The Australian Dollar - should the RBA intervene?

[Uncle Festivus]

Is it just me or have our guardians of the economy fallen asleep at the wheel with regards to the Australian dollar exchange rate? Or is it just part of a grand plan of blame shifting by the RBA so they don't have to take the heat for raising interest rates higher, especially after the latest CPI came in above expectations?

So should they just sit on their hands as Australian industry & manufacturing close down and jobs lost to other countries?

Will this bring on a recession if it keeps going higher?

 

[Misterlazy]

I think this is an interesting topic to discuss,

However, please correct my limited knowledge of economics and logic if i am wrong.

Higher exchange rates, can only be corrected by Lowering interest rates correct?
So if the CPI and inflating is on the increase, the option to increase interest rates to dampen that is usually of ordinary nature.

Which begs the question, am i correct in saying the RBA is stuck in a tough position ?
However, with the floods being a somewhat influence on the higher CPI, won't the RBA eventually give in to reducing our interest rates?

Cheers

 

[TulipFX]

Is it just me or have our guardians of the economy fallen asleep at the wheel with regards to the Australian dollar exchange rate? Or is it just part of a grand plan of blame shifting by the RBA so they don't have to take the heat for raising interest rates higher, especially after the latest CPI came in above expectations?

So should they just sit on their hands as Australian industry & manufacturing close down and jobs lost to other countries?

Will this bring on a recession if it keeps going higher?

Hi Uncle Festivus,

A rising currency tempers inflation.

 

[TulipFX]

I think this is an interesting topic to discuss,

However, please correct my limited knowledge of economics and logic if i am wrong.

Higher exchange rates, can only be corrected by Lowering interest rates correct?
So if the CPI and inflating is on the increase, the option to increase interest rates to dampen that is usually of ordinary nature.

Which begs the question, am i correct in saying the RBA is stuck in a tough position ?
However, with the floods being a somewhat influence on the higher CPI, won't the RBA eventually give in to reducing our interest rates?

Cheers

Hi Misterlazy,

They could also reduce the exchange rate by printing more money. Both lowering interest rates and printing more money (or the modern version of it - central bank purchasing of government debt) have the same effect - increasing the supply of AUDs. Like any supply and demand situation the price will drop on supply increase.

Interest rates also have an effect on investment flows. Higher interest rates encourages people to hold AUD for the higher returns, and vice versa.

Regarding CPI, the core inflation is actually good. It is the headline inflation which spiked up due to higher produce costs due to the floods. The other statistical measures which remove the outlying products from the basket shows inflation is still under control. I saw a graph of it yesterday, but can't find it now - Alan Kohler also showed a version of it on ABC news last night.

Hope that helped somewhat.

 

[Smurf1976]

Borrow in the US at virtually zero interest rate and lend to Australia thus making a nice profit.

We'll be hit very, very hard when the trade reverses and the tide goes out. With the hollowing out of the economy due to the current situation, we won't have much to fall back on.

 

[Uncle Festivus]

It's starting to cost us real money -

LOS ANGELES (MarketWatch) -- Australian shares extended their fall into the midday Friday, as mining majors were dragged lower by a strong Australian dollar. The benchmark S&P/ASX 200 AU:XJO -1.05% gave up 1% to trade at 4,822.3. While the Australian dollar eased against its U.S. rival in early Friday trading, its overnight gains dragged on a variety of shares, including the top miners.

 

[warennie]

Borrow in the US at virtually zero interest rate and lend to Australia thus making a nice profit.

That'd be arbitrage if the opportunity existed, unfortunately the exchange rate would remove any possibility for a risk free profit (borrowing USD, converting to AUD = Bad)

Right?

 

[prawn_86]

Borrow in the US at virtually zero interest rate and lend to Australia thus making a nice profit.

That'd be arbitrage if the opportunity existed, unfortunately the exchange rate would remove any possibility for a risk free profit (borrowing USD, converting to AUD = Bad)

Right?

Its just a basic carry trade. Problem comes when they need to take the funds back home if the rates have changed.

Same thing happened with the AUD/CHF back in the early 90's

 

[tothemax6]

Is it just me or have our guardians of the economy fallen asleep at the wheel with regards to the Australian dollar exchange rate? Or is it just part of a grand plan of blame shifting by the RBA so they don't have to take the heat for raising interest rates higher, especially after the latest CPI came in above expectations?

So should they just sit on their hands as Australian industry & manufacturing close down and jobs lost to other countries?

Will this bring on a recession if it keeps going higher?

