COVID-19 has proven to be an unpreceded health crisis and has changed the way we communicate, work and spend our leisure time. In times of significant disruption, global markets and economic trends tend to follow suite, and also endure turbulent times.
This idea has once again come to light as the ASX 200 (Australia’s stock market) has fallen by more than 30% since the pandemic has caught an unprepared world off guard. To compare the high and low points, in mid-February of 2020, the ASX sat at 7150 basis points (value of market) and plummeted as low as 4550 towards the end of March, a staggering 36% fall in 1 month!
Simultaneous to this downfall, the Australian dollar has also fallen significantly.
On the eve of 2020, the AU$1 was worth US$0.70, a figure which has fallen to an 18-year low of US$0.57.
This shift was relatively instantaneous in nature as depicted in the graph below.
The downward pressure on the Australian dollar has also been reflected in the Trade Weighted Index which has fallen from an index of 58.1 in January of 2020 to 54.7 in March of 2020.
COVID-19 has created unprecedented impacts within our economic systems, ultimately illuminating uncertainty as a driver for change and disruption.
The data above demonstrates numerous concepts within the financial flows component of the globalisation topic. In times of high uncertainty, as COVID poses, we see lower investor confidence, and this has a flow on effects in the stock markets of the world. The instantaneous effect of financial flows has meant that when investors feel uncertain and begin to sell their shares, other investors follow and markets lose a significant amount of value in a short amount of time. This action of mirroring other investors’s decisions on an aggregated (total) level reflects the concept “herd mentality”. Herd behaviour is a phenomenon in which individuals act collectively as part of a group, often making decisions as a group that they would not make as an individual. This idea underpins the volatile quality of financial flows where sharp movements in markets are often derived from individuals not wanting to operate against the collective in an attempt to either maximise returns or offset losses from falling prices.
The depreciation of the exchange rate and plummeting of the stock market happening simultaneously is not a coincidence. Based on the fact that there is a large amount of foreign owned Australian shares, a mass selling off of shares will lead to an increase in the supply of $AUD and decrease in its value. This increase in supply occurs as these foreign investors will use the money (in Australian dollars) gained from the sale of their shares to obtain other currency via the Foreign Exchange Market (FOREX), in search of safer investments.
In effect the conversion of currency involves the “supply $AUD” within the FOREX market as depicted above and leads to a depreciation.
In the aggregate demand formula, consumption accounts for approximately 60% of total demand in the Australian economy. If consumers witness plummeting stock markets (also referred to as a “sea of red”) this will impact their confidence and decision making when it comes to their individual consumption levels. When stock markets perform poorly, consumer sentiment falls and consumers choose to spend less and in effect, when this occurs on a large scale, it will decrease aggregate demand levels in an economy, ceteris paribus (keeping everything else the same). This effect is currently occurring around us today where consumers are choosing to spend less in fear of an imminent recession where job losses could reduce household income, colloquially termed “saving for a rainy day”.
A significant portion of Australia’s shares are foreign owned, this means that when overseas investors sell their Australian shares, this money is then taken out of Australia’s economy. In terms of the balance of payments, the purchases and selling of shares is recorded in the financial account in the form of portfolio investment. If overseas investors sell Australian shares this will be recorded as a debit in the financial account, increasing the deficit of Australia’s Financial Account. Through this, in the mid-term, Australia’s Current Account would improve as there are less foreign owned shares that need to be serviced by dividend repayments, reducing debits in the current account.
If the Australian dollar depreciates, this will have implications on Australia’s net foreign debt. A depreciation reduces the purchasing power of the Australian dollar meaning that it will require more “Australian dollars” to pay for the same amount of debt. Here, when the Australian dollar decreases this leads to an increase in the size of Australia’s net foreign debt (in Australian dollar terms) and hence decreases Australia’s external stability. Compounded with this, Australia will also experience increases in their servicing costs for overseas debt. This will reduce Australia’s overseas liabilities, where increased debt commitments and servicing costs may see large amounts of financial flows moving out of Australia’s economy, potential capital that could have contributed to consumption and investment in Australia.