I would certainly have to agree with Grant here on most of his points. I for one believe that a sustained period of $A strength will result in serious structural problems within Australian economy, if they are not underway already. At some stage the higher $A dollar will translate to lower GDP growth.
In terms of structural problems, there is the real possibilty of the value-adding producers in this country being decimated over time with a high $A. Their profits will be reduced, they will employ less people, become insolvent, or move off-shore.
I would say the Reserve Bank is hoping that reductions in import prices flowing from the higher $A will offset any inflationary effect coming from higher oil prices, and they will therefore not need to lift rates.
Further to Rod's point about lifting rates to combat spending on imports:-
This was a tactic used by the Reserve and the Government in past years, to poor effect.
There is now a realisation that lifting interest rates in response to a higher $A has extremely adverse effects, as Grant alluded to.
Raising the interest rate would cause the $A to rise even further, and would promote even more import substitution/demand, this result being further wealth flowing out of the country. Further damage would be done to domestic producers which would impact further upon GDP. Importantly, raising the interest rate would also have the effect of curbing overall demand, including the demand for domestically produced goods and services, causing a double-whammy effect upon Australian producers. In addition to punishing growth, it would have a deflationary impact, as aggregate demand came right off the boil.
Apart from all this, I believe there is a subtle irony occurring right now, one which has been largely unseen by Australians and the media.
At this very moment, when the Australian Government is completing a free trade agreement with the U.S., and negotiating more agreements other Asian nations, the $A is trading above US78c...and going higher
This is not an ideal situation for our country. Far, far from it. No wonder that Secretary Stone is not the least bit concerned with the fall in the US dollar. His mates in Trade have just grandly succeeded in opening market access to countries like Australia. And the timing couldn't be more perfect.
The signing of a free trade agreement is completely at odds with the situation of a sustained excessive strength of your currency. Allowing full market access in a high currency environment simply facilitates greater outflow of your country's net wealth as foreign imports become even further in demand and they have full access. Your exports dwindle regardless of the fact you having full access to foreign markets, because your $A is higher. Your balance of trade only gets worse and more of your wealth flows overseas, and your country gets further into debt. Considering that Australia's net foreign debt is hovering around 50% of GDP this is disturbing to say the least.
It is even more acute for Australia; a country that imports a vast proportion of its overall consumption of value-added goods and services. In itself, this constitutes a massive outflow of wealth, sustained by burgeoning debt, wealth spent on expensive consumer goods that don't last. In contrast, Australia exports low value commodities. And it runs a trade deficit.
One could conclude that with the advent of free trade agreements, the pressure on the Reserve to maintain the currency at satisfactory level is much more important.
Moreover, the important value-adding sector of Australian industry must be feeling pretty dudded right now. It can certainly blame those bloody Aussie gold producers for the big rise in the $A (with the falling $US), this time.
But they can also blame the Federal government for making life even worse for them...with free trade agreements at a time when out terms of trade are acutely bad and getting worse.
