Rush to Swap Aussie Dollars - Assignment Example

Rush to Swap Aussie Dollars Student Name Course Tutor Institution Date Question (a) Brief summary of the main issues discussed in the article Due to the fast falling rates of the Aussie dollar, majority of people heading overseas for Christmas and January holidays have opted to an early swap of their Australian dollars. Waiting for the US dollar to recover is a massive risk; the US dollar might or might not recover. As a result, most of these travelers do not want to take this risk, hence the rush to swap Aussie dollars prior to the holiday season. According to the currency exchange trend, the euro, for example, receives the highest demand before June, which falls during the summer holidays, while the US dollar attracts highest demands towards the Christmas holidays. Margaret de Polignac, a product head at OzForex also asserts that the Australian dollar has fallen drastically. She links this drop to the change in travel patterns of the clients they serve. For Instance, OzForex being a currency exchange business that also offers the prepaid travel card service reports that they usually note a drop in the travel activities during the off peak months; July to September. However, this particular year things changed and more people seemed to purchase more travel cards and load more money during the same mentioned time frame. This reaffirms the point mentioned earlier in the article; more travelers are swapping their Aussie dollar before Christmas holidays because of the drop. Statistics reveals that for the past twelve months the Australian dollar has lost to the US dollar by an estimated 8%. Additionally it has also lost a hefty 20% since it reached the record level in 2011 (Collett, 2014 p.1). The author reiterates that forecasting currency exchange rates remain a rather tricky aspect in the foreign currency market, but travel cards have proven a beneficial way of locking exchange rates. Although analysts project the Aussie dollar to trade lower than the pound and greenback, many variables remain in existence; affecting the exchange rates. For example, one of the leading factors is the relative interest rates; if a country’s interest rates are higher than other countries, then their currency remains supported in the market. But for the case of Australia, currently facing the worst inflation rates, raising interest rates would not suffice, and, therefore, the drop in the Aussie dollar. According to the AMP Capital Investors chief economist, he restates that the likelihood of Australian cash rate remaining at the 2.5 percent 50-year low longer until when the US Federal Reserve hikes the interest rates again. Subsequently, the Aussie dollar’s rate of exchange against the US dollar will equally remain at the current low level; of 88US dollars per 1 Aussie dollar for the remainder of the year. Additionally, the Australian dollar might drop further in the middle of next year but remain steady with the yen and euro; whereas the same rate might hold fairly till the end year for the pound. This study discusses the movement of Aussie dollar against the US dollar, positive and negative impacts of its weak exchange rates and the possible actions that the Reserve Bank could implement to restore interest rates. Question (b) Australian Dollar relative movement against the US Dollar Although financial markets around the world have stabilized over the last three years, the international environment has not experienced any changes or improvements for the past few months. On the hand, the AUD has seen an upward trend in its movement against the USD with notable exceptions between the financial years 2008 June through November in the same year. During this period, the AUD dropped sharply to the below 50-year 2.5 percent and the struggled to peak against the US Dollar by 2010 (Fang & Muljono, 2003 p.20). This trend has seen the AUD appreciate by an estimated 21% by June 2010 against the USD and by another 14% against the TWI. Putting these two percentages into the calculation, the Australian Dollar has finally reached a massive 33% above its expected 75 US cents floatation average (Garton, Goudry & Wilcox, 2015 p. 1). Chart 1: The graph below explains the AUD/USD operations in the international market and how the AUD managed to get afloat since 1983 (Pringle, 1987 p.44). Australian Dollar Chart 2: A representation of the AUD movement against the USD until 2012 to assist in understanding of the AUD appreciation in the last recent years Factors that have influenced the Australian Dollar Appreciation against the USD A few key factors exist to explain the recent AUD appreciation in the foreign exchange market in relation to its movement against the USD. These factors include (Phillips, 1987 p.384): a) High Terms of Trade This aspect directly relates to the AUD appreciation since early 2000s and its doubling to date. High terms of trade, in this case, refer to the high global prices for Australia’s export commodities. In the real economic perspective, a rise in commodity prices especially for export commodities directly raises the equilibrium for the real exchange rate. The equilibrium exchange rate rises because of a subsequent rise in the return capital investment done in resources sector as well as higher interest rates due to higher demands on domestic income. For a foreign exchange market, this rise implies that a rise in the export commodities’ pricing equally increases the demand for the AUD; hence the appreciation. b) Economic Weakness Aside from the terms of trade other circumstances relating to advanced economies have also boosted the strength of the AUD since the great floatation in the 1990s (Gruen & Shrestha, 2000 p.21). Prolonged economic weaknesses have seen abnormally low-interest rates of other advanced economies, implying that the AUD interest rates remain unusually high than other. In addition to this high-interest policy, some central banks have implemented monetary expansion schemes easing pressure on currencies; hence contributing to the high AUD. Question (c) Impacts of a weak exchange rate to the Australian Dollar The conversion of one country’s currency to another’s remains a necessary tool in the majority of the transactions worldwide; thereby attaining the name foreign exchange. Globally, Forex dealers constantly buy and sell currencies of other countries and theirs with an estimated $US 