08/05/2012 - 10:12

Analysis: the dance of the dollar

08/05/2012 - 10:12


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Forget the budget. Watch the dollar. That’s a small piece of advice for investors, exporters, and anyone planning an overseas holiday because it is in the exchange rate, not in Parliament, that the Australian economy’s immediate future will be determined.

In theory, with official interest rates falling and Australia being clobbered with a barrage of criticism for being too exposed to China, the dollar should be sliding back through parity with its U.S. cousin.

It might do that, but last night’s trading activity on international markets indicated that while Australia has its problems they are minor compared with the rest of the world.

Rather than fall, ahead of tonight’s federal budget, the Australian dollar rose marginally, creeping back above $US1.02, when most forecasts had been for the parity level to be tested sooner rather than later.

What’s happening is that banks, fund managers, and the myriad of other people who control money, have looked at Australia’s future prospects, weighed them against the alternatives of Europe, the U.S. and Japan, and found that we are the best of a bad bunch.

That’s why hope for a significant fall in the Australian dollar as a mechanism to boost the flagging prospects of exporters, and manufacturers exposed to cheap overseas competition, might be a false hope.

Australia, whatever its faults, remains firmly anchored in the world’s high-growth region, and has the resources and investment appeal lacking in the old world of Europe and the U.S.

Some critics call that sort of statement “hubris”, or excessive pride verging on arrogance. No doubt there is some of that in Australia today, albeit for good reason. We have been a star performer in the world, and whether that’s by good luck or good management is irrelevant because the results are on the board.

Can our good luck continue, that’s the real question, and last night’s uptick in the dollar is hint that it might.

What the owners of money are asking is whether there is a better alternative for the funds they control, a country which has a more optimistic outlook, even if dogged by falling productivity, high costs, and an accident prone national government.

The international currency choices are: the U.S. dollar, the Yen, the Euro, or gold – and when those four are examined it is quickly discovered that the return available is miniscule compared to the Australian currency.

In the U.S., Europe and Japan, interest rates are close to zero, so shifting funds there yields a minimal return, and no guarantee of safety. Gold yields no return at all, but perhaps higher degree of safety thanks to its immunity to governments unleashing inflation by resorting to the printing press – which is essentially what the new French President, Francoise Hollande, wants to do.

Australian interest rates are far more appealing, even after the official 0.5% cut last week by the Reserve Bank, because while everyone was watching the reaction of commercial banks and their home mortgage rate they were not watching the deposit rate reaction.

Just as the banks refused to pass on the full 0.5% cut to mortgage holders, so too did they make only a modest adjustment to their deposit rates.

In other words, Australian banks are still keenly competitive for deposits from domestic and international investors.

Sure, the game changed modestly last week, but it did not change that much, and with the latest news from Greece, France and Spain indicating more trouble ahead for Europe it reinforces the appeal of Australia as a home for international money.

What will now be interesting to watch is whether the Australian Government delivers a genuine budget surplus, or a fudged set of accounts which promise a surplus sometime in the future.

If it is genuine, and that will mean a lot of pain for business, than even Australia’s most strident critics, such as the analysts at the French investment bank, Societe Generale, might have to eat their words.

SocGen, as it is called, famously described Australia last month as a “credit bubble” built on a Chinese credit bubble, or “leveraged leverage”, doomed to collapse.

Valid, up to a point, the French view of Australia is actually a variation of the greatest mistake many investors make when they believe that “the future will look like the past”, because what SocGen is saying is that the Australian economy is structured in the same way as that of SocGen’s home, Europe.

In other words, the chaps at SocGen looked out their window in Paris and applied the appalling conditions they saw there to Australia and its major trading partner, China.

What SocGen couldn’t see is that this part of the world is growing, albeit slower than last year, but still at a rate some four-to-five times that of Europe, which actually appears to be shrinking.

It’s for all of those reasons that anyone budgeting for a sharp fall in the Australian dollar will be disappointed. It might dip below parity, but not far.


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