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08-08-2014, 02:09 PM
Australia is probably one of the few economies in the world that has an effective monetary policy. Unfortunately the impact of the ongoing global economic tsunami is simply too big for Australia's diverse economic base...
CHRISTOPHER JOYE
Cash sacrificed on the altar of easy credit
Banks have chiselled deposit rates to the point where most no longer supply returns above the cost of living. Photo: James Davies
CHRISTOPHER JOYE
Deposit products have been murdered as viable investments and conservative savers are being compelled to absorb much more risk than they ordinarily would to meet their income needs.
Even before tax, “real” returns on deposits after core inflation are now negative for only the third time in the past quarter of a century. The king – cash – is dead and the trail of blood leads to Sydney’s Martin Place and central banks around the world, where cheap money and deliberately distorted asset prices are usurping economic reality.
When I first suggested that the Reserve Bank of Australia’s inflation-adjusted cash rate might have turned negative in December 2012, the governor, Glenn Stevens, correctly retorted that deposits still offered investors positive real returns.
Today that is no longer true. Since the RBA cut its target cash rate to a record low of 2.5 per cent in August last year, banks have chiselled deposit rates to the point where most no longer supply returns above your cost of living. After tax, you are falling way behind.
This is a big deal. Since the RBA started targeting inflation in 1993, its cash rate has, on average, returned a healthy 2.4 per cent above core inflation. The RBA’s cash rate settings have meant investors have typically been able to earn a decent real return of about 1.5 per cent a year, on average, above core inflation via three-month or six-month term deposits.
Investing in cash as a risk-free asset class and getting acceptable real returns beyond the cost of living, savers could rationally demand a significant premium from riskier investments like bonds, convertible preference shares (called “hybrids”), equities and housing. And if any particular sector became overvalued such that expected returns did not provide enough compensation for the risk of loss, savers could exercise the option of diverting their portfolios back into cash and still survive until more sensible valuations prevailed.
But the RBA has taken away that option. Even the most attractive “special” savings products promoted by banks, which come with bucket-loads of catches, now only furnish, on average, 3.45 per cent. After tax, you still cannot keep pace with living costs.
NEGATIVE RATES BEWILDERING
This was despite a jump in the jobless rate to 11.1 per cent in 1992.
The only time investors had to grapple with negative real deposit returns was in late 2001, when interest rates were probably left too low for too long (which precipitated the mother of all housing booms), and in early 2009, when house prices likewise rocketed at worrying rates.
When I called double-digit house price growth in mid-2013, some pundits poured cold water on the proposition. The economy was too weak, credit and wages growth too low and households had already levered up. We could not have a re-run of the previous housing booms, they argued. Yet over the past 12 months, property prices have climbed at three to four times wages while housing credit is expanding at twice the rate of incomes.
I was similarly isolated rattling on like a warmonger about geopolitical risks in these pages in recent years. My criticism was that the potential for conflicts was not being priced by financial markets. Ignorance was bliss until China and Japan started sabre-rattling and then, more starkly, Russia invaded its neighbour. The only prediction that has proved right is that political scientists and investors will consistently get national security risks wrong.
The same sense of bewilderment applies to negative real deposit rates.
It is surely hard to rationalise recessionary nominal cash returns, which rank among the lowest in modern history, when economic growth over the year to March was a trend-like 3.5 per cent, core inflation is sitting at the top half of the RBA’s target band, retail spending and credit growth have both expanded at rates well above wages, and equities and housing have boomed.
The odd man out is, of course, the noisy jobless rate, which until this week most thought would soon turn a corner.
TWO RISKS IN CASH PRICE CUT
Setting aside that anomalous data point, investors need to consider two related risks.
The first is that policymakers have fallen into the trap of thinking that continuously cutting the price of money, which is already at its cheapest level ever, will address our economic ills, which, people seem to forget, were severely mispriced assets in the first place.
The malaise identified by the global financial crisis, and which Australia probably still faces, is that too much capital and labour were being invested in the wrong places (financial services and existing housing). Instead of reallocating those resources to more productive sectors, we have been once again blowing financial bubbles. The big Australian banks are worth more than they were before the GFC, and US goliaths like Goldman Sachs and Morgan Stanley have recovered their pre-crisis valuation levels.
Getting families to increase leverage above 2007 marks by fuelling risky credit growth – and duping people into thinking bonds, equities and housing are great investments by having governments buy trillions of dollars of financial assets and bidding up prices (quantitative easing) – is categorically not the solution to the original valuation problems.
It’s like injecting Lance Armstrong with more drugs to combat his addiction to doping. While it might make sense to help wean him off, boosting his dosage for half a decade, as we’ve done with the cheap money craze, is madness.
This is the contradiction at the heart of capitalism: instead of allowing free markets to dynamically heal themselves and reallocate scarce resources via accurate price signals, we seem to believe governments, not markets, are our panacea.
The issue with negative real deposit rates in the absence of a bona fide crisis is that the RBA is encouraging destabilising asset price spirals.
With no effective risk-free investment and no need for the wealth-preserving qualities of cash without a cataclysm threatening portfolios, savers are forced to chase yield irrespective of the risks those investments entail.
But the more assets are bid up, the further yields fall. This destructive feedback loop results in investors taking on ever more risk to reach their income goals and can stretch prices way beyond fair value. The endgame is searing losses when the money-printing music stops and cash rates are belatedly normalised. Ironically, this is also when cash is king.
