It’s been quite a turnaround. As the Reserve Bank of Australia (RBA) would probably say, “following the collapse in global markets caused by the failure of Lehman Brothers,” the Aussie dollar tumbled close to USD$0.60.
The writing was on the wall. No-one was ever going to desire Australian dollars ever again. All investors wanted the ‘security’ of the US dollar…
But that’s changed and now the momentum seems to be in the other direction. The Aussie dollar has been driven back above USD$0.75. It’s still over 20% below the peak reached mid last year.
But it’s more than 20% higher than the dip reached in early March this year.
So, what’s happening?
For a start when I mention ‘momentum’, I’m referring to the fundamentals of the currency, not a technical analysts view. The fact is investors are buying Aussie dollars despite Australian government policies. Policies that would ordinarily push investors away. You see, current policy will eventually lead to higher inflation, higher interest rates, and a weaker currency. That’s typically not attractive to foreign investors.
But at the moment interest rates are low, the currency is getting stronger, and the inflation numbers are yet to show big inflationary pressure – even though other indicators are showing the danger signs. It’s just that these are being ignored.
What we are seeing is something very simple. And it is something that should benefit Australia to the tune of billions, if not trillions of dollars. There is only one thing that can possibly put a spanner in the works. But I’ll get to that shortly…
First, what is this ‘something’?
It’s an old story reborn, that’s what it is. It is the effects of the gravitational pull of China.
Do you remember when you first learned at school that the ocean tides were influenced by the gravitational pull of the Moon? Do you remember how amazing and, frankly, improbable it all sounded?
Well, the pull of China is equally amazing but far less improbable.
You don’t need to look far for evidence. This past week three of the 25 stocks in the Australian Small Cap Investigator portfolio have registered 30-50% gains thanks to business dealings with Chinese companies. And they aren’t pie-in-the-sky deals either. They involve actual cash transactions with the Chinese in exchange for ownership or products.
But those aren’t the only ones. Throw a few darts at the stocks page in the AFR and you’ll come up with plenty of resources or manufacturing companies that are on the brink of a big pay day with China.
And this is all having a positive effect on the Australian dollar. It’s the perfect example of how beneficial it is for an economy to produce goods (primary and manufactured) that other countries desire.
When the Chinese are buying Copper or Iron Ore, it may very well be paid for in US dollars, but a significant portion of that will be converted back to Australian dollars. The exception being the amounts the company chooses to keep in US dollars to pay for costs priced in USD .
That’s how real jobs are ‘created.’ They are created by the demand for a good or service. Not by some public servant ‘creating’ a job for something that nobody wants or needs. Anyway, that’s beside the point, we’ll have more to say on that tomorrow – in particular an extraordinary detail from last week’s US job numbers.
As I mentioned above, investors are buying Aussie dollars despite the actions of policy makers. And it is these actions by policy makers that could lead to trouble on the horizon.
With billions of dollars being wasted on infrastructure projects, this is going to create a huge demand for raw materials.
The same raw materials the Chinese are buying for real productive purposes.
Who’s going to win out? Who’s going to get the raw materials first? Or will there be enough to go around for everyone?
That’s the “trouble on the horizon.” You see, with all the scaling back of production and exploration in the mining and energy sector in the last twelve months, it will take some time to get capacity levels up again. In the meantime that could create a shortage of supply for the Chinese.
Although they may not like it, they do have the cash to pay up if prices have to move higher. The Australian government and its infrastructure projects do not. Even it knows it can’t afford to forcibly take too much taxpayers money for erroneous spending.
And that means: higher taxes, higher inflation (to help pay off government debt) or price and export controls on raw materials.
Of course the price and export controls would mean that the government gets its iron ore and copper cheap, and stands first in line. But someone will lose out in that transaction. Either the miner is forced to sell at below market price – where’s the incentive for them to do that? They just won’t produce as much, leading to more shortages, lower investment and higher market prices.
Or, the taxpayer gets stung for the higher costs. Either way…
The Chinese would have to wait their turn.
Do you think they’d stand for that?
Not a chance.
Not so long ago you would have been right in thinking that was crazy talk. But right this moment, it’s something that looks extremely probable.
It’s shaping up as the next phase in the public sector’s misguided attempts to save the economy, when in fact they are in danger of destroying one of Australia’s most productive sectors of the economy.
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