Australia may still pay for its “lost decade”: Kohler

Australia and Latvia have much in common and two important things that are different. In his interview with the ABC’s Insiders on Sunday, Finance Minister Lindsay Tanner talked about Australia’s “lost decade” – of productivity, savings, skills and export development – and repeated Ross Garnaut’s line about the “great complacency”. It was a much-needed shake of the national shoulders, after the avoidance of recession in the March quarter – a reminder that we are not out of the woods.

Latvia also had a “lost decade” and now its economy is imploding, shrinking at the rate of 20% per annum.

During the 2000-07 financial services boom, Latvia and all the Baltic states enjoyed a foreign investment influx that accelerated after Latvia joined the EU in 2004. But the money went to real estate speculation and mortgages, rather than an export-oriented manufacturing base.

It is exactly what has been happening in Australia, as Lindsay Tanner reminded us on Sunday.

The two big differences between the hapless Latvia and non-recessionary Australia are that we have China and they have Germany, and we have a strong, floating currency. Latvia’s currency, the lat, is pegged to the euro so that while Latvia’s economy desperately needs a devaluation, the central bank is burning through its foreign exchange reserves trying to defend the peg.

However, the governor of Latvia’s central bank, Ilmars Rimsevics, ruled out a devaluation yesterday because of the damage it would do to this tiny nation’s mortgagees, whose loans are in either euros or Swedish kroner. And in any case the country does not have enough export industries to take advantage of the greater competitiveness that a devaluation would provide.

Australia’s problem right now is that we could also do with a devaluation (the Australian dollar is clearly overvalued) but it’s not happening because we are NOT pegged to the US dollar.

The US dollar bear market and the related rise in commodity prices, which are traded in dollars, has pushed the Aussie to US80 cents, a shocking burden on exporters who are already struggling with a huge drop in global demand.

The result in April was a collapse in the trade balance from a $2.3 billion surplus to a deficit, thanks to the largest fall in exports for 12 years.

In a way, when the Australian dollar was floated in 1983 it was effectively pegged to commodity prices – as well as to the interest rate differential.

It worked in our favour in 1997 during the Asian crisis because commodity prices fell while the US dollar strengthened, but now it is working against us because the US dollar is weak and commodities are strong.

And neither Ilmars Rimsevics nor Glenn Stevens can do anything about it.

Our other defence against the fate of Latvia – China – is also a double-edged sword, as we are now discovering.

One of China’s great strengths is the control the Communist Party exerts over the economy. The party not only has a monopoly of political power, with tentacles entering every corner of Chinese life, it also controls the business sector, with every important company under state ownership. So if it decides that economic growth must be maintained at 8%, then that just might be what happens.

The trouble is that if you offend one company, you offend all of them – as well as their owner, the government. After Rio Tinto spurned Chinalco last week and went for a supplier monopoly with BHP, the full force of Chinese fury is now directed at Australia – as a whole.

Chinese understanding that Rio and BHP are quite separate and uncontrolled by the Australian government is limited at best, and Australia’s best customer is now unhappy with all of us.

Perhaps this anger will just peter out in the realism of need.

But we are being reminded that, as in investing, it can be dangerous to put all your eggs in one basket.