Essay Four (Exchange Rates): Topic 2 – Australia in the global Economy
Outline the causes of a decrease in demand for the Australian dollar, and discuss the impacts on the Australian economy of a sustained depreciation of the Australian currency.
The exchange rate is a measure of the value of a currency relative to another and is influenced by the demand and supply of the Australian Dollar (AUD). Changes in any of the factors that affect supply and demand causes the AUD to rise or fall. The demand for the AUD is derived from the demand of Australia’s goods, services and assets, which is impacted by domestic and international economic conditions. Therefore, factors such as decreased ...view middle of the document...
During 2014 growth of the December quarter was expected to reach 1% and instead only reached 0.5% causing the economic growth for the year to only reach 2.5%. A clear gradual downtrend in economic growth over the past decade is evident, with only 2 clear spikes above 4% within the past 10 years. Speculators believe that this trend in slowing economic growth will continue, therefore foreign investors become more reluctant to invest in the Australian economy resulting in a decreased demand for the AUD and a depreciation in the Australian currency. It is demonstrated in Figure 1 below, that Australia is falling behind the GDP growth rate of the world and major trading partners due to the end of the mining boom. Mining investment has fallen from 6% of GDP to its long term figure of 1-2% of GDP, and it is evident that non-mining investment has failed to cover this fall.
The demand for Australian exports also dramatically influences the demand for the AUD. When overseas consumers buy Australian goods and services, they must convert their currency into Australian dollars in order to pay the exporters. The demand for Australian exports is influenced by the tastes and preferences of overseas consumers for Australian exports. For example the tourism industry was one of Australia’s largest exports throughout the 1990s, however the event of 9/11 reduced the number of tourists visiting Australia and consequently, the demand for the AUD.
International competitiveness heavily influences the demand for Australia’s exports. In order to compete in the global market, Australia’s goods and services must be as cheap as its international competitors. If Australia’s inflation rates and costs are higher than its overseas competitors our goods will be more expensive and won’t be internationally competitive. Australia’s inflation rate increased from 1.2% in July 2012 to 3% in July 2014. This high inflation rate has caused a loss of export markets, reducing the demand for AUD and forced a depreciation of the Australian dollar.
The major factor influencing the demand for exports is the change in commodity prices and terms of trade. The AUD is seen as a “commodity currency” that rises and falls with changes in the terms of trade. Australia’s commodity boom has slowed during 2014/15 causing a decrease in demand for Australian exports, particularly coal and iron ore. Figure 2 indicates that the index of commodity prices has fallen by 15.6% in AUD terms over the past year. The largest contributor to this decline was the price of iron ore hitting an all time low of $US50 a tonne on the 2nd of April 2015. This decrease in price is mainly due to a rapid increase in iron ore supply combined with moderating growth in China’s steel production. As a result of the...