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1.
The high exchange rate's threat to the competitiveness of the nations products;
the loss of industries and the jobs they represent; the threat to national prosperity if exports are put at risk; and a mounting current account deficit;
are issues of concern that have often arisen in Australia over the last several decades. The concern is valid and the issues real. Those issues are also symptomatic of the growing economic chaos evident in other G-20 countries. Unfortunately, G-20 central banks, such as the Reserve Bank of Australia (RBA) have proved incapable of coming to grips with the economic realities that underlie these issues. An appraisal of the monetary systems that they uphold (i.e.: the floating exchange rates system; and deregulation of banking) and the distortions in the market created by those systems, offers insight into those economic realities.
4. Prior to adopting the float, money earned from exports added to national savings in the form of accumulated foreign reserves.2 When converted to domestic currency, those reserves added to the economies money supply and fuelled growth in the domestic market, and the economy as a whole. Not so, under Friedmans isolated monetary system - Incoming foreign money is spent on imports and other foreign commitments, and leaves the economy. Exporters are paid, but no matter how much is exported, they cannot add to Australias existing money supply.3&3a That is, under an isolated monetary system exports bring no additional wealth to the nation! An alternative variable exchange rate system would allow exports to add wealth.
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6. Isolation of the money supply interferes with, and distorts, the demand and supply mechanism of that economy. Demand skews to favour imports as supply skews to focus on exports. It is in effect an interference in, and distortion of, the market! That distortion diverts the economys wealth away from domestic industries to exporters. Investment in capital equipment tends to reflect that trend. Australias export industries such as mining, wood chipping, and 'live cattle to Indonesia' to do well and expand at the expense of the nations other productive industries and jobs.6 7. A classic example of the diversion of wealth phenomenon is Western Australias mining boom that causes it to be seen in stark contrast to the more economically challenged south-eastern states. This is the so-called 'two-speed or multi-speed economy' effect, which has often been extolled as a blessing by those unaware of the true circumstances.# It is a phenomenon also evident in the European Monetary Union (EMU). It has benefited the great exporting nation, Germany, with positive Current Account Balances over the last 10 years that are mirrored as negative balances for GIPS countries (Greece, Italy, Portugal, and Spain). Paul Krugmans diagram below illustrates the Two Speed (diversion of wealth) the float .interferes with, and distorts, the demand and supply effect of the float. Some believe that the GIPS countries are mechanism of an economy (causing it to go pear-shaped. See Fig 1 below). detrimental to the survival of the EMU, and that the departure of one or more of them from the union can save the euro. But that would cause the debilitating burden that is being borne by those countries to pass on to the next most vulnerable EMU members. They in turn would succumb and leave. As the EMU steadily shrunk, the currency exchange rate for Germanys export goods would rise, and make their domestic industries less competitive with imports. The rust contagion already evident in Germanys industrial regions would spread. (Saving the Euro http://www.buoyanteconomies.com/Saving theEuro.pdf refers). More recently, the growing concern about GIPS countries debts has been causing the downward pressure on the euro exchange rate, and in the process making Germanys exports more competitive. Thanks to the isolated money supply system, Germanys prosperity is tied to survival of the EMU. Similarly, Western Australia is dependent on the rest of Australia.
Fig 1 Germany and GIPS Countries Mirror Reverse Current Account Balances
(Wishful Thinking And The Road To Eurogeddon, The Opiinion Pages, NY Times 7 Nov 2011 refers).
