The $A
Now, what can the RBA do about the Aussie Dollar? We think that the RBA will attempt to slow the rise of the Australian dollar this year by buying Australian bonds and semi-government bonds, keeping our long-term interest rates low, relative to U.S. bonds. In theory and in practice, it's long-term interest rates, not short-term interest rates, that actually drive where the real exchange rate will be.
What's happening here is not so much the Australian dollar going up; it's the US dollar going down. The RBA can't stop the US dollar from going down. The falling US dollar is caused by an enormous expansion of the US Budget deficit to 15% of GDP, which is the largest Budget deficit since WW2. This is over 10% higher than the deficit was the previous year. That's an enormous increase in the flow of bonds onto the international market. In order to clear the market for these bonds, the real value of the US dollar has to fall and the Aussie dollar go up.
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What the RBA gains for the Australian economy, by intervening in the bond market firstly, may be that it can slow the rise of the Australian dollar, but not prevent it. By buying Australian bonds, this increases the money base in Australia which increases the money supply. Therefore, there's the flow of credit in Australia which increases non-mining investment and that drives employment.
We'll have a stronger domestic economy and faster domestic growth because of what the RBA is doing. Still, the Australian dollar has to rise. It is the US dollar going down that is making the Australian dollar go up.
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