As economic power shifts to the East, Australia’s turbo-charged dollar may be a mixed blessing, writes Jessica Irvine.
Predicting the next move in the Australian dollar has become something of a national pastime since our dollar dazzler struck parity with the US greenback late last year. With bargain online purchases and cheap holidays to the United States hanging in the balance, interest in the dollar’s next move has perhaps never been higher.
But forecasting swings in the currency has always been, at best, a stab in the dark.
“I forecast the Aussie dollar with my wet finger,” jokes Chris Caton, the long-time chief economist at BT Financial Group. “And my wet finger tells me it’s got to come down, and with absolutely no confidence I think it’s got to return to the lower 90s. Whether that’s this year or next, I have no idea and nor does anyone else.”
Others are more bullish on the dollar’s long-term prospects. Westpac is tipping the dollar will rise to $US1.20 by mid-decade. A visiting global currency analyst, Dr Savvas Savouri, tipped a rise to $US1.70 by 2014.
Amid all the guesswork, it pays to take a step back and consider the bigger picture. And it doesn’t come much bigger than this.
The Australian dollar is caught in the updraught between a shift in world economic power away from the the United States towards China.
The global economic cosmos is realigning. The bright stars of the last century – the US and Europe – are fading, while the new Asian stars – China and India – appear ever brighter, lit by the burning ambition of their billions-strong populations to lift themselves out of poverty.
By 2020, it is predicted, there will be more middle-class consumers in Asia than the rest of the world put together. In Mumbai, Beijing and countless other Asian cities, this burgeoning middle class has set its sights on all the trappings of life in the developed world, such as cars, fridges, airconditioning and televisions.
The story of this new “Asian century”, in which developed countries make their living supplying the desires of the developing world, rather than the other way around, is the backdrop to the budget delivered by the Treasurer, Wayne Swan, this week.
Investment in training to give Australian workers the skills needed to satisfy the growing desires of the Asian middle class is the basis of the Gillard government’s plan to create “opportunity” for Australians out of this historic shift in world power from West to East.
Of course, there was nothing inherent about the old world order. A study of world economic production back to AD1 by the late economic historian Angus Maddison has shown that back then, India accounted for a third of global output, China a quarter and Europe just one-seventh (see graph below). The industrialisation of Europe in the 1800s changed all that, as did the settlement of the United States. But now the pendulum has begun to swing the other way.
“Nobody is looking at the US any more as the primary economic model for the rest of the world,” Caton says. America’s risky banking practices nearly caused the collapse of the entire world financial system, sealing the decline of the US as the world’s economic superpower, which began with the tech wreck of 2001.
This seismic shift in power from the US is the first part of the explanation for why the Australian dollar is strong. China’s demand for our raw materials is the second half.
It is hard to think of another developed country so well positioned to take advantage of this shift in economic power from West to East. Caton says: “Australia is fortunate in that the growth of the developing world helps us hugely. Number one, they want what we have got, and, number two, they want it to such an extent that they are willing to pay huge prices for it.”
Higher export prices relative to import prices means Australia has begun to run trade surpluses again. This means that more foreigners need to buy dollars to buy our products than we need to sell to buy foreign goods, pushing up the value of the dollar.
Currency investors are also contributing to the turbocharged dollar, borrowing funds in countries with low interest rates, such as the US and Japan, and converting them into Aussie dollars before buying higher-yielding Australian assets like bonds.
Having sunk below US50¢ in 2001, the Australia dollar has shot up as high as $US1.10 last month and settled this week back down at $US1.06. Can it last?
AMP Capital Investor’s chief economist, Dr Shane Oliver, thinks it can. Oliver has produced an innovative chart of the currency’s movements since Federation, converting the Australian pound into US dollars for the first half of the century (see graph below).
Viewed over this longer period, it is the period after the 1983 float in which the Australian dollar was below $US1 that looks like the aberration. Oliver says this period was marked by much lower commodity prices and a perception of Australia as a poorly managed “old world” economy – both factors which reverse in the Asian century. “In the grand scheme of things, the normal thing is for the Australian dollar to be above $US1,” Oliver says.
THE damaging side effects of the dollar’s relentless rise are by now well known. A high currency makes Australian exports more expensive for foreigners, hurting industries such as manufacturing, tourism and education services. On the flip side, it helps to spread some of the benefits of the mining boom by making it cheaper to buy foreign imports, helping to keep prices down for shoppers.
If Australia is to prosper in this Asian century it will need to do so despite the high Australian dollar. In a speech after the budget Swan acknowledged the harm caused by the higher currency. But, he argued, the strength of Asia would also create new opportunities for Australia to export high-end services to Asia’s growing middle class.
“While mining has rarely been more important to the Australian economy than it is today, most of us make our living in creating and delivering services,” he said. “This is why the vast shift of world production, consumption and wealth into the region of which we are a part is so important to our future.”
Three out of four Australians already make a living selling their services, such as hairdressers, doctors, teachers, architects, consultants, finance workers, accountants and lawyers. The sector is to a large degree protected from the worst effects of the rising dollar, because a large part of services are sold by Australians to other Australians in Australian dollars.
But the growing Asian middle class also creates a new market for Australian services right on our doorstep. Chinese visitors to Australia outnumbered Japanese visitors for the first time last year.
The Gillard government wants to invest more in skills to equip this future workforce to meet the growing demand.
Huw McKay, a senior international economist at Westpac, believes this is the right strategy. While government spending on big infrastructure projects, such as roads and rail, is potentially inflationary because the government competes with the mining sector for workers, government investment in “soft commodities” such as universities, schools and health research is welcome. In this way, McKay says, Australia can insulate against the higher Australian dollar.
“If Australia gets a lot smarter and produces goods and services that are highly different to what else is out there, the high Australian dollar isn’t going to affect demand. People come to you and they’re price-insensitive because you have got the best stuff.”
If Australians are to prosper in the Asian century it will require them to work smarter, not harder.
Dollar dazzler since Federation:
Analysts commonly refer to record movements in the Australian dollar only since 1983, when it was floated. But it is possible to calculate the value of the currency in US dollars back to Federation. From 1946 to 1971 the currency was fixed against the British pound and in the mid-1970s itwas fixed first against the US dollar, then a trade-weighted basket of currencies. Of course, the Australian dollar was introduced in 1966, and before that the currency was theAustralian pound. This graph shows that for most of the time the currency has been worth more than $US1.
A brief economic history of the world since AD1:
The late economic historian Angus Maddison put together this graph, which shows shares ofworld economic production since AD1. It reveals how, formost of the past two millenniums, the economies of India and China were dominant. In the 1800s, industrial revolutions swept Europe and the newly colonised US, changing the balance of world economic power. But once again China and India are expanding their share, arguably returning the world to a historically more normal distribution of economic power.