Summary of Article by Mulligan - Case Study Example

ssеssmеnt 1 – Саsе Study Word Count: 1804 (a) Summary of article by Mulligan (2016) First, although the Australian dollar fell relative to the US dollar in 2015, the governor of the Reserve Bank of Australia believes that the movement of the Australian dollar relative to the US dollar is in accordance with changes in the international market, such as a decline in commodity prices. Another issue is that as of January 2016, commodity prices were still falling; hence it was possible that a further fall of the Australian dollar would occur since Australia exports commodities. But despite the decline in the value of the Australian dollar, the currency lost no more than seven percent when one looks at the trade-weighted index, which is a critical measure of a country’s competitiveness as an exporter of goods and services. Thus, Australia can be deemed to be still competitive as an exporter of commodities and services like higher education and tourism. Thirdly, Australia’s weak dollar makes the country’s exports more competitive, which boosts the sectors that have been mentioned above. The fourth point is that the main factors that have driven the fall of the Australian dollar are falling commodity prices and divergent policies by central banks in the US and Australia. (b) The demand model functions in such a way that other things remaining the same, when the exchange rate of a given currency (such as the Australian dollar) is high, a small quantity of that currency will be demanded, and vice versa (McTaggart, Findlay & Parkin 2013, p. 521). In contrast, the supply model applies in such a way that when the exchange rate of a given currency (for instance the Australian dollar) is high, more of that currency will be supplied, and vice versa. What this means that if Australian business becomes more competitive, there would be a greater demand for Australian goods, and an increase in the demand for Australian goods will cause an increase in the value of the Australian dollar relative to other currencies such as the US dollar. That is, if Australia’s exports increase, the demand for the Australian dollar will increase (Dwivedi 2013, p. 287), and this will increase the value of the Australian dollar relative to other currencies. On the other hand, if markets are worried in regard to the future of the Australian economy, they would tend to relinquish their Australian dollars, leading to a fall in the value of the Australian dollar in comparison to other currencies such as the US dollar (McTaggart, Findlay & Parkin 2013, p. 521). The factors that influence currency fluctuations are as follows. Source: Grant and Vidler (2000, pp. 283-284); Dwivedi (2013, p. 288). Inflation: If inflation in Australia is lower than the level in other countries, then Australian exports will become more competitive and this will raise the value of the Australian dollar. Interest rates: If Australia’s interest rate is higher than other countries, more people will want to deposit their money in Australia. In turn, this will result in an appreciation of the Australian dollar. Lowering interest rates in Australia will result in a depreciation of the Australian currency. Speculation: If speculators think that the Australian dollar will rise in the future, they will hoard Australian dollars, leading to high demand for the currency and hence a rise in value. Competitiveness/quality of the country’s goods: If goods from Australia become more competitive in the international market, this will cause an increase in the exchange rate of the Australian dollar against other currencies. If Australian goods/services become less competitive, the value of the Australian dollar will fall. Other factors: Government intervention, government debt, economic recession/growth, balance of payment, and comparative strength of other currencies. (c) The Australian dollar has been fluctuating relative to the US dollar over the three-year period between September 2013 and September 2016. The following is an analysis of the changes in the value of the Australian dollar against the US dollar based on data from the Reserve Bank of Australia (RBA) (2016) for the said period. A graphical illustration of the changes is shown in figure 1. To start with, one Australian dollar was worth about 0.92 US dollar in September 2013. This increased to around 0.95 US dollar in the following month. The next three months saw the Australian dollar drop steadily to about 0.88 US dollar, this being January 2014. From January 2014, the value of the Australian dollar appreciated steadily and remained above the 0.9 US dollar mark over the next few months (specifically between March 2014 and October 2014). From November 2014 to January 2016, a fluctuation that involved a significant depreciation of the Australian dollar was observed. Between July 2015 and January 2016, the value of the Australian dollar relative to the US dollar remained just slightly above 0.70 US dollar. Thereafter, there was some appreciation in the Australian dollar value in that even though the value was fluctuating, it remained close to the 0.75 US dollar mark. As of September 2016, the Australian dollar was valued at 0.76 US dollar, a value that still remains until today. Figure 1: Values of the Australian dollar relative to the US dollar, September 2013 to September 2016. Source: Graph data derived from RBA (2016) According to Carroll (2013), the movement of the value of the Australian dollar relative to the US dollar is affected by several factors, but the prices of commodities have the most profound effect. An analysis of the world commodity prices is as follows. The focus of this analysis is iron ore, which is one of the major commodities that Australia exports. It can be seen that iron ore price movements have taken an almost similar trend as the movement of the Australia dollar relative to the US dollar. As shown in figure 2, there was an almost steady decline in the price of iron ore between September 2013 and March 2016. The same trend can be said about the value of the Australian dollar, save for the fact that the AUD experienced an increase in value during some months in 2014. Also, the period around December 2015 to January 