The American flip-flop is here, our economic model is broken. Where are you going to hide your money?
Take a look at this chart here. This is what the ruins of the modern economic model looks like.
This compares the unemployment rate – a generally broad measure of how the Australian economy is tracking, with the ASX – the value of the share-market. Theoretically that should also be a pretty good indicator of how the economy’s doing.
But right now, the two are going in different directions. Unemployment is creeping up, leaving nervous beads of sweat of Joe Hockey’s forehead. But the ASX is close to posting record highs.
It’s a bit odd, isn’t it? So what do we believe?
a) A count of the number of people actually making things; or
b) A semi-fictional measure of company value that’s known for wild and erratic fluctuations.
(Answers at the end of the book.)
Something funny’s going on. I smell like a fish.
But hang on, haven’t we seen this before?
Well, yes, we have.
This is the ol’ American flip-flop – the bad news is good news inversion.
Take this chart here. This compares the American S&P 500 with “US Macro” – an index of positive or negative surprises in US data releases.
Same story there. Overall there’s a brighter tone to the US economy, but there have still been a number of downside surprises.
Has it stopped the share market? Oh no! It’s the running of the bulls in Wall Street right now.
There’s only one thing to blame for the flip flop – liquidity.
Through the Quantitative Easing era, the US Fed’s response was to leave the money taps on full-bore. Effectively printing money and throwing it around.
No one really knows exactly what QE did. Maybe it saved the economy. Maybe it didn’t.
But one thing for sure is that it gave share prices a boost.
Why? Because the Feds gave money to the banks. The banks gave money to companies. Companies bought back their own shares and gave their executives a bonus.
And that, seems to be about it.
In theory, companies should have invested the money – built a new factory, employed some more workers, refurbish the staff kitchen. That, theoretically, should have given output a boost.
But it didn’t work out that way. Companies didn’t expand production. They paid down debt, and bought back their own shares – driving up their share prices in the process.
And so the harder the Fed leant on the printing press– the higher share prices went.
And so if the economy posted some bad news – say a worse than expected unemployment rate – the markets knew that the Fed would likely send them some more money – and so share prices spiked.
Bad news was good news.
But if there was a positive surprise, markets worried that the Fed might take the punch bowl away – and share prices dropped.
Good news was bad news.
This is the American flip flop.
And economists don’t get it.
Because companies aren’t doing what they’re supposed to do. In the economists models, firms borrow to invest in productive capacity, not buy back their own shares.
(The government’s strategy seems to be to keep throwing money at them until they start behaving like the models say they should.)
IBM is a case in point. After WWII, IBM was an innovation powerhouse – it was behind such marvels as the credit card, the floppy disk, and the ATM. But things got tough in the nineties, and went on to shed 180,000 workers in the next ten years.
But did shareholders suffer? Oh no. IBM managed to find billions of dollars to pay shareholders – much of it funded by debt. It was a trend that started in the 90s, and went into over drive in the QE era.
Between 2003 and 2012, IBM spent more on shareholder rewards — $130 billion — than it earned in revenue. In 2012 alone, IBM issued $34 billion in debt. Its rewards to shareholders that year: $38 billion.
Like much of corporate America, IBM borrowed money to boost it’s own share prices. Why?
It may have something to do with business in the 21st Century. There is massive productive capacity, and business niches are much harder to defend than they once were. There’s a lot more churn in the S&P 500 than there used to be.
So maybe firms just don’t see as much value in investing in new capacity or new ideas.
It may also be that CEOs are just greedy bastards. Most have much of their pay in stock, so if the share price goes up, they benefit directly.
A totally misplaced incentive.
But whatever the case, until corporate America starts spending again, the US economy will struggle to get into its higher gears.
But should we be concerned that the flip-flop seems to have landed on our shores? That’s what the first chart shows. People think the RBA is going to cut rates and keep cutting rates, pumping liquidity into the system…
You beauty. Share prices spike.
This isn’t a good thing.
This is a break down in the basic economic model – the model that’s driven growth over the past 50 years. It’s also the tombstone on top of monetary policy as we know it.
So what do we do about it?
Well, as I’ve said before, if the government is pumping up asset prices – if money printing is about to cause a massive spike in asset inflation – the thing you want to do is obviously own assets.
Now you might get into the share market, but it’s probably going to be a much wilder ride.
I’ll be sticking with property. Liquidity from all over the globe is making its way into the Australian property market right now, and its only just getting started.
The RBA is about to throw trillions more at the Australian economy.
