Australian dollar strength - just a short term improvement?

Exchange rates movements are very difficult to predict. The reason is that there are many short term influences that cause volatility and long term influences that determine a  'fundamental value' for a currency.

This week the Australian dollar has strengthened against the US dollar (US$). A relief for the many Australian travellers abroad? Maybe not. All currencies have got stronger against the US$ so Australians will only see a real difference if visiting the US itself.

In the short run the demand and supply of currencies is influenced by a number of factors, which can change quickly, such as commodity prices and interest rates. Once the market takes the view that a currency's value will change the speculative forces that are brought to bear make that change inevitable - at least for a while.

In the long run the theory of 'purchasing power parity' suggests that a currency's exchange value should reflect how many real goods and services will actually buy and the rate moves to equate that purchasing power. So the long run trend is set and the short run variations move around that.

If the theory of purchasing power parity applies to Australia then with the end of the mining boom Australia's dollar should have depreciated against other currencies since 2012. This is because Australians will be worse off as a nation.

The article from The Age looks at some of the recent influences on the Australian dollar. An excellent case study in demand and supply factors affecting exchange rates.

The Age article is here

This article has particular relevance to IB students  for exchange rates and is a possible IA article  For VCE students the article also provides essential reading on the influence of the exchange rates of economic goals and the standard of living.

Summary of Australian Economic data

Here is some data to remember for the VCE Economics exam.

Remember - the last four years only required and you need to look at TRENDS not the specific minor variations.

Growth has fluctuated over the period. In 2008/9 the primary influence was the GFC and the fall in demand from the rest of the world. The period feom 2010 is most strongly influenced by Chinese growth and the strength of the dollar. Currently growth is moderating and this is due to slower Chinese growth and falling commodity prices. Therefore Demand Side factors have dominated.

Unemployment rose at the onset of the GFC but then moderated to fluctuate a little around FULL EMPLOYMENT at 5%. The principle influences are demand side factors and immigration.

 

Employment has risen, quickly as the effects of the GFC were overcome and then very slowly since late 2010, but clearly on an upward trend. This suggests the small variations in unemployment are not major causes for concern.

Inflation has risen steadily, but the rate has moderated since mid 2011. The concerns about future growth (such as Chinese growth slowing) and the lower rate of inflation itself has allowed the RBA to lower interest rates. Remember that interest rates take up to two years to take their full effect on inflation so it could be argued that the RBA has acted too late.

Monetary policy does seem to have lagged behind changes in the inflation rate. Central banks try to keep 'ahead of the game' and we would expect to see interest rates falling before the rate of inflation turns up or down, not at the time as we see here. Low marks for the RBA on this one.

 The exchange rate is influenced by many factors, but in Australia's case the price and quantity of mineral exports and the relatively high Australian interest rates (The UK and USA have had rates of 0.5% for almost the whole period) have been the primary influences. The high exchange rates have made Australian exports less competative abroad, while it has raised the value of exports from the resources sector.

 

Australia has run a current account deficit since the mid 1970's. Adjusting the figures to a percentage of GDP gives the best indication of relative trade performance. The mineral resources boom has helped close the size of the deficit steadily, although Australia continues to run a deficit, meaning that foreign debt will inevitably rise.

 

However exteral debt has not risen much and as a proportion of GDP has increased hardly at all.

 

The budget has been in deficit and is currently in a contractionary stance.  The Government wants to return to surplus for reasons that are difficult to explain. Possibly they worry about the debt burden in the future.

 

Despite this clear upward trend Australia has one of the lowest public sector deficits and debts in the OECD. 

I hope these snapshots of the data will be useful.