Media and business commentators continue their infatuation with the unstoppable rise of the Australian dollar. Cheering on its “appreciation” like a football score, commentators are near giddy at the prospect of a higher dollar, ignorant to the reasons for its increase and the implications.

The primary (and practically sole) reason for the Australian dollar’s strength has little to do with Australia and its so-called miracle economy, but a lot to do with the United States. The Australian dollar has barely risen against many other currencies — in fact, since January, the AUD has actually depreciated by almost 5% compared with the euro and remained relatively steady compared with the yen. The AUD has easily been outperformed by Scandinavian currencies such as the Swedish krona this year.

The reason the Australian dollar appears strong is largely due to US dollar weakness. Since September last year, when the AUD started its ascent, it has increased by about 19% compared with the USD. During that time, the euro has increased by 16% and the Canadian dollar by 13% — even the Russian ruble has risen by 12.5%.

So while commentators claim that Australia’s economic performance and booming commodity exports is behind the AUD strength, that is almost certainly incorrect. Australia’s relative level of prevailing high interest rates are one factor, but the main reason for the AUD strength is due to the world finally catching on that US Federal Reserve chairman Ben Bernanke is systematically destroying the US dollar through rampant quantitative easing, near zero interest rates and excessive liquidity in the financial system. This monetary flood is partially to recapitalise the almost certainly insolvent US banking system, and also to help fund the US’ crippling budget deficits.

Last week, S&P belatedly placed the US on “negative credit watch”, putting in peril the US’ vaunted AAA rating. The market was probably not so concerned that the S&P finally realised that US fiscal policy is completely unsustainable, but rather, when the much maligned ratings agencies actually make a change (even an outlook change), it usually means that the subject is already broken. If the experience of the GFC showed, as a paramedic, the ratings agencies make fine undertakers.

That the euro has appreciated in recent months compared with the USD just shows what investors and speculators think of the US fiscal situation. (While the US admits to a debt of about $US14 trillion, Laurence Kotlikoff, a professor at Boston University and former member of the President’s Council of Economic Advisers, warned that the actual debt, including all future liabilities is closer to $US200 billion — or 840% of GDP).

For Europe itself is hardly a model of economic stability. As Nick Hubble in the Daily Reckoning last Saturday:

The EU members are in a lifeboat. Ireland fell out and almost drowned, only to be saved by the helping hands of its comrades. Greece fell out after too much ouzo and the Portuguese decided to take a dip without knowing how to swim.

Everyone’s rush to save Ireland, Greece and Portugal caused the lifeboat to tilt unexpectedly. If the rescuers pull too hard to save their soggy friends, they might capsize the boat. The Germans, seemingly resigned to letting Greece drown, have moved to rebalance the boat, making Spain and Italy sea sick.

The US sails past in an ocean liner, throwing life rings down to the lifeboat, while heading for an iceberg.

The US and Europe will of course, do everything in their power to delay the inevitable. Instead of clamping down on spending (the US, for fiscal, rather than political reasons must drastically reduce military spending, including removing forces from Iraq and Afghanistan), they have chosen to print money and devalue the respective currencies. In Europe, instead of forcing countries such as Ireland and Greece to fully own up to their mistakes (and default on the debt owing to German, French and Spanish banks), they have allowed them to continue as to operate the same wretched economies. This will end soon, as bond vigilantes drive the cost of Greek and Irish debt to unsustainable levels.

All this, while apparently good for the Australian dollar, doesn’t necessarily improve things for all Australians. While overseas travel and imported TVs are cheaper, most importers fail to pass on cost savings to Australian consumers, instead, using the higher AUD to buttress their profits. Further, exporters, and especially the tourism and education sectors, face a substantial and sustained drop in sales and earnings, placing in peril hundreds of thousands of Australian service-related jobs (manufacturing will also be badly affected by the rising dollar).

So don’t cheer for the Australian dollar. Cheaper holidays will come at a cost.

Peter Fray

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