Genadmin – Financially Wise

Jobs and growth – the myth

Unless you’ve been stranded on a desert island (we should all be so lucky), you will undoubtedly have heard the term “jobs and growth” bandied about the place as the federal election draws near.

All sides of politics like to promise jobs and economic growth. People are generally reassured if they think that there will be jobs available for them and the economy is likely to grow.

But how realistic is this promise of job creation and economic growth?

Let’s look at jobs first. Governments don’t create jobs. Businesses do. And no, creating more government jobs is not job creation. At best, governments can foster an environment that is conducive for businesses to create jobs.

Large infrastructure projects, even if they are public and private partnerships, are also not really job creators. These usually have a limited lifespan and do not create jobs for the long term. Once a project is finished, there are no ongoing jobs.

Compounding this is the fact that the whole jobs landscape is changing. Jobs are becoming more transient. Employers find they only need people for shorter periods and outsourcing has also changed the job environment. Businesses would rather put on casual or part time people than a full time person as it makes it easier to manage changing workloads. But this makes it harder for people looking for work and increases underemployment, something not being addressed by governments.

The nature of knowledge is also changing within the jobs framework. The amount of information in the world now is doubling every 18 months. To put that into perspective, 50 years ago, it took 25 years for information to double. It means that in some areas of knowledge, for a standard three year university degree there’s a distinct possibility that by the time the student graduates, what was taught and learnt in the first and possibly even the second year, is already obsolete. Many students will have degrees that are no longer useful by the time they graduate. There might not even be jobs in that industry. Our education system is not moving quickly enough to keep up with technological advances.

Experienced commentators and futurists are predicting that anywhere between 40 and 70 percent of jobs that exist today won’t exist in 10 years thanks to automation, artificial intelligence, robotics and virtual reality. It also means that there are new types of jobs being created now that didn’t exist a few years ago. Whoever heard of content marketers, social media engineers and virtual assistants until recently?

The focus needs to shift to entrepreneurism and innovation rather than the traditional job where a person works for someone else. People working for themselves, setting up micro or small businesses and solopreneurs are one of the few areas that is actually growing. Our education system needs to be more nimble and adaptable.

And then there’s economic growth. A growing economy is good for the country and the electorate, as this indicates economic stability, guaranteed jobs and other indicators like wage growth. However, realistically, governments can no more increase or create economic growth than they can create jobs, particularly in the current global economic climate.

Let us look at some reasons why this is the case.

Firstly, we are in a global slow growth environment. Most developed countries are experiencing their slowest growth in decades. We are entering a deflationary period where asset prices are falling. I believe we are reverting back to the mean, as discussed in this previous post.

Most countries have tried various stimulatory measures. Central bankers use monetary policy by altering interest rates. In the past few years, most have reduced official interest rates to record low levels. In some countries, such as those in Europe, the interest rate is effectively zero and in others, such as Japan, Switzerland and Sweden, they have negative interest rates. This has not worked in stimulating their economies.

Low interest rates are supposed encourage people and businesses to borrow more thereby increasing demand. But that will only work up to a point. Interest rates are now so low, that any person or company that has wanted to borrow has done so by now. Instead, many people are taking advantage of the low rates to reduce their debt levels.

Reducing interest rates has its biggest effect early in the cycle of rate reductions. Thanks to diminishing marginal returns, each subsequent rate cut has a lesser and shorter impact than those made earlier in the cycle. Eventually they have no impact at all. I believe we are already at this stage and this is particularly evident in countries with zero and negative interest rates.

People and businesses cannot be forced to borrow more, particularly when they are already up to their eyeballs in debt. Australia has one of the fastest growing debt levels and our borrowing is at record levels already.

Governments are also increasing public debt levels, and in many countries, a great deal of this debt is to meet welfare requirements. Hardly a productive use of money. This also affects a country’s credit rating and makes credit more expensive if and when they are downgraded.

In addition, low interest rates have the effect of reducing confidence in the economy. Interest rates are usually only dropped in difficult economic times, so continually dropping them sends the message to people and businesses that the economy is not well and there are bad times ahead. Subsequently buying and investing slows or stops altogether.

