financial markets get particularly anxious about economic prospects, investors liquidate their short-term investments offshore and bring their money home to the safe haven of investment in government bonds. So the dollar appreciates (rises in value) and most other currencies depreciate (fall in value). Remarkably, this knee-jerk reaction can occur even when uncertainty about the fate of the economy is a major part of the anxiety.

That's step 1. Step 2 is for investors to calm down and start moving their money back overseas to destinations such as Australia in pursuit of higher returns than offered by bonds. If so, maybe that's what happened this week.

And if that's so, maybe step 2 has merely taken us back to square 1 - a dollar that settles well above parity. But who could be sure US cents Who knows what will happen the next time something really scary happens in Europe or the US cents Will the Aussie drop to, and stay at, a new level significantly below the 105 US cents it seemed to have settled at, or will it just go through a period of high volatility without actually changing its general level US cents

A point to note is that, though the media and markets' focus is always on our exchange rate with the greenback, economics teaches that what matters to the economy is our exchange rate with all our trading partners, not just the Americans.

Say you were taking a holiday in Britain. What would matter to you is our exchange rate with the pound. If you were going to Japan, it would be our exchange rate with the yen. In neither case would you regard our exchange rate against the greenback as particularly relevant.

It's the same story when Australian firms trade with Britain or Japan. Even if the price happens to be set in dollars - as it often is - the Aussie firm will translate that price into Aussie dollars, while the British or Japanese firm will translate it into their own currency.

Put the two together and what matters for the transaction is the Aussie-pound or Aussie-yen exchange rate. So we should be interested in our exchange rate with each of the countries with which we trade. And how much each bilateral exchange rate matters to us depends on how much trade we do with the particular country.

See where this is leading US cents The exchange rate that matters to the economy overall is the average exchange rate for all our trading partners, with each country's currency weighted according to its share of our two-way trade. Economists call this our ''effective'' exchange rate, which is represented by the trade-weighted index.

When you look at what's happened to our exchange rate against that index, you find the volatility in recent weeks is less. While we've depreciated against the greenback, we've appreciated against the euro and the Korean won.

There's always a lot of focus on what's happening to interest rates because we all know how important the rate of interest is to the strength of the economy. A rise in rates will slow economic growth by discouraging borrowing and spending; a fall in rates will hasten growth by encouraging borrowing and spending.

What's less well recognised is that the level of the exchange rate also affects the strength of the economy. So much so that the Reserve Bank brackets the two - interest rate and exchange rate - as ''monetary conditions''. When the exchange rate appreciates, this tends to slow the economy by reducing the price-competitiveness of exports and those domestically produced goods that compete against the now-cheaper imports in our domestic market.

It doesn't have much effect on domestic demand (our spending), but it does slow the growth of aggregate demand (our production - gross domestic product, in fact) by reducing exports and by diverting more of our spending into imports.

Conversely, when the exchange rate depreciates, this tends to speed the economy by improving the price-competitiveness of our export and import-competing industries. Domestic demand isn't much affected, but GDP improves because we export more, and more of our spending goes on domestically produced goods and services rather than imports.

This, of course, is why our manufacturers have been doing it tough under the high exchange rate. They've found it harder to export and to compete against imports. Though it's received far less public sympathy, our tourist industry has suffered in the same way, with fewer foreigners coming to Australia and more Aussies holidaying abroad rather than locally.

Our universities and other education exporters have been hit also.

So I'm quite sorry to see the dollar going back up this week after having fallen by up to 10 per cent from its heights. It would have been great to take a bit of the pressure off the manufacturers, tourist operators and education exporters.

The econocrats have a rule of thumb saying a sustained fall in the exchange rate of 10 per cent should lead to a rise in real GDP of about 0.75 percentage points over the following two years - say, 0.4 points in each year. (The rule also holds for a rise in the exchange rate causing slower GDP growth.)

So whereas a lasting fall in the Aussie might have been bad news for motorists (price of petrol) and people planning overseas trips, it would have helped make our multi-speed economy a little less uneven.


