The Fed has already taken short-term rates down to zero, pushing income-seeking investors and savers to chase after higher-yielding, higher-credit-risk and/or higher-duration (riskier) bonds. Now, with the magic of QE2, the Fed wants to drive long-term rates down to unseen levels and push investors of any Treasuries (short or long) towards higher-risk assets – junk bonds, real estate, stocks, and commodities.

The Fed also hopes (that is all it can do at this point) that low interest rates will nudge businesses to invest and to hire. That’s unlikely. The value of any asset is the present value of its future cash flow. As my favorite philosopher, Yogi Berra, (allegedly) said, “In theory, there is no difference between theory and practice. In practice there is.”

In theory, lower interest rates decrease the rate that businesses use to discount future cash flows – making future cash flows more valuable today – and that is what the Fed is betting on. In practice, however, the fickle source of lowered interest rates is not lost on businesses.

Rising government debt levels and overheating printing presses don’t generate confidence about future cash flows. High government debt eventually leads to higher taxation, higher interest rates, and lower growth. So the Fed’s action may produce an opposite result from what it intends.

QE2 is like a drug prescription that comes with the list of side effects that are often worse than the disease it was supposed to cure. It is difficult to know all the side effects and unintended consequences of QE2, but it may result in a substantial decline in the dollar, stagflation (inflation will show up not where the Fed wants it – i.e., in house prices – but where the Fed does not want it: in prices for things like food, gasoline, clothing, electricity etc.), lower economic growth and much higher interest rates. Yes, paradoxically QE2 may actually result in higher interest rates – investors expecting higher inflation will demand higher interest.

Despite the Fed’s efforts, the dollar may or may not decline against the euro. As in a race to the bottom, the US is racing with PIIGS rampaging through Europe. The Fed’s artificial manipulation of short- term and long-term interest rates creates a long-term problem for the economy. Government intervention (be it Chinese or US) in the free market creates excesses that are not allowed to self-correct and thus, leads to bubbles.

QE2’s possible success worries me more than its failure, because it will come with all the side effects I just mentioned, plus the eventual popping of newly created stock market and real estate bubbles. The Fed wants to create asset bubbles, praying for the wealth effect – stock and real estate appreciation to make people feel wealthier (at least on paper, for a while) so they will spend their phantom wealth. However, the Fed is like a Judas goat leading gullible (yield-deprived) savers to the slaughterhouse. The paper wealth that is created will vanish as bubbles burst (they always do), wealth will be destroyed, and consumers will find themselves further in debt.

Japan was QEing from 2001 to 2006 and created a bubble in Japanese bonds that partially burst, but the economy did not lift out of stagnation. Eventually, Japan stopped hiding its true intentions of propping up the equity market – on November 4th of this year the Bank of Japan announced it will be buying Japanese stock ETFs and REITs.

The Fed’s actions over the last two decades remind us of Scarlett’s famous line from Gone with the Wind: “I can’t think about that right now. If I do, I’ll go crazy. I’ll think about that tomorrow.”

Unfortunately, the Fed’s toolbox is missing a very important, must-have tool to fix the current problem: the “do nothing” tool. The “do nothing” tool would let the economy self-heal, even if unemployment stayed at 10% for a while and housing prices found (declined to) their true level.

However, that is unlikely to happen, as it requires pain. Americans have little tolerance for pain – after all, the most prescribed drug in the US is Vicodin, a painkiller. This is why, regrettably for the US, QE2 is unlikely to be the last QE: as the QE2 effect wears off (assuming it succeeds at all), then QE3, 4…10 and so on will follow.

What should investors do?

If the Fed “succeeds” and creates a short-term bubble in stocks and other asset classes, investors’ true time horizons and investment disciplines (i.e. adherence to the investment process) will be put to the test. They will have to engage in the game of looking-for-a-bigger- fool-to-buy-your-overvalued-assets.

In the giddy phase of a bubble, ignorance is wonderful bliss and knowledge and adherence to the investment process are a curse – as disciplined investors will always sell too soon and will not partake in the bigger fool game. However, when the bubble bursts, the money will flow to its rightful owners. The Fed doesn’t want you to be in cash, it wants you to reach for yield and to speculate – but don’t. In the absence of good investment opportunities, the worst thing you can do is take guidance from the Fed.

