Aussie Dollar Set to Tumble

Aussie Dollar Set to Tumble

Currencies don’t crash overnight.

When you do see a currency plunge without warning, it’s the result of political bumbling and central banking conditions.

Turkey is an easy example.

The Turkish lira has lost some 70% in value against the US dollar in a little over five years.

But that didn’t happen by accident.

The Turkish government has mismanaged its foreign debt obligations, told international creditors what they want to hear, and used monetary policy to influence the value of the lira.

It’s a similar story for the Argentinian peso, too.

Successive governments destroyed the value of the peso, set policies that created massive inflation…and then sought bailouts from the International Monetary Fund.

But these are extreme examples, right?

It couldn’t possibly happen with the Aussie dollar…

Could it?

The slow erosion of your wealth

We think of crashing currencies as other people’s problems.

Something that happens with tin-pot dictators in emerging markets.

Basket-case economies that rely on handouts from the IMF they can’t possibly pay back anyway.

Many countries like to take out international loans. But then they default and devalue their currencies via rampant inflation, as well as the little wealth their people have.

Venezuela. Zimbabwe. South Sudan. Libya.

Aussies would never consider our country having a triple-digit inflation rate.

We may not.

However, what we will see is our wealth eroded through stealth.

Over the next few years, we will witness our government and central bank unleash policies that will drastically reduce the value of the Aussie dollar.

Perhaps they’ll even crash it…

Check this out:

Aussie dollar-US dollar exchange rate – year to date

Source: TradingView

Today, every one Aussie dollar will get you 67.34 US cents. That’s down from 72.72 US cents in February.

Meaning, the Aussie dollar has slid by 7.57% against the US dollar.

That doesn’t sound too bad, does it?

Well, if we look back to July 2011 — when the Aussie dollar was worth more then the US dollar — we discover the Aussie has dropped a whopping 39% in the past eight years.

Now that sounds a little more like a currency crisis.

Granted, it was highly unusual for the Aussie dollar to be worth more than greenbacks. Nonetheless, a decline of that magnitude should be alarming.

Especially when commodities like iron ore have been relatively strong for most of this year…

Red dirt drives the Aussie dollar

Currency movements are complex.

But when it comes to the Aussie dollar, we can simplify it somewhat.

You see, the Aussie dollar is a commodity-based currency.

Because Australia is a major exporter of commodities, changes in the value of commodities affect the value of the Aussie dollar.

The most notable one is iron ore.

We predominantly export iron ore to the world, and for that reason the Aussie dollar tends to track the movements in iron ore quite closely.

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Iron ore price in US dollars (left axis)
versus Aussie dollars (right axis)

Source: Trading Economics

While it’s not a lockstep movement, this chart shows us that the Aussie dollar (represented by the black dotted line) tends to follow the overall trend of the iron ore price (the blue line).

Why is that?

Mostly because iron ore is Australia’s largest export. When iron ore prices are high, it generates a high income for the Aussie economy. In fact, iron ore prices have the biggest effect on Australia’s national income.

So when the price of iron ore rises, it stands to reason that Australia will ‘earn’ more money, and the Aussie dollar goes up as a result.

However, when iron ore falls, it means our income will fall too. So the Aussie dollar falls to reflect the reduction in national income.

To boot, a lower iron ore price means that our government will receive less income through tax. Meaning the government may need to increase debt in order to maintain its budget.

This relationship shows us just how important iron ore is to the Aussie economy.

But our red dirt isn’t the only factor when it comes to the Aussie dollar. The other crucial component is interest rates.

Cash rate supports the Aussie dollar

Think of it like this.

Iron ore prices may drive the Aussie dollar.

But the cash rate, as set by the Reserve Bank of Australia, supports the Aussie dollar.

And right now, the Aussie dollar is about to have this support whipped out from underneath it.

You see, a high Aussie cash rate means we are likely to attract foreign capital to our shores. Companies and people park their money here as it is likely to earn more interest compared to other countries.

In turn, the higher dollar value helps bring more investment into the country.

However, the lower interest rate reduces the appeal of the Aussie dollar, and subsequently the demand for it. In other words, the value of the Aussie dollar falls.

And this is about to get a whole lot worse.

See, the RBA went for back-to-back rate cuts in the middle of this year.

These two rate cuts are actually a bad sign.

To make matters worse, rates are tipped to be cut again.

Word on the street is that we could have a cash rate of 0.50% within 12 months.

And that will flow into the Aussie dollar and see it fall dramatically.

Should that play out, my prediction of the Aussie dollar falling to 65 US cents by December is conservative.

Another two rate cuts, and you’re looking at an Aussie dollar worth, perhaps, 60 US cents.

New gold high indicates your money is worthless

Blink and you would’ve missed it.

On Monday this week — in the very early Asian trading hours — the Aussie dollar gold price hit $2,300 per ounce.

As I write this, the Aussie dollar gold price is trading at $2,268.

The Aussie dollar gold price is up 38% this year. A dip from Monday’s price isn’t too concerning.

But if you’re an Aussie investor, you need to pay attention to what gold is telling you in Aussie dollar terms.

And that is: The worth of your money is falling.

It’s a signal.

The more the Aussie dollar drops, the more powerful the message becomes.

We now need more Aussie dollars to buy the same one ounce of gold.

You aren’t just watching a booming market. You are witnessing the erosion of your purchasing power.

We might not have a tin-pot dictator like other countries — but we are watching our money lose its value before our very eyes.

By all means, cheer on the Aussie dollar gold price rally. But heed its message.

The rising Aussie dollar gold price could be wealth destroying, if you aren’t taking steps to protect what you have.

Until next time,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia