How Does Australia Encourage Foreign Savings

Throughout its history Australia has had to rely on foreign savings to finance its development as did America until the World War I. This savings inflow showed up as a current account deficit that averaged 2.5 per cent of GDP. The 1980s monetary explosion under Keating saw this average leap to about 4.5 per cent.

The soothing argument was that this sudden rise only meant that more foreign savings are being invested in Australia. That most of the foreign debt was incurred by the private sector was waved about as proof of this proposition. The debt, we were told, was being used to generate future income.

If only it had been that simple. The painful truth is that a good part, if not most, of that capital inflow was wasted and the previous
It is claimed by some that Australia has been forced to finance this debt by selling off the farm, and this is largely the fault of the private sector borrowing. This is economic nonsense. The 1980s saw the money supply spin out of control; at one point monetary growth was averaging 25 per cent a year. (In 2001 the present government allowed M1 to explode by 22 per cent and deposits by 25 per cent).

As any classical economist — a much maligned breed — would have warned, the results were rising interest rates and rising current account deficits. True, the monetary expansion stimulated the economy — it also gave us an unsustainable boom followed by the inevitable bust.

With monetary demand rising, interest rates at historically high levels and inadequate domestic savings the private sector was forced to borrow abroad. Much of the borrowings by business went into mal-investments: investments that would turnout to be unprofitable. This happened because the monetary expansion (inflation) misdirected production and hence investment by sending distorted price signals to investors.

The situation was aggravated by a speculative fever fuelled by the boom and by any elements of the tax structure that favoured debt. Only accelerating inflation could maintain these mal-investments. Eventually, as we know, the government finally punctured its monetary boom with 20 per cent plus interest
Exports, as every student of economics used to know, are the price of imports. Our ‘80s and ‘90s current account deficits, which we are still running, mean we are exporting surplus dollars that the Reserve Bank of Australia created. Not surprisingly, foreigners have used their dollar claims on Australian goods to buy companies, shares, real estate, etc.

These goods have been exchanged for all those lovely imports. In other words, they are what we have used to buy foreign goods. That this simple fact appears to have escaped most economic commentators' attention is a disgrace.

This is a monetary lesson and it has obviously not been learnt. Now we have Kenneth ‘Chomsky' Davidson seriously arguing that "budget cuts, combined with the refusal of the Government to borrow to finance infrastructure investment in rail and ports in the sacred name of balanced budgets, has been the major constraint on Australia's ability to earn or save foreign exchange and the reason the current account deficit has blown out to a mind-boggling 7 per cent of GDP". (The Age, Going bananas for a big debt elephant, 3 March 2005).

The mind boggles. But what does one expect from a man who thinks tax hikes cure recessions. (The Age, From superpower to dinosaur: America's destiny, 29 July