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The rising Aussie dollar could kill a hard-won economic recovery

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·Contributing Editor
·4-min read
In this article:
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australian dollar close up on desk
The rising Aussie dollar could kill a hard-won economic recovery. Source: Getty

The price of iron ore is on an absolute tear.

Iron ore's recent run up to US$136 (AU$183) per tonne -- the highest level since 2013 and up 45 per cent this year -- couldn't have come at a better time for Australia.

With incredibly tense China relations, it provides, as independent economist Saul Eslake puts it, ‘insurance’ against further economic damage China may like to inflict on Australia.

That’s because iron ore’s surge is on the back of supply cuts in Brazil – Australia’s major competitor. And the more Brazil falters in its production capacity, the fewer options China has with its iron ore purchases.

China: looks like you’re stuck with us!

But just as we go some way to solving one big problem… another pops up, because the more iron ore surges, the higher the Australian dollar rises.

The dollar’s now bouncing between 73 and 75 US cents – around 2-year highs.

The longer it stays elevated, the more time it will have to inflict damage on the broader economy.

Economy showing life again

The good news though is that Australia is now, technically, out of recession.

I’ve been quite amused in recent days how angry some economists have been about calling “the end” of the recession.

No! They say, Australia still has an enormous amount of ground to make up.

That’s true, but it’s also true that, based on one textbook definition, Australia is indeed back into economic growth territory.

The problem is that the recovery, if you can call it that, is still quite fragile.

A coronavirus vaccine is yet to be distributed and the unemployment rate is expected to remain relatively high for many years.

What will help the recovery is businesses being able to invest, grow and hire workers, the Reserve Bank says.

That, unfortunately, is liable to be frustrated by a rising dollar.

The kicker

One in five Australian jobs depend on exports.

And the international competitiveness of exporters lives and dies on the exchange rate.

The logic is very simple.

Foreigners need to exchange their currency for Australian dollars in order to buy Australian goods. So, when their currency doesn’t go as far as it used to, it costs them more.

That reduces demand and, in turn, the Australian exporters’ profits and ability to hire workers.

I’m told an Australian dollar trading at around 65 US cents is ideal for Australian companies selling goods offshore.

The dollar’s now close to being 10 US cents above that level.

So a rising and elevated Australian dollar against the greenback is a risk to jobs.

Reserve Bank’s solution

We do have some fire power to limit the damage caused by a rising dollar.

Last month the Reserve Bank announced it would buy $100 billion worth of government bonds in the secondary market.

Buying bonds on mass forces their prices up which in turn forces their interest rates down. Don’t ask me how, that’s just what happens.

As interest rates (or yields fall), investing in Australia becomes less attractive and so the demand for Australian dollars (to do that investing) also falls.

The RBA policy should reduce the Australian dollar, or at the very least cap any rises in the dollar.

Unfortunately, recently, the upwards pressure on the Aussie dollar from higher iron ore prices, and indeed the lower US dollar, has proved too much.

All the Reserve Bank can do now is just keep buying more bonds.

Shoppers to benefit

Of course as the Australian dollar rises, imported product become relatively cheaper because our dollar goes further.

It means that from groceries to electronic goods, a sustainably higher dollar should lead to lower prices at the stores.

This is good news especially when wages are so sticky and folks will take any breaks they can get for a bit of financial respite.

As for boosting the wider economy, well it probably won’t even make a dent. It may help here and there at the individual level for larger purchases, but it’s unlikely to lead to stronger demand overall for products.

Next 6 months will be critical

The sustainability of the recovery will come down to how workers and business fair coming off government supports like JobKeeper and JobSeeker.

It will of course also depend upon the effectiveness of a globally distributed coronavirus vaccine.

How will we know if the recovery is taking hold? Easy! The unemployment rate will come down.

It doesn’t need to be a significant fall, but a gradual expansion of the jobs market will help keep the economic engines turning.

Get the unemployment rate down, and a rising dollar loses its sting. Keep the dollar at bay, or at least at a level that supports, rather than hurts industry, and economic life’s just a lot easier to manage.

A rising dollar remains one of the economy’s biggest threats.

@DaveTaylorNews

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