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banks have been creating money for which there is no prior entitlement (i.e. unendowed or unentitled) to their nations productive capacity Money that no-one worked for or saved. 8b.In 1984 and 1985, to stimulate its economy, the Australian government deregulated the nation's banking industry. They relaxed constraints on the banks money creation process. This allowed the nation's expenditure to be no longer constrained by its income.7b Banks have been allowed to create more money, causing demand to further outstrip supply, and distort the market. As a result, Australians have increasingly spent future national earnings in the present. For the banks, things have never been so good.8
Fig. 2 Australia Bank credit, the current account, and fiscal deficit - per http://www.buoyanteconomies.com/AustCADMoney.htm 12
9. Deregulation of the banks has enabled Australia and other G-20 countries to buy more than they have produced. That is, unrestrained bank lending (backed by foreign capital) has caused them to import more than they have exported.9 See Figures 2 and 7 for examples of the correlation between growth in bank lending and the growth in Current Account Deficits. It is a corruption of the market mechanism that imposes other significant distortions on a nations whole economy. Those distortions include a corresponding growths in the: persistent trade deficits (see Fig. 6 below), and inflation (see Fig. 2a above).10# The law discourages forgers because of this kind of damage to the economy that their unendowed money can produce. However, banks the do the very same thing with their unendowed money!
Inflationary Madness
10. Uncomprehending or in disregard of these various systemic distortions, G-20 central banks worldwide are eager supporters and facilitators of the deregulation and the isolated monetary system. Perhaps not surprising, given these instruments of monetary policy are designed to favor the profitability of banks, not benefit the economy as a whole. 10a. Indicative of G-20 central banks, the Reserve Bank of Australia (RBA) make much of inflation rather than exchange rate level being the prime target of monetary policy.10a However, as Fig.2a testifies, RBAs battle to rein-in inflation is ineffective. Significantly, the values for money price pressure show a strong correlation with CPI over nearly three decades - But exchange rate and fiscal policy has not had any noticeable impact on that relationship. 11. For its assault on inflation, RBA (indicative of other central banks) utilise the variable exchange rate to encourage cheap imports into the Australian economy and drive down domestic industry prices. Towards this end, RBA chooses not to target or limit the level to which the exchange rate rises. From time to time, RBA has traded currency to adjust the exchange rate in keeping with this strategy. Their maintenance of high interest rates that attract foreign investment has also played its part in driving up the exchange rate and making imports cheaper.17 RBAs advocacy on behalf of foreign suppliers is unnecessarily generous, given that it provides no benefit in controlling inflation. RBAs irrational encouragement of high exchange rates also accentuates the two speed transfer of wealth) distortion of the Australian economy. The consequent loss of Australian industries and jobs is not only an unnecessary and costly waste, it also undermines the nations productivity.17a Typical of
An insight into the impact of Central Banks, the Floating Exchange Rate System, & Deregulation of Banking on an Economy
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other G-20 central banks, RBA dismisses these victims of its policies as being incompetent and inefficient. More obvious, (especially to exporters, is the high exchange rates inflationary and anti-competitive impact on the price of Australian export products, and their component costs such as labour. RBAs obsession with a strong but uncompetitive Australian dollar is taking its toll. If collateral damage is to be regarded as irrelevant, then the method in this madness can be rationalised - RBAs unrelenting destruction of the economys productive capacity, taken to its not so logical long-term conclusion, will certainly eliminate inflation.
Declining Wages
12. Another indicator of the negative effect of the float and deregulation is average award wages. In Australia, average real wages were rising until June 1984. The real rate of wages growth had been around 4% between 1969 to 1975. Then it slowed to 0.6% until 1983 when Australia floated its dollar. It jumped more than 8% in the year to June 1984 following the float and when the value of the Australian dollar declined rapidly. In the six years from June 1984 to June 1990, average real wages declined at an average rate of more than 1.6% per annum. Since then, average real wages have been rising at about 1.4% per annum. Despite this improvement, the rate of real wages growth is less than half the rate of the 1960s and 70s. Average real wages did not return to their June 1984 levels until June 2003. That is, Australia experienced nineteen years without any growth in average real wages above 1984 levels (See Fig 3). As minimum wages are regulated in Australia, Australian workers did not experience the same dramatic reduction in wages as in the USA. Per Impact of the
Floating Exchange Rate System on Employment and Growth.
