Jerry Parwada

There has been a mass of negative information over the past few days, and investors can’t just ignore it.

Even though Australian shares have staged a strong rally, it follows Wall Street’s sixth biggest points drop on record. Investors have dumped riskier assets on fears the US is headed back into recession and after the US was stripped of its triple-A credit rating.

Market players are looking for any signs as to the conditions they are going to face in the markets in the short term, and maybe the medium term as well. Uncertainty is stalking the market, even though there isn’t a logical reason for the markets to melt down, as the US debt downgrade had been widely anticipated. However there is a lot of uncertainty about what is going to happen in Europe, and although there are reports that the European Central Bank bought Italian and Spanish government bonds yesterday to try and stem the crisis, there is real fear. While Italy is too big to fail, it is also too big to bail out, and unless there is more belt tightening in Europe, we could see defaults there.

Overnight the Moody’s ratings agency has presented a more hopeful perspective than S&P on last week’s debt-reduction deal, which will cut more than US$2 trillion (S$2.44 trillion) from US government spending over the next decade. Moody’s says that the United States remains on a fiscal footing that is as solid as other AAA-rated countries.

The US debt downgrade will have little practical impact as the US remains the world’s biggest economy and Europe provides no alternative to US bonds as a safe haven. A rating is a measure of probability of a lender getting their money back. In this case it is an estimate that a government is going to ignore its borrowings, but there is little question of that with the US. People will still lend to the US. China will continue to buy US debts. The markets have tanked, but it is just a knee-jerk reaction to the need for information. And all the information is negative, so it has a negative effect on market sentiment.

The Australian dollar has dipped below parity, losing nearly 10 per cent against the US greenback in just two weeks. Meanwhile Chinese data shows consumer prices rose at the fastest pace in more than three years, stoking concern China will not be able to respond to weak global growth by dropping interest rates.

With all this going on, it might mean that a country such as Australia will not be immune to this unfolding crisis after all, particularly in markets for liquid assets such as equities.

Associate Professor Jerry Parwada is Head of the School of Banking & Finance at the Australian School of Business.

Jonathan Reeves

As it tries to find a way out of its debt ceiling crisis and the economic doldrums, a consequence of US policy is that inflation is being exported to the world, and that includes Australia.

Unlike the European Union, or indeed any other enterprise in the world, the US Federal Reserve has the unique ability to print more US dollars if it – and the US Treasury – deems that this is in the US economic interest.

We have had QE1, we have had QE2, and as a result of the debt ceiling compromise we may well also have QE3. The US debt deal includes major fiscal cut-backs, increasing the likelihood that the US will continue to rely on heavy monetary stimulus in its post GFC recovery phase.

It is a policy which is keeping the value of the greenback down and contributing to the record high values for the Australian dollar, a factor which is not necessarily good for our economy. Just ask the Australian education, tourism and manufacturing sectors how they are faring right now.

Inflation is a global issue and the Americans are only one, albeit large, factor in fuelling its momentum. Energy costs are rising, as is the cost of food around the world.

The reality is that US policy has intentionally devalued the $US through the mass printing of money, putting substantial pressure on the AUD$ exchange rate and the Reserve Bank’s inflation and interest rate policy.

Currently, the RBA has an inflation target of between 2 and 3 percent. Referring to this target has been a major reason why the RBA’s official cash rate have progressively risen to 4.75 percent. With a widening interest rate differential it is no surprise that the $AUD has climbed so high against the greenback, as speculators pile into a currency which – like the Brazilian real – is one of the hottest in the world right now.

All this calls into question the wisdom of the RBA’s target inflation numbers. The 2 to 3 percent per annum target is far too low in the current economic climate, and adhering to it can only exacerbate the developing exchange rate, interest rate and export issues we are currently experiencing.

Instead, the RBA should raise its inflation target to 4 percent, a move which would help us avoid some of the economic problems we have seen internationally. Raising the target would certainly take some of the pressure off the RBA to raise interest rates, and it would also take some momentum out of the $AUD’s strength.

Mining magnates may be sitting on unprecedented wealth, but a look at the rest of the economy shows that personal debt levels are at record levels – comparable to struggling economies such as Ireland. Raising rates to fight inflation would create significant financial distress and prompt sharp falls in property values, further dampening already fragile consumer and business sentiment.

Inflation at 4 percent would assist in reducing debt levels, as it did in World War II following the Great Depression.

It seems that the RBA may be mindful of this, despite maintaining its current inflation targets. Earlier this month RBA Governor Glenn Stevens said the board believed “it was prudent to maintain the current setting of monetary policy” in view of the “acute sense of uncertainty in global financial markets over recent weeks.”

The RBA has not raised rates since November 2010, and inflation has been creeping upwards and currently sits at 3.6 percent. Officially amending the inflation target would take the wind out of ongoing expectations of a rate rise and could prompt some easing in the value of the $AUD.

At 3.6 percent, Australian inflation is not high by current international comparisons and does not pose as much of a threat to our economy as record highs for the currency. Given two “evils” – inflation or an appreciating currency – it is clear that our current level of inflation is by far the lesser evil of the two.

In fact, tolerating a higher level of inflation could be the key to helping Australia navigate the turbulence of the global economy.

Dr Jonathan Reeves is a financial economist at the Australian School of Business at the University of New South Wales.

A version of this opinion piece appeared in the Australian Financial Review on the 9 August 2011.

– Ray Spurr

There is little doubt that the strength of the dollar is hurting the Australian tourism industry. As with other trade exposed industries, Australia’s tourism industry will face increasingly tough times in a high Australian dollar world.

The Tourism and Transport Forum has reported that the number of Australians heading overseas outstripped international visitors in the past year. This is the biggest deficit in tourism data history, with 7.4 million trips out of the country and only 5.9 million trips inbound.

A time lag between planning a trip, and arrival, means the full effect on international tourists coming to Australia still isn’t showing up in the statistics. For international tourists coming to Australia full awareness of the extent to which Down Under has become a more expensive destination is likely to filter through only gradually – and having filtered through, these perceptions will take time to dispel when eventually the dollar turns down again.

The Aussie dollar has been at a high of 110 US cents, although it has dropped a little from there. It is also at a 28 year high against Sterling. Against a broad basket of currencies the Aussie Dollar is the best-performing major currency in the past year. The strong dollar is encouraging many locals to leave the country. There is a deficit of 1.5 million people and that is the largest gap ever between the number of Aussies going overseas compared to people from overseas coming to our country.

We can expect to see a further decline in visitor numbers as the impact of the more expensive Australian dollar on our price competitiveness, relative to competing destinations, becomes more widely appreciated. In the meantime tourism incomes will suffer a further cut as those visitors who have set a limit on their holiday budget in advance of their arrival in Australia spend less on tours, wine, food, and souvenirs during their stay.

It is not just tourists from overseas who are staying away from Australia – so are home-grown tourists. Just as important as the loss of income from inbound visitors, however, is the effect of the rising dollar for those leaving the country. As Australians recognise how much further their dollars now go, more of them are choosing to take their holidays overseas. They fund that travel by reducing their spending on consumer goods within Australia or by not paying down their mortgage, and very often by switching from taking a holiday in Australia. The loss is likely to fall most heavily on longer-haul Australian destinations like Far North Queensland, the Gold Coast and the Northern Territory, which compete most directly with holidays abroad.

Ray Spurr is a senior research fellow at the Australian School of Business.