In the long run the Aussie is a wager against entrepreneurs

Philip Salter
Follow Philip
ON 2 May, the Australian dollar climbed to a high of $1.1011, not reached since its 1983 float. Despite a small retreat, this upward trend is largely expected to resume on the back of continued demand for commodities and a hawkish Reserve Bank of Australia (RBA). Yet over the long-term, trouble in China and technological innovation could reverse rising commodity prices and with it the Aussie dollar.

This week the RBA decided to keep rates at 4.75 per cent, despite a prior unanticipated jump in CPI inflation of 1.6 per cent to 3.3 per cent in the first quarter of 2011. But markets are anticipating a rate rise in the coming months, as the RBA’s post-meeting statement talked tough on inflation. Michael Blythe, chief economist at the Commonwealth Bank of Australia believes “the door to another rate rise is opening.” He predicts it will happen in August, although suggests that it could come even earlier.

The critical factor in the rising Australian dollar is demand for commodities, because so much of its economy is reliant upon mining exports. “As commodity prices have increased, the Australian economy has boomed and along with it the currency,” says Angus Campbell of London Capital Group. Richard Driver of Caxton FX says: “With an economy heavily geared towards raw materials, the Aussie dollar has been a major beneficiary of the soaring commodity prices. China’s economic strength in particular is ensuring demand for Australian exports despite these high prices.”

Alistair Cotton of Currencies Direct thinks that “the terms of trade for commodity producers will continue to improve as prices keep rising, and that means the Aussie may still have significant room for improvement against the pound and dollar over the coming years.” According to Campbell, “there are expectations for further increases for the Aussie dollar with some calling for Australian dollar-dollar to go as high as $1.2400, so another 14 per cent higher than where we are now.” However, Driver says that although “it is difficult to see any significant reversal of the Aussie’s strength in the short-term, when the liquidity provided by the US quantitative easing (QE) programme dries up in June as is expected, then the Aussie may cease to benefit from the current generous dollar inflows.”

Despite the end of QE2, a number of authoritative investors believe that high commodity prices are here to stay. The much admired investor Jim Rogers, who amongst other things foresaw the commodity price inflation well before it took off, believes that commodities still have some way to go. Also, the much respected Jeremy Grantham of Grantham, Mayo, Van Otterloo (GMO) in his latest quarterly letter “Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever” argues that “statistically, most commodities are now so far away from their former downward trend that it makes it very probable that the old trend has changed – that there is in fact a paradigm shift – perhaps the most important economic event since the industrial revolution.” Rogers and Grantham both think that high commodity prices are based on the fundamentals of limited supply and increasing demand.

However, whether the Chinese authorities, which still centrally plan the coordination of vast swathes of economic activity, will spot, let alone pop, bubbles prior to their formation is highly questionable. If the country manages to avoid epic malinvestment and its attendant crashes even the most Keynesian of economics textbooks will need to be revised. More importantly, as the famous example of the environmentalist doomsayer Paul Ehrlich – who lost a wager with Julian Simon that copper, chromium, nickel, tin, and tungsten would fall between 1980 and 1990 – shows, technological innovation can throw a spanner in the predictions of Malthusian catastrophes.

If Rogers and Grantham turn out to be right, rising commodities and an Aussie dollar are here to stay. However, a stumble in China or the innovation of entrepreneurs could bring down the price of commodities and with it the Aussie dollar.