Loose Monetary Policy and Commodity Based Currencies
The International Monetary Fund, quite simply, is an organization that looks to secure economic and financial stability between its member countries; exchange rate stability is helpful in achieving this. Ultra-easy monetary policies, however, can create instability. Actions from central banks such as quantitative easing that we see in the US, Japan, and Great Britain create worries elsewhere in the world as developing economies particularly (the BRIC’s) see their respective currencies appreciate in foreign exchange markets. Furthermore, their foreign exchange reserves risk losing value as the status of a depreciating US dollar as the international reserve currency remains in question.
Over the last few years, gold bugs loved the idea that central banks have once again become net buyers of the yellow metal. It not only created an increase in demand that helped send the price skyrocketing, but also made apparent that gold was once again regarded as an asset of value with a foreseeable role in international finance. But, it was not just this shift to gold that we will witness from emerging market economies and Asian central banks, according to the IMF; Canadian (CAD) and Australian (AUD) dollars could potentially play that role as well.
The IMF regularly reviews the “Composition of Foreign Exchange Reserves” (COFER) of central banks around the world. The enlisted currencies belong to the economic giants of the developed world: the US dollar, the Euro, the Pound, the Yen, and the Swiss Franc. The reason being, that the fund considers any currency held in a central banks COFER as easily exchangeable, and appropriate for settling international transactions. As of late, those are two characteristics which suit both the CAD and AUD.
The question is, why? And the answer corresponds with the easy monetary policies of the developed economies that are only looking to prevent the onset of a second global recession. The clearest example is in the US. With no help from their government, the US Federal Reserve has kept their domestic economy afloat since 2009. Expansionary monetary policies have kept both long and short term interest rates at sustained lows, and as a result brought back a housing market that looked all but doomed. Quantitative easing effectively held down mortgage rates to entice new buyers and keep existing home owners from going underwater on their mortgage payments. For the sake of their economy, it was a necessity. The consequence, however, was the devaluation of their dollar, which at times saw a decreasing demand from international buyers and created a shift into gold and other currencies.
Inevitably, it is not the fact that the CAD and AUD act as a substitute to the US dollar as countries would not hold our currencies for the prospective dominance we might carry in international markets in the years to come. It’s the fact that both the CAD and AUD are backed by commodity based economies with sound governments. If we were to see an ultimate global recession, which some extreme economists are predicting, no one will be immune. Moreover, in an ever changing global economy, CAD and AUD represent what might be considered the least dirty shirt.