Welcome to Finance and Fury – 

This Episode – Look at Where to not invest in negative rates world – if it comes to that – other options

First – what does the world in negative rates look like?

– dive further into this to start – look at other countries, Japan, Denmark and how this affects an economy –

  1. Also – what sort of investments won’t fare well – run through alternative assets
  2. Going to be 2 parts – go further into alternatives next week

What asset classes may be at risk – financial sector

Negative interest rates are terrible for banks – They destroy the business model for banks.

  1. Put further pressures on banks margin (profits) – make future bank collapses more likely because banks cannot build capital to absorb losses
  2. Commercial banks act as streams in the modern economy – Glacier (Central Bank) melts and the money flows through commercial banks and financial systems
    1. No ice – no flow – but no rivers – water nowhere to go – a dam that breaks and floods everything
  3. European banks are looking to be in poor shape – have negative yields but getting the exact opposite of what they need – Growth from stimulus spending and inflation
  4. Japan – same thing – used QE strategy to lower rates back before the term QE was muttered – originals – how well did it work long term?
    1. Japan has had near-zero or below zero interest rates for 20 years – stuck in liquidity trap
    2. How well has financial sector performed – 1980s – in Japan’s bubble years
      1. TOPIX Banks Index – Peak 1989 at 1,500 – now it is about 130 – loss of 91% over 30 years
    3. If this spreads to the rest of the worlds financial sector – financial sector suffers – by extension – the economy suffers as low-risk decisions are required – lower business lending
    4. Banks make money from the difference between the interest rates they charge on loans and costs on deposits (liability as a reserve to lend out) – you get interest due to risk – also issue FI –
      1. Rates go negative = ability to make a profit gets thinner  – but risks get larger on the assets loans collateralised against – i.e. property for mortgages
    5. Remember – pieces of the assets used as collateral have been inflated by these low-interest rates –
      1. Seen that play out with Japan back in the late 80s
  5. Denmark currently – 3rd largest bank offering 10-year mortgage rates at -0.5% – 20year fixed at 0% –
    1. borrowers will make repayment as usual – but the amount still outstanding will be reduced each month by the negative interest
    2. but savers see nothing paid in interest on their deposits – and may also suffer as they go negative
  6. Switzerland – UBS a few weeks ago sent a memo to HNW clients -introduce 0.6% p.a. charge on deposits more than €500,000 –
  7. Bank of England at 0.75%, ECB at 0%, Denmark (not ECB based) -0.4% cash rates
    1. Lower savings rates across Europe – Commercial banks need to take deposits and extend loans. That’s their primary function. This credit intermediation, as it’s called, is like a financial utility. One bank can be allowed to fail. But the banking system overall cannot be allowed to fail – why capital notes are being used as ‘reserve capital’ – replace lower deposits
  8. How banking meant to work – profit motive needs to make them aggressive on lending, and the fear of loss needs to make them prudent.
    1. Those two forces are supposed to balance each other out over time, with banks swinging too far in one direction and then too far in the other direction as part of the normal business cycle.
    2. Generally worked through history – when back with gold or other currencies – some hiccups, as long as banks can do this profitably – meaning they make enough money and set aside enough capital during good times to be able to eat the losses during bad times without collapsing.
      1. This sort of event created Central Banks – lender of last resort to provide liquidity – today – manage insolvency as fiat is debt-based
    3. Negative interest rates make banks start losing money on their assets – need to chase yield to make some kind of profit
      1. Have to do risky investments – sometimes will come with inadequate returns or compound systems risks
      2. ECB, the BoJ, and Swiss National Bank have admitted that negative interest rates weaken banks – not speculating here – The ECB has even been talking about a strategy to “mitigate” the destructive effects its policies have on the bank – cash bans
  9. The real economy – negative interest rates have an even more profoundly destructive impact: They distort or eliminate the single-most-important factor in economic decision making – the pricing of risk.
    1. Bit of a guess – Similarly, portfolio management tools like Capital Asset Pricing Model (CAPM), Modern Portfolio Theory (MPT), Value At Risk (VAR), Risk Parity are all ill-equipped to handle a world of lasting negative interest rates
    2. Risk is priced via the cost of capital. If capital is invested in a risky enterprise, investors demand a larger return to compensate them for the risk. And the cost of capital for the risky company is higher. If capital is invested in a low-risk activity, the return for the investor and the cost of capital for the company should both be lower. And the market decides how that pans out.
    3. But if central banks push interest rates below zero, this essential function of an economy doesn’t function anymore. Now risk cannot be priced anymore. The perfect example of this: Certain junk bonds in Europe are now trading with a negative yield. This shows that the risk-pricing system in Europe is kaput.
    4. World where risks cannot be priced correctly anymore – consequences – probably going to be bad over the longer term for the real economy – creates misallocation – malinvestment and bad decision making
      1. Means overproduction and overcapacity – asset bubbles of where borrowings flow
      2. Load the entire financial system up with huge risks because these assets are used as collateral, and their value has been inflated by negative yields.
  10. The observable outcome from these policies – strange combinations – massive housing bubbles in cities while slowing economy – Germany – Berlin and Munich while they look to be about in a recession –
    1. Or Aus – Syd, Melb – Not much wage growth, slowing GDP growth – misallocation of lending – bubble in consumption (demand side) without supply (businesses/overall economy, wages, etc.) catching up
    2. Monetary Policy remedy to this situation caused in part by negative interest rates – more of the same thing
    3. Longer negative interest rates continue – more upside down and unpredictable our economic system will become
    4. Harder for us to reverse course – without financial system throwing their hands up, bailing and starting afresh – Nothing new
  11. And a major reset is of course precisely what every central bank fears the most – How will this end?
    1. No one knows because this size of a reset has never occurred before – some idea: When there is no reward for saving and bonus to borrow – the economy stops functioning properly – slow decline before being abandoned
    2. What this all shows – that the financial system is pretty sick – the cost of its money is so low –
    3. Financial reset is likely needed –Few options the IMF have been publishing about – with SDRs, or Crypto backed by gold or SDRs
  12. Over the next few years – may see a dollar-denominated asset collapse due to the USD going through replacement speculation
    1. A lot of the Debt in the global financial system is back by USD – so if you can collapse the value – you collapse the size of the debt owed
    2. If rates continue to go down – if they go Negative in Aus would be bad for ASX index investments – 25% in Financials – mostly big 4 banks – crash to index from a handful of shares triggers wider panics and sell offs
    3. Passive investments (indexes) along with the FAANG shares – may not fare so well
  13. A lot of factors look to be pointing towards systemic risks –
    1. Passive/Index ETFs – liquidity risks – not selling underlying shares but selling the ETF – need a buyer – May be hard to find in a panic –

