Last night on Wall Street we saw the pattern that has hit Australian markets so hard in the past six months emerge again — a worsening of the US economic situation, lower American share prices which spill over to Australian shares, plus lower commodity prices led by oil and copper which give our markets an extra kick lower.
On the surface it’s misery all round and it indicates that the markets have grave doubts about the Obama rescue package. But for Australia there is another side to this unhappy pattern — the US dollar rises as global money chases “safety” and the Australian dollar falls. Markets do not recognise the relief this provides for Australia.
There are many reports of how the Chinese are going to take revenge on BHP, Rio Tinto and the other Australian miners by slashing the prices paid for iron ore and coal by 30, 40 or 50 per cent. Not only are shares in our miners trashed, but Canberra watchers calculate just how much government revenue will be obliterated by any price cut.
But the Chinese are talking about US dollars. Theoretically, if the Australian currency falls by as much as the iron ore/coal price decline then the revenue impact will be nil. Between July and October the Australian dollar fell more than 38 per cent from 98 US cents to around 60 US cents. It has since recovered to around 72.5 US cents last week, but last night it was trading at 68.1 US cents, cutting the fall since July 2008 to around 30 per cent.
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BHP, of course, states its profits in US dollars, but Australians need to convert those profits to Australian dollars because we buy and sell BHP shares in Australian dollars and BHP pays taxes in Australian dollars.
The same applies to Rio Tinto except that the company has a nasty debt obligation in US dollars.
A lower Australian dollar increases the cost of imports, but with demand being depressed, inflation is not a serious worry. However, the lower dollar does lift the cost of capital investment, though that is more than offset by the cushion the currency provides to a wide range of Australian industries.
There is no doubt that former Treasurer Peter Costello was able to claim credit for getting through the Asian financial crisis partly because of the fall in the Australian dollar. Our dollar has risen in recent weeks partly because Australian interest rates still look attractive compared to Japan and the US despite the recent reductions, and our banks offer an Australian government guarantee.
When there is a stampede to the so called “safety” of the US dollar these forces are swamped. Nevertheless, as President Obama cranks up the US dollar printing press, the American dollar could again come under pressure. If that happens it will require a balancing act from the Reserve Bank. If they lower Australian interest rates to cause the Australian dollar to fall further they will be helping government and corporate revenues offset the mineral price blows. But if the Australian dollar falls too far because of low interest rates, it may limit the much needed supply of funds to our banking sector (Multiple advantages, January 12).