Don't bet on the Australian dollar

08 February 2013

A commonly expressed witticism in the currency markets is that there are two types of traders in the Australian dollar: those who don't know what it will do and those who know they don't know what it will do.

The mysteries of the Australian dollar remain as deep as ever. The currency is trading at about US$1.04, close to its highest level since being floated in 1983 and a 48 per cent rise since the end of 2008 — the biggest gain among more than 150 currencies, according to Bloomberg. It is trading well above the trade weighted index of 77.8, which is as close as there is to a benchmark of what the currency is 'really' worth.

The strength of the Australian dollar is being variously attributed to aspects of what is happening in the 'real' economy: the AAA rating of Federal government bonds, the country's close trade links with China, Australia's comparatively high interest rates compared with the rest of the developed world, the carry trade with Japan (whereby Japanese traders take low interest yen and 'carry' it into Australian dollars with higher interest rates) or Australia's reasonable growth prospects.

These factors are influences, but they are not the true cause of what the Australian dollar does. What determines the direction of the currency is not what happens in the domestic economy. Rather, it is driven by sentiment in the financial markets. In this sense, it is arguably the most 'unreal', or virtual currency in the world.

A feature of the global financial markets over the last decade has been the decoupling of finance and what finance is supposed to be facilitating. More than $US4 trillion is exchanged each day in the global capital markets according to the Bank for International Settlements (BIS). This amount vastly exceeds world GDP, foreign direct investment or trade. In about 100 days, it is the equivalent of all the capital stock in the world.

The decoupling of finance and the real economy is especially extreme with the Australian dollar. It is the fifth most traded currency in the world (after the US dollar, the Euro, the yen and the British pound).

The activity is heavily skewed towards Australian-United States dollar transactions, despite the fact that China and Japan are the nation's biggest trading partners. According to the BIS, the average daily turnover between the Australian dollar and US dollar is over $US250 billion, 6 per cent of global

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ECONOMICS

Don't bet on the Australian dollar

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