A Glimpse into the Future…It’s Not Pretty. Part Two

‘I’m out.’

‘Yeah, I’ve only got two left in the clip.’

The dialogue above is from a typical shoot out scene in a movie.

With the odds stacked against them and almost out of ammo, the bandits somehow manage to conjure up a way to live to fight another day.

And that’s how the script will go for the central bandits (sorry, bankers) when they are next under siege by a debt crisis.

With their backs against the wall — appearing to be out of interest rate ammo and with QE firing blanks — they too will conjure up an improbable ‘solution’…one that no one ever thought possible a decade ago.

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Here’s a quick recap of the story so far from last Friday’s Rum Rebellion

Central banks have set us for an epic fail.’

Whether we realise it or not, we’re in the biggest asset bubble in history.

U.S Household Net Worth As A Percent of GDP - 11-07-19

Source: Forbes

[Click to open in a new window]

Booms always bust

In expectation of the next bust, there was this warning from the ‘central bank of central banks’…

Bank for International Settlements (BIS) chief Agustin Carstens has urged top central banks to preserve their ammunition for more serious economic downturns rather than deplete it chasing higher growth.

How much interest rate ammo does the IMF think the average central banker should have in reserve?

Severe recessions have historically required 3–6 percentage points cut in policy rates.

And as if we didn’t already know, the IMF tells us…

If another crisis happens, few countries would have that kind of room for monetary policy to respond.

Without the three–six percentage point buffer, how do our central banker bandits get out of this pickle?

The IMF is all over the script.

Back in February 2019, the IMF released a paper titled…

‘Cashing In: How to Make Negative Interest Rates Work’

The obvious problem with negative rates is that no one wants to be charged to deposit their funds with a bank…it goes against everything we’ve grown up with.

Better to take out the cash out and keep it under the mattress or in a safe-deposit box.

The banks are well aware that customers have this option…and have used this option.

This has been the experience in Europe.

In their efforts to discourage customers from withdrawing cash, banks have been caught in a real bind.

The banks have elected to not pass on the negative rates to customer accounts…instead, they’re absorbing the costs. Not good for the bottom line.

The whole point of negative rates is to deter people from saving and to encourage borrowing.

Spend. Spend. Spend.

That’s the debt-funded and savings depleting economic model we have.

The ideal world for the IMF would be one that’s cashless.

According to the IMF paper (emphasis added)…

In a cashless world, there would be no lower bound on interest rates. A central bank could reduce the policy rate from, say, 2 percent to minus 4 percent to counter a severe recession.

See the highlighted section…no lower bound on interest rates!!!

Could that mean negative five, 10 or even 15%?

Central bankers will have us trapped

Thankfully, we don’t live in a cashless world…at least not yet.

But they are working on it.

Plans are being hatched to phase out high denomination notes.

The justification given is that these notes are ‘almost exclusively used by criminals’.

How convenient.

High denomination notes could also be used to satisfy the withdrawal demands of disgruntled deposit holders…the ones who don’t want to be subjected to negative rates.

But the IMF are plotting an ingenious way to make it a ‘damned if you do or damned if you don’t’ outcome for physical cash and bank deposits.

What do I mean?

This is straight from the IMF’s mouth…

To get around this problem [deposit holders withdrawing cash], in a recent IMF staff study and previous research, we examine a proposal for central banks to make cash as costly as bank deposits with negative interest rates, thereby making deeply negative interest rates feasible while preserving the role of cash.

Got that?

If the central banks puts in place a mechanism to make the buying power of cash — whether the dollar is in your wallet or bank account — as worthless as each other, then it’s feasible (their word, not mine) to take rates deeply negative (again, their words, not mine).

How do they propose this could be done?

The proposal is for a central bank to divide the monetary base into two separate local currencies — cash and electronic money (e-money). E-money would be issued only electronically and would pay the policy rate of interest, and cash would have an exchange rate — the conversion rate — against e-money.

To demonstrate how this divided monetary base would work, let’s assume the cash rate is NEGATIVE 5%.

The $100 cash you take to the grocery store will be converted by the cashier into the equivalent E-money value…$95.

Why?

Because when a store deposits its day’s takings into the bank, the bank will apply the E-money exchange rate to those cash deposits.

The central bankers will have us trapped.

Whether you leave the money in the bank or take it out, makes no difference…you’ll lose 5% of the face value.

Sneaky, thieving so and so’s.

In a conventional world, we think the central banks are all but out of ammo.

The fact that the IMF proposals have not been dismissed as the mutterings of some economic nutter, means we’ve entered the realms of the truly unconventional.

There is no precedent for this.

If an E-money exchange rate gets written into the script, then central banks have plenty of ammo at their disposal…they could go deeply negative.

How deep? Well, that depends on how bad things get.

In addition to negative rates, economic crackpots like presidential hopeful, Bernie Sanders are all abuzz about the merits of ‘Modern Monetary Theory’ (MMT).

Don’t be fooled by the fancy title.

MMT is nothing more than printing money to finance government deficits…allowing governments to go on an unlimited spend-a-thon.

Of course, we’ll be told this officially counterfeited money will be spent responsibly.

Yeah right. Do pink batts and school halls ring a bell?

The supporters of MMT point to Japan and say the Land of the Rising Debt (sorry, Sun) has being doing this for years…what’s the harm?

For every action, there’s always a reaction…and in the world of economics, that reaction can often be delayed.

If all countries go down this path, what are the long term consequences?

While MMT in Japan has not yet produced inflation, that doesn’t mean high or hyper-inflation can’t happen. Especially if every major central bank embraces MMT.

At present, Modern Monetary Theory is just that…a theory.

However, when the next crisis hits, my guess is MMT — in some way, shape or form — will be fast-tracked from theory and into practice.

Why?

The system has become so dependent on debt and central bank intervention that it’s incapable of functioning on its own.

The dire economic and social consequences of a collapsing system will force policy makers to act…do something, do anything.

And that something and anything, is most likely going to be deeply negative rates and the monetising of government deficits.

It won’t be pretty for those who are not prepared.

Out of adversity comes opportunity.

During the busting of the bubble — when assets are trading at deeply discount levels — investors will need to mobilise cash into hard assets…shares, property and gold.

That’s my plan, to counteract negative rates and to hedge against global inflationary forces.

Regards,

Vern Gowdie,
Editor, The Rum Rebellion

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Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia. In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback. In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry. In 2013, he joined Port Phillip Publishing as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter. Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors. His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.


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