Australia’s economy heavily relies on its natural resources, with iron ore being the country’s largest export. That roller coaster ride of iron ore prices is felt most immediately by the Australian dollar, but by extension the prosperity of the entire economy. China’s booming demand for iron ore is accelerating the pressure. This increase in demand strengthens all other currencies against the Australian dollar. This relationship between Australian iron ore prices and the Australian economy is important to understand to appreciate today’s economic landscape.
The health of China’s economy plays a vital role in this dynamic, as it is the primary destination for Australia’s iron ore exports. Furthermore, relatively high inflation levels inside Australia, as well as the growth rate of the Commonwealth, further decrease this relationship. The balance of trade, on the other hand, considers only exports and imports and measures the difference. An undervalued currency would factor heavily into raising the Australian dollar.
The Role of Iron Ore in Australia’s Economy
Iron ore remains Australia’s single biggest export commodity, bringing in a windfall through national revenue. This oil export is an important component of our total trade. As such it serves as an important barometer for the health of the overall Australian economy. Countries around the globe are increasing their manufacturing capacity. To feed all of their ongoing construction and manufacturing, they very much rely on iron ore imports.
China has continued to be Australia’s largest iron ore importer, illustrating the essentiality of this relationship. In other words, economic growth in China has a one for one link to rising demand for iron ore. As China’s infrastructure footprint grows so too does its thirst for this natural resource. This has enormous implications for Australia’s trade balance and ongoing economic prosperity.
Additionally, rising iron ore prices more than offset the boom’s negative impact on Australia’s trade surplus. When exports are more than imports, Australia experiences a trade surplus. This increased positive balance tends to raise the exchange rate of the Australian dollar in international markets. A fall in iron ore prices can push the trade balance into deficit, exerting downward pressure on the currency.
Influences on the Australian Dollar
No other commodity has as much impact over the Australian dollar as price of iron ore. This last effect is especially strong because it operates through a direct effect on trade balances. When iron ore prices rise, there is usually an uptick in demand for the Australian dollar as foreign buyers seek to purchase more of this commodity. In both cases, this new demand leads to currency appreciation.
A decrease in prices reduces the aggregate demand for the Australian dollar, increasing the chance that Australia’s currency will depreciate. These changes in currency value have a broad influence on Australia’s inflation and overall economic health. While a stronger dollar lowers the price of imports, it has the negative effect of reducing the competitiveness of our exports.
The Reserve Bank of Australia (RBA) plays a crucial role in managing these dynamics by setting interest rates that influence lending among banks. Through these rate adjustments, the RBA seeks to keep inflation at 2-3%. Should inflation rise significantly due to external pressures or domestic factors, the RBA may increase interest rates to stabilize the economy. On the other hand, cut interest rates and boost economic activity but risk inflationary worries.
The Interplay Between Trade Balance and Economic Growth
Australia’s trade balance is very sensitive to movements in iron ore prices and to global economic growth rates. A positive trade balance not only means that we export more than we import, it means that we have strong economic activity. When iron ore prices are high, Australia’s trade balance is usually high as well, illustrating an economic powerhouse.
Inflation in Australia has an equally important part in this equation. If inflation is shown to be significantly above the RBA’s target band, increases to monetary policy will soon come. These proposed changes potentially pose the largest impact to domestic consumption and investment. This could result in a much lower growth rate as businesses may expect less consumer spending because of increased prices.
Alongside these developments, the state of the global economy should be watched carefully. If China does indeed decelerate, it will almost certainly need less iron ore. This decrease in demand will be detrimental to Australia’s trade balance. This complex interplay means that economic analysts must consider multiple variables when assessing future trends in both iron ore prices and the Australian economy.