Australian dollar’s warning signals

Photo of Marcus Padley By Marcus Padley

min read

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Investors need to prepare for further currency falls.

Between February 2001 and July 2011 the Australian dollar rose from 47.73 US cents to 110.8 US cents, a 132 per cent rise.

Since the peak in 2011 it has fallen over 30 per cent to levels around 71.00 US cents and has done something similar against the British pound and most European currencies.

In the last financial year alone the Australian dollar fell 18 per cent against the US dollar and 11 per cent against the pound, and at the time of writing is at a six-year low.

Source: DFAT

To understand why our dollar boomed and why it has fallen, think of a currency as a reflection of the relative strength of two economies.

Australia is a commodities-based economy and the rise in our dollar in the 10 years to 2011 was because of a boom in our economy triggered by a boom in commodity prices, on the back of a huge lift in demand, particularly from China, for coal and iron ore.

Imagine the impact on profit and tax revenue from a huge increase in the volume of commodity-based exports compounded by an almost tenfold increase in the price of iron ore and coal. Both these essentially dull and readily available commodities were propelled from around $20 a tonne to almost $200 a tonne.

Between 2001 and 2011 the value of coal exports grew from $10 billion to almost $50 billion and the value of iron ore exports leapt from around $5 billion to $63.5 billion. The volume of iron ore exports between 2001 and 2011 increased by an average of 24.4 per cent per annum and the value increased by an average of 46.4 per cent per annum.

Source: DFAT

You can begin to imagine the huge increase in profit for BHP Billiton and Rio Tinto and the huge increase in revenue for the Australian Government through taxes, and you begin to understand why the economy boomed and the Australian dollar started to outstrip almost all other currencies.

What goes up...
But just as the main driver of the Australian dollar was the resources boom, the main driver for the fall in the dollar since 2011 has been a peak in iron ore and coal demand, and in iron ore and coal prices, which have more than halved if not quartered. That flop follows a peak in Chinese demand and a huge increase in supply, which is programmed to continue despite the commodity price falls.

The unfortunate reality for Australia is that the economy, currency and investment markets were transformed by the resources boom from a relative backwater to a position of international relevance, with the Australian dollar the representation of that new status.

But the whole resources boom along with the Australian dollar boom, suddenly begins to look like a rather transitory, once-in-a-lifetime event rather than a new norm. And with iron ore, oil and coal prices still falling, the trend in commodity prices and the Australian dollar seems set to continue.

Before the resources boom in 2002, when the Australian dollar was trading at 50 US cents the Australian economy was less relevant for global investors. We risk a return to this irrelevance if commodity prices do not rebound and the industrial manufacturing and services base remains globally irrelevant, which seems likely.

The relevance of all this is that if the Australian dollar continues to fall, any Australian who wants to buy offshore goods on the internet, drive a European car or travel abroad ever again, needs to do something to hedge (insure) themselves against global financial irrelevance and isolation.

For retirees and asset-rich baby-boomers, the options include getting your assets out of the Australian dollar, investing them overseas, and hedging the Australian economic malaise before a weak Australian dollar paupers, isolates and confines you to a perpetual Australia-based existence.

Asset-poor Australians have a choice: accept that you are not going to drive a Mercedes, travel abroad or shop on the internet, and be happy with that; or go and work in a nation with a strong currency; or plan on investing so much in your education, career and business that you are going to end up so rich that it really doesn’t matter.

The latter option is probably the best.

About the author

Marcus Padley is the founder of the popular Marcus Today investment newsletter, and one of Australia's leading stockbrokers and investment commentators.

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