#inflation

Drinking the UnKool-Aid

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It appears President Trump has been bullying the US Federal Reserve to drop rates by 1% and get them to reopen the spigots on QE. What he is failing to grasp is that businesses invest because they see a cycle, not because interest rates fall.

Trump tweeted,

China is adding great stimulus to its economy while at the same time keeping interest rates low. Our Federal Reserve has incessantly lifted interest rates, even though inflation is very low, and instituted a very big dose of quantitative tightening. We have the potential to go…up like a rocket if we did some lowering of rates, like one point, and some quantitative easing. Yes, we are doing very well at 3.2% GDP, but with our wonderfully low inflation, we could be setting major records &, at the same time, make our National Debt start to look small!

This is a frightening proposal. Rates are at 2.25~2.50%. Although it masks a more important reality. Can Trump avoid a market calamity ahead of the next election? The real engine of the economy is slowing.

Despite the headline US GDP print of 3.2%, consumer spending and business investment slumped to the lowest levels under his presidency. Business investment spending was dominated by “intellectual capital” (soft) which is a pretty hard metric to put a reliable number next to. Equipment and structures (hard) contribution to business investment was near as makes no difference zero. Personal consumption of durable goods slumped to their lowest reading since 2011. Wholesale inventories (ex-autos/petroleum) surged ahead of sales.

Trump might argue China is adding stimulus. He is right. China’s Aggregate Financing (approximately system Credit growth less government borrowings) jumped 2.860 billion yuan, or $427 billion – during the 31 days of March ($13.8bn/day or $5.0 Trillion annualised (a Japanese GDP)). This was 55% above estimates and a full 80% ahead of March 2018. This pump priming added 8% to the Chinese stock indices but since then the market has been rolling off.

The world does not need more debt to be inflated away to get us out of the current mess we are in. A recession is inevitable. To put it into context, the world, since GFC, has added $140 trillion in debt for a grand total of $20 trillion in global GDP growth. That is right. $7 of debt only got us $1 of GDP. So if the Fed acquiesces President Trump he will probably get even worse metrics.

Then again perhaps we can take the words of a venture capitalist, Chamath Palihapitiya, who said on CNBC that “central banks have created an environment where major downturns and expansions are almost impossible.” It is statements like this that almost guarantee that central banks have lost control. Central banks have one role – ensure that markets maintain “confidence”. Powell’s latest move to cut rates after such a shallow peak tells us that “confidence” is waning. 

Profligacy paid for by wishful thinking

Lots of promises. Lots of grand assumptions. To be honest, best just ignore the minutiae. It’s a complete waste of time. The biggest question is, if the global economy, by Treasurer Josh Frydenberg’s own admission, is slowing down (just look at government bond yields flattening/gone negative) how on earth is Australia going to grow receipts from $485.2bn in 2018/19 to $566.9b in 2021/22? A 17% growth in tax revenue. Expenses will rise from $487bn to $559.9bn respectively. Give aways +15%. Best hope the world economy doesn’t tank. Expenses are locked in. Tax revenues aren’t.

Worse, these projections have all been massaged higher than the 2018-19 budget. What has changed to our overall net position in the last 12 months to gain such confidence? Climate alarmists would blush at the extent of the upward massaging of numbers. Did Treasury sit down after consuming 3 bottles of Absinthe to come up with these revisions? Think about it. How can we get an extra $5.9bn in tax receipts in 2021-22 when conditions are sure to be worsening?

This is NOT an old school Coalition budget by any measure. This is a crossing fingers, closing the eyes and hoping we muddle through budget. If the proverbial hits the fan, a monster deficit is assured. Take it to the bank.

We are technically at full employment. Unless we embark on mass migration (which we’re looking to cut) how will flat wage enduring Aussies and corporates contribute to a 17% rise in the Canberra coffers? Wishful thinking. The government targets around 23.9% of GDP for tax receipts and pats itself on the back for “the government’s average real spending growth is expected to be the lowest of any Commonwealth government in over 50 years.” Although that claim is dispelled by their own tables contained here.

Cutting taxes can create more tax revenue. Poland sliced its corporate taxes in half in 2004 and doubled revenue. However that was more a grey money grab than pure unadulterated tax policy spurring public revenue growth.

Giving away more money to the middle class through tax cuts and hand outs in the hope they spend more seems wishful thinking. The problem is if global growth hits a wall, we don’t have a Howard/Costello surplus to buffer the storm. No $38bn backstop in the war chest.

China, the US and EU are struggling. Things are so bad in the US that the Federal Reserve had to chicken out of any more rate rises because it would tank the economy. Our growth will stall if the world slows. Forget 28 straight years of continuous growth in Australia. The knock on effects will see unemployment surge, consumption fall off a cliff, housing prices crash and tax revenues slump. Forget a $7.1bn surplus. Think $20bn deficit because the promises are too grand and the tax receipts blindingly optimistic.

Of note in the 2019-20 budget is the expansion of the ATO’s tax grab from evil multinationals and HNW individuals who’ve avoided paying their fair share. That will result in a $3.612bn extr over the next 4 years. That against the $5.74bn tax cut for middle class Aussies over the same period. Spending up everywhere. Just not sure why the Treasury hasn’t pointed to where the extra revenue is coming from.

Take the assumptions of 2.75% GDP growth flat to 2020/21. Unrealistic. Treasury assumes the same labour force participation rate with unemployment remaining to 5% and wage growth of 3.25% in 2020/21, up from 2.1%. All looks so simple. Yet inflation is expected to grow to 2.5% meaning real wages will be flat.

Aussies, saddled under 180% debt to GDP, shouldn’t take any sense of comfort from this budget. What Frydenberg presented tonight was nothing more than a hope that the most rosy scenarios play out when thunder clouds are so obviously rolling in. It’s utterly irresponsible. Yet that’s today’s political class – spineless. They’re unprepared to tell Aussies that they have to be prepared to live with much less. Instead of asking us to tighten our belts, a whole load of freebies that can’t be paid for end in our laps so they can hold on to power for a bit longer.

A reminder on the extra market downside risk created by ETFs

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As a reminder in markets selling off in recent days, please find a report which touches on the extra volatility created by ETFs on the downside that amplifies market sell offs.

An excerpt of the report is as follows;

CEO Larry Fink of Blackrock, the world’s largest ETF creator, has made it clear that leveraged ETFs (at present 1.2% of total ETF AUM) have the potential to “blow up the whole industry one day.” The argument is that the underlying assets that provide the leverage (which tend to have less liquidity) could cause losses very quickly in volatile markets. To put this in perspective we looked at the Direxion Daily Fin Bull 3x (FAS) 3x leverage of the Russell 1000 Financial Services Index…The point Mr Fink is driving at is…the average daily return is closer to 10x (in both directions) than the 3x it is seeking to offer. This is post any market meltdown. On a daily basis the minimum and maximum has ended up being -1756x to 1483x of the index return, albeit those extremes driven by the law of small numbers of the return of the underlying index. Which suggests that in a nasty downturn the ETF performance of the leveraged plays could be well outside the expectations of the holders.

Australia vs Japan – Coca Cola Index

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Whenever buying a Coke in Australia it is hard not to notice the exorbitant prices for a 500ml bottle – usually around $4. Here in parts of Japan you can pick up a 500ml Coke for less than $1. In convenience stores 500ml Coke sells for ¥129 or around $1.50. Either way Japan is a bargain basement country which is often contrary to expectations.