By Joe Montero

Yesterday’s headline was that the Australian dollar went down yesterday by 0.7 percent, after the Reserve Bank announced it was going to hold the interest rate steady at 1.5 percent percent . Australia’s dollar is falling against all other major currencies as well.

It was already going down and is weaker relative the American currency, although it dipped 0.5 percent against other currencies, despite experiencing a recent period of rises.  The fall was worldwide. The differences are in the extent of the falls. Australia is doing worse than the others.

What is going on?

Basically,with the U.S. dollar being worth more than the Australian alternative, the big investors have been dumping the Australian dollar. A good reason for this is that there is an expectation  that doing this will bring a bigger future return. There may still be jitters about the future of the American economy. But this is the bottom line.

The reason is that there has been a modest improvement there, mostly brought about by a better return on investments in emerging economies, like China and India and a little from the impact of some stimulus government spending in Europe.

The United States is dependent on its overseas investments, rather than its real economy performance at home. But even the home economy has experienced a little growth, led by the car industry. Overall, there has been some increase in capital spending, which is a turn-around from the same time last year. And there is the prospect of major corporate tax cuts under the Trump administration and more importantly, the outcome of stimulus spending during the latter part of the Obama period.

Australia is missing out on the gain. The dumping of the Australian dollar increases an oversupply of currency circulation and this pushes down the natural rate of interest. It is the reason why the Reserve Bank had no other choice but to keep it down. Raising the interest rate would have created a greater misalignment with the natural rate and this would have put pressure on a fragile economy.

This is especially true when the housing bubble looks like it might have ceilinged and is in danger of popping. A rise in the interest rate could make all the difference.

Australia remains far too dependent on the export of fossil fuels and ore, and must increasingly import other needs. There has been a failure to set the economy on a different course.

Australia’s extreme level of deregulation of the financial market has been the great enabler, creating a situation where big banks dictate, without hindrance, where investment funds will go and the government is largely powerless to influence and set limits. Other countries do not allow this. They retain a measure of government control and with this, they are better prepared to take protective action.

There has been and continues to be an opportunity for Australia to move ahead by shifting towards a new technology based manufacturing economy. The knowledge base exists and there is a market with our major trading partners. All it needs is some government support.

One of the outcomes of the failure, is potential greater instability for the Australian dollar as the capital flow current increases. Investors chase the greatest return and will tend towards those currencies that offer them a higher rate of interest and where there is greater economic growth.  A change in demand, changes the relative values of the currencies.

Ultimately, it is the stagnation of investment in Australia and falling demand, coupled with insufficient foreign earnings and capital export that has determined what the Australian dollar is worth.

An ideological barrier has stopped the capacity to turn this around. Governments have been infected with an unshakable confidence that there must be total reliance on the market to allocate resources and a minimum of government interference. This is what has brought us to where we are now. The market is not working.

At the same time, the relatively better present performance of the global market, including that of the US economy, should not be taken for more than it is. The expectation is that the immediate upswing will be short lived. The reason is that the fundamentals driving its longer-term decline are still there.

Nevertheless, Australia cannot draw comfort from this. We are also affected by these fundamentals.

A looming threat is the possibility of the U.S. launching a trade war against China. This has been threatened. If it comes to pass, it will have a major negative impact on the global economy.

Australia is more dependent on trade with China than other countries and the cost of a trade war could cost Australia up to $80 billion a year. China also holds about a third of American debt and if this is dumped, the American and global economies would face a huge crisis. Australia will not be able to evade the tsunami.