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The rise and fall of the Australian dollar - by Felipe Rodriquez (Nonsenso)


The Australian dollar has fallen to a record low. Australian politicians, and the Reserve Bank of Australia are telling the market that the dollar is now very undervalued. The question is if this is true, or if there are fundamental reasons for the drop in the Australian dollar, relative to the US dollar. An important reason for the strength in the US dollar is the transparency and efficiency of its equity market. Another reason is the stimulating competitive economic environment in the US, which fosters excellence and quality.

Researching US companies is a relatively easy job, compared to researching companies in Europe and Australia. Disclosure rules in the United States are the toughest in the world, forcing companies to disclose substantially more information than elsewhere in the world. And all this information is available on the Internet. On top of that US legal professionals regularly punish companies with costly class action lawsuits if there is only the hint of unlawful activity by an American company. Quarterly reporting, which is not mandatory in Australia and most of Europe, also makes companies more transparent, and makes it easier to assess the performance of US companies. This transparency leads to a lower risk premium on valuation, which is why US companies are relatively more expensive than their AU and European peers. Transparency and more efficient markets are the reasons why it is usually more attractive to invest in US companies, instead of investing in Australian or European companies. Australia shares with Europe a lack of transparency and efficiency in its equity markets, when compared to the US.

An important obstacle for growth in Australia is the dividend imputation system, which encourages companies to pay out a franked dividend in order to attract investors. The dividend imputation system provides a tax free dividend only to the local investor. Foreign investors do not care about franked dividends, they have to pay taxes in their own country, and are more interested in quality of growth.
Australian investors often make investment decisions on the basis of the franked dividend yield of a company. Australian companies try to attract investors by paying substantial franked dividends, often at the expense of investing this money in optimal quality growth. Abolishing the dividend imputation system, exchanging it for a CGT free environment, will create an environment where companies are stimulated to invest in quality growth and international expansion. Companies should be encouraged to only pay out a dividend when the company cannot invest capital at a favorable rate of return. Only with the abolition of the franking system will Australian companies be able to grow at their optimal growth rate.
A CGT free environment would also be an incentive for wealthy individuals to become residents of Australia, bringing their assets along with them into the country. Furthermore a CGT free environment is likely to make markets more efficient, because shareholders are no longer prevented from selling their shares in companies with questionable performance, transferring their money to higher quality companies. Currently switching assets creates a CGT event, thereby creating a tax obstacle which decreases liquidity, and thereby efficiency, in the market. The recent changes in the CGT regulation are not enough, because on short-term gains the tax is still 50%, which discourages short term trading of shares and derivatives, creating a superficial inefficiency in the market.

Abolishing the dividend imputation system will be a very unpopular measure with the electorate, although abolishing CGT would be a reasonable tradeoff. Additionally the government could consider making interest payments on government and Australian corporate bonds tax-free or tax limited. Such a measure would encourage debt to remain in the country, and thereby prevents future capital outflows out of the country in the form of interest payments. Tax free corporate bonds would make it easier for companies to borrow capital for expansion, thereby making them more competitive relative to their international peers. These measures would give investors the choice to invest in a bond that returns a tax-free interest payment, just like a franked dividend currently gives them. It would provide Australian companies with an environment that encourages faster growth, thereby fostering an environment that stimulates foreign investment, with the result being stronger capital inflows, and a stronger dollar.

Another worry for Australia is the lack of transparency in the political decision making process. The current political system does not encourage a consensus based decision process. Whatever decision the liberal party supports, the ALP usually opposes, and vice versa. A change of power could therefore have traumatic consequences, because it is unpredictable what regulatory changes the next government would implement. In the US the democrats and republicans are almost always forced into a compromise, because the president can veto proposals from congress, and congress can frustrate and delay proposals from the president. Although a situation where the congress is dominated by the same party as the presidency could potentially lead to dangerous situations. Such as providing substantial tax cuts in an already overheated economy, which in turn leads to higher inflation, requiring further increases in interest rates, lowering company valuations.
In Australia the government can often do as it pleases, without much need to negotiate a substantial compromise that pleases most of the members of parliament. The Internet censorship regulation is a good example. This law proves to be quite ineffective in preventing access to global content that would be rated RC. Opinion leaders abroad because of this regulation have called Australia the global village idiot. Not exactly a stimulating signal to foreign IT companies to setup shop in Australia. Australia regulates where it should promote a deregulated environment. Australia could benefit greatly from a consensus based political decision process, instead of the usual destructive confrontational factionalism that dominates the Australian political environment.

Australia's dependence on commodity products is yet another reason for a low dollar. Economic growth depends to a substantial extent on key international commodity prices. Because of the cyclical nature of commodity prices, there are inherent risks for Australian future economic growth, which are discounted in the currency price. To overcome these risks, the government should decide to make substantial investments, in the order of 50 billion dollars, in encouraging a state of art IT and technology industry in this country to develop.
But this can only be achieved when the telecommunications environment is completely deregulated, privatized, and de-monopolized. Bill Gates was not disappointed in the Australian telecommunications industry without a reason! The fact that Telstra owns the largest mobile operator, the largest cable network operator, as well as the largest landline network in this country does not encourage a competitive broadband environment. Why else is Telstra still able to charge commercial broadband customers at a rate in excess of 10 cents per megabyte of data transferred, whereas US companies are providing flat rate priced broadband products?
Ideally Telstra would be forced by the regulator to auction its cable assets to the highest bidder, foreign or domestic. Not only would this provide a substantial cash injection for Telstra to invest in global expansion, domestically it would achieve an optimal competitive environment in the broadband industry. Such a forced measure would drive telecommunications product prices down, which would benefit all Australians, and would make the country much more attractive as a base for IT companies. In this case the Australian government could take an example from Europe; in Holland KPN was forced to sell its cable network, Casema. Thereby creating a competitive environment that has greatly benefited consumers.

The Australian government should address these issues, before it can expect greater capital inflows into the Australian economy, benefiting the strength of the Australian dollar. Relative to the foreign competition Australia is simply not a very attractive country to invest in. As long as this remains so, the dollar will be suffering from weakness, instead of potentially becoming one of the world's strongest currencies.


Felipe Rodriquez
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