Fig. 3 - Australia: Average Real Weekly Wages (Discounted by CPI base 1989/90) 1973 US floated its currency, 1983 Australia floated its dollar.
Defensive Strategies
13. Several strategies have been tried repeatedly in an effort to redress the anti-competitive nature of the float and the imbalance in trade caused by deregulation of banking. One has been in the form of export drives - But unfortunately, an export drive is liable to cause a more concerted upward pressure on the exchange rate for the Australian dollar thus making Australian products even less competitive. Another approach is a Buy Australian campaign. Nor is this a panacea for addressing the attrition of our domestic industries by the float. The demand generated by such a campaign inevitably competes for the same supply of Australian dollars that exporters seek in exchange for their foreign currency earnings. This puts further upward pressure on the exchange rate for our dollar, and ironically makes imports more competitive.
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spending to foreign goods and services now made cheaper. Exporters incomes suffer as well, as their competitive edge is blunted, as in the case of BlueScope Steel in Australia. Some companies like QANTAS go offshore to escape Australias high cost economy. BHP and other companies postpone multi-billion dollar projects like Olympic Dam. 16. Whether a persistent high (and uncompetitive) exchange rate is a result of foreign investment, or the mining industry receiving foreign income for their ongoing exports, it costs the economy dearly. The longer it continues, the deeper countries like Australia will find itself sinking in the recession that it doesn't 'have to have'.
Government Debt 17. Also consequential and symptomatic of 'the float', is the problem world wide of the
growth in government debt. 'The float's persistent attrition of the productive capacity of countries such as the USA and the UK means that government revenue base cannot keep pace with government expenditure commitments to its populace. Australias position in this regard is much better than many others are, but diminishing GDP per capita since 2008 (Fig. 4 below) indicates that the Australian situation is deteriorating. Slowing growth of its revenue base makes a government persistent attrition of the productive increasingly vulnerable to having to fund its commitments with ever-expanding capacity budget deficits. Fig. 2 above shows the Australian Government recently having to respond to its revenue limitation with a fiscal deficit. Expenditure cuts and asset sales by various national governments to reduce their debt do nothing towards resolving the systemic failure emanating from the float. Likewise, Europes recent symptomatic solution of fiscal discipline on its members (the Fiscal Pact), and massive loan bailouts, stands to make no impression on the systemic illness that is bringing the EMU undone. Such measures will tend to make things worse. Australias horizontal fiscal equalisation union of its member state governments has provided an offset for the floats wealth transfer effect on their revenue bases - However, the fiscal redistribution does not compensate the economy as a whole for the attrition that the float steadily inflicts on it and government revenue generally. Fig 2 also reveals that contrary to the twin deficits theory, government budgets do not necessarily influence the current account deficit.12
Fig. 4 Australian GDP per Capita per Quarter (per Buoyant Economies)
Unsustainable Debt
18. As Australias spending in the present has swallowed up future earnings, its capacity to service the mounting foreign debt has steadily diminished (Fig. 5 above refers). After three decades of recurring and growing trade deficits, it seems now that Australia must increasingly generate trade surpluses to pay the interest on its foreign debt. (See 13 Fig. 6 below) Furthermore, the 'float's unrelenting erosion of Australias domestic industries will continue to wear away its capacity to repay its mounting debt.14 Eventually Australias debt will be beyond its capacity to service, and like Greece, it will be at the mercy of its creditors.15
An insight into the impact of Central Banks, the Floating Exchange Rate System, & Deregulation of Banking on an Economy
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19. The two-speed (pear-shaped) effect will tend to accelerate this process. The more populated, and increasingly impoverished southeastern Australian states will progressively diminish Australias capacity for buying imports. Because exports are offset by imports, the exchange rate for the Australian dollar will, in response, rise to make imports cheaper and Australias exports less competitive e.g. iron ore mined in Western Australia by Hancock Prospecting P/L.15b Foreign earnings from expanding productivity of massive mining projects will incur additional upward pressure on the exchange rate, facilitate the flow of cheap imports, and erode mining profitability. In the event of diminished international demand for Chinas products that use Australian ore, the flow-on effect will put further downward pressure on ore production. Mining and carbon taxes will be the least of their worries. The consequent decline in exports will prompt a reduction in the exchange rate. The downward trend may be rapid and the precursor to severe conditions.
