The monster CAD (current account deficit) has come despite recent evidence of falling housing approvals, weak retail sales, “acceptable” inflation and record terms of trade. The general conclusion about this unholy conjunction is that the Australian economy is far less competitive than we’d like to imagine.

If domestic demand remains weak, competitiveness may not deteriorate from here and import volumes may decline, or at least stop growing. If global growth continues then export volumes may rise. If the export/import balance improves and the terms of trade stay high, or rise further, the CAD may improve.

Remember that global interest rates are rising and this makes Australia’s debt service – already large because our international debts are large – larger. Tim Colebatch emphasised this point in The Age today. David Morgan is running Westpac cautiously and has pointed out that we’d have been better off if the Reserve Bank had raised interest rates sooner.

BOTTOM LINE: If international investors decide Australia’s CAD is too big, the exchange rate will drop and market interest rates will rise. This will eventually restore competitiveness, but if the necessary movements are large there could be considerable damage to prospects for growth and jobs. The political leadership struggle will increase the chances of this messy end to the long boom.

Read more here.

Peter Fray

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