Currency Risks And Rewards

Sydney Morning Herald

Monday November 22, 2004

With little fanfare, the Australian dollar has been heading back up towards US80 cents, matching last February's high. That is good news for those going overseas but less so for the economy.

To some extent, the stronger currency reflects the optimism of international investors about the Australian economy. However, the dollar's recent gains may have more to do with the Bush Administration's apparent desire for a weaker US dollar. That is one way to tackle the large trade deficit - a sizeable and growing government deficit - of the United States. Australia, like the US, has a large trade deficit, although our federal budget is in surplus, thanks to sustained economic growth following two decades of economic reform. Yet as we approach 21 years of having a free-floating currency, sentiment may be changing - and that could pose a serious dilemma for policymakers.

The Australian currency's float has proved the first step in a restructuring of the economy which has gone in fits and starts ever since, but is responsible for much of the buoyant economic growth of the past decade. For much of this time, the currency was hurt by the common view that the world faced a glut of the very commodities that Australia exported. The continued slide in the real prices of commodities pushed our currency down, giving industry the chance to rebuild after becoming woefully uncompetitive during decades of tariff protection.

Over the past few years, thanks in part to the boom in China and India, commodity prices have risen sharply, buoying profits of mining companies and pushing our sharemarket to record levels. This newfound prosperity is reflected in the price of our dollar. And that is the emerging dilemma. After a super-cheap currency gave industry the chance to rebuild, the strong currency is now pressuring exports of manufactures and services. Despite the rebound in manufacturers over the past decade, commodities still make up two-thirds of our exports. The slowing of global growth as we head into 2005 will mean an even lower demand for Australia's exports - and that will push up our trade deficit. This may help check the strength of our currency, but this will take time to become apparent.

It may be unrealistic to expect the Australian dollar to maintain its present levels. But by the same token, the lows, below US48 cents, of just a few years ago were equally overdone. It is some time since Australia has paid its way internationally; exports matched imports only very briefly, in 2000, and since then imports have surged.

The increasing technological sophistication ofour manufacturers provides greater protection against the damaging effects of a stronger currency. However, it takes several decades for such strengths to emerge.In the meantime one effect of a surging dollar may be to force many exporters to shift production offshorejust to survive.

© 2004 Sydney Morning Herald

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