What a stong dollar really means
THE Aussie dollar’s meteoric rise has attracted headlines lately. It may be a sign of our healthy economy but the strength of the dollar won’t be welcomed by everyone.
The Australian dollar has been punching above its weight for much of 2010, and at the time of writing it’s sitting at around 95 US cents. The situation is reminiscent of mid-2008 when the Aussie dollar almost reached level pegging with the greenback – something that’s never happened since our currency was floated in 1983.
There are a number of reasons behind the dollar’s rise. Put simply, our interest rates are high relative to those of many developed nations. As a guide, US investors tipping their money into a 5-year term deposit can expect to earn around 1.7% on their money. Online savings accounts are paying a measly 0.7%. Here in Australia, term deposits are paying up to around 7.0% over five years, and online savers are returning about 6%.
The prospect of earning a far stronger return on their cash is seeing foreign investors buy into the Australian dollar, and higher demand for the Aussie is raising its price.
In addition, the resource boom means we’re selling substantial quantities of our minerals overseas. Key export partners like India and China need Australian dollars to pay for these purchases, and this adds to the appreciation of the dollar.
For ordinary Australians, a strong dollar brings positives and negatives. It’s great news if you’re traveling overseas as your money buys more. Imports will also become cheaper and shoppers have the opportunity to grab some red hot bargains on big ticket imports like cars, appliances and white goods.
The flipside is that a higher dollar won’t work in the favor of Australian exporters, who receive less for the goods and services they sell overseas.
For investors, a rising dollar has the effect of watering down gains made on overseas investments. So if you have an investment in international shares, as many of us do through our super fund, the rise in the Aussie dollar could wipe out some of the gains on your investment once the returns are converted back to local currency.
If you invest in an international share fund outside of super it’s possible to avoid the effect of currency fluctuations through hedging. This means the fund has filters in place to reduce exposure to currency movements. Many fund managers offer the option of both hedged and unhedged funds on international shares, and if you’re unsure about which direction the dollar will take, it may be worth taking an each way bet and hedging part of your investment.
That said, currency movements are notoriously hard enough to predict. Add in the current global economic uncertainty the picture becomes even murkier.
Nonetheless if you’re heading overseas in the near future, it may be worth stocking up on foreign currency now. Or think about prepaying the more expensive parts of your journey, like accommodation. Just be sure to have adequate travel insurance in place so that if your trip gets canned, you won’t be left out of pocket.
Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.