1.3 billion moving into the market daily. The demand rate of an individual currency sets the exchange rate for the same in the foreign market. Exchange rates work on one-to-one principle which states that if the Aussie dollar takes an equivalent of 0.7US cents then this will determine the US Dollar exchange rate as $A1.43. The US Dollar stands out as the major currency against which the Australian dollar gets measured. This aspect implies that any effects on the USD-Aussie Dollar exchange rates will equally impact on Australia’s economy; both positively and negatively (Lim, 1990 p. 45). Just like interest rates, the exchange rates fluctuate to in response to different factors in the foreign market environment. Therefore such depreciations and rises in the exchange rates would have both negative and positive impacts. In reference to depreciation; a fall in the exchange rates or a weak exchange rate only implies that the exchange rate would have fallen below the $US50 cents (Lim, 1990 p. 46). Depreciation or a weak exchange rate has a positive impact on the Australian economy in that it lowers the Australian Dollar value. When the Australian Dollar value drops, it also makes the Australian goods cheaper therefore allowing owners with foreign currencies to indulge more buy goods. This action boosts the Australian economy tremendously. However, the same impact linked to weak exchange rates will also raise the cost of imported goods; the Australian people pay more for their imported goods. In this context, the weak currency rate for the Australian Dollar adds more value to their economy as their business then become more competitive globally. But the rise in the cost of imports infringes in the consumers as they have to pay more for their goods, as well as the high costs of international travel. Therefore to the consumers they experience the weak interest rate as a negative impact on the Australian economy. Additionally, the weak exchange rate does not support the Australian currency in the foreign exchange market; therefore this gap leads to high inflation rates and poor standards of living which is equally bad for the economy. Question (d) Possible Actions to Restore Exchange Rates The Reserve Bank can opt to offset the effects of fluctuations in exchange rate through a process known as sterilization. This process involves them creating a demand- supply for the Australian Dollar through the buying and selling of AUD against other currencies. Considering that the greatest liquidity and turnover rates exist in the Australian dollar-US dollar currency pair, the sale of AUD across financial markets would significantly neutralize the exchange rates. This change is because the Australian Dollar will gain more strength to stay afloat and support itself in the foreign exchange market against other currencies. Another typical intervention the Reserve Bank could do involve foreign exchange swaps to offset the pressure on the Australian domestic market. Once the domestic markets’ pressure goes down the commodities for export gain more demand increasing the capital turnover invested in the foreign resource market. As a result, the high capital turnover will directly raise the equilibrium of the real exchange rate; thereby restoring the exchange rate to Australian Dollar’s competitive level. The actions mentioned above would directly impact the Australian economic activity. For example, if the exchange rates do not support balance in the macroeconomics’ balance, then the economy will begin falling to unsustainable levels. Also, since the exchange rates directly link to the monetary policy any attempt to influence or restore the exchange rate would directly impact on the monetary policy. For example, the exchange rate will appreciate significantly if the domestic interest rate drops compared to foreign interest rates. This trend is the channel of operation for the monetary policy (Newman, Potter & Wright,2011 p.1). Subsequently, it has proven difficult to measure the effectiveness of such interventions, although Reserve Banks have reported recording high profits through purchasing foreign currencies against the sale of local currency. As a result, the high selling and low buying has relatively limited the exchange rate fluctuations; restoring exchange rates in the past. Conclusion In conclusion the Reserve Banks actions would only become effective if they consider the balance of macroeconomics against other sectors of the economy and the inseparable monetary policy-Australian Dollar link. Influencing anything in an effort to restore the exchange rates must have a stable economy and monetary policy to sustain the intervention. List of References Australian Industry Group. 2000, The dollar & trade: factors and influences. Sydney, Australian Industry Group. Australian Financial Markets Association. 1990, Australian financial markets report AFMR. Sydney, Australian Financial Markets Association. Collett, J. 2014, November 1. Travellers rush to exchange their Australian currency. Retrieved March 20, 2015, from http://www.theage.com.au/money/planning/travellers-rush-to-exchange-their-australian-currency-20141101-11e1s1.html#ixzz3Ktc7HVhQ Fang, V. & Muljono, R. 2003, An empirical analysis of the Australian dollar swap spreads. Elsevier. Elsevier. [Accessed March 20,2015] from http://arrow.monash.edu.au/hdl/1959.1/114414.18-26 Garton, P., Goudry, D., & Wilcox, R 2015, Statement Policy: Understanding the appreciation of the Australian dollar and its policy implications. Retrieved March 20, 2015, from http://www.treasury.gov.au/~/media/Treasury/Publications and Media/Publications/2012/Economic Roundup Issue 2/Downloads/03_Appreciation_of_the_Aust_dollar.ashx. 1-59 Gruen, D. W. R., & Shrestha, S 2000, The Australian economy in the 1990s: proceedings of a conference. [Sydney], Reserve Bank of Australia. 20-22 Lim, G. C. 1990, Foreign exchange markets and the Australian dollar. Australian Economic Review. -. 44-50. Newman V, C Potter and M Wright 2011, ‘Foreign Exchange Market Intervention’, RBA Bulletin, December. Phillips, M. 1987. The Australian dollar and the foreign exchange market since the float. Journal of Foreign Exchange and International Finance. -. 14, 381-385. Pringle, J. R. H. 1987. International financial trends in East and South-East Asia. Canberra, Australia, National Centre for Development Studies, Australian National University. P.44 Read More