When we buy a pie at the football on Saturday afternoon, it’s a simple transaction. The pie was baked somewhere up the road using Australian labour and Australian ingredients. The price is quoted in Australian dollars and the seller expects to be paid in Australian dollars.
With international transactions, things are not so simple. Some bulk commodities are priced in US dollars even if an American company is neither the seller nor the purchaser. Some goods and services are priced in the sellers’ currency, and some in the purchaser’s currency.
So it’s not helpful to focus on just one currency. For example since January 2 this year, the $A has depreciated by 14.8% against the US dollar, by 16.8% against the Chinese renmimbi (our biggest trading partner), and by 0.19% against the Japanese yen (our second biggest trading partner).
Australian prices of traded goods don’t respond straight away to changes in exchange rates; nor do firms, consumers and longer-term investors respond immediately to changes in prices. In rough and ready terms, the “appropriate” exchange rate, after those lags have worked through the system, is one where Australian producers can earn enough to stay in business and provide something close to full employment.
If we were honest as economists, we would say that the appropriate exchange rate “is probably a bit lower than it is now”. For those who think they know better, there are plenty of opportunities to put their money to work on foreign exchange markets.
There’s definitely a fundamental value for our exchange rate. A simple way of looking at it is by comparing price levels in Australia to price levels abroad. When we go travelling, we find that it’s much more expensive here — even more so than countries in Western Europe, where it has traditionally been much more expensive.
Clearly, we need to be achieving similar price levels to the countries we compete with. That fundamental value will not be far from US80 cents, assuming that the European and Asian currencies stay at par with the American dollar in the long run. If you look at Australia’s real effective exchange rate for the past 50 years, it has been fluctuating nicely around this constant trend that’s determined by the price levels of our competitors — against Europe and the food producers of the world, such as the United States.
We don’t want the exchange rate to fall too much because our foreign debt will go up. We look like a Third World country that has been living off selling commodities for two decades. We need to get a competitive edge on education and agriculture; that’s where the future is for Australia. The future is not in commodities. If we are going to compete in these areas, we are going to need a lower exchange rate.
Gillian Terzis holds a Commerce/Arts degree from the University of Melbourne. Read the original article.