I think there are some fundamental misunderstandings floating around about exchange rates. For instance, if all of Australia's exporters 'closed down', what would support a high exchange rate?
The exchange rate is high because of actual things. It doesn't just float around randomly. The exchange rate is currently high because there is a high demand for AUDs (ignoring the fundamentals of the USD). There is a high demand for AUDs because AUDs need to be purchased to buy what our exporters are exporting (coal, iron ore, whatever). The high demand for our goods means a high demand for AUDs which means a higher AUD price in terms of other currencies.

The high AUD is not a sign of future economic malais, it is a sign of current economic strength. The RBA (which like all central banks, should not exist) should do precisely nothing except continue to target low inflation by tightening the money supply.

I think this is an interesting topic to discuss,

However, please correct my limited knowledge of economics and logic if i am wrong.

Higher exchange rates, can only be corrected by Lowering interest rates correct?
So if the CPI and inflating is on the increase, the option to increase interest rates to dampen that is usually of ordinary nature.

Which begs the question, am i correct in saying the RBA is stuck in a tough position ?
However, with the floods being a somewhat influence on the higher CPI, won't the RBA eventually give in to reducing our interest rates?

If a central bank wishes to play with the exchange rate of its currency, it simply buys or sells its currency directly on the foreign-exchange market.
Exactly the same effect as selling a bunch of shares causing the share price to go down.

 

[Uncle Festivus]

I think there are some fundamental misunderstandings floating around about exchange rates. For instance, if all of Australia's exporters 'closed down', what would support a high exchange rate?
The exchange rate is high because of actual things. It doesn't just float around randomly. The exchange rate is currently high because there is a high demand for AUDs (ignoring the fundamentals of the USD). There is a high demand for AUDs because AUDs need to be purchased to buy what our exporters are exporting (coal, iron ore, whatever). The high demand for our goods means a high demand for AUDs which means a higher AUD price in terms of other currencies.

The high AUD is not a sign of future economic malais, it is a sign of current economic strength. The RBA (which like all central banks, should not exist) should do precisely nothing except continue to target low inflation by tightening the money supply.

Exporters (non commodity) are closing down, that's the problem. And those that don't export but make goods for the local market are having to compete with ever cheaper imports. I was looking for a lounge recently - there is just no comparison - Chinese imports are substantially cheaper, or at least, even cheaper than usual. How can the local manufacturer compete with that?

Demand for currency to pay for commodities plays a part, but by far the greatest influence on the level is as a direct counter trade to the $USD, as per the chart below, which shows a very high correlation. How else can the very large daily fluctuations be explained?

Every other country, in this climate, wants a low exchange rate to bolster local industry, and their CB's comply for that outcome by intervention, either directly or QE etc.

At the current level (and higher) it will be 'a sign of future economic malais' as one by one local manufacturing and producers get swamped by cheap imports. It will happen - it's already happening.

Investors are becoming increasingly worried about the impacts of the AUD on Australian corporate earnings.
Given another strong US session overnight, the magnitude of today’s falls is somewhat surprising. While it’s been talked about for couple of weeks, it seems the strength of the AUD is now starting to bite. This is particularly relevant in terms of profit expectations for Australian corporate earnings, and by effect, the performance of the broader equity market.

 

[Smurf1976]

Its just a basic carry trade. Problem comes when they need to take the funds back home if the rates have changed.

Same thing happened with the AUD/CHF back in the early 90's

Agreed. The only reason I mention it is because I've seen various reports from the US referring to the rise of the AUD in precisely this context as though it were common knowledge that there is an active carry trade involving USD and AUD.

 

[Smurf1976]

At the current level (and higher) it will be 'a sign of future economic malais' as one by one local manufacturing and producers get swamped by cheap imports. It will happen - it's already happening.

Agreed. Apart from mining, Australian industry faces being virtually wiped out by this situation. Even the mineral processors don't like it and it's the same with things like tourism too.

 

[tothemax6]

Exporters (non commodity) are closing down, that's the problem. And those that don't export but make goods for the local market are having to compete with ever cheaper imports. I was looking for a lounge recently - there is just no comparison - Chinese imports are substantially cheaper, or at least, even cheaper than usual. How can the local manufacturer compete with that?

Every other country, in this climate, wants a low exchange rate to bolster local industry, and their CB's comply for that outcome by intervention, either directly or QE etc.

At the current level (and higher) it will be 'a sign of future economic malais' as one by one local manufacturing and producers get swamped by cheap imports. It will happen - it's already happening.

