Even though the sound of the tumbrel is growing, you can say one thing about Julia Gillard’s economic speech yesterday: at least her advisers understand quite clearly what the biggest issue and influence in Australia is going to be for the next few years — the strength of the Australian dollar. Perhaps they have read the numerous speeches from Reserve Bank governor Glenn Stevens and other officials in the past year in which they carefully explain why the dollar will remain higher than it did last decade.

That’s more than you can say about Tony Abbott after his appearance at the National Press Club on Tuesday.

Gillard and her advisers have the benefit of advice from Treasury. Abbott doesn’t. But it was striking and quite worrying that Abbott failed to mention the strength of the dollar and the damage it will do to Australian business and the ambitions of politicians and federal governments.

The high dollar is sending a massive shock through the economy, one that will have impacts on companies and governments for years to come. Gillard was at least realistic in her comments accepting this new reality that the dollar will remain high for some time to come. It will drive much of the change that Gillard sees in creating “the new Australian economy”, a horrible cliché to go with her election slogan “moving forward”. But that change won’t be the way she sees it. Strong currencies crunch, not stimulate as weak currencies do.

We understand the impact of the strong dollar on sectors such as manufacturing. But the strength of the dollar will be a huge influence on government revenues in coming years. It will influence the drive to get the budget back into surplus next year and it will also be the single largest influence on employment. A strong currency cuts collections from company tax, slashing the lazy, easy revenue for companies used to riding the weak dollar for all it’s worth and picking up on the swings (and burying the losses). In turn, it makes life tougher for employees and unions as companies become more cost-conscious. GST revenue stays static or falls as revenue shifts offshore and inflation is curbed. That also means all those indexed government charges and excise duties linked to CPI come under pressure.

So controlling government spending becomes even more important, at all levels, federal, state and local. That means the capacity for tax cuts is severely circumscribed: they have to be paid for with real expenditure cuts (forget the option favoured by conservative economists and other daydreamers to claim that tax cuts will stimulate revenue).

More and more local companies are coming to terms with this reality. Some manufacturers are shedding jobs (Holden, BHP, Ford, Toyota in the car industry, Mortein and others). Manufacturing is maintaining output while continuing to cut jobs, suggesting productivity is lifting. The Performance of Manufacturing Industry survey for January (which measures activity in the sector), climbed above 51, which indicates solid expansion. It has been rising for several months after being depressed for much of 2011.

This will be a slow process of adaptation, and it will be painful for those in sectors such as manufacturing. But the process will continue. Whether the dollar is now the safe haven the Prime Minister claimed yesterday is debatable –- the potential for volatility remains, given it’s the sixth most traded in the world (for economy that’s about the 20th biggest around the globe). The Australian dollar is one of six foreign currencies the Chinese government allows its currency to be “paired” with for trading purposes. The currency is in far greater demand than the size of the economy would dictate.

But foreign investors, including central banks, have been buying Australian government bonds to diversify their reserves away from the US dollar and euros. With the US Fed to keep rates at the current record low until 2014 instead of 2013 (that could change if the US economy continues its solid performance of the moment), the Aussie dollar will stay around current levels for another couple of years.

You only have to look at the way the currency bounced from the October low of just over 92 US cents back above parity with the US dollar, and then remained above that level during December and January as the US dollar rose against the faltering euro. The Aussie didn’t lose ground. As we pointed out last month, the Aussie actually rose against the greenback in December and January, one of the few times it has gone against trading convention and not fallen as the greenback has appreciated. The Aussie dollar rose at a time when fears about Europe and the euro were at their peak (they have since fallen sharply): normally such fears send the currency lower, as they did last October. But not this time around.

That was because of solid demand for Australian dollar debt and assets, and the lack of full convertibility for the Chinese yuan. That has allowed our dollar to become a proxy for China for foreign investors. China’s not likely to change for some years, so our currency will continue to be sort by foreigners wanting to hedge their exposure to China and other emerging markets.

The government has had a crash course in the implications of a strong currency over the past year. The opposition still doesn’t get it. If and when he’s elected, Tony Abbott will be in for a rude shock: the strong dollar will confine his ambitions every bit as much as it will confine those of the Gillard government.

Peter Fray

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