Budget Deficit

Here’s an interesting article that explains why the value of the AUD is so unlinked to fundamentals of the Australian economy and also why it fluctuates wildly compared to other currencies – http://bit.ly/1PVUDLA

The trouble with these effects is that they impact upon the ability of Australian businesses to both export as well as to import for capital investment purposes.

That is, the over-fluctuating and weirdly valued currency removes the certainty which is required for business investment.

I believe this is a prime reason why Australian economy is so focused on the domestic services sector, simply because this is the one sector where there is more business certainty, shielded as it is from currency movements.

One potential solution to this problem would be for our governments to fund their annual deficits with newly printed currency, rather than long term bonds or foreign debt.

This would put downwards pressure on the currency and help link the value of the currency to the economy in a more first-order manner.

In fact, when there are budget surpluses the government could also destroy currency, much like a corporation doing a share buy-back. This should enhance the value of the currency.

A side benefit of funding budget deficits by quantitative easing would be that it would be a form of taxation that is biased against unwanted trade deficits. By devaluing the currency all noteholders have reduced ability to buy imports or spend money overseas.

Such an immediate and transparent impact of government budgets upon the population might even shift the political process because the voting population would realise that they, rather than future generations, will have to pay for all proposed government expenditure. This would also put government pork-barrelling under closer scrutiny.

One query I have with this plan is the relative distribution of taxation under quantitative easing. It would appear on the surface to be a relatively flat taxation lever thus disadvantaging those with less income or wealth. But then this may be ameliorated by the fact those with wealth would be more focused on buying imported goods or spending money overseas. In any case, we do have a weighted income tax system to help overcome any such measured discrepancies.

Another issue would be the ability of businesses to buy overseas capital equipment and technology for investment purposes as the currency is devalued by quantitative easing. Here I would argue that the value of exports would be concomitantly enhanced and, indeed, this whole mechanism is structured to create certainty for business wishing to export, which in the long run is in everyone’s best interests.