Will the Australian Dollar Fall to the Euro?

Goldman Sachs reckons the Australian dollar is in deep trouble. ‘One of the best long term trades out there at the moment is long euro versus short Aussie,’ said Thomas Stolper, chief currency strategist at the investment bank. In other words, he expects the Australian dollar to fall in Euro terms.

Ignore for the moment that Thomas’ last name means ‘stumble’ in German (ours means ‘bump’). What would a drop in the Australian dollar mean for Australians and our economy?

To be honest, it’s an invalid question from the start. It presumes the value of a currency affects the economy. It’s really the other way around. The currency reacts to the economy. It tries to balance imports and exports by falling and rising when one of them gets out of hand. At least, that’s what’s supposed to happen.

But currencies are the last bastion of central planning. Governments control how much money is in the economy, and how much it costs you to borrow it. That stops things from working the way they should. The result is instability.

And because money is half of every transaction, the government’s involvement causes instability right across the economy. It’s ironic that governments have rolled back many of their interventions in the economy, but left the one that really matters. And then they blame free markets for anything that goes wrong.

Anyway, the Europeans and the Americans are printing lots of money. The Australian central bank isn’t anywhere near as much. Surely that means the Aussie dollar will rise, not fall as Goldman Sachs expects?

But what if the Aussie dollar has already risen to reflect the newly printed money? As traders would say, it has ‘priced it in’. If it has, where to from here? What will make our currency fall?

Well, Europe and America have had their housing bubbles pop. Ours is yet to burst. And we’ve got a resources curse too. Our economy is dependent on exporting dirt, which can change in price and demand very quickly. Worst of all, our banks are reliant on foreign financial markets. All that bodes ill for our currency.

Economic Forces vs Manipulators

What you’ve got here is a clash over who controls exchange rates, between currency manipulators and economies. Do central banks, which print money and sometimes intervene in foreign exchange rates, have control? Or do currencies move to try and reflect economic reality?

The answer might not matter if you’re an Australian. That’s because our currency manipulators (the RBA) probably want a lower Australian dollar at the same time that the weakening economy will cause one. If the Australian economy suddenly worsens as the housing bubble pops, the resource boom ends and the banks face a funding drought, the Aussie will plunge. That’s what Goldman Sachs expects, to some extent.

When things go wrong, they tend to do it at the same time. On Wednesday, our steak leaked blood all over our shopping. Then, while cooking the steak, a shelf which holds vast amounts of glassware and beverages fell, shattering everything over the floor. After we vacuumed it all up, we knocked over the glass we were drinking from in exactly the same spot (and before you make any assumptions, it was only cordial).

The economic equivalent is about to happen to Australia. And poor economic times usually mean a weaker currency. You can take advantage of Goldman Sachs ‘trade of the century’ using the Euro ETF listed on the ASX. As the Aussie falls against the Euro, the ETF should rise in price.

But what bugs us about that idea isn’t the Australian dollar. It’s the Euro side of the trade. Why on earth bet on something that is the focus of economic pessimism at the moment? Usually, being a contrarian is a good idea. To paraphrase a famous investment maxim, ‘buy when tear gas is in the streets’.

From a Bad Currency to a Worse One

But what if the Euro’s rot runs deeper than anyone realises? And what if the solution to the Euro mess is actually going to be a complete disaster?

Most historians will tell you about the rise of Hitler in terms of inflation and the treaty of Versailles. But the story really starts with a badly thought out political union.

By combining several different cultures into one Austro-Hungarian Empire, the ruling family fostered all sorts of internal strife. That’s where Hitler got his obsessive nationalistic fervour from. He hated having the Austrian Germans grouped in with the Slavs instead of their own ‘race’ to the north.

For the record, we’re not too sure how ‘German’ Austria’s neighbours, the Bavarians, are. They wear pants with flaps and slap each other in time to strange music to impress girls. But we plan on doing some research this weekend at Melbourne’s Hofbrauhaus. They’re celebrating Oktoberfest.

Meanwhile, in response to the Euro crisis, European politicians are trying to create another political union to rule over people that don’t fit together. Rather than being free to trade with each other, they’re forced to accept each other’s rules and courts. Pretty soon the infighting will begin. Infighting is solved by strongmen like Stalin and Mao. That’s what Hayek’s book ‘The Road to Serfdom’ is about.

Back to the currency question. There are three ways the Euro could break up. One favours the Euro over the Aussie Dollar, and the second suggests it could plunge alongside the Dollar. If the weaker countries leave the Eurozone, that will send the Euro upwards, because of the remaining strong countries.

