Wall Street has now taken a double-dip off the table. With the Dow within striking distance of 11,000 after a near 2% surge last night, it’s clear the market is removing deflation risk.

Everything is going up — stocks, bonds, gold, oil, metals — and it’s the currency wars, folks. The US dollar is going down and every other country is trying to get its currency to go down as well (even Australia kept rates on hold yesterday). Competitive devaluations, the market has decided, are good for us, as they were (sort of) in the 1930s.

It looks like a war with no civilian casualties, only winners. The US Federal Reserve is contemplating more quantitative easing (money printing), with the Chicago Fed President Charles Evans last night calling for more aggressive action to boost the economy.

The Bank of Japan yesterday went from nearly zero interest rates (0.1%) to virtually zero (0 to 0.1%) as part of what it calls “a comprehensive monetary easing policy”.

Around the world, governments and central banks are pouring liquidity into the system and lowering interest rates to suppress their currencies, in an attempt to import growth and employment — or at the very least to stop others from importing it from them.

Basically, policy makers have decided that currency devaluation is the only political acceptable choice for  boosting demand and reducing debt.

Classical economists are not too happy about it, arguing that it’s chaotic, disorderly and untargeted.

But as Barry Eichengren, of the University of California, Berkeley, has been arguing for a while, monetary easing achieved through competitive devaluations is better than none at all: “With quantitative easing all around, the world will receive the additional dose of monetary stimulus that it desperately needs.”

Yesterday, Paul Krugman in the New York Times grumpily admitted that it won’t hurt, although he doesn’t think it will help either.

As currencies fall and money is printed, real assets must inevitably rise in value — especially gold, but also stocks as the prospect of recession is removed from the forecast pricing models. As a result there is the real prospect now of a strong commodities and stockmarket rally into Christmas.

If so, Australian interest rate hikes will probably resume.

The question from yesterday’s non-decision is: did Glenn Stevens deliberately pull the rug out from under the market, or just go a bit far in hinting at a rate hike in his Shepparton speech last month?

The line that probably caught everyone’s eye was the one about us being in the greatest minerals and energy boom since the 19th century. It might have been a statement of fact, but it certainly got most market economists thinking that he’ll want to try to stamp it out.

As a result, two weeks ago it was almost unanimous that the RBA would hike in October — until former RBA staffer and now HSBC’s Australian economist, Paul Bloxham, said October would be a “hold” (while predicting 1.25% of hikes by the end of next year).

By lunchtime yesterday, it was 70% —  in the proportion of economists predicting a rate hike and the percentage odds shown by the futures market. Therefore the decision to hold was a “surprise”.

We’ll never know whether the governor deliberately raised expectations, but in any case the effect has been to keep the market on its toes and has added to the general impression around the world of central bank support for economic growth and strong markets that was evident in last night’s Wall Street rally.

Peter Fray

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