Australia's Export Composition and Trade Dynamics

• Australia exports slightly more than it imports, with imports being roughly 25% of the total.
• China accounts for 1/3 of Australia's exports, a rate that has risen substantially since 2000, when the export rate was 4.4%.
• Import growth is now at a rate of 20% and above, indicating a massive reliance on China for both imports and exports.
• Trade has increased with Asian countries like Indonesia, Vietnam, and Singapore, which have a comparative advantage.
• The main focus of the Australian economy in terms of exports is in the primary sector, including agriculture and minerals.
• Minerals include gold and iron, and agriculture includes beef, wheat, and wool, collectively making up 80% of exports.
• Since 1999, the composition of exports has changed significantly; agriculture and farming have decreased due to the comparative advantage of other nations.

Recent Composition Changes in Australia's Exports

• Mineral exports have increased due to greater demand.
• Agricultural exports have decreased due to large fluctuations in world prices.
• Manufacturing has declined as a result of comparative advantage.

Financial Flows

• Financial flow is the movement of money, particularly investments both domestically and internationally.
• Financial flows were of less importance between the 1950s and 1970s due to protectionist policies and limitations on investments
• Financial deregulation in the 1970s and 1980s allowed financial flows to grow rapidly.
• International markets opened up, exchange rates were floated, and technological changes made shifting money easier.

Key Terms of Financial Flows

• FDI (Foreign Direct Investment) consists of long-term investments resulting in ownership of a company totaling more than 10%.
• Portfolio Investment refers to short-term investments for speculative and short-term capital gains, such as small shareholdings in securities.
• Deregulation allowed portfolio investment to thrive because more people can now invest funds internationally, and technology has made it easier.
• Deregulation is the removal of government regulations, rules, and restrictions in a market or economy.

Effects of Deregulation

• Improved efficiency and consumer sovereignty
• More competition amongst businesses
• More innovation and technology
• One major event was the 1983 float, when the market gained control of the value of the dollar rather than the RBA, set by supply and demand.
• Australia is a net importer, receiving more in investments than it invests in other economies.

Advantages of Financial Flows

• Transfers of technology and management skills
• Access to forex markets
• Creation of employment opportunities

Disadvantages of Financial Flows

• Loss of domestic ownership
• Reliance on foreign investors and business
• The volatile nature of speculative portfolio investment

Other Terms

• Debt Borrowings: Foreign loans, making up roughly 65% of total foreign liabilities
• Equity Borrowings: Direct and portfolio investment, making up roughly 35% of total foreign liabilities

Balance of Payments (BOP)

• Balance of payments is the record of all financial transactions between Australia and the rest of the world.
• The Balance of Payments (BOP) tracks two flows, real flows (physical goods and services), and financial flows (the flow of money/capital)

Balance of Payment Categories

• Money flowing into Australia is a credit.
• Money flowing out of Australia is a debt.
• The BOP is presented in two accounts, current and capital/financial.

Current Accounts (Non-Reversible)

• Balance of Goods: Export (credits) and import (debits) of goods
• Balance of Services: Export (credits) and import (debits) of services
• Net Primary Income (NPY): The income and dividends received (credits) and paid (debits) on foreign loans, investments, and foreign ownership.
• Net Secondary Income: Current transfer payments involving small items such as insurance claims, unconditional foreign aid, and pensions.
• When calculating the current account, the formula is 1+2+3+4 = balance
• Includes goods (net goods), services (net services), balance on goods and services, net primary income (previously Net Income), and net secondary income (previously Net Current Transfers).

The Structure of Balance on Current Account

• Net goods + Net services = Balance on goods and services + Net primary income + Net secondary income = Balance on current account

Capital and Financial Accounts

• This account concerns financial assets and liabilities flowing into and out of Australia, it is reversible, meaning an investor can withdraw money from a project.
• It incorporates assets and liabilities, and the movement of money from international borrowing and the purchase of assets like shares and real estate.
• Capital refers to the movement of money and includes capital transfers like foreign aid and debt forgiveness
• Assets also include non-produced goods like trademarks, patents, and franchises.

