The Australian Dollar is Down Under

by | Mar 21, 2001

The Australian Dollar, while recently sinking to 19-year lows, doesn’t seem to have gotten a lot of attention. In fact, the currency has never had the sort of impact on global currency markets as the Yen, the Euro, or the Pound, and even currencies like Brazil’s Real have taken a lot more of the limelight […]

The Australian Dollar, while recently sinking to 19-year lows, doesn’t seem to have gotten a lot of attention. In fact, the currency has never had the sort of impact on global currency markets as the Yen, the Euro, or the Pound, and even currencies like Brazil’s Real have taken a lot more of the limelight than the “Aussie” over the years.

And it’s not as if nothing’s happening. A few years ago one Australian dollar was worth about 75 cents U.S., but by 3/15/01, it had dropped to less than 50 cents. While such a decline may make it a good time for Americans to vacation in Australia, it certainly casts a shadow on Australia’s economic future.

As is so often the case, Australia’s economic problems are being caused by government ineptitude. The country’s central bank is running its interest rate policy as if it had a seat next to Alan Greenspan on the Federal Reserve board – matching his moves almost exactly. Yet the Australian government has made no attempt to keep its currency policy in tune with its interest rate policy – with it’s currency more closely resembling the Thai Baht than the U.S. dollar. The results are a little like playing Chopin with the right hand and Shostakovich with the left.

Since 1997, the Australian central bank has been attempting to mimic U.S. interest rate policy, while doing nothing to effectively staunch the Aussie’ s decline. Historically, investors in Australian bonds demanded a premium to U.S. rates as compensation for greater perceived currency risk. In 1991 Australian 1-year rates were over 10%, while US rates were 6%. In 1994, Australian rates were 10% versus 7% in the U.S., and in 1996, rates were 8% versus 6% in the U.S. From 1990 to 1997, Australian bonds typically offered about a 2% higher yield than U.S. bonds.

A turning point in Australian currency and interest rate policy appeared to come in 1997, the year of the Asian currency crisis. The Australian dollar fell over 10%, yet 1-year government interest rates actually fell, and fell below U.S. government rates. In times of currency weakness, global investors almost always require higher interest rates to compensate for currency risk. So those low rates smacked of central bank intervention, rather than investor confidence in the Aussie. Since that time in 1997, Australian interest rates have generally tracked U.S. rates closely, while the Australian dollar has substantially weakened.

The Australian Central Bank seems unconcerned, and has even made statements praising the Aussie’s weakness, suggesting that this has made Australia’s exporters “very competitive.” Given this implied weak-currency policy, it appears that global bond and currency investors have done a double take on Australian government interest rates and said “Are you kidding me? I know U.S.$ treasuries, and you’re no U.S.$ treasury – sell Australian dollars!”

Traditionally, it was thought that the Australian dollar was influenced by the prices of commodities, which represent a substantial portion of Australia’s economy. Yet commodity prices have generally been higher in the past few years, while the currency has tanked. Australia is one of the world’s major gold producers, yet over approximately the past year and a half, the Aussie has devalued about 28% relative to gold.

In the short term, the weakness of the Australian dollar should boost the profits of certain exporters – gold mining companies can sell their products on the US$ gold market while paying employees in cheapened Australian dollars. Our investments in Australian stocks (at IAAC) are primarily exporters, so I haven’t yet been too concerned about the currency’s weakness. Within a few years, however, these companies will likely be paying higher prices for imported energy and equipment, driving profitability back to normal.

In coming years, I expect effects of the Australian dollar’s weakness to flow through the Australian economy by driving inflation up. This is already occurring, as recent statistics have shown the annual CPI rising in excess of 6%, the highest figure since 1990. Unfortunately, the government appears blind to this and is blaming it on extraneous factors, unable to see that its weak-currency policy, if not reversed, will be driving costs, and eventually interest rates, higher for years to come.

Andrew West is a Contributing Economics Editor for Capitalism Magazine. In 1997 he received the Chartered Financial Analyst designation from the Association for Investment Management and Research.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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