Will a current account surplus rip the Australian dollar higher?

See the latest Australian dollar analysis here:

Macro Afternoon

Via New York fundie Exante:

Australia is standing out globally. The improvement in the current account is extreme when the positions of other countries such as Korea are collapsing in the wrong direction.

There are some internal economic weaknesses and everyone is focusing in the RBA but underneath the surface this improvement in flows could dominate the RBA.

If you put the pieces together, Australia is set to move into current account surplus.

A current account surplus is a big deal, particularly if sustained, as we think it may be.

…Simple compounding sees Australia as a net creditor in the next 10 to 15 years.

There are a lot of moving parts. But since Super was formalised in 1992, gross foreign assets are compounding around six per cent a year versus gross foreign liabilities at around three and a half per cent. So it’s certainly plausible. Simple compounding sees Australia as a net creditor in the next 10 to 15 years.

The Australian dollar was floated in 1983. We have never had a floating Australian dollar and a current account surplus.

A 10 percentage point shift in super fund hedge ratios was equivalent to a flow of 1.5 per cent of GDP in 2013. This is now 3.5 per cent.

A discrete increase in hedge ratios by Australian super funds now has the capacity to overwhelm the underlying outflow.

Here’s the chart:

We are certainly headed for a current account surplus in the near term. On that we can agree. But Exante’s contention that it is sustainable is highly questionable. At least it is questionable if Australia wants to keep growing. The major driver of the approaching CAS is a massive trade surplus:

As you can see, this is based upon a convergence of crazy export growth and a near complete stall in imports owing to shattered domestic demand as house prices collapsed. Neither of these is sustainable politically or economically.

Exports are obviously going to retrace cyclically and structurally. Bulk commodities will fall a long way from today’s highs with iron ore especially headed back to its previous lows as supply rebounds and China goes ex-growth through the 2020s. Oil and LNG pricing will only get worse ahead as well. And that screws coal. Basically, the last leg up in that blue line is all serendipity and will evaporate in time.

Imports will remain subdued so long as house prices do. But imports are driven structurally by Australia’s mass immigration growth model which artificially props up consumption (and boosts capital outflows as remittances).

That said, I do not expect the CAD to return to former huge wides because I don’t expect housing and consumption to rebound strongly ever again. But it matters how that better balance is sustained. If it is a surging trade account and strong growth that is delivering a better external balance then that’s currency bullish.

But, if it is secular stagnation of domestic demand keeping pace with falling external income then that’s massively deflationary and is hardly currency bullish! Indeed, those are the dynamics of a slow motion financial crisis that force corrects an external imbalance.

In short, I fully expect an Aussie CAS to last about the same amount of time it did last time in 1970 as the trade account reverts to deficit. For me that renders the second half of Exante’s argument, about super outflows and inflows, redundant.

David Llewellyn-Smith
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