Why the $AUD is hurting the economy

A lot has changed since the start of 2013. A Federal Election has been announced by our (now marginal) Government, growth in China has eased more than expected, the budget deficit has ballooned further and the share market has risen considerably without supporting fundamentals. Furthermore, our currency remains at all-time highs and official interest rates are also high (by global standards). There’s no doubting these factors, when combined, make for an interesting economic forecast for Australia.

Arguably, the high $AUD is the most significant factor here. With the exception of cheap imports and overseas holidays, an overvalued currency is detrimental to Australia’s economy. Tourism, exports and private sector investment are all big concerns right now. It’s expensive for overseas travellers to come to Australia, our exports are overpriced compared to our global competitors and businesses (both local and overseas) are cancelling projects left, right and centre in Australia because it’s cheaper to do business offshore. Since the start of the year, $120b in projects have been cancelled, the most notable being Woodside Petroleum’s cancellation of the Browse LNG Project worth $45b.

It goes without saying that an enormous number of Australian businesses have been affected. Flow-on effects include a reduction in government tax revenues (they have fallen off a cliff) and pressure on unemployment. Add to this a high level of inflation that has largely been fuelled by the Government’s industrial relations policies that reward workers for no increases in productivity (e.g. increased rate of pay on weekends and public holidays), and it suddenly becomes clear that Australian businesses have been doing it tough recently.

Now, we are starting to see the effects of a high currency flow through to the economy and with growth in China now moderating, Australia can no longer rely on demand for our (overpriced) resources to keep us afloat. The so-called 2-speed economy of recent years is over.

Problem is, the Government didn’t see this coming. Until now, their strategy has been to create new taxes (namely the mining tax and carbon tax) to cash in on continued resources demand from China. Simply put, they have missed the boat and in the interim, Australian businesses have been left to suffer the damaging effects of an overvalued currency. Only now has the penny dropped with Treasurer Wayne Swan stating the budget deficit is now far greater than anticipated and as a result, to expect significant expenditure cuts (as well as more new taxes) in next week’s budget.

Rather than attempting to tax their way out of debt, what the Government should have done was act to devalue the currency. Had they done this 12-18 months ago (and there still seems to be no intention to take action on this, creating more new taxes and cutting expenditure seem to be preferred options), then Australian businesses would be in a healthier position and we probably wouldn’t have companies cancelling investment in Australia. Furthermore, our economy would be better placed to cope with the slowdown in resource demand which single-handedly kept us out of recession during the GFC.

With a change of Government seeming likely in September, we can only hope the Coalition would act quickly to devalue the $AUD and scrap the current industrial relations policies. The Government should consider a quantitative easing strategy (e.g. print more money) like the US, Europe and most recently Japan, have done. In addition, they should cut interest rates to further reduce the attractiveness of the currency. Doing this would increase tax revenues (as business turnover improves), increase commodity prices (as demand comes back) and stimulate the share market (particularly companies like BHP whose share price is strongly correlated with commodity prices, and cyclical growth stocks whose earnings are being held back by the high currency).

However, a trade off is we may see high-yielding stocks (think banks, retailers, telcos and health care companies) decline in value sharply as investors sell out and get back in to growth companies. There is a real risk of this occurring as share prices for high yielding companies have, for the most part, been driven up purely by investors’ demand for yield due to low interest rates (i.e. fundamentals don’t support current valuations). Time will tell but in the interim, bring on the election.