Factors influencing the value of the Australian dollar

Discuss About The Overvaluation In Australian Housing Market?

The past weeks have been good for the Australian dollar (AUD) as it has been the best performing currency globally which has put entities such as the Reserve Bank at ease. However, the same could be said for all economists as some of them feel that the levels the Australian dollar is trading at cannot be sustained. When put against the US dollar, the Australian dollar is up 6 percent and compared to the British pound sterling, Indonesian rupiah and the Chinese renminbi it is up 5 percent. Against the European Euro, the Australian dollar is up 4 percent and the Japanese yen 2 percent (Robin, 2017).

According to a statement by the Reserve Bank of Australian (RBA) regarding interest rates, since 2013, the dollar has been losing its strength, and that has considerably helped the country’s economy as it transitions to the final stages of its mining investment boom.  We would not have been possible to adjust as well as we have if the exchange rate is appreciated. However in response to this statement, a currency strategist working at the NAB feel that the RBA did not consider one important thing, the fact the Australian dollar has experienced a steady appreciation from September 2015. He states that it will be obvious to see that the Australian dollar has considerably risen if you study it using the trade-weighted basis. His statement does not support what Philip Lowe, governor of RBA said which indicated that it would be difficult to establish whether or not the exchange rate has gone up too high. There are other strategists who are in support of Mr. Low such as the chief current strategist at Westpac who states that the period in which you run a model determines the value of a current and he has found that the Australian dollar is somewhat undervalued.

The Australian exchange rate is floating; what this means is that multiple factors might be causing its change repeatedly or that those factors are fixed to another currency, and although they still float, they move in synchronization with the currency to which they are fixed. It is important for Australian investors to know the value of their home currency has it enables them to evaluate investments that are valued at the foreign dollar. For example, if an Australian investor wants to invest in the U.S, he will have to determine whether or not the AUD to US dollar exchange rate is profitable as a declining AUD could make could positively impact the foreign investment in terms of value. Similarly, an increasing AUD could decrease the value of the foreign investment.

Advantages of an overvalued AUD

In the forex market, supply and demand are used to determine the value of the Australian dollar (Reserve Bank of Australia, 2017). The level of demand that is present in correlation to the supply of the AUD will determine the Australian dollar’s value when put against another currency such as the US dollar, the British pound sterling or the Chinese renminbi. For instance, if the demand for the AUD by the Chinese rises, the supply-demand relationship will cause the price of the AUD to increase when put against the Chinese renminbi (Fry and Voukelatos, 2010).

The value of the Australian dollar is influenced by many factors. The country’s economy is at the mercy of commodities including grains and metals. Data regarding mine output, the cost of metal, crop planting, yields and the weather is capable of increasing or decreasing the value of the Australian dollar. Further, how much strength the AUD has is determined by the commodity cycle, how exposed it is to Asia and the slightly countercyclical position the AUD has in relation to other important currencies such as the US dollar. For example in the article, the value of the Australian dollar might have risen due to a high demand of natural resources in India and China, but if the demand were to decrease, it would fall. 

In general, commodity prices that are high develop, it gives developed countries in Europe, North American as well as Japan the same burdens as the would have if they were in a recession because there will concern regarding the sustainability and growth of their economies. But the Australian economy is not among them as it looks healthier most of the time.

By and large, while there have been very sensational cost falls, especially in late 2008, there were for the most part enduring increments in ware costs in the years following 2008. There is no uncertainty item costs will stay unpredictable for quite a while to come, with developing interest for products from China and India and also the unavoidable changes sought after that go with the adjustments in the financial prosperity of the created economies like Europe, Japan and the US. It has been contended that the Australian dollar is exaggerated at present, given acquiring power equality measures and that relative customer value record (CPI) developments propose a long haul US dollar cost of at around $0.77. While the Australian dollar remains at a cost of around US$1.00, our fare enterprises think that its less beneficial to offer their items abroad, This incorporates the ware makers. A fall of around 25% would have a significantly beneficial outcome on exporters.The Australian dollar is frequently contended to be basically a product cash, thus if the world cost of items fall then it is normal that the Australian dollar will deteriorate too. On the off chance that these developments are decently firmly synchronized, at that point falls in item costs as long as Australian makers are as yet offering their wares – may have minimal genuine effect on the Australian dollar benefits earned by the ware makers, while making our different exporters more aggressive on the world market.

Disadvantages of an overvalued AUD

Late monetary ware value vacillations unquestionably reflect changes in free market activity, however it is hard to state what the long haul impact will be. A 5% fall in product costs today could be trailed by a 5% rise tomorrow. These are absolutely unstable circumstances.