Fig 6 - Australias Balance of Trade Jan 1971 to October 2012 - per http://www.tradingeconomics.com/australia/balance-of-trade
In the USA
20. Not unlike Australia, in respect of having incurred an ever-growing current account deficit and a corresponding domestic debt owed to banks, is the United States. But unlike Australia, the US is struggling with massive, crippling, fiscal debt (Fig. 7 below refers). The float has effectively gutted the United States economy. The US economy is now like an egg emptied of substance; just a shell of its former self. A fragile faith in the US dollar is all that has prevented the US economy from collapsing. (http://www.buoyanteconomies.com/DebtIncome.htm refers)
Fig.7 - US Fiscal Deficit, Current Account Deficit, and Bank Lending - per Buoyant Economies
An insight into the impact of Central Banks, the Floating Exchange Rate System, & Deregulation of Banking on an Economy
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21. Though adopting the float in December 1983, Australias first setback in consequence of the float occurred in 1973. President Richard Nixon caused the United States to adopt the float, and thus isolate its money supply in March of that year, having coerced Americas major trading partners to follow suit. Continuing constraints on bank lending (Banks having not yet been deregulated), and the elimination of the ability to accumulate foreign reserves as national savings through international trade, stymied the US (and its trading partners) capacity for economic expansion. A worldwide recession ensued that was to last some two years. As Fig 8 below indicates, the recession was already well on its way when on 18 October 1973, the OPEC oil embargo began because of Americas active support for Israel in the Yom Kippur war. The embargo lasted for 5 months and was undoubtedly the source of major difficulties and costs. Ironically, rather than buffer the float economies, the impact of the oil crisis was made worse by the float initiated recession, and the float mechanism itself. The recession having begun before the oil embargo, continued because the factors that had caused it were still in place. It was the precursor to the particularly unfortunate debt trend for advanced G-20 economies.
Fig 8 - The Recession of 197375 in the USA can be described as a U-shaped recession, because of its prolonged period of weak growth &contraction.[1] Percent Change From Preceding Period in Real Gross Domestic Product (annualized; seasonally adjusted); Average GDP growth 19472009 Source:US Bureau of Economic Analysis also see http://en.wikipedia.org/wiki/1973%E2%80%9375_recession
Misre Economies
Fig 9 Debt to GDP ratios across country groups1880-2009 - IMF Working Paper WP/10/245 A historical public debt database
An insight into the impact of Central Banks, the Floating Exchange Rate System, & Deregulation of Banking on an Economy
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22. The IMF chart above (Fig 9) shows that the turning point where debt to GDP starts to rise for G-20 countries is 1973, the year that the US floated its exchange rate. It reveals a noticeably persistent upward trend in debt levels of advanced G20 countries subsequent to 1973. Page 11 of the paper states that "by 1960 . . . the advanced G-20 economy average debt ratio declined to 50 percent of GDP. . .. Average advanced G-20 economy debt ratios trended down further through the early 1970s; however, debt began to accumulate starting in the mid-1970s, with the end of the Bretton Woods system of exchange rates and two oil price shocks. This upward trend continued until the current global financial crisis.15a
RBA chooses to allow Australian banks to exchange Australian dollars that have no prior claim to the nations productivity (i.e. unendowed money) for foreign currency. (paras 8 to 11 refer). RBA encourages the banks to lend those unendowed dollars, backed by foreign loans, to Australians so that they may buy more foreign goods made cheap by a high exchange rate And add to the nations indebtedness. The consequent loss of many Australian industries and jobs says much about RBAs stewardship. 25. Recently, it had seemed the US was about to leave Australia behind in recognising and taking action to address the systemic disaster that confronts them. President Barack Obama's speech of Tuesday, 6 December 2011, in Osawatomie, Kansas, suggested this. He drew attention to American banks (and ultimately the US Federal Reserves) culpability for much of the US economic woes. A small improvement in employment figures after 6 Dec 2011, indications by the Federal Reserve on 29 Feb 2012 that another quantitative easing monetary stimulus (QE3) was Quantitative Easing - Digging a deeper hole not imminent, and their anticipation of low and steady inflation; also pointed to the possibility that the US had got its act together. QE3 announced 13 September 2012 made nonsense of this. The improvement in US fiscal deficit and employment figures,18and the availability of massive shale oil reserves, has generated belief that the US decent into recession has finished. The only obstacle to recovery perceived by such hopefuls is the political confrontation at the top of the fiscal cliff. However; the US current account deficit continues to grow, and loom large in the background.