Saturday, June 25, 2011

Raising the bar on the dollar's change in fortune

You may not have noticed, but the econocrats have raised the bar on the amount of economics you need to know to follow the debate about the economy - or, at least, to follow what they are saying about it. The jargon phrase of the year is the "real" exchange rate.

Until recently, heavies from Treasury and the Reserve Bank were content just to say the exchange rate - the overseas value of the Australian dollar - had depreciated (gone down) or appreciated (gone up) by a certain amount.

This was a reference to the "nominal" exchange rate - the one they tell you about at the end of a news bulletin, the one you can find in the business pages and the one your bank will use if you want to change some Aussie dollars into US dollars, euros or whatever.

As its name implies, the "real" exchange rate is the nominal exchange rate adjusted for inflation. But it's not just our inflation rate that comes into the calculation, it's our rate relative to the inflation rate of the country whose currency we're exchanging for the Aussie dollar.

Actually, just to complicate it a bit further, when economists talk of the real exchange rate, they're usually referring to the real "effective" exchange rate. This is our exchange rate, not against the US dollar or any other particular currency, but against all the currencies of our major trading partners, with each partner's currency weighted according to that country's share of our two-way (exports plus imports) trade. In other words, our effective exchange rate is the trade-weighted index.

(Of the 22 currencies in the trade-weighted basket, the Chinese yuan gets a weight of almost 23 per cent, then the yen with 15 per cent, the euro with 10 per cent, the US dollar on 9 per cent, South Korean won on 6 per cent, India rupee on 5 per cent and so on.)

Whether they talk about the nominal exchange rate or the real exchange rate, economists always think in terms of the real exchange rate because they believe it's always real (inflation-adjusted) variables that matter.

It's the real growth in gross domestic product that's important, and real interest rates and real wage rates that influence people's behaviour. (When people pay too much attention to nominal variables, they're said to be suffering from "money illusion".)

Let's assume the nominal effective exchange rate stays stable for a period. If our inflation rate is higher than the average inflation rate of our trading partners, the real exchange rate is appreciating.

If our inflation rate is lower than the average for our trading partners the real exchange rate is depreciating.

Why? Because they are the adjustments necessary to ensure the prices of internationally traded goods and services end up being the same in all countries, as predicted by the theory of "purchasing power parity" (PPP) - economists' main theory about what determines the way exchange rates move.

When economists say a particular currency is overvalued by X per cent, or undervalued by Y per cent, it's the assumption of PPP they're using as the basis for their calculation. But the fact that economists are always making such calculations is a reminder that the actual market exchange rate of a currency can go for years being significantly at variance with where the PPP theory says it should be.

So if PPP holds in the real world, it can only be said to hold over the long term. In the shorter term, lots of other factors affect the way exchange rates move.

However, if we stick to the theory and assume there's an inexorable, "equilibrating" force (a force that moves everything towards equilibrium, or balance) moving every currency towards PPP, then countries that don't allow their currencies to float freely - by, for instance, fixing their currency to that of another country - will find their inflation rate adjusting to move their real exchange rate in required direction.

Thus if you're holding your currency's value too low (according to PPP), you'll end up with an inflation rate that's a lot higher than your trading partners' rates, which will cause your real exchange rate to appreciate. Many economists would say this is China's problem at the moment.

All this is great fun if you like fancy analysis (as economists do), but does it matter? It matters to the economy - and to a lot of business people - because our real effective exchange rate is the best measure of the "international competitiveness" of our export and import-competing industries.

And thanks to the huge appreciation in the nominal exchange rate brought about by the foreign exchange market's response to the sky-high prices we're getting for our coal and iron ore, our real effective exchange rate is the highest it's been since the mid-1970s and about 40 per cent higher than its average since the dollar was floated in 1983. In other words, it's a long time since our tradeables industries were less competitive internationally than they are today. This isn't a great problem for our miners, because the world prices they're getting are so high at present, nor is it a great problem for our farmers, whose prices for many items are high, too.

