How Australia has come out on top in this currency war

The Australian dollar's plunge to a seven-year low is turning out to be a blessing as China steers its slowing economy away from the heavy industries that helped fuel the country's mining boom.

It's more than four years since a record-high Aussie threatened to destroy manufacturing and hamstring the economy. Instead, the currency's steepest three-year slide since it was floated in 1983 is working its magic -- a weaker local dollar has spurred record tourist arrivals and education income. And it's tempered the drag from iron ore's plunge to unprecedented lows while making the nation home to the world's lowest-cost miners.

At US68¢ to US69¢, the nation is more cost competitive and may even see the return of manufacturing investment, Baur said.
At US68¢ to US69¢, the nation is more cost competitive and may even see the return of manufacturing investment, Baur said. 

Australia stands out in getting the currency boost it needs at a time when economies the world over are grappling with exchange rates considered undesirable. The Aussie is in line with economic fundamentals, after being 25 per cent or more overvalued in 2013. China is struggling to curb yuan declines and Saudi Arabia is burning through reserves to maintain its peg to a strengthening greenback. Policymakers in Europe and Japan have pushed interest rates below zero, risking accusations of competitive devaluations.

"The fall in the Australian dollar has helped support the recovery and restructure the economy, so it is a good example of how a floating exchange rate should act," said Greg Gibbs, director of Amplifying Global FX Capital in Colorado, who has spent over two decades in the currency markets including stints at the Reserve Bank of Australia and with lenders in Sydney, New York, London and Singapore.

The Australian dollar is trading at US70.84¢ having, fallen from $US1.108 in 2011.
The Australian dollar is trading at US70.84¢ having, fallen from $US1.108 in 2011. 

RBA governor Glenn Stevens stopped calling for a weaker currency in August and subsequent declines drove the Aussie closer to fair value than at any time since the global financial crisis, according to a measure of purchasing power parity based on producer prices.

Stevens pointed in December to new opportunities for growth as Asia's middle class demands more services, energy and food, filling the economic vacuum left by a contraction in mining investment.

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'Unbelievably Lucky'

The impact of the Aussie's decline has been particularly apparent in the "sizeable contribution" of services exports to growth, the RBA said in November, acknowledging the labor- intensive sector's role in helping to push unemployment to a two-year low.

The currency has also absorbed much of the impact of a more than 60 per cent slide in prices for iron ore and coal from their 2011 highs. Earnings from goods shipments fell just 14 per cent till November from a peak two years earlier, also aided by rising volumes of Australia's main resources as the mining boom's bounty comes on line.

A weaker local dollar has spurred record tourist arrivals and education income.
A weaker local dollar has spurred record tourist arrivals and education income. 

"In many ways Australia has proven to be unbelievably lucky once again," said Klaus Baader, chief Asia-Pacific economist at Societe Generale SA in Hong Kong. The Aussie was high when the country needed to import capital goods to build new mines and now it's fallen "very significantly, which helps to contain production costs and it's contributed to making Australia very competitive even at lower prices."

At 9:00am, the Aussie traded at US70.84¢ having fallen 36 per cent from a post-float record of $US1.1081 reached in July 2011 at the height of the mining bonanza. It averaged more than $US1 for three years to the middle of 2013, spurring Stevens to signal the need for currency depreciation -- and to cut interest rates -- to wean the economy off a dependence on resource-sector spending. Forecasters see it at US69¢ cents by year-end.

The Aussie is 1.2 per cent overvalued according to the purchase price parity (PPP) measure. It reached about fair value at the end of September from being about 30 per cent overvalued as recently as three years ago.

While the RBA's battle with foreign-exchange traders appears to have ended, China's has just begun.

In many ways Australia has proven to be unbelievably lucky once again.

Klaus Baader

China has run down reserves, squeezed traders in Hong Kong with 67 per cent overnight borrowing costs and used state media to warn speculators, including billionaire investor George Soros, to deter bets on rapid yuan depreciation. Saudi Arabia, the world's largest oil exporter, used 16 per cent of its currency stockpile last year to defend the riyal while Mexico's shrank to a two-year low in November amid intervention to bolster the peso.

Inflation Concern

Central bankers in Europe and Japan are meanwhile wary of strengthening currencies as they struggle to spur inflation and economic activity. Japan's central bank on Friday surprised markets by introducing negative rates, weakening the yen as much as 2.4 per cent. European Central Bank president Mario Draghi, already using negative policy settings, on Jan. 21 signalled a further expansion of unprecedented accommodation. The actions hint at the type of race to the bottom known as a currency war, said John Kanas, chief executive officer of Florida-based BankUnited after the BOJ's decision.

In Australia, the currency boost to activity will help the economy expand 2.6 per cent this year, up from 2.3 per cent in 2015, the fastest pace among 11 developed economies after Sweden. It will also help drive a 7.2 per cent gain in exports, up from 6.3 per cent last year, analysts forecast.

"Net trade is likely to remain a key growth driver over the next few years," said Rick Harrell, an analyst at Loomis, Sayles in Boston. "This also means the Australian economy has become increasingly fragile and hostage to demand from emerging Asia and the broader global economy."

Harrell said he expects that dependence to keep the Aussie in a lower trading range given the weakness in Asian economies and in commodity prices, while also driving greater currency volatility.

As Australia's export profile improves, at home it faces the risks of a slowing housing construction boom, record low wage growth and the potential for a slump in consumer spending. That's prompted markets to maintain pricing for the central bank to cut its record low 2 per cent benchmark rate at least once this year.

Australia's transition toward non-mining activity is synchronised with China's move toward consumer-driven growth, opening up opportunities for the nation's most populous states New South Wales and Victoria, which had been at the periphery of the mining boom, Treasurer Scott Morrison said in last month.

The Aussie's drop "makes us far more competitive," he said. "Our economy is broadening, it's diversifying and this is very important. Our economy in the future, and even now, will be less dependent on one market, one commodity, one part of what we do."

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