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Effects Of A Strong Dollar On Australian Economy Economics Essay

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Published: Mon, 5 Dec 2016

The value of the Australian dollar has risen dramatically since late 2008 against the US dollar and other currencies,such as the pound and euro.Actually, China overheating investment in Australia mining industry and improved interest rate by Reserve Bank of Australia promote this appreciation of Australian dollar and the situation seems optimistic.A lot of Australian are optimistic about this appreciation of Australian dollor,because they can have cheaper shopping and tourism overseas.However,whether strong Australian dollar is a positive development for the Australian economy has aroused heated argument.This paper will argue that the strong dollar has negative effect on Australian economy.Strong dollar can cause trade deficit because of increasing import and decreasing export.This trade deficit is negative for Australian economy in the long-term.Additionally,strong dollar can cause the decrease of investment because of higher cost and low profit of investment in Australia.This decreasing investment can hinder the development of Australian economy.Furthermore,strong dollar can also have negative effect on tourism because of the increasing costs of tour.This damaged tourism can drive down Australia GDP.

Strong dollar can lead to trade deficit through falling export and rising import. Strong Australia dollar means high exchange rate between Australian dollar and other currencies, this high exchange rate will make Australia commodity export contract prices seem higher than other countries.This high prices will reduce the competitiveness of export industries in international market. Consequently, the value of export will decrease.This decrease especially occurred in manufacturing and agricultural sector.For example,the exports of manufacturing industry reduced by 7.8% from 2008 to 2009 because of the dramatically increasing exchange rate over 2009(Ridout 2010,pp.6). Similarly,

according to the Australian Bureau of Agriculture and Resource Economics(cited in AAP 2009),the value of farm exports is predicted to decline by 2.5 per cent to $31.1 billion from 2009 to 2010 because of the strength of Australia dollar.

On the contrary, strong dollar will make the commodity import contract prices seem lower than before, therefore import will rise. This rising import particularly occurred in energy resources. According to ANZ international economist Alex Joiner(cited in AAP 2007), the Australian dollar which appreciate to 92 US cents by the end of October in 2007, drove up the commodities imports,especially in energy resources.The imports of mineral fuels ,lubricants and related materials raised by about 0.3 billion in October when compared to September.

Therefore,trade deficit will occur when export decrease and import increase.

According to Australian Bureau of Statistics(ABS,2010), when Australian dollar rise to a high level in 2010,in seasonally adjusted terms, the balance of goods and services was a deficit of $2,082m in March 2010, a turnaround of $4,384m on a revised surplus in March 2009. In addition,trade deficit can lead to decreasing foreign exchange reserves.This decreasing foreign exchange rate means weak ability to repay foreign debt.And this weak ability to repay foreign debt can put huge pressure on the economic development.In conclusion,

strong dollar is negative for Australian economy because of trade deficit.

In addition, investment in Australia can decline in the short-term because of the strong dollar.This investment is from both foreign investors and domestic investors. For domestic investors, especially the investors who invest in a company with larger share of sales in export markets, will reduce investment in response to a strong domestic dollar (Swift 2006,pp.19).This is because strong dollar make their profits decline dramatically. For example, a theoretical model which is developed by Campa and Goldberg (1999, cited in Swift 2006,pp.20) showed that a 10 per cent real increase of the Australian dollar causes a net decrease of 4.2 per cent in total investment on average between 1988 and 2001.Furthermore,for foreign investors,the strong dollar make Australian assets seem more expensive while other countries’ assets seem comparatively cheaper.Consequently,they will not consider to invest in Australia in the short-term.This kind of investment from foreign investors can also be defined as Australia’s inward Direct Foreign Investment(DFI).Therefore,the appreciation of Australian currency can decrease the DFI. For example, according to Tcha (1999,pp.93),a unit(million) appreciation of Australian currency against the foreign currency will cause 0.3 million dollar decrease in inward DFI.Moreover,investment is important for Australian economy because it can improve the productivity.Investment includes importing new equipment and new foreign technology,all of this can improve the productivity and then develop the economy.If the investment decrease to a certain extent,the economy will suffer from the slow development.Therefore, Australian economy will suffer from strong dollar because of the dramatic decrease of investment.