An insight into the impact of Central Banks, the Floating Exchange Rate System, & Deregulation of Banking on an Economy
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26. Whether it is the US, Australia, Britain, Iceland, the European Monetary Union, or countries within that union, such as Greece, Friedmans float has taken its toll. Aside from the volatility and instability associated with it, the float progressively erodes the ability of domestic industries to compete against imports; it destroys those industries, and the jobs that go with them; and it prevents exports contributing to economic growth. In tandem with unsustainable debt that the deregulation of the banking industry facilitates, the future faced under the float, instead of prosperity, is inevitably one of massive recession and grinding poverty A vulnerable situation with considerable potential for giving rise to serious national security issues. It is little wonder that China has been so dismissive of the floats peddlers.
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27. It is clear that there needs to be a market-determined variable exchange rate system that excludes the distortions inherent in an isolated monetary system and associated deregulation of the banking industry. One such system is the Optimum Exchange Rate (OER) System. This system allows exports to add wealth to the economy and facilitate growth. The OER also enables incentives to be provided for the market to manage the exchange rate to achieve economic objectives such as full employment, and low inflation. Why not OER? John Griffiths
Originated July 2011 last updated 27 January 2013
The above observations include my attempt to summarise the problem that is the subject of research presented by Leigh Harkness of Buoyant Economies in various papers available at:-http://www.buoyanteconomies.com/ Contact: Gestiefeltbote at gmail.com
End Notes:
1. Australias central bank. 1a. The Floating Exchange Rate System concept was a creation of Milton Friedman, who became an economic adviser to US President Richard Nixon. External shocks and shifts in terms of trade' described as being disruptive that might cause major inflation or deflation effects. (See footnote 10 regarding inflation post 'float'.). This was the declared purpose and benefit for Australia adopting the float in 1983. Banking Industry and the Reserve Bank both advocated adopting the floating exchange rate system. For them, aside from being perceived as mutually convenient in terms of simplifying administrative controls, the 'internationalisation of the Australian dollar' seemed to offer aspects that were seen as desirable. 'A Generation of an Internationalised Australian Dollar', Ric Battellino, Michael Plumb, RBA, address Seoul Korea, March 2009. http://www.bis.org/repofficepubl/arpresearch200903.11.pdf . (see footnote 3). Treasurer Paul Keating was awarded Finance Minister of the Year by Euromoney Magazine in 1984 on the strength of this and related policy implementation. See http://www.davidbrown1801nsw.info/LostStoryFound.html 2. Foreign reserves are the accumulated savings of foreign currencies and gold as in consequence of international trade. 3. Under the previous (fixed) exchange rate system, exporters earned additional income for their economy. That income raised the money supply by raising foreign reserves, that is, national savings. Those savings added to national wealth and economic growth. However, there were other aspects about this system that made it unattractive to banking industry and the Reserve Bank of Australia (RBA), and made them willing to opt for what they thought was a better exchange rate system. (see footnote 1) 3a. While trading does not add to foreign reserves, it does not stop a central bank from adding to the money supply by speculating in the money market for specific purposes. Under the float, sufficient foreign reserves are kept for day to day and longer term administrative requirements (including accommodate the RBAs need to speculate in currency and influence the exchange rate) the but with no intention to accumulate beyond that. 4. Impact of the Floating Exchange Rate System on Employment and Growth at http://www.buoyanteconomies.com/Impact%20of%20floating%20exchange%20rate%20Growth.htm refers. Also, lost industries and jobs translate into lost revenue. 