Australia | Dec 04 2007
By Greg Peel
As we speak, the Aussie dollar has slipped away again, falling in Tuesday trade from its closing level in the US to be at US$0.8740 or so. It seemed like only yesterday the Aussie was at 94 with a bullet, and parity was supposedly just around the corner. At the time the Fed had cut its cash rate and the RBA had taken the unprecedented step of raising its cash rate in the middle of an election campaign.
But as a simple lesson in why currencies of mature economies tend, for the most part, to lack constant substantial volatility, the Aussie has largely fallen victim to itself. An economy is supposedly in a permanent state of searching for equilibrium – a non-existent holy grail – thus ensuring long cycles of swings and roundabouts.
The reason for weakness over the last couple of days – all global effects being equal – has been yesterday’s release of the Australian trade balance and corporate profit figures. The Australian economy is surging along at some 5% growth, fuelled by the resource boom which in turn has meant overstretched capacity and record low unemployment. As a result, the Aussie dollar has also risen strongly as international investors have poured into Australian mining stocks and government bonds. In the case of the latter, Australia, with its relatively high interest rate, is a popular choice of the infamous yen carry traders.
The Aussie has also simply risen as the US dollar has fallen.
If we are so flush with commodities, you’d think that the world would be beating a path to our door to get hold of them. You’d thus expect large wads of foreign currency to be collected, and hence our trade balance to be running in surplus. Surely China’s iron ore demand outstrips that of our small population’s desire for imported televisions?
Not so. Australia is still running a trade deficit, and in October that deficit blew out even further – by $1.1bn to $3bn. That’s the worst monthly deficit for 23 years. What’s more, economists only expected the deficit to reach $1.8bn. That is one hell of a difference.
One of the culprits is the ongoing problem of infrastructure constraints. Yes – we’re sick of going on about, but Australia is suffering from decades of underinvestment in rail and port facilities. Anyone who’s flown over Newcastle lately, for example, can see the waiting armada of bulk carriers with their own eyes. The world is beating a path to our door, but then waiting forever to be served.
What this means is Australian resource producers cannot sell the stuff fast enough. It’s not that they can’t dig it out of the ground. Queensland coal miners have such enormous stockpiles by now mountaineers will soon be turning up wanting to attempt an assault on their summits. The Pilbara in Western Australia is not just a good place to find iron ore, it’s made of iron ore. But Fortescue Metals is in court to try to take rail time off BHP.
The result of the transport bottlenecks has been a series of earnings downgrades, particularly from more junior miners with less clout in state government. Stock analysts have not seen it coming, and report every day as if it were some new and unexpected problem.
So Australia has been unable to step up its export revenues to meet demand. All it can do is drip-feed foreign buyers as infrastructure allows. The only thing stopping our export position from looking worse is the actual rise in commodity prices. But at the same time, spend-frenzied Aussies, loaded with full pay packets and tax cuts, have been buying wide-screen teles with their ears pinned back. And computers, and iPods, and cars, and clothing, and anything the rest of the world can produce.
But the other reason Australia’s trade deficit is so bad is because of the strength of the Aussie dollar. Exporters are now receiving less for what they can actually sell, while imports just get cheaper. That’s why in October exports fell 3.4% in Australian dollar terms while imports rose 2.3%. And it’s not just resource companies that have suffered – any Australian company selling product to the world, be it ear implants, blood plasma, construction services or surf clothing, has suffered at the bottom line.
So therein lies the contradiction. The Aussie is strong because it is a “commodity currency”. Yet because the Aussie is strong Australia is making less from its commodities. This was further evident by yesterday’s September quarter corporate profit result. Profits fell 2.1% when economists expected a rise of 2%. Were economists working off stock analyst earnings forecasts? For that would explain the difference. Analysts have been extremely slow to adjust for a higher Aussie, and again, have kept being shocked by company downgrades.
So why is the world buying the Aussie? Commodities – can’t sell them. Profits – can’t make them. Bonds – well if Australia keeps increasing its current account deficit then the lustre will go out of that trade as well. Pre credit crunch, the US dollar was falling steadily due simply to its overblown current account deficit.
And that’s why the Aussie has been weak these last couple of days, which, of course, actually goes some way to alleviating the problem in the first place. It’s push-pull.
Before yesterday’s figures came out you would have to go a long way to find an economist who is not expecting more RBA interest rate hikes, if not in December then at least in February and beyond. As the world now expects the Fed to cut rates again, the scene was definitely set for the US$1.000 Aussie. The Australian economy is still very strong, and the US weak, but while we sit here uncertainly at US$0.87 does parity still look like an easy bet?
The Fed will likely cut rates again in response to credit problems that have only worsened, and recession fears. If credit problems which are now difficult deepen into something quite calamitous (perhaps a major global bank or brokerage goes under) then it is possible yen carry traders will lose their bottle and start unwinding in earnest. That would mean Goodnight Irene for the Aussie. It would also mean the RBA would likely hold off on any further rises.
But failing that a fall in the US rate will only put upward pressure on the Aussie – not just because of the mathematical equation but because now the US dollar carry trade is growing in popularity and Australia, with its high bond rates, is again a popular target. The Arabs would probably buy any global bank about to go under so it’s a close run thing.
Yesterday’s economic data should leave the RBA having to think long and hard. The central bank would much prefer not to raise rates, as the debt levels of average Australians is already precarious. But inflation is the big threat in the strong economy. Furthermore, economists are still expecting rate rises ahead for the simple fact Australia’s business investment is running hot, which mean infrastructure constraints are on the way to being lifted and the trade balance can finally have a go at recording a surplus.
In the meantime, while import prices may be lower, a higher interest rate will put a curb on indiscriminate spending on consumer discretionary items.
So Australian resource companies should soon be able to at least sell more, even if revenues are still crimped by a strong Aussie. But then – why are global commodity prices so high? Because every miner in the world is suffering from the same constraints. What will commodity prices do if soon there is as much iron ore available when China wants it?
Commodity prices are already falling, driven by fears of a contagious US economic slowdown. This, too, makes it tough for the RBA, for if the oil price slips away manifestly for example, inflation will no longer be quite as much of a risk.
But then commodity prices are long overdue for a pullback, and once again economists are not concerned. In the bigger scheme of things, the likes of China and India should still drive strong demand for years to come. Which should mean a strong Australian economy, high interest rates and a strong Aussie dollar. But as you can see from all the pushes and pulls, it’s just not that simple.