The rising value of the Australian dollar is a game changer for many businesses in the west.
THE Australian dollar is moving close to parity with its US counterpart, something it has looked like achieving in the past three decades but never quite got there.
This week the Aussie is trading around US96 cents, continuing the roller-coaster ride that often characterises the currency market.
The last time the dollar approached parity with the US was just over two years ago, in July 2008 when it reached US98 cents.
Since then it has tumbled as low as US61 cents in late 2008, risen to US94 cents early this year, dropped again to US81 cents in June before commencing its latest rise.
That brief history highlights the risks associated with currency volatility.
Anyone who bought US dollars in late 2008, when the Aussie currency was weak, must be ruing their decision.
Conversely, anyone selling US dollars at the time will be feeling pleased with their trade, since they locked in a very attractive rate.
Looking back is one thing. Looking forward is much scarier because the future value of currencies is so difficult to predict.
On most measures, the Aussie dollar is at historic highs, at least since 1983 when the Hawke government floated the currency.
A recent Reserve Bank study put this in perspective, comparing the value of the Aussie relative to the average value of other currencies since the 1983 float.
It is 26 per cent above the average US dollar exchange rate, 29 per cent above the average UK pound exchange rate, 19 per cent above the trade weighted index, and a whopping 119 per cent above the Indonesian rupiah.
The main exception to this pattern is the Japanese yen; the Aussie is 16 per cent below the average yen exchange rate.
There are two main drivers behind the strength of the local currency.
One is the strength of commodity prices, such as coal and iron ore.
The best measure is the terms of trade, which tracks the average price of exports and the average price of imports. Recent gains in the terms of trade have taken it to a higher level than applied in 2008, which was the peak of the last resources boom.
A second factor has been interest rates, specifically the differential between Australian rates and overseas rates.
Investors get a much better return holding Aussie dollars, and the return is set to get even better with the Reserve Bank signaling it is likely to push official interest rates higher to dampen the possibility of rising inflation.
Conversely, interest rates in the US and much of Europe are close to zero and likely to stay that way as the major northern hemisphere economies struggle to show much life.
Exporters are among the winners from a strong dollar, since their products are more competitive in international markets.
Consumers are also winners, for the opposite reason. The cost of imported goods – everything from cars to flat-screen TVs to petrol – is lower than would otherwise apply.
In fact, any person or business buying goods and services from overseas is better off. That helps explain the rise in overseas travel, and the lackluster state of the domestic tourism industry; it can be a lot cheaper to take the family overseas, especially to destinations like Bali or Vietnam, than closer to home like Rottnest or a resort at Margaret River, let along skiing at Thredbo.
It also helps explain why local manufacturers are struggling to win work, most pointedly on major resources projects. The high dollar, combined with the improving capabilities of low-cost Asian manufacturers, make it tough for relatively small steel fabrication workshops in Kwinana to compete.
The strong currency risks exaggerating Australia’s reliance on primary exports, such as minerals, petroleum and farm products.
Tempting as it may be to intervene in order to support struggling sectors, the market is sending a signal. Australia is highly competitive in certain sectors and that is why we have a growing economy, rising investment, low unemployment and a strong dollar. That’s a good outcome.