Aussie Dollar Heads South
The Australian dollar hit its lowest level in over a year last week, dropping to below 80c against the US dollar on Wednesday
Yet two months ago the buzz word was parity.
So why the decline?
To understand that, it helps to look at what pushed the dollar so high against the US and other currencies in the first place.
It’s a story with plenty of colourful characters. There’s Osama Bin Ladin, George Bush, former US Federal Reserve Bank chairman Alan Greenspan, the emerging economic powerhouses of China , India, Russia and Brazil and of course John Howard and Peter Costello.
It started with the Wold Trade Centre attacks on September 11 2001.
In the wake of the numbing insanity of that event, Greenspan made an audacious move. Concerned the attacks would frighten off investors and cause the US economy to seize, he slashed US interest rates, flooding the US economy, and effectively the world, with cheep money.
Typically business boomed.
There was nothing you couldn’t buy because you could borrow money at a low rate of interest.
Just as importantly, there was nothing you couldn’t sell for more than what you paid.
The cycle was spinning merrily.
Then big business found how to spin it even faster.
By borrowing lots of the cheep money floating around the globe and using it to set up operations in countries with cheep abundant labour like China and India, they made even more money.
Company profits in the First World economies soared.
Share prices leapt. So did shareholders – with joy, as their dividends swelled. And politicians strutted, as increasing public-sector share of private-sector profits through corporate taxation helped them to look like superstar economic managers.
In the aftermath of September 11, the Australian dollar was buying just US50c. Prices for Australia’s key mineral exports like coal were languishing at around $US25 per tonne. Gold was around $US250 per ounce. Minerals were old economy, right?
Problem was, the new economy had just evaporated.
It was time for the next character in this story to step forward and, as Greenspan cut rates to historic lows in the US, something was happening to Australia’s north.
With their manufacturing and construction industries booming from foreign investment and infrastructure spending, China and India found they had a whole lot of people with money in their pockets.
Countries that supply the raw materials for the item the new consumer class sought found themselves besieged with buy orders. Step up Australia.
Stable, prosperous, with bulk commodity export infrastructure already in place.
Australia’s economy began to surge as it sold more and more materials. Interest rates were low here, too, and John Howard and Peter Costello made sure they stayed that way with their pro-business, pro-aspirational classes, pro-keep-voting-for-us economic policies.
Booming economies attract investors. They buy Australian shares and bonds. They buy into Australian businesses through joint ventures, and certain classes of investors buy the Aussie dollar.
Louis South, chief economist at Macquarie Bank’s Funds division, said the rising Aussie dollar was inextricably linked to the increasing cost of commodities, particularly coal, gas, oil, copper and iron ore.
He said a strong commodity environment helps business investment and drives the economy much stronger on a relative basis. This in turn started to push interest rates higher as our Reserve Bank tried to reign in inflation.
Then, a few months ago, the Reserve Bank indicated that an interest rate cut was on the cards.
For investors, the idea that the Australian economy was slowing was the ultimate indication that the world was coming off the boil.
The Aussie dollar suddenly looked leprous and speculators began selling the Aussie dollar, buying US dollars with the profits. In less than two months, the local dollar has lost sixteen percent of its value.
How It Works
Speculators look for two currencies – one with low rates, the other already rising. Recently that has been the Yen and the Aussie. Speculators borrow currencies like the Yen at low interest rates, because it’s cheep, and buy the Aussie in the hope it rises in value, so they can pay back their Yen with their appreciated Aussie dollars and walk away with a profit.
Demand from speculators is enormous, forcing the dollar up.
Conversely, when the interest rates fall and demand for commodities wanes, speculators sell. Because Australian interest rates are on the way down, speculators have been dumping the currency.
When commodity prices rise, the Australian dollar rises. This is because foreign commodity traders want to buy Australian commodities with Australian dollars.
Commodity prices have fallen in 2008. Suddenly there is less demand for Australian dollars. Less demand means lower prices.