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.