‘If the worst thing that people say is that we got the economics right again but fell short on the politics, I say, well so be it.’
‘At the end of the day I don’t care about the political outcomes, I care about the economic outcomes.’
‘It’s not because the government is spending too much, it’s because we didn’t collect the revenues we expected to collect.’
Those are the words of Australian federal treasurer, Wayne Swan.
He was breaking the news that the Australian budget wouldn’t return to a surplus this financial year…just as we told you it wouldn’t.
The question is, just what does this mean for you as an investor? We’ll share our view on that in today’s Money Morning…
First off, let’s get one thing straight. No Aussie treasurer cares about economics…because they don’t understand economics. All they care about is politics…the politics of taking and spending other people’s money (OPM).
But we love Mr Swan’s comment that it’s not because the government is spending too much, but rather because it didn’t swipe enough tax dollars.
We’re sure bailiffs and debt collectors hear similar excuses every day, ‘It’s not that we borrowed too much, it’s that we didn’t earn enough.’
The fact is we warned this would happen. The government always had the ‘at-least-we’re-not-as-bad-as-Europe/US/Japan’ argument.
So it was only a matter of time the fabled surplus would disappear.
But you know our view. We never cheered for the government to return to surplus. Not that we want a deficit either. We’d prefer it if the government just left people alone and stopped taxing so much.
Remember, it actually doesn’t matter whether the government runs a deficit or a surplus. They both mean the same thing. It means diverting cash from private sector investment to public sector waste.
Instead of individuals having more cash in their pocket to save, invest or spend, the government gets the cash, which it wastes on buying votes.
That’s the same regardless of whether the government taxes or borrows.
(We’ll leave that thought there, as we’re encroaching on the topics we cover over at Pursuit of Happiness.)
But what’s the implication of this for investors and markets?
For a start, this could (notice the emphasis on could) mean the end of the Australian dollar’s dream run. As you can see on the chart below, the Australian dollar has mostly traded above USD$1 since early 2011:
Click here to enlarge
But considering everything going on in Europe and the US – fiscal cliffs and Greek bailouts – the Aussie dollar hasn’t had a major sustained gain since it climbed over 20% in 2010.
That tells us that far from being a ‘new reserve currency’, the Aussie dollar is hanging on for dear life.
A lower Aussie dollar would have a bigger impact for you than you may think. The obvious things are that imported goods will be more expensive and overseas holidays will cost more.
But it will impact your investments too.
If it costs you to import goods, it will cost Australian businesses more as well.
Now, it won’t be all bad news because Australian companies can use derivatives contracts to hedge their foreign exchange exposure. If they manage these contracts well it can protect the business against adverse price moves.
Trouble is it doesn’t always mean you’ll get the benefit. That’s because firms are still working in a competitive market. If companies can get away with raising prices even though input costs are lower, they’ll do it.
And we don’t have a problem with that…that’s how the market works.
But that’s not much of a consolation for you.
Fortunately, there is a way to hedge your Aussie dollar exposure without using complex derivatives. For a start, most complex derivatives contracts used by big firms have a minimum exposure that stretches into the millions.
A better option is to use a group of securities that trade on the Australian Securities Exchange (ASX). These ‘shares’ give you exposure to rising and falling currencies without having to trade complex investments.
These ‘shares’ are a type of exchange traded fund (ETF) that trades on the ASX. The best thing about these ETFs is that you buy and sell them just like a share. You don’t to take out complex options, forward or futures contracts.
At the moment a firm called BetaShares has three currency ETFs:
British Pound ETF [ASX: POU]
Euro ETF [ASX: EEU]
US Dollar ETF [ASX: USD]
If the British pound goes up against the Aussie dollar then the value of your British pound ETF will go up too. If the British pound falls then your British pound ETF will go down.
(In the interests of disclosure, your editor has invested in the British Pound ETF to protect the value of our spending money before a planned holiday there in a couple of years.)
Protecting your investments against a falling Aussie dollar is a subject our old pal Greg Canavan wrote about several months ago. He’s given his readers advice on how best to do this.
There are other ways to guard your investments too. One that we’re sure our technical trading guru, Murray Dawes, will like is the BetaShares Australian Equities Bear Hedge Fund [ASX: BEAR].
As you can guess, this ETF rises as the market falls. Of course, in recent weeks the BEAR ETF has fallen as the Australian stock market has gone up.
And as we’ve written in recent months, we’re betting on the stock market going up in 2013…that’s why we’ve got more buy recommendations in Australian Small-Cap Investigator than we’ve had in over two years.
But we also know the market is still as fragile as heck. So adding some hedging strategies to your portfolio (or at the very least being aware they exist) makes a lot of sense.
That’s especially important considering the recent rapid rise in Aussie stocks.