Last time the Australian dollar traded at its current levels (around 96.00 US cents at the time of writing), Malcolm Fraser was Prime Minister and Men at Work's Down Under was storming the charts.

Now at its highest since early 1983, our dollar's value has rocketed by 55 per cent in trade-weighted index terms since bottoming at 47.75 cents in 2001*.  This was due partly to our high interest rates, which make Australia a more attractive place to deposit funds than the US where rates are lower, and partly to the global increase in the price of goods we export - particularly commodities.

However, the dollar has fallen from its July 16 high of 98.49 cents, dragged down by an 11-week low in commodity prices, and growing belief that interest rates may have peaked after the RBA held the cash rate last month at its 12-month high of 7.25 per cent.

With the former 'little Aussie battler' poised at the threshold of parity with the mighty Greenback, could it be running out of steam at the last minute? Has it already passed its peak?

The economic impact of a strong dollar
A strong dollar makes imports cheaper, whereas it negatively affects any company that earns revenue from US and Asian markets. For the big resource companies, and particularly for those feeding China's apparently insatiable demand for iron ore and coal, the huge commodity price rises of the last few years have more than compensated for the decrease in their earnings due to the higher dollar. But for non-commodity based exporting businesses, the rising dollar makes life a lot harder.

Most prominent in the latter category are farmers, already reeling from the effects of years of drought. The National Farmers Federation calculates that the dollar's rise has cost our farm sector over AUD$1.9 billion since May 2007.

And if you're about to pack your bags for a holiday in the US or Asia (where currency movements tend to follow those of the US dollar), a strong Aussie dollar means your spending money will go further than it has at any time since the late 1990s. The same also applies, but to a lesser extent, to travellers to Europe.

But it's a different story for visitors to Australia. The inbound tourist market has been hit hard as Australia becomes relatively less affordable to overseas tourists.

To hedge or not to hedge
With over half the MSCI World Index allocated to the US, most international share portfolios therefore have considerable exposure to the US dollar. With the Australian dollar having risen 101.59 per cent against the Greenback since March 2001*, returns of unhedged international share portfolios have been hammered. A strong dollar is worse for large cap shares, which have greater foreign exposure, whereas small caps often benefit from cheaper imports.

With questions emerging about the sustainability of our dollar's rise, one issue for Australian investors may therefore be whether an increased weighting towards an unhedged fund is becoming more desirable.

Where to now for the dollar?
As always, opinions about what the future holds are numerous and varied. Many analysts are predicting the Australian dollar will soon overtake the Greenback in value. Earlier this month ANZ Bank predicted that the Australian dollar would be worth US$1.01 in the third quarter of 2008, bolstered by continuing high commodities prices and sustained high interest rates here.�

Other analysts are less bullish, on the basis of a possible faltering of Chinese demand and global commodities sell-off (with resultant reduction in Australia's terms of trade), and interest rate increases in the US leading to a widening of the interest rate differential between there and here. A Bloomberg survey of 33 analysts revealed that the mean price of the Aussie dollar in quarter three of 2008 is forecast to be 94.00 US cents**.

But in the end it may be that the future of our dollar is determined by the US taking matters into its own hands. Ben Bernanke, head of the US Federal Reserve, made it clear in a speech last month that controlling inflation and securing a strong US dollar are now the Fed's top priorities.

Perhaps sooner, rather than later, may be the time to take the family on that long-promised trip to Disneyland.



Sources
* Reserve Bank of Australia; increase calculated as at 30 June 2008 
** Business Day, 7 July 2008