Apr 24, 2020
Welcome to Finance and Fury, the Furious Friday edition. In
today’s episode we look at what the future of the economy looks
like?
First – I want to say a massive thank you to everyone who has
given great feedback and your support – many of you have reached
out – great to hear you are enjoying the content – so thank you –
really great to hear that many of you are enjoying it
Before we get into the content – quick recap on the previous two
episodes -
- First episode two weeks ago - went through how we are the
economy –
- Last week – went through numbers being used as justification
for these lock downs – These numbers sound very scary –
- Recapping on some numbers- but this time from the Covid shut
downs - What other numbers sound scary – In Aus - Three million
people have lost working hours and 390,000 have lost their jobs due
to the shutdowns – 26% of the working population have been directly
affected to date from the shut downs – 1 in 4 - Australia’s working
population – 13m – 62% Full time – 38% casual – Underemployment –
one of our major issues – even prior to the government shut
downs
- What does unemployment and underemployment create – beyond the
lower economic output – but also deaths - Study and Numbers come
from – meta analysis – Study: losing life and livelihood:
systematic review and meta-analysis of unemployment and all-cause
mortality
- For every 1% unemployment – 5,300-10,000 deaths – so if
unemployment goes up by 10% - may be up to 100,000 deaths - Drug
overdoses, despair, alcoholism
- Scaling for population – big assumption we are similar – but
lets say unemployment goes up by just 3% - about 2,400 people who
will die in Australia – for each year that they cannot find
work
- Outside of our first world nations – what is going on in the
3rd world?
- Potential of massive amounts of deaths – Especially in India –
Not from Covid – but Starvation is their major concern right now –
They have about 15k active cases and 680 deaths – in a country of
1.3 billion – so 0.001% case rate
- Remember – we are the economy – regardless of the function –
even if you are doing daily jobs in Mumbai
- Over 7000 Indians die of hunger every day –
likely to go up massively if people aren’t allowed to work – no
social safety net there
- Why did the Indian prime minister do these shut downs, even
though more people die in the streets of Mumbai of starvation
related illnesses every day when compared to coronaviruses – WHO
and World Bank loans – had to do it to meet conditions for $6bn of
funds to be leant – question: will this go to the starving people?
Or remain within the oligarchic system India has going on? Who
knows – but personally doubt it
- There is the term being thrown around of unprecedented – but
only in relation to the virus - The response is the thing that I
find to be unprecedented – but in all media reports it is covid19
that is the unprecedented event – that is this is the most
dangerous illness – but with no evidence to show it –even with the
skewed numbers of deaths – and historically no pandemic or loss of
life has caused the markets to panic in this way, or governments to
shut down our way of life – and with it the economy –
- But What is also unprecedented is the extensive responses by
Governments and Central banks – these responses whilst
unprecedented in their implementation today – were already in talks
within the Central banking and global economic communities – was
reading about it all and covered it 8 or 9 months ago on the
podcast - Check out the episode from September/October last year –
one of the first Episodes: We are entering new economic and
investment territory – An introduction to QE, what does it look
like and what does it mean for investments?
Regardless of the cause - We are living through transformational
times – new environment for finances, investing and our economic
way of life To get that – run through main components of the market
economy going forward – what is being implemented -
- Few components – but in summary – the Permanent QE, also low
interest rates and moving towards cashless economy, additional
Fiscal expansion through Government spending, additional direct
payments to the population in an effort to help boost demand
through Helicopter money policies – these are all now playing
out
- The only thing that hasn’t that was being covered last year was
the Abandonment of the dollar – to be replaced with the IMF SDR –
new reserve digital currency replacing this –
- But with oil demand collapsing – the petrodollar system may be
on its last legs given the pressure of government shut downs in
addition – new financial reset may be coming soon – especially with
the levels of the debt economy being driven up further right
now
Looking to Australia and the RBA – what are they doing – focus
on two broad issues – current outlook for economy and the recovery
= today – look at the immediate outlook for the economy in relation
to the overall components to the new market economy
- First – lets look at the economic indicators which are used as
a measurement for the economic health of a nation -
- GDP - The result of both the restrictions and the uncertainty -
over the first half of 2020 RBA expecting the biggest contraction
in national output and income witnessed since the 1930s – great
depression
- Putting precise numbers on the magnitude of this contraction is
difficult, but our current thinking is along the following lines:
GDP fall by around 10% over the first half of 2020, with most
of this decline taking place in the June quarter
- Employment - Total hours worked in Australia are likely to
decline by around 20% over the first half of this year. The
unemployment rate is likely to be around 10% by June
- Inflation - expecting a significant decline in the June
quarter. The large fall in oil prices, combined with the
introduction of free childcare and the deferral or reduction in
some price increases mean that it is quite likely that year-ended
headline inflation will turn negative in June. If so, this would be
the first time since the early 1960s that the price level has
fallen over a full year.
