A Bubble in Search of a Pin

The Dow continues its march towards the psychologically important 20,000 points. Euphoria and positive momentum will lure more into the greatest bear trap in history. A final and fitting crescendo to this investor Neverland. One last bang before the bust.

Gold continues to languish.

The US 10-year bond went close to nudging 2.5%…a full one percent higher than five months ago.

Yet, with rising interesting rates — both in the bond market and the Fed’s likelihood of upping the cash rate by 0.25% — the share market rises to new highs on a daily basis. Interesting.

Call it intuition. Call it logic. Call it crazy.

Call it whatever you like, but something tells me that before 2020 (possibly as soon as next year), this bubble we’re living in — unaffordable entitlement promises; asset prices that bear no reality to underlying income; governments being paid (via negative rates) to issue bonds; corporate and public sector pension plans that are woefully underfunded; and deficit spending as far as the eye can see — is about to meet a pin.

Not that anyone seems overly worried about this prospect. Most people don’t see a bubble and, therefore, aren’t even looking for the stray pin that brings this whole experiment in overpromise to an end.

Last Sunday, I was watching Sky News and the Finance Minister was being grilled about the prospect of another quarter of negative GDP growth…the prospect of the dreaded recession. Typically, the interviewer asked, ‘What’s the government’s plan to stimulate growth?’

The honest and most responsible answer should have been, ‘Nothing. The system needs to take a breather. A few quarters of economic contraction will be healthy. Hopefully it will wake people up to the realities of the world. Debt accumulation cannot go on indefinitely.’

Fat chance. The response given was typical political speak… ‘Blah, blah, we don’t expect another quarter, blah, blah.’

The interviewer persisted. Surely the government has to do something — anything — to move the GDP needle into the positive. These people must have no clue how this so-called ‘growth’ is generated. Economic growth, in recent times, has been a by-product of a very simple and unsustainable equation: $4 of debt produces $1 of economic output.

Why would you openly and aggressively advocate for a plan that clearly involves going deeper into debt? Did the events of 2008–09 not serve as a warning?

Give it a break, sunshine. Why does government have to do anything?

This obsession with growth, growth and more growth is what’s created the debt, deficit and entitlement mess we’re in today.

People want more and more with money they have not yet earned or saved.

How about we try something different?

What about we replace negative gearing with positive saving? Encourage saving over debt.

This is far too radical.

Why? Because the whole thing would come crashing down.

Therefore, the illusion of growth continues.

Talking heads demand action from government to ‘solve the growth problem’. The great catchcry for government-sponsored growth these days is ‘infrastructure spending’.

Every politician has obviously received the Keynesian memo.

The public nods in agreement about the government’s decision to spend money (we don’t have) on infrastructure.

On Friday, 9 December, The Australian ran the following headline on its front page: ‘Labor blow to economy after GFC’.

A damning Treasury-commissioned independent review of the former Labor government’s unprecedented spending response to the global financial crisis has found it was a “misconceived” waste of money, fundamentally weakened Australia’s economy, almost destroyed parts of the manufacturing sector and inflicted more long-term harm than good.

My first thought was: how much did that review cost?

For a rather modest subscription to Port Phillip Publishing, Treasury could have been told this in a timelier manner… Like, as it was happening.

Rudd and Swan acted like drunken lottery winners. Throwing money at school halls, pink batts schemes, and cheques to the dearly departed.

These initiatives were sold as ‘investing in Australia’. But in reality, it was a ‘“misconceived” waste of money.

But we should not be surprised to see the words ‘government’ and ‘waste’ in the same sentence.

In August 2014, the International Monetary Fund published a working paper titled ‘Public Investment as an Engine of Growth’ (emphasis is mine):

The general idea that public capital and infrastructure will boost economic growth is a prominent feature of government economic programs across the world.

