Harry’s right on. Australia has a lot of great things going for it right now. It’s an amazing place to visit, from a tourist’s perspective, and it’s one of the world’s most envied economies.
With everyone going Australia’s way, for now, it’s prudent to consider what could threaten the country’s continued success.
There are three major risks present in Australia at the moment. Harry mentioned one of them – the country’s highly inflated, bubble-to-bust bound property market. Let’s consider this one first.
The Australian property market never crashed when the U.S. property bubble burst. Despite that fact, the Australian dollar – or the Aussie, as it’s commonly called – lost 39% of its value between mid-July 2008 and the end of October!
There’s often talk of “contagion” in the context of the interconnectedness of our global economies. The idea that “sickness” in one country’s economy will spread, negatively affecting other country’s economies. The Aussie’s massive drop, despite the country never actually going through a property market crisis, is proof positive of this concept.
Take a look for yourself…
The Australian dollar went on to recover all of its lost value by October 2010, thanks to China. And that’s the second big risk facing Australia’s strong currency.
Australia is the main supplier of commodities to China. As China grows, it buys more and more from Australia. China’s voracious appetite for commodities has greatly boosted the value of the Aussie dollar, as China buys more and more of the country’s currency to pay trade partners in the country.
This relationship is great for the Aussie dollar… when China is growing. When China’s growth stalls, as it has over the past 18 months or so, the Australian economy and Aussie dollar suffer. You can see this in the chart above, with the Aussie dollar mainly moving sideways in a volatile fashion since the beginning of 2011.
The third main risk to the Australian dollar is related to the first two risks. That is, any loosening of monetary policy in Australia would send the currency into a tailspin.
If Australia’s property market starts to stumble, the country’s central bank is likely to lower interest rates. Right now, the Aussie dollar is the highest yielding major currency, paying 3.25%. That’s huge compared to the U.S. dollar’s 0.25%, and the yen’s pathetic 0.1%.
Of course, this high yield is yet another reason why the Aussie dollar is so strong. Currency investors buy the Aussie for this reason… but they’ll also ditch the Aussie when the central bank begins cutting rates.
I’m not convinced China’s growth will be as dismal as many China bears suggest. So I’m not expecting the Aussie dollar to drop 39% overnight. But it will drop eventually.
I’ll echo Harry’s warning against buying Australian real estate and add to that a second warning: buyers of the Aussie dollar beware!
Still, I agree with Harry. When things turn bad ahead, Oz will be the best place to be.
If you haven’t done so already read the Survive & Prosper issue on “The Best Place to Be When the Worst Happens.“