What happens when the $AU goes up or down?
The Australian dollar ($A) is allowed to fluctuate freely according to movement in supply and demand for the currency in the foreign exchange market or ‘forex’ market.
The Forex Market
The $A is demanded by buyers of our exports, by foreign investors in Australia and by speculators who may be expecting a rise in the value of the $A.
The forex market is supplied with $A by Australian importers, by Australian investors overseas and by speculators expecting a fall in the value of the $A.
If there is an increase in demand for the $A would result in a rise in its value. This is called an appreciation of the $A and could be caused by an increase in demand for our exports, more foreign investment in Australia or speculators buying $A.
A decrease in demand for the $A would mean it depreciates and could be caused by a reverse of the factors mentioned above.
Importantly, the exchange rate of the $A for another currency will influence the international competitiveness of Australian products.
What happens when the $A depreciates?
Let's say, for example, that Aussie Sports Co produces joggers and sells them to the US for $100 a pair. The existing exchange rate is $A1 = $US1.
This means the sale of one pair of joggers would bring revenue of $US100 which the Australian firm would then exchange for $A100.
Two months later the $A depreciates to $A1 = $US0.90.
In this circumstance the Aussie Sports Co will receive $A100 for a pair of joggers that it exports and need only change $0.90. That is a of $90 in the US would convert to $A100 when the $US are exchanged for $A.
US consumers would probably be delighted at the lower price of this Australian product and no doubt many more pairs of joggers would be sold. But US sports companies may be upset by the depreciation of the Australian dollar.
The reason is that there is a benefit here to Australia as our depreciating currency is improving the international competitiveness of our exports and this tends to raise the output and sales revenue of Australian exporting firms.
What happens when the $A appreciates?
The opposite movement of the exchange rate is called an appreciation of the $A.
If the exchange rate was now $A1 = $US1.05. This means a pair of joggers would have to sell for $US105 if the exporting firm were to gain its desired revenue of $A100.
If a US sports company wanted to sell its joggers in Australia it would only have to charge $95.24 a pair to return the desired $US100.
(95.24 x 105/100) = $US100
Consequently an appreciating currency tends to reduce export sales and makes imports cheaper. The result is the appreciation of the $A encourages the sales of imported goods in Australia.