$A rides commodity currency wave towards US76cLink to article
The Australian dollar has risen to US76c as commodity prices surged on the back of China’s steel price rally, signs of stabilisation in the Chinese economy and the ECB’s significantly loosened monetary policy. China has released a growth forecast of 6.5 – 7% which is above expectation while also revaluing the yuan, diminishing the negative outlook for the Chinese economy.
How does this relate to the HSC syllabus?
- The appreciation of the Australian dollar can be attributed to an increase in demand for it by investors (HSC Topic 2 – Australia in the Global Economy). This increase in demand is due to a number of factors:
- Rallying of commodity prices. In particular, due to a price rally in steel, iron ore surged 18.5% on 7th March 2016 (iron is input for the production of steel). Since Australia is a major exporter iron ore, there was an increase in demand for the Australian dollar as iron ore importers locked into contracts to buy iron ore were required to pay more for the same quantity of iron ore.
- Stabilisation of the Chinese economy. The Australian dollar can be considered a proxy for the Chinese yuan (CNY). Due to its strong trade ties with China, Australia’s economic results are closely tied to China’s economic activity. Since CNY is a managed rate subject to change by the Chinese central bank, investors tend to shy away from investing in CNY. Furthermore, the CNY is still facing considerable uncertainty despite revaluation as China continues to contain significant selling of the CNY amidst speculation that the CNY will fall. Instead, investors buy AUD which is a floating and liquid currency that responds to changes in the Chinese economy. As such, positive outlook for economic growth in China and the possibility of stabilisation has created positive speculation for the Australian dollar’s appreciation, causing an increase in demand (HSC Topic 2 – Australia in the Global Economy).
- Australia’s relatively high cash rate. The RBA decided to hold the cash rate steady at 2% during its last meeting. Meanwhile, the ECB has announced drastic measures to loosen monetary policy including negative interest rates and further quantitative easing. To earn higher returns on their investment, investors have been targeting investment at countries with higher cash rates such as Australia’s. To invest in Australia, however, investors require Australian dollars which has caused an increase in demand as investors sell foreign currency to buy Australian dollars (HSC Topic 2 – Australia in the Global Economy).
- Appreciation of the Australian dollar comes as a concern Australian economy, especially exporters. Given the receding mining boom, the Australian economy is endeavouring to transition to a services based economy. A higher Australian dollar means that one dollar of foreign currency is worth less which would make Australian services more expensive. The decline in international competitiveness will make it difficult for the Australian economy to transition and support economic growth in the medium-long term (HSC Topic 2 – Australia in the Global Economy).
- Putting downward pressure on the Australian dollar has been a priority for the RBA given that a high Australian dollar will be damaging to Australian exports and economic growth if the economy does not transition fast enough. The optimal level of the Australian dollar has been given to be US65c. This could signal that the RBA may need to consider loosening monetary policy in order to lower the exchange rate to more competitive levels.
Porsche looks to Bosch, Panasonic for Tesla-beating batteryLink to article
Porsche is considering bids from both Panasonic and Bosch for a long-range battery to compete with Tesla in building an all-electric sports car. Porsche has dedicated 1 billion euros to developing its first battery powered sports car in an effort produce more low-emission electric and hybrid cars. Other car producers are also investing in electric cars with Mercedes-Benz investing 500 million euros to build a second battery factor in response to expectation for increased demand of electric cars.
How does this relate to the HSC syllabus?
- Investment into electric cars by car producers is in response to technological change which moves away from using fossil fuels as an energy source (Preliminary Topic 2 – Consumers and Business). Therefore, there is expected to be a gradual shift in the type of product produced by car companies from cars running on fossil fuels to electric cars.
- As consumers become more conscious of environmental sustainability and global warming, demand is expected to shift towards more ‘environmentally friendly’ cars such as electric cars or fuel efficient cars to limit their carbon emissions. In response, car producers are investing into the production of electric cars (Preliminary Topic 2 – Consumers and Business). This also reflects the idea of consumer sovereignty, where businesses produce what consumers demand.
- An increase in the production and consumption of electric cars would lead to improvements in environmental sustainability as carbon emissions are minimised (Preliminary Topic 2 – Consumers and Business; HSC Topic 3 – Economic Issues).
- Porsche’s investment into development in electric cars is also in response to increased competition from Tesla and Mercedes-Benz. Given that both companies are already within the electric car space and assuming that the demand for electric cars will increase, Porsche would face a decrease in its market share as consumers buy more Tesla and Mercedes-Benz products (Preliminary Topic 2 – Consumers and Business).
