Australian dollar takes a dive

The spectacular plunge in the Aussie dollar is unprecedented since the currency was floated. Marc Moncrief examines what went wrong.

IMAGINE three crystal balls sitting on a shelf, each one cloudier than the next. The plaque on the base of the first reads "Shares", the second, "Interest Rates" and the third, "Currency".

Over the past two weeks, the people who attempt to divine economic futures have all but thrown their scrying tools at the wall. Shares are off more than 10% and interest rates have been cut twice as much as predicted, but the dollar is the thing most confounding to forecast.

Predicting the future movements of currencies is among the most obscure of the dark arts in financial markets.

A currency expresses confi dence in a nation's economy, in the broadest sense, but that confidence is sometimes affected by things people forget about day to day; things such as the interest rate we all pay on our credit cards and home loans, the country's relationship with its trading partners, and the relative position in the world-wide network that sends money zipping from one place to another.

Over the past two weeks, Australia's dollar has plummeted like an Airbus over Exmouth. Put this in perspective: in 1986, when Paul Keating warned Australia was in danger of becoming a "banana republic", the dollar fell from about 75 US cents to about 60 US cents over 2½ months.

That's a fall of about 19%. Anyone travelling in the US would have found a $A400 a night Manhattan hotel room suddenly costing $A480. Ouch.

But if you think that's big, take a breather. We have had nearly the same percentage cut from the currency over just the past two weeks.

As it happens, it was just about 2½ months ago that we were flying high at 98 US cents. That's puts Australia's dollar 32% lower over about the same time it took to lose 19% in 1986.

And that is history's closest approximation to the drubbing the currency's taking at the moment.

So, why? After all, Australia's still got the iron ore and coal that people - particularly people in China - want and need.

Just this week, a global brains trust on financial regulation headed by former US Federal Reserve chairman Paul Volcker said Australia's system (along with that of the Netherlands) was closest in the world to "optimal".

So, why? The RBA's monumental one percentage point cut to put the base rate of interest at 6% gives part of the answer.

Lower interest rates make it less profitable to lend money in a particular currency, making that currency less attractive to the world's finance gurus to invest with.

Investors now expect another 0.5 percentage points to be cut next month, and see rates falling to about 4.5% before they turn up again.

Another, more fundamental reason for the fall is included in the statement the RBA made accompanying the cut.

"Evidence is accumulating of a significant moderation in growth in Australia's trading partners in Asia," it says.

All that rhetoric about the buffer China was supposed to provide Australia against the tumult in the US? Forget it. That bank is beginning to erode, and the world knows it.

It's still true that, within its own borders, China has a lot going for it. Domestic demand is still strong and people still marvel at the booming growth there.

But exports from China - particularly to the US - are starting to thin. That means less money for China to buy such things as copper, iron and coal from Australia, and that spells trouble.

Most of the world ties Australia's currency to the prices for commodities such as iron, nickel, copper and coal, and the prices for these things are plummeting.

The US-based Commodity Research Bureau (CRB) index of world commodity prices has lost 35% since early July.

National Australia Bank currency strategist John Kyriakopoulos says a "typical" recession usually cuts about 30% from commodities prices. During the Asian crisis the dip was closer to 20%.

The bigger-than-normal dip suggests the world's investors now think something more severe than what might be considered a "normal" recession is on the cards.

"If commodity prices are going to be falling over the next couple of years then that should hit the Australian economy rather abruptly," Kyriakopoulos says.

Australia's terms of trade - the difference between the price we charge for our exports and the price we pay for our imports - is at a record high, but one the RBA warns won't be beaten next year.

Rather than being a consistent boon, it could end up slowing the economy. And then there is the matter of the current account. Australia's ability consistently to import more than it exports, yet grow its economy for 17 consecutive years, has been the stuff of economic legend.

The consumption economy, however, has saddled us with a bucket of debt - most of which is held as home mortgages that banks have had to go to the global capital markets to provide.

Those are the bad markets, the places where the US subprime debacle is tearing apart the world economy, and even our cashed-up banks are complaining of the strain they are under as they try to keep lending.

Currency from a country heavy with debt and used to paying its bills with things that aren't worth as much as they used to be - sound like a good thing to hold on to?

Investors all over the world have looked into their crystals balls and decided not, for now.

Sector by sector



PETROL



THE oil price has tanked. If the money Australians use to buy oil had not also taken a plunge, we might even be seeing some of the change at the pump.

The dollar's 32% dive against the US dollar has happened almost in lock-step with a 40% fall in the US dollar price of oil. In July, a barrel of oil cost as much as $US146. At the time, that equalled about $A150.

Yesterday, a barrel of oil sold for about $US88. Thanks to the weakened Australian currency, that comes to about $A128 - down, but only by about 12%.

Yesterday, the average price of petrol in Melbourne was $1.57, according to the Australian Competition and Consumer Commission. When the crude oil price peaked in July, the average price weekly was about $1.64 - a fall of about 4%.

So, over the period crude oil has dropped by about 40%, Australian petrol has fallen by about 4%. Part of the reason for this is that oil is sold in US dollars. Another part is that it is sold in US dollars in Singapore, the regional hub for petrol refiners.

Last year, Chinese buyers purchased 360,000 "sport utility vehicles", the petrol guzzling four-wheel-drives vilifi ed by global warming activists. The fi gure was 50% higher than in 2006 and looks to keep growing at 20% a year.