If the strong countries get sick of the Euro mess and leave, the Euro would be left with weak countries, and would fall. Under the third option, a complete abandonment of the Euro, who knows what would happen to people holding the currency? Do you get Deutschmarks or Drachma?

Until next week,

Nickolai Hubble.
The Markets and Money Weekend Edition

ALSO THIS WEEK in Markets and Money

An Investment Strategy for the End of Australia’s Lucky Run
By Dan Denning

BHP’s announcement confirms the idea that mining booms end when costs are high and commodity prices fall. At the very least, all the easy profits from a boom have been made when you have to start shifting jobs from your most profitable operating segment. This fact calls for a rethink of 2013 investment strategies, which is exactly what we’ve done in our latest video feature.

How The Fed’s Forecast Fallacy Leads to Stagflation
By Nick Hubble

The American central bank, the Federal Reserve, has decided that pumping money into the economy creates jobs. They just have to print enough (that’s the funny part). And so now their policy is open ended, meaning they’ll print more and more money until unemployment falls (the terrifying bit). The problem is that unemployment and money printing aren’t related to each other in the way central bankers expect.

Global Economy Health Check
By Satyajit Das

As requested, I have undertaken an extensive examination of Mr. Global Economy, both physical and psychological…Mr. Economy is delusional, believing complete recovery is imminent. Presented with contrary evidence, he quoted philosopher Friedrich Nietzsche, ‘There are no facts only interpretations.’

Oh to be so Lucky to Get Free Money from the Financial System
By Bill Bonner

It’s amazing how lucky you get when you have the Fed giving you money! We call it what it really is – cheating. It’s what happens when the feds fiddle the financial system. Money – created not made – is up for grabs. And who grabs most? Those closest to the source – the insiders. The more loot the feds distribute, the more the insiders get. The rich get richer.

Has the China Boom Made You Wealthy?
By Greg Canavan

What happens when Asia ‘rises’ and decides to consume the capital it has for years been lending to Australia? The rise of Asia will indeed be a profound event. But it will come with changing trade and capital flows. Instead of lending to ‘wealthy’ countries like Australia, these newly wealthy countries will probably find better things to do with their savings, like spend it on themselves.

Nick Hubble
Nick Hubble is a feature editor of Markets and Money and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about Markets and Money, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails.

Leave a Reply

6 Comments on "Will the Australian Dollar Fall to the Euro?"

Notify of
Sort by:   newest | oldest | most voted

I think Golden Sacks is having you on Nick. Maybe they are trying to do what they do best, manipulate the market. I ‘realise’ that thought has not crossed your mind but are there any ‘whispers’ out there ?.

That same GS position falls in behind Katie Koch’s flogging of her GS emerging markets portfolio. See http://www.businessspectator.com.au/bs.nsf/Article/Katie-Koch-GSAM-KGB-Europe-America-portfolios-pd20120718-WB2HB?opendocument So if 60% growth for the BRICS now looks impossible, what else can GS do to lure Australian savers? Oh yes, now we can work the AUD risk angle…. Before bringing a GS position to us, and until such time as all prop desk positions are eliminated from merchant banks, perhaps you should request a guarantee that reads like this : they have no position on the other side of the book, and/or they agree not to take a position on the… Read more »

Nick I think the AUD/USD can have a sharp but short lived sell off any old time. However it’s a rise to 1.20’s zone I am more concerned about… in keeping with the longer term trend.
Goldman will always want to keep speculators on the opposite side of their trade. I would expect them to start pushing the long trade idea some time after we break above the historic highs. And those are naught more than my intuitions on the subject.

zane zeehan
I must admit the rise of the AUD has surprised me. I never thought I would see a return to parity with the USD in my lifetime. But what goes up can also come down, and I suspect the speed and size of a future fall may stun a few people. When the financial markets decide to punish a country, they really put the boots in. No mercy is shown. It’s like being stomped by a bunch of Glasgow skinheads… I pretty much see the current strength of the AUD as pure luck. Not that I am in the business… Read more »

Don’t understand Golden Sacks, the other day someone was writing that the Euro dollar is deep in the brown stuff, now GS are going long, what is their game? Come to think of it, I also read that Greece and maybe Spain will do a runner, or be pushed, thereby saving the Euro and the rest of the Union. Or Germany will go and leave them to wallow in the mess they created. Fascinating stuff what?


Addendum to the above., your last sentence is right on the money Asper.

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au