The global economy

An exchange rate is the price of one currency in terms of another. If one Australian dollar buys 65 US cents, a phone priced at US$650 costs A$1,000 before shipping and GST.

Since December 1983 the Australian dollar has floated: its price is set by supply and demand in foreign exchange markets, not fixed by the government. The RBA explains that the dollar tends to rise when the prices of our commodity exports rise (the terms of trade) and when Australian interest rates are high compared with other countries, and that over shorter periods it moves with the mood of global investors. That is why it is often called a commodity currency.

A falling dollar makes Australian exports cheaper for foreigners and imports dearer for us. RBA research found that most of an exchange rate change, around 80 per cent, shows up in the prices importers pay at the border, much of it within a quarter. Only a small part reaches the overall consumer price index, and slowly, because local costs such as wages, rent and transport make up much of what we pay in shops. The RBA has described the floating dollar as a shock absorber: when commodity prices slump, the dollar falls and cushions the blow to exporters.

Exports are what Australia sells to the rest of the world; imports are what we buy. The difference is the trade balance. Add the income Australia pays and receives on investments across borders, such as interest and dividends, plus some transfers, and you get the current account.

The other half of the accounts is the capital and financial account, which records who buys whose assets. Under double-entry bookkeeping the two add up to zero, apart from measurement errors. If Australia buys more from the world than it sells, foreigners must be adding to their holdings of Australian assets, such as shares, bonds, property and bank deposits, by the same amount. This is an accounting identity, not a theory about whether deficits are good or bad.

Australia ran current account deficits for most of the period from the mid-1970s, using foreign capital to fund more investment than domestic saving covered. It moved into surplus in mid-2019 for the first time since 1975, but was back in deficit by $27.2 billion in the June quarter of 2026. The accumulated result of past deficits is Australia's net foreign liabilities: what foreigners own in Australia minus what Australians own abroad, which the ABS put at $638.9 billion at 30 June 2026.

Owing money to foreigners is not automatically dangerous. What matters a great deal is the currency the debts are in.

An RBA study of the ABS's 2022 survey found that around three-quarters of Australia's foreign liabilities are in Australian dollars, while most of our foreign assets, largely superannuation funds' overseas shares, are in foreign currencies. Banks, the main borrowers in foreign currency, hedge most of it with derivatives. Overall Australia has a net foreign currency asset position. So when the dollar falls, the Australian-dollar value of our foreign assets rises, and our net foreign liabilities shrink rather than grow.

Many countries are in the opposite position. If a government or its businesses borrow in US dollars, every fall in the local currency raises the local-currency cost of each repayment. That is how a currency crisis turns into a debt crisis. Economists call the difficulty many countries have in borrowing abroad in their own currency original sin. Research at the Bank for International Settlements suggests that borrowing in local currency reduces this vulnerability but does not remove it, because foreign lenders still pull back when global conditions tighten.

Countries differ in how much control they have over their own money. It helps to think of a spectrum.

• Floating own-currency issuers, such as Australia, the United States, the United Kingdom and Japan. The government spends and borrows in a currency its own central bank issues, and the exchange rate moves freely. It cannot run out of that currency, but it can still run into inflation, exchange-rate and real-resource limits.
• Pegs and currency boards. Hong Kong keeps its dollar between 7.75 and 7.85 to the US dollar, and its monetary base is fully backed by US dollar assets, so local interest rates adjust automatically to defend the peg. That buys stability at the cost of independent interest-rate policy.
• Members of a currency union. The 21 EU countries in the euro area spend a currency none of them issues alone. The economist Paul De Grauwe argued this leaves them exposed to market panics, rather like emerging economies.
• Countries with large foreign-currency debts. Many developing countries issue their own currency but owe heavily in US dollars, so a falling exchange rate can make their debts unpayable.

Real countries can sit between these categories, and their position can change.

Even a floating currency issuer depends on the rest of the world for things it does not make, or does not make enough of. Australia buys much of its fuel, many medicines and a great deal of machinery and equipment from overseas. Paying for them takes foreign currency, which Australians obtain by selling exports, attracting foreign investment or borrowing.

The Australian Government can create Australian dollars. It cannot create the US dollars an overseas fuel supplier wants; Australians can only buy them on the market, and if many more Australian dollars are offered, their price falls. A sharp fall in the dollar makes imports dearer and can add to inflation for a while.

MMT economists accept this. They argue that for a country like Australia the binding limits are real resources and inflation rather than finance, and that the floating exchange rate absorbs external shocks. Critics give more weight to the risk that very large deficits or very low interest rates could weaken the currency and push up prices. For countries that must import food and fuel and owe in dollars, Kaboub argues, the external constraint is the one that bites first. Keep this in mind as you watch: 'the government can always pay' is true of debts in its own currency, and it is not the whole story.