QE2 not fazing investors


“Print, baby, print” echoes the chorus of economists, investors and currency speculators worldwide. The strong possibility the US will create more money out of thin air has led to a significant depreciation of the US dollar and an appreciation of asset prices, including equities and bonds.

Investors do not seem to be concerned by the fact that money is not really being printed. It appears to matter even less that all that occurs when quantitative easing takes place is that banks sell the Federal Reserve treasuries and receive cash (in the form of a credit on the Feds’ balance sheet) in return for the hope they will lend the extra money out.

Importantly, none of this new money actually buys anything – not gold, shares, or even Australian dollars. Investors buying these assets are mostly speculators expecting a debasement of the US dollar or an increase in risk appetite.

What is most interesting, however, is that banks are not short of cash to lend. Excess cash on US bank balance sheets is over one trillion dollars. The real problem is that borrowers – scarred by weak demand, no employment growth and increasing regulation – just don’t feel the need to borrow to invest. Consumers have learnt the long-forgotten virtue of thrift in conjunction with a decline in the value of their collateral. Hence the problem of too much cash and not enough borrowers is unlikely to be solved by injecting liquidity. It appears this is a route chosen when all other alternatives are exhausted.

The US economy will march to its own rhythm and not be significantly swayed by the odd purchase of treasuries by the Federal Reserve. The bigger issue is whether investors should sell assets that have most recently been inflated, or buy more in the expectation it will continue.

Only time will tell, but our view is that purchasing assets in the hope that central bank policy actions will steer a complex series of economic events is fraught with danger.

It is true that equities currently represent fair to good value and a long term investment at these prices will likely be well rewarded. However, it would be foolish not to acknowledge a sense of short term euphoria that is liable to produce some level of disappointment in the near future. When the excitement of the second round of quantitative easing in the US fades, perhaps so will the froth in these outperforming assets.

For domestic investors, the surge in the Australian dollar has been of tremendous interest. We note with a healthy dose of cynicism that the higher the Australian dollar rises, so too do the forecasts of where it will go. Concepts of overvaluation seem to be discarded in favour of a belief in a new world where China is king, the US and Europe are declining empires and the Australian dollar is a proxy for the changing of the guards. The euphoria surrounding the local currency evokes the myopic views towards dotcom versus old economy stocks a decade ago.

At the moment, the market does not appear to be pricing in any risks to the Australian dollar.  However, any wobble or sneeze in the global economy – or the mere hint of a slowdown in China – will be met with a significant and sudden currency reversal.

It should not be forgotten that the pillars of local strength are the Australian property market and Chinese growth. The former is regarded as one of the world’s most overvalued markets while the latter is, by many accounts, overheating. Both countries are raising interest rates, which is never good for economic growth or property prices.

If for no other reason than risk management, investors should be taking advantage of the strong currency and purchasing assets globally.

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