Also with every interest rate cut, people who rely on interest for income such as savers and self-funded retirees, earn less and so spend less in the economy as their income drops. It also makes it harder for those who are saving for things like house deposits who earn less on their savings, thus delaying their entry into the market.

Demand for things is also falling. Manufacturers and countries relying on export, such as China and Japan, are finding that there is less demand for their goods. This is partly because the weaker economy erodes confidence in the market, and people are concerned for their jobs. They therefore decide they don’t need as many “things” or “stuff”. Many countries, such as China, have invested massive (borrowed) amounts on increasing the capacity of their factories and manufacturing just as demand slowed. Many of these plants are now underutilised or sitting idle.

Governments also don’t like deflationary periods. It reflects badly on them and their policies if the economy does not grow under their stewardship. In order to try and stimulate their economies, governments will use fiscal policies, or government spending. This gives the illusion of growth through increasing GDP figures, but this is at best a short term solution and rarely leads to long term growth and employment. Running stimulus or quantitative easing programs, more commonly known as money printing, presumes the money created will make its way to the greater economy by trickling through the banks to people and businesses.

The trouble with these programs is that very little of the printed money has actually made its way into the real economy. Instead, most of it has stayed with the banks or gone to large companies where they have used the funds to buy back their own shares. This increases stock market prices, but has not made a direct contribution into the economy.

Asset prices, such as real estate and stocks have been artificially boosted by people and investment funds searching for any yields they can find because they get nothing from holding cash. Unfortunately these asset price rises have nothing to do with productivity increases.

As previously mentioned, this stimulation is increasingly done with borrowed money, as few countries now run surpluses. Public and private debt burdens keep increasing. Unfortunately, private debt is increasingly funnelled into unproductive endeavours and assets.

It doesn’t actually create jobs and has exponentially decreasing returns. In other words, it’s costing more money or debt, to create increasingly smaller returns. Where once every dollar invested might create greater returns than that initial dollar, now that invested dollar is returning less than the initial investment. These days the original dollar is debt, so we’re using more and more debt to create a lesser return.

This will ultimately create a drag on the economy and slow it down. We are already seeing the result of this with low growth, stagnating wages and low inflation and even deflation, because the economy is weighed down by this enormous unproductive debt hanging over it.

But the biggest reason for the low growth and slowdown in jobs is demographic change in developed countries. Almost all developed countries have smaller generations following the baby boomers. This means that the welfare and handouts that everyone has come expect as an entitled right may not be able to be funded, as the burden of paying for this falls on the next generation.

The Australian birth rate is below replacement at 1.8 children per couple. Our current immigration levels are enough to increase the population at this stage, but is this a sustainable model? It could be argued that the continent of Australia is not able to sustain the Big Australia vision of most of our politicians, given the vast interior of desert not suitable for agriculture and we are the second driest continent on the planet. Food and water security cannot be guaranteed.

Unfortunately our current and growing welfare requirements, demanded as a right rather than a privilege, depends on succeeding generations being larger than the preceding ones. Everybody wants the “free” education, “free” healthcare, disability allowances, faster broadband, greater pensions, stadiums and everything else expected to be provided by bigger and multiple levels of government. The trouble is nobody actually wants to pay for it. We all want someone else to pay. Obviously this is unsustainable, and was only ever really possible during the baby boom years.

So the bottom line is, in our current slowing productivity, slowing population and slowing credit environment, more jobs and economic growth are unlikely to happen without some forward and long term thinking by both politicians and the populace and real action taken now.

No Interest – Our record low interest rates

Most eyes and attention were on the federal treasurer on 3^rd May as the budget was brought down. But being the first Tuesday of the month, the Board of the Reserve Bank of Australia also met. After many months of leaving official interest rates steady, they made the decision to cut them this month. What does that mean for you?

The majority of people don’t worry about interest rates other than how it impacts on them. Many people don’t really give much thought to the rise and fall of interest rates and the reasons behind them.

But the world’s central bankers usually only cut interest rates when they think their economies need a boost. In other words, when a country’s economy is tanking, a central bank may cut interest rates to try and stimulate demand.