 

Few different alternatives next week –

  1. Inverse ETFs (BBOZ and BBUS) – various assets and derivatives, like options, used to create profits when the underlying index declines in value. Basically, it’s an index ETF that gains value when its correlating index falls
  2. Versus – the “old money” strategy – about capital preservation – gold, land or art ETF
  3. Both have pros and cons –

Thanks for listening, if you want to get in contact, you can do so here.

Understanding currency markets and exchange rates

Welcome to Finance and Fury. I’ve seen news about the AUD being at a 15-month high Today – wanted to do an episode on exchange rates and look at some of the fundamental driving factors in the price movements – next week put this together and look at the current trend...

Investing for an income yield in the current economic environment – which asset class is best?

Welcome to Finance and Fury. In this episode we will be looking at where to invest in the current economic environments for yields, or passive incomes in the current environment. Best place to invest for yields changes, a lot of this has to do with market...

Say What Wednesday: Welcome to the Wild West

Say What Wednesdays Welcome to the Wild West Welcome to Say What Wednesday This week we’re going to answer some of the burning questions that have been on a lot of peoples’ minds around the banking royal commission…and rather than repeat everything you’ve been hearing...

Furious Fridays: Why must Governments and Central Banks force inflation on a Nation?

Welcome to Finance and Fury, the Furious Friday edition! I’ve been thinking a lot about what we are taught in economics, the basic ‘101’. Specifically, if you print a lot of money you get hyper-inflation. There are plenty of stories to back this up Germany Weimar...

How to avoid getting further into debt and get spending habits back in line

Welcome to Finance and Fury. Credit cards and pay day lenders are on the rise, as some of those out of work are becoming strapped for cash. Today, we look at this further but also look at some alternative strategies to avoid the debt traps. We’ll also look at how to...

The Lucky Country isn’t what most think – A look back in history on how we are destroying our own luck

Welcome to Finance and Fury, the Furious Friday edition A reminder of how lucky we are and why we are called the lucky country. Also, what we have to lose if we neglect to remember this Some perspective: You don’t know what you have until you have lost it Taking...

The Economics of War – conducted for the benefit for the very few, at the expense of millions

Welcome to Finance and Fury, The Furious Friday Edition. War is a racket – Something that always catches my attention is when politicians get on What is one thing they seem to get on about? Police enforcement, regulations on industries On a more global scale - Going...

Tax Scams and the Brexit Mess

Welcome to Finance and Fury, the Furious Friday edition. Today we are discussing what is happening with Brexit? At the time of the release of this episode, we will be approaching the 11th hour of the 2nd deadline to negotiate a deal for the UK to leave the EU. Why...

How does corporate debt fuel market bubbles?

Welcome to Finance and Fury, The Furious Friday Edition Today – want to look at how much Corporate debt has been fuelling the top end of the share markets growth – signs that if liquidity is withdrawn, companies and markets collapse   Last FF ep – went through...

Are tech shares like Afterpay and Facebook are a good long-term investment option?

Welcome to Finance and Fury, the Say What Wednesday edition.  Today's question comes from Mike - "Hey Louis, Wondering if you think buying Tech shares are worthwhile"  We have the FANG and the WAAAX – US – FANG - Facebook, Amazon, Netflix and Google Aus – WAAAX -...

Pin It on Pinterest

Share This