Forex Macroeconomics: How Do AIIB and CHAFTA Impact the AUD?

In 2009, there were dire warnings for Aussies of a "giant iceberg more than seven times the size of Rottnest Island" drifting towards the nation. The Sydney Morning Herald suggested this might be due to environmental change. But, the real story might be the economic change, facing Australia after the 2008 Credit Crunch.

Australia has come a long way since its origins as a penal colony of England. Over the years, it has gradually weaned itself away from the mother country, gaining more independence. With the signing of the China Australia Free Trade Agreement (CHAFTA) and membership in the Asian Infrastructure Investment Bank (AIIB), Australia might be taking the next step.

Are the AIIB and CHAFTA pillars of a new international trade system? Do these signings represent a shift of Australia focus from the West to the East? This Forex macroeconomics review will discuss Australia's trade history, the advantages of signing the aforementioned agreements and their possible impact on the Australian dollar (AUD).

China is Australia's #1 Trade Partner

You could take a survey on the streets of Sydney, asking the folks "Who is the #1 trade partner of Australia?" The majority might say "England, that was easy." No. "Well, how about the United States, the two countries share the same currency, right?" No. What is the answer?

China

China is Australia's largest trading partner, accounting for some 32% of Australian total exports. The next trading partner is not even close - Japan is 16% and the United States is 5%. Of course, if you think about geography and natural resources, this all makes sense:

• Distance between Australia and China is 4,628 miles (7,448 kilometers)

• Distance between Australia and the US is 9,437 miles (15,187 kilometers)

Australia supplies important raw materials to China.

"You've Come a Long Way, Australia"

On 26 January 1788, the first "Australia Day" was inaugurated with the arrival of 700 convicts to modern-day Australia. British Captain Arthur Phillip of the HMS Sirius brought these prisoners to what was then known as New South Wales, to set up a penal colony (prison). The rest is, as they say history.

As a colony, Australia provided raw materials (commodities) such as wool, coal and gold to England. As of 1906, 59% of Australia imports and 49% of Australian exports were with the UK. Naturally, the dominance by England over its economic affairs, prevented Australia from developing its own independent economic policy.

On 14 February 1966, Australia took another step towards independence by replacing its pound with the dollar. Now, in 2016, Australia might be taking the next step by turning its back on the United States Western bloc and approaching the China Eastern bloc. Geographically, this move makes sense.

Australia Trade with China

The Government of Australia must continue to develop trade agreements to help its local exporting businesses, as well as find the cheapest "Made in China" merchandise for its Australian consumers. The latest 2016 trade agreements reflect China's rise as a significant agricultural and industrial producer for the world.

Australian Exports to China

China accounts for one-third of all Australia exports. Key Australia exports to China include iron ore, coal, copper, gold, silver, wheat, barley, meat and live animals. Australia provides some of the raw materials used for Chinese factories to manufacture finished goods.

Australian Imports from China

China is the #1 importer to Australia, providing a wide range of cheap goods, including clothing, computers, toys, furniture and sporting goods.

Strategic Value of AIIB & CHAFTA Hypothesis

Australia and China share a number of common geo-political and economic interests. Both are emerging powers, who were somewhat insignificant when the 1944 Bretton Woods agreement was signed. Therefore, they both may share the interest in achieving the following three goals: 1. Replace outdated international monetary systems, 2. Create a more equitable international trade system, and 3. Flex new financial muscle. Together, Australia and China can challenge the inadequate international economic system's status quo.

1. Replace Bretton Woods

How many agreements last for more than 70 years? The Bretton Woods Agreement of 1944 established the framework for the modern international monetary system. Delegates from 44 countries created the foundation for organizations, such as the United Nations, World Bank and International Monetary Fund (IMF). But, Bretton Woods is almost 70 years old and is hopelessly out-dated.

The weaknesses of the present international economic system have been revealed by the PIIGS, 2008 Credit Crunch and continued distrust of its banking sector. China wonders why it only has #6 voting rights at the World Bank, when it has the #1 GNP and highest growth rates in the world. Therefore, CHAFTA could be a bandage for ineffective World Trade Organization (WTO) policies and AIIB could be a World Bank replacement.

2. Create Future Trading Platform

Australia's AIIB and CHAFTA agreements were both signed in 2015. Thus, both were probably discussed simultaneously at meetings between Australia and China trade representatives. There might have even been a quid pro quo. Perhaps, China offered favorable CHAFTA terms, if Australia joined AIIB.

