John Hewson
What the Australian dollar says about the economy

Among the various pressures pushing up our cost of living, one that is often overlooked is the exchange rate, or the value of Australia’s dollar relative to other currencies. Our currency is usually quoted against either the United States dollar, or a basket of our major trading partners’ currencies, known as the trade-weighted index. By both measures, it has been on a weakening trend, and has slid from levels above parity with the US dollar just over a decade ago,  to around 77 US cents in early 2021, to the low- to mid-60s today.

This is important because, while a softer dollar can help protect our export competitiveness, a strong dollar can be a key element of an effective anti-inflationary strategy, as it mitigates the cost of imports. This can be seen most clearly in oil prices. It’s notable that over the past year, our relatively cheap dollar has compounded the effects of tighter supplies of oil from the major producers, pushing petrol prices higher still. Fuel costs have been a big contributor to the sharp increases in consumer prices overall. This kind of imported inflation can be very significant in an open trading nation such as Australia.

The dollar’s weakness has surprised economists at the major banks. It’s persisted despite aggressive monetary policy tightening, because the rapid increases in the Reserve Bank’s official cash rates haven’t kept up with the even sharper increases in the US. Nor have the additional supports of a trade surplus – in place since about 2017 – and the government’s recent achievement of the first budget surplus in a decade and a half done anything to reverse the trend.

A key cause is the slowdown in China, as a major source of demand for our iron ore, coal and other resources. There is still a significant view in global markets that our dollar is primarily a commodity-driven currency, reflecting the heavy concentration of our exports in minerals and agricultural products. It has tended to move in the opposite direction to other significant currencies, sometimes in volatile ways – to appreciate during global commodity booms and to devalue when, say, minerals prices slump or there is a recession, or when domestic spending exceeds export earnings. A good example is how our dollar strengthened in 2013 with China’s large-scale purchases of our commodities, and subsequently fell away as those purchases tapered.

Banks now seem to see the dollar remaining weak into 2024, consistent with the slower growth predicted for Australia and for China and given the mounting expectations that the Reserve Bank may have reached the peak of interest rates and will probably start to lower the cash rate next year, reducing our attractiveness to foreign investors. It may take a recession in both the US and Europe, a significant lowering of interest rates there and a sudden bounce in commodity prices to avoid a slide below 60 US cents.

Taking all this discussion into account, there is an important question as to whether we are witnessing the end of a commodity currency. That argument ignores the elephant in the room – the global shift away from the emissions-heavy resources that have sustained our economic growth for so long will open up new and potentially greater export opportunities, as inventor and renewable energy advocate Saul Griffith argued in The Saturday Paper last week.

The prospects for Australia to emerge as a renewable energy and critical minerals superpower are very real and a successful transition could see a significant shift in our export potential from fossil fuels such as coal and natural gas to renewable electricity, harnessing our resources of ammonia, hydrogen and renewable biogas, as well as the full range of critical minerals and rare earths. In addition, Australia has developed world-class technologies and transition systems that are also exportable. The potential here is limited only by our imagination, and supportive government policy is needed to help accelerate our domestic transitions and cement our global credibility.

Australia’s is among the top five most-traded currencies in global foreign exchange markets, and one of the top 10 most held in global reserves. Our dollar has been popular in global foreign exchange trading for several reasons, including importantly being free from government and central bank intervention, our relatively high interest rates, and because of Australia’s links to major Asian economies and to several key commodity cycles. Our dollar is therefore seen as offering significant portfolio diversification benefits.

It has gained this status over decades of transformative policy and massive global economic shifts.

For most of the postwar period, our currency was pegged, initially to the British pound and then to the US dollar. However, it became clear that tethering it in this way left the value of our dollar subject to the vagaries of another economy. When the pound was devalued in 1967, Australia chose, correctly, not to follow and then remained pegged to the US dollar at A$1=US$1.12. It wasn’t until late 1983 that the decision was taken to float the dollar – a move by the Hawke government in response to another run on the currency. The dollar’s value became determined by balance of payments dynamics and global supply and demand factors.

A float had been recommended years earlier by the Fraser government’s Campbell Committee – the inquiry into Australia’s financial system that took place from 1979 to 1981. But it’s not unfair to say that throughout most of the committee’s deliberations, official advisers from the Treasury and the Reserve Bank had been resistant to the move. This was primarily because they often used the threat of an exchange rate collapse as a “discipline” on governments. That is, devaluation was often threatened as a possible consequence of the government not accepting their monetary, fiscal or other policy advice. Australia was faced with a series of exchange rate crises in the 1970s where, from a market point of view, our pegged exchange rate easily became a self-fulfilling one-way bet, as sustained market selling pressure usually forced the government and authorities to devalue, as they had limited capacity to keep intervening to support the peg.

There was, of course, some initial scaremongering in the more popular mainstream media that the float would see the dollar rocket higher. This was also fed by comments of some union leaders that the government had handed the determination of its value to uncontrolled global investment banks – thereby putting jobs and pay packets at risk. The first day’s trading, although a little frenetic, saw only a modest appreciation relative to the previous week.

Since then, the value of our dollar has fluctuated in a fairly wide range, reaching parity with the US dollar in mid-October 2010, a high of US$1.10 in July 2011, and a low of 47.75 US cents in April 2001.

On the few occasions when our dollar dipped below 50 cents, defining factors were having an impact on foreign exchange markets. The first, in the mid 1980s, followed the warning of the then treasurer, Paul Keating, that Australia could end up a “banana republic” if we didn’t implement critical reforms. The second, the all-time low of April 2001, followed the bursting of the dotcom bubble. The third instance was in September 2001, after the terrorist attacks on the World Trade Center threatened to derail global trade. Unfortunately for this country, we were caught somewhat in the confusion, as the Australian dollar subsequently vaulted to post-float highs on China’s cash splash to stimulate its economy, which caused the iron ore price to soar well beyond expectations. This all inflicted some serious damage, by hollowing out our economy and most obviously our manufacturing industries, which couldn’t compete with cheap Chinese imports. For a while, the Australian economy became “two-speed”, with the west booming on mining exports and the east inundated by the influx of Asian goods.

So what is the next great shift in the dollar’s prospects? Is it to slump further in an economy driven by dirty exports that are less and less in demand, or to find support as Australia steps up to a central role in greener global trade?

To fail in this transition could well see our dollar slide back into the 50 cent bracket, entrenching the inflation problem and likely encouraging the Reserve Bank to resort to even higher interest rates.

This article was first published in the print edition of The Saturday Paper on September 23, 2023 as "The one price that’s falling".

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