With what used to be called "The Little Aussie Battler" at an 18-year high against the $US, a sober overview of what drives our currency and the difficulties in forecasting its value is timely.
Q: Is there any useful textbook theory which explains our currency's machinations?
A: No. If there was the $A would hardly move at all, as all speculators would be able to use such a theory to predict the $A's movements.
Q: Is the $A left purely to market forces?
A: No, our float is dirtied by the Reserve Bank in two main ways.
First, it can buy or sell $A's to stop it fluctuating too much - for example, if the depreciation is too sharp it can sell other currencies it holds and buy $A's.
Secondly, it can take measures to push up - or reduce - our domestic interest rates, relative to those of other countries, thereby affecting capital inflows and outflows and hence the demand for and value of the $A.
Q: Is there one key variable or statistical series which one can watch?
A: No. Commodity price falls, reductions in our interest rate levels relative to US ones, and sharp deteriorations in our current account deficit can encourage sell-offs of the $A at times. But each of these variables has different degrees of impact at differing times and one factor can countervail the others.
For example, commodity price falls usually mean lower export proceeds and more pressure on our trade and current account deficits. When this happens, traders expecting a weakening of the $A, often then sell it, forcing down its relative value.
But if, at the same time, our interest rates are considerably higher than those in the US, then that differential can put a floor under the $A by encouraging funds to flow to Australia and thus hold up the demand and value of our currency.
Interestingly, the Economist magazine's "Big Mac" index which tracks the cost in $US's of this product in many countries, as a guide as to whether a currency is overvalued or undervalued did predict the recent appreciation of the $A against the $US.
And it worth noting, that it suggests the $A has further to rise against the $US.
But one should not have fries with that crude guide all of the time.
Q: How does the $A's value affect Australian investor returns?
A: Over one-third of the earnings of Australian companies now comes from overseas and a lot of that total is earned in $US.
Thus, when the $A appreciates dramatically against the $US and these profits are repatriated to Australia, they then convert into fewer $A's than they would have if the $A had been weaker. The converse also applies.
For example, when one $A was worth only US50 cents then a $US1 earning would have given the Australian-based company $A2. If it went to US100 cents, then the return in $A's would be a mere $A1.
Q: Should we take even consensus $A forecasts seriously?
A: Over the past 20 years, the average economists' predictions for the $A/$US rate was usually very close to the actual level of the exchange rate when they made their prediction.
In other words, their chances of being correct are heavily dependent on the $A/$US rate remaining stable!
This reminds us that because the foreign exchange market currently incorporates the consensus view of future events whether it eventually turns out to be right or not to guess future movements in the exchange rate correctly one has to predict correctly events in the market that the market is not currently expecting.
Quite a tall order!
In short, attempts to forecast the $A hardly are more significant than just using a no-change extrapolation approach, despite all the efforts by forecasters to get a minute's worth of media fame.
True, the $A usually falls down the lift shaft and climbs up the stairs. But both the timing and speed of these moves are beyond accurate prediction.
Finally, never forget that the worse thing that can happen to an exchange rate forecaster is a few months of success.
That is when they start having their biggest nightmares!
Dr David Clark taught Business Economics at the