3. Establish Economic Influence

Australia was still using the pound as its currency when Bretton Woods was signed in 1944. Thus, in 2016 it might want to assert its new economic independence and power with these agreements. The AUD is becoming more important in Forex circles.

Of course, Communist China did not really exist in 1944, so it probably is using these agreements to increase its leverage, prestige and global power. The new Australia and China economic arrangements threaten to leave the United States "out in the cold."

CHAFTA Importance

According to its government, "Australia has committed itself over the years to reducing its trade barriers and has supported multilateral efforts through organisations such as the World Trade Organization. In the past two decades, however, there has been a significant increase in the signing of preferential trade agreements, commonly referred to as Free Trade Agreements (FTAs) around the world." The international economic framework is beginning to break down as nations feel forced to "go-it-alone" using bi-lateral trade pacts.

Australia has about a dozen of these bilateral trade agreements, signing the China Australia Free Trade Agreement (CHAFTA) on 20 December 2015. This is a significant win-win for both nations.

The Australian Government Department of Foreign Affairs & Trade has stated that there will be a three phase cut in tariffs starting with the immediate reduction of 7,289 Chinese tariffs. The second phase of cuts was on 1 January 2016 and the third phase is on 1 January 2017.

Benefits for Australia

Australia exporting firms gain a distinct comparative advantage over other nations with CHAFTA. CHAFTA also includes the promise by China that it will promote 77 Australian universities. Aussie financial firms could sell more products to the burgeoning Chinese middle class.

CHAFTA is a Nail in Coffin of Bretton Woods

Aussie consumers can enjoy cheaper garments and electronics. The Chinese might even hope to sell more automobiles to Australians.

CHAFTA is one more nail in the coffin of the Western economic system. Australia is a mature nation, not needing permission from the United States, United Kingdom or Japan to determine its destiny.

Benefits for China

CHAFTA provides China with a fully-developed consumer market for its merchandise, as well as cheaper natural resources. If the US threatens sanctions, then China can defend itself behind a "Great Wall Around the East (which includes resource-rich Australia)." If need be, Chinese exporters can shift exports from the US to Australia.

Australia Joins AIIB

For many, Australia's decision to join the AIIB on 29 June 2015 was a no-brainer. Australia Prime Minister Tony Abbott contributed $930 million for a seat on the AIIB Board of Directors, which made Australia the sixth-largest shareholder.

The Australian Financial Review has reported that Australia would not receive one of the five vice president positions in the AIIB. These went to England, Germany, India, Indonesia and South Korea.

How Does Australia Benefit from AIIB?

With its position on the AIIB Board of Directors, Australia would be a key decision-maker, determining where the construction projects would take place, which contractors were hired and financing. Australian mines, builders, architects and banks would benefit financially, by being part of future AIIB development projects. These projects could be quite lucrative.

Economists list Australia as #13 for global production in 2016. By signing the AIIB, Australia can gain more geo-political leverage based on its GDP for 2017, not on its GDP from the 1940s.

AIIB is Another Nail in Coffin of Bretton Woods

The founding members of AIIB agreed on 24 October 2014 to create this organization in order to satisfy important Asian needs for infrastructure upgrades. Some complain that the World Bank has used its influence to make the West wealthy, by ignoring the interests of developing nations. Neither the United States nor Japan are members of the AIIB.

As the AIIB gains momentum, the world's focus would naturally shift East. Australia would have an inside track on future Asian trade development.

AUD Correlations May Change

In 2016, there have been very close positive AUD correlations with both gold and the S&P (gold represents 5% of Aussie trade.)

BetaShares' Drew Corbett explained, "[b]y analyzing the movements in the gold spot price and the AUD/USD exchange rate we have found that, generally speaking, over the last three decades, when the price of gold bullion has risen, so too has the Australian dollar relative to the U.S. dollar." This could change if Australia manufacturing expands; moreover, closer ties to the East could lead to the AUD becoming more correlated with a Chinese stock index.

Perhaps, that 2009 warning about an iceberg approaching Australia, was code for "China." By creating these mutually-beneficial trade agreements - AIIB and CHAFTA - Australia and China have created a solid foundation for future international trade. The AUD might gain more importance as an up-and-coming Asian currency; only time will tell.