Australia competes with Chinese demand for petrol because both countries look to Singapore's market for price, making this the wrong hemisphere to live in for those seeking cheap petrol.

What this means is that pump prices are wedged between a depressed Aussie dollar and a depressed oil price. If the dollar recovers first, bowsers may get cheaper. If oil jumps up again, it may be time to buy a bicycle.

MARC MONCRIEF

TOURISM

WHO needs Baz Luhrmann to lure overseas travellers to Australia when you have a domestic currency willing to do it for you?

In the same week that Tourism Australia announced a $40 million advertising campaign centred on filmmaker Luhrmann's soon-to-be-released epic Australia, the nation's dollar fell to a five-year low of about 65 cents.

The fall in the dollar is set to boost Australia's tourism industry by making the country a cheaper destination for overseas tourists and, perhaps more importantly, by providing less of an incentive for Australians to holiday overseas.

Tourism and tras*port Forum general manager Olivia Wirth says that over the past 12 months there has been a 9.5% increase in the number of Australians spending their holidays abroad, particularly in destinations serviced by low-cost carriers. "We would expect, if the Australian dollar continues at the current rate, that you would see a shift towards more Australians travelling at home for their holidays," Wirth says.

But she says global fi nancial turmoil is likely to decrease foreign demand for overseas holidays, especially in countries such as Britain and the United States, effectively offsetting any increase local tourism operators might have expected from a falling dollar.

"The current economic instability and uncertainty would be an overriding factor, above and beyond the exchange rate of the dollar," Wirth says. "What you find when economic times are tough, is that people don't have as much discretionary income to spend on holidays and therefore (long-haul) destinations like Australia … will be impacted."

It seems Baz Luhrmann's helping hand might be needed, after all.

DANIELLA MILETIC

FARMERS AND FOOD

THE falling dollar is very good news for Australian farmers - and it's even better news for farmers who export.

But for shoppers already worried about rising grocery prices, a diving dollar is more likely to push food prices up, than down.

A depreciating local currency makes Australian farm produce more competitive in international markets. It even helps local farmers who don't export if their products are exposed to imports domestically, as imports become relatively more expensive to buy.

National Farmers Federation manager of economics Charles McElhone says the NFF has calculated that every 1 US cent fall in the value of the Australian dollar increases farm incomes by about $190 million on an annual basis.

"It means improved competitiveness on international markets. Not only for those commodities which are export focused, which is the vast majority, but also those that are very import exposed," he says.

Mike Guerin, managing director of agribusiness company Elders, says the arithmetic is simple. "As a net exporter a low dollar supports a better return, in this case at the farm gate. And when you've seen the drop of the level we have, it must have an impact positively. (Our) terms of trade will improve, however, it will be drawn back a bit by the fact that fertilisers and other inputs will rise."

DARREN GRAY

CAR INDUSTRY

THE sudden drop in the value of the dollar has presented the local car industry with many problems.

In the past three years, the strength of the dollar has allowed importers to load up their cars with lots of antiestéticatures, while still being able to keep prices at the crucial points in the market - $14,990 and $19,990.

In the short term, all importers - and the three local manufacturers - are going to have to take a hit on their profit margins, says Nissan chief product planner Ross Booth.

"I don't think anyone is going to automatically jump and raise prices. We are all grappling with the currency turbulence."

He says Nissan is analysing the currency market to see if any fi rm assumptions could be drawn on which to base decisions.

"Initially, importers have to absorb the hit in their profit margins, but eventually, if the currency stays at the new levels, they will have to take out specifi cations or raise prices."

The chairman and chief executive of GM Holden, Mark Reuss, says the drop in the value of the dollar will assist the company on its exports of Commodores.

"We've got a good exchange rate now," he says, when asked about export programs at the Sydney Motor Show yesterday.

But the company is also a big importer of vehicles and parts and he was not prepared to say what overall effect the dollar's drop would have on the company.

But he says the company never makes short-term decisions based on currency. "I never want to make any capacity or engineering decision based on today. You have to look to tomorrow."

IAN PORTER

MINING

THE dollar's collapse is welcome news for the mining industry. As drastic as the plunge from the mid-July peak of 98 US cents to 69 US cents yesterday has been, the current exchange rate is not all that far off from the 20-year average of 72 US cents.

That 72 US cents average is something that the miners and farmers have long used to base their long-term planning on. Even so, when the currency raced off to its near parity levels, the miners and farmers were feeling serious pain.

The strong currency was wiping away much of the revenue benefi ts of record commodity prices. Now the reverse is the case, with the dollar's plunge offsetting the recent retreat in commodity prices in response to the global fi nancial crisis and antiestéticars that it might lead to a global recession.

Rio Tinto recently said that every 1 US cent movement in the exchange rate from the June-half average of 92 US cents would have a $US59 million impact on its annual profit. So if the current rate were to stick, Rio could received an extra $A2 billion in annual profits.

But the slump in the exchange rate reflects Australia's status as a major commodity producer. Demand for commodities is under pressure and their prices are tumbling as a result. The only area of strength is gold. It is now at record levels in Australian dollars of $1300 an ounce.

But to get there the world's financial systems has had to go to the brink.

BARRY FITZGERALD

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