Why the dollar could fall after the election

We could be in for two US greenback bull markets rolled into one… and the risks to the Australian dollar are decidedly on the downside.

If the Coalition wins this election, as seems likely, it might have to deal with a similar decline in the currency as it did in 1996.

On the day of the 1996 election, the dollar was US76.1 cents. Five years later, on April 2nd 2001, it bottomed at US47.78 cents, a decline of 37 per cent. That devaluation set Australia up for the great China resources boom of the 2000s, but also for years of battling rising inflation.

That decline in the Australian dollar between 1996 and 2001 was mostly about the US dollar rising, as well as global investors turning off Asia, and that scenario is now being repeated.

Between 1995 and 2002 the US dollar was the world’s growth currency, thanks to a combination of the dot.com boom of the 90s and imported deflation from Asia, which increased US real interest rates.

Between 2007 and 2010 it was the turn of the commodity currencies, led by Australia, to take over as the growth currencies of the world. As a result the Aussie entered an eight-year bull market that saw it peak at $US1.10 in July 2011.

That bull market is over, thanks to falling interest rates and the slowdown in China, but has the bear market only just begun? Trying to forecast currencies is always a dangerous game, but the risks to the Australian dollar are decidedly to the downside, in my view.

That’s because the US dollar may be entering its third great secular bull market since the end of the Bretton Woods system and the floating of its own currency in August 1971.

As discussed, the second came after the 1996 Australian election as a result of the productivity boom from Silicon Valley. The first US dollar bull market, between 1979 and 1985, resulted entirely from the very aggressive monetary tightening of Paul Volcker, the then chairman of the Federal Reserve.

If it occurs the third US dollar bull market, from 2013 onwards, will be a combination of the forces behind two previous ones: monetary tightening by Ben Bernanke (who is no Paul Volcker, that’s for sure, but even he will have to stop stimulating soon) and a productivity boom resulting from cheap energy and lower wage costs due to high unemployment.

It could, therefore, be two bull markets rolled into one.

US bond yields are now rising rapidly, although they retraced a bit last night, as investors switch out of the safety of fixed interest and back into equities in anticipation of higher growth and inflation, and improved corporate profits.

It’s hardly surprising that the US economy is starting to do better. It will soon clock up five years of near zero interest rates, the bond yield has been at or below 2 per cent for two years, the Federal Reserve has added more than $US2 trillion to bank balance sheets and the government has been running massive deficits.

Never in the history of the world has an economy been subjected to such concerted economic stimulus for so long. Given that, and the fact that the corporate sector is massively cashed up with low costs thanks to falling energy and real wages, surely the likelihood is that US growth is faster in 2014 than the consensus forecasts expect.

And while US household incomes have been flat, debt has been reduced as a percentage of income (from 130 to 102 per cent) and net worth is rising thanks to a four-year, 150 per cent, rally in the stock market and, lately, rising house prices.

Possibly in a matter of weeks, the Federal Reserve will start tapering its bond buying program – the great monetary experiment called Quantitative Easing. It’s currently buying $US85 billion a month worth of bonds and mortgage securities, which has increased US bank liquidity (cash and liquid securities) from 25 per cent to nearly 50 per cent of total credit.

It’s unlikely to be the sort of aggressive monetary tightening undertaken by Paul Volcker in the early 80s, which doubled the US dollar index over five years, but everything’s relative. The market is already reacting nervously, and no doubt the tightening of US monetary policy will feel aggressive when it gets into full swing next year.

So there could be a big post-election fall in the Australian currency, not because of anything we’re doing, but because of another great US dollar bull market.

The Aussie has already come down 16 per cent from the 2011 peak, and 12 per cent from the average of the Gillard/Rudd years (104 cents). Another 16 per cent, which is not out of the question, would see it at US80 cents.

Industrial rebirth – and inflation – here we come.

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