Welcome to Finance and Fury

Today – want to explore the chances of the ASX booming next year

  1. Have been talking about complexity theory for the past few Monday episodes – Focusing on collapses – but what if positive feedback loops kick in further – in the form of potential QE from the RBA
    1. Want to cover this as a few developments have happened recently – pointing towards this possibility in 2020
    2. Speculation from Banks – the RBA balance sheets show this


First – the process of QE – covered what it is in the past and why it doesn’t help the population – just raise prices

  1. Why? there is a concept of what is called the Cantillon effect –
    1. Cantillon effects – Under the assumption that all resources are fully utilised in equilibrium, a credit expansion implies that producers of capital goods in the ‘new’ processes of production bid away resources from ‘older’ processes. This is where the Cantillon Effect begins to work.
      1. The injection of additional money increases the purchasing power in the part of the economy it arrives first – in other words – it changes the price structure through the reallocation of resources and income
    2. This comes from Hayek – you could call him Keynes adversary in economics back in the 30s
      1. Inflation in the Hayekian sense is thus strictly defined as a rise in the quantity of money, not in the price level
      2. Inflation is not uniquely reflected movements of the price level, and the monetary cause of change the price structure will hardly be perceived as such.
      3. What Hayek was missing is the amount of money that flows through to the people – main street
      4. When Wall Street – i.e. the Bank and financial system get this – you actually won’t see inflation
        1. See price increases in property and share market, and bond market with QE
        2. But won’t see it in the population – the majority of loans to consumers are non-productive –i.e. – they don’t yield economic output – like loans for businesses or growth of economy goes
        3. Housing prices rising doesn’t create real growth – thanks to the debt backing it – long term the interest and massive principal repayments take away from economic investment or spending in economy
  1. In modern Banking system – printed money flows into banks first – redistribution of resources and prices – printing money doesn’t increase inflation if it never hits main street – Money flowing into Aus share market from Australia QE –
  2. Market collapse occurs – the RBA buys up shares ETFs using QE, i.e. printed money to reduce the effects
    1. RBA one of the last to do this – seen the BoJ get in, Fed, Bank of England – we look to be next
    2. But who benefits? How does the printing of money to buy assets (shares and bonds) help?
      1. If you are invested it raises the prices – if you aren’t – it just makes costs of living higher through property purchase, rates, and rental increases
        1. Wealth effect – not observed in economy though – theory only
      2. Also Governments – It is massively valuable for the state/local governments to have higher prices on land – more ongoing rates/taxes and lump sum – stamp duty/transfer costs
        1. Also beneficial to Fed Government – GST and CGT incomes- pump the prices up and make profit off the sale
  3. With the theory out of the way – where do we stand?
    1. The RBA and banking system seems to be increasing their balance sheets – based around the released data
    2. Look at the issuance of capital by the banks – equity and debt – share purchases and subordinated notes issuances
    3. Big 4 banks been on a frenzy of both – public issuances of notes, SPPs, capital raisings, warrant issuances
  4. Where it becomes even more interesting is the RBA data releases –
    1. First some terminology – The RBA defines the monetary aggregates as:
      1. M1: currency in circulation plus bank current deposits from the private non-bank sector – $1.04 trillion
      2. M3: M1 + all other bank deposits from the private non-bank sector, plus bank certificate of deposits, less inter-bank deposits – $2.14 trillion
    2. These stagnant numbers don’t tell the whole story – M1 – has seen a massive money increase – June 19 was $360bn – July $1.014 trillion – then till sept last figures – this crept up slightly to $1.033 bn by $19bn – in one month almost doubled – 185%
      1. Note that M3 decreased from June to July – $2.157 to $2.128 trillion – $29bn drop
    3. There has been a massive increase in M1- But Back in 2009 – was $220bn – past 10 years grown by 370% –
      1. M3 – Total money has gone from $1.200 Trn to $2.128 Trn – about a 77% growth – but nothing compared to M1
  5. What does this mean – look at the US fed and it tells a story that helps –
    1. When M1 increased in 2009 and 2011 – but M3 didn’t – what periods were those – During QE1 and QE2
    2. In which the Federal Reserve expanded its balance sheet through large-scale purchases of Treasuries and other securities
    3. M1 growth was highly positively correlated with the growth in reserves generated by Fed asset purchases
      1. Reason – reserves held with the central bank are assets for banks
      2. When central banks expand reserves – commercial banks must either sell other assets (keeping the overall level of assets unchanged), issue more liabilities or equity (expanding the level of assets), or some combination of the two.
        1. In the USA – banks did not reduce their overall holdings of assets as reserves increased
        2. Instead – funded these new assets by issuing additional liabilities – like capital notes
  6. Banks in Aus issuing billions every month in Capital Notes, warrant products and Share purchase plans
    1. Look at announcements of banks over past 6 months – Just last month in November
      1. CBA – $1.65bn of PERLS notes
      2. NAB – $1.4bn of Sub notes
      3. WBC – $2.5bn capital raising from Equity – $2bn institutional and $500m SPP
      4. ANZ – 1bn Euros of Subordinated notes
    2. Remember that QE occurs through the purchase of these assets off the secondary market – i.e. institutional investors or super funds – who buy the assets at issuances (direct from companies or Gov) – then sell at a premium to the Central Banks
  1. If the trend in our markets is true – and RBA has printed $640bn with billions more on the way for QE – markets may go up
    1. Last week – Australian shares surged to a record closing high on Wednesday, supported by growing speculation the Reserve Bank of Australia will cut official interest rates and launch quantitative easing (QE) next year.
    2. The benchmark S&P/ASX 200 jumped 63.1 points, or 0.9%, to a record closing high of 6850.6, less than 0.4 per cent below the record intraday high set in late July
    3. Following a speech from RBA governor Philip Loweon Tuesday evening that outlined what could prompt the bank to implement unconventional monetary policy measures to support economic growth, lower unemployment and push underlying inflation higher
    4. additional support as Westpac Bank became the first of Australia’s big four banks to forecast the RBA will introduce QE next year – they expect two rate cuts next year (down to 0.25% by June 2020
      1. QE also expected to begin in the second half of 2020
      2. The Westpac call, joining a growing number of forecasters who expect the RBA to rollout QE next year, helped drive every sector to end the session higher
      3. Rising tide lifts all boats – gains of 1.2% for utilities, communications, information technology, consumer discretionary, REITs and materials.
      4. With QE speculation in overdrive, the All Ords Gold Index surged 2.8 per cent, helped by a lower Aussie dollar and government bond yields.
  1. Take All of this with a grain of salt – if US share market crash occurs we will be tanked – QE wont be able to save us

