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WHAT MAKES THE AUSSIE DOLLAR SO SPECIAL?
As we pass the halfway mark in 2018, the Australian dollar is still holding strong as the fifth most globally traded currency - sitting behind the US dollar, the Euro, Japanese yen and British pound in that order. Most Australian's would take for granted this prized seat at the 'big boy's table', though if we pause to consider, Australia's position in the top seven most actively traded currencies seems almost surprising. After all, as our nation only achieved independence in 1901 we are by far the youngest economic entity, not just in this top 7, but in the top 10 globally traded currencies bar New Zealand. In addition, we have a comparatively small population to almost all the nations in the top seven, dwarfed by China for example. Yet this mega-nation sits 3 places behind Australia as the 8th most traded currency. Where does our fresh-faced nation get its edge over powerhouses like China, and economically similar states such as Canada, which currently lags behind us in 6th position?
From political to geographical reasons (with a side helping of luck); below is a brief look into what makes the Australian dollar so special.
EconomyJust how similar is Australia and Canada really? Economically speaking both nations are members of the British Commonwealth, have small population sizes relative to land occupied, and both economies are open with free-flowing trade.
Yet while Australia's landscape may seem sparse and drought-stricken, we sit above a healthy and diverse supply of prized minerals. We're considered a "commodity currency" meaning our economy is reliant on the natural resources sector. So in basic terms, when commodity prices such as oil and iron ore for example go up, it is expected the Australian dollar will also rise, and when commodity prices fall, the Australian dollar should follow.
Today, Australia is among the top five producers of most of the world's key mineral commodities including bauxite, uranium, lead, lithium, iron ore and zinc.
Yet Canada's dollar is also considered a "commodity currency". In fact, energy and minerals accounted for almost 10% of their GDP in 2016 - whereas the Australian minerals sector dropped to 6% of GDP in 2015-16. So where does Australia get it's edge?
While Canada's exports include a larger share of crude oil and natural gas, Australia has a larger share of exports in metals, coal and iron ore. Between 2002 and 2008, the Canadian 'terms of trade' (the ratio of an index of a country's export prices versus import prices) had risen by more than 30 per cent. Yet during the same period, Australia's had risen by over double that due to commodities having a higher share in overall exports and conveniently experienced the largest price increases.
GeographyIt also helps that Australia's geographical location is in close proximity to Asian nations. Asian economies, particularly China's, have been growing incredibly quickly and the demand for Australia's commodity resources continues to be high despite projected drops in the value of some export commodities such as iron ore. Currently, China amasses between 80 to 85% of all our iron ore exports. This demand is one of the major influences on the Australian dollar, and has seen the commodity market cycle go from strength to strength. Even during times of economic insecurity, such as the global financial crisis, Australia's resources-driven export cycle helped to 'hold the fort'. In comparison, with its close economic ties to the United States, Canada felt the knock-on-effects of the GFC much sooner and for longer afterwards.
PoliticsThe word 'stable' may not come into mind when describing Australian politics. However, in global terms our economy and political system has managed to remain relatively strong and stable. This is another contributing factor to our dollar's position in the top 5. In general, the Australian government rarely intervenes in the exchange rate mechanism. The Chinese yuan (officially known as the renminbi) exchange rate, on the other hand, has been allowed to float but within limitation - only in a narrow margin around a fixed base rate against an index. Yet as the Chinese government continues to gradually lift restrictions on its exchange rate, we are likely to see the yuan climb even higher in global exchange rankings.
Does that mean the Australian dollar could lose its status as the 5th most traded currency? Potentially. But there are other factors that come into play, such as interest rates. Increasing globalisation and deregulation means the Aussie dollar is influenced by interest rate differentials (the difference between our interest rates versus other countries). Australia has one of the highest interest rates in the global market and our Reserve Bank works to keep inflation between 2-3%. And when interest rates in Australia are high relative to say the US for example, that makes it attractive for investors to trade in their US dollars for Australian dollars and make Australian investments. This in turn affects the Australian dollar because of the change in supply and demand between the two currencies.
Additionally, the relative stability of inflation means the Australian dollar is able to offer one of the highest yields of the top seven currencies.
Credit RatingLike big banks, countries also receive credit ratings. A country's credit rating is designed to reveal how trustworthy they are to lend money to, rated on a scale of risk from D (in Default) all the way up to AAA, the highest rating obtainable. The score provides an indication of how likely a country will pay back its debts on time and in full. Ratings are determined by credit rating agencies such as Standard and Poor's (S&P), Moody's and Fitch Ratings - known as the "Big Three". It may come as no surprise that Australia is listed as a Triple A borrower.
Credit ratings do have an effect on foreign exchange rates. When these agencies determine a rating they are considering factors like a country's economic structure, governmental debt, political risk and more. So a country with a high rating is seen as a safer place to lend money to (i.e. through bond investments), and this in turn boosts the demand for their currency.
As a side note, you may have read in the news in recent years that Australia's credit rating is at risk of being downgraded. Agencies tend to issue advance warnings when a country's credit rating is in review. For example, they might warn a government it needs to hit its economic targets or else a downgrade is likely. Keep in mind notices such as these are common and do not automatically equate to a guaranteed downgrade.
It's Not Size that CountsAustralia may be young and small, relatively speaking, but we are fortunate in this post-industrial era to have a wealth of natural resources, fast-expanding neighbours and a stable political system.
The Foreign Exchange Market (Forex) is the largest and most liquid financial market in the world and Australia remains a popular contestant. If you enjoy reading about the underlying mechanics that affect the Aussie dollar, you may consider looking into foreign currency trading,
One of the first rules of trading is learning the inter-workings of your chosen market. This is highly applicable when it comes to trading on the Forex; understanding how a currency is affected by socio-economic and geo-political news as well as the price data itself is a must.
First Published: 17 July 2018 - Copyright © Electronic Information Solutions Pty Ltd 1990 - . All Rights Reserved.
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