But it is a big problem for our manufacturers and the producers of our two biggest services exports: tourism and education. Actually, both manufacturing and tourism are import-competing industries as well as export industries. They're getting wacked.

Remember this, however: because economists are so obsessed by prices, they often forget to make it clear they're talking about international price competitiveness. When you're exporting undifferentiated, bulk commodities - whether mineral or agricultural - price competition is the main game.

But for more sophisticated products, there's plenty of non-price competition. You can compete on quality, stylishness, reputation, reliability, service and so forth. You can cater to niche markets the big boys don't bother with. Such "business models" can allow you to have higher prices and still make sales.

Since there's nothing sensible the authorities can do to lower our exchange rate - real or nominal - and since it looks likely to stay high for many moons, the more our hard-pressed tradeables industries focus on non-price competition, the better they'll survive.


Saturday, June 18, 2011

Resources boom has mined a rich seam for everyone

If you haven't said it yourself, I bet you've heard others saying it: ''Resources boom? What resources boom? Whoever's benefiting from it, I'm not. None of it's come my way.''

Is that what you think? Well, don't kid yourself. Whether or not you realise it, you almost certainly have benefited from the boom.

But how have people who don't work in or near the mining industry - and don't live in Western Australia or Queensland - benefited from the miners' good fortune in being paid way higher prices for their coal and iron ore?

Short answer: everyone's benefited because, as Marx observed, in the economy everything's connected to everything else. Or, to put it in economists' lingo, we're all benefiting because of ''the circular flow of income''.

When I spend my income buying something from you, my spending becomes your income. Then, when you spend your income, that becomes the income of someone else and so on, round and round.
How do you know the notes in your wallet didn't start in the hands of a mining company? You don't. Some of them probably did.

The governor of the Reserve Bank, Glenn Stevens, observed in a speech this week that the higher prices the miners are getting have improved our ''terms of trade'' - the prices we receive for our exports relative to the prices we pay for our imports - by about 85 per cent above their 20th century average.

This constitutes an increase in the nation's real income because the same quantity of exports now buys a great quantity of imports. And Mr Stevens estimates the additional income is equal to at least 15 per cent of our annual income (gross domestic product). Although a substantial fraction of that income accrues to foreign investors who own large stakes in many of our resource companies, what's left still represents a very large boost to national income.

Let's trace the extra income going to the mining companies. Some of it would be going to the people employed in the mines, who've had big pay rises in recent years. This wouldn't be a major factor, however, because mining, being so highly capital-intensive, employs less than 2 per cent of the workforce.

Even so, Stevens estimates that, to produce a dollar of income, the mining companies spend about 40¢ on acquiring ''non-labour intermediate inputs'' - goods and services bought from other businesses.

''Apart from the direct physical inputs, there are effects on utilities, transport, [and] business services such as engineering, accounting, legal, exploration and other industries. It is noteworthy that a number of these areas are growing quickly at present,'' Mr Stevens says.

Most of those businesses would be Australian but many would be from other states. Remember, there are no trade or currency barriers between our states, so a lot of trade occurs across state borders.

Once the costs of producing the mining companies' output, and their taxes , are taken into account, the remaining revenue is distributed to shareholders or retained. While a significant proportion of the earnings distributed goes offshore, local shareholders also benefit.

Who are those local shareholders? We are. Most of us are shareholders in the mining industry through our superannuation schemes. We don't get this income directly to spend now - it's in our super. ''Nonetheless, it is genuine income and a genuine increase in wealth,'' Mr Stevens says.

His rough estimate suggests that about 10 per cent of our superannuation assets - $130 billion - is invested in resource companies. And this 10 per cent has been providing a healthy return: over the past year alone, the average return on resources company shares has been about 20 per cent.

A good proportion of the earnings retained by companies is being used to fund the construction of new mines and natural gas facilities. Mr Stevens estimates that about half the demand generated by these projects - for construction and manufacturing - is filled locally.

