Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Could Gold Price Reach $7,000 by 2030? - 6th Aug 20
Bananas for All! Keep Dancing… FOMC - 6th Aug 20
How to Do Bets During This Time - 6th Aug 20
How to develop your stock trading strategy - 6th Aug 20
Stock Investors What to do if Trump Bans TikTok - 5th Aug 20
Gold Trifecta of Key Signals for Gold Mining Stocks - 5th Aug 20
Stock Market Uptrend Continues? - 4th Aug 20
The Dimensions of Covid-19: The Hong Kong Flu Redux - 4th Aug 20
High Yield Junk Bonds Are Hot Again -- Despite Warning Signs - 4th Aug 20
Gold Stocks Autumn Rally - 4th Aug 20
“Government Sachs” Is Worried About the Federal Reserve Note - 4th Aug 20
Gold Miners Still Pushing That Cart of Rocks Up Hill - 4th Aug 20
UK Government to Cancel Christmas - Crazy Covid Eid 2020! - 4th Aug 20
Covid-19 Exposes NHS Institutional Racism Against Black and Asian Staff and Patients - 4th Aug 20
How Sony Is Fueling the Computer Vision Boom - 3rd Aug 20
Computer Gaming System Rig Top Tips For 6 Years Future Proofing Build Spec - 3rd Aug 20
Cornwwall Bude Caravan Park Holidays 2020 - Look Inside Holiday Resort Caravan - 3rd Aug 20
UK Caravan Park Holidays 2020 Review - Hoseasons Cayton Bay North East England - 3rd Aug 20
Best Travel Bags for 2020 Summer Holidays , Back Sling packs, water proof, money belt and tactical - 3rd Aug 20
Precious Metals Warn Of Increased Volatility Ahead - 2nd Aug 20
The Key USDX Sign for Gold and Silver - 2nd Aug 20
Corona Crisis Will Have Lasting Impact on Gold Market - 2nd Aug 20
Gold & Silver: Two Pictures - 1st Aug 20
The Bullish Case for Stocks Isn't Over Yet - 1st Aug 20
Is Gold Price Action Warning Of Imminent Monetary Collapse - Part 2? - 1st Aug 20
Will America Accept the World's Worst Pandemic Response Government - 1st Aug 20
Stock Market Technical Patterns, Future Expectations and More – Part II - 1st Aug 20
Trump White House Accelerating Toward a US Dollar Crisis - 31st Jul 20
Why US Commercial Real Estate is Set to Get Slammed - 31st Jul 20
Gold Price Blows Through Upside Resistance - The Chase Is On - 31st Jul 20
Is Crude Oil Price Setting Up for a Waterfall Decline? - 31st Jul 20
Stock Market Technical Patterns, Future Expectations and More - 30th Jul 20
Why Big Money Is Already Pouring Into Edge Computing Tech Stocks - 30th Jul 20
Economic and Geopolitical Worries Fuel Gold’s Rally - 30th Jul 20
How to Finance an Investment Property - 30th Jul 20
I Hate Banks - Including Goldman Sachs - 29th Jul 20
NASDAQ Stock Market Double Top & Price Channels Suggest Pending Price Correction - 29th Jul 20
Silver Price Surge Leaves Naysayers in the Dust - 29th Jul 20
UK Supermarket Covid-19 Shop - Few Masks, Lack of Social Distancing (Tesco) - 29th Jul 20
Budgie Clipped Wings, How Long Before it Can Fly Again? - 29th Jul 20
How To Take Advantage Of Tesla's 400% Stock Surge - 29th Jul 20
Gold Makes Record High and Targets $6,000 in New Bull Cycle - 28th Jul 20
Gold Strong Signal For A Secular Bull Market - 28th Jul 20
Anatomy of a Gold and Silver Precious Metals Bull Market - 28th Jul 20
Shopify Is Seizing an $80 Billion Pot of Gold - 28th Jul 20
Stock Market Minor Correction Underway - 28th Jul 20
Why College Is Never Coming Back - 27th Jul 20
Stocks Disconnect from Economy, Gold Responds - 27th Jul 20
Silver Begins Big Upside Rally Attempt - 27th Jul 20
The Gold and Silver Markets Have Changed… What About You? - 27th Jul 20
Google, Apple And Amazon Are Leading A $30 Trillion Assault On Wall Street - 27th Jul 20
This Stock Market Indicator Reaches "Lowest Level in Nearly 20 Years" - 26th Jul 20
New Wave of Economic Stimulus Lifts Gold Price - 26th Jul 20
Stock Market Slow Grind Higher Above the Early June Stock Highs - 26th Jul 20
How High Will Silver Go? - 25th Jul 20
If You Own Gold, Look Out Below - 25th Jul 20
Crude Oil and Energy Sets Up Near Major Resistance – Breakdown Pending - 25th Jul 20
FREE Access to Premium Market Forecasts by Elliott Wave International - 25th Jul 20
The Promise of Silver as August Approaches: Accumulation and Conversation - 25th Jul 20
The Silver Bull Gateway is at Hand - 24th Jul 20
The Prospects of S&P 500 Above the Early June Highs - 24th Jul 20
How Silver Could Surpass Its All-Time High - 24th Jul 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Is China Driving the Australian Economy Out of Business?

