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Tuesday, 30 November 1976


Mr LYNCH (Flinders) (Treasurer and Minister for Finance) - by leave- When this Government came to office the Australian economy was in the grip of its most serious post-war recession, and inflation was still well into double digits. At the end of 1975 the private sector was employing no more people than it had been 3 years earlier although the labour force had grown by 370 000. Unemployment was at about 4 1/2 per cent and had remained at that level throughout the year. Non-farm production was still about 5 per cent below its level 2 years earlier, and the farm sector was in a state of collapse. Company profits had fallen absolutely in 1974-75, and their share in total income remained depressed well below the long run average, and business investment was falling. The consumer price index in December was 14 per cent higher than a year earlier, and inflation showed no real prospect of a sustained downward shift.

Right at the heart of the problem, particularly the inflation problem, was the unrealistic view held by the Labor Government- our opponents in this House- as to the role of the public sector. Quite unrealistic views were also fostered in the community about future incomes and the capacity of the economy to sustain those incomes. The expectations aroused by our predecessors have bedevilled the economy to this day. Even so, under the policies that have been pursued by the Government significant progress has been made in reducing the rate of inflation and in setting the economy on a path towards sustainable growth in output and activity. Suggestions that the Government's economic strategy has failed are without foundation; what has not been possible is the continuation of efforts to hold the exchange rate. It has not been possible because of the obvious limitations in the extent to which reliance can be placed on any single instrument of economic policy. Let me repeat: Assertions that the Government's economic strategy has not worked neglect the achievements that are the direct result of that strategy.

The rate of inflation has moderated in each quarter since the 5.6 per cent increase in prices recorded in the December quarter of last year. Prices increased by 3 per cent in the March quarter, 2.5 per cent in the June quarter and 2.2 per cent in the September quarter. Figures published recently show that Australia's rate of inflation is now broadly in line with the Organisation for Economic Co-operation and Development average. Industrial production has firmed since July. Activity in the housing sector remains buoyant. Registrations of new passenger vehicles have recovered to more normal levels, following the sharp decline in July and August due to the introduction of more stringent emission control standards. The weakening in the labour market has been largely arrested over the course of the September quarter. There are also currently some fundamental differences in the economy compared with a year ago which, taken together, point clearly in the direction of continued growth. First, the growth in the June half-year occurred despite a decline in Government demand; momentum for growth lay entirely in the private sector. Secondly, recovery in many of the world's major economies has consolidated. Thirdly, as a result of these factors, and the moderation in the rate of inflation, many of the distortions inflicted on the economy during 1974-75 have begun to correct themselves. For example, business profitability has grown and the savings ratio has declined. Fourthly, and connected with the foregoing, consumer confidence and business confidence have been improving and are higher than a year ago. Fifthly, the shake-out in stocks which depressed product during 1975 appears to have run its course.

I turn now to the measures that I announced on behalf of the Government on Sunday evening. In large part, the devaluation was forced on the Government by the deterioration in the underlying external situation which occurred during the period of the previous Government. When our predecessors came to office, Australia's international reserves stood at an all time record level of $4.6 billion. By the time the present Government took office a substantial part of those reserves had been squandered. They fell by no less that $ 1 ,600m during the previous Government's period of office to stand at less than $3,000m at 12 December 1975. The number of months' cover of reserves to imports fell from 13.5 in 1972-73 to 4.4 in 1975-76.

There were a number of fundamental reasons for this extreme weakening in Australia's external position. An important element in the overall deterioration was the falling away of overseas investment. During the 3 years from the beginning of 1973 to the end of 1975 annual total private capital inflow averaged only $2 15m, compared with an average annual inflow of $ 1,080m in the previous 5 years. The factors behind this fall-off are, of course, well known. Our opponents in this House literally drove overseas capital away by their hostile and narrow ideological attitudes to foreign investors and by the domestic economic policies they pursued. These policies completely failed to come to grips with inflation; indeed they greatly exacerbated the inflation thrust.

The Labor Government, by its own policies, initiated a wage explosion of unprecedented magnitude. First, it lent general support to excessive union claims, particularly in submissions before the Australian Conciliation and Arbitration commission. Secondly, it deliberately pushed up wages, and more significantly, promoted improved conditions of service for Commonwealth employees in a pace-setting fashion that had highly significant flow-on effects throughout the community. As a result there was a dramatic deterioration in the international competitive position of Australian industry. After allowing for the effect of exchange rate changes, wage costs in this country increased by 1 5 per cent more than the increase in our trading partners between 1972 and 1975. In the last 6 years wages in Australia's manufacturing industry increased by 130 per cent, compared with 53 per cent in the United States of America and 70 percent in West Germany. This single fact, more than any other, serves to demonstrate the extent of the problem which the present Government inherited when it took office. Not only did we have to get Australia's cost inflation rate down to that which was being experienced by our competitors; we also had to try to make up the ground that was lost during those 3 disastrous years.