Sure, I can believe that non-commodity exporters are closing down. I didn't even know we had much in the way of these types of exporters. Why should Australia be allocating its capital and labour into low yield ventures, when much higher yield can be obtained by focusing on our highest-yielding ventures? Would you rather have your money in an investment yielding 20% or 5%? For the same reason you choose 20%, Australian's choose to invest more in mining that manufacture - Australia is internationally uncompetitive in manufacture, but competitive in mining.

If China's imports are cheap, how is that a bad thing? Cheap consumer goods are great - consumption is the end goal of production after all.

If foreign nations wish to spew money, increasing the value of our money and subsidizing their exports to us, why should we complain? For example, when China stockpiles US bonds in its central bank as it prevents the yuan appreciating, this is money that has been denied the Chinese citizens in exchange for their exports. Who is really better off, those chinese exporting cheap goods in exchange for little, or those americans who buy those goods - and end up having to provide nothing in return?

 

[Uncle Festivus]

The problem is, it's not sustainable in the long term. China has $3T in freshly minted $USD's looking for a good home ie inflation. So when the crunch time comes ie a re-balancing of the global financial system aka GFC2, or sometjhing less inocuous as a hard landing in china after cooling attempts fail, we as a country won't have anything to offer the world, nor have the ability to make it outselves because it had long ago been out-sourced to the cheapest labour country.

So with a commodity boom in full swing, the $AU is negating any benefits, as shown by the following charts -

 

[TulipFX]

When a country has things which are in demand, the currency rises - increasing their price.

When a country has things which aren't in demand, the currency falls - decreasing their price.

It is why we have exchange rates. The act as a balancing factor. Both rewarding countries when their products are in demand and helping them when they are not.

 

[Julia]

Tulip, thank you for succinct explanation. So should we expect eg the SP of the big miners to continue to be thrashed as long as the $A remains high?

 

[Uncle Festivus]

When a country has things which are in demand, the currency rises - increasing their price.

When a country has things which aren't in demand, the currency falls - decreasing their price.

It is why we have exchange rates. The act as a balancing factor. Both rewarding countries when their products are in demand and helping them when they are not.

Nice in theory. What reward are we getting? All the benefits get negated as per Julias' bit about miners sp's?

 

[tothemax6]

The problem is, it's not sustainable in the long term. China has $3T in freshly minted $USD's looking for a good home ie inflation. So when the crunch time comes ie a re-balancing of the global financial system aka GFC2, or sometjhing less inocuous as a hard landing in china after cooling attempts fail, we as a country won't have anything to offer the world, nor have the ability to make it outselves because it had long ago been out-sourced to the cheapest labour country.

It certainly isn't sustainable, I agree. Where is all of this iron ore and coal going? The Chinese are constructing like its about to be outlawed. It is a frenzy, and it will crash. When it does, or if there is any other calamity, the AUD will plummet, our prices (including labour) become cheaper in global terms. The economy has a habit of balancing itself like this.
The thing is, whatever happens nothing can actually be done about it on the macro level. Its just how it is. People just need to be prudent and maintain a high savings rate.
The RBA fiddling with things will do no better than the US, UK or (especially) the Japanese central bank did by fiddling with things.

 

[Uncle Festivus]

It certainly isn't sustainable, I agree. Where is all of this iron ore and coal going? The Chinese are constructing like its about to be outlawed. It is a frenzy, and it will crash. When it does, or if there is any other calamity, the AUD will plummet, our prices (including labour) become cheaper in global terms. The economy has a habit of balancing itself like this.
The thing is, whatever happens nothing can actually be done about it on the macro level. Its just how it is. People just need to be prudent and maintain a high savings rate.
The RBA fiddling with things will do no better than the US, UK or (especially) the Japanese central bank did by fiddling with things.

Actually I think the seeds were sown for the GFC many years ago with the Yen carry trade looking for yield and finding it in global real estate, and it looks like they are doing it again thanks to their natural disasters?

 

[tothemax6]

Actually I think the seeds were sown for the GFC many years ago with the Yen carry trade looking for yield and finding it in global real estate, and it looks like they are doing it again thanks to their natural disasters?

I don't know about that, the yen is now just one of many currencies with minuscule cash rates.
Regarding the GFC, the economics were fairly straight-forward. The US central bank lowered interest rates to 1% following the tech crash. Credit expansion took off, and the central bank made no real effort to arrest the credit expansion. On top of that, the US had government backed agencies (Fannie Mae and Freddie Mac) which were mandated to make housing loans available to those who couldn't afford them. Hence a huge bubble inflated in the housing market. It is no surprise that the GFC started with a collapse in the sub-prime mortgage market.