Tag: depression

How Money Printing Can Fail

The world economy came crashing in 2009 but was rescued through money printing. Standard economic theory would say that money printing would increase inflation, but we haven’t seen that.

If anything, the threat has been deflation (prices falling), and central banks lower interest rates or print money to cause inflation and fight deflation.

Lower interest rates encourage more people to borrow, and borrowing increases the money supply, so the effect is similar to money printing in that there is more money in the economy.

When people are confident, they tend to borrow money so that they can e.g. expand their business or buy more shares or real estate so that they can make even more money. However, when people are bearish, they don’t borrow because they may not be able to make enough money to pay off the loan, and so they tend to focus on paying off the debt. If going into debt increases money supply, paying off debt does the opposite, which is reduce the money supply. Paying off debt destroys money, which leads to deflation.

The game central banks seem to be playing is to wait for a dip in the market or a time when there is falling confidence and hence there is deflation. Then they lower interest rates or print money. People then expect the higher money supply will push up the prices of the property, shares, businesses, etc that they hold due to higher money supply increasing inflation, and then they borrow or leverage more, which pushes the market back up.

In theory, this can go on forever. As deflation occurs, just stimulate more.

There is one problem with this, which is what happens when money is printed but the recipients of printed money don’t do anything with it because they are concerned and want to “wait and see.” If interest rates are lowered, the expectation is that people will borrow more, but what if they don’t? Even if interest rates are zero, if returns on investments are negative, it’s not worth borrowing to invest. Likewise, if the recipients of printed money feel that all investments are poor and that the best use of money is to just leave it as cash, then this reduces the so-called velocity of money in the economy, which is deflationary.

In the past, assets produced great income. However, as money is bring printed in record quantities and interest rates are lowered, people are grabbing that easy money and investing it. If, say, a house in South America produced a rental yield of 10 percent, then as investors borrow money and buy the house, the prices go up, which lowers the rental yield. As the yield goes down, investors search for other assets. This is the so-called global hunt for yield.

As the global hunt for yield continues, investors need to search far and wide to find returns. Two ETFs have been released for the ASX that satisfy investor appetite for yield. There is an ETF that invests in junk bonds, i.e. lending money to bad companies (iShares Global High Yield Bond (AUD Hedged) ETF). There is also an ETF that lends money to emerging market governments (iShares J.P. Morgan USD Emerging Markets Bond (AUD Hedged) ETF).

As interest rates and money printing intensify, investors may reach the point where the global hunt for yield ends because all avenues will be exhausted. Investors then either don’t borrow at all or if money is printed and thrown at them, they do nothing with it. This bubble in yield pops.

This is when stimulus fails, and it looks like we are getting close to that day.

The Dismal Future of the Australian Economy

gold price vs asx200 27 august 2015
GOLD vs the ASX200 (Commsec)

The recent volatility in stock markets has gotten me worried. Everyone keeps telling me to relax because “economic fundamentals are sound,” but when I ask them to explain how this is true, it’s revealed that they don’t really know what they’re talking about. It seems that most people just hope for the best and rationalize away bad news.

The Chinese stock market is certainly wobbly. Some say the Chinese economy is very healthy. After all, they have low debt and a massive foreign exchange reserve. They are the biggest lender nation in the world with the USA the biggest creditor nation. However, we don’t really know much about the true size of China’s debt because there is significant activity in the underground economy that is not transparent, and I’m not too confident in official figures provided by the Chinese government. Of course, China has been manufacturing products from t-shirts to smartphones, but the government has in recent years been intervening in the economy to prop up the stock and property markets. It’s uncertain whether these distortions can be held together by the government or whether the market will eventually strike back.

America has resorted to printing money, which has resulted in surges in the stock and bond markets. However, unemployment is still high and wage growth is low. Printing money doesn’t seem to have done anything other than make the holders of stocks and bonds wealthy (these are mostly wealthy people anyway).

In Australia, our economy used to be dominated by two sectors: the banks and the miners. The miners dug resources from the ground and shipped them to China. China makes goods and ships them to US consumer who buys these goods.

But the American consumer (or consumers from any other developed country) is not buying as much as they did before the GFC. This means China is slowing down, the price of resources is dropping, and the mining sector in Australia is getting crushed. We only have the banks left, and how do they make money? The balance sheets of Australian banks is mostly in loans to consumers who buy real estate. Real estate prices have been going up thanks to profits from mining. In other words, banks do well because house prices have been sustained by profits from the resources sector. Now that mining is dead, what will sustain us? Where are our strong fundamentals? House prices only go up with people buy houses, but to buy houses you need to make money in the first place. You can’t make money from houses without putting money into it in the first place.

Many who have bought stocks have made great wealth from quantitative easing, but now that tears are emerging in a bubbling world economy held together by printed money, it’s time to look at investing in gold.

Gold tends to shoot up significantly when stocks tumble, and when stocks go down, gold tends to go sideways or go up anyway, so there doesn’t seem to be any downside to investing in gold.

Personally, I will be buying this shiny metal from now on.