The thinking behind this is that if credit is cheaper, people might be more inclined to borrow. Preferably, they’d like them to borrow a larger amount than they might otherwise have borrowed if interest rates were higher. Our economies are not growing if debt is not increasing.

But because lower interest rates are associated with lower economic growth, this also has the effect of lowering confidence in the markets and the economy, even if it is at a subconscious level. It is worth remembering that we are now well below the so called “emergency” interest rate level we were at during the GFC. This means that lowering rates is likely to have the opposite effect than was intended by the Reserve Bank. All that negative interest rates do is confirm that our economies are in grave trouble and reduce overall confidence in our economies.

In addition lower interest rates are not good news for those who save or people who rely on income from cash deposits, whose incomes have just dropped yet again. Ironically, while low interest rates benefit those who already have mortgages and other loans, it hurts those who are actually saving for a home or other big ticket item, thus keeping them from borrowing sooner than they might with higher interest rates. It also means that people who rely on interest for income have less to spend, thus contributing less into the economy.

There is also the law of diminishing returns, in that each subsequent interest rate cut has less effect and the impact of the cut has a shorter actual duration. So any possible benefits this cut might have had will last a shorter time and be less effective than the last round of rate cuts, until they lose all effectiveness.

It brings to mind Einstein’s definition of insanity. Doing the same thing over and over and expecting a different result. This cut will not be any different. If the last dozen or so cuts that we have had have not had the required result of stimulating the economy, why will this one be any different?

Japan, Sweden and Switzerland currently have a negative interest rate policy (NIRP) and countries like Europe and until recently, the US have zero interest rate policies, based on this very assumption that it will stimulate the economy and increase demand.

It’s not working. For example, in Japan, more people are saving and hoarding cash the lower interest rates go, especially when they go into negative territory. If these zero or negative interest rate policies were effective at all, these countries would have booming economies. They don’t.

The world is already awash with debt. Trying to solve a debt problem with more debt by lowering interest rates will not work, particularly when a lot of that debt is tied up in non-productive assets that do nothing to make a real contribution to the economy.

Given the sluggish nature of global economies and the uncertainty of our own, now might not be the time to be getting further into debt, as attractive as the low interest rates might be.

Here are some things to consider in a low interest rate environment:

Pay off debts: Instead of racking up more debt, use the low interest to pay off debts instead.
Look for better rates for debts: Use the low interest rate as an opportunity to negotiate a lower rate on the debts you do have. Home loans are a good place to start, but also look at other loans and credit cards. Maybe consolidating them all into one low interest rate loan can help.
Start saving or boost existing savings: If you have low or no debt, think about channeling more money into savings. This can then be directed into investments.
Search for yield: Lower interest rates mean it can be a struggle to obtain a reasonable interest rate on your savings, but there are tools available to help you find those higher interest bearing accounts. Websites such as Canstar, Finder and others, for example, can help you search for and compare various bank accounts for higher interest rates. Be aware though that these websites may not list all banks or accounts available and always read the terms and conditions. These sites can also be useful for finding low interest rates for loans as well.
Take advantage of low interest rates if necessary: Conversely, while it might not actually be the best time to take on more debt, if your car or a big ticket item is long overdue for replacement, there might be no better time to use low interest to your advantage. However, try to make extra payments to pay this off as soon as possible, rather than just make the minimum repayments.

Lower interest rates might make it tempting to borrow more money than you normally would, or get further into debt, but warned this may be a trap. It can be easy to become overextended should interest rates rise.

It is unlikely that official interest rates will rise soon, but that doesn’t mean that the banks won’t raise interest rates outside of the official interest rate. Banks obtain a percentage of their loan funds from overseas and are reliant on Australia maintaining its AAA credit rating and confidence in Australia’s economy. Banks are also reliant on depositor’s money to provide the balance of their loan funds. They are unlikely to attract too many depositors if interest rates are too low.

