Tuesday 19th October, 2010 – Melbourne, Australia
By Kris Sayce

One of the reasons why you may read this letter each day is because you like reading about the economy and economics.

Although I’m sure there are plenty of other reasons too… not that I can think of any off the top of my head, but there must be some.

Your interest in the economy and economics may even have caused you to take up a class at night school or even made you encourage your kids to study economics at university.

Before you jump into that, I hope you don’t mind if I offer you some free advice… FOR THE LOVE OF GOD, DO NOT STUDY ECONOMICS AT UNIVERSITY!

I’m serious. Enrolling yourself or your offspring in a university economics course is the worst thing you could ever do.

Their mind will be poisoned with Keynesian claptrap that will take you a lifetime to cure them of.

Taking an economics degree… well, you may as well just sign them up for a religious cult. We’re sure there are plenty of those around. And quite frankly, a religious cult would probably be better for them too.

Of course if you are an economics professor at an Australian university and you don’t spread nonsensical Keynesian bilge then drop us a line and I’ll give your Uni a free plug…

But as an example of the nonsense that’ll get shoved down their throats at most universities, look no further than a truly terrible and simplistic article from Peter Martin over at The Age.

It contains everything that is wrong with modern mainstream economics. It’s the best – or worst – example of not understanding how an economy works and how the individuals that make up an economy behave.

We knew what to expect when we read this sentence from his article:

“But the main way a boost in export income spreads throughout the nation is by increasing the value of the dollar. Think of it as automatic socialism – spreading the gains…”

Oh dear! What else should we expect from The Age, their journalists dreaming of socialism.

But that’s not all, Mr. Martin goes on:

“In a direct sense manufacturers also benefit from the higher dollar. Every dollar a manufacturer earns, every dollar a manufacturer has already saved, buys more. But in the same way as having a higher wage might put a job seeker at a disadvantage when it comes to getting or keeping a job, suddenly charging a higher price when expressed in foreign dollars will make it harder to sell your product.At home you will be competing against suddenly more affordable imports.”

“It’s less of a concern now, in part because there’s less manufacturing than there was. Most of the Australian textile and clothing firms that used to compete with overseas suppliers have shut up shop. Mitsubishi has stopped making Australian cars.”

“And the manufacturers that are still here are increasingly importers as well as exporters.”

I’ve underlined the middle paragraph because that was the one that made your editor weep with despair.

But it’s also pleasing to see that Mr. Martin recognises the disastrous policy of a minimum wage. When he states, “But in the same way as having a higher wage might put a job seeker at a disadvantage when it comes to getting or keeping a job…”

That’s right, minimum wage rates put job seekers at a disadvantage because they can’t voluntarily offer their labour at a lower rate. We’re glad to see even the socialists admit now it.

Back to the underlined section. Only in the addle-brained world of mainstream Keynesian economics is it seen as a good thing for the economy to make fewer things. Only in the muddle-headed world of mainstream Keynesian economics is it seen as a good thing for “textile and clothing firms [to]… shut up shop.”

Yet unfortunately, this is the kind of thing almost every economics professor is teaching their students in Australia today.

That manufacturing jobs are low value jobs, that they aren’t needed, that the Australian economy has moved on to something better such as… erm, mobile phone stores and call centres.

Not that there’s anything wrong with those industries. Don’t get me wrong. They provide a useful service and benefit to the economy and to consumers.

But odds are, the service they’re providing is to sell mobile phones and other products that are made overseas and imported into Australia.

Now, not that we’re calling for protectionism here. And we’re certainly not doing a Dick Smith jingoistic ‘buy Australia’ dance. No, with the dollar as high as it is, you should take advantage of cheaper goods from overseas… as I’ve mentioned before, I do it all the time.

The point is, that contrary to what the mainstream bods tell you, a rising dollar is only half the story. It’s not, as they might lead you to believe, the full story.

Sure, Mr. Martin is right – as we’ve argued all along – that Australia’s resources sector is keeping the Australian economy afloat. That the demand for Australia’s natural resources is helping to beef up the Aussie dollar as exporters convert US dollars – the currency in which most commodities are priced – back into Aussie dollars.

But don’t be mistaken for thinking that’s the only reason for the advance of the Australian dollar. Don’t forget about those cheeky speculators and derivatives.

Think back to the near collapse of the global economy in 2008. What caused it?

Well, one of the catalysts was falling house prices. People who had borrowed more than they could afford, suddenly realised they couldn’t afford the mortgage repayments. So, they upped and walked away, leaving banks and creditors in the lurch.