- Major problem for central banks – debt deflation – covered this
as well – but take numbers with grain of salt – modelling never
accurate -
Essentially – the economy and a large chunk of the populations
livelihoods are going to be ruined - so There is a lot of
cash being thrown around to solve this – where is this coming from
– Permanent QE policies to fund the Deficit spending – which is
facilitating the helicopter money policies – But also need to have
lower interest rates -so governments can continue this – which
reduced funding costs – along with moving towards a cashless
economy to avoid a further deflationary spike
- First – Permanent QE – The funding arm for deficit spending by
Governments - as is facilitated through QE – bonds issued by
Government are bought up in the secondary market – allows the Gov
to continue to raise funds through issuing bonds = that money can
then be distributed out
- RBA Purchases of government bonds had been scaled up
significantly. As a result of these purchases, central bank balance
sheets had expanded rapidly in March.
- Central banks had also sought to accommodate increased demand
for cash and support market functioning. They had increased the
provision of liquidity to the financial system by increasing the
size and extending the maturity of their regular open market
operations. Many central banks had also sought to improve market
functioning – particularly of key bond markets that provide
important pricing benchmarks – by directly purchasing securities in
secondary markets.
- The Bank had purchased in aggregate around $36 billion of
government bonds in secondary markets. This had contributed to
generally improved functioning of these markets, including a
reduction in bid-ask spreads and achievement of the three-year
yield target. Furthermore, the Australian Office of Financial
Management (AOFM) and state and territory government borrowing
authorities had issued securities, consistent with market
conditions having improved.
- Alongside these purchases, the Bank had injected around
$50 billion of liquidity into the financial system through its
daily open market operations to support credit and maintain low
funding costs in the economy
- The lowering of rates is also very important – This is the
costs to this method –
- If it was going to cost governments 10% p.a. to deficit spend
in interest – would spiral very quickly –
- But if it costs them 0.25% or 0.1% in some cases – is
maintainable in the longer term –
- Especially if through the redistribution policies of funding –
can help to get inflation back up to 2-3% as the RBA target sits
–
- This way – the real value of repayments over the life of these
bonds is actually negative – Paying 0.25% but the value of the bond
decreases by 2.5% p.a. – means that when you have to repay the bond
to the investor in 50 years – have to pay less –
- Example – Per $100 of debt (bonds issued) – You would have to
repay $29 in 50 years’ time – you would have had to pay $12.50 in
coupon payments – but discounting this – to todays value over 50
years = $7 – so in total – about $36 is the cost for raising $100
today – so you walk away 64% better off being a government doing
this – assuming you can get 2.5% of inflation
- Now – this seems like an awful deal for anyone who buys these
bonds, right? Like a super fund or investor- you would be correct –
but that is where the RBA comes into it with QE – as they are
buying these bonds in the secondary market – as when you can print
money to buy these bonds – like the RBA can – any funds you print
to buy debt are profits – so the RBA prints say that $100 in the
previous example- they then can make a further $12.5 in nominal
income off it over 50 years – free money for them - If you could
print money to buy anything paying you a positive return, wouldn’t
you?
