The Australian dollar is rallying: do something!

Productivity is low because those who lose their jobs to more productive and less expensive machines become less productive. Pic: Reuters

On Friday night the Australian dollar broke through US78 cents for the first time in more than two years. This is starting to get awkward; brows will be furrowing in Martin Place.

Despite the narrowing interest rate differential and commodity price weakness recently, the AUD has rallied 8.5 per cent this year and more than 6 per cent since the start of June.

In fact the efforts of the Reserve bank to get the exchange rate down have been failing for two years: the latest surge has confirmed a steady uptrend since August 2015.

Until a few month ago, it looked as if the Australian dollar was stuck in a horizontal trading band, unable to break US77c, but it doesn’t look like that anymore. The trend is clearly up and that was confirmed on Friday night.

The reason for Friday’s surge was that American retail sales fell, against expectations of a rise, and the monthly CPI change was zero. Annual inflation remains mired at 1.6 per cent.

The US dollar promptly fell — again — and stocks and bonds rallied. Since peaking on January 3 in a mist of Trump euphoria, the US dollar trade weighted index has depreciated 8 per cent — basically the same as the AUDUSD rate has risen.

Against the euro, the US dollar has fallen 10 per cent; against the yen it’s down 5 per cent. The greenback has given back all of the post-election rally and then some — it’s back to where it was at the beginning of 2015, after its incredible six month rise of 20 per cent. Since then it’s been horizontal, despite four rate hikes and plenty of hawkish rhetoric.

But talk is just that, and in fact on Wednesday last week Fed chair Janet Yellen produced the first sharp fall in the US dollar for the week, and rally in stock and bond markets, with what was breathlessly reported as “dovish” comments.

“Monetary policy is not on a preset course,” she said. “… inflation continues to run below our 2 per cent objective and has declined recently … the committee continues to anticipate that the longer-run neutral level of the federal funds rate is likely to remain below levels that prevailed in previous decades.”

Last December, when announcing a 25 basis point rate hike, the Fed said: “The stance of monetary policy remains accommodative, thereby supporting … a return to 2 per cent inflation.”

Except it hasn’t and doesn’t look like it. At the time, the forecasts for a US bull market were virtually unanimous, understandably. The Fed was normalising interest rates, the economy looked strong, the labour market was tightening by the month and President-elect Trump was about to unleash massive fiscal stimulus and give the US economy whiplash.

It seemed like a one-way bet, including a lower Aussie dollar, except it wasn’t. How did everyone get it so wrong?

The answer is the misbehaving inflation rate. The labour market is certainly behaving as expected — the US unemployment rate has continued to fall this year and is now 4.4 per cent, and in June new employment totalled 222,000, well beyond expectations.

But inflation is stuck below 2 per cent and the Fed is in the frustrating position of saying, every month: it’ll start moving next month for sure!

But employment and wages have decoupled. Two weeks ago, the Fed put this down to weak productivity, which it couldn’t explain despite a two-page box in the Monetary Policy Report on the subject.

I have an explanation they can have for free: productivity is low because those who lose their jobs to more productive and less expensive machines become less productive because they end up doing something they’re not as good at.

The measure of productivity is GDP per hours worked. When a firm replaces workers with machines, they don’t produce more stuff because output is determined by demand — they just reduce costs.

The replaced workers go off and do something else that they’re not as good at. The output of the firm — and the economy — stays the same; output per worker falls.

Moreover, as wages growth declines, demand falls as well because there is less where it counts — among the lower and middle classes who spend.

And wages are low because workers have lost bargaining power and will never get it back.

That’s because technology has decisively and permanently shifted the balance of power between capital and labour towards capital, and with artificial intelligence, machine learning, facial recognition, voice recognition, autonomous vehicles, and blockchain still to come, that shift has a long way to run.

That’s why the US dollar is falling and the Australian dollar is rising against it. Much the same thing is happening here — low productivity growth, low wages growth and low inflation — it’s just that the US dollar is the most powerful force in global finance and it overwhelms all else, including the RBA’s puny efforts to get it down.

Bottom line: predictions of no further rate cuts in Australia are now moot.

With the Australian dollar sitting at US0.7828 on Saturday morning and the US dollar looking weak, if that situation doesn’t reverse soon, the RBA will start to come under enormous pressure to cut again.

* Alan Kohler is Publisher of The Constant Investor — www.theconstantinvestor.com