If you want to sleep well tonight, I probably wouldn’t read this.
The emperor has no clothes.
There, I said. I know we were all thinking it, but I’ve come out and said it. Everyone is pretending like they know what’s going on. The central bankers and the finance ministers want us to believe they’ve got things under control.
But they don’t. The truth of it is all their tools are broken, and the economy is completely off the chain. That’s what this post is about.
And what are they going to do about? My bet is sweet F-A. Their tools have been broken for years now, but it hasn’t stopped them pumping more and more money into the system. They’ll keep at it til their banking puppeteers pry their cold dead fingers from the policy levers.
And one of the reasons why I’m still buying up property, both here and overseas, even as the current price cycle in Australia matures, is that over the longer-run, endless money can only pump up the dollar value of assets that are in fixed supply.
And what assets are in fixed supply? Land and commodities.
Now I think gold and silver can be a good bet if you’re predicting the collapse of the current economic order – if the Pax America and the capitalism it’s nurtured are overturned and replaced with something else.
In whatever the new money will be, gold will still be gold.
But pole reversals in the economic order are pretty rare. Empires don’t last forever, but they do last for generations. Empires can limp on, mortally wounded, a lot longer than you can stay solvent.
And this is precisely the game now. Limp on. We used to dream of creating marvellous civilisations and thriving economies. Now it’s just limp on and see if we can get past the next election.
And what do we do in a limp-on economic system?
Personally, I’m buying property.
Let’s remind ourselves how we got here.
The conventional wisdom goes that the GFC caused a massive global demand shock. In America and a number of other important countries, people lost their jobs and saw their housing wealth evaporate.
In response, the central banks did what they always did. They lowered interest rates to reduce the cost of borrowing and spur demand – consumption and investment.
Trouble was, interest rates were too close to zero and they ran out of room to manoeuvre. And so they took to printing money – hoping that if they increased the “quantity” of money in the system, it would wash around a lot faster.
At the peak of Quantitative Easing, America was adding $85 billion dollars to the system – every month!
But it didn’t work. In fact, it seemed to make no difference at all.
And the reason for that is, the GFC wasn’t a temporary demand shock to an otherwise healthy economy. The truth is that demand in the developed economies had been weak for years, a fact which China had been helping to hide.
And the subprime mortgage crisis was really about an absence of attractive investment alternatives. With domestic economies in the developed world weak at best, there weren’t a lot of great options for your money.
So the banking sector got ‘creative’.
The monetary policy tools we have now were founded in a post-war era where there was no shortage of things to invest in. Roads needed to be built, factories constructed, proto-types rolled out.
And in such a world, if you reduced interest rates, you brought down hurdle rates, and more projects got off the ground.
But in the current era, as our developed economies mature towards a dignified retirement, there aren’t as many projects to invest in. Without enticing things to invest in, it doesn’t matter what interest rates are. As policy makers found out, people didn’t want to invest – at any price.
But the ‘price’ of money (interest rates) is the only tool they have, and they just keep pumping it.
And so where did all that money go?
Well, in the absence of new things to invest in, it just went into existing assets.
You can track it through this way. This chart here shows the debt and profitability of non-finance sector firms in the US.
With all the cheap credit available, we can see they went on a debt binge. They borrowed heaps and net debt spiked.
But look at what happened to profitability (EBITA) growth. It’s fallen and has actually slipped into negative territory.
That’s odd isn’t it? It’s the first time the two have moved in opposite directions since WWII. Where’s all that investment going if not into making firms more productive and profitable?
Here’s where. Buybacks and acquisitions.
This chart shows what firms did with their debt. Since the GFC almost all of it has gone into buying back their shares, or buying other companies (purple bars). Almost none of it went on capital expenditure (green bars).
As a result, share prices of existing companies have spiked (making their CEOs very rich!) But if they’re not investing now, where are they going to be in 5 years? What will they be doing? How are they going to make money?
(Another reason I keep a limited exposure to the share market.)
And so this is the true story of what happened. As developed country economies (including Australia) matured and their consumers maxed out, their economies started to stagnate. Their governments responded by continually dropping interest rates, until they couldn’t go any further. That cheap money started flowing to some “creative” places, resulting in imbalanced rupturings like the GFC (it won’t be the last).
But in response, officials just took rates even lower, and actually started printing money. But without anything to invest in banks and corporates just lined their pockets, bidding up the price of existing assets, while doing nothing to promote actual economic activity.
We’re going nowhere, fast.
And in my mind, the future looks much the same. Given the choice between dealing with the structural challenges of maxed out economies, or just throwing more money at the problem, my bet is politicians will go with the money-throwing option.
And what’s out best play? Well, if government are throwing money at existing assets we want to get in the way of some of it! We could buy shares, but share values are tied to earnings, and right now they’re eating their seed corn.
It can’t last.
Property on the other hand is tied to population flows. People will always need houses.
Of course, I can’t promise it’s not going to be a bumpy ride. All that cheap money flowing into high-rise towers is going to create a few waves for example. But over the longer run, it seems like the best bet to me.
It’s real, it’s in fixed supply, and it generates income.
In a limp-on economy, that’s as much as you can hope for.
Do you agree? If not why not?
What’s stopping you from crushing it right now ?