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Australian Economy Heading Into Stormy Seas

Economics / Austrailia Dec 20, 2007 - 09:16 AM GMT

By: Gerard_Jackson

Economics The problem with Terry McCrann's economic opinions is not that they are terrible but that they are largely shared by the rest of our economic commentariat. For instance, McCrann cheerfully reports that over the year to October credit for business rapidly expanded. Now he did temper his enthusiasm with the observation that the trade deficit jumped from $1 billion in July to $1.8 billion in August before jumping to $3 billion in October. As he put it: "Import volumes are soaring, thanks to the high Aussie dollar."

He should have said over-valued dollar. What is missing here is anything resembling economic logic. This is why he ? along with his fellow commentators ? has been unable to make the link between the Reserve's reckless monetary policy, soaring imports, an increasingly burdensome foreign debt and business investment.

I am truly sick and tired of having to point out to our brilliant commentators some basic monetary facts. The most important of which is that money matters . From March 1996 to July 2007 currency grew by 101.6 per cent, bank deposits by 177.7 per cent and M1 by 169 per cent. Ponder these figures for a moment and then ask yourself this simple question: How can any economic commentator worthy of the name pretend that these money supply figures have had absolutely no influence on the economy? Older economists would have had no difficulty in making the connection. As one economist said:

In a free economy the principal cause of a cumulative deficit in a country's international payments is to be found in inflation. . . In a country whose currency is not convertible into gold, inflation leads to its continuous devaluation in terms of foreign currencies. (Michael A. Heilperin, International Monetary Economics , Longman?s, Green and Co., 1939, p. 123).

At the time of writing Heilperin's economic thinking was well within the mainstream. These economists understood that a country that ran a heavy current account deficit year after year was in a state of monetary disequilibrium. If prices in a

. . . particular country have become so high in comparison with prices abroad as to weaken that country's competitive position, a price adjustment would have to take place to restore equilibrium. (Michael A. Heilperin Aspects of the Pathology of Money , Michael Joseph LTD, 1968, p. 22).

We can conclude that by raising nominal incomes monetary expansion has fueled the current account deficit. It follows that a monetary tightening is the only way out. There is no gainsaying the fact that a monetary squeeze would send the economy into recession. But it needs to be stressed that a recession would have its roots in the Reserve's previous loose monetary policies. Moreover, delaying a recession will in all probability make the situation even worse. The signs are about that emerging bottlenecks and rising inflation along with the trade deficit may force the Reserve's hand early next years.

It can be argued that because Price Waterhouse Coopers Australian manufacturing index (Australian PMI) stood at 53.8 in November this proves that the currency is not having a detrimental effect on the economy. Things are not always what they seem ? particularly in economics. A great deal of manufacturing inputs are being imported. This, I believe, has helped to avert a profits squeeze. There is another point that needs to be addressed. Because the structure of prices has been distorted manufacturing has probably become more oriented to domestic production while other manufacturing enterprises have been driven overseas by the over-valued dollar. In other words, the country's capital structure has become badly distorted.

The response of the Treasurer Wayne Swan to these problems was not reassuring. It is his belief that the solution to the deficit lies in expanding the country's productive capacity. Swan has committed the glaring error of thinking that the deficit and bottlenecks are structural and can be overcome by increased investment. Like everyone of his predecessors and their advisors Swan is completely ignorant of monetary and capital theory.

Even if the Reserve does not turn off the monetary spigot real factors will eventually move to terminate the boom. Any attempt to overcome this with a monetary binge will only serve to aggravate the inevitable financial hangover.


By Gerard Jackson

Gerard Jackson is Brookes' economics editor.

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