Many years ago, a friend, who was a pilot in PNG, told me a funny story.
The plane had been chartered by PNG locals who were being flown, for the first time, from their hometown to Port Moresby.
During the flight, the propeller on the left-hand engine stopped spinning.
Then something totally unexpected happened.
Those sitting on the right-hand side of the plane starting laughing at their fellow villagers on the other side of the aisle.
I asked my friend ‘What was so funny?’
His reply, ‘in their minds they were OK because the propeller on their side of the plane was still spinning.’
The recent actions of the RBA brought this story back into my consciousness.
This extract from 18 June 2019 edition of The Sydney Morning Herald (emphasis added), goes to the heart of the matter…
‘Rising expectations of further interest rate cuts drove Australian shares higher on Tuesday, as the Reserve Bank’s minutes from its June meeting revealed the possibility of two rate cuts before the end of the year.’
The interest rate propeller has (all but) stopped spinning, so those on the other side of the investment aisle — watching the share market spin ever faster — are laughing.
What investors fail to realise is…we’re all in this together.
Nothing happens in isolation.
Rates are being suppressed because the global economy is, shall we say…lacklustre.
The more blunt term would be…stuffed.
Against this background, it’s illogical for share investors to be so happy.
Somehow, the connection between waning economic activity and the flow on effect to corporate profitability, has not been made. More on this shortly.
Central banks delude themselves into believing that the cure to any economic malaise is…the ‘wealth effect’.
The theory goes something like this: Deflate interest rates to inflate asset prices. People feel richer and consequently, spend more.
The wealth trickles down through the economy…hey presto, we have growth for all.
Reality is proving to be altogether different from theory.
The wealthy have never been wealthier…thanks to countless rounds of QE (money printing) and interest rates being kept close to, at or below zero.
Yet, (almost) every major central bank has signalled its intent to lower the already low rates…why?
The Fed ‘faces an economy that is expected to grow more slowly going forward…’
The Wall Street Journal 3 June 2019
‘The president of the European Central Bank surprised investors when he said that a new round of easy money “will be required” if the economic situation in the euro zone doesn’t improve.’
Barron’s 21 June 2019
‘Interest rates are heading for unprecedented lows below 1% and the Reserve Bank could even be forced into extraordinary measures such as money printing to stimulate the struggling economy…’
The Guardian 21 June 2019
The wealth part of the equation has worked like a charm…but it has not had the desired effect.
US Household Net Worth (as a percentage of GDP) has surged to an all-time high since the dark days of 2008/09.
Source: Economic Greenfields
However, as evidenced by the recent statement from the Fed, this historic level of ‘wealth’ has not delivered the much desired trickle-down effect.
What’s the answer?
Lower rates to such a level that even the mere thought of having savings brings on a wave of nausea.
Central banks want the concept of money in the bank to become as repugnant as someone who tweets a quote from the Bible.
Dare to mention to anyone today that you have money in term deposits and you’ll get that ‘are you nuts’ look…I’m speaking from personal experience here.
The central bankers are unwavering in their determination to prosecute their economic growth ideology…even though it has proven to be a complete failure…not once, not twice but soon to be, three times. More on that shortly.
Since 2008, the RBA has cut the cash rate from 7.25% to 1.25%.
Conservative retirees have been forced to accept an 83% reduction in the return on their capital.
Why has the RBA singled them out for such harsh treatment?
Does their standard of living not matter?
Has anyone spoken out against this injustice?
No. Not a peep.
To paraphrase Pastor Niemöller’s quotation…
‘First they came for the savers, and I did not speak out — because I was not a saver.’
We have an economic growth model that’s entirely dependent upon debt, debt and more debt, to remain functioning.
If you ‘go along to get along’ with this (seriously flawed) model, then central banks will reward you with even lower debt servicing costs.
Therefore, why should borrowers give a flying fig about how low rates go?
‘Send them even lower’ is the chant.
Be careful what you wish for…because we’re all in this financial ‘aeroplane’ together.