5# Blanchard O and GM Milesi-Ferretti (2011), (Why) Should Current Account Balances be Reduced?, IMF Staff Discussion Note 11/03. Olivier Blanchard and Gian Maria Milesi-Ferretti provide a concise summary of the global imbalance argument in a recent IMF paper.] They describe the difference between good and bad current account deficits. Bad current account deficits are those which result from domestic distortions or excessive fiscal positions. Good ones are those which do not have such causes.' per Guy Debelle, Assistant Governor (Financial Markets) RBA Address at ADBI/UniSA Workshop on Growth and Integration in Asia Adelaide 8 July 2011. 'Leigh Harkness on the RBA CAD perspective' article and succeeding comments on 'Macrobusiness' discussion website of 11 August 2011 also expands on this. 6. Government exchange rate policy has caused the failure of many productive Australian industries - Web page 'The Demise of Australian Industry' lists some of those. 6.# More recently, reference has been made to Australia having a three-speed economy, with the state of Victoria and the Australian Capital Territory sitting in middle place due to retail industry and housing finance. Nevertheless, it is still symptomatic of the floats mechanism that facilitates the redistribution of an economys (isolated) money supply, and foreshadows a looming crisis 7. The adoption of the 'float' placed the banking industry in a pivotal position within the economy, and increased its potential for income.. (see footnote 1). Banks are quite unlike Savings and Loans (S&L) organisations. S & L organisations like building societies and credit unions can only lend from the money that members deposit with them. They cannot alter the money supply. Bank credit is not limited to the money that customers lodge with them as deposits. 7a. Leigh Harkness 14 Jan 2013. See 7 above re creation of money by banks as opposed to S& L organisations. 7b.Treasurer Paul Keating deregulated the system by. (b) granting 40 new foreign exchange licences in June 1984; and (c) granting 16 banking licences to 16 foreign banks in February 1985. Australian Banking History - by Trevor Sykes, Senior Writer, The Australian Financial Review 8. Growth of commercial bank credit due to deregulation whereby the nation's expenditure is greater than its income can be expressed logically as E = Y + Cr, where: E is national expenditure; Y is national income; and Cr is the growth of commercial bank credit. Conversely Y = E - Cr. Para 34 by Leigh Harkness at Impact of the Floating Exchange Rate System on Debt refers. Deregulation was in effect a license for the banking industry 'to print money' (un-entitled money) and guaranteed their profitability. (see footnote 1). In contrast, the money S&L lend has a prior entitlement to the economys productive capacity. (footnote 7) 9. Buying more than we produce by importing more that we export in consequence of 'deregulation' can logically be expressed as M - X = Cr (Cr = Commercial Bank Credit) as explained in paras 32 39 by Leigh Harkness at http://www.buoyanteconomies.com/Impact%20of%20floating%20exchange%20rate%20Debt.htm as M - X = Cr or M = X + Cr (or Cr = M-X.) --
An insight into the impact of Central Banks, the Floating Exchange Rate System, & Deregulation of Banking on an Economy
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See:
An economy dependent on debt for growth, as opposed to one that grows by accumulating savings from international trade, is on the path to recession and exploitation by the other
Gestiefeltbote
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An insight into the impact of Central Banks, the Floating Exchange Rate System, & Deregulation of Banking on an Economy