Impact of exchange rates

Our Aussie dollar moves up and down against the US$, Euro, Pound and Yen daily - but what does it all mean and how does it affect everyday Australians?

Imagine you wanted to buy a computer game online from America. You have Australian dollars, so you have to make two purchases - firstly, you buy US$ and then you buy the computer game. Let's say the game costs US$100 and the exchange rate is 98 cents. Ignoring transaction costs, you would have to spend approximately $102 (US$100/$0.98) to buy the US dollars before buying the game.

If the exchange rate of the Australian dollar passed the US dollar, say $1.02, you would need to spend less Aussie dollars to buy the US dollars so the game would cost only $98 (US$100/$1.02). So a higher exchange rate means goods bought overseas cost less.

But what about where we are investing overseas, in company shares for example, to make a profit? Even if you don't actively invest in shares overseas outside of superannuation, super funds invest your super balance for you; for example the Intrust Super default Balanced Investment Option invests in overseas shares. So when an Australian superannuation fund invests overseas, the investment returns to that fund can be influenced, both positively and negatively by the change in exchange rates between the two currencies. Some Funds attempt to remove or mitigate these currency effects on returns by what is known as Currency Hedging. That simply means that they move the effects associated with the change in the relative value of the currencies off to another party; one that is willing to take on the risk. Many funds adopt a Hedging Strategy based around where the Australian dollar sits against the overseas country's currency at any point in time - taking into account historical highs and lows in their valuations.

There's always another side

As the value of the Australian dollar fluctuates against other foreign currencies our export goods become either cheaper or more expensive to the international buyer. The purchaser first has to buy the local currency before they buy the product so if our Australian dollar appreciates greatly against the home currency of the purchaser they will have to use more of their local currency to buy our Australian dollars. The product they are purchasing becomes more expensive and they will be inclined to buy less of that product. That means less income to the domestic Australian producer. As the Australian dollar falls against the foreign currency our products become more attractive to the foreign buyer and they are likely to buy more of those products.

This is why exporters, and our Tourism operators who sell a substantial amount of their product to overseas customers, are generally not happy to see exchange rates rising - their incomes will fall as exchange rates rise.

Nothing is this simple in practice, though in general terms there are always winners and losers from an appreciating Aussie dollar.