Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Investing in the Tulip Crypto Mania 2021 - 19th Jun 21
Here’s Why Historic US Housing Market Boom Can Continue - 19th Jun 21
Cryptos: What the "Bizarre" World of Non-Fungible Tokens May Be Signaling - 19th Jun 21
Hyperinflationary Expectations: Reflections on Cryptocurrency and the Markets - 19th Jun 21
Gold Prices Investors beat Central Banks and Jewelry, as having the most Impact - 18th Jun 21
Has the Dust Settled After Fed Day? Not Just Yet - 18th Jun 21
Gold Asks: Will the Economic Boom Continue? - 18th Jun 21
STABLE COINS PONZI Crypto SCAM WARNING! Iron Titan CRASH to ZERO! Exit USDT While You Can! - 18th Jun 21
FOMC Surprise Takeaways - 18th Jun 21
Youtube Upload Stuck at 0% QUICK FIXES Solutions Tutorial - 18th Jun 21
AI Stock Buying Levels, Ratings, Valuations Video - 18th Jun 21
AI Stock Buying Levels, Ratings, Valuations and Trend Analysis into Market Correction - 17th Jun 21
Stocks, Gold, Silver Markets Inflation Tipping Point - 17th Jun 21
Letting Yourself Relax with Activities That You Might Not Have Considered - 17th Jun 21
The Federal Reserve and Inflation - 16th Jun 21
Inflation Soars 5%! Will Gold Skyrocket? - 16th Jun 21
Stock Market Sentiment Speaks: Inflation Is For Fools - 16th Jun 21
Four News Events That Could Drive Gold Bullion Demand - 16th Jun 21
5 ways that crypto is changing the face of online casinos - 16th Jun 21
Transitory Inflation Debate - 15th Jun 21
USDX: The Cleanest Shirt Among the Dirty Laundry - 15th Jun 21
Inflation and Stock Market SPX Record Highs. PPI, FOMC Meeting in Focus - 15th Jun 21
Stock Market SPX 4310 Right Around the Corner! - 15th Jun 21
AI Stocks Strength vs Weakness - Why Selling Google or Facebook is a Big Mistake! - 14th Jun 21
The Bitcoin Crime Wave Hits - 14th Jun 21
Gold Time for Consolidation and Lower Volatility - 14th Jun 21
More Banks & Investors Are NOT Believing Fed Propaganda - 14th Jun 21
Market Inflation Bets – Squaring or Not - 14th Jun 21
Is Gold Really an Inflation Hedge? - 14th Jun 21
The FED Holds the Market. How Long Will It Last? - 14th Jun 21
Coinbase vs Binance for Bitcoin, Ethereum Crypto Trading & Investing During Bear Market 2021 - 11th Jun 21
Gold Price $4000 – Insurance, A Hedge, An Investment - 11th Jun 21
What Drives Gold Prices? (Don't Say "the Fed!") - 11th Jun 21
Why You Need to Buy and Hold Gold Now - 11th Jun 21
Big Pharma Is Back! Biotech Skyrockets On Biogen’s New Alzheimer Drug Approval - 11th Jun 21
Top 5 AI Tech Stocks Trend Analysis, Buying Levels, Ratings and Valuations - 10th Jun 21
Gold’s Inflation Utility - 10th Jun 21
The Fuel Of The Future That’s 9 Times More Efficient Than Lithium - 10th Jun 21
Challenges facing the law industry in 2021 - 10th Jun 21
SELL USDT Tether Before Ponzi Scheme Implodes Triggering 90% Bitcoin CRASH in Cryptos Lehman Bros - 9th Jun 21
Stock Market Sentiment Speaks: Prepare For Volatility - 9th Jun 21
Gold Mining Stocks: Which Door Will Investors Choose? - 9th Jun 21
Fed ‘Taper’ Talk Is Back: Will a Tantrum Follow? - 9th Jun 21
Scientists Discover New Renewable Fuel 3 Times More Powerful Than Gasoline - 9th Jun 21
How do I Choose an Online Trading Broker? - 9th Jun 21
Fed’s Tools are Broken - 8th Jun 21
Stock Market Approaching an Intermediate peak! - 8th Jun 21
Could This Household Chemical Become The Superfuel Of The Future? - 8th Jun 21
The Return of Inflation. Can Gold Withstand the Dark Side? - 7th Jun 21
Why "Trouble is Brewing" for the U.S. Housing Market - 7th Jun 21
Stock Market Volatility Crash Course (VIX vs VVIX) – Learn How to Profit From Volatility - 7th Jun 21
Computer Vision Is Like Investing in the Internet in the ‘90s - 7th Jun 21
MAPLINS - Sheffield Down Memory Lane, Before the Shop Closed its Doors for the Last Time - 7th Jun 21
Wire Brush vs Block Paving Driveway Weeds - How Much Work, Nest Way to Kill Weeds? - 7th Jun 21
When Markets Get Scared and Reverse - 7th Jun 21
Is A New Superfuel About To Take Over Energy Markets? - 7th Jun 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

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