Like Smart Money on Facebook for more stories.
The Australian Financial Review
BY CHRISTOPHER JOYE
CHRISTOPHER JOYE
Cash sacrificed on the altar of easy credit
Banks have chiselled deposit rates to the point where most no longer supply returns above the cost of living. Photo: James Davies
CHRISTOPHER JOYE
Deposit products have been murdered as viable investments and conservative savers are being compelled to absorb much more risk than they ordinarily would to meet their income needs.
Even before tax, “real” returns on deposits after core inflation are now negative for only the third time in the past quarter of a century. The king – cash – is dead and the trail of blood leads to Sydney’s Martin Place and central banks around the world, where cheap money and deliberately distorted asset prices are usurping economic reality.
When I first suggested that the Reserve Bank of Australia’s inflation-adjusted cash rate might have turned negative in December 2012, the governor, Glenn Stevens, correctly retorted that deposits still offered investors positive real returns.
Today that is no longer true. Since the RBA cut its target cash rate to a record low of 2.5 per cent in August last year, banks have chiselled deposit rates to the point where most no longer supply returns above your cost of living. After tax, you are falling way behind.
This is a big deal. Since the RBA started targeting inflation in 1993, its cash rate has, on average, returned a healthy 2.4 per cent above core inflation. The RBA’s cash rate settings have meant investors have typically been able to earn a decent real return of about 1.5 per cent a year, on average, above core inflation via three-month or six-month term deposits.
Investing in cash as a risk-free asset class and getting acceptable real returns beyond the cost of living, savers could rationally demand a significant premium from riskier investments like bonds, convertible preference shares (called “hybrids”), equities and housing. And if any particular sector became overvalued such that expected returns did not provide enough compensation for the risk of loss, savers could exercise the option of diverting their portfolios back into cash and still survive until more sensible valuations prevailed.
But the RBA has taken away that option. Even the most attractive “special” savings products promoted by banks, which come with bucket-loads of catches, now only furnish, on average, 3.45 per cent. After tax, you still cannot keep pace with living costs.
NEGATIVE RATES BEWILDERING
This was despite a jump in the jobless rate to 11.1 per cent in 1992.
The only time investors had to grapple with negative real deposit returns was in late 2001, when interest rates were probably left too low for too long (which precipitated the mother of all housing booms), and in early 2009, when house prices likewise rocketed at worrying rates.
When I called double-digit house price growth in mid-2013, some pundits poured cold water on the proposition. The economy was too weak, credit and wages growth too low and households had already levered up. We could not have a re-run of the previous housing booms, they argued. Yet over the past 12 months, property prices have climbed at three to four times wages while housing credit is expanding at twice the rate of incomes.
I was similarly isolated rattling on like a warmonger about geopolitical risks in these pages in recent years. My criticism was that the potential for conflicts was not being priced by financial markets. Ignorance was bliss until China and Japan started sabre-rattling and then, more starkly, Russia invaded its neighbour. The only prediction that has proved right is that political scientists and investors will consistently get national security risks wrong.
The same sense of bewilderment applies to negative real deposit rates.
It is surely hard to rationalise recessionary nominal cash returns, which rank among the lowest in modern history, when economic growth over the year to March was a trend-like 3.5 per cent, core inflation is sitting at the top half of the RBA’s target band, retail spending and credit growth have both expanded at rates well above wages, and equities and housing have boomed.
The odd man out is, of course, the noisy jobless rate, which until this week most thought would soon turn a corner.
TWO RISKS IN CASH PRICE CUT
Setting aside that anomalous data point, investors need to consider two related risks.
The first is that policymakers have fallen into the trap of thinking that continuously cutting the price of money, which is already at its cheapest level ever, will address our economic ills, which, people seem to forget, were severely mispriced assets in the first place.
The malaise identified by the global financial crisis, and which Australia probably still faces, is that too much capital and labour were being invested in the wrong places (financial services and existing housing). Instead of reallocating those resources to more productive sectors, we have been once again blowing financial bubbles. The big Australian banks are worth more than they were before the GFC, and US goliaths like Goldman Sachs and Morgan Stanley have recovered their pre-crisis valuation levels.
Getting families to increase leverage above 2007 marks by fuelling risky credit growth – and duping people into thinking bonds, equities and housing are great investments by having governments buy trillions of dollars of financial assets and bidding up prices (quantitative easing) – is categorically not the solution to the original valuation problems.
It’s like injecting Lance Armstrong with more drugs to combat his addiction to doping. While it might make sense to help wean him off, boosting his dosage for half a decade, as we’ve done with the cheap money craze, is madness.
This is the contradiction at the heart of capitalism: instead of allowing free markets to dynamically heal themselves and reallocate scarce resources via accurate price signals, we seem to believe governments, not markets, are our panacea.
The issue with negative real deposit rates in the absence of a bona fide crisis is that the RBA is encouraging destabilising asset price spirals.
With no effective risk-free investment and no need for the wealth-preserving qualities of cash without a cataclysm threatening portfolios, savers are forced to chase yield irrespective of the risks those investments entail.
But the more assets are bid up, the further yields fall. This destructive feedback loop results in investors taking on ever more risk to reach their income goals and can stretch prices way beyond fair value. The endgame is searing losses when the money-printing music stops and cash rates are belatedly normalised. Ironically, this is also when cash is king.
Like Smart Money on Facebook for more stories.
The Australian Financial Review
BY CHRISTOPHER JOYE