The Australian Dollar, Iron Ore and the Property Ponzi

Good luck, Mike.’

While there’s plenty to choose from, this faux well-wishing of Socceroos captain Mile ‘Mike’ Jedinak by Aussie Prime Minister, Tony Abbott, will go down as one of the best stuff-ups of his short (and looking increasingly shorter) career at the top.

It is beyond belief that the PM and his spinners could get this one wrong. But they did. Not the sort of people you want in charge with Australia facing its biggest economic challenge in years. But that’s who we’ve got so strap yourself in…

Probably the biggest challenge right now for Australia is the persistently strong Australian dollar. Over the past few months, the price of iron ore (our largest export earner) has collapsed yet the dollar remains stubbornly high.

The dollar usually acts as a shock absorber. When we’re hit with an external price shock (either positive or negative) the dollar usually rises or falls to absorb the impact. The role of the fluctuating dollar is to ensure price stability and control demand for our exports and imports.

But now the Aussie battler is a victim of out of control global monetary policy. Before I get into the why…have a look at the dollars’ performance against the US dollar over the past year. After peaking at just over 97 cents in October last year, the Aussie dollar fell 10 cents in around three months, a significant decline in such a short space of time.

At the low point in late January, the iron ore price was trading at just over US$120/tonne. Since then, the dollar has rallied by around seven cents (about 8%) while the iron ore price has collapsed by 25%.

Australian dollar — battling higher

Source: Stockcharts

What’s going on? Why isn’t the dollar following the script and heading lower?

There are two main reasons that I can think of, both related to ultra-loose global monetary policy.

First, there was the post 2008 China credit boom. This created a huge demand for iron ore and sent the price soaring. It created a signal (which is what prices are meant to do) that iron ore production was highly profitable and that if you had a deposit, you had better dig it out of the ground and get it to China as quick as possible.

Predictably, such a strong price signal generates a supply response, and you’re starting to see that in the Pilbara and Brazil now. Tens of millions of tonnes of new supply is now coming on line from the likes of BHP, Rio and Vale. And the supply surplus will only get worse in 2015.

Read the rest of this article at The Daily Reckoning