Mission Accomplished!

Quantitative Easing must have some purpose, right...?

IF the POINT OF talking up Quantitative Easing was to boost stocks, mission accomplished! says Dan Denning in his Daily Reckoning Australia.

But what happens now if the Fed does not follow through and actually buy more Treasury bonds and other assets? Will all the inflation front runners be smashed if the Fed fails to deliver?

You'd think evidence of a recovery-less recovery in the US would take the rally out of risk assets and be the high-water mark for the Aussie Dollar. That is one trading scenario for next week. The market fully prices in QEII and then waits...and waits...and waits. And meanwhile news from the real economy reveals stocks are priced for earnings that won't show up.

The alternative view is that as long as the Federal Reserve, the European Central Bank, the Bank of Japan, and the Bank of England keep rates low and engage in QE or competitive currency devaluation, the Aussie will, by default, remain attractive. As it is, the Aussie Dollar is now traded more often than the Swiss Franc. Australia's GDP is just 1.6% of world GDP. Yet 7.6% of daily forex currency trading involves the Aussie Dollar.

The positive spin on this is that a high-yield commodity currency is a lot more desirable than no-yield debt-backed currency. In practice, the Aussie is not directly backed by hard assets. But it IS indirectly backed by them insofar as the commodity boom drives demand for Aussie assets. As long as the boom lasts, the Aussie remains relatively more attractive.

But if the boom itself is a fraud – or a product of the inflationary melt up as a result of Quantitative easing – then the local currency has become the plaything of international speculators. Being speculators, these folks are likely market neutral, if not exactly amoral. That means that as much as they like kangaroos and cricket and Paul Hogan, they won't hesitate from dumping the Aussie when the trade gets too risky or the global economy hits a pothole.

About the only good news from that second scenario is that you know its coming and have time to do something about it. And "doing something" doesn't just mean avoiding losses. For example, if the Aussie currency really is 27% overvalued on a purchasing power parity basis, any fall in the currency should be accompanied, more or less, by a rise in the Aussie Gold Price. Holders of bullion or exchange traded gold funds priced in AUD ought to see a nice surge on a falling Aussie.

But who knows? Maybe this melt up could really be the prelude of accelerating inflation. Dare we say hyperinflation?

If the Fed doesn't make good on its threat for QEII, stocks will fall right into the American election. So will commodities. And god knows what will happen to the disaster area that is the American housing market. But if the Fed DOES make good on its threat (and it probably HAS to to prevent rising real rates from destroying debtors)?

Well, if the Fed makes good on its threat...then any corrections by gold will be followed by higher highs. Bonds, despite benefitting from Fed purchases, will get crushed by inflation. And commodities will remain the speculator's playground as investors become desperate to trade bad money for real goods.

Enjoy the party if you must. But make sure you've canvassed the room for the nearest exit. And grab us a champagne, would you?

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