Aussie dollar falls to fast money folly


Falling dollar signsWhen the Australian dollar fell almost 5 per cent in a few days it was a salutary reminder of how fast the currency markets can move. Fast change has been a feature of globalised capital markets for at least two decades, especially in the smaller currencies. They can quickly rise because of trader sentiment and just as quickly fall.

The after-the-fact explanations seem perfectly reasonable, but the rapidity with which the re-pricing occurs is not. There has been a decoupling of what money does and what money is supposed to represent. Suddenly, Australian manufacturing exporters become more competitive, and importers of foreign goods for local sale less competitive. People involved in the real economy have to respond to the financial markets as well as their customer markets.

A currency's value is supposed to represent the state of the country's underlying economy. Yet very little changed about the Australian economy during a week in which the value of the dollar was substantially altered. It is a small instance of how rapidly change occurs in currency markets, sometimes to devastating effect. During the Asian financial crisis, entire economies were brought to their knees in a matter of weeks.

Since about the 14th century, time and money have been inextricably linked, and as we change our approach to that relationship, we also change money itself. This is creating deep problems in the capital markets of the 21st century. A massive disjunction is appearing, due in part to higher levels of technological sophistication. There is a mismatch between the speed of pricing, and the much slower changes in what the pricing is supposed to reflect.

It is one reason why the capital markets are ruling rather than serving. Local manufacturers are being ruled by the currency markets because the high Australian dollar is making local labour too expensive. The world of high speed 'meta-money' is developing a logic of its own, and increasingly has a predatory relationship with more conventional economic and financial activity.

Worse, transactions in most financial markets now occur in micro seconds and even nano-seconds. This has little to do with what capital is for. In the stock market, how can the value of a public company change meaningfully in a nano-second? Yet that is increasingly happening in the United States (about 70 per cent of trade is high frequency trading). Much of the activity is facilitated by mathematical formulae which are timeless by definition. So the stock, currency and other markets are increasingly driven by a strange world of hyper-speed and timelessness.

The counter argument to this criticism is that financial markets find their right level over time; that short term volatility is just noise. This claim is impossible to validate in the currency markets, because, since the abolition of the gold standard, there is no 'objective' external yardstick to measure currencies. They are only valued in relation to each other; an exercise in relativism.

To the extent that there is evidence, it suggests that currencies, if they do have a 'right' level, do not usually find it. Even the biggest currency pair, the US dollar and the Euro, has swung in almost 100 per cent ranges over time. The different performance of the American and European economies can scarcely justify such large swings.

The Australian dollar, when it was at $US1.05, was double what it was worth at its low point, about a decade ago. Was Australia twice the economy that it was then? It seems, at best, arguable. And then we have the continuous currency crises in Asia, Latin America and Russia, which have resulted in extreme devaluations that certainly occurred too fast, destroying the countries' banking systems and making the devaluation a self fulfilling prophecy.

So what is the Australian dollar worth? The trade weighted index is one proxy which suggests it should be valued at about US70c. But that measure is based on trade flows, and activity in the Australian dollar is mostly focused on the US dollar-Australian dollar trade. The United States only ranks behind China and Japan as a trading partner.

There are many other learned estimates about what is 'fair value' for the Australian dollar, most of which put it at between US90–95c. Many analysts consider interest rate differentials to be important (Australia's interest rates are higher than most other developed nations). But these are annual, and substantial repricing can occur in hours.

These estimates are problematic as they are viewed by currency traders as a starting point: a measure of what people expect the currency to do. Traders exploit such expectations to make profits, which means the currency goes in another direction to that anticipated. Predicting the direction of the Australian dollar is thus as difficult as ever. One would need to know the mind of the traders, and how they think they can exploit rational expectations.

Perhaps the only certainty is that when sentiment among traders about the Australian dollar does change for the worse, the currency will devalue very fast and very far. Excess seems to be the only constant.

David James headshotDavid James has been a business journalist for 25 years and is the author of Managing for the Twenty First Century and The Business Devil's Dictionary. He has a PhD in English Literature from Monash University.

Falling dollars image from Shutterstock

Topic tags: David James, economics, Australian dollar



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Existing comments

My only income is an American pension. When the ratio hits Au$1.05/US$1 and bank charges are added I have been losing some 12% of my monthly income. If the Au$ settles at 70c/US$1 life will be's to the day!
Caroline Storm | 03 July 2013

How can you blame anybody? We have the worst PM in Australia's history back again. There is no bigger danger to our economy than Kevin Rudd. At least Julia Gillard had some common sense.
Beat Odermatt | 03 July 2013

Thank you David. Your description of the money markets and the valuing of currencies echos my experience of standing in betting rings and watching the board odds of a horse winning fluctuate wildly and often for no good reason because some punters are rorting the market. As Michael Pascoe described it so well recently when assessing the Gai Waterhouse/John Singleton circus, gambling on racehorses is the one utterly unregulated market where insider trading has full authority and "knowledge" supreme value. But it would appear that the money markets are just as mercurial as horse racing! Little comfort there.
Michael Kelly | 03 July 2013

As an electrical engineer, I have long firmly believed that trading systems are unstable, swinging quickly to an extreme of boom or bust. The transfer of information is so rapid there is no natural point of stability, but rather, a region of matastability, where things seem stable but can be driven either way. Speed of communication only makes the system more sensitive (more volatile) so such behaviour is more dramatic and perhaps it makes it more frequent. I also wonder if the spped of modern communication, such as twitter and facebook, makes society more volatile and sensitive to ideas or memes which are more "infectious" and propagate rather than die a natural death.
Peter Horan | 03 July 2013

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