Peter Lavelle, 10.01.2013
As you may know, the Australian dollar is famous for its close correlation to China's economy.
Just on Wednesday for instance, the Aussie dollar climbed more than a cent against the pound, US dollar and euro, on news China exported far more than forecast in December.
Given that, what I want to do in this post is provide a guide as to why this correlation exists, as well as look at the broader links between China's and Australia's economies.
What this means is, the performance of the Australian dollar is closely linked to the performance of China's economy. If China's economy performs well, the same can usually be said of the Aussie, and vice versa. Hence, for example, reports that the Australian dollar gained overnight, as China exported $11.9bn more goods than predicted last month. More broadly, there's also a very close correlation between the value of the Australian dollar and Chinese electrical output (which could be used as a proxy for China's economic performance.)
The Australian dollar is tied to China's economy chiefly because of the trade ties between the two countries. For instance, in 2011/12 Chinese/Australian trade added up to AU $120,229m, making China easily Australia's biggest trade partner. Given this, the Australian dollar is often used as a proxy for this relationship between the two. As it changes, the Australian dollar rises and falls.
On Australia's part, easily the lion's share of its exports to China comprise of iron ore. Of the AU $78,824m Australia exported to China in 2011/12, AU $43,497m of that was made up of the mining of iron ore. The rest comes from a combination of coal mining, and education services (Australia is a big destination for Chinese wanting to learn English.) Meanwhile, China exports cheap manufactured goods to Australia, much as it does to the rest of the world.
From the point of view of the Australian dollar, this partnership is important because it's a useful barometer of Australia's economic success. For instance, the Australia-China Business Council estimates that, in 2011, Chinese/Australian trade benefited each Australian family to the tune of AU $10,500. If Australia is succeeding, that's hence a reason to buy the Aussie dollar.
More broadly, the partnership matters because it points to the changing economic and political balance in the world. To some extent, the rise of China can also be interpreted as the rise of Australia. For instance, Australia was one of the only developed economies to avoid recession after the Great Financial Crash, chiefly because it could depend on its trade links with China. In addition, Australia is one of only seven countries in the world to retain a stable AAA credit rating from all three credit rating agencies, in part for the same reason.
As you might guess, the link with China's economy has benefited the Australia dollar enormously. In May 2001, exchanging an Australian dollar would get you just 0.41 US dollars (or 41 cents.) Since then, closer trade links with China have lifted the Aussie by orders of multitudes, to the point where today it's above parity with the greenback. This means for each 1.00 Australian dollar you exchange, you now get 1.05 US dollars.
For Australia, the biggest downside is that it's effectively put all its economic eggs in one basket. For instance, a recent slowdown in China's economy has been directly responsible for a dramatic decline in the price of iron ore (Australia's most abundant commodity), as well as Australia's terms of trade. This has led the Reserve Bank of Australia to repeatedly cut interest rates, as well as scale back its forecasts for GDP growth in Australia. In addition, it also means Australian Treasurer Wayne Swan no longer expects to balance the budget in 2012/13.
For Australian society, the question has become one of how far it wants this relationship with China to go. For instance, last year Julia Gillard's Labour government launched what it calls Australia in the Asian Century", its plan to ensure Australia makes the most of its trade links with China. This includes dramatically expanding the teaching of Mandarin in Australian schools, and setting up Australia as a tourist destination for China's burgeoning middle class.
Yet on the other hand, there's also reluctance about expanding Australia's links with China. Speaking on the 5th July 2012, Australia opposition leader Tony Abbott expressed doubts at the idea that Chinese companies could directly invest in Australian industry, saying, "it would rarely be in Australia's national interest to allow a foreign government or its agencies to control an Australian business". This suggests there are also Australians who want to keep China at arm's length.
In the near future, the trade ties between Australia and China look set to deepen. Shortly, China will allow the Australian dollar to become only the third currency to be directly convertible into the yuan. Currently, if Australian businesses want to convert their dollars into yuan, they must do so either through the US dollar or Japanese yen first, which makes the transaction more expensive. This will therefore reduce the cost of doing business.
Regarding the Australian dollar, it's difficult to bet against it. This is because, though China's economic growth may slow in the short term, there's no doubt that, with time, China will expand to become the world's biggest economy. Thanks to its trade ties, that gives both Australia and its currency a huge advantage.
What do you think about Australia's relationship with China? Is it good for Australia, or will it all end in tears? And do you think, as I do, that the Australian dollar will continue to climb? Let us know your thoughts in the comments.