Despite the positives about the Australian economy and financial system, the local currency is still a barometer of global-risk appetite, argues MLC’s Brian Parker.

I don’t think there are many people who would have thought that they’d ever see the Australian dollar not just return to, but significantly exceed, parity with the US dollar in their lifetimes.

For many, it’s kind of a badge of national pride. For others – most notably in tourism, education, and manufacturing – it’s nothing of the sort.

On a purchasing-power-parity basis, the currency is overvalued. Estimates from the Organisation for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF) put fair value for the Australian dollar against the US dollar in the mid-to-high-60-cent range.

On a good day, currency forecasting over shorter time periods – say, up to a year or two – is a mug’s game. Currencies can stay substantially over or undervalued for some years.

Over longer time periods, you can say reasonably sensible things about the likely direction of currencies, but you need to be patient – sometimes extremely patient.

It is possible to imagine scenarios under which the Australian dollar remains elevated or indeed rises substantially further.

If the US Federal Reserve and the European Central Bank were to embark on another round of quantitative easing – perhaps even in a coordinated fashion – world share markets could go for quite a run, and that kind of environment tends to boost the Australian dollar.

Reasons for love factored in

There are some very good structural reasons to love the Australian dollar: we have relatively high interest rates; the terms of trade are still elevated; our trade links to Asia in general and China in particular rather than the US or Europe; we have a strong banking system; and we have a solid AAA credit rating underpinned by very low levels of public debt.

However, the list of reasons to love the Australian dollar are very well known, which means they’re quite possibly factored into exchange rates already and at least some of them are not without risk. Some of them may actually work against the economy in the event of a crisis.

For example, the Chinese economy is now clearly slowing and if it were to experience a much harder landing than anyone expects, the magnitude of our trade links with China and the rest of Asia would clearly work against us.

In this scenario, we would surely want a sharply lower Australian dollar to be part of our defence mechanism. However, if the Australian dollar is kept higher than desirable because of the perceived AAA-rated safety of Australian bonds, or because Chinese investors viewed Australia as a desirable safe haven in the event of troubles at home, then the economy would lose a valuable safety valve.

It is also possible to imagine other crisis scenarios under which the Australian dollar falls quite some way. Despite the positives about the Australian economy and financial system, the Australian dollar is still a barometer of global risk appetite. A global crisis more often than not sees the Australian dollar fall.