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…
Economists disagree. PPP-based measures suggest the Australian dollar is above fair value and might need to fall toward about US$0.75–US$0.80, while measures that factor in commodity prices and interest-rate differentials put fair value nearer US$0.88–US$0.90. The Big Mac Index recently judged the AUD near fair value around US$0.90. The article notes the AUD was about US$0.9418 late on Monday.
Purchasing power parity (PPP) compares the price of the same good in different countries using local currencies to judge relative currency value. The article cites PPP-based analysis (and economists quoted by ANZ) that places a PPP fair value for the Australian dollar at roughly US$0.75–US$0.80.
The Big Mac Index is a simple PPP-style comparison using the price of a McDonald’s Big Mac across countries. According to the article, The Economist’s Big Mac Index recently concluded the Australian dollar was close to fair value in July when the AUD was around US$0.90.
Analysts say commodity prices and the interest-rate differential jointly influence longer-term fair value for the Australian dollar. The article quotes ANZ strategist Andrew Salter saying that when you include those factors, fair value is closer to US$0.88–US$0.90, higher than the PPP-only estimate.
Using long-run effective exchange rate indices (like those from the Bank for International Settlements), RBS strategist Greg Gibbs notes the Australian dollar has risen well above its long-term historical average. The article says the AUD is roughly 30% above its average over the past two decades and stands above the earlier US$0.70–US$0.80 historical range.
The article reports views that a persistently strong AUD can restrain economic growth. RBS’s Greg Gibbs suggests that if the currency were more average at current interest rates, the economy might be growing faster. For everyday investors, a strong AUD can affect the competitiveness of exporters, domestic inflation/import prices and the returns on foreign assets — though the article focuses on the broader economic restraint rather than specific investment advice.
Yes — the article cites a Commonwealth Securities survey comparing 16GB iPad prices across 46 countries using PPP. It found Australia the fourth-cheapest place to buy that iPad, which raises questions about measures of the currency’s valuation and how consumer prices reflect currency strength.
Based on the article’s coverage: PPP-oriented fair value is cited around US$0.75–US$0.80; commodity-and-rate-adjusted fair value is put at about US$0.88–US$0.90; the Big Mac Index suggested near US$0.90 in July. The article also notes the AUD was about US$0.9418 late on Monday, so investors tracking valuation debates may watch those ranges for context.
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