- If you needed to work for your money – and you had savings –
probably wouldn’t do it – but if you could print billions and these
are the only investments that you can buy = free money
- And if you are the government – who can spend today in your
political term – at a future discount of 64% - good deal –
- But all of this is bad for us – well unless in the short term
you are a recipient of the helicopter money policies – go through
in a second - we were already fast reaching the limits of monetary
printing - markets are still trying to work out how to price that
in
- Past model – print money - Get GDP growth through aggregate
demand increase – mainly consumption
- Therefore – due to velocity of money (turnover) – get
multiplier effect – more times money changes hands the bigger the
effect = $1 might lead to $3.2
- Trouble is that turns out inflation is mostly driven by
behaviours/psychological phenomenon
- GDP growth, inflation, productivity are all missing in action
despite 9 years of declining rates and 6 years of monetary doping
and financial engineering the world over.
- If you increase money supply – money needs to go somewhere –
sometimes through existing off investment managers or pension funds
or new bonds issued from the bank
- RBA will give CBA $1bn of newly printed money – in return gets
CBA Bond to the value of $1bn with a coupon
- Bank uses new money as deposits to fund further lending –
leading to more economic growth through increased consumption –
then we are meant to get inflation –
- Found to be very ineffective – UK QE = £375 billion of new
money just to create £23-28bn billion of extra spending in the real
economy
- Over time reduces growth if money went into mortgages – lowers
spending due to larger loans to repay as borrowing capacities rise
as rates drop due to this policy
- Where does this money go? Well into hard asset prices going up
– making it harder for the average joe to get into property for
instance – but it doesn’t create inflation – as there is no
velocity to the money
- Even before this – there were No positive outcomes from QE-
leading falling credibility of Central Bankers, as they ran out of
policy space – but in an ‘emergency’ – people will be desperate for
the money and also distracted to what is going on behind the scenes
- But given the economic crisis – they now are the saving heroes
– rather than provenly failed controllers of the monetary
world
- Yet - Australia – Lowering rates – calls for QE – Quantitative
easing – printing money for liquidity
- Officially - known as large-scale asset purchases through
using newly created money
- Type of monetary policy – an extreme one – where
a central bank creates a policy to buy predetermined
amounts of government bonds or other financial
assets in order to inject liquidity directly into
the economy
- Purchase of bonds and assets – starting to see the mandate
expanded in the USA – Corporate debts – in Japan and SNB – into
ETFs – i.e. the share market
That is where the new evolutionary phase of combining QE,
deficit spending, and ‘helicopter money’ – is the nuclear fusion of
monetary and fiscal policies – With helicopter money – well imagine
a helicopter – no one by the police thermal imagine people for
social distancing – but to drop cash on the population – this is
the combination of monetary and fiscal policy now that is being
implemented to create the velocity of money and as they are hoping
– get some inflation back
- Helicopter drop is an expansionary fiscal policy that is
financed by an increase in a economy's money supply –
I.e. deficit spending through QE- it involves printing large sums
of money and distributing it to the public in order to
stimulate the economy – demand side economics – but if supply is
shut down – does it work? Well for business allowed to remain open
– it does – go through this side to the economy next FF episode
-
- Funded through deficit spending – so Gov issues bonds to fund
spending – more debt every year
- Money to spend/buyers of bonds are the Central Banks by more QE
– in perpetuity
- Trouble is that there is a lot of evidence that this policy
type won’t work – well – for our economic benefit anyway – just
leave with money to pay back for future generations – but based
around the basic calculations – governments can benefit and so can
central banks – as when you can create money to buy up ‘assets’ –
even if they are debt instruments – you make the coupon rate –
regardless of how small it may seem – when talking in the billions
and trillions – is a lot of money
- But extending this – beyond what the RBA is doing – what other
central banks are doing is buying up debt in companies or the
equity in those companies- this is not he free market – but what a
soviet Russia would be proud of
- Next FF episode – look at the potential recovery along with
what the nature of the economy might look like at the top end –
i.e. large companies versus smaller business –
Sources –
https://www.rba.gov.au/monetary-policy/rba-board-minutes/2020/2020-04-07.html
https://www.rba.gov.au/speeches/2020/sp-gov-2020-04-21.html?fbclid=IwAR2GrfTiT5UxHRuYwwXR7DoM7Kiiu2RwsDypO8hAiZ3GA4zNxgj7OyE29Iw
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