The rise and rise of Pasconomics, otherwise known as the worship of the confidence fairy, is fast choking off the flow of oxygen to the Australian brains trust. Following the RBA’s refrain in Parliament last week, the whining about confidence has reached fever pitch across the media. In just one example, entrepreneur Josh Liberman recently told The Australian the business culture in this country was risk-averse:

“’Government should be identifying what competitive ­advantages Australia has as a ­nation. And, based on that, backing industries where we have that competitive advantage as a world leader,’ he tells The Weekend Australian in a rare interview.

“… But, more importantly, Liberman wants to see more risk-­taking in the Australian eco­n­omy, something he believes is dangerously lacking right now in the mindset of governments.

“That theme was a key focus at the [Australian Davos Connection] Forum’s recent Australian Leadership Retreat, which was attended by Liberman and a host of top chief executives, thought leaders and policy­makers as well as local and ­international academics and entrepreneurs.

“The theme of the retreat was A Culture for Prosperity, and in that context one of the key ­debates centred on the current contradiction in Australia and the world — while there is currently great risk appetite in the financial markets, there is still a huge reluctance to take risks by investing in the ‘real economy’ to bolster ­productivity.”

Let’s explore a few home truths here. Why are Australian companies not investing in the real economy? This is why:

Unused supply side capacity is sitting at recessionary highs. Companies aren’t investing because they have no need to. They have too much floor space, too many empty factories, too many idle machines and too many staff. Bashing them up for lacking confidence is some weird kind of moral socialism. Are these charities or businesses? The only reason to invest in this environment is to increase efficiency, and that’s only going to make the problem worse in aggregate.

Why is that? Because the supply side slack is emanating from a paucity of demand relative to what was expected when the capacity was all installed. It doesn’t take Einstein to figure out why:

The Australian economy is 70% consumption, so when households start to save, overcapacity appears quickly on the supply side.

Why are households saving, you ask? House prices are rising, unemployment is still low, we’re still the lucky country. But a crucial link in the household consumption chain is broken. The 20-year rise of consumption-driven growth that ended in 2008 went hand-in-hand with rising house and share prices, the conversion of which into spending is obvious in the falling away of the savings rate from 1990 to 2008. But since the GFC, households no longer believe in spending everything they have and relying on asset inflation to save. They want real savings thanks very much, and so they should after witnessing a cavalcade of asset bubbles mercilessly implode across the world for six years. Add in an ageing population and, hey presto, people want reliable savings.

If you’re looking for a confidence problem it is here, not in businesses, though I’d rather see this as the return of household rationality after a period of lunacy. Because, really, do we want to send everyone back to the old asset inflation delusion? It turned our banks into building societies, crowded out business lending and led directly to their nationalisation in the GFC. Even though the RBA has managed to re-inflate the housing bubble with help from the Chinese, households still ain’t spending the “wealth” and, in all likelihood, won’t do so for another generation.

That brings us to the real issue. The RBA’s and government’s mad chase for “confidence”  has delivered another consequence. Housing inflation is really land price inflation, a crucial input cost for business that contributes to capital values, rents, wage demands, inflation, interest rates and, thus, the value of the Australian dollar. When you put all of these together and measure it against the same in other economies, you get what is called the real effective exchange rate (REER):

Focus on the blue line. The REER is an index of the nation’s relative competitiveness, and the RBA’s great re-inflation has succeeded in keeping it at astronomical levels. Normally, as mining boom prices fall away, the REER would fall with them via a depreciating Australian dollar and real wage deflation. But the RBA has stopped that in its tracks. As a result, Australia is being exposed as not only expensive but exorbitantly so.

So what is the answer here? Is it to gather with the “leadership” boffins of Australian Davos Connection on Hayman Island to whine about slack confidence? Is it to earnestly discuss the rise of regulation over a pina colada? Is it to bluster from your banana chair about a lack of innovation? The picking winners thesis is throwing darts with a blindfold on. Pass the suntan lotion, will you!

The real answer is to address the REER. Improving Australian competitiveness in general will repair the price signal that brings business investment to life in all sorts of expected and unexpected ways, as history has shown us. Everyone expected resource exports to benefit when the REER was repaired in the 1980s following the ’70s mining boom, but nobody reckoned on Australian business taking control of global markets for blood products, shipping pallets, shopping malls and board shorts. More to the point of today’s Pasconomic narrative, confidence and innovation will flow automatically with the return of a competitive edge, not the other way around. Of course, the notion of improving competitiveness should not be confused with some simplistic drive by corporate Australia to neuter unions and drive down wage costs.

Repairing the REER is a national interest project in which all parties must participate on the basis of mutual sacrifice and protection of the vulnerable. It requires monetary, wage, tax, productivity and competition reform. Right now the RBA has done far more harm than good in cutting interest rates without using macroprudential policy to contain housing prices so that the dollar could fall, and the Abbott government has directed policy diametrically backwards in its assault upon the vulnerable and protection of rent-seeking corporate margins.

If Australia wants to remain a high-wage, high-cost economy — and it should — directing effort towards restoring innovation and sophisticated value-adding is the right thing to do, as the RBA’s Phil Lowe argues. But it can’t be done when the REER is so outrageously bloated and policy so ill-directed at protecting rent-seekers.