Action Needed Now, Or A Bad Dream Could Turn Into A Real-life Nightmare

The Age

Friday March 28, 2008

Ernest Rodeck

Australia's trade policy may bring about a severe recession, writes Ernest Rodeck.

WHAT a nightmare. New Holland, our biggest state, seceded and was governed by a dictatorship. Movement of people and money were controlled. A new currency, the dillar, was introduced. Local prices changed from $A1 to one New Holland dillar.

But the external exchange rate was 10 dillars to $A1. So goods from New Holland dropped to one-tenth of their previous cost in $A. They were dirt cheap and imports were streaming into Australia. Our factories could not compete. We earned some dillars from our minerals exported to New Holland. But not enough to pay for our mounting imports from New Holland.

What were we to do? Our leaders said we must not turn back the clock. In future the world will be one big trading area. No quotas, no tariffs, no subsidies.

Then our government pronounced the answer: we borrow the money. Not individually, but through our trading banks. The banks have a first-class reputation and can borrow at fair but modest interest rates, on short term, say 180 days, revolving. The banks will charge a hefty margin. But retail prices will still beat the old locally produced goods by a country mile.

A great solution, except for makers of the local goods. They lost their shirts. But they soon found other pursuits. Some became importers. Others went into mining or farming. Many went into local services such as cleaning or lawn mowing.

We soon got used to cheaper goods from New Holland. Our standard of living improved markedly and our economic experts said that our ever-increasing foreign debt did not matter.

Our debt was mainly in dillars and if the newly established Republic of New Holland wanted to keep exporting to us, it could not expect to get paid in a hurry.

And who can foretell the future? That thought woke me. Free trade agreements, I reasoned, are really agreements for reciprocal concessions. They allow carefully defined trade by one country in return for equivalent trade by another. Hardly free trade.

The problem lies with the way we set exchange rates. Free trade works well within a country. If Western Australia and Queensland experience boom conditions, people move there for better jobs. In time, supply exceeds demand for jobs and some people return. Not so across borders. Why?

We allow exchange rates between currencies to be governed by supply and demand. This is an improvement from when these rates were arbitrarily set by governments and were subject to investor speculation.

The present method requires no official intervention and adjusts continuously. However, it does not reflect relative values between countries. Neither wages, nor the cost of production, nor the cost of living.

The problem is worse where governments deliberately set exchange rates to gain an advantage. Over the past 20 years, from a very low base, China has gradually become an efficient manufacturer. The country has built and tooled modern factories that efficiently make well-designed products to world standards. Consequently, the value of the yuan should have increased about 10 times.

But China has fixed the exchange rate against the US dollar and is outselling the leading manufacturing countries. So these countries or zones, such as the European Union, protect their economies with controls.

The US also controls imports with licences, tariffs and subsidies. However, foreign exchange losses are allowed to mount. But the next administration may reverse this.

But Australia has tolerated a consistent loss policy in international trade for more than 20 years. This may bring about a severe recession and may spell the end of Australia as a financially independent country. Corrective action is needed while our mineral boom lasts.

Initially, we need to balance our trade account. This can be done simply by copying what other countries of the Organisation for Economic Co-operation and Development are doing: free trade where it works, controls where it does not.

Ernest Rodeck is a former national president of the Australian Institute of Management.

© 2008 The Age

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