Tuesday, March 20, 2007

80 US cents and rising. Good for some.

The Australian dollar jumped to its highest level in a decade Tuesday and every sign suggests it will climb higher still. The Aussie hit 80.33 US cents early on before falling back on profit taking to 79.65 US cents. It closed back up at 80.00 US cents - a feat achieved only once before in the last ten years.

Much of the buying came from Japan, spurred on by talk of an imminent hike in Australian interest rates. Japan’s own money market interest rate is extraordinarily low – 0.5 per cent interest after a recent hike - and so Australia’s 6.25 per cent looks incredibly attractive.

If, as is now expected, Australia’s Reserve Bank increases our rate to 6.5 per cent, our rates will look better still.

It is that expectation which has pushed up the Australian dollar by around 2 US cents in the last week - that and the fact that our rates are now about the highest in the world.

The US equivalent is 5.25 pct, and there is a chance that it’ll be cut this week.
The Chief Economist at TD Securities Stephen Koukoulas told me last night that if you excluded New Zealand and maybe Turkey, and some emerging markets, Australia’s interest rate structure is the world’s most attractive.

But there’s much more to the sudden buying of Aussie dollars than the immediate outlook for interest rates... There is an emerging consensus that the commodity price boom sparked by China has a long way to run. That means even higher prices for Australian iron ore, gold, coal and gas and as resource projects get up to speed quite possibly very big increases in export volumes.

Some of the currency traders buying Aussie dollars right now are buying them in the near certainty that the inflow of foreign money that will be used to buy our iron ore, gold, coal and the like will keep the Aussie at or above 80 US cents for a very long time.

The higher dollar is disastrous for Australian firms that manufacture goods that try to compete with imports.

Only last week Labor’s Industry spokesman Kim Carr bemoaned the fact that a small Japanese car that used to cost $20,000 to import when the Aussie dollar traded at 60 Japanese yen need cost only $13,793 with our dollar at ¥87.

It would be even cheaper today. With our Japanese exchange rate at ¥93 that car need only cost $12,900.

This problem for Australian manufacturers - the downside of being blessed with mineral riches during a resources boom - has been predicted before. The ANU’s professor Bob Gregory pointed to it in the lead-up to late 1970’s resources boom. He unwittingly gave lent it his name – the “Gregory effect”.

He says what is different, and better, this time is that there are no longer as many manufacturers to be hurt.

“In the 1970s when we made huge income gains there was a very large manufacturing sector that could be hurt,” he told me. “That is not true this time to the same degree. All of those areas of the economy that were exchange rate sensitive have more or less been adjusted down as a result of earlier episodes and lower tariffs.”

That there is still some Gregory effect, is seen in the uneven way the resources boom is affecting different states. NSW, Victoria and South Australia, all homes to car, textiles, and white goods manufacturers, are doing relatively worse than Australia’s minerals-rich west and north.

Gregory says there’s another big difference this time as well. The current resources boom doesn’t look cyclical.

“Last time it was a result of world upswings that looked as if they were going to disappear. It was the result of an oil crisis, partly related to oil demand. This time it is a China story. Unless China really slows down, which looks very unlikely, we are going to be a much higher exchange rate country than in the past.”

The current exchange rate of 80 US cents looks to be the new bedrock. 82 and 83 US cents look entirely possible in the months ahead. Our dollars will go further but they’re likely to be spent even more on cheap imports and even less on the things we make ourselves.