In contrast to the operation of mines, the construction of them is labour-intensive. Workers are being attracted from all over Australia, which creates job vacancies in the parts of Australia from which they come and also puts upward pressure on the wages paid to people in the relevant occupations - whether or not they make the move. Now let's think about all the taxes the mining companies pay. The federal government's company tax takes 30 per cent off the top of the companies' profits (after granting the companies generous deductions for the depreciation of their assets).

It was booming company tax collections that prompted the Howard government to offer cuts in personal income tax for eight years in a row. So if you've enjoyed any of those tax cuts you can't claim to have had no benefit from the resources boom.

The mining companies also make big royalty payments to their state governments as a price for all the publicly owned resources they pull from the ground. But even if you don't live in WA or Queensland you've still benefited.

How so? The proceeds from the federal government's goods and services tax are divided between the states using a complicated formula that has the effect of spreading the royalty proceeds proportionately between all the states and territories.

Yet another less-than-obvious way the proceeds from the resources boom have been spread around the economy is via the exchange rate. The primary reason our dollar is so high at present is the high prices we're getting for our exports of minerals and energy. And the high dollar has reduced the price of imported goods and services.

So every business that buys imported equipment or components is benefiting from the resources boom, as is every consumer who buys imported stuff - which is all of us. If you've taken an overseas holiday, for instance, you've benefited. If you've taken a local holiday you've probably benefited, too, because foreign competition is holding down local prices.

If you've bought petrol, you've benefited (because the higher dollar has reduced the effect of the rise in the world price of oil).

Now, if you say our non-mining export and import-competing industries have been harmed by the boom-caused rise in the dollar, that's true. In economics, nothing that has benefits comes without costs.

So it's fair enough for those people in the adversely affected industries to argue that, for them, the costs of the resources boom have outweighed the benefits.

But they're a minority. For the great majority of us, the benefits have far outweighed the costs.

Monday, October 18, 2010

Welcome to the harsher, tougher economy

Our high dollar - which could easily go higher - is imposing considerable pain on our farmers, manufacturers, tourist operators and education providers. The pain will intensify over time, but guess what? The econocrats think it's a good thing.

The pollies don't mind either, because the punters think parity with the US dollar is Christmas come early.

Remember, too, that about three-quarters of Australian industry is non-tradeable - it neither exports nor competes against imports. So it is not directly affected, except to the extent that it uses (the now cheaper) imported components and capital equipment.

A higher exchange rate is anti-inflationary and thus does a similar job to a rise in interest rates. It lowers the price of imported goods and services, which reduces consumer prices directly (though, these days, the process is quite attenuated, with foreign suppliers and importers tending to absorb rather than pass on the short-term ups and downs in the exchange rate).

As well, a higher dollar helps to ease inflation pressure by redirecting some domestic demand into imports (for instance, it makes locals more inclined to holiday abroad than at home) and by dampening production of exports (such as accommodation for foreign tourists or education for foreign students).

So, to some extent, a higher exchange rate is a substitute for further rises in the official interest rate. But I wouldn't take this to mean a further rise in rates this year is now unlikely. At best it could mean a rise in early December rather than Melbourne Cup Day.

And I wouldn't even count on that. It might mean one less rise over the next year.

But these short-term considerations for monetary policy (interest rates) are just part of the story. The econocrats - Treasury as well as the Reserve Bank - are very conscious that, thanks to the mildness of the recession, we're fast approaching full employment, which they take to be an unemployment rate of about 4.75 per cent (though no one knows precisely where the point is).

This is happening at a time when the resources boom is back with a vengeance, with our terms of trade (export prices relative to import prices) at their most favourable in a century (ignoring the two-quarter spike in wool prices during the Korean War).

The initial effect is a huge increase in the nation's real income which, as it is spent, threatens the inflationary blowout we've experienced in all previous resources booms. If it doesn't happen this time it will be partly because of the vigilance of the authorities. (Now you know why the Reserve is so concerned about inflation even though the underlying inflation rate is within the 2 to 3 per cent target.)

