The Evaluation of the Australian Currency - Coursework Example

Introduction In October 2010 the Australian dollar broke its parity with the United States dollar for the first time. Following this trend arguments have continued to stream into the public circles and the media on whether it is beneficial or not beneficial for the AUS dollar to fall or rise in its value (Battelino, 2010). In the past one week the Australian dollar has continued to lose ground or it has continued to depreciate below the one-for-one swap with the US dollar which means that heated debate is expected to hit all sectors of the economy with every quarter trying to determine the effects of the falling dollar on their operations (Kohler, 2011). It is imperative to mention at the onset that various sectors of the economy such as the manufacturing export industries, the market for real-estate, education sector and tourism (to mention a few) are the most affected by the fall or rise of the Australian dollar (Battelino, 2010). In this perspective it is true to state that the Australian dollar is both a source of national pride and economic angst and its value affects every individual both young and adults in the country. The purpose of this paper is to analyse and discuss the current driving factors on the Australian dollar. In this analysis and discussion, both the both demand and supply concepts will be applied. Further, the impending future changes such as the slowdown in the Chinese economy and carbon tax laws will also be explored. Finally, the impact of the movements exhibited by the Australian dollar on Australian economy and other markets will be identified. Analysis and Evaluation Overview The powerful Australian currency commonly referred to as Aussie is a significant symbol of the recovery path that has been taken by the Australian economy from the economic recession that hit world economies in 2008. It is also a significant indicator of the economic force held by Australia against many other economic giants such as China, Japan, the US and the economic region of Europe (Critchlow, 2011). Australians brag of vast natural resources, a mixture of rising commodity prices and also a strong currency. It means that in more than 100 years, Australia has experienced the most favourable terms of trade which means that exporters fetch more foreign revenues and the importers purchase capital goods at relatively low prices. In the last fiscal year, the Australian budget deficit was estimated to be 54 billion dollars. As a percentage of the gross domestic product (GDP) the budget deficit was estimated at 6%. This is a percentage that can be envied by even the most developed nations globally. Even with the strong currency, Australia has continued a favourable balance of trade with the demand of coal and iron from China remaining steadily high (Critchlow, 2011). The subsequent section will look at the driving factors causing the upsurge and the downward of the Australian dollar. Driving factors on the Australian dollar In analysing the movements by the Australian dollar it is prudent to explore both the driving factors that led to the appreciation of the Aussie from last year and the driving factors that have led to the depreciation of Aussie in the recent past. Factors leading to appreciation of Aussie The Demand side for the Aussie Economically, the law of demand holds that an increase in demand for a commodity results into an increase in the price of the commodity (Bernanke, Olekalns & Frank, 2008). This law can be applied towards the explanation of the appreciation of Aussie in the year 2010 and the better part of 2011. Some of the factors attributed to the rising demand for the Australian dollar include; (a) Demand for Australian goods Demand for Australian products particularly natural resources such as iron and coal has been on the increasing trend with countries such as China importing large amounts of these resources. In order to procure these resources from Australia, China needs to have substantial amounts of Australian dollars in its reserves because only the local currency can be used to procure capital goods from another country. As a result, the value of the Australian dollar rose significantly in 2010 and 2011 following the increasing demand of iron and coal in China (Edge, 2010). (b) Changes in economic conditions The period between 2007 and 2008 when other countries were languishing in economic recession, Australia was the leading country in terms of exportation of vast amounts of raw materials which led to the period being referred to as the resource boom. Among the countries that imported raw materials in large quantities from Australia during this period were Japan and China which strengthened the value of the Australian dollar against other world major currencies such as the US dollar which is widely used by China and Japan in undertaking foreign procurements (Bernanke, Olekalns & Frank, 2008). Hence, the resource boom was one of the driving factors that drove the value of the Aussie to higher levels from 2007 to 2011. (c) Inflow of capital As stated there above, the Aussie became a safe haven for many investors around the world due to its stability during the economic recession rising above the US dollar. This was a clear reflection of high economic growth in the domestic market (Edge, 2010). The strength of Aussie in 2008 when other major currencies were affected by the recession resulted into the movement of capital investments from other economies to Australia to the speculative motive that Australian economy would continue to grow or it would be less affected by the economic recession. Capital inflow into the Australian economy