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Australian Luxury of High Interest Rates, Should the U.S. Follow Suit?

Interest-Rates / US Interest Rates Dec 06, 2009 - 05:52 PM GMT

By: Oakshire_Financial

Interest-Rates

Best Financial Markets Analysis ArticleMany are quick to question the logic behind Australia's recent pattern of raising interest rates, citing the risk involved with this strategy and the "danger" it puts Australia's economy in by lowering housing demand and making financing more difficult for businesses. Some call it an outright mistake.

Boo hoo. The finance gurus of the world sound like a bunch of children jealous that their little brother opened a Christmas present that they asked for. 'Tis the season.


I contend that the most significant aspect of this situation is, in fact, jealousy. Australia has maintained relatively high interest rates in comparison with the rest of the developed world, only being forced to cut their cash rate to a low of 3% during this semi-worldwide recession. In the US, our markets have climbed nearly 65% while Australia's have only climbed about 53%. This island/nation/continent, however, has been infinitely more successful in its recovery.

The luxury of high rates

As a supplier of natural resources to Asia, (an enviable position given Asia's recent demands), Australia has been able to keep afloat and avoid the financial misery that has plagued the United States as well as Europe. Although their economy was also in trouble at the "bottom", they never reached a point where they needed to turn their interest rate slicer into a chainsaw.

This partial immunity (or at least lesser injury) that Australia has enjoyed has floated their economy into a position that has given them the freedom to adjust their rates as they see fit for the near future. In other words, they have a built-in weapon to combat a recession.This is a weapon that the United States and several other countries have been forced to fight without since, of course, you can't cut the rate from zero. The good news is, it's not too late.

Should the United States take the plunge?

If we're being honest with ourselves, the only weapon we have left to combat worse economic downturn or stagnation is more government stimulus. This strategy would make a mockery of our economy and would almost certainly backfire as it would that we distrust of our system and make painfully obvious our inability to cope with our problems. Good luck paying back that debt afterwards, and good luck pawning it off on the American taxpayers. I will be moving to Australia.

Ok, now that I've gotten that off my chest, we should seriously consider the pros and cons of taking this opportunity to raise interest rates. That's right, I said "opportunity". The cons are obvious – more difficulty borrowing, lower business spending, money being dragged out of the stock market to other investments, and possibly stifling what little job growth we would otherwise expect. That might seem like a lot of cons, but it is far, far superior to the cons that we will be facing if this market takes a turn for other reasons and we're left with one thumb stuck up our asses and the other one pushing an "eject" button.

Here's why it's an opportunity: We are currently up 65% off the lows, and the market is still showing signs (albeit possibly the last signs) of strength. Raising rates will drop the market, but so what. Tell me what happens to the market when six months go by, there's little growth, gold is still rising, the market has drifted lower on its own, we are stuck with the glaring realities of inflation and desperation with no weapons to combat them.

There are only two positives that would come with a rate increase. The first would be an improvement for our currency's currently decimated valuation, falling 20% against the Euro in the past year, and 20% against the Yen in the past two years. The Australian dollar has appreciated about 40% in comparison to the US dollar since early March, and is sitting right near its highs. A country with as much debt as we have should be more serious about instilling confidence in and, more importantly, doing something about our currency's valuation. The second positive is simple yet powerful: we would have an economic weapon, just in case. It would be our insurance policy. I would much rather have to row six miles with an oar than try to get one mile with only the hope of wind.

The trade

Currency appreciation occurs for the same reasons other assets appreciate - Supply and Demand. There is a high demand for the Australian dollar because its interest rate is higher, and  because its interest rate is expected to rise again next year. In other words, foreign investors can purchase bonds, bank CDs, and other safe investments and earn a higher rate of return than they could from similar products in the US, Europe, or nearly any other developed country in the world.

This demand, however, will not last forever. Even though the Australian dollar may have further to go, I believe we have missed most of the move.

How do we play this situation if we agree that the US should, and hopefully will, increase interest rates in the next six months to a year? (I won't to pretend that the Fed is going to listen to reason and surprise everyone with a rate increase in a month or two, especially if we're not seeing any light at the end of the unemployment tunnel). This makes me hesitant...

But here's where I'm leaning:

If you're one of the more experienced investors who tussels with currency trades, and you're in a short-dollar position, I would consider getting the heck out. It could fall further, but I think risk is increasing exponentially on that side of the trade.

If you're an investor who is currently long on the market, remember this: if the dollar reverses and begins gaining strength, our equity markets will be pressured. Currencies are more powerful than stocks, and as goes the dollar, so too foes the market for the past ...well... just take a look at the charts of the EUR/USD and the S&P Spyders over the past nine months:

Quite similar, especially the last couple of months. Markets are forward-looking, and if anyone expects a rate increase, you'll see it both in the dollar, and in the equities market. This   confirms my intense lack of desire to own large amounts of stock at this level.

I may miss out on a few percentage points, but I see many more reasons to sit on my hands right now than to force myself into a long equities position.

Good investing,

John Whitehall
Analyst, Oxbury Research

Oxbury Research originally formed as an underground investment club, Oxbury Publishing is comprised of a wide variety of Wall Street professionals - from equity analysts to futures floor traders – all independent thinkers and all capital market veterans.

© 2009 Copyright Oxbury Research - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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