There has been a lot of talk of late about the two speed economy, but what does that mean?

It basically means that certain parts of the economy, namely mining and agriculture, are enjoying strong prices and strong demand whilst other areas of the economy are in near recession type conditions.

How has this come about?

The strong demand for our exports has meant a very strong Australian dollar. We have experienced 30 year plus highs against the US$ but also strong movements against other currencies as well.

Whilst the strong dollar has negative impacts for our export industries, the high prices and demand has more than offset any negative effects from the appreciating exchange rate. The strength of the dollar has meant that our import-competing industries are a lot less competitive and areas such as tourism and education services have been severely impacted.

In the case of tourism the high AUD$ means that it is more expensive for overseas visitors to come to Australia, whilst for Australians it means it is cheaper to go on overseas holidays and as a result they undertake less domestic holidays. In a similar vein the number of foreign overseas students coming to Australia is down up to 30 per cent as the cost of being educated within Australia increases.

This phenomena of a high domestic currency and its impact on other sections of the economy is known as the ‘Dutch’ disease (after a similar occurrence in the Netherlands with respect to oil and gas exports) or in more academic terms, the Gregory thesis.

What is the answer to this problem?

Over time there is a self-equilibrating mechanism that will tend to limit the extent of any AUD increase, but the end result will be a reallocation of resources to the export-related sectors. The Government can also use fiscal policy to cushion the impact of adjustments, providing necessary assistance where required. As an increasing exchange rate is also a de facto monetary tightening, the central bank can take this into account when setting interest rates.

What has been the impact on the Australian sharemarket?

Whilst the Australian equity market has moved in a sideways pattern for nearly two years now, the stocks in the mining and energy sectors have continued to rally reflecting the strong underlying fundamentals in this sector. If it was not for the mining stocks the Australian equity market would be quite a bit lower from where it currently is.