Components of Financial Accounts

• Direct Investment: More than 10% share ownership of a company
• Portfolio Investment: Buying/selling land, shares (over 10%)
• Financial Derivatives: Purchase of financial assets where value is determined by demand at that moment (futures)
• Reserve Assets: RBA stored money used for stabilising markets and international organization contributions
• Other Investments: Leftover transactions, trade credits
• Net errors and omissions refer to statistical discrepancies on the Capital and Financial Account.

Example Question on the BoP

• An Australian car dealer purchases Mazda cars to sell, the Mazda cars coming into Australia are imports
• The money flows out of Australia, marking this as a goods debit.
• For the rate of inflows equals outflows in a year, it is represented as 0 - 0.
• So current account + KAFA + net errors and omissions = 0

Links Between BOP Categories

• Shortfall of investments leads to a need for foreign investment.
• Financial flows into Australia are credit on the Capital and Financial Accounts (KAFA).
• Dividends from Australia to foreign investors are a debit on the NPY credit account.
• Borrowing money from overseas is credit on KAFA, as it is an inflow.
• Debt on KAFA will be larger than credit because of interest or dividends with borrowed funds Australia has a low rate of domestic investment, as there is a need for immense investments.
• Investments received are credit on the Capital and Financial Accounts (KAFA).
• Money leaves the country in the form of dividends and interest, resulting in debts CA and reducing net primary income

International Borrowing

• Borrowed funds are seen as credit in terms of KAFA, because money flows into Australia
• Repayment costs for the debt are a debit on NPY (CA)
• A high rate of foreign borrowing will create a deficit as the rate of money leaving will be larger than the amount of money entering the nation.
• A deficit on the entire current account is known as CAD, meaning current account deficit

Foreign Investment

• Foreign investors invest in Australia by buying land, shares, and portions of companies (over 10% qualifies as FDI).
• Investors receive rent, dividends, and profit for this investment
• Foreign investment is recorded as credit on KAFA
• Returns on investment for investors are debts on NPY (CA), leading to a deficit on NPY (cad).

Downsides to CAD

• Exchange rates decrease due to a loss in investor confidence, leading to reduced demand and a drop in the price of the Australian dollar.
• Balance of Payments Constraint: The economy cannot undergo economic growth because higher rates require an increase in imports, limiting economic performance.
• Monetary Changes: Australia must develop a tighter monetary policy in order to ensure and increase imports and deteriorate the element of CAD.

Exchange Rate

• It refers to the price of one currency in comparison to another.
• It is an asset price that determines import and export rates between nations.
• Too high of an exchange rate might mean a nation might not choose to trade with that nation.
• In Australia, exchange rates are identified using the indirect method, when currencies are converted from one to another.
• Direct is when we calculate how much of a currency to use in order to buy one unit of foreign currency
• $A 1.27 = $US 1.00

How to Determine Exchange Rates

• Floating: Supply and demand determine the price of a currency, and with no government intervention.
• Dirty Float: Some government intervention ensures the exchange rate is steady and does not fluctuate to the point where it can limit exports and imports.
• Flexible Peg: A fixed exchange rate between two nations agreed beforehand.
• Fixed or Managed: Rate set by the government's central bank to control exchange rates effectively, with no intervention of supply and demand.

Exchange Rates are Determined in Two Ways

• Bilateral: The normal process of converting a currency into a foreign currency.
• Trade Weight Index: A measure of the (Aud) against a basket of currencies that are regularly traded with. Each currency is weighted according to its trade importance.
• The index includes 21 counties that Australia trades with. It must account for at least 90% of trade.
• The TWI is accurate as it takes into account Australia's balance of payments performance over time.
• Its limitations are that the weightings are based on trade volumes, regardless of the currency in which exports and imports take place.
• Increasing purchasing power means appreciation, and decreasing purchasing power means depreciation.

Australia's trade dynamics reveal a reliance on China, which accounts for one-third of Australia's exports. Import growth is 20% and above. The economy is focused on the primary sector (agriculture and minerals), accounting for 80% of exports.