What if…the Reserve Bank of Australia started quantitative easing in 2020

Stock markets are on an incredible run…

The Dow is soaring over 58,000 points and NASDAQ is close to 24,000 points. Australia’s S&P/ASX 200 index is now hovering at 10,000 points.

So is Australian housing…

After a short blip between 2017 and 2019, prices have continued their upward trend. Sydney median house prices are now close to $1.5 million and Melbourne’s are at $1.1 million.

At the same time, growth has slowed.

EXPOSED: The truth behind Australia’s ‘miracle’ economy

Truth is, we are struggling to create inflation. While inflation is very much present in asset prices, salaries aren’t keeping up with home prices. This means that housing affordability has worsened and younger people are having a hard time buying a home.

With salaries stagnant and savings accounts paying no returns, it’s now almost impossible to save for a deposit. To buy a property in Sydney, people have to save on average 14 years just to get a deposit.

The only way to access housing is to take on more debt. In fact, households are now extremely indebted with household debt hovering at a whopping 250% to income.

With consumer spending slowing, the Reserve Bank of Australia started quantitative easing in 2020…

Yep, you guessed it. I’m not writing about the present.

This is a very simple and flawed exercise. One that extrapolates the past into the future to see what Australia could look like in the year 2026.

Flawed for mainly two reasons. One, trying to predict the future is impossible. Second, it assumes that what has happened in the past will keep happening in the future.

But let me quickly pop that bubble: things never stay the same.

But, what if they did? What if we could repeat the past into the future? That is, see the same performance we’ve seen since January 2013 into the next six years?

The Dow today is at around 28,000 points and has seen a 109% gain since January 2013. The NASDAQ is at 8,700 points with a 180% gain in the last six years. The S&P/ASX200 is at around 6,800 and has seen a more modest 43% gain in that period.

At the same time, in the last five years Sydney property has seen a 20% increase, Melbourne a 27.8% and Hobart a 39.1% increase. Remember, this includes the recent drops in property prices.

But to get into property we have had to take on more debt. Australian debt to income is now close to 200%. We are seeing the effects of this in consumption.

Anyway, the whole point is to show you how this whole thing is unsustainable as long as salaries don’t start to increase. Real estate will keep going up higher only as long a people have money to pay for it, and stocks will keep going higher as long as companies have earnings.

Unless something changes, this whole thing will fall under its own weight.

The Effects of Quantitative Easing (QE)

In Australia so far, we have seen the effects of low interest rates, which has propped up housing, but not quantitative easing (QE)…at least not yet.

During a Business Economist dinner in Sydney this week, RBA’s governor Philip Lowe said the central bank is in no rush to start QE:

[W]e have no appetite to undertake outright purchases of private sector assets as part of a QE program.[…]

Our current thinking is that QE becomes an option to be considered at a cash rate of 0.25 per cent, but not before that. At a cash rate of 0.25 per cent, the interest rate paid on surplus balances at the Reserve Bank would already be at zero given the corridor system we operate. So from that perspective, we would, at that point, be dealing with zero interest rates.[…]

[I]f — and it is important to emphasise the word if — the Reserve Bank were to undertake a program of quantitative easing, we would purchase government bonds, and we would do so in the secondary market.

While we take the possibility of a reversal rate seriously,[this is when low interest rates no longer boosts the economy but has the opposite effect] I am confident that here, in Australia, we are still a fair way from it. Conventional monetary policy is still working in Australia and we see the evidence of this in the exchange rate, in asset prices and in the boost to aggregate household disposable income.

After three rate cuts this year interest rates are now at a low 0.75%. If things worsen, we could see QE as early as next year.

The US economy is now under the effects of both, low interest rates and QE programs.

Between 2008 and 2015 the US Federal Reserve bought trillions in government bonds and mortgage backed securities. As you can see below, their balance sheet expanded from US$900 billion to US$4.5 trillion.

The Rum Rebellion 30-11-19

Source: CNBC

[Click to open in a new window]

This effectively flooded money into the system.

How could QE affect the Australian economy?

In an article for The Conversation, Isaac Gross, a former RBA employee, uses MAcroeconomic Relationships for Targeting INflation (MARTIN), an RBA tool to forecast how a QE program could affect the economy.

Assuming the RBA performs QE in the same way the US did, Gross says MARTIN shows QE would have two effects: It would lower the cost of borrowing for Australian businesses and would weaken the Australian dollar by up to 5 US cents.

The idea is that lower borrowing costs makes it cheaper for companies and the government to take on debt, which would boost spending. Cheaper exports would also make Australia more competitive as exports become cheaper and imports become more expensive.

This in turn would create more jobs which should lead to higher wages and higher growth. This would spark inflation, which would then push interest rates back to normal.

As Gross concludes:

Combining these two effects, MARTIN suggests a large quantitative easing program would reduce unemployment by 0.3 percentage points, equivalent to 40,000 extra jobs, and boost wages across the economy.

The output of any model is only as good as the information and data that are fed into it, but the output of MARTIN is why more and more economists expect the bank to quantitatively ease in the new year. Its brain says it should work.

Theory says it should work.

Yet looking at countries that have experimented with QE like Japan, Europe and the US, things haven’t worked out that well.

Lower interest rates and QE have only brought in meek growth. Both the Fed and the ECB have tried to go back to ‘normal’ after using QE and haven’t been able to. Now both the US and the ECB are back to increasing stimulus.

It’s true that our demographics are better, because of immigration. Yet the problem is that all that stimulus distorts the system, and the true value of money. It relies on taking on more debt to keep things going. But who will pay all this debt?

The future is not linear. Best thing you can do is prepare for change.

Best,


Selva Freigedo Signature
Selva Freigedo,
Editor, The Rum Rebellion

PS: There’s a BIG surprise coming for the AUD in 2020. Click here to find out what it is (free report)


Selva Freigedo is a research analyst for The Rum Rebellion. Born in Argentina, her passion for economic analysis started at a young age. Her father was an economist for the Argentinean governments and the family used to discuss politics and economics at the dinner table. Argentina is a country with an unusual economic history. Growing up there gave Selva first-hand experience on different economic phenomena such as hyperinflation, devaluation and debt default. Selva has also lived in Brazil, Spain and the USA. Back in 2000 she was living in the US as the dot com bubble popped… And in 2008 she was in Spain as the property market exploded and then collapsed… She has seen first-hand what happens when bubbles burst. Selva joined Port Phillip Publishing’s team in 2016, as an analyst. She now writes from her vantage point in Australia, where she settled in 2015.


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