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Australian dollar update

I post this to follow up on a question from a reader concerning the advisability of investing in Australia. The main risk I see is that everyone loves Australia right now, and that's why the currency is about as strong relative to the U.S. dollar as it has ever been. If you are a U.S. investor putting money to work in Australia today, the price of admission is very high. That's not to say the investment doesn't make sense, just that the relative value of the investment is not terribly attractive, and there is the potential for significant downside currency risk.

To explain the chart: the blue line is simply the Aussie dollar exchange rate, while the green line is what I calculate the purchasing power parity (PPP) of the exchange rate to be over time. The PPP calculation takes account of the differential in inflation between Australia and the U.S., and it is theoretically the value of the currency that would make a given basket of goods and services cost the same in both countries. With the blue line exceeding the green line by a wide margin, this means that a U.S. visitor to Australia is likely to find that most things are expensive relative to what they cost in the U.S.

The downtrend evident in the PPP line means that Australian inflation has tended to be higher than U.S. inflation, so the currency therefore has a tendency to trend lower over time against the dollar. This may of course change in the future, and that wouldn't be impossible at all, especially considering that the Aussie central bank has already tightened monetary policy but the Fed is many months away from doing so.

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