- By investing in electric cars at present, Porsche can ensure that it maximises its growth and profits in the future as demand for electric cars increase and cars running on fossil fuels decline (Preliminary Topic 2 – Consumers and Business). If Porsche were to continue on its current trajectory and keep its product mix the same, a decrease in the demand for cars using fossil fuels (which seems likely given the increased interest in electric cars) would decrease the demand for Porsche products. As a result, Porsche would, ceteris paribus, face declines in revenue since revenue = price × quantity and therefore experience a decrease in profits, contrary to its goal of maximising profits (in the short term).
- The decision to choose between Panasonic and Bosch for a battery is a significant one in terms of how to produce. Since Porsche is a premium brand, it should seek to ensure its inputs are of high quality. At the same time, Porsche is mindful of costs since costs directly take away from profits (profit = revenues – costs). The Bosch package would be more costly than Panasonic. However, in terms of logistics, Bosch’s offer would be less complex and entail less costs since both Bosch and Porsche are based in Germany while Panasonic is based in Japan.
- Panasonic supplies Tesla its batteries and choosing Panasonic would mean that Porsche can directly match the quality of Tesla’s cars. As such, consumers could view Tesla and Porsche as similar in terms of functionality and therefore, ignoring design and branding, substitutable for each other. This would help Porsche compete with Tesla and retain or increase its market share (Preliminary Topic 2 – Consumers and Business).
Draghi expands ECB stimulus with more QE and lower ratesLink to article
Mario Draghi, the European Central Bank’s (ECB) President, has announced various rate cuts and increased quantitative easing to stimulate economic activity in the European region. These rate cuts see the overnight cash rate decreased by 0.1% to -0.4% and an additional 20 billion euros intended to be used to purchase government bonds. Corporate bonds have also been made eligible for purchase by the ECB. Draghi added that further rate cuts are not likely to occur. The ECB cut is outlook for growth from 1.7% to 1.4% for 2016 to reflect weakening global growth prospects. Furthermore, the inflation forecast has been cut from 1% to 0.1%, presenting a real risk of deflation which the ECB is endeavouring to avoid by significantly loosening monetary policy.
How does this relate to the HSC syllabus?
- The ECB’s rate cuts and increased quantitative easing represent loosening of monetary policy. Assuming that banks would pass on the full cut, this would make money more easily accessible by consumers and therefore increase the supply of money in the economy (Preliminary Topic 5 – Financial Markets; HSC Topic 4 – Economic Policies and Management).
- Note: European banks have expressed their reluctance and scepticism of lowering their interest rates to negative territory. They have claimed that it would damage their profit margins as borrowers pay less to borrow. Furthermore, charging negative interest rates would mean that the banks may pay lenders to borrow from them which would further squeeze their profit margins. See Economics Update 31 Jan 2016 for more details and analysis.
- Quantitative easing is an unconventional form of monetary policy. It involves the ECB buying government bonds back from the market to further lower interest rates and increase money supply (Preliminary Topic 5 – Financial Market; HSC Topic 4 – Economic Policies and Management). Government bonds are generally safer (i.e. less likely to default) than corporate bonds. The fact that the ECB is expanding eligibility of bond purchases to corporate bonds reflects the drastic action it is taking to stimulate the economy.
- Quantitative easing in the US has been a factor in driving the US’s bullish equity market over the past 7 years.
- The ECB has loosened monetary policy significantly in order to address the increasing threat of deflation given that the ECB has cut inflation outlooks from 1% to 0.1% in 2016. Draghi has repeatedly stated that the ECB is dedicated to ‘revive inflation’. While high inflation is undesirable since it erodes the purchasing power of money and can affect the economy’s standard of living, deflation is also undesirable (HSC Topic 3 – Economic Issues). Recall the negative effects of deflation (see Economic Update 31 Jan 2016).
- Loosening monetary policy is expected to see inflation to be 1.3% in 2017 and 1.6% in 2018 (HSC Topic 3 – Economic Issues). However, on announcement of the policy changes, oil prices fell below $38, remaining at levels inconsistent with increasing inflation. Since oil is an input to most goods and services produced, lower oil prices means that the prices of goods and services produced remain low which puts downward pressure on price levels (HSC Topic 3 – Economic Issues).
Euro rallies and ECB stimulus fails to steady stocks; Crude drops
ECB splurge set off new currency war
Theresa Dang is an economics mentor at Keystone Education. She attended Sydney Girls High and achieved an ATAR of 99.70 in 2012. She is now studying Commerce and Law at the University of Sydney. She has experience in a global technology firm and a mutual fund.
Gary Liang is the founder and director of Keystone Education. He attended Sydney Boys High and achieved an ATAR of 99.95 in 2012. He achieved 5 state ranks in Mathematics, Mathematics Ext 1, Mathematics Ext 2, Chemistry and Economics. He is now studying Economics and Science (Advanced Mathematics) at the UNSW Australia, where he is the recipient of four scholarships.