From the outset this Government sought to hold the exchange rate as part of its overall antiinflation strategy. We did so with the full knowledge that the Australian dollar was over-valued and that economic developments, particularly the disparity in Australia's cost structure compared with other countries, could have justified a variation in the exchange rate earlier this year. Towards this end we resumed official borrowing overseas as necessary to support the overall level of reserves. At the same time we moved to bring down, as rapidly as possible, cost and price increases, in order to restore our competitive position. In addition we have acted to encourage a resumption of private capital inflow more consistent with the developmental needs of this country. We have made it clear to foreign investors that they do have a role to play in Australia 's development and that we welcome their involvement in partnership with Australians. These efforts led to the development of extensive investment proposals that were, in spite of approval in many cases by the Foreign Investment Review Board, not being implemented.

I turn now to a vital determinant in the weakening of Australia's external position, particularly in recent months. I refer to speculation about the Australian dollar. It is a matter of the greatest concern that senior members of the Opposition in this House should have fuelled speculation about devaluation by their public comments since December of last year. It will be recalled that the former Treasurer, the honourable member for Oxley (Mr Hayden), predicted during the last election campaign that a LiberalNational Country Party Government would devalue the dollar, if confirmed in office at the election. Those remarks, made during a halfhour television debate with me, as a Treasurer in the then caretaker Government, greatly added to the speculation in the Christmas-New Year period of last year when Australia lost more than $600m of overseas reserves. On 19 February of this year, the Opposition spokesman on economic matters, the honourable member for Adelaide, (Mr Hurford), said:

Costs of production in Australia are out of line with overseas costs at the present exchange rate, so that the import competing sector will continue to lose ground to imported goods. And a further devaluation scare . . . must be expected at any time.

On 7 September the honourable member for Oxley said publicly that 'Blind Freddy and his dog' could see that the dollar was over-valued and went on to say that devaluation was inevitable and gave general support to the figure of 15 per cent. These grossly irresponsible comments were headlined in all of Australia's major newspapers and led directly to a weakening of Australia's reserves position. The honourable member for Oxley is quoted in some parts of yesterday's Press as saying that the decision was inevitable' and, in other parts, describing it as madness'. His comments yesterday reflect only his naked complicity in developing a climate for profiteers to make a killing at the expense of the Australian nation.

In recent weeks the Deputy Leader of the Opposition (Mr Uren) has persistently questioned me in the Parliament about the exchange rate and loss of reserves. In one such question on 1 1 November, having listed the loss in reserves in previous months, the Deputy Leader described the position as a 'disaster'. It is also a matter for concern that the Conciliation and Arbitration Commission should have been part of the general speculation in this country about devaluation. In awarding its recent wage increase, which was contrary to the whole thrust of the Government's attempts to restore this country's competitive position, the Commission saw fit to cast public doubt on the future position of the currency. By doing this the Commission greatly worsened a situation which was, ironically, in no small way due to its previous decisions to increase wages at a rate beyond Australia's economic capacity to absorb. In all these circumstances, the Government was unable to prevent the continuing decline in reserves. The loss of reserves, aside from Government borrowing, in fact increased significantly in recent months, with a fall of around $80m since the end of July- almost four times the amount the Government was able to borrow overseas in that period. In September reserves declined by $204m, excluding overseas borrowings. In October the reserves figure fell by $269m. Up to 26 November there was a further fall of over $260m.

This decline in reserves had continued despite the additional monetary measures announced on 7 November and left official reserves at 26 November at around $2, 100m, sufficient to cover less than 3 months' imports; to be precise reserves were covered by just 2.7 months of imports last Friday. Moreover, the level of reserves, net of borrowings, was becoming increasingly untenable relative to the current account position that was in prospect. I emphasise, in this connection, that the Government faced the prospect of an even greater rate of outflow around the end of December early January period and I remind the House that more than $600m flowed out of Australia during the equivalent period last year.

As I emphasised on Sunday night, to have allowed the situation to deteriorate further would have been to admit the possibility of enormous speculative gains, with consequent costs to the authorities. The fact is that, faced with the rundown in reserves, there were only 2 alternatives before the Government. The options put to the Government by its advisers were devaluation or borrowing on official account, of the order of $ 1 billion, to shore up the reserves position. In these circumstances the Government could have allowed the situation to drift on and attempted to arrange further borrowings overseas to finance what would inevitably have been further outflows of private capital. The announcement of large additional borrowings, in a situation where our underlying external situation remained out of line with our competitors abroad, would have had perverse effects, leading to an escalating increase in the rate of loss of reserves.

