Welcome to Finance and Fury, the Say What Wednesday edition.
Policies that governments and CBs have implemented that affect asset values
Relates back to Ryan’s investment thesis – As a millennial I understand that the government has to do their best to keep the ageing baby boomer asset prices (predominantly US share market and Australia property) high so they don’t have to fund them in retirement through pension- though I am not sure I am that interested in paying top dollars for these assets in which puts me right out there in the risk curve for not a high enough potential return.
Go through monetary policy and how this has affected asset prices – and how it will likely continue to do so
Reasoning for policies that have inflated asset prices – Not for the reason of pension funds –
- Not sure about the government not wanting fund pension – They aren’t funding them – we are with tax money – there is no asset sitting there to fund it –
- If They are trying to keep asset prices high – it is for the wealth effect – spending effects due to confidence
- Or for their own wealth – financial disclosure for the fed board came out and they are all multi millionaires with trusts and investments into indexes and shares that suspicious benefit like GE
- Also politically expedient for the larger chunk of the population – keeping the largest group of the voting public happy – or those why pay them the most in the way of lobbying
- Property – most people live in this and cant fund their retirement off it –
- land restrictions and taxes haven’t helped
- Look at traditional assets – for investment Strategy in places i.e. can’t beat them, join them – However – monetary policy is not fiscal policy – Governments are directly keeping a lot of asset prices high – Monetary policy from CBs has a greater effect – lets run through them one by one
Cash itself – in times of uncertainty or need of liquidity is king – but not a good asset class – shouldn’t be seen as an investment – it is a medium of exchange
- infinite money-printing will eventually destroy fiat currencies – by when? Why knows –
- With the acceleration of printing it may be far quicker than might be generally thought
- This final act of monetary destruction follows a 98% loss of purchasing power for dollars since the London gold pool failed – established in 1961 under the Bretton Woods system – but lasted less than 10 years with France first pulling out in 1968 – and then the gold window fully collapsing in 1971
- And now the Fed and other major central banks are committing to an accelerated, infinite monetary debasement to underwrite their entire private sectors and their governments’ spending, to prop up bond markets and therefore all financial asset prices
- Have to rethink inflation theory – Inflation of prices – not goods
- inflation is commonly presented by modern economists as a rise in the general level of prices – based around theory this is correct – but misleading
- Going back to the pre-Keynesian definition – inflation is an increase in the quantity of money which can be expected to be reflected in higher prices
- Expected to be reflected in higher prices – important the expected part – as it is theoretical as the effects on prices can be a number of different factors
- Split into two categories – prices of consumable goods -and prices of other assets – shares, property and bonds
- For price inflation of goods – The effect of an increase in the quantity of money and credit in circulation on prices is dependent on the aggregate human response.
- In a nation of savers, an increase in the money quantity is likely to add to savers’ bank balances instead of it all being spent – in which case the route to circulation favours lending for the purpose of industrial investment – this was historically the case
- Product innovation, more efficient production and competitive prices result; and a price countertrend is introduced, whereby many prices will tend to fall, despite the increase in the money-quantity.
- Banks used to need savers – but not anymore – have capital notes and investors – along with Central Banks to provide all the funds – plus – there is no free market for interest rates due to competition between banks for your cash now
- When you don’t need savers – you can have very low interest rates –
- Trends for higher levels of household debt which then takes away from savings further
- Which lowers people’s ability to consume domestically – and need more imports from other countries where goods are produced more cheaply – this has a deflationary effect on goods
- On the other hand – Asset prices increasing can be a by-product of increased level of money – money created through credit (or debt) has to flow somewhere –
- Now the breaks are off when it comes to additional credit being produced – means more money into the system –
- If this goes to main street – may see inflation in consumer goods – helicopter money policies
- In a nation of savers, an increase in the money quantity is likely to add to savers’ bank balances instead of it all being spent – in which case the route to circulation favours lending for the purpose of industrial investment – this was historically the case
- For price inflation of goods – The effect of an increase in the quantity of money and credit in circulation on prices is dependent on the aggregate human response.
- If this goes to wall street – which most is – will see inflation of prices –
- Regardless of where the money goes – eventually when too much money is introduced you get too much debt to be covered by the economy – ran though this in the debt jubilee episode – eventually a fiat currency collapses – what happens to the assets in the country where the currency fails?
