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There’s a lot riding on the fate of the Aussie dollar

I did something a little silly last year – I made a firm, blanket prediction about the Australian dollar. I said it wouldn’t recover.

There was a caveat, however. I said it was sitting in a range and could rise a few cents, before falling back again. I didn’t anticipate it would rise as much as 7 cents against the greenback.

I still hold firmly to my view though that the upside to the Australian dollar is limited, and, in the long term, it has a long way to fall.

And fall it must. Policy makers have limited scope to ‘stimulate’ the economy without the help of a lower currency.

Let me outline for you how the Australian economy is tracking, where the dollar is heading, and why the Reserve Bank is sweating on its monthly movements.

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Indeed those guys at the Reserve Bank may want to come across as cool, calm and collected, but would you be relaxed if the value of your currency had the potential to derail your entire life’s work?

Prisoner’s dilemma

Let’s move away from the dollar for just a second, and look at the heart of what’s holding us back.

Prime Minister Malcolm Turnbull began his prime ministership by saying, “it has never been a more exciting time to be an Australian”. It followed on from former Treasurer Joe Hockey’s war cry of “have a go”… and “get out there and invest”.

The issue of course is that despite a low interest rate environment, generally speaking businesses don’t particularly want to borrow and invest.

There’s simply too much uncertainty about the future of both the domestic and global economies. Nothing’s really changed in that respect since the financial crisis of 2008 and 2009.

A frustration for policy makers is that it only takes the collective to invest, and the economic engine does begin to turn with more power. Often it only takes one business to step out in front. But that’s just not happening.

Smoke screen

On the surface, measurements of economic success have looked good. The stock market, for example, rose steadily from 2012 to the start of 2015.

A diversified portfolio would have performed quite well for you. Falling interest rates and rising dividends fed the bulls.

In fact many companies chose to raise dividends rather than engage in capital expenditure to lock in investors. That was essentially a sugar hit for income investors but has been an obvious dampener on overall economic growth.

The bigger picture

Of course the reality is that the Australian economic narrative over the past few years has been painfully simple... and a source of frustration.

A Chinese-led mining boom helped insulate the Australian economy from the Great Recession. That faded earlier than expected. In addition, the federal government (after under-taxing and over-spending) found itself in a structural deficit.

The Reserve Bank then took the reins by dropping interest rates to record lows. The idea was to breathe life into the property market: building, construction, investment, employment… the works! It’s had some positive effects but it’s now showing signs of slowing, and we’ve been left with property market bubbles in Sydney and Melbourne.

The latest attempt to expand the economy seems to be via the consumer (retail and services sectors). There’s a problem though. Currently consumers are struggling with record low wage growth and widespread job insecurity.

Last quarter the consumer chose to save less and spend more (perhaps because of rising house prices). It did help boost GDP.

The latest data points show, however, that that may be stalling. Retail sales for February actually came in flat, and the Australian Industry Group/Australian Performance of Services Index dropped by 2.3 points in March to 49.5 (readings below 50 points indicate a contraction in activity). Importantly to note too that it was the business-facing sub-sectors of transport and storage, and property and business services that remained in contraction.

And surprise… surprise… the missing ingredient? Well it was continuing business investment. Despite the best efforts of policy makers they just can’t seem to encourage business to make long-term investment decisions to drive growth.

Last stop… the Australian Dollar

One ‘instrument’ policy makers around the world have found useful to stimulate economic growth is through a lower currency.

It can help bring money into an economy via commodities trade, tourism and education (the lower the currency, the more attractive these services are to those overseas).

In fact countries around the world have been trying to out-do each other on this front by competing to lower their currencies.

It’s been dubbed the “currency wars’.

The Reserve Bank hasn’t needed to actively devalue the dollar because it has come down all on its own. Until recently that is. As mentioned above it’s now regularly trading above 75 US cents.

There’s been speculation the RBA may step in to reduce its value by talking it down (aka “jawboning”), or cutting interest rates, but that hasn’t really happened.

The biggest recent development has been for the RBA to spend more time on its commentary of the dollar within is Monetary Policy Decision statement. Here’s an excerpt from the bank’s April statement:

“The Australian dollar has appreciated somewhat recently. In part, this reflects some increase in commodity prices, but monetary developments elsewhere in the world have also played a role. Under present circumstances, an appreciating exchange rate could complicate the adjustment under way in the economy.”

In other words, yes the dollar has climbed higher. We don’t like it. We hope to high heaven it will come back down on its own to below 70 US cents because that’ll mean we won’t have to cut interest rates again… which we really, really don’t want to do. We’d much prefer a lower dollar work to cushion the economy than further record low interest rates.

Where’s the dollar heading?

My reasons for being bearish on the Australian dollar haven’t changed. There are various forces that drive the dollar: commodities prices (will remain subdued); US interest rates (will ultimately turn up); and global risk appetite (highly unpredictable, and at present, rather fickle).

I believe the forces that drive the dollar lower will intensify over the remainder of the year. How low can it go? That’s anyone’s guess, but it could easily fall below 70 US cents.

For now though, governments and central banks around the world are lowering their currencies to help prop-up their economies, which is ultimately pushing the Australian dollar higher (along with resilient commodities prices).

The higher the Aussie dollar is ‘forced’, the more downward pressure will be on those areas of the economy (trade, education, tourism) that policy makers want to see expanding.

I can’t see the dollar heading north of 80 US cents, but if it does, the Reserve Bank would have a real dilemma on its hands, and Australia’s economic recovery would be at risk.

Taking advantage of a falling dollar

I’m not going to go into detail here but know that you can benefit financially from an eventual falling dollar (against the greenback).

That is, if you own US assets: a bank deposit or stocks, for example, the value of those assets will rise as the Australian dollar falls against the US dollar. Follow me on Twitter if you’d like to know more.

Budget Day

Did you know Treasurer Morrison is handing down the 2016 Federal Budget on the same day as the May Reserve Bank interest rates meeting?

It’ll be a rare opportunity to witness the obvious disparity of having a central bank with its foot firmly on the accelerator and a government tapping the breaks – notwithstanding the occasional shout out the window by the PM to help make the car go faster.

 

David Taylor is a journalist with the ABC. Before taking up a position with the ABC, David was a financial markets analyst and economics commentator. You can follow him on Twitter: @DavidTaylorABC.