Here’s a question for you. What does a US job market recovery, low rates from the Fed, ECB, BOE and a rally in risk assets equal for Australia?
TROUBLE!
Trouble for Australian manufacturing, trouble for Australian tourism operators, trouble for Australian universities and the outward facing education sector in general, trouble for Australian retailers, trouble for the RBA and trouble for the Australian government.
Why all this trouble? The easy answer is that in the current global environment and with current global interest rate and economic settings, Australia stands out as a haven of relative safety. Against this backdrop the Australian dollar could fairly roar all the way to 1.15 and beyond.
You are probably asking why this is possible in a slowing economy with RBA rate cuts coming.
The simple answer is that markets are being set up for more asset inflation via quantitative easing in Britain, more spending by the ECB and the Fed’s commitment to low rates for the long-term.
It’s a recipe for a weaker US dollar and because currencies are bilateral a stronger Australian dollar.
Bloomberg quoted John Taylor, the Head of the World’s biggest currency fund – FX Concepts, over the weekend saying that he’s betting against the dollar after Federal Reserve policy makers extended their pledge to keep interest rates close to zero and indicated they’re prepared to make additional asset purchases:
“I am shorter the U.S. dollar than I am the euro,” Taylor said…“We are going to have QE3 at some point and they stretched the time we are not going to have higher rates. That was a tremendous hit to the dollar. The dollar was doing fine until Bernanke came up with that idea…Everybody in the market is sure that whenever the dollar looks strong, Bernanke will come up with another idea to make it weak,” said Taylor
This policy of a weaker US dollar is explicitly aimed at benefitting the US and aiding its economy at the expense of other nations.
At the expense of nations such as Australia that is, our businesses and our long-term economic future.
Now don’t get me wrong. I am a strong supporter of the floating of the Australian dollar. I believe that it has been a most welcome shock absorber for our economy for the past 28 years. It fell and provided stimulus when necessary and rose to provide economic restraint. In many ways it was pro-cyclical, with the direction of RBA rates, it worked to dampen the magnitude of RBA rate cycles.
But the float is now operating in a different world with the current and prospective strength is just too much.
Check out the chart below – it’s the Australian dollar over the past 5 years from Bloomberg:
See the big dip in the 2008/09 period when markets went into a funk that’s the shock absorber at work. The Aussie fell to 0.5960 because everyone was worried about the global economy falling apart, about China collapsing in a heap, about an end to mining boom round one and crucially, at the time, that the Australian housing bubble (not my words but the perceptions of offshore investors) would burst, and the RBA cut rates from 7.25% to 3%.
Pretty much everything in our Aussie dollar toolkit and particularly when distilled to our 5 drivers was negative – so the Aussie went down. But after the pessimistic crescendo of early March 2009, a relief rally lead to the asset markets, Fed, and QE induced rallies.
That’s ok, the Aussie rallied to the mid 0.90’s region before falling back again to 0.8050ish when we had the first round of European troubles in mid 2010. That is what I would consider to be normal moves for the Aussie.
Then QE2 changed the game again. This, along with the fact that the Australian economy had not collapsed, that the mining resumed and the fact that the RBA and government rauciously cheered, contributed to offshore investors taking another look at Australia as an investment destination. And so it was that in late 2010 the Aussie started to break higher and last year, against the expectations of all policy makers, most pundits and certainly Australian business it broke and had held above 1.00 trading up to a high at 1.1080 mid last year.
It is currently 17 cents above the 200 week moving average of 0.90 even after being up here for a very long time. That’s tough for business – against the crosses – Aussie/euro, Aussie/sterling, Aussie/Kiwi – the Aussie is similarly strong. Against the history of the last 20 years and the long run average the current levels are even more starkly out of line.
For Australian businesses focussed on the domestic economy or exporting it’s a sad tale of Aussie dollar strength in a world where central bankers and elected officials are using their currencies to try to bolster weak economies. You might argue that Germany wants to hold the euro together so the Club Med south acts as a foil to the Teutonic North’s obvious attraction if the Deutschmark returned. Thus Germany has a lower exchange rate than it should have. Likewise the Fed is and remains committed to keeping the US dollar as weak as possible without collapse, the Swiss called “time” and fixed their rate, the Chinese likewise are only allowing the renminbi to appreciate on their timeframe not what a free, or at least freer, float would demand. In the UK the BOE continues with its own quantitative easing, is allowing inflation to run at a higher pace, all the while keeping rates near zero.
And so Australia and our industry becomes the victim in the undeclared currency war of 2011-2012. Retail sales in 2011 were reported yesterday to have had the lowest growth since the mid 1980’s and who is surprised. I can buy things on Amazon landed on my desk often for less than half the price of a local purchase.
We are seeing the impact of this strong Aussie dollar in the job losses recently. Whether it was Heinz in the Riverina, Aluminium workers in the Hunter, workers at Holden or even BHP Nickel the outlook is materially impacted by the high Aussie. Retail is one of Australia’s biggest employers, how long can it hold one without letting more people go?
But what can we do?
Can we fix the Aussie dollar US dollar rate? Of course we can. But I’m not a fan of fixed rates in a small open economy like Australia. We’ve been there and we’ll just end up with different pressures elsewhere.
Perhaps the RBA could start selling plenty of Aussie dollars to feed the dogs while they are barking. We could build a sovereign wealth fund by stealth in this way – swap our Aussie dollars for relatively cheap foreign currencies of the US and China (maybe not euro though) or other assets for the RBA portfolio. In this way we build national wealth and keep the Aussie lower than otherwise.
But where are all those Aussie dollars going to go?
Into Aussie dollar denominated assets is the most likely guess. So the pricing problem just gets transferred to another Australian asset or could potentially cause inflation as the money washes around the economy.
So maybe that’s not such an easy fix after all.
Could this RBA selling Aussie dollars miraculously generate foreign currency that can then be loaned to the banks to reduce their requirement for offshore borrowings as some have argued? Yes of course, but that still needs to be paid back to the RBA at some point so it is just an accounting equation and doesn’t help. In fact, I’d argue it may hinder the overall economy as the Aussie dollars float around the system or become short-term deposits in the Australian banking system by foreigners and replaced long-term investments by foreigners.
So it could actually change the current reliance on long-term foreign investors to deposits that are short-term in nature and thus prone to flight.
My answer is simple – decide as a nation what industries we see as strategic and support them. Food security, manufacturing security, education, tourism. For those industries we can’t help avoid change, say retail which is as much technological in my view as currency related, we need to build replacement industries.
Treat the Aussie’s strength like we do a drought in the bush – support our industry until the currency turns tail and falls once more. And fall it will because a lot of the Aussie’s strength is simply the fact it’s currently a safe port in the global economic and market storm. Storms pass, the global economy will heal and investors will ultimately sell their Aussie dollars.
We should also have a proper debate about how to harvest the wealth being generated by miners selling Australia’s finite assets and paying little more than a parking fee for them. There is enough wealth being generated at present in the mining boom for the state to take a larger share. Is this wealth really best allocated to media assets?
We need to engage our political and policy making with the risks of the current strategy of benign neglect with regard to the Aussie dollar’s strength and we need to support our industry.
Lets make sure we have industry left to take advantage of our natural stabiliser when this happens once again and the Aussie dollar falls.
www.twitter.com/gregorymckenna
Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, this blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation