Unit 3 AOS3 Economics - Lesson 4 Exchange Rates & Recent Trends

All right. Hello, hello everyone and welcome to part four of our PowerPoint about Australia and the World Economy Unit three areas day three today we're going to be talking about the exchange rate and then a few more recent aggregate demand and aggregate supply side conditions that have been impacting the overall overall external transactions. I was about to say our goal of external stability. That would be an old study design which ended in 2016 and we don't call that anymore, which is good because that topic was so vague and this makes it more clear overall. So we're going to talk about how some of these other external transactions affect our living standards, how changes in the exchange rate affects these external transactions. The part of the key knowledge this falls under is all about the factors affecting the value of our exchange rate, including relative interest rates, demand for exports and imports, capital flows, the terms of trade and relative rates of inflation, and the effective exchange rate movements on the current account balance, domestic macroeconomic goals and living standards. So let's get into this. So with the exchange rate, there's two main ways to measure it. We mainly use individual exchange rates. The trade weighted index has come up a little bit in the past. It was more explicitly outlined in, in previous study design. Now it's kind of just like vaguely it's kind of there, but it's kind of not. They haven't asked about it because it's not explicitly set in the key knowledge. It's always just an option of something you can talk about. I'm not going to ask you a specific question about it in a sack, but it's good to know of its existence just in case it is a multiple choice answer at some point, which it could be. So two key ways to measure our exchange rate are through individual exchange rates, which is the rate of expressing our currency units against another country. So how many of our dollars it takes to or how many of another country's dollars we can purchase with one Australian dollar. So for one Australian dollar at the moment we can get about 64 to 67 US cents and that's our exchange rate. That's the most common one that we use our dollar against the US Dollar. You sometimes like if you are shopping online, you've probably been checking a lot of exchange rates over the time without even thinking about it, just to see how much you can buy from other countries. Because I bet at some point in your life you have gotten to the last stage of an online shop, got into the cart, exchanged, changed the money from Australian dollars into Australian dollars and then freaked out because it was so much more expensive and you couldn't afford it. So individual exchange rates greatly affect imports and exports, which you doing that is a clear example of. So then we've got the trade weighted index which I've never liked to explain, so bear with me, but it represents the value of our dollar against a basket of foreign currencies weighted according to their relative importance to Australia's trade. Because in index a base year is used to compare changes in the currency's value. So basically what the trade weight index is, it's basically a score where 100 is the base level and the value of our currency is ranked against our trading partners. So how strong our currency is doing against China, how strong it's doing against the USA, etc. And it's given a value like if it's the higher the trade weighted index is, the more positive our dollar is valued amongst our trading partners, the lower it is, the worse off it is overall. You're never going to have to calculate these yourself, you just need to know what they are and how they impact us overall. When we're going through the slides today, we're going to be mainly talking about individual exchange rates because this is the most common one that comes up and it's the one that you're going to be using when you answer questions. All right, so we're going to look at the relationship between the current account net foreign debt and the exchange rate, how they influence each other, the direct impacts that one has on another. So first up we're going to look at the current account deficit and net foreign debt. So if we have an increasing current account deficit, which hopefully you remember from our balance of payments, looked at the balance of net goods, net services, net primary incomes and net secondary incomes, it looked at all the money that was coming into and out of Australia in 12 month period. So if the current account deficit rises, we have to cover that money somehow. So if we, because we need that to balance out, we may have greater reliance on overseas borrowing to cancel out some of that deficit that's occurring there. And so that leads to us having a greater net foreign debt because of that increased overseas borrowing and increased foreign capital that we need coming to Australia to cancel out our current account deficit at the moment, because we have a current account surplus, we've actually been paying off some of our net foreign debt. But because of this insane pandemic, we're likely to be in a current account deficit again very soon. And then after that our net foreign debt is likely to begin increasing again with the Australian dollar or the exchange rate and current account deficit when we have a rising Australian dollar. So when it's appreciating in value, it makes exports fall and imports rise. So as the Australian dollar starts to appreciate, we start exporting less because our trading partners do not want to buy our more expensive imports. And consumers start importing more because it's suddenly cheaper to buy things from overseas. And because of this, because of our net goods and net services section of the current account, we end up being in a greater deficit because all of a sudden we have less credits coming in and way more debits going out. And so this makes the current account deficit larger overall. With net foreign debt and the Australian dollar, a large unsustainable rise in unproductive foreign debt tends to decrease the Australian dollar as it means bigger interest payments abroad. How the exchange rate works is it's completely based on supply and demand. So if we are flooding the foreign exchange market with more Australian dollars to pay for our foreign debts to other countries, the more Australian dollars that are left on the foreign exchange market as we exchange them for foreign currencies, the less it is valued overall. So it's all about scarcity. And so the more scarce the currency is, the higher in value it is. But the more available the currency is, the lower it is valued overall. So if we have a large net foreign debt, it often leads to a lower valued Australian dollar, because when we pay our interest repayments overseas, we take Australian dollars and exchange them for foreign currency and leave Australian dollars on the foreign exchange market, and therefore they become less in value. So we're going to look at trends in a couple of these things over the last two years. So with everything, like I always say, we only care from 2018 onwards. So we can just ignore the rest of this over here with some beautiful scribbles. Okay, so if we look at the current account, so it's actually been trending towards surplus, then has gotten a surplus in recent times, like, look at that. We have been doing very well at having more money coming into Australia than leaving it. But as you can see, we kind of peaked at the end of 2019 up here and started decreasing in January. And as you've probably been beaten over the head with over the last few months, you may have heard that a pandemic started at the start of this year. And so that started trending downwards. And I feel like it's gonna keep going down in the near, in the short term, into the future. So basically, because one of our major trading partners, our major trading partner is China. China is not going to be buying as much of our exports while they're dealing with the fallout of this pandemic. And that's going to decrease credits coming into Australia through the current account. And it's likely all the extra foreign borrowing we're going to have to do to finance the stimulus packages like the jobseeker and jobkeeper payments, it's going to mean that more interest is going out through the net primary incomes and the current account is likely to fall into a larger deficit. So although it has been decreasing substantially, I feel that by the time you sit an exam in December, we are going to be in deficit again. So there's going to be one of those things that if you look at recent trends in the current account deficit, you'll be talking about how we started in a deficit of a significant amount, then there was a large reduction until we hit a surplus. But in recent times the current account has been increasing in size or increasing in deficit. Then we have trends in the Australian dollar or the exchange rate. So as you can see for a lot of 2019, the Australian dollar was pretty stable. Like it fluctuates on a second by second basis. So it's one of the things that tracking it, we're never going to expect you to know exactly what the Australian dollar is worth at one period of time, but just around is always going to be okay. So like I made these slides on the 21st of April to now the 24th. That value is probably different. I'm not going to look it up right now because that would not make for a good video. I might pause and do it. So let's see. Alright, so I'm back and I probably shouldn't have paused because it's basically the same. It's 63.5 US cents is the current exchange rate. It was 63 when I made this slide. So pretty similar overall. If we'd mark that there. If you looked at the recent trend for the exchange rate, it has been trending downwards. There was an argument that for a long period of time before we go into this plummet here, the Australian dollar, even though it had been decreasing in value, was still valued too high. Our exports were not attractive to our trading partners because the Australian dollar was still too high. And so if you could guess what happened when we hit this low point here of 58 US cents, our interest rates got decreased to the lowest they've ever been. So the cash rate is 0.25%. Many of us with home loans etc are paying the lowest interest rates in history in Australia for our mortgages. But what happens is when they decrease the interest rates, everyone who has money invested in Australian banks from overseas withdraws their money and this leads to the Australian dollar plummeting in value. And so you could see that in basically the space of a day actually happened really quickly. It went from 66 US cents to 58 US cents. And since then it's climbed back up and has stabilized kind of around that US$0.63 points at the moment. So now if you buy anything from the US, basically you're adding 50% onto the price, which is pretty terrible if you want to import some things from overseas. But the upside of a pandemic is you are, if you're buying things locally from Australia, doing good things for employment, etc. So with the trend, with the exchange rate, it has been trending downwards. Trends in net foreign debt. Net foreign debt has been increasing for the last significant portion of time. If we looked at the last 10 to 20 years, our government's been in deficit. If you look more specifically at the government saying what they're going to do with their budget, for about the last 10 years they've been promising a return to surplus, but other things have been occurring that have meant they've had to keep outlaying more than they receive. And so this is meant for a government to run in deficit and outlay more than they receive. They have to borrow that money from overseas and that contributes to our net foreign debt. So we have a net foreign debt of more than $1.43 trillion. I remember I was teaching economics when it ticked over 1 trillion and people were freaking out like students often cannot believe it when you say that we have a net foreign debt of over a trillion dollars. But if you look at countries like the us, they owe like tens of trillions of dollars. And that is far more scary than this could ever be for us. Recently, the government has been trying to repay some of our net foreign debt, but it's likely to bounce back up very soon to finance all of these stimulus packages that we need to basically sustain ourselves through this dark economic period. The terms of trade, we've already looked at this in the previous video, but terms of trade were moving very positively until the pandemic hit when export compared to import values dropped significantly and may still continue to drop. A large proportion of this is because suddenly we're not having as much trade with China and therefore our exports aren't as valuable. And that has meant the terms of trade have fallen significantly. So aggregate demand side factors that influence our external transactions. So changes in economic activities overseas affects our terms of trade index. Terms of trade is always used as an aggregate demand side factor. So if terms of trade are increasing, that's positive for aggregate