Why the dollar has fallen

Why the dollar has fallen

By Allen Myers

When the Australian dollar fell below US$0.60 on June 8, swimming metaphors were popular, and they suggested that Australia is about to go down the gurgler. The Australian headline was “Dollar dives to record low”, and the Sydney Morning Herald headline bewailed “Our drowning dollar”.

 

The business press was more restrained. The Financial Review, for example, focused on business fears of an interest rate rise rather than on the exchange rate falling through the “psychologically important” 60 cents barrier.

Still, it's clear that something important has been happening. A year ago, the Australian dollar was worth around US$0.75. The 20% fall in its exchange rate, after the much more dramatic falls in several Asian currencies last year, inevitably raises questions of how much further the Australian dollar might fall.

The exchange rate of the dollar, or any other currency that is freely traded (nearly all are these days), is basically determined by capitalists' expectations of how easy it is to increase funds held in that currency.

The US dollar has a high exchange rate at present, for example, because profits in the US are high and its stock market has been rising strongly. High interest rates also raise a currency's exchange rate, because capitalists buy the currency in order to lend it at those high rates.

On the other hand, few want to hold a currency which is undergoing a significantly higher rate of inflation than alternative currencies, or if the country concerned is in serious recession.

Speculators

Some capitalists who trade in currencies do so not with the expectation of profiting from a particular economy over months or years. They may buy and sell millions of a currency in a few days, or even a few hours. These are the notorious speculators.

Speculators profit by guessing ahead of most of the market where the market is going: if they believe that widgets next week will cost half of what they cost today, they sign a futures contract to deliver widgets next week at today's price.

Speculators therefore thrive in a market where there are frequent rapid changes in prices (including the prices of currencies).

However, if it were purely a matter of guessing, speculators would guess wrong as often as they guess right, and on balance they would break even (as a group) rather than profiting. Speculators normally rely either on information which is not available to others, or on an ability to control, at least partially, the events on which they speculate.

This is the charge made by Malaysian Prime Minister Mahathir Mohamad, among others, against big investors known as “hedge funds”. If such a fund bets that a currency is going to fall in the near future, it may be able to bring about such a fall by selling the currency in large amounts and scaring other holders of the currency into selling.

The more funds available to the speculator and the smaller the economy concerned, the easier it is for speculation to alter the exchange rate. But it's in the very character of speculation that such changes are short term, violent and contradictory. A gradual decline like that the Australian dollar has experienced over the past year is beyond the ability of speculators to engineer — and in any case is not the kind of event that speculators can profit from.

Dim prospects

The fall of the dollar reflects international and Australian capital's evaluation of the prospects for the Australian economy.

The economic crisis that is moving through Asia is a major part of the cause of the dollar's fall. Capitalist investors are clearly sceptical about the Howard government's claim that it has “fireproofed” the economy against the effects of the Asian crisis.

Most of Asia — not merely the four or five underdeveloped countries worst hit by last year's currency falls — appears headed for a major recession.

Japan, which dominates the region economically, is already in its worst recession in 23 years. Because of massive overcapacity in Japan, and in Asia more generally, huge fiscal stimulus packages of the Japanese government have stimulated very little economic activity.

Thus, rather than helping the wounded “dragon” and “tiger” economies over their difficulties by taking more of their exports, Japan is reinforcing their recession. Like the Australian dollar, the yen has lost around 20% of its value against the US dollar over the last year.

Since 60% of Australian trade is with Asia, and Japan in particular is so important for Australian exports, the idea that Australia could escape being seriously affected by the crisis was always a pipedream.

The impact of the Asian crisis here may be all the sharper if, as seems to be happening, it coincides with a downturn in the Australian business cycle. The national accounts figures released on June 3, despite treasurer Peter Costello's attempt to put a cheerful gloss on them, were interpreted by business commentators as a sign that the economy is past its peak.

The figures showed that the economy had grown by 1.3% in the March quarter (4.9% for the 12 months to March). However, domestic final demand had fallen (by 0.3%), so the increased production went to increasing stocks in warehouses. Domestic markets are running out of steam at the same time as export prospects are hit.

This implies a curtailing of growth — and jobs — in the June quarter, and evidence of this is already available. An ANZ Banking Group survey released on June 10 showed job vacancies down 1.1% in May, the first drop since January.

In the same month, official unemployment rose to 8.1%, from 7.9% in April. In addition, nearly 40,000 workers went from full-time to part-time jobs.

Interest rates

Within limits, Australian capitalists and the government can live quite comfortably with a low dollar. Unlike the Third World capitalists forced into technical (and sometimes actual) bankruptcy by the Asian currency crashes, Australian capitalists with US dollar debts normally have these “hedged” — protected against big changes in exchange rates. And a low value of the Australian dollar makes Australian exports more competitive.

But a lower dollar also raises the price of imports and thus increases inflation. The Reserve Bank, which is charged with keeping inflation in check, is thus under pressure to raise interest rates to keep the dollar from falling further.

Moreover, the Financial Review reported on June 10 that the biggest Japanese life insurance companies are halting new investments in Australia because of the falling dollar. Such a decision puts further downward pressure on the dollar, and could undermine the prices of Australian shares across the board.

A rise in interest rates is about the last thing the Howard government wants right now: it has been planning to use low interest rates as one of its “achievements” in an early election campaign. Legally, the Reserve Bank is supposed to make its decisions independently of the government.

However, business also appears generally against a rise in interest rates. This is because of the signs that the business cycle has gone past its peak. It is at this point of the cycle that economic theory normally calls for reducing interest rates, not increasing them.

Not waiting for the Reserve Bank to act, the banks have already begun raising their commercial and housing interest rates. This will give John Howard an additional reason to rush to the polls before the economy worsens.