Such a loss, together with any additional borrowings the Government had been able to undertake, would have involved enormous costs to the authorities in the event that we were forced to make an exchange adjustment. Further to that, the most recent decision of the Conciliation and Arbitration Commission effectively put paid to any prospect of restoring, within a tolerable time span, the competitiveness of Australia's industries by purely domestic policies. Beyond all of the foregoing considerations the Government would not have been able to borrow funds on private markets sufficient to cover the rate at which reserves were running down over recent months and, particularly, to cover the loss that was in prospect over the Christmas period. A possible drawing of some $1 billion from the International Monetary Fund would only have bridged the situation temporarily. Given these facts no responsible government would have acted differently to the present Administration of this country. We were not prepared to put the national interest in hock. We were not prepared to let profiteers take this country to the cleaners. I have no doubt that our opponents in this House would have chosen the opposite course. They would have employed another Khemlani to raise $4 billion.

I turn now to the size of the devaluation. It should be clearly understood that nothing would have been achieved by a devaluation that was insufficient. An inadequate devaluation would have failed to restore our competitive position and would not have been credible. That would have left great uncertainty in the minds of business and investors. The Government is fully aware of the potential for increased capital inflow. Indeed it is a primary objective of the devaluation to increase the level of inflow. We will be monitoring closely external developments, including developments in capital inflow. The Government has indicated that the rate will be administered on a flexible basis.

Adjustments will be made to the rate to the extent necessary to ensure that it remains consistent with overall external and domestic policy objectives, particularly monetary policy. Under the new pattern of management of the exchange rate a tradeweighted average rate will continue to be computed daily on the same basis as previously. However, the exchange rate will no longer necessarily be pegged on a fixed relationship to the basket of currencies. Instead it will be kept under review and varied as appropriate in the context of overall management of the economy.

The new pattern of management of the exchange rate will enable more frequent, more timely and smaller adjustments to be made to the rate; is appropriate to the changing nature of the world economy and to Australia's international trade relationship; is designed to avoid the build-up of an expectation of major changes at long intervals in the future; will permit the use of the exchange rate as appropriate, as a more flexible arm of economic policy; and will require little or no institutional changes. The new arrangements are a further step in the development of the Australian foreign exchange system.

A close watch will need to be maintained in order to see how things develop from this point. There are elements in the new system which must be held close; in particular the management objectives used in determining the variable link to the basket of currencies. Otherwise, the system would lose flexibility and there would be a strong possibility of speculation against the central bank. Exaggerated fears have been expressed about possible effects of increased capital inflow on domestic liquidity. The Government will not allow any such developments to occur. Such investment capital will be an important ingredient in ensuring the continued recovery in economic activity. The reserve losses of recent months should be reversed as the delays in export receipts and early payment of imports, which have been induced by exchange rate uncertainties, are in turn reversed.

The Government's action has been criticised on the grounds that it will lead to further inflation. Unlike the devaluation of our predecessors in September 1974 that took place at a time when inflation was running at a quarterly rate of some 5 per cent, Sunday night's adjustment was against the background of a moderating rate of inflation from S.6 per cent in the December quarter of last year to 2.2 per cent in the most recent quarter. The devaluation will, of course, affect prices to some extent, even though stringent off-setting measures have been simultaneously taken. In particular, the price of imported goods will be higher, in terms of Australian dollars. But imports account for only 16 per cent of the gross domestic product and, further to that, the prices of all imported products would not be expected to rise by the extent of the devaluation.

The overall price-raising effects of devaluation depend very much on the circumstances in which the measure occurs; devaluation necessarily has a lesser impact at the early stages of recovery that it does when activity is at full swing. When demand is still short of capacity, as it is presently, there is scope and incentive for business to increase output rather than to increase prices. In fact, some costs should actually fall, as a result of devaluation. An over-valued exchange rate has prevented import-competing and export industries from approaching their most efficient scale of output. In these circumstances devaluation can be expected to actually lower unit costs in some industries.

The price impact must also be assessed against the accompanying measures. Unlike the circumstances of the last devaluation in September 1974, when there were no off-setting measures taken by the former Government, there has been a significant toughening of monetary, fiscal and wages policies. The favourable effects of devaluation will therefore be allowed to work through the economy in an appropriate domestic setting, by comparison with the former Government's devaluation which was followed by a substantial easing of fiscal and monetary policies. I emphasise that the package has been designed to counteract, to a significant extent, the inflation impact of devaluation. The monetary measures will contain the effects of devaluation on domestic liquidity; they will not lead to any excessive tightening of liquidity. The Government's policy remains that monetary growth will be sufficient to underwrite economic recovery without at the same time being accommodating to inflation. Normal financing requirements of business and the housing industry will be met. The fiscal measures will support the Government's monetary policy and maintain a balance in overall policy. The measures which will be taken on the wages front will prevent, to the maximum extent possible, the feed-through of any price rises into general wage increases.