But most importantly, think about why interest rates are being lowered by the RBA. It’s a sign the economy might not be doing as well as many people suppose. Some businesses might not be financially sound due to slower economic conditions and the threat of closure is ever present. If your job is your only source of income, how well could you pay back your loans if you lost your job?

The Australian Housing Bubble

We, as Australians, seem to have developed a love affair with property over the past 40 plus years. Property has became an investment class rather than just a provider of shelter and the consumable item that it should be. A place to park wealth rather than used to create it. This continuously raises the possibility of a bubble.

There has been a lot said, many megabytes devoted to and much news ink used in commentary about a bubble in Australian housing.

People ask me if I think that Australian housing is in a bubble. I usually answer in the affirmative saying it’s looking very frothy and furthermore tell them that Australia’s and many of the world’s housing has existed in a bubble for the past 45 or so years.

I will get back to this in a moment, but first I’d like to say that just because Australian housing is in a bubble, does not mean that it cannot continue for a while longer, although I personally believe we are closer to the end point than the start point. As John Maynard Keynes supposedly noted, the market can remain irrational longer than we can remain solvent.

Now, a very quick history lesson on events that happened 45 or so years ago and why this has created numerous property bubbles in Australia and the world. In 1968 then US President Lyndon Johnson eliminated US dollar gold cover. That is, the US no longer had to have a percentage of gold in their reserves to cover each US dollar that was in existence. This was taken a step further in 1971 by the then US president Richard Nixon who suspended the US dollar’s convertibility into gold, which meant that a US dollar could no longer be exchanged for gold.

Prior to this, under the Bretton Woods agreement in 1944, the US dollar was backed by gold and by proxy, so were the world’s currencies as they were valued against the US dollar on the exchange rates.

When the gold link was severed, the world changed from a gold backed to a credit backed and driven economy. This meant the economy would only grow if credit was increasing, so people were greatly encouraged to accumulate more debt by governments and central bankers. Many people were happy to oblige.

Anybody who bought property in the past 45 or so years has been the beneficiary of this huge loosening of credit brought about by the actions of both Presidents Johnson and Nixon.

When looking at Australian house prices from about 1880 until late 1960’s/early 1970’s, prices were relatively flat, when adjusted for inflation. Once credit was loosened however, from the late 1960’s onward house prices went parabolic over and above the inflation rate. The gains seen over the past 45 or so years are a product of this huge credit expansion.

Pretty much anybody who purchased property in that time, benefitted from increasing values. With few exceptions, property prices generally went up far in excess of the inflation rate.

The people who benefitted from this windfall weren’t geniuses, they were just in the right place at the right time. But many thought they were, because they made money each time they sold property and because they didn’t understand the underlying parameters that allowed this to occur.

So the myth of property prices doubling every seven to 10 years was born. The fact that this had only happened over the past 45 or so years wasn’t recognised. “45 years” somehow became “always”.

There were even pretty graphs with a starting year point and an ending year point to support this property doubling “fact”, but once again, the data was extrapolated and prices averaged out over the time frame, rather than show actual annual prices for the period in question. And more often than not, these were not adjusted for inflation. As previously mentioned, inflation adjusted property prices stayed fairly flat until the late 1960’s. They certainly didn’t double, for example, from 1910 to 1920 or 1930 to 1940, but the graphs made it appear as though it did.

However, in the current environment of low inflation and low interest rates, property prices are now starting to pull back and I believe they are reverting back to the more normal mean of only increasing in line with inflation.

Changing demographics as baby boomers retire and change from spenders into savers, will impact on property prices as well, particularly when they start to sell their assets to fund their retirement. Not just prices for property, but shares and businesses as well.

Overbuilding of flats around Australia’s capital cities will also have a dampening effect on housing prices, particularly in attached dwellings. Real sustained property price corrections could happen as soon as the 2017-2018 financial year, if not sooner.

The way global economies are at the moment, there are no guarantees that prices will remain stable, let alone increase any time soon. And with the oversupply of flats coming into the market, most likely just as the global markets enter a serious downturn, falling real estate prices are a very real possibility, particularly from investors exiting the market. When they are not seeing any real capital gain (after inflation), have very low or no yields and longer vacancy periods, but still have to put their hand in their pocket every month for expenses, there could be a rush for the exits.

