China and the Australian Dollar

I follow Michael Pettis' writings. Michael Pettis is a finance professor at Peking University’s Guanghua School of Management. His analyses of China's financial market are always insightful and thought provoking.

Last month, he published a piece titled "When will China emerge from the global crisis?" It follows up on an argument that he has made in the previous years: The impact of the GFC will affect United States first. It will spread to Europe, and eventually Asian countries and China, but with a delay. The States will also be the first economy recovering from the crisis. The delay is the result of different fiscal policies and monetary policies adapted by different countries

(Pettis' piece worths reading even if you are not interested in Australia's economy.)

We haven't seen the impact on China yet. But it appears we are now at the point of inflexion. China has just  reported their largest trade deficit in two decades. It also announced last week it would lower the growth target to 7.5% which is more symbolic than anything. Besides, there are more and more accounts reported in the Western media in the recent months about China's shaky financial status. (Examples are here and here and here.)

Even if there is no hard landing, a slowed down China will hurt Australia's economy. It looks like many people in Australia, including the politicians, pay no attention to it. They either pretend that won't happen or don't know that will happen. Australia has suffered from the Dutch Disease for some time. The economy has been buttressed solely by the resource and mining exports. Excluding the resource sector, all other industries have lost their competitiveness because of the high Australian dollar and are deteriorating fast. Since the GFC, China has accelerated their infrastructure investments. They've brought forward many of their infrastructure projects in order to keep the economy going. That's what keeping the resource sector strong. But such acceleration must come to an end at some point. By that time, it will be a major slowdown (recession?) in Australia.


One way to "short" the Australia economy is to bet against its currency. And the simplest way to do so is to buy USD. When resource exports slow down, AUD has to come down. The Economist's not-too-scientific Big Mac Index says it's about currently ~20% overvalued with respect to USD.


You got to wonder what Forex has to do on a value blog. I'm wondering that too. :-) There are so many factors influencing a currency. Macro economics, carry trades, geopolitical factors, to name a few. There is no way to predict its short term and medium term movements. However, I just can't help but think the underlying fundamentals is pointing to only one direction in long term. Given the pace how the impact of GFC unfolds around the world, when I say long term, the time scale I'm thinking of is 1-3 years. 


Probably the relative high 6% interest rate one can easily get in AUD$ bank accounts is the biggest hurdle. The way I see it, when I have a significant portion of my assets in Australia, moving some money into USD is a reasonable hedging strategy and the 6% is one has to pay for such hedge.


By the way, for Australian readers, I found one can get the best exchange rates at HSBC. The buy/sell spreads at the major banks like Westpac are just ridiculous.