Our opponents in this House, who have sought to undermine Australia's external position, have demonstrated again their capacity for hypocrisy and double standards. The devaluation of September 1974 was a panic reaction to the credit squeeze which the former Government's policies caused. It devalued at a time of near record high inflation and when average weekly earnings were running at unprecedented levels. It took no measures at all to counteract the price effects of devaluation.

It acted at a time when reserves were at a level of nearly $3 billion, or almost $1 billion higher than recorded at the end of last week. At the end of September 1974 the ratio of reserves to imports was equal to 4.8 months' cover; as at 26 November of this year- last Friday- the equivalent figure was 2.7. In addition to all of this our predecessors leaked their decision to devalue in such a way that speculative profits were made on the London Stock Exchange. The former Government's decision to devalue was taken at around 10 p.m. on Tuesday, 24 September. The announcement was timed for 6 a.m. on Wednesday, 25 September when financial markets would be closed.

The record shows that the Melbourne Sun reported the devaluation, including the figure of 12 per cent, and the story in question was put together at around 1 1 p.m. on 24 Septembersome one hour after the decision was taken. Subsequently, at around 1.30 a.m. on 25 September, Reuters reported the Melbourne Sun story. The Reuters news report was made public at around 4.30 p.m. on 24 September in London and led to immediate trading on the London market during the final part of that day's trading. The present Leader of the Opposition refused to answer questions in the Parliament on the following day and refused to initiate an appropriate investigation as to the cause of that leak and its consequences on the London market. In short, the scandal surrounding the leakage of information- an act which under our parliamentary system of government would normally require the resignation of the Treasurer- was covered up by the present Leader of the Opposition and his ministerial colleagues.

What I have said illustrates the blatant opportunism of the criticism that has been made by the Opposition of the statement which we made last Sunday. The Government's measures have support. For example, the majority of State Premiers- Premiers Hamer, Court, Petersen and Labor Premier Nielsen- have welcomed the package. The Government's measures have undeniably a number of major advantages for important sectors within the Australian economy. The devaluation of the dollar will greatly improve the profitability of Australia's export and import competing industries and underwrite Australia's external situation. The rural sector, which has suffered a disastrous fall in real income in recent years, will now receive substantially higher prices for their exports and their ability to expand market shares will be enhanced. The annual rate of rural exports, currently running at $4.5 billion, should increase by around $700m.

In the mining sector, which is an important focal point for economic growth, new ventures had become unprofitable and some existing mines had closed. The devaluation will restore the long run growth prospects for this sector and increase annual export returns significantlyperhaps by approaching half a billion dollars. The devaluation will also go a long way towards off-setting the effects of excessive wage increases on costs of manufacturing and service industries such as tourism, enhancing their competitive ability. The removal of uncertainty about the exchange rate will restore investor confidence. Firms will be encouraged to borrow overseas and long-term foreign equity investment will increase.

In summary, the devaluation will restore balance between economic policies, easing the excessive burden that has built up on the external side. It will restore balance between economic sectors, easing the burdens on those vital areas of the economy that depend on world markets for their livelihood. Above all, it will remove uncertainty. Uncertainty about the exchange rate has bedevilled many aspects of the economy in recent days. Energy has been diverted from more productive ends into efforts to avoid the losses that large changes in the exchange rate entail. Uncertainty has stifled investment, most particularly investment from abroad. All that can now be put behind us. These are very substantial benefits.

There are, we acknowledge, costs in the decision we have taken. There will be an early addition to prices from the higher costs of imports. But we have acted, in the fiscal and monetary sphere, to do what we can by off-setting action. We have put in hand an examination of Commonwealth outlays to see where further restraint can be imposed. I look to this review to produce a final expenditure outcome that will be even lower than the Budget figure. The monetary measures I announced are designed to soak up any excess liquidity that devaluation may bring in its train. No one can know with precision what may develop by way of capital inflows, but we stand ready to meet the situation as it emerges. I stress that the aim will be to soak up the additional liquidity that may result from devaluation. In that context, any talk in this country of a credit squeeze is nonsense. The general monetary objectives remain: To foster conditions that will be conducive to economic recovery while keeping inflation to a minimum.

These actions, important though they are, will not be enough in themselves. Action will also be needed on the wage front. But others must play their part- in particular, of course, the Conciliation and Arbitration Commission. It is vital that the price effects of devaluation are not translated, through the indexation process, into a spiral of wage /price increases. Such an outcome would negate the benefits that devaluation will provide. The Government will not stand by and allow that to happen. Clearly, we need good sense by all who participate in the wagedetermination process. Given that, there is every reason for confidence in the gradual emergence of stable, prosperous conditions from which all Australians will benefit. The Government has acted in the national interest to give greater balance, and thereby greater strength, to the basic economic strategy that has been pursued since we came to office. I present the following paper:







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