The Australian dollar has found some thicker ice to stand on. After falling 14 cents, it’s been trading comfortably around 91 cents. Where to from here?
Long gone are the days when interest rate differentials and trade balances determined currency values. Today it’s all about who can get away with trashing their own currency by printing the most money. It’s beautifully ironic to see Australia’s currency take a 12% hit since April when we’re one of the few countries without an extremist monetary policy. It must really baffle all those central bankers overseas trying to engineer an export boom.
The recent stability in the dollar is of course interest rate speculation. The CPI numbers influence the Reserve Bank Board and the Reserve Bank Board controls the interest rate. So all eyes are on today’s CPI release, which put inflation below expectations. Even though the swap markets imply a 65% chance of a cut when the Board meets next month, to Europeans and Americans, Australia’s rates would still be juicy. But they have been falling, so the Aussie dollar has fallen with them.
All that’s just a theory though. One that the media runs with to explain anything it can from currency moves and stock market rallies to the meaning of life. We never understood the argument that interest rates determine or affect currency exchange rates.
The interest rate parity theory says that currency exchange rates adjust to equalise returns. So if Australian interest rates are higher than American ones, as they are, the Australian dollar should fall. That way an American can’t take advantage of an Aussie bank account’s interest, because the currency would impose a loss when he repatriated the money. The theory is counterintuitive because people have to pile into the Aussie dollar to get the returns in the first place, pushing it up. That adds to the gains instead of reducing them…
As always, it’s a matter of timing. If you were an American and invested in the Australian dollar years ago, you would’ve picked up a currency gain and an interest rate gain. Interest rate parity is catching up with latecomers though. The Aussie is falling now, costing any foreigners holding Aussie dollars their returns.
If interest rate differentials really are controlling the Australian dollar, its direction from here is a question of monetary policy…like everything else in the investment world these days. Greg Canavan has news from the US that Larry Summers has taken over from Janet Yellen as the favourite to succeed Ben Bernanke. ‘From Volcker, to Greenspan, to Bernanke to Summers…what a spectacular demise,’ Greg wrote.All the front runners for the Fed’s leadership role are ‘do whatever it takes’ types. They think being in charge means you have to do something. That’s dangerous when you’re a central banker.
Australia’s higher interest rates compared to the rest of the world aren’t just affecting exchange rates. The money has to flow into a part of the Australian economy to actually earn the higher rates. In propping up our currency, the world has also been funding our banks and investing in our interest paying assets. Dan Denning sent over a chart of Australand, an Australian Real Estate Investment Trust. It’s up 10% more than the ASX200 over the past year and yields 4.3%. But this morning it announced disappointing earnings.
4.3% is reasonable to an Aussie investor, but it’s great to a foreigner. The investment opportunity in these types of assets may or may not be gone. All those foreigners will eventually try and escape from Aussie assets before the currency falls further. But the distortive effects on the Australian economy are interesting. What would Australand’s stock price be without foreign money? What would its yield be?
That’s the investment side. Foreigners are propping up our asset prices. Over on the demand side, the Chinese are keeping the Aussie economy going with their resource imports. Which begs the question — what are Australians doing to keep our economy going?
If we’re funded by investors from Europe and the US, and our economy runs on Chinese demand, where do the Australians in Australia fit into the picture? Are we just employees of the West supplying the construction of the East? Those two don’t seem like the kind of people you want to rely on. They could be pulling our own wool over our eyes.
for Markets and Money
Ed Note: This is an edited version of China’s Game of Texas Hold ‘Em, which originally appeared in Markets and Money USA.
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