By not raising our collective voices (borrowers, savers and investors alike) against the folly of cutting rates so savagely, look at where we are today…
‘Australia’s households are among the most leveraged in the developed world, with much of that tied to the property market, Moody’s Analytics economists noted.’
Australian Financial Review 24 June 2019
We took the RBA low interest rate bait ‘hook, line and sinker’ and now have one of the most indebted household sectors in the world. Well done.
‘Then they came for the over-leveraged homeowner, and I did not speak out — because I was not an over-leveraged homeowner.’
And one record follows another…as reported in Macro Business on 4 June 2019 (emphasis added)…
‘Once again, it’s the continuing story of pressure on households as ongoing wages growth is not offsetting costs of living, and mortgage repayments as total debt continues to rise. Moreover, the trends have continued post the election.
‘Across Australia, more than 1,071,829 households are estimated to be now in mortgage stress (last month 1,050,450), another new record. This equates to more than 31.9% of owner-occupied borrowing households.’
The predicament of those who borrowed too much is a case of ‘that’s their worry not mine’…my worry is I need a yield on my savings.
‘Then they came for the investor in corporate bonds, and I did not speak out — because I was not an investor in corporate bonds.’
Yield starved investors — not willing to accept 0–1% on their savings — have been forced to lend money to corporate borrowers promising much higher returns.
There’s no such thing as a ‘free lunch’, those higher returns on offer from corporate borrowers are being paid for a reason (emphasis added)…
‘Surging U.S. business debt, already at historic levels, is posing a potentially huge risk for the global financial system and the world economy, raising concerns among market players and policymakers.
‘Experts are growing increasingly uneasy about both the quality and quantity of debt in the U.S. corporate sector as the amount of loans to borrowers with lower credit ratings and already high levels of debt is increasing.
‘A newly created index shows corporate debt levels are now even higher than before the dot-com bubble or the global financial crisis triggered by the 2008 collapse of U.S. investment bank Lehman Brothers.
‘Some experts warn that the ticking debt bomb in the U.S. corporate sector could eventually explode, triggering a new global financial meltdown.’
Nikkei Asian Review 16 June 2019
As the quantity of corporate credit increases, the quality (creditworthiness) of what’s offered decreases.
But I don’t have corporate debt, I’m a share and/or property investor…
‘Then they came for the investor…’
Remember that chart on US Household Net Worth I showed earlier?
The data used to compile that chart is sourced from ‘The Federal Reserve Flow of Funds Report’ — using share values, estimates of home equity, retirement plans, total funds in bank accounts, etc.
Rising markets are a great way to boost household net worth.
But what about falling markets?
We’ve seen this movie before…
To recap what I said earlier…
‘The central bankers are unwavering in their determination to prosecute their economic growth ideology…even though it has proven to be a complete failure…not once, not twice but soon to be, three times.’
This is the third bubble that’s been blown by low interest rates…and money printing.
Investors may be feeling pleased with the growth in their portfolio…but unless they’ve cashed it out, it’s just paper profits. And if history is a guide, it’s here today and gone tomorrow.
Central banks have proven time and time and time again that they’re incapable of prudent stewardship of our economy…yet, out of vested interest, we have remained silent.
Lower cash rates have led to higher debt levels.
Higher debt levels have led to an increase in mortgage stress.
Stressed household budgets force spending restraint.
Less money going through the tills, impact corporate profitability.
Zombie corporates (without sufficient profit to cover interest costs) start defaulting.
Investors in corporate debt lose money and exercise spending restraint.
Corporate earnings fall further followed by share prices.
Lack of confidence and rising unemployment levels trigger falls in property values.
The next ‘Great Recession’ will happen because we did not speak up to defend the rights of savers to earn a decent rate of return.
Ironically, when both propellers stop spinning…the only ones who’ll be laughing are those with cash in the bank…they’ll be buying the assets of distressed sellers.
[Editor’s note: The above article was originally published by The Rum Rebellion on Friday, 28 June.]