Australian dollar approaching a dangerous level, economists warn

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Whether you think the coronavirus recession has ended or not, it’s hard to deny an economic recovery is underway.

The closely watched National Australia Business survey points to this:

“Overall both confidence and conditions are now above average, and stronger than the period right before the pandemic,” NAB senior economist Gareth Spence wrote.

And with the economic recovery, the Australian dollar has found a spring in its step.

The converse is also true. It hit a low against the greenback on March 20 (57.4 US cents) when the COVID economic crisis reached a crescendo.

Basically, a rising Australian dollar is a sign of a strengthening economy.

There is a point, however, where the value of the Aussie dollar begins to put the brakes on economic growth.

We’re just about at that point now, and if it goes much higher it will become a serious threat to the recovery.

So, what’s pushing it up?

Dollar rising

There are several forces driving the Australian dollar higher.

First and foremost are the rising prices of commodities, particularly iron ore.

The price of iron ore is trading at a near eight-year high as China supercharges its spending on infrastructure, which requires steel, which relies on iron ore from Australia.

Chinese businesses need to buy Australian dollars in order to purchase Australian iron ore, so the more in demand it is, the higher the currency goes.

Next up is what’s called “risk appetite”. Think of this as the global “mood”. The better the mood, the more the Australian dollar rises.

With evidence a vaccine could be widely available at some point next year, the global economic outlook has improved substantially (as evidenced too by soaring share markets).

Finally, interest rates influence the value of the dollar.

Believe it or not, despite Australia’s cash rate being close to zero, Australian interest rates more broadly are relatively higher than comparable interest rates around the world — especially in the United States.

Money and investors gravitate toward countries with relatively high interest rates (yields), and this also puts upwards pressure on the Australian dollar.

RBA to the rescue?

The interest rate premium on Australian dollar denominated assets is the key reason the Reserve Bank chose to embark on its ramped-up Quantitative Easing program.

The RBA is currently in the process of buying $100 billion worth of government bonds from major financial intermediaries like the big banks, and superannuation funds.

This bond buying bonanza should have the effect of increasing the price of bonds and lowering the yield or interest rate attached to them.

Bond prices move inversely to their yields.

It’s hoped that by lowering interest rates across the board (from the rate on the overnight cash rate to the 10-year government bond), Australian money investments (term deposits etc) will begin to look less attractive to offshore investors.

At the very least it’s designed to stop the Australian dollar from rising much higher.

Breaking point

The Reserve Bank began its bond buying program when the Australian dollar ticked over 70 US cents.

The dollar is now edging closer towards 75 US cents.

Market economists Su-Lin Ong and Stephen Koukoulas agree that 75 US cents is the point at which the rise in the Australian dollar starts acting as a hand break on economic growth.

It’s akin, Koukoulas says, to a tightening of monetary policy or actually raising interest rates — an unthinkable notion right now for policy makers.

Some areas of the economy though will be harder hit than others.

Losers from a rising dollar

The sectors most at risk from an Australian dollar above 75 US cents, Ong says, are manufacturing and agriculture.

Tourism also gets hurt but that’s not such a problem now because there are not so many international tourists (apart from New Zealanders).

Iron ore miners escape much of the economic damage too because demand remains strong.

Ong notes that it’s the hundreds of thousands of smaller export businesses that will get hurt the most.

And, of course, as their products become less competitive and their profits are crimped, they’ll be less keen to hire new staff.

Perhaps that’s why the NAB noted in its latest business survey that “employment indexes remain in negative territory”.

Winners from a rising dollar

On the flipside, shoppers usually benefit from a higher Australian dollar.

That’s because imported goods become cheaper.

Now, realistically you’re not going to feel any tangible financial gain from buying small goods, but a refrigerator or couch may come down in price, for example.

The COVID kicker though, economist Su-Lin Ong warns, is that many businesses “will absorb the gains”, or pocket the cost savings.

Forces pushing the dollar higher may not support wider economy

The Australian dollar was floated on the 12th of December 1983 — this Saturday marks the 37th anniversary.

A floating dollar — or a dollar that’s at the mercy of market demand — can be beneficial because as the global economy deteriorates, and the dollar falls, it cushions the blow.

The reverse is also true.

The problem we have now is that the forces pushing the dollar higher are not necessarily going to support the wider economy as well.

For a strong, sustainable economic recovery to take hold, a coronavirus vaccine will need to become widely available.

Some have suggested the Reserve Bank should directly, rather than indirectly, exert downwards pressure on the dollar by actively selling its AUD reserves in the currency market.

We’re not quite at that point yet, but then again this year has seen plenty of extraordinary policy moves.

By David Taylor (Original ABC Article)