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Parity Party or Parity Nightmare?

Recently Australia has celebrated a milestone in reaching parity to the US dollar.  Since the currency was listed back in the early 1980’s, the Australian dollar has never returned to parity.  In fact, over the decades the long-term average for the Australian dollar has sat around 70 cents to the US dollar.

Now, not only does Australia stand alongside the US, but it has also entered economic stardom by reportedly being one of the most highly traded currencies ahead of the Swiss Franc.  Historically, these titles have been held only for the US, Euro, Yen and the Swiss Franc.

Accolades aside, should one get slightly nervous when a tropical island in the south pacific with a share market capitalisation of less than 7% of world market, is pushed into the Wall Street spotlight?

As exciting as this might sound, we may begin to worry about how it is a good thing to have a heavily traded currency – particularly when the trading of a currency serves no real benefit to its population other than increased uncertainty of its future market direction.  In fact a situation like this makes it difficult for local exporters and importers to predict its future direction.

You may also begin to wonder if Australia is moving down a dangerous path of other small nations like Iceland who tried to play with the “big boys.”

So is Australia’s currency really high because of sound economic management, or was it driven higher by the US Fed proposing to print $2 trillion dollars? Or is it simply to do with the straight out fact that the Australian cash rate is 400% higher than the US, Europe, Japan, UK and most other developed nations. 

Whilst you simply cannot deny the reality that Australia has a higher cash rate than most developed nations because the economy has faired well, it appears they have quickly forgotten the fact that they spent close to 6% of GDP to stimulate the economy.  This was 500% more than most developed nations excluding the US.

It is also evident that whilst Australia is busy celebrating they have forgotten that 20% of Australia’s GDP economic growth comes from exports.  The Australian economic model is similar to their Asian neighbours of China and Japan whereby they rely on the global market place to fuel local economic growth.

The most interesting part about this story is that as Australia is out partying about parity, the rest of the world, like the US, Europe, Japan and Brazil, are desperately trying to depreciate their currency in an attempt to capture larger export market shares and boost GDP numbers over the short to medium term. 

So whilst they celebrate now, moving forwards the systemic problems of a high currency will also create serious future problems with the economic management of Australia. The most obvious one is the ability of the Reserve Bank of Australia (NYSE:RBA) to effectively manage inflation through the manipulation of interest rates. 

For example, with the likely future impact of inflation at some point in time, the RBA would be required to lift interest rates potentially pushing the Australian dollar higher resulting in a devastating blow to our export market. This in turn will no doubt create challenges for the RBA in the future. 

Like most things, Australia will no doubt follow suit with a similar response of increasing the monetary supply base such as they have done consistently over the past decades. However, this will result in an erosion of local purchasing power and hopefully a realignment of exchange rates - that is until the US decides to introduce another trillion of liquidity and the next party begins.

 

 

Disclosure: Currently holding Australian and US Dollars