But it will be mainly because, this time, we have a floating exchange rate and it has done what the textbooks promise it will do: appreciate significantly, thus easing inflation pressures. One part of this mechanism is that the higher dollar effectively transfers real income from the miners to all those industries and individuals who buy imports.

Here you see a further reason why the econocrats think a high dollar is good, not bad, in our present circumstances. But I'm trying to get from the immediate cyclical issue to the longer-term structural one. Sooner or later, coal and iron ore prices will fall back from their present dizzy heights, though they're likely to stay well above their long-term average.

The second element of this boom - the thing that distinguishes it from previous commodity booms, giving it a medium-term, structural element - is the unprecedented boom in mining investment that's about to get started, coming on top of a level of business investment spending during the downturn that was already remarkably high.

Even if some of these projects are abandoned and some are delayed, we're still talking about a huge expansion in our mining sector that constitutes a historic change in Australia's industry structure, affecting the oil and mining industry, the mining services industry and - for a decade or more - the engineering construction industry.

This will require a huge application of resources: labour and financial and physical capital. But because it comes at a time when we're already at full employment then, to the extent we're not adding to our supply of skilled labour via immigration, this will require a reallocation of resources within Australia.

Labour and capital will need to move from non-mining industries to the mining sector and from the non-mining states to the mining states.

The textbook, closed-economy way for this to happen is for the mining sector to bid up wages and other ''factor'' prices until it gets what it needs and can still afford. But in an open economy, the textbook promises the process of reallocation will be assisted by a high exchange rate, which will cause the non-mining tradeables sector to contract, thus releasing labour and other resources to shift to the mining sector.

Now do you see the other reason the econocrats want a high dollar? It is a key part of the market mechanism by which the industrial restructuring of our economy will be brought about without it exploding.

So don't bother telling yourself the dollar is overvalued because of the ''currency war'' (so far its effect on our trade-weighted index is small) or because our rates are so high (our rates are always and inevitably high because our returns on investment are high relative to other countries).

All this says is that times are going to be very tough for people in the non-mining tradeables sector. It's true; there is no denying it.

But whether this weak Gillard government - goaded at every point by an utterly unprincipled opposition - has the courage to stick with good policy is another matter.


Saturday, October 16, 2010

A little fiddling is fine in terms of our currencies

WHAT contrary times: up the front of the paper we're celebrating the Australian dollar's approach to parity with the greenback; up the back we're worrying about the global currency war. Take both with a grain of salt. The Aussie's latest bout of strength is, of course, a byproduct of the alleged currency war. Perhaps a better term is "competitive devaluation". It seems a lot of countries would like their currency to be weaker than it is.

Or, in China's case, weaker than it should be. At the heart of the "war" is the Americans' long-held belief that the Chinese are holding the value of the yuan lower than it should be and this is disadvantaging US export and import-competing industries, adding to the US trade deficit and reducing its economic growth.

The Yanks are half right. The Chinese are holding their exchange rate too low, fixing its value to the US dollar and revaluing it only very slowly. But the Americans are deluding themselves if they think a higher yuan would solve most of their problems. It would just help a bit.

And they have form in blaming other countries for home-grown problems. Before China became the bogeyman they used to blame all their troubles on an overvalued yen. And they don't seem to have heard of "face". The more they lecture the Chinese in public, the less likely it is they'll get what they want.

What's provoked most of the talk about a currency war is the likelihood the US Federal Reserve is about to engage in another round of "quantitative easing" (colloquially, printing money). It's not clear the primary objective would be to lower the value of the greenback but that's certainly a consequence.

It's more likely the Fed just wants to stimulate the sickly US economy. The US government has little scope for more fiscal (budgetary) stimulus and the official interest rate is already down almost to zero, so printing money is all that's left.

