The Aussie Dollar Dilemma

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Be thankful for the bottomless gluttony of man today. It's probably going to help Australian stocks! The US markets came out of their Turkey Coma to rally higher on Friday. Both the S&P 500 and the Dow finished more than one per cent higher. That should be good enough for a positive start to the week in Australia.

Not only are people eating like there's no tomorrow, they're spending that way too. Shoppers spent over a $1 billion online Friday for the first time ever, according to CNET. It was a 23% increase over last year. And in the US, they didn't even wait for the Thanksgiving indigestion to die down. Thursday's sales were $633 million, up 32% from last year.

What kind of appetite can never be satisfied by more food or more things? It's not really an appetite we're talking about. It's the sense that something meaningful is missing in life. You try to fill up the empty spot with gravy, or a new jumper.

By the way, we don't mean 'bottomless gluttony' in a pejorative sense. It is what it is. But it does remind us that Gibbon attributed the decline and fall of Rome to the use of public monies on bread and circuses. In the modern day consumer empire, there are no public monies left. It's all on credit. But the principle of declining standards of human behaviour in the face of a system breaking down...that's basically the same.

But as we said, at least stocks are going up. And in Australia's case, how can they not? The currency wars favour capital flows into Australia. Japan, the US, and Europe are all deliberatus dollaerely weakening their currencies to try and boost growth and avoid debt deflation. This makes the Aussie dollar relatively stronger, and probably stronger than it ought to be based on lower commodity prices and a lower terms of trade.

However in a world of relative prices, one mustn't stick too closely to absolutes. The Aussie dollar is strong because it is strong, whatever the reason. The more useful question is whether the strong Australian dollar is actually capping what would be a larger move in Aussie stocks prices.

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Source: StockCharts 

On a year-to-date basis, a side-by-side chart of the Aussie dollar and the All Ordinaries wouldn't tell you that much. In fact in the last year, both have tracked sideways. But let's go back before the era of QE got underway in earnest, back to March 2009.

You can see that since then, the S&P 500 has doubled. Meanwhile, the Aussie dollar is up almost 64% against the US dollar. The All Ords are up just under 40%. Forty per cent in a few years certainly isn't bad. But it makes you wonder, would a weaker Aussie dollar - say the Reserve Bank cut interest rates 150 basis points or so - kick off a rally in stocks?

Hmm. Lower interest rates could move savers out of conservative investments and into growth stocks. But they could also trigger capital flight - foreign investors taking their money elsewhere. This is the RBA's dollar dilemma.

We'll ask around the office to see if anyone has ideas about this relationship between the Aussie dollar and the All Ords. Murray's thoughts on the matter are already pretty clear. He's referring to a kind of financial extinction event - the sort of thing where your money dies but your body survives. In fact, he reckons the extinction event is already under way.

But extinction events aren't anything to lose sleep over. There's nothing you can do about them anyway. Regards,

Dan Denning for The Daily Reckoning Australia

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