- Looking historically – process of a developing collapse of a currency usually starts with outsiders reducing their exposure to it
- astute speculators would start selling off assets that back the fiat currency – bonds and treasury notes
- In the modern economy – it is impossible to judge how it will play out – but the USD dollar having the role of reserve currency appears to be most exposed to foreign liquidation – outside of the US economy – foreigners account for $25 trillion USD in assets held – from equities, treasury notes and bonds, deposits and cash – most of this cash is in assets outside of deposits though –
- Looking historically – process of a developing collapse of a currency usually starts with outsiders reducing their exposure to it
- There is little incentive to hold cash – beyond the stability and liquidity it provides – interest rates are too low –
- Inflation creates a negative real return – without Even the thought of negative rates
Currency destruction and the policies that have affected asset prices – again – created money has to flow somewhere
- In addition – due to cash being devalued – and saving rates being low – people put money into other assets that are expected to beat cash returns and inflation – these are your more traditional assets like shares, property
- Need for assets with good capital growth – but the issue with most Major assets that have been propped up by monetary policy – the same monetary policy that is destroying the dollar
- Not all assets within these groups are the same – go into this more next episode – But property – block of land or an inner city apartment – shares in a tiny mining company that is still yet to make a profit or shares in Telstra or WOW – Bonds – Aus Government bonds or capital notes issued by Virgin
This being said – for the purpose of simplicity when talking about how policies have affected them – I will be talking about as an aggregate –
- Bonds – the debt instruments themselves
- Increase of supply – but also increase of demand from the debt instruments
- March saw record outflows from corporate bond funds (-$42bn) – investors worried about corporate defaults – but since then = now witnessing record inflows to corporate bond funds (+$85bn since the start of April) – as the back-stopper in the form of SPVs and the Fed are there to soak up supply
- Traditionally – Bond yields – which cannot fall by much – should begin to rise as a government deficit increases – due to risks of holding – but with the Fed and other CBs actively pushing these down – no additional returns for the higher levels of risks of defaults –
- This also pushes up other assets with it – Monday episode on WACC – that is for shares
- Also the episode on CAMP – with the risk free assets expected return going down
- For property – the purchase of mortgage funds also has an effect
- Bonds have had a good run for the past 20 years – negative price relation to interest rates
- Interest rates decline – price of bonds goes up – with older bonds with fixed coupons at 4% – they are in high demand – but you pay top dollar off them
- As a millennial investor – probably not the best long term investment to put large chunks of money into if capital growth from here is a goal
- Property – are paying top dollar in Aus – Banking regulations and inflation targets – lowering interest rates
- I think high property prices is a by-product – inflation targets and demand side theory = lowering interest rates an easing of credit
- If interest rates rise – bad for property – affordability for interest rates – I think will be a driving factor for growth
- On the Government side – it is town planning and taxes/regulation that keeps property prices high
- Don’t think that this is the intention of these policies – more a second-order effect
- But in conjunction with monetary policy – which has spiked demand – created high property prices
- Demand- not viewed as people alone – but how much credit people have access to
- Aus population not that large compared to other countries – especially for the amount of available land that we have – but the amount of household debt we have is large
- Limited supply to a handful of major cities – decent average incomes to service debts
- And large demand through falling interest rates – giving the additional perception
- Inflation targets – real value of debt goes down – so borrow money to invest in an asset class that gets capital growth
- Shares – Main factors – Increased credit availability, QE and lowering interest also affected demand for shares
- Shares are a representation of a company -not all companies made alike –
- Money through QE – enters the financial system and has to flow somewhere –
- Example – investment manager or Super fund – sells bonds – gets cash – cash gets invested somewhere – shares or re-rolled into bonds –
- Shares are a representation of a company -not all companies made alike –
- Increased ‘liquidity’ turns into artificial demand for assets – pushing prices up
- Increased debt and availability of credit it has pushed the market up
- Leveraged investments in shares – either from home equity, margin loans, leveraged products
- Large rise in margin trading accounts – all increasing the size that can be demanded for shares – if you have one person with $10,000 – that can gear at a 75% LVR – create $40k of cash – equivalent of having 4 people with $10k each –
- Increased share prices through share buy backs
- Leveraged investments in shares – either from home equity, margin loans, leveraged products
- Similar to Property – investors are aware of Inflation targets – real value of debt goes down – so borrow money to invest in an asset class that gets capital growth
- Another factor – Lowering interest rates make people move up the risk curve to get an income
- Bonds and Cash both pay almost no income at the moment – so the ‘blue chips’ can be seen as an alternative
All assets can be propped up on prices – overdemand – hand sanitizer or toilet paper
- Not to avoid these – but be aware – That some of the assets that have benefited – and likely will continue to be benefited – relating to Ryan’s point on potential returns
- Out of these – Don’t expect Shares to have a significantly lowered returns –
- Aus Shares – Returns come from Dividends – 2-4% growth on average – but more comes from dividends and FCs
- Unlike US share – Aus shares haven’t been the major recipients of US QE policy
- The increase of credit doesn’t look like it is going away any time soon – and with it – asset price inflation
- However – this may create a situation in which they will have to “reset” the system in some way or another – based around CB and IMF white papers – looks like they are thinking of a completely centralized digital currency – whether it is country by country or a one world system – hard to tell – but a shift to digital is likely – central banks that were researching CBDC’s has now risen to 80%
- Don’t think that CBs will really let the dollar fail at face value – will do a monetary reset before that
- Shifting to digital – Final part next week will look at alternatives like Crypto or gold
- Also look at the investment strategy of focusing on real assets – and the importance of this in a world with increasing funny money
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