RISING interest rates and higher home prices are pushing the great Australian dream of home ownership further out of reach, a new housing affordability report shows.

The latest Housing Industry Association-Commonwealth Bank of Australia Housing Affordability Report released yesterday shows Adelaide’s housing affordability dropped 8.7 per cent during the 2010 June quarter, down 25.5 per cent from the 2009 June quarter.

The report also shows that the average monthly loan repayments on a first home in Adelaide have risen almost $700 over the past year to $2536 a month, compared with $1861 in the 2009 June quarter.

South Australia remains the most affordable mainland state in the country but HIA SA executive director Robert Harding said this was no consolation for first homebuyers.

“As housing affordability slips away, so too does the chance for many South Australians to realise their dream of owning a home,” Mr Harding said.

“Unless as a nation we are willing to accept that home ownership is no longer a fundamental tenet of our society worth fighting for, then substantial Federal Government engagement in addressing plummeting housing affordability is required.”

Mr Harding said the rising affordability issues were a result of a lack of supply and governments had to ensure enough new land was released and excessive taxes and costs weren’t imposed on developers. He also said that strict bank lending criteria was impacting affordability.

Brock Harcourts chief executive Greg Moulton said it was becoming tougher to crack into the market but the fact that interest rates are forecast to stay steady for the rest of the year would make it easier for first-time buyers.

The latest unemployment data out of Australia is very interesting to us, as it is not that often that you see Australian data disappoint, and even less often that you see the data disappoint by so much (we realize that there was some silver lining with better employment change numbers but this is not our focus here). Analysts had been looking for a 5.0% unemployment rate on Thursday, but instead, the data series produced a much higher and very concerning 5.4% print. There has been a very strong inverse correlation between the unemployment rate and Australian Dollar (see below; orange line is Aussie and white line is unemployment rate), and this latest jump in the unemployment rate could very well warn of a shift in the trend.

We have warned that we see risks for significant downside in the Australian Dollar over the coming months, with the single currency trading by record highs and looking very stretched on a cyclical basis. All of the fundamental drivers of the Aussie strength look to be approaching exhaustion and we believe that things will not be sustainable from here. RBA monetary policy has been extremely aggressive in the face of a global slowdown to produce attractive yield differentials, while booming commodity prices and a flourishing Chinese economy have also helped to propel the antipodean. However, at this point, we see the RBA starting to slow down with its tightening bias while other central banks play catch up, commodities prices rolling over sharply in favor of a much needed and sizeable corrective pullback (recent actions at the CME to up margin requirements could help fuel the pullback), and the Chinese economy cooling off as the government takes measures to curb growth and fight inflation.

With this in mind, we have gone ahead and established a fresh short Aussie position on Thursday. We have chosen to short the Aussie through the Euro instead of the Dollar as we believe it is a safer play from here and also could offer a more attractive risk/reward play. We are long Eur/Aud at 1.3725, with an open objective and stop in place by 1.3575. The cross sits at 20 year lows and by the bottom of a major range. Monthly studies are severely oversold (very rare) with the RSI by 25 and in desperate need of a healthy bounce. We contend that this latest unemployment data gives us a good excuse to enter the position, and we believe that the cross could very mount a significant rally from here.

Up to this point, the Eur/Aud cross has been somewhat inversely correlated to the Eur/Usd, particularly in periods of Eur/Usd strength. When the Euro rises, markets have taken this as a risk positive and the higher yielding Aussie then rallies even more on the favorable yield differentials. Meanwhile, when the Eur/Usd sells off, the markets have been inclined to take this as a risk negative and in turn look to liquidate the higher yielding Aussie more aggressively.

At this point however, we see the Australian Dollar at risk even in the event of more broad based USD depreciation. The basis for our argument is that with the Australian economic data finally starting to show a dent in its armor, the attractive yield differential in periods of USD weakness will no longer be as attractive, with market participants starting to price in a slowdown in the local economy. We like the idea of playing the short Aussie position through the Euro, as at this point, USD exposure seems a little more risky, and as we have argued above, this cross could very well head higher no matter what the direction of Eur/Usd.

The Federal Government is expecting a bigger budget deficit this financial year than originally forecast.

The updated budget papers predict a $41.5 billion deficit, which is almost $1 billion more than the July forecast.

