The terms of trade (export prices relative to import prices) are important but they are not the sole determinant of relative currency valuations. If Australia’s terms of trade – on a steep rise over the past 8 years – begin to deteriorate in a major way, the real purchasing power of Australian dollar holders will be eroded. Australian output will be worth less as income and capacity to spend abroad shrinks.

In normal times the Australian exchange rate relative to the currencies of its big trading partners is driven by many things apart from the terms of trade with them. Over the last thirty years there has been wide divergence between Australia’s terms of trade and the value of the Oz dollar vis a vis its East Asian partners.

But the last 8 years have seen an unusual lift in Australia’s terms of trade that has taken the Oz right up there with them. And the old aphorism seems full of wisdom. If commodities prices really have turned down – even if only cyclically – the Oz can be expected to have a sharp fall.  Even before the Reserve Bank starts winding back interest rates, pressures in the capital market are beginning to kick in too.

One can still be bullish about the Australian dollar in the medium to longer term. The forces that have boosted Australian resource prices are structural, as well as cyclical, and they are likely to be in the play for a quite a while yet. The response of export volumes to higher export prices in the resource sector are only just beginning to kick in in a big way.

Which is where I started with Ishizaka-san before his question got the attention that it deserved.