increased the demand for the Aussie hence leading to the appreciation of the currency. (d) Speculation The speculative motive is another major cause of the appreciation of the Aussie in period between 2007 all through to 2011. Speculation is a strategy used by foreign investors to buy and sell foreign currencies in order to make profit (Edge, 2010).The fact that Australian dollar remained stable in the better part of the economic recession was a reason enough for many foreign investors to purchase the Australian currency in large amounts in speculation that its value would continue increasing and thus they would sell it in future at a higher value in order to make profit. The effect of this is that the demand for Aussie increased drastically leading to the appreciation in its value. The supply side The supply side of the Australian dollar led to the increase in its value. Economically, the law of supply holds that the higher the supply of a good the lower the price of the good. (a) Demand for overseas goods It is imperative to note that that Australia has continued to enjoy a favourable balance of payments with its exports exceeding its imports. This was particularly the case in 2010 where the value of exports increased by more than $2, 112m and the value of imports increased by $1, 123. This shows that exports were more than important resulting into a favourable balance of payments (Edge, 2010). As a result, the supply of Australian dollar required to import goods was lower than the amount of Australian dollar earned from exporting goods. This factor alone led to a stronger Australian dollar because the demand for imported goods was not higher and thus there was no significant pressure on Aussie. Hence, the lower supply of Australian dollar due to lower levels of imports than exports led to a strong value of the Australian dollar and its appreciation. Factors leading to depreciation of Aussie As has been witnessed in the recent past, the Australian dollar has been on a downward trend meaning that the currency has lost its value. Different driving factors causing these movements can also be analysed and evaluated from the demand and the supply sides. Demand side (a) Decreasing inbound tourists It is estimated that more that 600,000 Australians left their country in 2010 when Aussie gained considerable value against the US dollar. The resultant factor is that the supply of the Australian dollar in the domestic market increased as more people sought to tour different parts of the world (Edge, 2010). On the other hand, foreign tourists found it expensive to tour Australia because their currencies were of lower value than the Australian dollar. The decreasing demand of the Australian dollar by foreign tourist and the increasing supply of the dollar in the domestic market have eroded the value of Aussie making it expensive for the Australians to tour other regions of the world (Kritzer, 2009). Hence, the decreasing demand of the Australian dollar by foreign tourists and visitors is one of the major driving factors causing the depreciation of the AUS dollar. (b) China factor As stated above, China is a key and strategic market for Australian products such as iron and coal. The growing feeling that China and other emerging markets such as India, South Korea (to mention a few) can’t remain unaffected by the second phase of recession has also been a major driving factor towards the downward adjustment of the Australian dollar (Fitzgerald, 2011). What this means is that the amount of natural resources such as iron and coal importuned by China from Australia is bound to decrease as the second phase of recession hits the world economies. The resultant factor is that the demand for Australian dollar is expected to decrease drastically as China, South Korea, India and other emerging economies reduce the amounts of imports from Australia in preparation for the second phase of the credit crisis. (c) Drop in Commodity prices This can be attributed to the strong value of Aussie in 2010. The strong value of the currency in 2010 meant that manufacturers were able to import large amounts or raw materials for production purposes at lower prices. When this is viewed in consumer terms it means that goods produced by local manufacturers are cheaper (Australian Bureau of Statistics, 2010). However, this effect is now being felt by the manufacturers whose profit margins have continued to drop as the value of the dollar goes down. This explains why manufacturing companies are laying off workers in order to reduce operational costs and break-even. With dropping profits it means that manufacturers are not willing to import raw materials from the foreign markets (Fitzgerald, 2011). As a result, the demand for the Aussie by the manufacturers has also dropped because the importers are not willing to procure capital goods from foreign markets. Supply side (a) Inflation rate It is evident that during the economic recession, the inflation rate in Australia dropped drastically to a record low of 1.6%. However, the resource boom and the continued trend of economic recovery have seen inflation rates increase making commodities in the domestic market expensive for the ordinary consumers (Fitzgerald, 2011). Economically, an increase in inflation rate in the economy makes the goods relatively expensive. In order to check on inflation the supply of the Australian dollar has been stepped up in order to encourage traders to import cheaper goods from other foreign markets. The law of supply holds that the higher the supply the lower the price of a commodity. The increasing supply of the AUS dollar has therefore resulted to a decrease in its value in the domestic market (Gittins, 2009). (b) Rising unemployment rates According to Kohler (2011) the rate of unemployment in Australian economy has been on an upward trend going from 4.9% at the beginning of the year to over 5% currently. The trend is expected to rise further reaching 5.5% by the end of the year. In order to discourage unemployment from rising, the Reserve Bank will likely to respond by cutting down the interests rates in order to encourage borrowing (Mahony & Dixon, 2008). This means that the amount of supply of the Australian dollar is expected to increase drastically. The higher the supply of the Australian dollar the lower the value of the currency this explains why the Australian dollar has been on a downward trend. Future changes One of the future changes expected to hit the Australian economy is the introduction of the carbon tax in 2012. This refers to the tax that will be levied on each tone of carbon gases emitted into the atmosphere. In order to cover this tax burden, the manufacturers and producers will transfer the burden to the consumers thus increasing further the rate of inflation in the economy (Mahony & Dixon, 2008). Increase in inflation will further erode the value of the Australian dollar. The slowdown in China’s economy is also another change expected to occur in the future due to the credit crisis. This will affect or reduce the amount of imports from Australia and thus it will in turn reduce the demand for Australian currency leading to further depreciation. Impact on other economies and domestic economy (i) Reduction in imports From the analysis above, it is clear that a depreciating currency makes imports expensive because importers have to use more money to purchase goods from foreign markets. One of the impacts of the downward adjustment of the Australian dollar is that other markets are likely to witness a reduction in the amount of goods imported by Australian traders (Mahony & Dixon, 2008). Hence, other markets are likely to experience an unfavourable balance of payment as compared to Australia whose exports are likely to increase as the export manufacturers are encouraged by the falling dollar. (ii) Increase in imports from Australia Traders from other markets will be encouraged by the falling AUS dollar and increase the amount of imports because the goods in Australia will be relatively cheaper. This is likely to be witnessed in major trade partners such as China. (iii) Drop in the rate of unemployment This is an impact of the downward adjustment of the AUS dollar in the domestic economy. The downward adjustment will increase the amount of revenues by the export manufacturers which will in turn result into the expansion of manufacturing operations in the country. Laying off of workers will stop and more job opportunities will be created in the Australian economy. (iv) Expansion of the tourism sector The downward adjustment of the Australian dollar means that visitors and tourists from other markets will find it cheaper to visit Australia and hence the number of tourists to Australia will increase drastically (Mahony & Dixon, 2008). As a result, more job opportunities will be created in the tourism sector and thus the problem of rates of unemployment are likely to drop. Conclusion From the analysis and the evaluation of the Australian currency and the driving factors responsible for its movements either upward or downward, it is evident that the Australian dollar plays a major role in the country’s economy. As established in the paper, the appreciation of the Australian dollar affects the economy negatively and positively. Similarly, the depreciation of the currency also impacts on the economy positively and negatively. The driving factors responsible for the movements of Australian dollar have been analysed from the demand the supply side with each factor being analysed an evaluated in terms of its effects on demand the supply of the Australian dollar and how the demand and supply results into appreciation and depreciation of the currency. As a self-regulatory mechanism the demand and supply forces should therefore be left to determine the value of the currency. However, minimal government interventions through the Reserve Bank. References Australian Bureau of Statistics. (2010). Balance of Payments and International Investment Position, Australia, 2010. Media Release. Available from http://www.abs.gov.au/ausstats/abs@.nsf/mediareleasesbyTopic/AA1AB3A3B5E70418CA25778F001F5AD6?OpenDocument Battelino, R. (2010). ‘Mining Boom and the Australian Economy’, Address to The Sydney Institute, 23 February, Sydney. Bernanke, B., Olekalns, N. & Frank, R. (2008). Principles of Microeconomics, McGraw Hill Sydney- Australia. Critchlow, A. (2011). Aussie’s Dollar Fall: Good News or Bad? The Wall Street Journal. Available from http://online.wsj.com/article/SB10001424052970204010604576592091154911536.html Edge, K. (2010). Factors Affecting the Demand and Supply for Australian dollars. Charles Sturt University. Available from http://hsc.csu.edu.au/economics/place/rates/Tutorial4ExchangeRatesmeas.html Fitzgerald, M. (2011). Factors affecting the demand for demand for Australian Dollar. Available from http://www.audusd.org/factors-affecting-the-demand-for-australian-dollars Gittins, R. (2009). ‘Ignore Cries of woe over soaring dollar’, Sydney Morning Herald, 13 June, pg5. Kohler, A. (2011). Alan Weekend Briefing, 24 September 2011. Kritzer, A. (2009). Australian Dollar Rises, Remains Closely Correlated to stocks. http://www.forexblog.org/2009/08/australian-dollar-rises-remains-closely-correlated-with-stocks.html Mahony, J. & Dixon, T. (2008). Australia in the Global Economy, Leading Edge Education, Sydney. Read More