Key points: Budget to return to black in 2012/13 with $3.1b surplusProjected budget surplus in 2012/13 down $400mBudget deficit to increase to $41.5b in 2010/11Unemployment rate to fall to 4.5% by June 2012

Treasurer Wayne Swan’s release of the Mid-Year Economic and Fiscal Outlook (MYEFO) confirmed predictions that a rising Australian dollar would hinder the Government’s bottom line.

But while the 2010-11 budget forecast has blown out, the Government is still on track to return a surplus of $3.1 billion in the 2012-13 financial year.

This compares with the $3.5 billion predicted by Treasury and Finance in the Pre-election Economic and Fiscal Outlook (PEFO) released in July.

The economic update also shows employment conditions will continue to strengthen, with the jobless rate falling to 4.5 per cent by 2012.

A return to surplus by 2012-13 was one of the Labor Government’s key election pledges.

Mr Swan says it is the fastest positive turnaround in the budget in more than 40 years.

And he says the Government is determined not to repeat the mistakes of the past.

“We put our fiscal rules in place in February last year because we understood that as we moved to strengthen the economy we had to formulate the exit strategy for the future,” he said.

Mr Swan says he is optimistic about Australia’s economic future.

“A strong economy is an economy that creates jobs, creates opportunities for people,” he said.

“What they (the figures) represent is hundreds of thousands of more Australians in work.

“To be coming back to surplus in three years, well ahead of any other major advanced economy, is something that we should all be optimistic about.”

Mr Swan also defended changes to the revenues generated from the minerals resources tax.

He says the revised forecast for the tax relates to the change in the exchange rate.

“What we’re dealing with is solely here the exchange rate effect. That’s why tax [revenues] overall are down about $10 billion. It largely reflects lesser company profitability,” he said.

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Australia’s surging dollar will not derail plans to get the national budget back into surplus by 2013 despite its impact on tax revenue, Australian Prime Minister Julia Gillard said on Sunday.

In the last week the Australian dollar <AUD=D4> has strengthened beyond parity with the US dollar, hitting successive record highs over several days. On Friday it hit a 28-year high of $1.0183, the highest since the currency was floated in 1983.

The rise has fuelled concerns about the indirect impact on taxation revenue, particularly from Australia’s key commodities exports, which are mostly priced in U.S. dollars.

In a television interview, Gillard told Channel Nine the budget would be returning to surplus “in 2012-2013 as promised”, referring to Australia’s fiscal year which ends in June. However, she admitted that the “high Australian dollar has had an impact on revenues”.

These would have impacts for the government economic outlook and a new resource rent tax on mining profits, but Gillard said she was determined to seek new savings.

“We are going to keep up the discipline and we will bring the budget back to surplus as promised,” she said.

Treasurer Wayne Swan said the strong Australian dollar would inevitably affect tax revenue.

“The higher dollar means our exporters bring home less income and that flows through to reduced company and resource taxes,” he wrote in a weekly economic note. “Commodity export earnings are particularly affected, because they are contracted in U.S. dollars.”

During the global economic crisis, Australia’s Labor government spent a huge fiscal surplus accumulated under the former conservative government to prop up its economy.

The move helped the country avoid going into recession but also sent the budget into deficit.

The Australian dollar’s recent surge has been driven by a strong economy, strong international demand for Australia’s resources exports, a surprise interest rate hike by the central Reserve Bank of Australia last week and weakness in the U.S. dollar.

Swan has firmly ruled out any direct government intervention to halt its rise, saying the free-market mechanism in place since 1983 has served the country well

To be honest, I’d probably do more shopping from local online retailers if the postage costs were more competitive. Australia Post hasn’t really encouraged shopping online because their costs are so high.

Clearly, I’m not alone. Even more so now, thanks to our rising dollar, more and more Australians are logging on to shop overseas.

However, for many Australians, we don’t just shop online for convenience. More than ever before, we are shopping online, and sending our hard earned dollars overseas, simply because it’s cheaper to get it from America. Or China. Or Europe. Perhaps even Greenland these days!

And guess what? Aussie retailers don’t like it. The Australian retail industry is worth about $292 billion, and it’s estimated that this year Australians will spend about $6 billion online.

They think they’re losing out on a chunk of that income. Well, they are, but not a whole lot.

Quite simply, why should you pay more when you know you can get a product cheaper elsewhere?