It's done by the Fed buying government bonds from the banks, paying for them by crediting money to (as we'd call it) the banks' exchange settlement accounts with the Fed. Where does this money come from? The Fed creates it from thin air.

The effect of the increased demand for government bonds is to force up their price, which reduces their "yield". (The yield is the interest to be earned on the bond, expressed as a percentage not of the bond's face value but its now-higher market value.)

Because American home buyers and businesses tend to borrow at long-term interest rates, lowering the rate on long-term government bonds tends to push down borrowing rates generally. This should encourage more borrowing and spending. And the extra money in the banks' exchange settlement accounts (where it earns very low interest) should encourage them to do more lending.

The lower yield on long-term government bonds should encourage local financial investors to shift to other, better paying financial assets, including corporate bonds. The higher demand for corporate bonds raises their price and lowers their yield, making it cheaper for big American corporations to borrow for expansion.

(That's how it works in principle. At present, however, US households are trying to reduce their debts, not add to them. And businesses facing weak demand for their products aren't of a mood to expand.)

The lower yields on US government and corporate bonds make US financial investors inclined to take their money overseas in search of better returns. They also make foreign investors more inclined to seek higher yields in countries other than the US (including one down under).

This, of course, causes the US dollar to fall in value. For the past month or so it's been depreciating against other currencies as the financial markets merely anticipate another round of quantitative easing.

Some countries have been trying to prevent their currencies appreciating. The Japanese have spent billions intervening in their foreign exchange market, to little effect. A bunch of Asian countries - South Korea, Taiwan and the south east Asians - have been holding their currencies down with the greenback, mainly because they don't want to appreciate against the yuan.

A few big economies - particularly Britain - have also been making noises about further quantitative easing.

And other countries - including Sweden, Canada and us - have been appreciating against the greenback and any other countries than have succeeded in keeping their exchange rates low.

Why do countries prefer a low exchange rate? Because it makes their export and import-competing industries more price competitive internationally.

This, by the way, explains why only those who buy imports - or go on overseas trips - are pleased to see the Aussie reaching parity with the greenback. Our farmers, manufacturers, tourist operators and education providers hate the idea.

So by how much has the supposed currency war overvalued the Aussie? Not much. We were up at about US92 before the war started and that was caused by our own "fundamentals": commodity prices the highest in a century, quite high interest rates by world standards and a rosy outlook for economic growth.

But even the difference between US92 and parity overstates the extent of any over-

valuation. Everyone focuses on our exchange rate with the US dollar, but the US accounts for less than 9 per cent of our two-way trade (exports plus imports).

The best way to judge what's happening is to look at changes in the Aussie's value against the "trade-weighted index" - a basket of the currencies of our 20 biggest trading partners, with each country's currency weighted according to its share of our two-way trade.

The annually revised weights, adopted this month, are: the yuan, 22.5 per cent (up 4 percentage points); yen, 15 per cent (down 2 points); the euro, 10 per cent; US dollar, 8.5 per cent; Korean won, 6 per cent and Indian rupee, 5 per cent. Then, in descending order: Thai baht, Singapore dollar, New Zealand dollar, British pound, Malaysian ringgit, Taiwan dollar and Indonesian rupiah etc.

Since September 10, we've risen by about 8 per cent against the greenback but only by 4 per cent against the TWI, partly because we've actually fallen by almost 3 per cent against the euro. This says we're not particularly overvalued relative to the fundamentals.

As long as countries merely fiddle with their currencies, it's not too terrible. It's if the currency war turns into a trade war - with the US Congress restricting Chinese imports and the Chinese retaliating - that we should worry.


Wednesday, June 2, 2010

Stay calm, this too shall pass

Talk about a two-track economy. Have you noticed how the government and others have been focused on the return of the resources boom, with all the tax bonanzas and challenges that could bring, while the rest of the world has been worrying itself sick about the debt problems in Europe, sending our sharemarket and the Aussie dollar tumbling?

