Wednesday, January 05, 2005

Will Exchange Rate Appreciation Kill the Australian Economy?

Some good news from the Australian economy points to something I've been suspecting for a while. While exchange rate appreciation might hurt export industries and generate deflationary pressure, there are also positive effects. One of the most important is that it encourages consumption, as a more appreciated exchange rate increases the price of services relative to goods. Most employment in most economies (especially industrialized economies) is tied to the service sector, so the drag from lower competitiveness isn't as big as the boost from greater purchasing power as goods become cheaper, compared to wages in the service sector and to asset prices.

This is why the US economy didn't implode in the 1990's, when the dollar strengthened so dramatically. Now the Euro is staging a come-back, and most observers are calling for "maximum pain". While I don't expect a boom of dot-com proportions (or anything even close), I think people will be surprised at how well the European economy fares despite Euro appreciation.

Australian Dec. Services Index Rises to 2-Yr High (Update1)

Jan. 6 (Bloomberg) -- Australian service industries expanded in December at the fastest pace in two years as demand increased at recreation, property and business services companies and retailers.

The performance of services index, which measures activity for retailers and other service companies, jumped 5.9 points to 65.4 in December, Commonwealth Bank of Australia and the Australian Industry Group said in a report e-mailed to Bloomberg News. A reading greater than 50 indicates the services industry, which accounts for two-thirds of the economy, is expanding.

An increase in the services index, coupled with a report showing December retail spending surged, suggest the Australian economy may rebound from its slowest growth in almost four years. The fifth-largest economy in the Asia-Pacific region expanded 0.3 percent in the three months ended Sept. 30 as exports and home building fell.

Then again, the Korean economy is pointing in the opposite direction. That said, I think there are confounding factors peculiar to the Korean economy here, and the slump is not just a function of the won's exchange rate.

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