Furthermore, strong dollar can also negatively affect tourism in the short-term. This tourism is made up of domestic tourists and foreign tourists. For domestic tourists,strong dollar make overseas tour seems cheaper than before. Consequently, most of them will travel overseas rather than stay at Australia for their holiday. For instance, when Australian dollar shot up to around 93 US cents in 2010, nearly 18 percent more people(about more than 554,400 Australians) departure from Australia for holidays compared with the same time last year (Money Matters 2010).Besides, for foreign tourists, the costs of travelling to Australia seem higher than other countries, therefore they will reconsider the destination of their tour rather than Australia.For example, when the Australian dollar increased from about 80 US cents at the beginning of 2007 to near 92 US cents at the beginning of 2008, the number of foreign visitors has declined 0.7 percent during this period (Chong 2008). Given all this, it is clear that strong dollar damage Australian tourism through stimulating outbound growth and weakening inbound arrivals.

Additionally, Tourism plays an important role in Australian economy. It has direct and indirect contribution to Australian Gross Domestic Product (GDP). The direct contribution includes tourist consumption and direct employment in tourism industry.The indirect contribution comes from other industries who satisfy tourism demand,such as hotel,transportation and catering industry.In the same way,this indirect contribution also includes direct consumption and employment in these industries.According to Australian Bureau of Statistics (2007,cited in Kookana,Maurer and Hales 2008,pp.4-5),from 2005 to 2006,the tourism contributed directly approximately 4% to Australia GDP,including tourist consumption and employment in tourism industry.The indirect contribution from other related industries is about 3%.Totally,tourism actually contributed about 7% to Australia GDP.Therefore,the strong dollar will cause the decline of Australian GDP to a great extent through damaging tourism.

However, some argue that a strong dollar can help the Australian economy by controlling inflation, because the strong dollar can decrease the money supply in domestic market.Strong dollar make the export products seem more expensive in foreign market while the import products seem cheaper. Consequently, the export tends to decline while the import tends to increase.This means less money flow into Australia market and more money flow out of Australia market. Therefore, there will be less circulation of money in the Australia market. This falling money supply can control the inflation to a certain extent. According to Sung Won Sohn (cited in Gongloff 2001), chief economist for Wells Fargo & Co,”For every 10 percent appreciation in the dollar, it cuts inflation by one full percentage point, assuming the strength of the dollar is sustained”.

Nevertheless, although the strong dollar can cut inflation, it still be negative for Australia economy.Strong dollar can control inflation in the short-term by increasing import and decreasing export, however the increasing import and decreasing export will cause trade deficit,and this trade deficit will bring unstable economy to Australia in the long-term. Moreover, strong dollar can not effectively control the inflation. Although many export industries suffer from strong Australian dollar, there are still some resource export industries suffer little and even boom from strong dollar, such as mining industry. These export industries still gain a large number of money from overseas customers.This means strong dollar can not effectively decrease the money flowing into Australia. According to ABS numbers (cited in Hayes 2010), due to increasing Chinese demand, Australia exported 32.8 million tones of iron ore in November 2009, raised by 69% when compared to the same time in 2008. And Reserve Bank of Australia (RBA) Deputy Governor Ric Battellino said, “every major mining boom in Australia’s history had added to inflationary pressure, noting that only during one boom was the rise in inflation contained to single digits”.This clearly shows that the inflation in Australia can not be controlled because of the booming mining industry.Therefore,strong dollar can not effectively control the inflation in Australia to a certain extent.

In conclusion, Australian economy can suffer from strong dollar because of trade deficit from decreasing export and increasing import. This will cause unstable economy in the long-term.Moreover, strong dollar can cool the domestic investment and foreign direct investment in Australia.This decreasing investment will hinder the development of economy in the short-term. Furthermore, tourism can also suffer from the strong dollar.This declining tourism can damage other related service industries,then drive down Australia GDP further.All of these can prove that strong dollar is negative for Australian economy.Unlimited strength of one currency can have a devastating effect on one country’s economy.Therefore,Australia government needs to take action to keep dollar in a reasonable level.

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