Real estate, after all, is a non-productive consumption item.

Prices may rise but people seem oblivious to the fact they can also fall. What goes up can also come down. So capital gain only really exists if it is realised. Unless capital gain is locked in (ie. sold at the highest valuation price), it’s not real capital gain. You cannot rely on the greater fool theory forever. This is the theory that a greater fool will come along and pay you more for your “asset” than you paid for it initially. The banks have been complicit in this, allowing borrowing against any increase in equity so the debt load is constantly increasing. This strategy is also pushed by property spruikers as a means of increasing your property portfolio.

Yes, a property investor might have a two million dollar property portfolio. But if it’s secured against a debt of $2.5 million thanks to falling property prices, that’s hardly a sound financial position to be in. If and when that happens, the friendly bank won’t be quite so friendly any more.

The problem is that, as previously mentioned, housing is a non-productive consumption item whose purpose is to provide shelter, but is being sold as an investment item reliant on capital gain to create wealth rather than yield to provide cash flow.

So, as well as property not doubling every seven to 10 years over a long period of time, Australian property prices can also actually fall. And this is even more likely at this particular juncture.

We are entering a deflationary period, a period of asset price falls. The reason the massive money printing or quantitative easing programs we have seen over the past few years by many countries have not succeeded in increasing asset prices consistently, kick starting the economy or causing massive inflation or even hyperinflation, is that this money printing has just stopped the deflationary forces from having their full effect. It’s why the global economy is sluggish at best. With the amount of money printing carried out by various governments, global economies should be booming. They are not.

Just as record low, and in some cases negative, interest rates have similarly been unsuccessful in getting the global economy moving.

There is a train of thought, particularly amongst politicians and central bankers that inflation is good and deflation is bad. But I disagree. Before the turn of the last century, (and incidentally before the proliferation of central banks), deflation was as much a part of an economy as inflation. Before the 1900’s, periods of inflation were generally always matched with periods of deflation.

It was only when central banks decided that deflation was a bad thing that we have had persistent inflation. Inflation has only been a feature of modern economies from about the early 1900’s onwards (incidentally, the US Federal Reserve Bank came into being in 1913).

Why is deflation the enemy? Deflationary periods are useful to dampen and remove mal-investments from the markets and bring the economy back into equilibrium. This is now being prevented from happening.

Japan is well into its third decade of deflation. Asset prices (property, stocks and businesses) are about half the value they were during the 1980’s and have never recovered those highs. The various governments of the day have tried desperately to stimulate inflation and asset price growth through massive quantitative easing (far greater than the US) and zero and negative interest rate policies. It hasn’t worked. Inflation is still negligible and asset prices are still languishing. And yet Japan is still ticking along nicely and they’re in no immediate economic trouble. Why? Because inflation isn’t needed!

And why are our politicians and central banks so desperate to see inflation? Because it increases asset prices, which brings about the so called “wealth effect”. When asset prices are rising, people feel wealthier and more secure and this supposedly encourages people to spend more. And why is this a good thing? Because under a fiat (debt backed, not gold backed) monetary system (pretty much all developed nations and most developing nations) in order for the economy to grow, we need to borrow more and get further and further into debt. In other words consume today with tomorrow’s income.

The record amount of debt we currently have in Australia does not bode well either. Australia is currently one of the most indebted nations in the world. We have record amounts of private and corporate debt, and public debt is increasing faster than any other developed nation.

Rising public debt endangers our AAA credit rating, which in turn will increase borrowing costs for the major banks causing interest rate rises above the RBA “official” rate. Many of the private debt holders won’t be able to afford any interest rate rises. A massive amount of this private debt is secured against this non-productive consumption item, property, which will either be defaulted upon or sold at a loss.

What does this mean for the housing bubble? Who knows! It could continue for another 10 years, start to deflate next month or pop in a year.

The markets can only be gamed for so long before they revert back to the mean. We are probably now entering an extended deflationary period and sluggish global economic growth, after more than 100 years of constant inflation. Get used to it. This is most likely the new normal.