Economies settle in to a familiar cycle

RUDI Dornbusch is the Professor of Economics at Massachusetts Institute of Technology, regarded as one of the finer establishments in the world.

On a recent trip to Australia, Professor Dornbusch addressed a gathering of interested partici-pants at a private dinner held with the Australian Business Econo-mists Executive Committee. He was fairly persuasive in the following arguments.

United States

The US would have a normal recovery starting in the second quarter of 2002 and showing 3 per cent plus annualised growth in the second half of the year because expansionary monetary and fiscal policy would overcome all the negatives people mention, including:

p the shock of September 11 would wear off;

p the overcapacity in IT would be whittled away (helped by extra defence spending;

p the world would continue to fund the US current account deficit (the alternatives of buying euros and yen are not attractive); and

p the wealth of US citizens has not collapsed despite the 2000-01 fall in stock prices because of accumulated stock price rises since 1993 and the fact that house prices continue to rise at a robust clip.

Japan and Asia

Japan and Asia will not return to normal growth, however, because:

p the US cannot recover to 4 per cent growth since the once-every-30-years-type boom is over;

p Japan has nowhere to go. Structural reform would ensure deeper recession immediately and expansionary monetary and fiscal policy is all used up. Indeed, Professor Dornbusch worries that Japan may be on the verge of an emerging-markets-type crisis, which would see, among other things, a plunging yen. It depends on whether Japanese bondholders lose faith and seek offshore investments; and

p the Asian economies remain unreformed, saddled with high debt, very cyclical (tied to electronics) and have a weak neighbour, Japan. Dornbusch talks about “half-speed Asia” for the next 10 years, meaning he expects GDP growth of 3 to 4 per cent a year, not 8 per cent as in the past. Of all the Asian economies, he thinks China is the best managed.

Australian dollar

p Unlikely to be a major commodity boom ahead (slower recovery than in the past, low metals intensity of global IP).

p Unlikely to be much $US weakness (until Europe makes the transition to the competitive industry structures and productive practices that a single currency promised but has not yet delivered – and will not for some years – because the Europeans like their lifestyles more than new wealth creation).

This implies that the $A would not rebound to anywhere near 60 cents over the next few years. That is contrary to PPP-based or unit labour cost based or commodity price related frameworks used by many Australian economic forecasters.

When we look at Professor Dornbusch’s economic commentary there are no obvious surprises. I think we are all comforted by the analysis that suggests that the flow-on effects of September 11 will not be as severe as originally believed.

The issue related to the take up of technology as a result of the increased defence spending is also quite pleasing.

The prospective increase in defence spending will mean that the capacity built up over the recent past will now start to be utilised more fully and should result in corporate profits in the technology sector picking up again.

The news for our dollar is not good from one point of view.

For travellers heading overseas, the low value of the Aussie dollar means a much lower purchasing power.

However, it is the low dollar that has allowed our economy to be so resilient in the recent past. The dollar has meant that our exporters have seen boom conditions that have moved our trade balance to a surplus situation, something not seen for a very long time in this country.

The continuation of the dollar at the low levels means that these conditions should, hopefully, continue for some time.

One of the basic tenets that we lived by in the past was that if we had a low Australian dollar we would have a spike in inflation as we had to pay more for our goods from overseas. That “imported inflation” would flow through to our CPI numbers in Australia.

In the recent years this certainly has not been the case.

We have seen the increased import prices being more than offset by the massive surge in exports, which has allowed the Reserve Bank to maintain its very vigilant overview of the inflation rate.

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