Surely the two don't fit. Are we living in fantasyland? Is reality about to hit us on the head? Or could it be that Europe's problems don't have all that much to do with us and before long the global financial markets will stop panicking and our share prices and currency will recover?

Standard product warning: no one knows what the future holds and economists aren't good at predicting it. But my guess is the end of our world isn't nigh.

Although the Greek government was in over its head even before the global financial crisis reached its peak in late 2008 (and was fudging its figures to hide the truth), most of the other European governments now have big budget deficits and huge levels of debt because of their efforts to rescue their banks and their heavy spending to stimulate their economies.

Those national governments with rocky banks (including the United States) have, in effect, transferred their banks' debt on to their own books. So what started as excessive private debt is now excessive public debt.

I don't criticise them for this. Had they not rescued their banks the outcome would have been a lot worse. No, the real problem is that, unlike us, their affairs weren't in order before the crisis. They'd been running budget deficits even in the boom years and had high levels of debt even before they were obliged to borrow so heavily.

The particularly acute problems in Greece served to draw the attention of the world financial markets to problems in other countries - Portugal, Spain, Italy and Ireland. Even the Brits have huge debt levels.

As often happens, the markets flipped from inattention to panic. When they're in that sort of mood, all the news is catastrophic. The Chinese had jammed on the brakes to burst a property bubble, putting an end to the global recovery. The Australians had nationalised their mining industry (something like that, anyway; not sure of the fine detail).

Whenever the players in world financial markets are gripped by panic their tendency is to sell whatever shares they can wherever they can and buy US Treasury bills. Even when it's the US economy that's at the heart of the problem, they still do it.

The result is a fall in sharemarkets around the world and a rise in the value of the US dollar at the expense of most other currencies. If you remember, this is what happened after the collapse of Lehman Brothers. Our dollar went from US98 in July 2008 to US63 in November. It stayed there until March, then eventually climbed back to US92.

The likelihood is that, as the present panic subsides, our share prices will recover and our dollar will go back up (as it has already begun to). But this return of the staggers is a reminder that a lot of the underlying problems exposed by the global financial crisis are still with us, and will be for a long time.

So perhaps the recovery of sharemarkets in the months following the crisis was a bit too optimistic and this time it won't be as strong.

Certainly, the Europeans won't easily dispense with their debt problems. And the more they feel pressured by the markets to turn around their budget balances by slashing government spending and raising taxes the more they'll slow the recovery in their economies.

The Europeans' problems are compounded by the existence of the euro currency arrangement, and their efforts to hold it together may end up extracting a high price in terms of economic growth. All the troubled member-countries would be better off being able to set their own interest rates and allow their own currency to fall against those of their stronger European trading partners, but

they can't.

The Greeks are so deeply in hock their best solution would be to default on their debt and start again, but that isn't possible. Even leaving the euro would be terribly messy.

So Europe isn't likely to show much growth for the rest of the decade. But this won't hold Australia back as much as it would have in the old days. Our fortunes are now much more aligned with those of China, India and the rest of developing Asia. Are they likely to be adversely affected by Europe's troubles? My guess is, a bit but not a lot.

China's efforts to deal with its property bubble are quite circumscribed, so I don't expect its growth to suffer too much. If so, our authorities' expectations of a return of the resources boom aren't likely to be too far astray.

The thing about financial markets is they make judgments in haste and repent at leisure. If it's right that the prospects for our economy haven't been greatly impaired by the problems of the Europeans and the fine-tuning of the Chinese, eventually our strong position relative to the other developed economies will again be reflected in our higher share prices and exchange rate.

As ever, the ups and downs of the sharemarket will prove an unreliable guide to the prospects for the economy (even though the innocent souls who write headlines sometimes seem to imagine the sharemarket is the economy).

Similarly, the headline-writers' assumption that a fall in our dollar is an unmitigated evil says more about their innocence of economics than their grip on reality.

On this I'm with our farmers, manufacturers, tourist operators and education industry in hoping the dollar's return to the 90s takes as long as possible. There's more to life than overseas holidays.