10/08/2011 - 10:50

Hard calls needed for a competitive West

10/08/2011 - 10:50

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Western leaders face some tough political decisions in the near future.

IT’S all about China, good and bad. That’s the first lesson from what some observers see as a re-run of the 2008 global financial crisis.

The second lesson is that the people in charge of most major economies haven’t got a clue how to tackle the first lesson.

China has been providing the demand that has driven up prices for natural resources, such as those exported by Australia. But it has also been providing the supply of manufactured goods that have driven jobs out of Europe and North America.

So, what does the rest of the world do about China without turning an economic problem into a political problem?

Become more competitive is the only answer to that question, and that means strengthening economies the hard way through sharp reductions in government spending while also targeting lower exchange rates to boost export competitiveness.

Raising taxes is also an option, but going too far down that route, or raising the wrong taxes such as those that make business less competitive, risks further damaging already fragile economies.

The last thing any country needs in a period of great uncertainty is a new form of tax, such as the carbon tax proposed for Australia, which will only serve to raise costs and make business less competitive.

The process started last week by a fresh bout of panic on world financial markets will have two outcomes:

• the start of a delayed ‘race to the bottom’ through exchange rates, given that interest rates in most countries cannot fall further, except in a few rare places such as Australia where rate cuts are a certainty; and

• rapid political change as governments are forced to treat their economies (and voters) with the strong medicine of spending cuts, which was evaded after the 2008 meltdown.

This time around there will be few attempts at artificial government stimulus (the cupboard is bare, governments are broke), but relative calm in financial markets because the banks are awash with cash.

Europe and the US, the world’s two biggest economic regions, have officially run out of options. Neither can afford to continue wasting money on overly generous welfare schemes and social engineering experiments.

Greece is an early example of what to expect in the new world of austerity. Government pension and entitlement schemes will be wound back, the retirement age extended, and subsidies ended on rent, fuel and food.

Voters will hate the end of their free ride, which is why political instability will replace financial instability this time around.

Over the coming months, the debate about what to do will move through a fairly predictable process of finger pointing and fear about inflation as governments crank up their printing presses, or deflation as economies go into reverse, or stagflation, which is the worst of all worlds with high inflation and zero growth.

Who will be the first politician to acknowledge that the Western world is in deep trouble because it has become uncompetitive, thanks to the rise of China with its cheap labour and easy access to markets in the West, while keeping its own domestic market closed to most competition and holding down the value of its currency to boost exports?

China’s extremely competitive economy has enabled the country to siphon off trillions of dollars in surplus cash that was once circulating in the West but is now being hoarded by the People’s Bank of China.

Ironically, China’s cash mountain could now become a major victim of falling asset and currency values, especially US Treasury bonds.

These are delicate times for Australia. We have been a major beneficiary of Chinese demand for raw materials and will probably continue to benefit, albeit at a slower rate.

Marginal resources projects will struggle to survive (except gold), and new projects that lack strong underlying profit margins will not attract the funding they require.

Tough times are ahead, but the toughest test will be for politicians who will be forced to make decisions that will cost them their jobs.

Solar scheme

THE first example of what will happen over the next few years, as governments wake to the need to make serious spending cuts, is the end to generous solar-power purchase schemes.

Western Australia took the plunge last week when it ended an utterly ridiculous scheme which promised to pay homeowners with rooftop solar power systems 60 cents per kilowatt hour for electricity sold into the South West grid – a price close to 10 times the cost of coal-fired electricity.

Created as a tool to win Green votes at the last state election, the scheme was economic recklessness in the extreme, either forcing up the overall cost of electricity or forcing taxpayers to subsidise people with private power systems. Predictably, people who signed up solar power units are now crying foul (quite rightly), and companies selling the systems will probably go broke as business dries up.

There is an important lesson to learn from WA’s solar subsidy scheme and that is ‘someone always has to pay’.

That lesson will now flow through a number of other government schemes, including the National Broadband Network, and the multitude of green energy schemes being encouraged by the Australian government as it constructs its carbon tax and associated hand-out system.

What happened in WA will be played out around the country over the next decade, or until voters wake up to the fact that green energy has a price – a very substantial price.

Shadow world

AS a final thought; the latest bout of global uncertainty has lifted Australia into an elite group of countries with ‘shadow currencies’, a term invented to describe currencies that serve as proxies for the real thing. We’re a proxy for China, the Swiss franc is a proxy for Germany’s once all-powerful deutschmark, and the Canadian dollar a proxy for the US dollar.

What does this mean? For starters it probably means a higher foreign exchange rate for longer as money is diverted out of the troubled major currencies into their shadows – which is not good news for exporters.

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“If you don’t know where you’re going, you’ll end up somewhere else.”

Yogi Berra

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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