In 1995, The Economist ran an article comparing the current account deficit in Australia at the time to that of Mexico just before the Mexican Peso's devaluation in 1994. At the time, the current account deficit in Australia was 5% of gross domestic product (GDP). Over the next five years, the comparison proved itself to be accurate as the Australian dollar lost over 40% of its value. Currently, there are signs that an even larger problem is looming on their financial horizon. The same publication has compared the current account deficit that Australia currently has to that the was experienced by the United States in 2000. Both nations, at the time, were riding the wave of a very strong economy that increased confidence in the economy to unprecedented levels and led to unrealistic expectations.
Why Look at the Balance of Payments?
As we look at the Australian economy, we need to consider the balance of payments.
The current account and the capital/financial account provide a good indication of the market potential of a given economy as well as potential problems that could adversely affect the value of the Australian dollar, as happened from 1995 to 2000. The accounts will also show if there is any excessive foreign exchange pressure being exerted on the Australian dollar. Having this information can give a nations leadership the information that it needs to decide if it needs to take action to protect the value of its currency.
History of the Australian economy
Prior to 1976, Australia had a fixed currency with respect to a particular currency (British pound until 1971, US dollar from 1971 to 1974) or a trade weighted index of currencies (1974 to 1976). The view of the government was that the exchange rate of their currency was too important...