Australian Dollar & Exchange Rate

The Australian dollar was introduced on 14th February 1966 as a replacement for Australian pound, which existed since the year 1910. Conversely, the dollar was poised against the British pound than the American dollars. After almost two decades, in a major shift, the Australian dollar was drifted to the floating system. The major trading countries of the world use a system of floating exchange rates. Under this system, exchange rates are determined by the free market forces of supply and demand. In other words, the rate moves freely in response to competitive market forces. Get Professional Help by experts based in Australia for your Australian Dollar & Exchange Rate Assignment Help.  

An exchange rate is the ratio at which a country’s currency exchanges for the currency of another country. Exchange rates are typically expressed as the foreign currency equivalent of one unit of domestic currency. The exchange rate is determined by the demand for, and supply of, that currency in terms of other currencies.

VALUE OF THE AUSTRALIAN DOLLAR:

Australian Dollar has gone through a roller coaster ride since past few years. Over the past decades, the Australian dollar had appreciated strongly against the US dollar, rising from less than US $0.50 in 2001 to a peak of over US $1.10 in 2011. For the past three years Australian Dollar Value was specifically high due to rapid increase in demand, high commodity prices, high interest rates and the increase in investments due to Australian regarded as the ‘Safe Haven’ by investors. (Phil Garton, Danial Gaudry,Rhett Wilcox, 2012)

However, over the last few months, the Aussie dollar has experienced significant decline against the currencies of key trading partners.  Since January this year, the Australian Dollar has depreciated by 14.8% against the US dollar, by 16.8% against the Chinese renmimbi (Australia’s biggest trading partner), and by 0.19% against the Japanese yen (Australia’s second biggest trading partner). (The Conversation, 2013)

THE AUSTRALIAN DOLLAR VALUE:  THE ROLE OF SUPPLY AND DEMAND:

Currency values rise and fall for many reasons. Underlying most of these are the simple principle of supply and demand. If there are more currency buyers than available dollars, the price of a currency goes up. On the flip side, if there are more dollars than buyers, a currency can weaken. (Ngssuper, 2013)

The demand and supply of the Foreign Exchange impacts the determination of exchange rates and similarly the exchange rate influences the demand and supply of the Foreign Exchange. The demand however is inversely proportional to the exchange rate. As the exchange rate goes up, the demand for the foreign exchange goes down. For instance, if Australian Dollar goes up (Appreciates) in terms of US Dollar, the demand for the Australian Dollar will decrease as compared to US dollar. Whereas the supply of the Australian Dollar depends on the demand and would be a vertical plot on the graph since the supply of the foreign currency available at any time is fixed. If the supply of Australian currency increases it will decrease its value in terms of other currencies.

Australia is host to much foreign investment. Any increase in capital inflow means an increase in the demand for Australian dollars and a currency appreciation, and a decrease would result in depreciation.

In the current scenario, the downward trend in the Australian Dollar shows it has depreciated in value due to decrease in demand for the Australian Dollar. This may possibly increase the demand of Australian made goods, increasing exports and thus meaning eventual appreciation of the Australian Dollar. However, there is a need to look deep into the reason and cause of summersaults of Australian Dollar over past few years.

It is said that the key reason for the Australian dollar downfall to its lowest level in nearly three years is due to slow down in the economic growth in key trading partner China. (Nicole Hong, 2013)\

The recent fall in the value of the Aussie dollar must be reviewed in the context of the surge in the currency’s value between 2009 and 2012. Australia’s economy rode the GFC storm relatively well compared with most developed economies. Thus, Australia came to be regarded as a ‘safe haven’ with the effect that risk-averse investors ploughed their money into the country. The inflow of capital to Australia became particularly heavy during the sovereign debt crises in Europe from 2010. Demand for

Aussie dollars was also boosted by strong export demand from developing Asia and the accompanying commodities boom. High interest rates in Australia relative to other developed economies have ensured an attractive return on low risk assets, a security class in particular demand during the uncertainty of the GFC. (HIA, 2013)

While the rise can be attributed to a number of factors mentioned above, the mining boom has been the key driver of the appreciation over this period (Phil Garton, Danial Gaudry, Rhett Wilcox, 2012). The emergence of the Asian giants such as China and India has a lot of role to play in the rise as well. Over the past two decades, the GDP of India has tripled and in China’s case it has increased more than six times than the base year (RBA, 2011). The primary factor is strong demand from China and Asia for Australian mineral resources, chiefly iron ore and coal. The governments of these Asian countries wanted to renovate and develop their infrastructure in order to boost their economy (Ravimohan, 2010). As a result, Australia, a country that is gifted with ample minerals and proficient production system, had become a large resource provide to the Asian economy over the past twenty years or so.

 This demand creates both income from sales and capital inflows for further investment in the mineral resources sector, and it is this flow of money into Australia that lifts the Australian dollar.  The second factor is connected to the first – the strength of the mining sector also boosts the overall economy and that overall strength makes Australia a relatively attractive destination for international investors, especially when other economies, such as Europe and the US are struggling. (SSFS,2013) 

Thus, the main causing factor for the rise and fall of Australian Dollar can be in a way attributed to the rise and fall of growth in China. China in the past had been buying a lot of raw material. In particular, China requires steel to build the apartments in which the new city dwellers live and to build the infrastructure that supports those cities. For example, a typical 90m2 apartment in China requires about six tonnes of steel, and 10km of metropolitan subway requires around 75,000 tonnes. On average, every tonne of steel that is produced requires around 1.7 tonnes of iron ore and over half a tonne of coking coal, and Australia is in the fortunate position of having ample low-cost, high-quality supplies of both (MacroBusiness,2011).

 The chart depicts how important the Chinese economy is now to Australia.

The correlation between quarterly movements in Australian and Chinese GDP has steadily increased. Clearly what happens in the Australian economy is now more dependent upon what happens in China. So where China goes, to a significant other extent, so goes Australia (Macro Business, 2011).

AUSTRALIAN DOLLAR DEPRECIATION AND EMPLOYMENT:

A decline in the value of its currency can represent a boon for an economy. Depreciation lowers the value of the dollar and thus allows owners of foreign currencies to buy more Australian goods. As such, depreciation will make Australian exports cheaper (and thus more desirable) on the international market. Exports will generally increase due to the fact that Australian products are cheaper for oversea buyers. Similarly, imports will fall because they become relatively expensive compared with domestically produced goods. Increased exports and lower import suggests that overall economy will benefit from a significant demand stimulus (HIA, 2013). This increase in demand stimulus will give rise to productivity and thus should boom the economy and create more employment.

The cost of imports, however, will rise, given the relative weakness of our currency. In this scenario, Australian businesses are more competitive globally, which is good for the economy, but Australian consumers pay more for imported goods – not to mention the higher cost of international travel – and so they experience this depreciation as a negative (SOSE,2011).

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Over the longer term, the rebalancing of demand within the economy will see a shift away from imports and stronger levels of exports due to relative price effects. This is likely to boost activity amongst existing firms, with increases in employment across the economy likely to result.

However, the decline in the growth and demand by China as Australia’s major trade partner can actually offset the impact of employment created by rise in demand due to cheaper Australian goods.