Central banks can exaggerate their ability to manage exchange rates

Central banks can exaggerate their ability to manage exchange rates. The Reserve Bank has said further exchange rate depreciation was likely to be needed. A fall to 75 US cent has been widely canvassed as being close to its fundamental value. A small fall could be beneficial but a loss of control could be catastrophic. Taken too far, inflation pressures build, foreign debt rises, growth declines, living standards deteriorate, financial market volatility rises and investors steer clear until conditions settle. There is a tendency for weakness to feed on itself until selling is exhausted. A lower exchange rate is supposed to help competitiveness. Whether that happens depends on companies being able to respond. BHP Billiton will not sell any more iron ore. Holden is not going to start exporting cars. Bigger structural effects play a role. In urging markets to take the dollar lower, the Reserve Bank is invoking a force it will not easily control. What is worse: a currency that is too high or one that cannot stop falling?