This Australian Budget Madness Isn’t Sound Financial Management

coins in a jar. the provision for old age is always less. poverty in retirement / pension?
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There was little action across markets last night.

The Aussie dollar retreated under 75 US cents.

US markets continued their retreat on concerns over the sluggish pace of global growth and lacklustre corporate earnings.

Gold also gave up some of its recent gains.

Overall, there wasn’t a lot that will affect the Aussie market too much today.

The real action for Australians came in the form of interest rate cuts, alongside the long-awaited budget announcement for the financial year 2016–17.

Here’s a little background for you on Aussie interest rates, courtesy of RBA Governor Glenn Stevens, dated 19 April 2016:

Accumulation arrangements [in superannuation] are still predicated on some set of assumptions about future income needs and returns. It may take longer but surely many of the owners of these funds are going to feel disappointment.

The implicit promises — even if made only to themselves — about their retirement incomes are in danger of not being fulfilled. It is not a very daring prediction to say that these issues will loom ever larger over the years ahead.

Less than a month ago, in the warm embrace from New York investment bankers, Stevens pretended to understand the pain of savers. Low interest rates would lead to disappointment for savers…‘retirement incomes are in danger of not being fulfilled,’ he said.

How much empathy can you have with savers when you’re going to be in receipt of a taxpayer-funded pension for life? The answer is ‘bugger all’.

Stevens and co. deemed the inflation rate too low. Their solution? Those low rates, that a few weeks ago he acknowledged were causing savers angst, were dropped a notch, to a historic low of 1.75%.

Will dropping rates give Stevens the inflation number he craves? Probably not. Countries that have had much lower interest rates for longer — in Europe and Japan — are regularly flirting with deflation.

Anyway, what’s this obsession with producing a targeted level of inflation?

Ask your friends, work colleagues or relatives whether inflation is good or bad for the economy. I bet the majority respond with a terse ‘good’. Then ask them if they would they prefer if prices for goods and services went up or down? Naturally, people want prices to fall. Yet falling prices are deflationary.

On the one hand, we’ve been conditioned to believe inflation is good; yet, on the other, what we really want is deflation.

Governments and central banks have done an excellent job brainwashing us into believing rising prices are somehow good for us. Psychologically, getting a pay rise feels good. But if 35% or more of that raise goes towards paying taxes, while increased costs gobble up the rest, what’s the point? It’s a zero-sum game.

Inflation creates the illusion of a wealthier society…and with government it’s all about illusion. The real beneficiary of inflation is government. Rising wages and prices deliver greater tax revenues. Increased tax receipts opens up a range of pork barrelling opportunities. Billion, and trillion, dollar debt levels are gradually reduced in value without any real need for budget restraint.

And then there’s the dollar.

As expected, the Aussie dollar took a hit with the interest rate cut. We are told this will assist in making our exports more competitive. That’s true…for a while. What happens when Japan, China and Europe also decide they need to stimulate their economies by making their currencies more competitive?

Dropping interest rates was nonsensical, but it was predictable. Readers of The Gowdie Letter are well aware that my long term outlook for Australian interest rates has been that they will trend much lower.

Why?

It’s simple, really. When you have an economic growth model that functions purely on more debt being injected into the system, the cost of said debt must become cheaper.

When the longed-for-growth does not eventuate, the RBA will cut again, and again, and again. This is the well-trodden path that Northern Hemisphere economies have travelled…without success.

Targeted inflation rates are useless in a world that has a glut of cheap labour and capacity to produce ‘things’. However, when it comes to the actions of central bankers, academic theory has always prevailed over common sense. So be prepared for a lot of very nasty, unintended consequences from policies designed to target inflation in a deflationary world.

One of those consequences, as Glenn Stevens pointed out, is the impact on retirement incomes.

Obviously, Treasurer Scott Morrison never got the memo.

Did the government just suggest retirees place 100% of their portfolio in shares?

In last night’s budget, there was a surprise announcement on how much you can transfer into the tax-free pension phase of superannuation.

The retrospective cap is set at $1.6 million.

According to Scott Morrison in his budget address last night: ‘A balance of $1.6 million can support an income stream in retirement around four times the level of the single age pension.

Spoken like a true taxpayer funded superannuant, Scott. You have no idea mate.

The full age pension (with pension and energy supplements) for a single person is $22,721 per annum ($873.90 per fortnight).

Let’s do some simple math.

If we multiply the single age pension of $22,721 by four times, we get a figure of $90,884.

For $1.6 million to generate an income of $90,884 requires a 5.7% rate of return.

Please tell me Scott, where we can get that rate of return?

Cash and term deposits pay are around 2–3%.

Buy one of your 10-year government bonds and we get 2.5%.

Invest in a residential property and, after expenses, we’ll get 3% (if we’re lucky).

So what does that leave us with? Fully franked shares.

Scott, with corporate earnings coming under pressure due to the global deflationary squeeze, will companies be able to maintain the current dividend policy?

Let’s put that obvious question to one side; Scott, are you really suggesting that retirees place 100% of their portfolio in shares?

Financial planners would be hanged, drawn and quartered for doing this without proper risk analysis.

On the one hand, the government is rightly clamping down on irresponsible advice from financial planners, yet we have the Treasurer — indirectly — suggesting retirees go full tilt into the share market, risking the potential to expose their retirement funds to substantial capital loss.

Or perhaps Scott is thinking retirees can invest in some junk corporate bonds. Now there’s another good idea…not.

Our Treasurer’s reasoning for the cap fails the most basic of scrutiny. But his statement plays well to the crowd.

A conservative retiree with $1.6 million invested at 2% will generate $32,000 per annum…about $10,000 more a year than if they had not saved.

And, if interest rates go to 1%, they’ll earn less than if they were on the full pension.

Where’s the incentive to save?

Oh I forgot — the incentive is to keep borrowing to reach a targeted inflation rate.

This is the madness that passes as sound financial management.

Little wonder I see The End of Australia in our future. For more on this, click here.

Regards,

Vern Gowdie,

Editor, The Daily Reckoning

Vern Gowdie

Vern Gowdie

Vern Gowdie has been involved in financial planning in Australia 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 recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top 5 financial planning firms in Australia. He is a feature contributing editor to The Daily Reckoning and is Founder and Chairman of the Gowdie Family Wealth advisory service and editor of the Gowdie Letter To follow Vern's financial world view more closely you can you can subscribe to The Daily Reckoning for free here.
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