The Australian dollar has appreciated dramatically against the euro since April of 2009, when it first became clear that Greece might default on its debts. Before that, the euro was second only to the dollar as a “safe haven” and reserve currency. Plus, with everyone wanting to be in cash at the height of the GFC, the euro rallied.
Since then, the Australian dollar has smashed the euro. It’s conceivable that the Aussie dollar could even reach parity with the euro in 2012. A lot of things would have to happen for that to take place. But look what’s happened in the last five years!
Australian Dollar Making New Highs
The immediate issue for Aussie investors is that the interest rate differential between Australia (cash rate of 4.25%) and Europe (.25% by the ECB) could cause a lot of speculators to pump money into Australia. Those speculators wouldn’t be much different from previous speculators who borrowed cheap yen or US dollars to buy Aussie assets. Nor would the basic problem of huge speculative capital flows into Australia – soaring asset prices – belie what’s going on in the real economy.
In the real economy, the stronger the Australian dollar gets, the harder it is for Aussie exporters to compete globally. It’s pretty hard already. Just ask Toyota, which recently fired one-tenth of its Australian work force. A stronger dollar will accelerate the de-industrialisation of the Australian economy.
The only other country in the world to see its currency strengthen so much (thanks to commodities, the interest rate differential, and relatively low government debt) is Brazil. Remember the Brazilians were the first to publicly decry the “currency war” unleashed by the Federal Reserve in 2009. The huge inflow of capital to Brazil drove that country’s currency, the real, up.
Brazil retaliated by imposing a 2% tax on all foreign inflows into Brazilian stocks. Foreign investment in Brazilian bonds was taxed at a higher rate of 6%. And the country even slapped a 1% tax on currency derivatives. All of the measures were designed to weaken Brazil’s currency (the real) and thus preserve Brazil’s competitive advantage as an exporter.
Will the RBA Weaken the Australian Dollar?
It may seem strange to you that a country actually discourages foreign investment by taxing it. It’s even stranger that countries desire a weaker currency in order to remain competitive. But the fact that both things are true – despite how counter-intuitive they seem – tells you that we live in strange times.
There is a surplus of productive capacity in the world. As Jim Rickards has pointed out in his new book, Currency Wars, we are in a “race to the bottom”. It’s a war of all against all, in which nations are trying to out-compete each other by making each other’s export industries unprofitable. When the currency strengthens, a lot of jobs go.
This is certainly the case in Australia. The stronger the Australian dollar gets, the harder it will be for manufacturers to do business here. The economy will come to resemble the UK economy – dominated by financial and banking interests, devoid of manufacturing, and sprinkled with a healthy dose of only the lowest-cost exporters.
This leads me to believe the Reserve Bank of Australia will cut rates soon. It won’t do it to reduce currency speculation, mind you. It will do it to assist borrowers and consumers. But it will do it all the same.
Whether a rate cut will reduce the volume of speculative flows in Australia is hard to say. In fact, it’s hard to say just what the volume of speculative flows into Australia is. It’s likely a lot of the “hot money” coming into the country is in the currency markets. But if some of it is in the stock market too, keep in mind it can leave just as quickly as it came. See the chart below for evidence.
One thing you can be sure of is that the Australian dollar is not a “safe haven” currency as Prime Minister Julia Gillard has said. She needs to look at the chart above and reconsider the view she gave at an economic speech in Melbourne in early February. The chart above looks like a heart attack.
Of course some people will argue that the Australian dollar has been “re-rated” to reflect high-interest rates, commodity wealth, low unemployment, and relatively low government debt. Those people are cheer leaders and trend followers. They are wrong.
More importantly, if you listen to them, you’ll be unprepared for what happens to Australian stocks when the speculative capital flows reverse, as they did in 2008. It’s not a matter of “if”. It’s a matter of “when”.
In the meantime, the best way to be in the market is to only target companies whose share price and business are correlated with some larger, positive trend in the global economy.
Dan Denning
Editor, Australian Wealth Gameplan
Publisher’s Note: Dan Denning will be appearing at After America: the Port Phillip Publishing Investment Symposium, March 14th-16th at Sydney’s Intercontinental Hotel.
Australian Wealth Gameplan subscribers have been profiting from what editor Dan Denning calls ‘The Revolution in the Desert’ since last June. And in this case, profit means two tips up over 120% at last count.
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From the Archives…
Picking the Big Investment Story for 2012
2012-02-10 – Kris Sayce
Attention: If You Have Australian Bank Stocks – Sell Them Now
2012-02-09 – Kris Sayce
Why This Bearish Indicator Means it’s Time to BUY Stocks
2012-02-08 – Kris Sayce
Why The RBA Uses The Terms of Trade Indicator… And Why You Should Too
2012-02-07 – Greg Canavan
Why the US Unemployment Rate is a Slippery Statistic
2012-02-06 – Dr. Alex Cowie
February 15th, 2012 at 3:04 pm
“Those people are cheer leaders and trend followers. They are wrong.
More importantly, if you listen to them, you’ll be unprepared for what happens to Australian stocks when the speculative capital flows reverse”
There has to be an upswing before there can be a correction.
I hope you also predicted the upswing we’ve seen since 2009.
February 15th, 2012 at 7:23 pm
If devaluing your currency was the root to prosperity, then Zimbawae could be the manufacturing mecca of the world
February 15th, 2012 at 8:44 pm
The hollowing out of LOW VALUE ADDED manufacturing is happening everywhere across the globe bar China. The US are pumping paper while declaring zero interest rates for years in advance in a war against China… with the end goal being a revaluation of Chinese currency. This is the same result the US achieved against Japan in the 90s which spelled the end of the Japanese threat to buying every asset of the planet and was the start of the “lost decade”.
Australia has NEVER been a leading global scale manufacturing exporter, we’ve ALWAYS been a nation that exports zero-value added raw materials. It’s the same as before, but now on steroids!
February 16th, 2012 at 10:11 am
Interesting Dan,
In your opinion, to what extent did the RBA leave rates unchanged last week with a view to keep the AUD high? Could there be a reason that is making the RBA and the PM want a high AUD?
February 17th, 2012 at 4:27 pm
by the time the aud is trash, other currencies will be SUPER TRASH putting us back at square one (or worse). This does not help the sell the home for gold argument..