I certainly won’t. As every other basic living cost is on the rise, every dollar saved there is another dollar towards something you really want.

In a recent interview, Russell Zimmerman head of the Australian Retailers Association is ‘crying out’ to the government to fix this problem. What problem? He cites job losses, business closing down and all other dramatic scenarios if a stop isn’t put to this madness! When will the pesky consumer learn to pay higher prices for far less options?

In 2005 the government increased the amount you could spend overseas before paying any GST or duties. As of today, if you spend less than $1,000, anything you buy overseas won’t attract a tax charge.

But, for an Australian retailer because of the volume they purchase in, they must pay taxes. It’s simply unavoidable.

Zimmerman, appealing to the government’s need for someone else’s money has reminded the government that it’s missing out on revenue, ‘There’s around $6 billion worth of goods coming in without any form of duty or GST being paid on them… there is around $600 million worth of GST the government is missing out on.’

He’s even suggested that import value be lowered to $400 and then apply duties or GST. The problem isn’t that retailers are under threat of closing down. At the moment, people shopping online is more about eating into retailer profits, which no business likes.

But what’s worrying is that he expects that government to ’save’ the industry by forcing more tax on people. Considering that online shopping accounts for little more than 2% of the entire industry you have to think they must be really desperate for sales.

Instead of trying to get the government to tax you even more and make you pay more for goods, perhaps he should be listening to why consumers are shopping online rather than in stores? That way they may get some of the business back.

Yes, a strong Aussie dollar has encouraged me, and many others to increase internet shopping where possible. Thanks to central bankers fiddling around with things, you can now get more for your money from overseas online stores.

But there’s also the choice factor. There’s a far greater variety available overseas and online. Much more than the shops offer here, and Zimmerman is missing this opportunity to hear what consumers want from their retailers.

Last time I checked, retailers were supposed to serve a purpose, but right now, that purpose isn’t being met. So consumers have voted with their dollars and spent them elsewhere.

Yet, all Zimmerman wants the government to do is to ’save the industry and job losses’. Which really means increasing the taxes you pay.

Now, if items are too expensive in Australia, doesn’t it make more sense to appeal to the government to lower the taxes and duties paid by retailers in order to remain competitive and keep Australian retailers in business?

Of course it does. But he knows that the government is never willingly going to give up a nice revenue stream.

It appears that he knows the only way the government will listen to his pleas is to increase tax on items bought overseas, rather than lower it for retailers so they can try to compete with online retailers.

So before the government listens to the boy crying wolf by gouging you for more tax, and while the Aussie dollar is worth more than the greenback, jump online and get yourself a bargain.

Yet again we have another vested interest who thinks the only way to save an industry is to tax the consumer more, rather than give the consumer what they want.

You can’t save an industry, business or country by applying more taxing because all you end up doing are hurting the very people that support it.

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Germany and China have expressed concerns over US plans to pump $600bn (£373bn) into the US economy.

German Finance Minister Wolfgang Schaeuble said the US would not solve its problems, but create “extra problems for the world” instead.

Some countries fear that the US Federal Reserve’s move could hurt their exports by making their currencies stronger.

China’s Central Bank head Zhou Xiaochuan urged to look into “reforming the international currency system”.

He did not elaborate how the system should be changed.

The US central bank announced on Wednesday that it would spend $600bn to buy government bonds, in the hope that the cash injection can kickstart the country’s economy.

However, this weakens the dollar, boosting US exports while making imports more expensive.

‘Clueless’

“If the domestic policy is optimal policy for the United States alone, but at the same time it is not an optimal policy for he world, it may bring a lot of negative impact to the world,” said Mr Zhou.

“There is a spill over.”

China’s Vice Foreign Minister Cui Tiankai said the Federal Reserve had the right to take steps without consulting other countries beforehand, but added: “They owe us some explanation.”

Germany’s finance minister Wolfgang Schaeuble said on German television that “with all due respect, US policy is clueless.”

“It is not that the Americans have not pumped enough liquidity into the market and now to say let’s pump more into the market is not going to solve their problems.”

He added that the German government was going to hold bilateral talks with US officials and also discuss the topic at the G20 summit in Seoul next week.

The latest move by the Fed has been dubbed QE2 as it follows the central bank’s decision to pump $1.75tn into the economy during the downturn in its first round of quantitative easing.