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The Tyranny of Distance replaced by the Seduction of Depreciation

Published : 21 December 2015 Author : Harry Notaras Comments :

Many years ago the Economist Newspaper came up with a novel method of assessing the fundamental strength of a countries currency relative to that of other countries. The underlying premise of this assessment was that whatever the local 

Australian dollar vs other currencies

currency price of a certain good or service was in country one should be replicated in country two in its local currency when adjusted for the exchange rate.

For example, if a Big Mac cost $5 (AUD) in Australia and $10 (US) in the United States then since they are standardised goods then you could extrapolate from these numbers that the underlying or fundamental exchange rate between the two currencies should be 1:2, that is, one Australian dollar should be able to purchase two US dollars. If the market exchange rate was 1:1, that is, one Australian dollar could buy only one US dollar then the US dollar was overvalued by 100% or the Australian dollar was undervalued by 50%. 

The Economist Newspaper has been conducting this analysis across many countries of the world which have Big Macs and publish the results on a regular basis. Typically the currency that is used as the benchmark to assess over or under valuation is the US dollar. Since the newspaper has kindly made much of the raw data available it has been possible to recalibrate the calculations to make the Australian Dollar the benchmark using the Big Mac prices from the July edition and the market exchange rates from the last weekend in October. The table of data is included down below. 

The Pecking Order

The recalculation showed that the ranking of the currencies did not change substantially between July and October as the exchange rate movements during that period were limited. A result common to both sets of numbers became more apparent when the AUD was made the base currency. When the US dollar was the currency of comparison it showed that the only currencies that were stronger or overvalued were the currencies of the two large Scandinavian countries Norway and Sweden bookended by Switzerland and Denmark.

When the Australian Dollar became the benchmark these four overvalued currencies were joined by eight others. Among these were the US, Canada, Britain, the Euro area and New Zealand. These are countries and areas that have many cultural, historical and economic similarities with Australia. They are western hemisphere countries which provide Australia with much context. We have a shared heritage underwritten by initiations via lengthy industrial revolutions and democratic struggles to reach our statehood.

In a bygone era a tyranny of distance separated us from those kindred countries. Now we are seduced by the notion of currency depreciation with respect to those same countries to save us from economic stagnation and in so doing are hoping to impose a worse tyranny upon ourselves.

They are a peership to which we should rightly aspire to be part of yet we are ranked below them on the currency pecking order. 

Ocean Liner or Life Boats

Currency depreciation is best compared to lifeboats on ocean liners. They are placed there in case of emergency. It is barely a decade and a half since we were in this lifeboat when the AUD fell below 50 cents US. It is nearly 4 years since we reached parity and once more we are tumbling down the rankings again. 

According to the Big Mac analysis our currency is fundamentally undervalued among our important comparable peers but we are now relying on sentiment and momentum to depreciate it further. Our aspiration is now to be ranked among the lesser developed nations. That will be a pyrrhic victory. 

The notion that currency depreciation is a good thing has diverted us from our core task. That task is surely to fix the leaky boat rather than keep heading to the lifeboats. We are a country that has relied too much on a speculative form of wealth creation via things like property and commodity price cycles rather than a productive form of wealth creation through enterprise. Now that we have largely overcome the tyranny of distance that has kept us separate to the rest of the world, let us not be reduced to relying on currency depreciation to keep our head above water or we may find ourselves seduced into a third world status of our own unique Australian design.

 

Harry Notaras

Harry Notaras ABS Business Sales

Business Broker - ABS Business Sales

Phone: 07 3368 4010

Mobile: 0434 344 282