2016 is the one in which the least price of iron ore was recorded. The same can be said about the graph for the Australian dollar exchange rate, where January 2016 is one of the months in which the Australian dollar had the least value, at around 0.71 US dollar. However, the least exchange rate value for the Australian dollar between September 2013 and September 2016 was recorded in September 2015. At this time (September 2015), the price of iron ore was slightly higher than the lowest price recorded between September 2013 and March 2016. Figure 2: Movement of the world price of iron ore, September 2011 to March 2016 Source: Index Mundi (2016) The slight variations between the movement of the price of iron and the exchange rate of the Australian dollar show that apart from the price of commodities, there are other factors that contribute to the value or exchange rate of the Australian dollar. These factors include Australia’s interest rates, the US dollar index, the level of manufacturing in Australia’s major export markets such as China, and the US housing market (Carroll 2013). For instance, with respect to interest rates, the Australian dollar has remained in high demand since the RBA has been hesitant to reduce interest rates, therefore keeping a lot of investors attracted to the AUD (Newmann 2016). This has enabled the Australian dollar exchange rate to remain relatively higher despite the low prices of commodities. (d) I do not think that the AUD will fall as low as US 65C by the end of 2016. This is because overall, Australia’s economy remains competitive as shown by the small decline (by less than 7 percent) of the country’s trade-weighted index (Mulligan 2016). What this means is that Australia still remains competitive in terms of exporting other goods and services. This competitiveness will help ensure that the Australian dollar remains attractive; hence, the value of the AUD is not likely to go down that much despite the lull in export of commodities. As well, various factors have been identified that will work in favour of Australia’s economy and ensure that the value of the Australian dollar does not go down significantly (Scutt 2016). These are the resilience of Australia’s economy, an improvement in commodity prices, an improvement in the current account deficit of the country, and lowered anticipation for rate increases in the US. Combined, these factors are likely to ensure that Australia’s economy will endure and improve in the coming times, which will therefore be characterised by a relatively stable AUD (Scutt 2016). If the Australian dollar were to fall to below 0.65 US dollar, Australian manufacturers would be in a better position since they would be able to sell more of their goods overseas and in the domestic market. As well, tourism operators can expect a rise in tourists to Australia with a low-value AUD. Further, a low AUD can cause an increase in the number of overseas students enrolling in Australian education institutions (Beattie 2016). (e) The RBA can raise and maintain the exchange rate by applying any of the following measures: (1) selling foreign exchange assets to buy more of Australian dollars, (2) increasing interest rates, and (3) implementing measures to reduce inflation (Pettinger 2016). By buying Australian dollars, this will reduce the volume of the local currency in the economy, thus spurring demand for the currency. By increasing interest rates, more people will want to deposit their money in Australia, and this will increase the value of the AUD. By reducing inflation, Australian exports will become more competitive and this will increase the value of the Australian dollar. Having the Australian dollar maintained at 0.70 USD, which is above the market rate of 0.65 USD, will have the following effects on the Australian economy. First, it will make Australian exports more expensive and therefore less competitive (Eslake 2011). According to McHugh (2016), the rule of thumb is that the lower AUD, “the higher the income for miners, farmers, manufacturers and other specialist product exporters” from Australia. Thus, raising the value of the AUD beyond the market rate would hurt exporters. Increasing the value of the AUD would also stifle growth in areas such as inbound tourism and reduce the potential for international students to seek education in Australia since it will become more expensive (Eslake 2011). In the end, maintaining the Australian dollar at 0.70 USD, which is above the market rate, would hurt the country’s economy since it would make Australia’s exports (both goods and services) less competitive in the international market. Given that Australia is a “strong exporting nation” (McHugh 2016), actions to raise the exchange rate would not be effective. References Beattie, D 2016, ‘The fall in the Aussie dollar’, Canstar, 21 January, viewed 6 October 2016, . Carroll, N 2013, ‘Currency watch: why did the Aussie dollar fall and where is it headed?’, Transworld Business, 5 September, viewed 6 October 2016, . Dwivedi, DN 2013, International economics: theory and policy, Vikas Publishing House Pvt Ltd, New Delhi. Eslake, S 2011, ‘Explainer: what a strong Australian dollar actually means’, The Conversation, viewed 6 October 2016, . Grant, S & Vidler, C 2000, Economics in context, Heinemann Educational Publishers, Oxford. Index Mundi 2016, Iron ore monthly price - US dollars per dry metric ton, viewed 6 October 2016, . McHugh, B 2016, ‘Stronger Australian dollar having a muted effect on mining and agricultural exports, for now’, ABC, viewed 6 October 2016, . McTaggart, D, Findlay, C & Parkin, M 2013, Macroeconomics, 7th edn, Frenchs Forest, NSW. Mulligan, M 2016, ‘RBA happy with Australian dollar but further falls expected in 2016’, The Sydney Morning Herald, 4 January, viewed 6 October 2016, . Newmann, R 2016, ‘Will the Australian dollar really drop to US 40 cents?’, The Motley Fool, 11 June, viewed 6 October 2016, . Pettinger, T 2016, ‘How to increase the value of a currency’, Economics Help, 3 March, viewed 6 October 2016, . RBA 2016, Historical data, viewed 6 October 2016, . Scutt, D 2016, ‘LIFT-OFF: CBA sees the Australian dollar at 80 cents’, Business Insider Australia, 30 March, viewed 6 October 2016, . Read More