The Aussie dollar and inflation are rising in tandem. How long can the relationship last?It’s got me stumped why exchange rates go up when inflation goes up. I’ve heard the spiel a thousand times: higher inflation means higher interest rates and higher interest rates mean everyone wants to own the currency. I still don’t get it. Over a decent period of time, high inflation has to equate to a depreciating currency. That’s what inflation is – the depreciation of money. If the currency doesn’t depreciate, you end up with absurd situations where everything in the country with inflation costs ten times more, in real terms, than in the country without it. And you could in theory print as much money as you wanted and buy the rest of the world’s assets, goods and services. That’s the path we’re headed down, but I doubt the rest of the world will let us get away with it. Yesterday’s CPI data sent a strong message to the few remaining economists contending that inflation is not an issue: you’re wrong. Most of us have known prices are going through the roof for quite a while, but it seems even the official bean counters have run out of items to exclude from the ‘core’ number. The real number is undoubtedly higher than the 4.2% reported, but even that’s enough to have everyone concerned. In stark contrast to the US, growth in money supply (M3) here is rampant – it’s currently growing at a year-over-year rate in excess of 20% – and until the Reserve Bank slows it down, the problem is not going to go away. The dollar bounced this week, but the rest of the world won’t let us get away with printing money and running a huge current account deficit forever. There are a couple of arguments in favour of the Aussie. One is that we have a lot of stuff in the ground that the rest of the world needs to buy, and for that they need our money. Another is that inflation is a global problem, not a domestic one. Currencies are, after all, relative and if inflation is on the rise everywhere, we’re relatively fine. That doesn’t explain why the Aussie dollar rises when we report a high inflation number, but it does at least have some logic to it. I certainly agree that we’re in for a serious bout of global inflation, but I don’t know that it’s going to help our situation, even in a relative sense. It’s more likely that this only adds to our existing problems. There aren’t many attractive alternatives and it’s partly a case of picking your poison. But I’m bearish on the Aussie dollar.
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