An overvalued currency means that it is too high to compare to the state in which the economy is in; an overvalued AUD will mean that Australia’s exports will considerably expensive as the local goods will be more expensive making imported products very popular as they will be cheaper. Due to the overvalued AUD, there will be more spending on imports while the domestic demand will reduce. So in this case, due to the high costs of exporting a product from Australia, the demand for alcoholic beverages by the United States will significantly reduce; as a result, my income will go down.

An overvalued currency is determined by analyzing the purchasing power parity (PPP) which at more sophisticated levels considers the GDP.

An overvalued currency will be greatly beneficial to Australia when the economy is booming as it will help decrease inflationary pressure. Another benefit that is also a disadvantage is that an overvalued currency is that it enhances the values of domestic products in relation to foreign currencies.

An overvalued currency will be very problematic for Australia in case of an economic recession or when the growth is slow as the country will have to deal with a lot of deflationary pressures. Another disadvantage of the overvalued AUD is the discrimination regarding exports which will reduce exporters’ capability and willingness to compete in international markets as the largest percentage of their costs of production will be in AUD (Shatz, & Tarr, n.d.).  An overvalued currency can interfere with Australia’s economic growth as it will reduce the level of productivity as exporters and importers will be disadvantaged over time by the overvalued exchange rate which will impact their productivity, as a result, interfere with their competitiveness. The next disadvantage is that the government may be misled by the overvaluation and inefficiently allocate the foreign exchange. Also, an overvalued currency may create a serious economic recession for Australia due to the tight and severe monetary policy that will be used as a defensive response to the overvaluation.

An exchange rate showcases the value of a country’s currency when put against the value of another nation’s currency (Amadeo, 2017). An exchange rate is an important component of the Australian’s economy as it impacts the equilibrium of trade between Australia and the investment policies that influence the country. It can be assumed that the Reserve Bank of Australia of want to keep the exchange rate at US 72C because it is after stability in order to make the country more appealing for foreign capital. The best way to accomplish this is to create a fixed exchange rate by tying the value of the AUD to another currency or a popular commodity; for instance pegging it to the U.S dollar as it is widely used in international trade. This might mean that the Reserve Bank of Australia might have to augment the supply of money or decrease it if necessary in order to uphold the fixed rate.

Having a fixed exchange rate can be beneficial for the Australian dollar as it will give it the stability it needs especially as it has always been said to be volatile and unusually counter-cyclical. Investors will always know what the AUD is worth and as a result, the country’s markets will attract more direct foreign investments as they won’t have to hedge the currency risk. Fixing the AUD to the US dollar will allow Australia to evade inflation as it will profit from the strength of the economy of the United States. If the Australia continues to operate without fixed inflation, then the AUD will slide causing the price of imports, especially from large countries to increase significantly. So I believe that this action would be effective for Australia. Having a fixed exchange rate will enable investors to get the same amount when exchanging their money in other currency as well as make it easy to determine the exact amount you will get.

 But, having a fixed exchange rate also have its own side effects. One disadvantage of a fixed exchange rate is that it can be costly to uphold especially for countries who do not have sufficient foreign exchange reserves, but Australia could manage as the country’s foreign exchange reserves are relatively moderate by international standards. Another disadvantage is that speculators could make a target out of the Australian dollar. As a result, they can think that it is easy to “short” the AUD which will artificially reduce its value. If this were to happen, the Reserve Bank of Australia would have to convert its foreign exchange in order to drive up the value of the AUD. In the case where the RBA does not have enough, it will have to increase the interest rates. But the situation will not be ideal for the country as it will create an economic recession as what happened to the economy of Switzerland when the country decided to stop fixing the Swiss Franc to the Euro, and it causes it considerably drove the value of the currency down (Amadeo, 2017)

References 

Amadeo, K. 2017. Fixed Exchange Rate: Definition, Pros, Cons, and Examples. Retrieved from https://www.thebalance.com/fixed-exchange-rate-definition-pros-cons-examples-3306257

Fry, R.A., Martin, V.L. and Voukelatos, N., 2010. Overvaluation in Australian housing and equity markets: wealth effects or monetary policy?. Economic Record, 86(275), pp.465-485.

Reserve Bank of Australia. 2017. The Exchange Rate and the Reserve Bank’s Role in the Foreign Exchange Market. Retrieved from https://www.rba.gov.au/mkt-operations/ex-rate-rba-role-fx-mkt.html

Robin, M. 2017. Is the Australian dollar overvalued?. Sydney Morning Herald.

Shatz, H., and  Tarr, D. (n.d.). Exchange Rate Overvaluation and Trade Protection: Lessons from Experience. Retrieved from https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.483.2824&rep=rep1&type=pdf