Pesos to Mexico: Costello waits for dollar to go through the wash

The Australian

10.09.02

The Treasurer is pumping up exports as the dollar faces new pressures

You may have missed this. Yesterday Peter Costello was in Mexico launching a new plastic peso banknote.

What was the Australian Treasurer doing launching a Mexican banknote? Australia, as it happens, printed about 180 million of the new 20 peso notes for the Banco de Mexico. Another 300 million will be printed by Mexico's central bank using Australian plastic note technology.

The Reserve Bank's recent annual report reveals that it is spreading this polymer note plague widely around the world through its subsidiary, Note Printing Australia and a joint venture, Securency Pty Ltd, with Belgium firm UCB Films PLC. Ask our central bankers why they changed over from real currency notes to plastic and they will tell you the new ones can go through a washing machine if you leave them in your pocket.

Customers include New Zealand, New Guinea, Indonesia, the Solomon Islands, Sri Lanka, Bangladesh, Western Samoa, Thailand and Romania. Perhaps they also like banknotes that can be laundered. But Mexico is special, at least it is if you remember your monetary history.

Back in the early 1980s, there was a Latin American debt crisis severe enough to imperil the stability of the US banking system, a big lender to the region. The epicentre of the crisis was Mexico, with a collapse in the peso that made the country's name synonymous with financial default and exchange rate crisis.

A little later in the '80s, the Australian dollar began to slide and in 1986 it plunged after Paul Keating's banana republic remarks. Here is finance minister Peter Walsh's account of a meeting of the Hawke cabinet's Expenditure Review Committee in late July 1986: ``When the ERC met to wrap up the Budget's fine detail on Monday July 28, there was widespread apprehension that the dollar would continue to fall, possibly to below [US] 60c, which was perceived to be a psychological barrier below which it might go into free fall. During the ERC meeting Keating had in front of him a small portable Reuters screen upon which he could dial, every minute or so, the latest foreign exchange quotes from Sydney. He was calling them out, below 62, below 61, below 60, below 59. Finally it bottomed at US57.2c and only then because the Reserve Bank intervened heavily. I was closer to despair than I had been even in 1975 [when the Whitlam government was sacked].''

This episode earned the Australian currency the sobriquet of the Pacific peso, after the Mexican original. The title got a new airing last year, when the dollar plunged below US50c.

Against this background, the spectacle of an Australian Treasurer launching a plastic 20 peso note is both richly ironic and somehow fitting. It is like the symbolic closing of a circle.

The Banco de Mexico might be interested to know that since Australia introduced its first plastic banknote in 1988 the Australian dollar has dropped from around US80c to under US55c. Not that correlation proves causation, of course.

Launching the new Mexican currency is not without risks for Australia's Treasurer. Should the Australian dollar begin to sag he can expect to be known as Peso Pete. While the dollar was heading up towards US55c last night, it is possible to put together a story that could see markets changing their view again. It would go like this.

It seems clear from the national accounts figures last week that Australia's GDP cycle has peaked and economic growth is slowing. But domestic spending is running much faster than the economy as a whole -- about 7 per cent in the year to June versus just under 4 per cent for GDP.

That means Australia's spending is growing much faster than the rest of the world, sucking in imports, and this is showing up in a rising current account deficit. On the latest figures, for the June quarter it is up to more than 4 per cent of GDP.

There is another potential problem to come, the drought. The effect so far has been estimated at 0.5 percentage points of GDP. If the drought continues through this quarter, that result could easily double.

One implication is that Australia's growth rate could fall from the 3.75 per cent forecast in the Budget to 2.75 per cent, or less. A significant part of this lower growth would come in the form of lower exports, implying a rising current account deficit.

The lower growth and its impact on unemployment could be expected to also slow domestic spending, but that takes time. And even as Australia's growth slows, it is still likely to be a relatively strong performance compared with the weak outlook in the US, Europe and Japan, so there will be pressure on imports and on our export markets.

Offsetting these potential pressures on the balance of payments and perhaps the Australian dollar, are at least three factors. One is the attractive yield spread on Australian bonds compared with the US and other markets, which is attracting strong capital inflow from Japan, the US and elsewhere. A lot could depend on whether weaker growth forces the RBA to cut rates, and what happens to rates in the US.

Another is that on economic fundamentals the US dollar is overvalued and may continue to fall. While the Australian dollar has benefited only moderately from a falling greenback so far, this may yet prove a plus. Finally, the fall in Australia's rural exports may be offset by rising prices for some of them because of production shortfalls overseas as a result of drought and floods.

Both the US and Australia have shown it is possible to live with a high current account deficit. And as Alan Greenspan said recently, exchange rate forecasts are where economists make their worst mistakes. Still, we may need all the export earnings we can get from the Reserve Bank's plastic currency sales.