Zero Interest Rates Equal Negative Returns

In  the space of six hours nearly $60 billion was wiped out Tuesday on the Aussie market.

At  a rate of $10 billion per hour, it goes to show how fast you can lose your  dough in a nervous market.

After  the US markets finished in positive territory last night an uneasy calm should  descend on the Aussie market today.

But  for how long?

Are  you nervous yet? Do you buy the dip? Do you take fight or flight?

Is  this the beginning of The End of Australia?

What  can the Fed do to steady the ship?

How  will the Australian Government plug a $40, $50 or $57 billion budget black hole  with an economy in low growth mode?

Will  Glencore be able to raise enough capital or sell off enough assets to reduce  its $50 billion debt load?

Lots  of questions. But do really want to hear the answers? We are in the throes of a  system of greed, denial and fraud. That system is destroying itself.

Is  this a hyperbolic, apocalyptic and self-serving answer? Perhaps. But at least  I’ve put my money where my mouth is. Cash and term deposits dominate my  portfolio.

How  many warnings do you need? Even the IMF, an organisation that wouldn’t know a  bad economic number if it bit them on the backside, is talking down global  growth prospects. The Fed is holding back on raising interest rates a lousy  0.25% because things are too delicate. China is manipulating its share market  outright. In the US, 63% of publicly listed companies have not increased  revenue forecasts.

The  contraction is on and the deflationary forces are gaining the upper hand.

Zero  interest rates have hastened our journey into the valley of financial death.

The  grand plan after the GFC was to make capital so cheap that the debt dependent  economic growth model would once again fire up.

Savers  were forced to go in search of yield. Investment adviser client conversations  went along the lines of ‘some of that tax free 8% Puerto Rican debt looks good’  or ‘perhaps we should invest in a Glencore bond to give you some extra return?’

This  is from the Sydney Morning Herald on  11 September 2014 (emphasis is mine):

Glencore Australia  Holdings announced its inaugural five-year benchmark issue with initial pricing  guidance of about 140 basis points over the five-year swap rate, or  about 4.85 per cent. The notes are expected to be rated Baa2 by Moody’s and BBB  by Standard & Poor’s.

While the company did not  put a number on the amount of capital it hopes to raise, five-year benchmark  issues typically raise in the vicinity of $500 million.

The  BBB credit rating is a notch above junk bond status. For this high risk,  investors were willing to be paid a measly 1.4% above the five-year swap rate —  which currently is around 2.4%. In total, a Glencore bond holder is today being  paid 3.8%.

A  quick google search found me a building society (covered by the Government  Deposit Guarantee) paying 3.6% per annum for a five-year term deposit.

You  can argue whether the deposit guarantee is going to be honoured or not in the  event of a crisis. But I would sleep a hell of a lot better with my money in a  Government Guaranteed building society than I would with a Glencore bond —  especially for a wafer thin 0.2% difference in return.

Zero  interest rates encouraged Governments, Corporates and, to a lesser degree,  households worldwide to go on a post-GFC debt splurge.

China  borrowed to build more infrastructure and factories. US corporates borrowed for  share buybacks and oil drilling. Australians borrowed for homes and mines.  Governments borrowed to meet the ballooning costs of welfare, healthcare and  warfare.

All  this debt was registered as economic activity. We were triumphantly told that  the world has recovered from the worst financial crisis since The Great  Depression. All Hail Ben and Janet. It was sickening to see G20 finance  minister fawning over these Fed charlatans.

In  truth, China was the lead elephant which all the others followed trunk tied to  tail. China stayed upright and at a steady pace, pulling the others along with  it.

But  China has stumbled, and the others are following suit. Why? Because at some  stage someone has to buy something with real money. China can build as many  factories as it likes, but if there is falling demand, what’s the point? If  there is no money then both parties — borrower and investor — may declare  bankruptcy.

Zero  interest rates might make debt cheaper, but they can adversely impact on  investors…especially retiree incomes.

A  great number of Western consumers are transitioning into retirement. Credit  fuelled consumption days are but a distant memory for this demographic. They  need to live off their savings.

In  Australia the share market has been good to them. Fully franked dividends  bolstered many a self-managed super fund. Hybrids have also been go-to  investments for planners searching for higher income. In the US and Europe  shares pay around 2%…well below the Aussie dividend rate. Therefore Municipal  bonds, Corporate bonds and REITs (Real Estate Investment Trusts) have been the  poison of choice for income hungry overseas investors.

While  the sun is shining and the world is gearing up, these investments are a  no-brainer. You literally need no brains. But what happens to investors and  their advisers with no brains when the cycle turns from sunshine to storms?

You  guessed it…they lose some or all of their money.

Not  all these debt and quasi-debt offerings are going to be good for money. For  example, will Glencore be able to pay pack its bond holders if the commodity  cycle worsens? I doubt it. Will the US fracking companies that borrowed  billions of dollars from investors in exchange for a few percentage points  above a swap rate be able to pay if the Saudis keep producing oil at below  their break-even price? Unlikely.

Zero  interest rates spurred a debt spree that created headline economic activity…the  crowd cheered.

Increased  economic activity reassured investors in search of income that all was well, so  they financed these corporate pie-in-the-sky and bonus rewarding schemes. The  money-go-round was self-reinforcing.

After  the RBA cut rates to 2% earlier this year, the cry from the investment industry  was to get out of cash, because it was dead money. You should invest in  companies paying fully franked dividends and hybrids. The share market nearly  hit 6000 points. Where is the share market now? Below 5000 points. My money in  the bank may not be earning much, but I still have 100 cents in my dollar.

The  real problem with zero interest rates is that they’ve forced investors to take  on risks they were clueless about.

As  some of these trillions of dollars in dodgy corporate bonds start to default,  income hungry investors will be capital starved.

Capital  starved investors are going to be unable to spend or borrow. Welfare bills will  increase. Health care costs (due to stress) will increase. Governments will go  further into debt at a time when tax revenues are shrinking from declining  economic activity. More corporate bonds will go bad. Eventually some  Governments will raise their hands in defeat and also default.

Zero  interest rates deliver negative returns. The size will depend on where you are  invested. I suspect the majority of losses will fall into the 50–100% range.

Yes,  our market may recover today and even tomorrow, but the negative forces created  by seven years of zero interest rates are beginning to press in on all sides.

In due course the external forces will be too  great for a system built on and reliant on debt to function. When that day  arrives, sooner rather than later, if you have not already taken a defensive position, there will be zero  you can do.


Vern Gowdie,

Editor, The Gowdie Letter

From the Port Phillip Publishing Library

Special  Report: The  End of Australia Vern Gowdie’s new  book is called The End of Australia: The  Real Story Behind Australia’s Economic Collapse and What You Can do to Survive  It. We are mailing free copies of this book to anyone who requests  one online. It does not make for cheerful reading. But the idea is that you’ll be safer (and much  wealthier) in 10 years’ time from receiving a more sober and realistic analysis  of what’s going on…what happens next…and what you should be doing about it now…  (more)

Vern is a contributing editor to Money Morning — Australia’s biggest circulation daily financial email. (To have Money Morning delivered straight to your inbox you can subscribe for free here).

Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia's Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top 5 financial planning firms in Australia.

Vern has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. In his leisure time Vern remains active with triathlons and pilates.

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