When Less QE is More

Keeping up with the Joneses is a lot easier if they publish their national accounts. Aussie debt to GDP, wealth, employment, inflation, growth and just about everything else is bigger and better than our nation’s peers. We can hold our noses high.

That was RBA Governor Glenn Steven’s line of argument at his parliamentary hearing. And we like it. But throw in a crisis and see where Australia ends up. If house prices drop, China stops building empty cities or there’s a banking crisis we’d end up in deep do-do. Maybe even deeper do-do than the countries Stevens was comparing us to.

Comparing crisis ridden countries with a country set to have a crisis is a bit odd…unless you factor in that crisis. But central bankers specialise in convincing people everything’s all right. So they’re unlikely to publish a ‘Projections for Australia in Crisis’ report anytime soon.

The only real problem Stevens could find is with the national budget. Now keep in mind that Australians criticise Europe and the US for running deficits during the good years. That’s just a dumb thing to do, right? Because the government is supposed to save during good times and spend during the bad.

Good luck trusting a politician with that task. Anyway, it seems like we’re slowly falling into the same trap here in Australia. Government spending is surging while the economy is comparatively rosy, as Stevens pointed out. The rising level of government debt was the one thing Stevens was really worried about at the hearing. He even called it ‘a mid-term challenge’, whatever that means.

-But Australia still has its coveted AAA rating. In fact, currency risk aside, our government might be one of the most credible borrowers around. In The Money for Life Letter we explained how you can make the most of that. By the way, ‘credible borrower’ is an interesting phrase for any linguists out there. ‘Credibility’ and ‘credit’ have the same root for a reason.

Australia’s debt rating is one of the snobbish features of our economy that we can park in the driveway for our neighbours to see. But it turns out they’re not impressed. More than five years after the financial crisis began, politicians in Europe have figured out that those AAA ratings aren’t very accurate. Coincidentally, they figured it out as they started losing their AAA ratings. Even the EU itself has now lost the formerly coveted AAA. French President Francois Hollande promptly explained that this ‘changes nothing’. And he would know. His chance of getting elected surged when the same thing happened to France in 2012.

Now the EU is financed by its member states, with no bonds of its own. So having any kind of rating is a bit weird in the first place. But the story goes that because so many EU member states aren’t AAA any more, the EU itself can’t be AAA.

The Age’s article on the loss of the ratings has picked up on the European politicians’ line of argument nicely. It pointed out that even markets don’t seem to care about ratings anymore. The announcements of a downgrade don’t influence the government bond rates. Meanwhile, in Australia’s parliament, the AAA status is touted as a line in the sand. It turns out that in politics, sand shifts.

The other problem Stevens mentioned at the hearing is the Aussie dollar. It’s still too high and that’s crushing manufacturing. Jobs are being cut left right and centre as the government picks who to support (Coca-Cola Amatil), who to leave stranded (Holden) and who to tease with maybes (Qantas). The latest is that the ACT needs a bailout too because of the public sector cuts.

We think all these people are missing the point of the cuts in the first place. Back when Port Phillip Publishinghosted an event called ‘Australia in the Red’, we were laughed at for taking a temporary budget deficit during a crisis seriously. Now the rising debt and unsustainable budget is a mainstream issue. But it’s still under control, of course. Politicians and central bankers assure us. Yeah, righto…

In other news, the taper is in. And the market decided it likes less quantitative easing (QE). But why did stocks go up on the news there would be less money printing? Isn’t it money printing that’s been making the stock market go up?

Well, less money printing was only half of the story, as Greg Canavan pointed out. The Fed also extended how long it expects to keep interest rates low. Cheap debt is enough to goose a stock market on borrowed time.

We chose the words ‘borrowed time’ carefully. You see, most of economics ignores time. It doesn’t recognise that capital takes time to accumulate and allocate, for example. Another inter-temporal factor it ignores is that debt is really just borrowed time. You take from your production in the future. The saver is of course doing the opposite — sacrificing the fruits of the present for increased future wealth.

Anyway, the US stock market isn’t just reaching a new high in terms of prices. It also reached highs in terms of margin debt over the last few months. That’s money borrowed to invest in the stock market. But all that money has to be repaid. Which means selling stocks. That’s why the rally is literally on ‘borrowed time’.

Getting back to our original argument, the longer the Fed keeps rates low, the cheaper stealing from the future becomes. And so more people borrow money to buy stocks.

That’s one narrative. Another one is that the stock market’s rally may be nothing more than the old ‘less bad than expected’. In other words, if something bad is going to happen, stocks should ‘price it in’ beforehand. That’s because stocks predict what’s going to happen. At least they’re supposed to.

Sometimes they get it wrong. And when things are less bad than expected, bad news can lead to a rally instead of a fall. In this case, investors might’ve expected a bigger taper than the one they got. That doesn’t change the story of QE, tapering or the fact that the US economy is drugged on monetary stimulus.

In other words, as President Hollande said ‘it changes nothing’.


Nick Hubble
for Markets and Money  

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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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