Yesterday I posted an article about how the over-valued Aussie dollar is going to keep a lid on rates. I got a few questions on it so I thought I’d flesh it out a bit more.
Let’s start with a picture:
This comes from a recent HSBC report looking at the state of the global currency market. HSBC ranked all of the global currencies against their assessment of what ‘fair value’ is.
And who’s that all the way over on the right? It is. It’s the little Aussie Battler.
According to HSBC, the Aussie dollar (relative to the US dollar) is the most over-valued currency in the world right now.
They’re not the only ones. The RBA had a freedom of information request sprung on them by Bloomberg. In an internal memo they released, they said they thought the Aussie was anywhere between 4 and 15 percent overvalued.
Using the OECD’s measure of purchasing power parity, the Australian dollar comes in at a massive 60 percent over-valued.
There’s no precise way to measure how under or over-valued a currency is, and economists would probably have different definitions of what ‘fundamental value actually means.
Some people try to model supply and demand. Some try to compare the prices of similar things in each country. The Economist magazine famously publishes The Big Mac index. The idea is that MacDonald’s signature ‘turd in a bun’ is the same wherever you go, and the exchange rate should equalise the difference across countries.
(On the Big Mac measure by the way the Aussie is 12 percent overvalued…)
But while there are any number of opinions about how to calculate fundamental value, there is a clear consensus that the Aussie is overvalued – probably by a decent amount.
So how did we get here and what does it mean?
A lot of it has to do with capital flows.
Partly it’s about mining investment in Australia, which of course has to be done in Aussie dollars.
However, the really interesting story is debt.
Following the GFC, the global economy found itself stuck in a mire. Things had been given a shake and it looked like the whole show could fall to pieces. A string of sovereign debt crises in Europe gave investors the panics, while debt in the US threatened to send the government bankrupt and turn out all the lights.
But in these stormy seas, Australia shone like a rock of stability and fiscal responsibility. Of course when you’ve got 1.3 billion Chinese driving a commodity boom, it’s easy to pretend that you’ve got the smarts with the monies.
And so investors came flooding our way, looking for any port in a storm that could safely look after their money.
Take a look at the figures:
Foreign investors purchased $58 billion worth of Commonwealth government bonds in 2012. That’s a lot!
In 2012 our biggest exports were iron ore at $85 bn, followed by government debt, followed by coal at $48 bn.
Offshore investors couldn’t get enough of Aussie debt, and needed Aussie dollars to buy it. This extra demand drove the Aussie to new heights.
The other issue holding up the Aussie right now is the RBA’s recognised refusal to take part in the global currency war.
We are the Switzerland of currencies.
There’s a lot of concern that countries are out there actively trying to devalue their currencies – to help out their domestic industries. Japan’s come under a lot of fire lately, but I don’t reckon they’re the only ones doing it.
But that HSBC report found that while Australia had the most overvalued currency in the world, our policy makers were also the least active in manipulating the market.
You don’t have to have an economics degree to put that two and two together.
The RBA memo said they reckoned that up to 34 central banks around the world were hoarding Aussie dollars. These 34 banks together control more than US$3 trillion in foreign exchange reserves, so even a small change in their positions could have a big impact on the Aussie.
And the take home message for investors is that these factors don’t look like unwinding anytime soon.
It seems like it would take a miracle to bring the budget into surplus this year, so there’s going to be a solid on-going supply of Aussie debt. And while Europe and the rest of the world looks more stable these days, our economy is still streaks ahead.
Demand for Aussie dollars stays high.
The Aussie dollar will hang on to its safe haven status, and it would be a real change of direction for the RBA to start taking part in the currency wars. My bet would be not on Glenn’s watch.
And my bet is that the foreign central banks won’t be able to keep their fingers out of it.
And all this means that the Aussie will stay high and overvalued.
And as I said the other day, this means that interest rates will stay grounded.
Which as I keep saying, is just going to keep pumping more and more money into assets, particularly property.
And I say, if the Japanese central bank wants to make me rich…
… go ahead and let ‘em.
That’s my point of view and opinions …and I’m sticking to them.
Have a great weekend… down south it’s a 3 day kind…wippy !!