The ‘great rotation’ and quantitative easing infinity
46 weeks ago

The ‘great rotation’ and quantitative easing infinity

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In an article published in October 2016 William Hague note that: ‘Eight years after the GFC central banks are still pursuing emergency polices that are becoming steadily more unpopular and counterproductive.’ He also said ‘Independence was meant to help central banks make people face up to reality, not inflate bubbles full of make-believe money.’

I am not so sure. I perceive that most people don’t want to have to face up to reality. Certainly in Australia the general population want to retain their high wage rates, have security in their jobs and keep low interest rates despite the fact that these three factors mean that their young, adult children can’t secure jobs and when they do they’re in the gig economy; can’t afford to buy a house; and are being pressured to pay more for their education while the budget is redirected to the baby boomers (yet again) and their increasing health-care needs.

In 2008 the central banks reacted to a massive crises that they failed to see. They cut interest rates to record lows and embarked on quantitative easing…sounds like telling me I could drink all the wine I want and eat whatever I like and there’d be no consequences.

The only thing is, everyone’s got used to drinking and eating what they like and while they’ve put on a few kilos they still think they’re OK. After all what’s a few kilos? What’s another $50,000-$100,000-$300,000 more in debt when interest rates are SO LOW and the value of my house is going up?

Sound familiar? It should, it’s where the subprime crisis started in the USA. Just watch a film called 99 Homes.

I’ve been drawn back to this subject by two unconnected events.

  1. The wonderful Australasian comedian, John Clarke passed away last week while bush walking at the age of 68. He was a genius at cutting through all the bullshit and corporate speak. One of his better efforts was a description of quantitative easing. Here’s the link. Clarke and Dawe - Quantitative Easing. It’s brilliant.
  2. I read an article in the Australian Financial Review this week, ‘Great rotation about to start’ by Jonathan Shapiro. Shapiro’s article is enlightening not least of all because he explains the little known fact of the 401(K) rule in the US retirement plan system.

Simply put, in America, from 1 April people born in the first half of 1946 will have to begin the process of selling down assets in their 401(K) retirement plans. Most of them, apparently, have no idea that this is what they have to do to avoid tax penalties. As Schapiro notes: ‘Because most people accumulate they’ve never occurred to sell.’

The thing that really caught my attention was the sum of money involved and the timing given the central banks’ collective 'QE infinity' approach. Get this. There is around $US17 trillion in 401(k) plans and individual retirement accounts. This is FIVE TIMES MORE than the global hedge fund industry and TWICE the size of total sovereign wealth assets.

As Shapiro notes: ‘It is the growth of the global pension industry and the trillions that flow into the financial markets via these plans, that has been a constant and powerful force feeding the demand for financial assets.’ Add QE infinity and we’ve got one hell of a bubble.

Shapiro also quotes Aron Pataki portfolio manager, Newton Asset Management which manages $26 billion in a real return fund. Aron comments that:

‘Finance has become so dominant that is has started to drive economies rather than serving them.’

And this is where John Clarke, the central banks and Aron intersect.

Corporates have been using cheap debt and the proceeds to buy back stock and keep dividend payments up in a slow-growth environment, which increases short-term earnings but means less investment in future business, more slow growth.

Central banks have made the short-term gains that can be achieved in the financial markets (and property in Sydney and Melbourne) more enticing than actually investing in businesses for the medium-to-long term, your own business or others through the stock market.

Meanwhile, younger people, that is people under 35, have come up through a different scenario. They have to pay to go to university (read incur large debts to get an education that was free for their parents); house prices are stratospheric (well here in Sydney and Melbourne anyway) so there’s no way they can afford and even entry-level property. Even if they could, most are now part of the new ‘gig economy’ and don’t have a stable work pathway that banks would be willing to lend against.

Their parents are asset rich and have done an amazing job gaming the system. In Australia this means the negative gearing property investment system and 25+ years of economic growth. They’re, literally, sitting pretty. And unlike the US 401(k) requirement our superannuants have no such requirement to sell accumulated investment to fund their own retirement.

And still central banks around the world still haven’t got a clue on how to unwind QE infinity given the parlous state of most of the developed world’s economies.

The jitters about the Trump Presidency seem to have rather changed over the past few months. ‘Trump Action Man’ might not be able to get his key policies, any policies through Congress but he sure as hell can take on recalcitrant and abhorrent regimes around the world. Go figure. Having run a Presidential campaign on domestic issues he’s getting more traction for his foreign policy actions.

Going back to William Hague:

‘Pumping up the price of stock markets and houses without an underlying improvement in economic performance becomes more difficult to unwind and ultimately threatens an almighty crash when it comes to and end – wiping out business and home buyers who got used to ultra-low rates for too long. People are not stupid: when they see emergency measures going on for nearly a decade it undermines their confidence in authorities who they think have lost the plot.’

‘The whole point of their [central banks] independence was they could be brave enough to make people confront reality. Yet they are blowing up a bubble of make-believe money to avoid immediate pain.’

All of which reminds me of something I’ve discussed with my son. Human beings are wonderful things. We can justify anything if we want to. Daniel Kahneman in his book, Thinking, Fast and slow, explains in more detail how the human brain actually works, we reinforce what we want to know and already think we know.

In short, it’s no surprise that central banks and individuals are delusional about the state of the world financial markets. Recovery in the world economy won’t happen until there’s a decent dose of reality, something that is in short supply right now.