Don’t Get Used to the Aussie Economy’s Seemingly Unending Growth

It’s like 1989 all over again.

That momentous day when East Germans lined up in front of the Berlin Wall, approached it, climbed it, began hacking away at it…and then ultimately streamed through (and over) it.

The East German police knew they could do nothing but watch. The Soviet empire was already on its last legs at that stage.

East German leader Erich Honecker had been forced to step down a few weeks previously. Now Egon Krenz was in charge.

This was perhaps the last potential flashpoint for a Third World War between the Soviet Union and the US. That could very well have happened if East Germany’s police had begun shooting at those attempting to cross to the West.

At the very least, a Tiananmen Square type of situation could have evolved. (The Tiananmen Square massacre had occurred in June of that year.) Only this one would have been in the full glare of the world’s media. Another reason East Germany’s police likely thought it prudent to keep their guns holstered and their tanks garaged.

In that vein of the pursuit of freedom and unfettered movement, we rejoice at the news in Friday’s Financial Times:

‘[British Chancellor of the Exchequer] Philip Hammond has pledged to maintain free movement for top bankers after Britain leaves the EU, as he attempts to reassure the City that the financial services industry will be protected during Brexit negotiations.

Sure, I admit it. That is a tear you can see in the corner of my eye. I admit that I’ve just painted ‘hope’ on one cheek, and ‘freedom’ on the other.

Do you have a problem with that? This is the kind of freedom that Lech Walesa, Nelson Mandela, Dr Martin Luther King Jr and Mahatma Gandhi all fought for.

The right for free movement. The right for bankers to move without question from their Mayfair townhouse in London to their chalet in Switzerland, or apartment in Monaco.

What’s that, you say? Why should rich American, British, Japanese, French, and German bankers get preferential treatment? Why should they be rewarded, seeing as they were largely to blame for the 2008 financial meltdown?

I won’t even dignify that with a response. Except to say that, if you have a problem with bankers, the problem is with you — and that you’re very likely a racist.

Hats off to Mr Hammond. Bankers are people, too. They deserve to be treated with dignity and respect. The position of this newsletter is to wholeheartedly cheer the proposals enshrining the free movement of bankers anywhere within the EU.


Actions or words?

If you can’t beat them, join them.

As reported by the Australian Financial Review:

Reserve Bank of Australia governor Glenn Stevens has delivered a rebuke to the nation and its leaders, warning that 25 years of economic growth have bred complacency over what it takes to fix the budget and prepare for the next crisis.

That’s fine, so far. The AFR continues:

In his final extensive interview as governor, Mr Stevens said the record run of growth, officially confirmed on Wednesday, threatened to leave voters and politicians with the deluded view that it’s “just the natural state of affairs, that we don’t need to do anything to achieve it”.

“That’s not really so. It’s not a game. It’s not a sporting event that we like to spectate on. It’s real.”

Nice. We can go along with that. In fact, we’ve said the same thing all along. There is an unhealthy obsession to glorify and cheer on the 25 years of economic growth.

Such an obsession was perfectly on display in the Age column by Ross Gittins last week.

All that is very noble. But we must say that actions speak louder than words.

Perhaps Mr Stevens has had a memory lapse. But if we’re not mistaken (we are not mistaken), Mr Stevens has been governor of the Reserve Bank of Australia (RBA) for 10 years.

In that time, Mr Stevens could have, at any time, used interest rates to bring an end to the Aussie economy’s seemingly unending growth.

Not that we support central bank meddling. We see no reason for central banks. A better decision by Mr Stevens would have been to declare a free market for interest rates. That the banks could decide between themselves the overnight cash rate they are prepared to pay and receive.

That interest rates would depend purely on the supply of savings and the demand for loans.

Yet Mr Stevens chose not to do that. Instead, from what we have seen, Mr Stevens has led the RBA in such a way that has ensured ongoing economic growth, assisting the now ingrained view that growth is (in his words) ‘the natural state of affairs.

And despite Mr Stevens’ warnings about the unrealistic nature of continued economic growth, he appears to believe that the government and central bank should do all they can to maintain the growth.

Again, as he apparently told the AFR:

I still think we could do fiscal stimulus in an extreme setting if we needed to, but it will be a more complicated decision for whoever is in government at that time because we start with a higher stock [of debt].

There you have it. Growth at all costs.

Surely if Mr Stevens really was concerned about the ongoing and unrealistic expectations of perpetual growth, he would acknowledge that all booms must end in a bust.

This isn’t necessarily cheering or hoping for an economic bust. It’s simply realism, and understanding how markets and economies work.

Of course, it’s absolutely no surprise that Mr Stevens doesn’t acknowledge that, far from being the solution to the problem, central banks are mostly the cause of the problem.

Central banks and their cadre of PhD economists, diligently typing formulas into spreadsheets, as they attempt to centrally plan the economy from behind their Martin Place desks.

Monetary stimulus here. Fiscal stimulus there. Rats tails, bats wings, snail shells and beans — throw all of it in the cauldron, and watch the economy grow at a wonderful 3%…forever.

What if…?

Here’s why you should worry about low interest rates, and why you should worry about what will happen when rates begin to rise significantly.

As reported by Bloomberg:

One of the pillars of 2016’s record-setting global bond rally is starting to buckle.

Japan’s sovereign debt is suffering its worst rout in 13 years, handing investors biggest losses over the past two months than any other government bonds amid speculation the Bank of Japan plans to change its asset-purchase strategy. The reversal is spurring concern the second-largest debt market is the vanguard for a broader selloff. DoubleLine Capital Chief Investment Officer Jeffrey Gundlach said investors should prepare for bonds to fall.

Oh. Problems ahead. So, what exactly does a Japanese bond rout look like? The chart below shows you the horror story in clear detail:

Source: Bloomberg
Click to enlarge

We have taken the liberty of ‘boxing’ the rout for you in the lower right hand corner. This is the Japanese 10-year bond.

The interest rates has [cough] soared from minus 0.313% to minus 0.024%. In nominal terms, the jump is tiny. But in a market where investors can leverage many times their stake, a move of such proportions is huge.

No wonder investors are getting edgy. We can only ponder what the rout will look like if the yield should ever move into the positive and, heaven forbid, something close to 0.5%.

What an interesting thought.


Publisher’s Note: This article was originally published in Port Phillip Insider.

From the Port Phillip Publishing Library

Special Report: Central banks are losing control. Their efforts to prop up asset markets are failing. We’re now entering the endgame. What will the endgame look like? What are the short and long term investment implications? And how can you navigate this period of hyper central banking intervention…and emerge from the other side with a healthy portfolio? Vern Gowdie is one of the few minds in Australia with clear answers to these questions…[more]

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