Three Biggest Issues Facing Australian Economy

They are:

1. Inflation
2. Government Intervention, and
3. Protectionism

I’ll get onto that shortly, but first…

It’s probably a few days too early to get stuck into the federal budget. But come Wednesday or Thursday we’ll start to take a look at what it could mean for taxpayers, businesses and the markets.

But we’ll also look at some of the expenditures in there as well. Just one word of warning. If you didn’t like what we wrote about the minimum wage you may not like what we’ll have to say about the massive spending on health, education and welfare.

Of course, you can make up your own mind after you read it.

On Monday’s your editor is on a tight deadline to get Money Morning stuffed into the interweb pipes as early as possible. Before our email servers take a spot of R & R. So we’ll be in quickfire mode today.

Here’s a few related Money Morning reader’s questions we’ve received in recent weeks:

“If the governments handouts create extra demand for a reduced number of goods and services, will it have the same inflationary effect given so many of the goods we consume are produced overseas.”  Glen.

Yes. In fact, it has the potential to make things worse. Because not only do you have to worry about the direct impact of inflation of increased dollars competing for a limited supply, but you also have an issue with the Australian dollar depreciating making those same imported goods more expensive and even more scarce.

How so? We’ve covered this before so we’ll just give it a quick once over this morning. When you are paying for imported goods, the seller will either let you pay in Australian dollars or the currency he/she is exporting from.

Even if the seller allows you to pay in Australian dollars, the seller will have to do something with those Australian dollars. They can either invest the money locally (bonds, cash, etc), or they can buy Australian goods using Aussie dollars and then import those goods to their own country.

Or they can just sell the Aussie dollars in exchange for his/her local currency. That’s the principle problem when you are not producing enough goods in your own economy. Therefore if there is an excess of imports against exports it will naturally have a negative impact on the currency and put further pressure on inflation.

And this from TD:

“I guess I am quite left in my political and economic thinking, so my question(s): What industries have a strategic element (not just commercial) that our governments should protect from competition? How can we as Australians be confident that we are competiting on a remotely level playing field? For example; Japanese workers are paid double that of Aussie workers and VW is about to become the biggest car maker by volume. I have just guessed the pay differnces but you get my idea.”

It’s an excellent question. And it isn’t just those on the ‘left’ that immediately believe the cure for protectionism and uncompetitive local industries is to protect them even further. Just look at all the supposed free-marketeers and capitalists who have lined up begging for government handouts.

The truth is that the only way to improve Australia’s competitiveness in the global economy is for less regulation, less taxation, and more flexible employment and trade contracts – and yes, that would mean getting rid of the minimum wage and other labour protections.

However, that’s only one side of the coin. The other side is that employees would have more flexibility as well. And with less government bureaucracy, tax rates could be reduced to only a nominal level.

It may not be popular to say it or write it, but it’s a fact, no western economy can compete with overseas manufacturers when there is such a high burden of regulation and bureaucracy on businesses, and such a high level of taxation and burden on employees.

Further protectionism will only cause more problems.

Plus this one from Charles:

“My question here is, now that the Aus dollar has been devalued, wouldn’t I be better for me to hang in there, let this high interest come thru and then enjoy this high inflation property price after, rather than sell in a declining property market? It may be another 2years to 4 years time before we get there, but like all things, hard time require hard yakka, we just have to hang in there?”

That question from Charles is on a slightly different subject. But it is still related to the inflation, productivity and quality of life equation. We’ve received many, many emails from readers suggesting that the best thing to do is buy a house, take out a big mortgage and then let “inflation pay it off.”

We’re very, very, very uneasy about that scenario. Not that we disagree with the theory, because we don’t. However, the danger is that it is only feasible in isolation.

The idea that you could take out a mortgage for $1 million today and then pay it off in 10 years with inflated dollars is mouthwatering. As is the idea that the value of the house will have similarly become inflated to be worth tens of millions of dollars.

But even before you look at the theory, the best thing to do is look at practical examples of such scenarios. Look at Zimbabwe and Weimar Republic Germany, where they’ve experienced hyperinflation. There are very few people dancing for joy at having paid off their mortgage thanks to inflation.

Even in the case of high rather than hyper inflation, the outcome will not be as rosy as you would think. Sure, the mortgage drops as inflation rises and incomes rise with it. And sure, there could be an inflationary impact on the price of housing.

But don’t forget that other costs also increase as well. So even if the value of a $1 million house increased to $10 million in ten years, inflation will have impacted other costs too. Your weekly shopping that now costs $200 could cost you $2,000 per week by then.

Your average weekly income of $1,000 per week today, could mean the average person is earning $10,000 per week in ten years.

These are extreme examples. But would the standard of living necessarily be any higher? No, in fact it could be worse. Especially if increased regulation and bureaucracy causes even more of Australia’s manufacturing and production to be sent offshore.

Finally, there was also another excellent email a couple of weeks ago to the Money Morning mailbag which your incompetent editor seems to have accidentally deleted. The gist of it was, “What’s wrong with the government printing money and handing it out? Everyone will be happy then.”

Of course, we paraphrase because we can’t remember the entire thing.

Sometimes it’s the simplest questions we get that are the best. The funny thing of course is that there is virtually no difference between what the Money Morning reader wrote to us and the policy actions being taken and promoted by well-paid and “respected” economists.

If you were to picture two or three years ago a member of the general public asking NABs Alan Oster if the government should just print money and hand it out, he would have scoffed and laughed and said what a silly idea it was.

Roll forward to just a few weeks ago at an ASX presentation and Mr. Oster was in fact suggesting the government hadn’t spent enough.

The reason why the government shouldn’t simply print money to make everyone happy is that it devalues the dollars already in circulation. This causes the demand for goods to rise and therefore causes prices to rise.

“But why wouldn’t the shop keeper keep their prices the same?” is a common question to this response. The best way of putting it is to think of an auction for goods. Let’s use a house auction as an example.

Two bidders bid the price up to $300,000. They are both about to reach their maximum bidding limit – of course neither is aware of the others position. But then the government approaches each of them and gives them another $30,000 dollars each.

What will the bidders do? Will they stop bidding or will they both bid up until the $30,000 is exhausted?

In some way, that’s exactly what has happened with the first home-buyers grant. Except in that scenario there is even less of an incentive for the bidder to walk away, because in effect the government is saying you can have the $21,000 but only if you spend it on a house.

Embracing inflation, government intervention and protectionism is the surest way to ensure that the economy gets an increase in all three and will inevitably lead to bigger problems.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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