The Australian dollar, which was free floated in 1983, just hit an all-time high against the US dollar.
From 2003 to early 2008, it steadily climbed on the back of global economic growth. In late 2008, this rally was interrupted by the global financial crisis. During the height of the crisis, the Australian dollar plunged below 2003 levels as global trade collapsed. Moreover, the fight to safety into the US dollar drove it down.
However, as financial conditions eased, the global economy began to recover, and global trade resumed, the Australian dollar rebounded sharply.
Australia’s economy is heavily dependent on the export of commodities. The value of the Australian dollar therefore reflects both the international price of commodities and the economic strength of its trade partners.
China has been the biggest driver of both factors.
Even before the financial crisis, its growing wealth fueled domestic demand for automobiles, houses, and infrastructure, all of which required raw materials imported from countries like Australia.
However, back then, global demand was still dictated by the United States, whose growth in demand for raw materials was comparatively weak. Moreover, while China spent parts of its newfound wealth from its booming manufacturing sector, much of it was saved.
After the financial crisis, however, the global economic growth was powered by the savings of countries like China while Western countries struggled with debt. (The US is still the world’s largest source of overall demand; however, incremental demand has been driven by China.)
China pushed up the price of raw materials with its voracious demand. Moreover, it’s the biggest customer of Australian exports, thereby powering the latter’s economic growth. (Other big customers of Australian exports are India and South Korea).
However, because investments in China’s financial markets and currency are severely restricted to foreigners, Australia and the Australian dollar have become investment proxies for China.
The Australian dollar’s rise, therefore, reflects the outperformance of the Chinese economy over the US economy.
The strength of China and other emerging market economies are expected to continue. Moreover, their financial liberalizations to foreigners remain slow. These factors will likely push the Australian dollar to new heights.
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