The Butterfly Effect Will Level the Market

14.07.2017 • Australia

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Vern Gowdie – Markets and Money (Australia) –

It all happens at the margin.

Elections are won or lost at the margin. The swinging few percent can make or break a political career.

On any given day, less than 1% of shares on issue change hands. The price at which the 1% exchange their holdings affects the portfolio values of the remaining 99%.

Only a few houses in your area need to sell to establish a valuation benchmark for future sales.

The same principle applies to the economy.

An economy doesn’t need to collapse to create hardship…it only has to contract at the margins.

Greece shrank by a few percent and its citizens took to the streets.

Nobel Prize-winning monetary economist Milton Friedman said, ‘Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output…’

Ideally, central bankers would also like to see inflation at the margin…around 2% per annum. The gradual erosion of buying power is what keeps the debt-funded economic growth model ticking along. Reducing the value (in inflation-adjusted terms) of yesterday’s debt makes tomorrow’s loan more affordable.

However, in recent years, inflation has been less Kim Kardashian (always and everywhere) and more Scarlet Pimpernel (they seek it here, they seek it there).

Central banks have rapidly increased the quantity of money — trillions in newly minted currencies — yet the inflationary effects they yearn for have remained elusive.

There’s certainly been inflation in asset prices — as evidenced by historic highs in select share and property markets.

However, broader based inflation is proving more difficult to manufacture from the printing presses.

Those institutions with monopolistic pricing power — governments, councils, power suppliers — have taken full advantage of their positions. We’ve been easy targets. It’s not like there’s an alternative supplier for council rates or motor vehicle registrations. They’ve had free range to ‘shoot the consumer ducks in the barrel’.

Which is why the employees of these monopolies continue to enjoy wage increases that exceed those in the private sector.

According to March 2017 data from the Australian Bureau of Statistics (emphasis is mine): ‘Through the year, the Private sector rise to the March quarter 2017 was 1.8%, the same rise as for December quarter 2016 and an equal record low for the series. The Public sector rose 2.4%…’

How screwed up is a system that rewards the parasite more than the host? Anyway, that’s a discussion for another day.

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With non-discretionary spending (the bills we must pay to keep the lights on, our names on the title, and our car on the road) on the rise, surely something has got to give?

For some households, that means doing what most of us would find unthinkable…disconnecting power.

On 8 July, The Weekend Australian published the following line: ‘Energy bill pain: surge in cut-offs’.

Australia is entering the “realm of third world countries” with residential power disconnections rising by as much as 140 per cent in six years and the average household paying more than double what it did a decade ago to keep the lights on.

Australian Energy Regulator figures reveal almost 60,000 households are on electricity hardship payments and another 151,862 customers are on electricity payment plans…’

These cut-offs are at the margin, but it’s a margin that’s increasing. Pretty sad for a country that is hailed as an economic miracle.

And for the rest of us, it gives at the discretionary margin.

In a monetary statement on 4 July, the Reserve Bank of Australia acknowledged the problem facing Australian households (emphasis is mine): ‘At the same time, consumption growth remains subdued, reflecting slow growth in real wages and high levels of household debt.

The RBA is slightly downplaying our debt situation. Household debt is at record high levels. If there was a debt Olympics, we’d win gold.

Discretionary spending under pressure

With wage stagnation on one side and rising non-discretionary spending on the other, the vice is tightening.

In the middle is discretionary spending — the cost we can exercise some control over.

The squeeze is on.

On 8 July, The Weekend Australian published another interesting line: ‘Health cover at “tipping point”’. Here’s an excerpt from the article (emphasis is mine):

‘…[Medibank Private CEO] Mr Drummond, fresh from a tour of European and US health systems, said affordability concerns were accelerating, adding it was not just a private health insurance issue but one that spread across industries including banks, telecommunications and utilities.

The issue is more about the financial shape of Australian consumers relative to their debt burden,” he said. “We are at a critical juncture and the time to act on reform and change is now, for many industries, before the challenge gets even bigger.

‘…“You can push things under the carpet or take an approach that you need to make some changes now.”

People are choosing to either reduce, cancel or neglect to take up private health insurance. The shrinking dollars in the discretionary budget cannot stretch far enough to pay for the annual premium increases. This puts more pressure on an already straining public health system. Where does government get the extra dollars from? More taxes? More debt? Or a cutback in services?

Households are, collectively, under pressure. This, in turn, puts pressure back on the ‘monopolies’. A vicious cycle.

The debt-funded economic growth we pursued — to achieve a record recession-free run — is now coming back to seriously bite us.

Debt burdens raise affordability concerns? No kidding. Why does this predictable outcome come as a surprise?

When your strategy for economic growth is to actively encourage the bringing forward of future consumption, what else do you expect? An economic growth model entirely dependent on debt-funded consumption is nothing more than a giant Ponzi scheme. A bigger debt base is perpetually needed to support the system.

The aforementioned article went on to provide an insight into the structural problems associated with private health insurance (emphasis is mine):

‘…Mr Crombie [the Australian Managing Director of Bupa’s health insurance arm] said the industry had hit a “tipping point”, and said that people aged 31 and under were choosing not to take out insurance in greater numbers than previous years.

Under Australia’s risk equalisation and community rating system, young people need to pay for insurance to balance the claims payments of older people.

Whatever participation growth you have, if you look under it, the only growth is in the over 65s,” Mr Crombie said.

Does this structural problem sound familiar?

The age pension operates on the same basis.

Growth in the over-65s age bracket, and less participation from the younger generations, means future age pension payments are far from assured.

For political reasons, any changes to social security will be done incrementally at the margin. Continual tinkering with the assets and income test. The inclusion of the family home. In time, the system will morph into a user-pays model…use your own assets first before being eligible for a taxpayer-funded retirement income.

There’s very few guarantees in this life, but it’s a dead-set certainty that, within the next decade, age pension access is going to be much more restrictive. Demographics have baked this outcome into the cake.

The structural flaws in our economic model — too much debt, too little participation, and too many households with stagnant incomes — are starting to publicly reveal themselves.

What we’ve created is an economy where debt is always and everywhere.

And it’s not isolated to the Lucky Country.

This morning, I received an article from ValueWalk, titled ‘US Debt To GDP Hits A Record Level But China Catching Up Quickly’.

Here’s an extract (emphasis is mine):

‘…By 2016 [China’s] debt had increased to $22 trillion and the current rates [indicate] it will hit $50 trillion by 2020. In the first quarter of 2017, China added debt equal to more than 40% of GDP.

‘…However, it’s not just China that’s building a worrying level of debt. According to a June 29 report from Moody’s “leverage of the US nonfinancial sector has reached unprecedented heights according to the US’s never before seen ratio of nonfinancial-sector debt to GDP.” The report notes that the ratio of US nonfinancial-sector debt to GDP was 253% at the end of the second quarter “considerably higher than year-end 2007’s 230% that immediately preceded the Great Recession.”

Debt is now an economic retardant.

Once upon a time, debt-funded consumption produced inflation. Now that we’ve reached the mature stage of this ill-fated growth strategy, we may well find an equal and opposite effect takes hold…deflation.

Inflation favoured debt — gradually reducing the dollar value of debt.

Deflation favours cash — gradually improving the buying power of a dollar.

Things happen at the margins.

All it takes is enough households to decide to change their habits, and our miracle economy falls into a severe recession.

The warning signs are starting to appear in the mainstream press.

Take heed and you’ll be more than marginally better off.

Regards,

Vern Gowdie,
Editor, Markets & Money

-Read more at www.marketsandmoney.com.au-

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