The punishing of the Australian dollar

There are good reasons to believe that the Australian dollar will rise rapidly against the US dollar shortly. This is not good news.
 
The fall in the Australian dollar was extraordinary, it fell faster and further than currencies of countries that have literally gone bankrupt. Investors wanting to get liquid as quickly as possible dumped Australian investments.
 
This sudden decline added to Australia’s economic growth. Resource prices in Australian dollars are at a record high, even as they have halved in US dollars.
 
The next 12 months represent a far more dangerous situation - a rapidly rising dollar.
 
There are seven reasons why the Australian dollar could rise:
 
The US economy is sick and getting sicker
 
Most economic models factor a normal recovery for the US economy. This is unlikely; the US financial system has been badly damaged, and there is still a second round of write downs, or more, to come. Without an effective financial system creating credit, an economy’s growth has a ball and chain around both ankles.
 
Demand for US dollars is decreasing while supply is exploding
 
The US government is about to issue trillions of dollars at a time when their economy is not generating assets considered worth buying, or exporting goods and services people wish to buy. At the same time, those who usually purchase US bonds have less money - the Middle East - or have problems of their own; such as China and Japan.
 
Fundamentally when supply exceeds demand, the price must fall.
 
The Australian economy has limited exposure to external shocks
 
As 1998 demonstrated, Australia’s economy is reasonably diversified. Further, it is aligned with the one region that is still growing. It is humourous to listen to European commentators about how our economy is at risk because our trading partners are only growing at 6 per cent, while theirs are shrinking at more than 2 per cent. As mentioned before, our major exports are at record prices in Australian dollar terms.
 
This is possibly why the Australian economy was one of the few to grow in the final quarter of 2008.
 
Australian debt is low and matched
 
Core to Australia’s resilience is its debt profile: governments have none; corporates are reasonably geared, and households, while heavily indebted, are not as indebted if calculated similarly to overseas methods. And unlike other countries, these debts are overwhelmingly backed by assets. That is, most borrowing went into either purchasing housing stock or income producing assets. Elsewhere, much more went into consuming. There are currently 11 banks in the world with an AA rating or above. Four of them are based in Australia.
 
Short and medium term demand for resources will go up not down
 
Regardless of what happens in Organisation for Economic Co-operation and Development (OECD) nations, demand for resources was driven by India and China. These two economies are continuing to grow, and their demand for resources will increase over the next year as they attempt to support domestic demand. There is now mounting evidence that metal inventory in China is reaching critically low levels.
 
Inflationary pressure will force money into safe haven assets
 
A number of highly recognised commentators are saying that Bernanke’s policies are equivalent to the Weimar Republic. The policies are likely to lead to large scale inflation. The typical response to this environment has been rising gold prices. This outcome will further strengthen the Australian dollar.
 
Demand for Australian dollars is going up, while supply is going down
 
As risk appetite returns to the market, so will the carry trade. As this article is being written the differential between Australian and international interest rates appears to be widening. The number of currencies in which borrowings will be made at very low rates has dramatically increased. Meaning Australian assets will have a much higher return than others, and the supply of dollars to buy them, whether from the US, UK or Japan at close-to-zero interest rates, is about to expand considerably.
 
A rising Australian dollar presents the Australian economy with a number of risks. The Reserve Bank of Australia has been very slow to loosen monetary policy, and even now, after the banks increased their margins, it can be argued monetary policy is neutral and not expansionary. This, some 13 months after the US recession officially began.
 
To maintain the stimulus that the fall in the dollar has represented, as happened in 1990, the Reserve Bank will need to take a more aggressive stance before there is a lot less to stimulate.