Home > Macro Concept > Macro Concepts – Dutch Disease

Macro Concepts – Dutch Disease

Mid-December will see the very important Central Economic Work Conference in China. Hopefully, we will know soon whether Xi Jinping intends to reform the system (SOE), and how much he will rely on new investments. He could also announce the new growth target. The market looks optimistic. The big question for traders if of course whether it makes sense to buy China (and commodities / miners) at this stage. 

While working on that theme, I am looking at commodity currencies, and of course the AUD. And before elaborating on this star currency, I have to introduce the “Dutch Disease” concept. This is a policy issue so important that anyone trading AUD, BRL, NOK or CAD should be well aware of it. 

It is in the “some macro concepts” section, and here is also a copy of the section…

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Dutch Disease

The Dutch Disease is a very important concept for all commodity exporters today – particularly Norway, Australia and Brazil. Anyone trading AUD, NOK or BRL should be well aware of that issue. The concept is quite simple – when a country goes through a commodity boom, its currency tends to strengthen (improvement in the terms of trades), and consequently its manufacturing sector suffers  (see charts on Australia’s situation at the bottom). If the process is not dealt with properly, the mining sector can become dominant, and the manufacturing sector can disappear completely. It is one of the most important policy issue for commodity producers. And indeed we have seen AUD, NOK, CAD, BRL strengthen significantly during the Chinese induced commodity supercycle. But this cycle is now peaking, and that is going to be a moment of truth for some countries, particularly metal exporters.

The Norges bank has done an excellent research work on the subject. Here is a part of a reference speech – “a diversified economy” given by Governor Svein Gjedrem on June 8 2010.

DutchDisease

“The cost level in Norway is a thermometer indicating how much the Norwegian economy can sustain without developing a serious case of Dutch disease. The temperature is now high. Measured against Norway’s trading partners, the cost level is now almost 20 per cent higher than the average for the oil age. Norwegian labour has never been as costly as today. Norwegian businesses will often lose contracts given the current high level of spare capacity in other countries. And it has never been more profitable to relocate activities abroad.

The economic geography of Norway will change over the next 10-15 years. Norway’s cost level and low growth in Europe will bring pressure to bear on jobs and businesses in manufacturing communities. Job losses will have the most severe effects in areas where manufacturing is the most important industry. Entire manufacturing sectors may be lost.”

Note: An illustration with Australia

Exchange Rate (REER) and Terms of Trades (prices of exports relative to prices of imports)

REER&TOT

Manufacturing vs Mining sectors in Australia

AU_MiningVSManufacturing

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