Economics / Austrailia Apr 21, 2008 - 09:59 AM GMT

By: Gerard_Jackson

Economics I have written several articles drawing attention to the possibility that monetary policy may have reduced the ratio of manufacturing to GDP, only to have my concerns dismissed by the likes of Des Moore, a former Treasury official, as not being part of "the traditional explanation". But I was not saying anything new or radical. The possibility of an overvalued currency reducing the size of a country's manufacturing base is sometimes called the "Dutch disease" or the "dual economy".

This happens when foreign demand for a country's primary products, e.g., gas or oil, artificially raises the exchange rate which in turn makes domestic manufacturing more expensive relative to foreign manufactures. The result is a current account deficit. If this situation is maintained current account deficits will accumulate and the production structure 'of which the manufacturing base is a part ' will be severely distorted. Sooner or later these distortions will have to be dealt with.

Although Terry McCrann is fully aware of the "Dutch disease" , which is more than can be said of other commentators, he utterly failed to understand the forces at work even though he admitted that an overvalued currency can drive firms offshore. (Herald-Sun, China's rise bears different fruit, 18 April 2008). According to his line of thought everything is basically sound because of the huge number of jobs that have been created. (I>Herald-Sun, 'Two-speed' claims ring hollow, 11 April 2008).

The fallacy here should be obvious to any serious student of economics. First and foremost: so long as there is sufficient land and capital available widespread persistent unemployment cannot emerge in a free market. It follows from this that so long as labour costs are at least kept in line with the marginal value of the workers' productivity unemployment will not be a mass phenomenon, even when monetary policy has caused the manufacturing base to shrink. And monetary policy is the key to the problem. Therefore McCrann's conclusions are worthless in this respect because his employment figures tell us nothing in themselves about any detrimental changes to the production structure brought about by monetary expansion.

The view that an increase in the demand for Australian raw materials raised the exchange rate to the disadvantage of manufacturing invites more questions than it answers. The most important question being: why didn't the exchange return to its market rate as determined by the theory of purchasing power parity? This brings us to what was known as the "transfer problem" which is still very much with us. This "problem" dealt with the process by which international payments are transferred from one country to another and how transfers that disturb the balance of payments are corrected.

Under a gold standard the kind of exchange rate disturbance that we have been experiencing for years would be quickly dealt with. Let us say that a highly industrialized country discovered massive deposits of copper ore that could be cheaply extracted. The classical explanation has it that gold would flow in and raise domestic prices. This would reduce exports of manufactures and increase imports. The increased demand for imports would reverse the gold flow until domestic prices were at the level determined by their purchasing power parity.

In fact, what would really happen ? as was experienced at the time is that foreign demand for the country's raw material would raise domestic incomes which would rapidly increase the demand for imports without having to ship gold. Hence the transfer occurred without any changes to the domestic price level or the production structure.

The situation is very different , though the principle remains the same in a world where only paper money is allowed. China has engaged in massive credit expansion, one of the effects of which has been an enormous demand for raw materials, particularly in Australia. In order to buy Australian raw resources China must acquire Australian dollars. Now those who sell dollars acquire yuan in exchange. The dollars do not leave the country. They remain here and are used to buy Australian factors of production, including labour services.

Basically one of two things can happen when Australian dollars are exchanged for another currency. (The process is not quite as simple as I am making it out to be). The banks can use the foreign deposits to expand domestic credit and hence the money supply. (This happened in the 1960s with Eurodollars) or the deposits can be 'sterilized' so that the stock of money remains unchanged. If sound money policies were the order of the day, those who dealt with China would find that the quantity of dollars would increase in line with the amount of yuan that was exchanged.

This process would be an imitation of the gold standard and would have the same effect and would therefore eliminate any current account and exchange rate problems. But a world of paper currencies is one of continuously changing monetary stocks, severe exchange rates disturbances, chronic current account deficits, large-scale malinvestments, etc. In other words, world-wide inflation. If I am half-right then Australia's monetary policy will have been very loose. And this is exactly what we find. From March 1996 when Howard won his first election to November 2007 bank deposits rose by 224 per cent and M1 by 200 per cent.

Unfortunately the significance of these figures are completely lost on Mr McCrann. We already know that an obvious effect of an overvalued currency is to cheapen imports. But according to Mr McCrann

. . . the stuff we buy back from China (and, again, other similar places) that's made out of this increasingly expensive raw material is actually getting cheaper. Consumer goods. . . For example, plasma TVs have dropped in price by 25 per cent-30 per cent, just since Christmas. . . Those falling prices are of course cutting inflation. But also making it harder for the Reserve Bank to cut consumer spending with those interest rate rises.What it wants to achieve is to cut inflation even more, because of all the other pressures forcing up prices. (Herald-Sun, Our Budget to get a coal-fired boost, 13 April 2008)

Our analysis explains these 'cheap' goods terms of a monetary disorder created by loose monetary policies. (I am not disputing that part of the price declines is due to falling costs of production). In plain English, the process that Mr McCrann asserts is "cutting inflation" is in itself a product of inflation. Unfortunately Mr McCrann's ego does not allow for a sensible critique of his economic views.

The above raises the question of whether the damage done by inflation can be reversed. As Gottfried von Haberler put it:

... the process of inflation always leaves behind it permanent or at least comparatively long-run changes in the volume of trade and in the structure of industry. The impact effect is a change in the direction of demand. At he points where the extra money first comes into circulation purchasing-power expands; elsewhere it remains for a time unchanged. (Gottfried Haberler, The Theory of Free Trade, William Hodge and Company LTD, 1950, p. 54).

By Gerard Jackson

Gerard Jackson is Brookes' economics editor.

Copyright © 2008 Gerard Jackson

Gerard Jackson Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules