ECF1100

Assignment D

ECF1100
Nelly Tankov 10071278 Student

This topic discusses the exchange rate between the AUD and USD between the period of 2010 and 2013.

Exchange Rates of the AUD against USD

Each transaction recorded in the balance of payments between countries requires an exchange of currencies between the two, and this rate can have a huge impact on the economy in both a macroeconomic and microeconomic scale; affecting everything from family holidays, to the amount of goods one government is able to import from another. Over the past decade there has been much discussion of the strength of the Australian dollar in spite of high current account deficits and rising foreign debt. In the years leading up to the GFC, higher commodity prices drove up the minimum amount of commodities necessary for a country to make a purchase from Australia, hence beginning the appreciation for the Australian dollar. In this study I look at the exchange rate between America and Australia over 2010 2013. The below diagram illustrates the exchange rate between the AUD and USD over the period of 2010 to 2013. As it is possible to see, the USD rose appreciably until mid September 2013, when it fell again.

HISTORICAL EXCHANGE RATES OF THE AUSTRALIAN DOLLAR AGAINST USD (2010 - 2013)
U S D P E R 1 A U D 1.2 1 0.8 0.6 0.4 0.2 0

YEAR Exchange Rate AUD - USD

On February 1 2013, Company X contracted to buy $100,000 of goods from a company in another country. The contract was due for settlement on August 1 2013. This would mean that on February 1 the shares were contracted to buy for $103,900 at $1.039 USD per AUD, and on August 1 2013, the settlement date, the shares were valued at $89,690, at $ 0.8969 USD per AUD. With this rapid decline in the exchange rate over the 6 months between contract and settlement, Company X are now paying $14,210 ($103,900 minus $89,690) less for the goods which they originally contracted to purchase.

Accounting for Changes in the Exchange Rate

In reflection, we are able to see that the above graph indicates that the exchange rate has significantly changed over the 3 year period. To expand on the reasons why this may have occurred, we need to look at external economic factors such as differentials in inflation, interest rates, account deficits, public debt, and overall economic performance. The exchange rate of the currency in which a country hold the majority of its investments is what will influence their main return. Examining further the interest rate of the two countries over 2010 2013, we are able to reflect on why these changes may have occurred.

(FED Federal Funds Rate, American central banks interest rate, n.d.)

(Chart Pack, n.d.)

As we can see, there was not much movement on the American interest rate between 2010 and 2013, whereas Australia has an interest rate drop between these periods. Central banks hold much power, in that changing interest rates impact both inflation and currency values. Higher interest rates offer lenders in an economy higher return relative to other countries (Bergen, n.d.). If we consider the fact that Australias interest rate was decreasing during this period, we are able to then ascertain that the lower interest rate has attracted less foreign capital, and caused the Australian dollar to fall. Another factor that comes into play is the current state of inflation. As a general rule (Bergen, n.d.), a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other countries. In examining the below diagram (Australian Current Account, n.d.) again we see the pattern emerging, as the interests rise, so inflation lowers, and we see a spike in the value of the Australian Dollar.

Economic Impact of Changes in the Exchange Rate

Most people would agree that the appreciation of the Australian currency has both positive and diverse effects on the economy. On the trade market, imports will become cheaper for the government, whereas trading exports becomes more costly. This in short also means that we will be able to purchase more imports in exchange for exports than before; Thus reducing the demand for exports, and subsequently increasing unemployment temporarily as there is inefficient demand. But this is only in the short term. If we look to the future we will be able to see that this will in the long term give Australia a complete structural change. By having such a strong Australian dollar means that well only be able to export a certain amount of produce as the market becomes more competitive and pricey, and many sectors which cannot compete will contract, therefore leaving room to expand the already strong exports, and also provide for a possible relocation of resources, which in turn leads to businesses utilising their full power, more jobs created, and family income increasing. Changes in the real exchange rate have implications for Australias current account deficit (Ravimohan, n.d.). In the short term, an appreciation of the Australian dollar will see a reduction in the dollar value of our total foreign debt, as well as providing for a lower servicing of the debt account. As before mentioned, as the price of the AUD rises and we see with that the price of exports; which may force domestic consumption of exports, and also triggering a lower overseas demand for these products. An appreciating Australian dollar also may also lead to policy making challenges in the future; leading to increased unemployment due to the lessening favour of the non- resource sectors. Unemployment is already a big issue and should be tackled with microeconomic policies; these may include increased education, training, and structural changes such as ensuring long serving employees are kept.

References

Ravimohan, A. (2010). Appreiation of Australias Real Exchange Rate: Causes and effects. Retriev ed from the RBA website: http://www.rba.gov.au/econcompet/2010/pdf/first-year.pdf Australia Current Account. [n.d.] . Retrieved from the Trading Economics website: http://www.tradingeconomics.com/australia/current-account Bergen, B. [n.d.]. 6 Factors That Influence Exchange Rates. Retrieved from the Investopedia website: http://www.investopedia.com/articles/basics/04/050704.asp Chart Pack. [n.d.]. Retrieved from the RBA website: http://www.rba.gov.au/chart-pack/interest-rates.html#17 FED Federal Funds Rate, American central banks interest rate. *n.d.+. Retrieved from: http://www.global-rates.com/interest-rates/central-banks/centralbank-america/fed-interest-rate.aspx