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Lesson M10.L03: AUD History — From Fixed to Float and Key Drivers

Module: Exchange Rates and the Open Economy Level: intro Duration: 30 minutes Learning Objective: Identify the key drivers of AUD fluctuations since the 1983 float. Data as of: 2024 Provenance: RBA Education | OpenStax Macro 3e

Explanation

Before December 1983, the Australian dollar was pegged — its value was fixed against a basket of currencies, managed by the RBA with periodic adjustments. On 9 December 1983, Treasurer Paul Keating and Prime Minister Bob Hawke floated the AUD, allowing markets to set its value freely. Simultaneously, the capital account was liberalised, allowing foreigners to invest freely in Australia and Australians to invest abroad.

The float was driven by the difficulty of managing a fixed exchange rate while facing large capital flows and a desire to give monetary policy independence. Since then, the AUD has been determined by supply and demand in global foreign exchange markets — with the RBA only intervening in extreme cases.

Key drivers of AUD fluctuations since 1983:

  1. Commodity prices (especially iron ore and coal): Australia is a major exporter of iron ore, coal, and LNG. When commodity prices rise, Australian export revenues rise, increasing demand for AUD. The AUD is often called a "commodity currency". The AUD/USD hit a post-float high above 1.10 in 2011 during the mining boom when iron ore prices surged.

  2. Interest rate differentials: Higher Australian interest rates (relative to the US and others) attract capital inflows, appreciating the AUD. The RBA's rate decisions and expectations about future rate moves are watched closely by FX markets.

  3. Risk sentiment (global risk appetite): The AUD is a "risk-on" currency — it appreciates when global investors are confident and invest in higher-yielding assets, and depreciates during crises (e.g., the AUD fell sharply in March 2020 during the COVID-19 shock, reaching 0.55 briefly).

  4. Chinese economic growth: China absorbs about 28% of Australian exports. Strong Chinese growth drives iron ore and coal demand, boosting the AUD. A Chinese slowdown (as in 2015–16 and 2022–23) tends to weaken the AUD.

Worked Example

Scenario: Iron ore price shock and AUD movement

Context: In 2021, Australia's iron ore export value surged. Use a stylised example to estimate the effect on AUD demand.

Given data (2021, approximate): - Australia's iron ore export volume: 900 million tonnes - Iron ore price rise: from US$90/tonne to US$180/tonne (doubled) - AUD/USD at start: 0.72

Step 1 — Calculate export revenue before price rise:

Revenue_before = 900 million tonnes × US$90 = US$81,000 million = US$81 billion

Step 2 — Calculate export revenue after price rise:

Revenue_after = 900 million tonnes × US$180 = US$162,000 million = US$162 billion

Step 3 — Calculate increase in AUD demand:

Additional USD receipts = US$162b − US$81b = US$81 billion

To repatriate these earnings, exporters sell USD and buy AUD — creating additional demand of ~US$81b for Australian dollars.

Step 4 — Qualitative price impact:

This surge in AUD demand pushed the AUD/USD to approximately 0.78 by mid-2021. The percentage appreciation:

(0.78 − 0.72) / 0.72 × 100 = 0.06/0.72 × 100 = +8.3%

The AUD appreciated roughly 8% in response to the commodity boom — consistent with Australia's history as a commodity currency.

Common Misconception

Misconception: "Since the RBA floated the AUD in 1983, the RBA has had no influence over the exchange rate."

Correction: The RBA does not target an exchange rate level under the float, but it retains two indirect tools: (1) interest rate policy — changes to the cash rate affect capital flows and thus the AUD (e.g., rate cuts depreciate the AUD); and (2) direct FX intervention — the RBA can and occasionally does buy or sell AUD in markets to smooth excessive volatility, though this is rare. The RBA has also communicated views on the AUD in speeches when it considered the rate "uncomfortably high" (as in 2012–13 when the AUD was above parity with the USD). The float means no fixed target, not zero influence.

Practice Prompts

  1. Why did Australia float the AUD in December 1983, and what institutional change accompanied the float? → Answer: Under the fixed (or managed) peg, the RBA had to buy or sell unlimited quantities of foreign exchange to maintain the fixed rate, making monetary policy subordinate to exchange rate management. Capital account liberalisation made it increasingly difficult to hold the peg. Floating freed the RBA to use interest rates for domestic objectives (inflation, growth). Accompanying the float was financial deregulation — the capital account was opened, allowing free movement of funds in and out of Australia, and foreign banks were permitted to operate in Australia.

  2. NUMERICAL CALCULATION: In mid-2022, iron ore prices fell from US$150/tonne to US$100/tonne. Australia's export volume was 800 million tonnes. Calculate (a) the loss in annual export revenue in USD, and (b) if the AUD/USD was 0.74 before the price fall and the AUD depreciated by approximately 1% per US$10/tonne price fall, estimate the new AUD/USD rate. → Answer: (a) Revenue before: 800m × 150 = US$120 billion Revenue after: 800m × 100 = US$80 billion Loss = 120 − 80 = US$40 billion (b) Price fall = US$150 − US$100 = US$50/tonne AUD depreciation = (US$50 / US$10) × 1% = 5% New rate: 0.74 × (1 − 0.05) = 0.74 × 0.95 = 0.703 The AUD/USD falls from 0.74 to approximately 0.70 — consistent with observed AUD weakness when iron ore prices fell in 2022.

  3. During the COVID-19 pandemic (March 2020), the AUD fell sharply to around 0.55. Commodity prices had also fallen, but recovered quickly. Which of the three key drivers (commodities, interest differentials, risk sentiment) most likely caused the initial sharp fall, and why? → Answer: The initial sharp fall was primarily driven by risk sentiment (global risk-off) rather than commodity prices or interest differentials. In March 2020, global financial markets seized up — investors fled to safe-haven assets (USD, JPY, gold) and sold high-yielding, commodity-linked currencies like the AUD. The speed of the fall (within days) was too fast for commodity or interest rate changes to explain alone. The AUD's status as a "risk-on" currency made it a prime target for selling when global uncertainty spiked. Commodity prices did fall later, but the initial driver was the collapse in risk appetite.

Further Resources