Issue with our economy – Doesn’t matter if prices of assets go up if people can’t keep up in wages

  1. Also – if this is an effort to shore up banks and create credit to providing funding for bank bail outs – paints a different picture of where our markets are at
  2. Also – as rates go down create more free money – higher home prices and lower savings
    1. Make the current structural issues worse


Another interesting Factor –

  1. RBA off balance sheet – Interest rate contracts; OTC swaps; For series breaks see Series breaks – Interest rate swaps are the exchange of one set of cash flows for another. Because they trade over the counter (OTC), the contracts are between two or more parties according to their desired specifications and can be customized in many different ways
  2. Off the balance sheet Interest rate swaps massively increase – RBA data –
    1. Sitting at $32trn – 44% gain from Dec to June (6 months) – Up from $21.7trn – remember shares are $2bn
  3. Swaps are entered into when someone is in trouble –
    1. Example – Greece before their debt defaults – couldn’t meet their repayments – so swapped with someone who could – Germany and other EU members
    2. If your cashflow cant keep up with interest repayments – helps to swap the contractual repayments of interest with a counter party – i.e. one central bank or bank enters a contract to cover the other party’s interest repayments – fixed v floating
    3. Over-the-counter (OTC) derivatives have played a significant role in episodes of financial stress, including the global financial crisis
      1. because these derivatives are not traded on exchanges, detailed information about them has not generally been available.
    4. These products have become more easily usable – Central counterparties (CCPs) have become much more important, in large part because of G20 reforms to increase the central clearing of OTC derivatives.
      1. Australian banks still have significant exposures to other counterparties, including foreign banks.
    5. Most are Fixed to Floating – which is done when you think your rates are going down
    6. You want to fix at an income today – with other parties less likely to drop rates
  4. This could be in anticipation of struggling banks or other Central banks to help ease their cashflows to avoid defaults -this is just speculation at hard to get the counter parties to these contracts – Further Speculation of QE being done – as contracts are a hedge


Anyone’s guess- there are both positive feedback loops and potential negative feedback loops coming

Positive from RBA and QE – negative is USA ceasing QE and withdrawing credit


Thanks for listening, if you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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