And my bet is it will be years (and long after a major boom in property prices) before they realise that their model is broken.
Neonowl says
Hahaha….in paragraph six, I smell like a fish???
Brian Sketcher says
Whats going to be the new model then? do we need a major meltdown again to learn anything, the gfc 2008 doesn’t seem to have taught the central banks anything but repeat old previous mistakes….
John from Perth says
Jon this is all true. Australia has an over inflated share market, high debt and high unemployment… exactly the same condition that brought on the 1929 depression. If we keep going this way it is only a matter of time before we have a similar crash. The whole word is in the same situation and theoretical economic levers are not working because there is inadequate reward for effort – socialist do gooders are ruining our country with penalty taxation rates on income and savings and rewarding social welfare recipients with increasing amounts of free everything.
The best thing Australia can do is to protect its manufacturing industries and put in place productivity improvements – labour reform, (get rid of union restrictive practices,corruption and bullying) upgrade infrastructure and encourage effort by reducing taxation rates on income and stop bringing in immigrants who will never get a job and drain our taxes.
KatM says
How fortunate that you’ve brought these figures to light today Jon, especially now that a new paper from Melbourne/Berkeley business researchers about limiting executive pay has surfaced in the media. We need a restructuring of the top end of town because they can’t just fudge performances and destroy long-term company values and profitability. These days nearly every legally employed person is a shareholder, albeit indirectly through superannuation, i.e., socialism by stealth.
God help us all if the economic system is indeed broken and all those PhD, MBA and myriad post-nominal fellows in the banking/finance/governance can’t get us out of the deflationary grave they’ve been digging for us. Conspiracies abound!
Joe Hockey please kick more behinds because we’ve elected politicians to help straighten the crooked path and lead Australia to a more prosperous future.
Mark Kras says
The second next best thing Australia should do is flood the country with meaningful tax incentives (which do not require upfront cash) which provide positive and meaningful support for both employers and employees, such as a 133% tax deduction on wages! This will support business and the labour force strongly without any immediate cost! Give Aussies a break and we will do the rest.
George Xanthis says
The government should charge corporations 40 to 50k for each job that is outsourced overseas. You watch how quickly the corporations start insourcing lowering the unemployment rate thus ensuring money be kept and spent in Australia creating more demand for product in Australia. The government will have more revenue whether it’s from the corporations who are paying for the outsourced jobs or the newly employed individuals who will be paying taxes. It’s really not that complicated, it’s just common sense.
John from Perth says
George, companies outsource jobs to save you money in providing services. The extra costs you are proposing would get passed onto you – do you want to pay more for services?
Same thing applies with importing goods. Australia could increase tariffs on imported goods so it pushes up the cost of imported goods. It then becomes worthwhile manufacturing things here. Clearly, the government has gone too far with free trade agreements, outsourcing and allowing cheap imports etc. Australia can’t compete with anything except exporting minerals, providing education, some farming (e.g. not berry farming) and in some high tech specialist areas.
The government needs to start protecting our industries rather than trashing them, even if that means we start paying more. Australia also need to get more efficient to reduce costs and provide tax incentives to work and invest. Until these issues are addressed we will have high unemployment and Australia will continue become another high debt socialist economic basket case.
Kathy says
There’s also another explanation. The artificially low interest rates means that people have to find yield elsewhere, as they won’t get it from cash or bonds (unless they invest in highly risky markets such as Greek or Italian or Russian bonds).
Thanks to central banks around the world punishing the responsible savers and rewarding speculators with cheap money, people are forced to take money out of cash and invest it somewhere, anywhere, where they can find a return. Right now, the stock market’s it.
Unfortunately, we are looking to central banks to help fix the economic problems that were caused by them in the first place.
Hugh says
Abolish stamp duty on properties for permanent residents and Aussie citizens.
Will says
Abolish Income Tax, raise business costs, rego and lic costs etc and introduce a transaction tax of 1% – make banks collect it charging a 10% – 20% transact fee EG: $100 transacted – Tax $1 – Bank fee $0.10c to raise to $0.20c over 5 years. Change direction of taxation from mining locals to mining a progressive economy so the Googles and credit companies will need to be directly involved in Aussie tax system and no more hand backs.
Terry Brady says
Abolish all existing Taxes – install a flat Fee 25% GST on all Goods and Services- abolish the Tax department- then everyone pay’s their share- from large Companies- to Drug Lords and everyday people- now you can’t escape paying your share. Not popular with most people for sure!!