demand and positive for external transactions. Means we're exporting more, hopefully and importing less changes in the exchange rate. Well, we just talked about that all throughout this PowerPoint. So when the exchange rate is lower, we're going to export a whole lot more and import a whole lot less, which is favorable for aggregate demand. When the exchange rate is higher or it appreciates in value, we are going to export a lot less and import a lot more, which is unfavorable for our aggregate demand. Changes in consumer confidence, business confidence and disposable income. So, you know, at the moment all of these are falling or have fallen significantly. This means it's going to be hard to export as much because there's not as much business happening. Also, there's a lot less spending in general, so there's less production to export. An upside of changes in consumer confidence, etc. And lower disposable income is we actually import less, which is favorable for our current account change in interest rates. So we talked about that a little bit with the exchange rate and how that impacted the exchange rate, but also just in terms of our spending, etc. With low interest rates, you'd assume that that means there's going to be more spending overall and some of that spending can tip over into import spending, which can make the current account worse. But currently it's not a lot because consumer confidence is so low, we're not actually borrowing that much more money. Another effect with change in interest rates is that if our interest rates are higher than other parts of the world, we will borrow more money from overseas where interest rates are lower, which will lead to a higher net foreign debt. In Australia, then changes in government spending and foreign aid. This basically just means that if all government defence spending and foreign aid, often if the government's spending a lot on defence and foreign aid, this means that they've got to get that money from somewhere and if they don't have enough money for it, they've got to borrow from overseas, which increases our net foreign debt. Alright, now we're going to talk about aggregate supply side factors. So in Australia we have a massive deficiency in our national savings, big interest rate differentials or differences with overseas countries. What that means is that if businesses want to invest and expand in Australia, it's hard to do so with money in Australia. So often what happens is that businesses will borrow money from overseas, which adds to our net foreign debt overall, and they use that to invest and expand in Australia. But when they repay that debt, they have to repay interest repayments, which is a debit to the net primary income section of our current account and leads to us having a larger current account deficit because of that. And that happens a lot in recent times. Hopefully a little bit less now that interest rates are so low. But that has historically happened a lot in Australia. Secondly, we have weaker growth in labor productivity in Australia. Our labor is not quite as efficient as many other parts of the world. We're not improving at the same rate at a technological and physical standpoint in terms of our labor. And so that often means that we're not as competitive, which hurts our exports overall and increases the volume of imports, which makes our current account worse. Because that whole net goods and net services section changing oil prices can be pretty significant. Oil prices have been plummeting. Oil massive input into production for a lot of businesses. This can lower our cost of production and make us more competitive, which can be great for our exports while still lowering our overall value of our imports because oil is so much cheaper, which can make our current account better overall because in net goods, we're getting more credits from our exports and less debits from our imports. Number four is changes in real unit labor costs. So how much labor is costing you per hour without the effects of inflation? Because our minimum wage is so high, we cannot compete in terms of labor costs compared to the rest of the world. So therefore a lot of business gets offshored or moved overseas. And it means we've got more income either leaving Australia to go overseas or staying overseas, which hurts our current account because incomes are leaving Australia and not as much is coming in, which makes the current account deficit worse overall. And then lastly, severe climatic conditions. So in Australia, you know, recently we've had bushfires, we've had all kinds of different major weather events. And this has led to our natural resources being like, greatly damaged our agricultural resources. Our tourism has been completely destroyed this year through the bushfires and now the pandemic. So climatic conditions can really hurt our exports because agricultural type exports, like even like cattle, grain, etc. Are big things that we export. And these climatic conditions do not help with that, which makes the net goods section of our current account a lot worse and our current account deficit worse because of it. Because there are more. There's less credits leaving Australia and less credits coming into Australia and more debits leaving Australia. Alright, so if you made it to this point, thank you for watching. You've lasted through almost 19 minutes of economic information. As always. If you have any questions, leave a comment below or send me a message, start a chat, send me an email. I'm more than happy to help you. Especially with some of these international transaction type things. It's very complicated. There are a lot of things that affect each other in different ways and it just takes the practical application for you to get used to it and then you'll get better and better and you'll hopefully do very well in upcoming sacs. And at the end of the year, if there's anything you think would be beneficial to you, anything you want more information into, anything I could make or do that would make your life in economics a lot easier, I let me know and I'll do my best to make it happen on that. Thank you very much for watching. I hope this was helpful to you and I will see you next time. Where we're going to talk about all about free trade and protectionist policies and basically how the world has slowly moved towards free trade and why after this pandemic we might start moving more back towards protecting ourselves and being more insulated and producing many, many things inside one country rather than all across the world. Other than that, have a good day and I'll see you later. Bye.