Rising dollar delivers fresh challenges
Just when the prospects for the economy were improving, virtually out of left field, the Australian dollar has risen by more than 5 per cent and currency experts are now expecting it to firm around present levels.
This is a disappointing development for the manufacturing and rural sectors, which were expecting further falls in value below the US89c level that it had reached recently. At that exchange rate, it boosted the returns to exporters and import competitors by as much as 15 per cent from the sustained high levels of well over $US1.
These are early days yet to be sure that the dollar will remain around current levels of US94c or even move higher. Not least, there's the possibility that currency dealers and hedge funds are manipulating the dollar's value through their market trading.
Hedge funds taking a large position by shorting or buying the dollar can overwhelm the normal commercial foreign exchange transactions of business and investors.
In the medium term, there's still a large possibility that our still high commodity prices could retreat to much lower long-term trends. That, and the end of the associated mining boom, would bring the dollar down.
In the meantime, the more important consideration is the on again, off again possible action of the US Federal Reserve to taper off its quantitative easing program. That would increase US medium- and long-term interest rates and strengthen the value of the US dollar.
Indeed, expectations of this tapering helped drive the Australian dollar down over the past few months because of the repatriation of US investments in Australia.
These developments, especially the stronger dollar, have generated calls for further interest rate reductions by the Reserve Bank. These could possibly help reduce the value of the dollar but this outcome is by no means certain.
Whether our short-term interest rates are 2 or 2.5 per cent per annum could make little impact on the economy, especially if the Federal Reserve again decides to delay the reduction of its quantitative easing activities.
Domestically, also, further rate reductions would almost guarantee a property boom and continuing rises in share prices.
Artificially low cash rates not only make life extremely difficult for self-funded retirees and other investors but also distort investment decisions. The biggest concern is that investors will be forced to take higher risks to maintain their incomes or alternatively be forced to deplete their capital in order to maintain their living standards.
Depending on developments in the US including with raising the debt ceiling, the stronger Australian dollar could well end up being only a blip in the movement to more realistic lower levels.