When it comes to the currency, it seems there is no pleasing Reserve Bank governor Glenn Stevens.
This time last year he got traders’ pulses racing by calling for the dollar to fall to about US85c, when it was fetching US90c.
It has done that and much more since, reaching four-year lows near US82c, but Stevens remains frustrated. Last week he said he would prefer to see it trade near US75c, a level not seen for 10 years.
What’s going on?
At first glance you might think these two rare statements – it is unusual for the governor to nominate a preferred currency level – are inconsistent.
But it’s not that simple. In fact, what they really show is just how big a headache the dollar remains for the economy, even though it has fallen so sharply recently. And unfortunately for Stevens, the causes of this headache are largely out of his control, and they don’t look like fading any time soon.
So, why does Stevens remain so troubled about the dollar when it has tumbled 14 per cent in the year, even lower than the target he offered last December?
There are a few reasons, but a big one is that the importance of the United States dollar is overstated in much of the public discussion about the exchange rate.
We’ve been hearing the RBA and other economists bang on for several years about how a lower exchange rate would be good for the economy, because it would assist exporters and businesses that compete with importers.
When they say this, it is easy to assume they are talking about the much-quoted exchange rate versus the US dollar.
But how the Aussie fares against the greenback isn’t nearly as economically significant as the media and financial markets would have you think.
The rate that matters most to the economy is the trade weighted index. That measures our dollar against the currencies of our biggest trading partners, which are weighted according to their share of trade with Australia.
By this measure, the exchange rate has fallen much less than might be imagined.
The dollar is down 14 per cent this year against the greenback, but it has fallen only 3 per cent when measured on the trade weighted index.
The index has dipped so slightly because much of the dollar’s recent decline has been a case of US dollar strength, not Australian weakness.
Against the Japanese yen, the currency of our second-biggest trade partner, the Aussie has been rising throughout the year and last month hit its highest level in more than a year.
It’s a similar story against the euro. One Aussie dollar today buys about 66 euro cents, slightly more than it did at the beginning of the year.
Dwelling on the trade weighted index sounds technical, but the point is the dollar is doing a rather poor job as a “shock absorber” for the economy. For example, businesses exporting to Japan, or domestic companies competing with imports from Europe, are not getting much relief from recent changes in the currency.
And if ever there was a time when we needed the dollar to act as a shock absorber, it is now.
The price of our biggest export, iron ore, has crashed by 30 per cent since May, while the coal exported to power stations is down 15 per cent.
That takes us to the second reason Stevens has changed his tune and wants a US75c dollar now. National income is being crunched by plunging export prices and a weaker dollar would shield the country from some of this pain.
The government’s Mid-Year Economic and Fiscal Outlook on Monday forecast the terms of trade – export prices relative to income prices – would decline by the most since official records began in 1959.
These plunges in export prices, and the prospect of more pain, explains why Stevens has changed his tune to push for a US75c exchange rate, instead of US85c. The goal posts have shifted, because commodity prices are far lower than a year ago.
Throughout history, our dollar has tended to move in line with commodities that we export, which cushions us from swings in export prices such as these. But this relationship is much weaker now, partly because of the actions of foreign central banks.
The US has ended its US$4.5 trillion program of buying government bonds, but central banks in Japan, and to a lesser extent Europe, are pumping money (or liquidity) into financial markets in an attempt to encourage borrowing and economic activity.
The Bank of Japan is on track to add a staggering 355 trillion yen in currency and electronic money by the end of next year, while European Central Bank has expanded its balance sheet and is also under pressure to start buying government bonds.
All this money needs a home. AAA-rated Australia still looks good, despite Stevens’ protestations.
Get it? The Aussie is being buffeted by the policies of overseas central banks at a time when the biggest source of national income is plunging.
Stevens and the RBA board have a lot of power in their ability to set official interest rates, but there is only so much that will do in fighting this battle. It is little wonder he is getting frustrated.