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Austrlia Balance Of Payments And The Pressure On The Dollar

880 words - 4 pages

IntroductionIn 1995, The Economist ran an article comparing the current account deficit in Australia at the time to that of Mexico just before the Mexican Peso's devaluation in 1994. At the time, the current account deficit in Australia was 5% of gross domestic product (GDP). Over the next five years, the comparison proved itself to be accurate as the Australian dollar lost over 40% of its value. Currently, there are signs that an even larger problem is looming on their financial horizon. The same publication has compared the current account deficit that Australia currently has to that the was experienced by the United States in 2000. Both nations, at the time, were riding the wave of a very strong economy that increased confidence in the economy to unprecedented levels and led to unrealistic expectations.Why Look at the Balance of Payments?As we look at the Australian economy, we need to consider the balance of payments. The current account and the capital/financial account provide a good indication of the market potential of a given economy as well as potential problems that could adversely affect the value of the Australian dollar, as happened from 1995 to 2000. The accounts will also show if there is any excessive foreign exchange pressure being exerted on the Australian dollar. Having this information can give a nations leadership the information that it needs to decide if it needs to take action to protect the value of its currency.History of the Australian economyPrior to 1976, Australia had a fixed currency with respect to a particular currency (British pound until 1971, US dollar from 1971 to 1974) or a trade weighted index of currencies (1974 to 1976). The view of the government was that the exchange rate of their currency was too important to leave to the free market to decide. From 1976 until 1983, Australia operated under a managed float system. Due to the impact of adding Australian dollars to, or taking them from, the market to control the value of the Australian dollar, the Australian Reserve Bank, was no longer able to control domestic monetary conditions as the behavior of international trade and the flow of capital had more of an effect.In 1983, Australia switched to a floating system to alleviate this problem. The currency has been allowed to float ever since. While this has alleviated some problems, it has made the Australian dollar vulnerable to devaluation due to balance of payment discrepancies, as happened in 1995. A similar situation may be at hand.Since the drop in value of the Australian dollar starting in 1995, the currency has made a comeback. The Australian dollar has risen in value, over the last two years, by over 50% versus the US dollar. The...

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