But the global economy didn’t nearly collapse just because Mr. and Mrs. Weeboken from Skancapalooza, Wisconsin walked away from their mortgage debt. And it wasn’t just because hundreds of thousands of other borrowers did the same thing.

No, what helped to bring everything crashing down was the rush to the exit by investors and speculators. Speculators who no longer had any faith in the banking system and therefore looked to profit from its failure, or hedge against its failure.

Both are essentially the same thing.

Remember that the total value of the US subprime market was only around USD$1.3 trillion in 2007.

Yet because of the interwoven nature of financial markets, at risk was USD$62 trillion worth of credit derivatives. Not all of those derivatives were directly exposed to subprime mortgages, but they were at risk.

Simply because of relative risks in finance. An increased perception of risk in one asset class can cause investors to reassess the risks in other classes. It can cause a drag, dragging investments across the risk curve even though fundamentally nothing may have changed for other asset classes.

Investors and speculators shifted from being risk hungry to being risk averse.

The situation is similar now with the Australian dollar. Let’s be honest, even the burgeoning demand for Australia’s natural resources isn’t enough to cause the Australian dollar to rally by 20% in just five months:

Not when you consider that for the twelve months between September 2009 and August 2010 Australia’s exports totalled $265.6 billion. That’s potentially $265.6 billion being changed up from foreign currency into Aussie dollars.

But then of course, over the same period there was $264.1 billion of imports. That’s Australian dollars being sold in order to buy goods and services priced in foreign currencies.

That leaves you with a net boost to the Australian dollar of [ahem], $1.5 billion. A big number, but hardly something that could move a currency by itself by a massive 20%.

Just to show you what I mean, let me put things in perspective. Keep that $1.5 billion in the back of your mind for a few more moments and consider this…

Now, I’ll admit this is old data, but according to the Bank for International Settlements (BIS), in April 2007 the average daily turnover on foreign exchange markets was USD$3.2 trillion.

Got that? And that’s just the daily number. That makes the annual turnover something like USD$800 trillion.

That’s the total market of course. As of 2010, the Australian dollar contribution to the foreign exchange markets was about 7.6% of the total.

So if we take those numbers again you’re looking at about USD$243 billion and USD$4.8 trillion respectively.

And now use your personal Memory Recall button to bring back that $1.5 billion.

In other words, the goods and service contribution to the Australian dollar foreign exchange market is a puny 0.03% of the total annual turnover.

That means my friend, that 99.97% of the turnover is… speculation.

Don’t forget that the foreign exchange market is probably the most leveraged and speculative market there is. Even as a small-time retail punter you’re able to deposit a few hundred bucks with a CFD or FX provider and leverage – say – $1,000 up to $100,000.

In fact, I’m pretty sure there are some providers where you can leverage $1,000 in to a $400,000 position! Good luck with that…

What we’re saying is this, while the mainstream commentators are basking in the glow of a strong Aussie dollar and claiming that it’s a sign of a strong economy, and that a strong Aussie dollar is fine because we don’t have a crappy manufacturing sector anyway, just remember that 99.97% of the reason why the Aussie dollar is so strong is due to speculation.

Punters are betting on the resources boom continuing. A boom that contributed the following to the Australian economy in 2009:

– Coal exports $39.4 billion
– Iron ore exports $29.9 billion
– Gold exports $15 billion (net gain of $6 billion once you minus $9 billion of imports)
– Natural gas exports $7.6 billion
– Crude petroleum exports $7.2 billion (net loss of $5 billion once you minus $12.3 billion of imports)

In other words, $4.8 trillion is being gambled every year on foreign exchange markets on the expectation that Australia will continue to export around $100 billion or so of natural resources exports.

But because it’s speculation it means things can turn very quickly. You only have to look at the Aussie dollar price chart in 2008 to see that:

Once the resources boom grinds to halt, or even stops growing as fast as it used to, there’s nearly $5 trillion of speculative money that can turn on a sixpence and push the Aussie dollar in the opposite direction.

The message is clear, make the most of the strong Aussie dollar while you can, just don’t fall for the message that the likes of Peter Martin and other mainstream commentators are feeding you.

In economic terms, the fact that the Australian dollar is strong and Australia only has a minimal manufacturing base isn’t something to cheer. In the short term it’ll give you the appearance of strength, but in the long term it’ll only succeed in making Australia’s already lopsided economy even more unbalanced.

Cheers.
Kris Sayce
For Money Morning Australia

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