US Dollar Currency Collapse – where does that leave the Australian Dollar?
Before any major storm, there are usually signs to warn us of impeding danger. Animals are the first to react, unemotionally seeking shelter, running to higher ground, stampeding out of harm’s way. In 2004, the Indonesian Tsunami had seen Elephants running up into the hills long before the tidal waves hit the shores. While videos show people on the beach where the water had been sucked out ahead of the impeding tidal wave.
Throughout 2012 and 2013, we’ve had the warning signs of a US Currency Crisis. But like environmental disasters, investors are ignoring the signals or flippantly brushing them off. The danger, however, is very real!
What is a Currency Crisis?
Its definition is a sudden devaluation of a currency, resulting from chronic balance of payments deficits or from market speculation about the ability of a government to back its currency. In modern history, we have prime examples of this situation occurring with the 1994 economic crisis in Mexico, 1997 Asian Financial Crisis, 1998 Russian financial crisis, and the 1999 – 2002 Argentine economic crisis.
There are several situations that help build a Currency Crisis:
- Government running excessive deficits
- Irrational behaviour from investors, fleeing the currency en masse
- Doubts over whether the government is willing to maintain its exchange rate peg
- Problems in the banking and financial system, such as over-borrowing
- Self-fulfilling panics force liquidation of long run assets
- Company balance sheets affect their ability to spend
Are the elephants already running?
The US Federal Reserve is pumping $85 billion USD per month into the economy, buying up Bonds as a means to ensure money supply does not fall. This is referred to as Quantitative Easing (QE). In normal economic situations, the Central Bank would decrease Interest Rates to create the same effect. However, US Interest Rates are at rock bottom, and can be lowered no more. Compare this to the Japanese economy which has had Interest Rates at 0% for more than 10 years. The economy has literally been stagnant, fighting to keep its head above water in what is referred to as a lost decade (of economic growth).
Government statistics show that the US budget has been running in a deficit since 2002. The Global Financial Crisis (GFC) increased the deficit to -12.1% of GDP in 2010 from -4.8% the previous year. And in 2013 it has improved slightly to -8.5%.
QE has certainly helped avoid another Great Depression like that of the 1930’s, but in Japan, similar measures have resulted in this so called lost decade of economic growth. In the US, inflation remains low, Unemployment remains high, and the economy is propped up only by QE.
As we discussed in the US Economic outlook, Janet Yellen takes over as the new US Federal Reserve Chairwoman in early 2014. She inherits an economy that is struggling to find traction, that cannot stand on its own two feet, and that is being propped up by QE. An ending of QE at this stage would be disastrous for the stock market, sending prices plummeting. But Yellen is most unlikely to do that.
Currently, she is expected to raise the amount of QE being pumped into the economy. Initially, the stock market will view this as a positive, however, it will be the beginning of the end. Yellen believes that the Fed can create prosperity, create jobs, and improve economic growth by creating inflation and by printing more money. But this isn’t the Role of the Federal Reserve. It’s the role of the Government.
This increased supply of money being pumped, will serve to weaken the US dollar. With interest rates low, plus increased money supply and no real inflation or growth, the upside risk to the US dollar is hard to find. What else could happen to push the Greenback up??
That said, let’s be very clear, as far as a weaker US dollar is concerned. This is almost unquestionably a great thing for the US economy, as it has provided a welcome boost, in terms of helping US manufacturing and exporters regain some toe hold across the World markets.
Currency cannot be looked at in isolation
When looking at the currency markets, there is always a comparison that needs to be made. For example, the Euro vs the British Pound etc. This is what are referred to as “cross rates”. So having shared our bearish view on the US dollar, how do we see it in comparison to our dollar, the Aussie?
Our view on the Australian dollar
He contrast with the Australian economy could not be more marked. While the US has grappled with the GFC, collapse in housing prices, unemployment, massive debt bubble, political gameplay (The recent shutdown) and weaker dollar.
By contrast, in Australia, we have seen a greater level of stability – albeit with debt a growing concern. The reason for this – no not – the previous Labour Government and their “stewardship” but the colossal support from the resources boom and China.
The strength of the resources markets and the Companies that are exposed to this, have been largely responsible for the two speed economy with booming mining towns, huge wage and inflation pressures and of course, the boost in both property and stock markets. Surely not just resources though…
Well no, but it certainly has done us no harm. Lower interest rates – currently 2.5% have certainly opened the door for money to flow from the stock pile of cash that was being held, boosting most asset classes, and in particular, Property.
This presents a conundrum. The Australian dollar has been relatively strong, trading at parity and beyond, several times in recent history – and this against a backdrop of low interest rates. A stronger Australian dollar has been great for overseas travel, online shopping and the like, but has put great pressure on exporters, as they struggle to be competitive in the global marketplace.
With inflation relatively firm, at 2.5% the Reserve Bank are going to have a tricky job on their hands as they try to avoid an Australian dollar which is too strong, vs keeping inflation and any potential property bubble in check. Not easy and certainly very conflicting objectives. While we feel there is the potential for one more cut in rates, within the current cycle, that probability is beginning to diminish.
So, for the Australian dollar against most crosses, it will be performing strongly. Against the US, we feel particularly so. The relatively weakness in the US dollar, as outlined above, vs the relative strength here, are likely to see the Cross move back to parity.
FX can be a headline to headline proposition, from a trading perspective. A strong set of retail sales data from the US, often prompts a fall in the cross, while strong Chinese or domestic data will see the reverse. As such, short term scalping opportunities can often present themselves for the more engaged trader. However, from a broader perspective, the overall trend in these currencies can present huge opportunity.
Australian Dollar and US Dollar Forecast 2014
Recently, we have seen the Australian dollar give up almost a cent a week, for more than a month, taking things to a current rate of $0.91. However, as thoughts of a further rate cut in Australia diminish and, continued signs of US weakness continue, particularly as the recent government shutdown and its effects, filter into the stats, we expect to see the Aussie back above 94cents. Any potential rate rise in Australia – perhaps in response to stronger housing data and further inflationary pressure, would likely accelerate this, especially in the short term.
That said, with a change at the Fed, and some alternative applications of QE, as outlined within our US outlook, we may see the Greenback find some friends. That being the case, sub $0.90 – somewhere in the $0.87 to $0.90 range would be a very real possibility.
One thing for sure, these can be fast moving markets and with the leverage involved, make sure you wear your Kevlar helmet – if you don’t have one – get one!
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