Aussie QE Is a Stitch up: Why Quantitative Easing is Useless

It’s well into spring now in Melbourne. But we just had a very wintery weekend. Cold and showery, following a cold and wet winter.

Living in the bubble of a city, I sometimes forget that parts of the country are much drier. They’re doing it very tough right now with the drought.

There’s not much we can do about the weather. If it’s not raining, it’s not raining. By my guess is that there are other contributing factors adding to the misery many farmers are feeling right now.

Being pretty much ignorant of the situation, I’d feel like a phoney adding my two cents. But I know there are plenty of farmers who read The Rum Rebellion. So I’d love to hear from you if you’ve got something to say about the current predicament.

At the very least, it would give city dwellers like myself an opportunity to learn something.

Send your comments to cs@portphillippublishing.com.au

Getting back into our beat now, and the market just keeps grinding higher. US stocks rose on Friday. Apparently that’s because company earnings are ‘better than expected’. But they nearly always are.

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My guess is that prices are moving ahead of this week’s expected interest rate cut from the US Federal Reserve.

The Aussie stock market likes all this stimulus talk too. It finished higher on Friday and is set for another healthy rise today.

And why wouldn’t it. Former Prime Minister Paul Keating is out there talking up fiscal policy, saying that monetary policy ‘has run its race’.  Stuff the surplus, he reckons, it’s time to spend. I’ll tackle this one in detail tomorrow.

But don’t write off monetary policy just yet. It still has a few tricks up its sleeve. The Australian Financial Review reports this morning that Treasury officials are very much considering how unconventional monetary policy might look:

Treasury said if the RBA ran out of room to cut interest rates as the cash rate fell towards zero and if government spending didn’t kick in, the central bank could buy bank bonds and residential-mortgage backed securities (RMBS) to lower borrowing costs for households and business.

The internal government advice said, if required, the RBA could extend cheap direct funding to the banks, “where they can demonstrate they are, in turn, making loans for productive investments – typically non-mortgage business lending”, as done in the UK and Europe.

But Treasury also warned of risks from extreme monetary policies such as “excessive growth in asset prices, including house prices” and difficulty unwinding the measures.

Treasury is also concerned about lower interest rates squeezing bank profits. This is the problem when you want to have your cake and eat it too.

The squeeze in bank profits comes from banks passing on the RBA’s interest rate cuts. But the other side of that coin is more money in the pockets of consumers.

If the purpose of lower interest rates is to increase household incomes, why do we care about banks’ profits?

Well, those same households have banks in their investment and superannuation portfolios. The banking sector accounts for around 25% of the market. If bank profits take a hit, so will bank share prices.

But wait, lower interest rates prop up share prices, even in a weak earnings growth environment. It’s happening around the world right now.

But it’s a balancing act. One that Treasury is well aware of.

Who cares about opinions though? Let’s see what the market thinks. Despite the hand-wringing about a profit squeeze, the banks are doing ok.

The ASX 200 Financials index below shows the sector trending higher since the start of the year.

S&P/ASX 200 FInancial-x-Property Trust - XXJ (ASX) - 1 Day Bar Chart - AUD - 28-10-19

Source: Optuma

[Click to open in a new window]

In other words, the market isn’t too concerned about low interest rates smashing profits. That’s because the banks aren’t passing the full rate cuts on. They’re behaving like an oligopoly does.

So I really don’t know what Treasury is going on about. Maybe these bureaucrats just have no idea how the market really works?

Reality is different from the theory.

Why Quantitative Easing (QE) is appealing yet so useless…

Which is why the concept of quantitative easing (QE) is so appealing, but ultimately so useless.

Let me explain…

Our modern monetary system creates money when an individual or a business applies for and receives a loan. The bank assesses the credit risk, and as long as it has sufficient reserves to back the loan, it creates money/credit/debt out of nothing.

In other words, commercial banks create money based on the credibility of the person or entity applying for the loan. Central banks, in the case of QE, create money by monetising existing bank loans.

They purchase loans off the banks in exchange for cash. This newly created cash doesn’t just sit there. Banks need to buy assets with it to generate a suitable return. They don’t necessarily lend the cash back out. Remember, banks create money. They don’t need cash from the central bank to extend loans. They need creditworthy borrowers.

QE doesn’t do a single thing to increase the stock of creditworthy borrowers. Quantitative Easing simply increases the stock of cash in the system, which in turn forces banks to buy more assets, pushing up the price of those assets (and pushing the yield down at the same time).

Those who sell to the banks then have cash and wonder what to do with it. Surprise, surprise, they don’t want to hold it either. So they sell to someone else. In this way, the newly created cash continues to move around the system like a hot potato, bidding up asset prices.

Meanwhile, banks still struggle to lend because QE doesn’t do anything to increase consumer/business credibility or demand for loans.

It’s just a giant scam to benefit the asset price speculators. If it’s coming down the pike, you may just have to hold your nose and buy.

Regards,

Signature

Greg Canavan,
Editor, The Rum Rebellion

PS: EXPOSED – The truth behind Australia’s ‘miracle’ economy. Download your free report now. 


Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own. Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts. At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates. Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.


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