Australian Dollar Set to Grow for the Remainder of 2008

The Australian dollar is as strong as it's been since the beginning of the commodities boom. It takes just one dollar and five Australian cents to buy the greenback. The latest move probably comes as traders read the inflation tea leaves and do not see the Reserve Bank cutting rates this year. If today's CPI data don't confirm Monday's PPI date, look for the Aussie to retreat.

However, if the CPI data show official prices growing above the 3-4% range, then for the rest of 2008 the Australian dollar is going to enjoy a significant yield advantage over most major currencies in the world. The Fed won't be raising rates any time soon, and may cut them again. We believe that parity with the greenback is still a possibility this year.

It sounds extreme, especially since the Aussie has nearly doubled from its lows against the greenback in 2001. But if something grows at 7% a year, through the magic of compound interest, it will double in ten years. It's not a big ask to grow another five percent in the next twelve months.

Heck, the Australian dollar is near parity with the Canadian dollar, another commodity currency with favorable fundamentals. Canada's central bank cut its benchmark to three percent earlier this week, the fourth cut since December. Canada's biggest liability these days could be its location.

Canada, as you might know, shares a rather larger border with the United States, and is America's largest trading partner. America, as you might know, is in a recession. What's bad for America is not good for Canada, nor, apparently its economic growth and thus, its currency.

Meanwhile, the U.S. dollar trades at US$1.60 to the euro, another new high (or new low, depending on your perspective). It's astonishing isn't it?

There are two ways to inquire about the U.S. dollar's prospects. One is to ask: what would make it stronger? Higher interest rates, a lower deficit, reduced government spending, contraction in the money supply. None of those measures seem likely when foreclosures in California are up 327% from last year's level. So that brings us to the other way of putting the dollar's dilemma: what would make the euro weaker?

The obvious answer is: lower interest rates. But the old guard of the European Central Bank is dead set against lower rates. Europe's dual Jean-Claudes (Trichet and Juncker) have an old fashioned view of a Central Bank's mission: to combat inflation. "Inflation is a concern for all governments," Juncker said earlier this month.

Correction. Inflation "should" be a concern of all governments. But central banks in Japan and the U.S. have expanded their fictional mandates to include employment, economic growth, and managing the deflation of asset bubbles. By contrast, Europe's old-fashioned focus on price stability and money supply seems pretty single-minded and downright humble.

But then, Trichet and Juncker come from that generation of European money men who lived with the social and economic consequences of post-war inflation (both World Wars. ). They have real experience with the real world consequences of manipulating the value of the currency.

Wim Duisenberg, the first head of the ECB, once told politicians who told him to cut rates in order to promote growth, "I hear you. But I do not listen." The ECB is deaf, and it's not because it's run by old men. It's run by men, like our late mentor in these matters, Dr. Kurt Richebacher, who understand that stable prices mean a stable society. Unstable prices...and you have rice riots.

Mind you the euro has many critical problems of its own. Growth in the Eurozone occurs at different speeds in the North and the South. You have one price of money for twelve very different economies. The euro experiment may not last much longer than the dollar experiment. But relatively speaking, only some external shock (think bad things) can weaken the euro against the greenback this year.

Dan Denning
The Daily Reckoning Australia

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