The econometric evidence reveals small positive and instantaneous associations between public investment booms and economic growth, but little long run impact. Several aspects of the evidence cast doubt on the idea that past booms triggered or accelerated GDP growth. Most of the positive association occurs immediately; a spending boom tends to be immediately associated with a rise in GDP this year, but not subsequent years.

Overall it is difficult to find a clear-cut example that fits the oft-repeated narrative of a public investment boom followed by acceleration in GDP growth. If anything the cases of clear-cut booms illustrate the opposite – major drives in the past have been followed by slumps rather than booms.

It’s no mystery as to why these economic programs fail to deliver the bang for the multibillion-dollar buck:

Case studies indicate that public investment drives tend eventually to be financed by borrowing and have been plagued by poor analytics at the time investment projects were chosen, incentive problems and interest-group-infested investment choices.

Poor analytics. We know all about that. Let’s put some batts in the roof. Let’s have an education revolution…build school halls. What cost benefit studies, if any, were done to validate these expenditures? Zero, zip, none.

Interest-group-invested choices. Sound familiar? Cronies. Unions. Insiders. They all get in on the act. Contracts are padded out with payoffs, jobs for the boys, heavy-handed union demands, and a nice little earner for all those on the ‘infrastructure’ gravy train. Works invariably go overtime and over-budget, and are underwhelming.

Financed by borrowing. Here we go again. More debt to pay for the illusion of growth.

If infrastructure spending actually worked, Japan would be the poster child in this regard. Instead, it’s a basket case.

According to Bloomberg:

‘[Japanese] Prime Minister Shinzo Abe’s “bold” plan to revive the economy with a $273 billion package leaves him traveling down a well-trod path: it marks the 26th dose of fiscal stimulus since the country’s epic markets crash in 1990, in a warning for its effectiveness.

The nation has had extra budgets every year since at least 1993, and even with that extra spending, it has still had six recessions, an entrenched period of deflation, soaring debt and a rapidly aging population that has left the world’s third-largest economy still struggling to get off the floor…

…if previous episodes are any guide, an initial sugar hit to markets and growth will quickly fade amid a realization that extra spending does little to cure the economy’s underlying problems. A Goldman Sachs Inc. study found that markets gave up their gains in the first month after the cabinet approved the stimulus in 18 of the 25 packages it studied since 1990.

In one simple graphic, here’s the Japanese ‘growth’ story since 1990:

Source: Bloomberg
Click to enlarge

26 stimulus packages and what do you get?

An Everest-like debt pile and no growth. Pure genius.

When do they stop this madness?

Yet in spite of all this evidence that government stimulus fails dismally, we still have those who are paid to know better saying, ‘What’s the plan?’

It speaks volumes that no one is having an adult conversation with society. The days of credit-funded growth are all but over and we need to make the necessary (but very tough) adjustments.

Sharing the front page of The Australian last Friday was this headline: ‘IAG turns to robots as jobs cut’.

Australia’s biggest insurer, IAG, has told its 10,000-strong local workforce that some of them will be replaced by robots as it looks to strip $250 million in costs from 2019.

…Australia’s big four banks cut more than 4000 jobs in the past year as executives shrunk underperforming divisions to offset muted growth across the whole business.

You cannot have growth without jobs.

The pressure on jobs and wage growth is intensifying and relentless.

We have created a bubble world where more than half the households receive some form of welfare; employees in the public and unproductive sector receive incomes (and annual pay increases) in excess of the private and productive sector; and debt levels are in a stratosphere where no society has ever gone before.

This bubble is drifting closer to the pin of automation and highly competitive global labour forces.


Vern Gowdie,
For Money Morning

PS: Our colleague Callum Newman recently interviewed former News Corporation and Fairfax journalist Michael West.

You can hear the interview on Callum’s podcast, The Newman Show. As Callum told me, West talks about how newspapers are dead, business journalism is a joke in Australia, and no one takes on big end of town.

It’s sure to be an interesting episode.

To subscribe via iTunes, go here.

To subscribe via Stitcher, go here.

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.

Money Morning Australia