The Australian dollar: Still overvalued?

The resources boom is over but the currency remains stubbornly high. Will it stay that way?

Two years in investing, especially in turbulent times such as these, can feel longer. In October of 2010, I published this Doddsville article asking whether the Australian dollar was overvalued.  Back then I said that, although the dollar was historically high, this was no bubble; higher commodity prices meant that the dollar was behaving exactly as it should.

Today, however, the commodity boom is over. Prices for just about all resources have fallen heavily, none more so than coal and iron ore, Australia’s two largest exports.

If high commodity prices caused the dollar to soar, lower prices should prompt a fall, right? In theory, yes. In practice, that’s not what’s happening.

The dollar continues to power on, with central bank buying being especially strong. The Swiss central bank, for example, which has adopted an ambitious plan to place a ceiling on value of the Franc, is forced to sell Francs and buy something to meet their goal. Overwhelmingly, they are buying Aussie dollars; about $3bn worth a month. And they are not alone.

With Japanese, American and European central banks all pledging more quantitative easing, investors are nervous about where to park their assets. Australia is one of few safe destinations. US Fed Chairman Ben Bernanke recently outlined a commitment to purchase US$80bn of assets a month with newly printed money for as long as necessary to get unemployment down. No wonder holders of US dollars are getting nervous and the Aussie looks so good. It could stay that way for longer than many expect.

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