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The following are comments Reserve Bank of Australia Governor Glenn Stevens made in parliamentary testimony today. He was responding to questions about the strength of the local currency.
“The main story I think is we’ve had the very high terms of trade historically that has been associated -- there is an observable relationship with the real exchange rate. I think what’s happening is a sort of signal if you like of potentially attractive returns in this country, not just on financial assets but the real capital stock and investors find that attractive. There can be a kind of risk-seeking dynamic as well, some in the financial markets regard the Australian dollar as a kind of play, if you like, on the global economy, but then if the global economy does well, we typically would have high terms of trade and the high currency would go with that so those people are really just helping to make that happen.”
“I think there is more tendency now for some official flows seeking the high quality assets. I’d have to say that it’s most likely that the official investors, they’re not usually the most adventurous, they’re usually the ones that come along after others have been coming for a while, so I think all those things are at work.”
“I guess what I’d say is the fact that it’s high, you can say on its face that must be a distortion, it could be, but let’s put it this way. In the internal work that I’ve asked the staff for, we had various econometric relationships over the years that have what’s in the market now, compared with what would be predicted. In some of those, it’s higher than would be predicted, there are one or two models you can actually come up with that says it’s undervalued, I personally wouldn’t draw that conclusion. But as with any model you can find various answers.”
“I think probably it’s the case that on balance it looks higher relative to the mean prediction of models, though the size of that gap is not especially large in comparison to other forecasting errors or misalignments we’ve seen in the past.”
“So it’s a bit on the high side, I’d say, probably not dramatically so.”
“I’d describe it as probably, at present, trading a bit above where I would’ve thought it would be based on these past relationships and just based on my instinct of the sorts of things that have been happening in say the past six months: the terms of trade have declined, global growth outlook is not catastrophically bad but it’s softer than it was, and so on. So I’m probably, to be honest, a little surprised that it’s not a little bit lower than it is. But we’re not talking 20 cents or something, we’re talking, well I don’t want to give figures, so I’d say it’s probably a little on the high side but in terms of the statistical relationships you can fit, you can’t actually say that that error is all that significant.”
“If it’s a long way above fair value for a long time, then that’s, one would’ve thought, unnecessarily contractionary for those trade-exposed sectors so how far above is it and how long and they would be the questions. So that risk clearly exists.”
“The big strategic question is, if you think that there is a fundamental change in global relative prices, a lot of which is going to be persistent, not all of it, if that’s going to be the case then we will have a larger resource sector and some other sectors will be smaller to be at full employment. If that’s the case, then you would think that the mean exchange rate we used to see, we won’t see any more. You’ll see on average something higher, I can’t really tell you exactly where that would be. If that’s what you think, you still wouldn’t be sure the exchange rate is correct.”
Referring to the nation’s resource investment boom, he said: “If you really think the whole thing’s going to go away, imminently, the mining boom, this thing is going to completely crash, the relative price shift isn’t there, the whole thing’s not really going to persist, then the Aussie dollar in that scenario presumably would need to be much lower than it is. It probably will go there if that scenario unfolds.”
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