Fair or not, the Australian dollar remains overvalued
An analysis by Commonwealth Securities, which looked at the prices of a 16-gigabyte iPad across 46 countries, found that Australia was the fourth-cheapest place to buy the device, behind Malaysia, Hong Kong and Japan.
The survey compares the price of the iPad according to purchasing power parity (PPP). PPP looks at the prices of a particular good in different countries according to the local currency.
A similar survey by The Economist magazine, the Big Mac Index, recently concluded that the Australian dollar was near fair value in July when it was around US90¢.
But economists say the dollar has some way to fall to reach fair value. "Australia's very expensive. The level of the dollar which would be fair from a PPP-perspective is about 75 to 80 US cents," ANZ currency strategist Andrew Salter said.
"That's based on relative consumer prices in Australia and the US. That's a pretty stable relationship. In fact, the IMF and the World Bank, the Wharton Business School and HSBC also put PPP fair value within that range."
The idea of fair value for a currency is also one that is hotly debated among analysts. Measures used to judge the strength of currencies include PPP and the real effective exchange rate (REER) - the exchange rate against a range of currencies, adjusted for inflation.
The Australian dollar, when compared with the level of commodity prices - which surged to record levels before weakening in recent months - could also be seen as closer to its fair value than using the PPP models, Mr Salter said.
"If you take into account commodity prices and the interest rate differential - the two things that jointly determine longer-term fair value for the Australian dollar, we put that at about 88 to 90 US cents."
What is clear is that the Australian dollar has soared above its long-term historical average in the US70¢ to US80¢ range following the start of the mining investment boom, RBS senior currency strategist Greg Gibbs said, citing Bank for International Settlements' effective exchange rate indices. The BIS looks at up to 61 currencies since the 1960s and using weights based on trade data from 2008 to 2010.
The Australian dollar is sitting about 30 per cent above its average of the past two decades, Mr Gibbs said. "If you had record interest rates and a currency that was somewhat average, you would anticipate that the economy would be growing much faster than it is. All the evidence would suggest the currency is still restraining the economy."
The Australian dollar was buying US94.18¢ late on Monday.
Frequently Asked Questions about this Article…
Analysts in the article say the Australian dollar is trading above several measures of ‘fair value’. PPP-based estimates put fair value closer to US75–80 cents, while a commodity-and-interest-rate approach suggests about US88–90 cents. At the time of the article the AUD was around US94.18 cents, which many commentators viewed as expensive compared with historical norms.
Purchasing power parity (PPP) compares the local price of the same good across countries using local currency. The article cites a Commonwealth Securities survey using PPP on iPad prices and notes economists use PPP to estimate a currency’s fair value — in Australia’s case, several institutions put PPP fair value at roughly US75–80 cents.
Commonwealth Securities looked at the price of a 16GB iPad across 46 countries using PPP and found Australia was the fourth‑cheapest place to buy the device (behind Malaysia, Hong Kong and Japan), a result that raised questions about whether the Australian dollar was overvalued.
The Big Mac Index, which uses the price of a Big Mac as a PPP proxy, recently concluded the Australian dollar was near fair value in July when it was around US90 cents, according to the article.
Some economists argue that Australia’s currency is influenced by commodity prices and interest rate differentials, which jointly help determine longer‑term fair value. Using that approach, the article quotes ANZ’s Andrew Salter estimating fair value around US88–90 cents — higher than pure PPP estimates.
The article cites RBS senior currency strategist Greg Gibbs saying the Australian dollar has soared above its long‑term historical average (historically around US70–80 cents) and is sitting about 30% above its average over the past two decades.
The article notes RBS’s view that an unusually strong currency can restrain the economy — for example, GDP growth may be weaker than expected if the currency is high relative to rates. It also highlights that commodity price moves change how ‘fair value’ is assessed, so movements in the AUD and commodity markets matter for the broader economy.
The article reports the Australian dollar was buying about US94.18 cents late on Monday.
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