Stocks in the US took a breather overnight as Brent crude fell 2.5%. Gold was up a few dollars on US dollar weakness, while UK 10-year bond yields dipped into negative territory for the first time ever. The move sparked fears that negative yielding bonds could send the UK pension industry into crisis.
The plunge in UK bond yields is thanks to the Bank of England’s latest (and futile) attempt to ‘stimulate’ the economy by buying an extra £70 billion in bonds each year. The market is front-running the central banks’ purchases.
In fact, central banks and their bond buying activities have turned the formerly conservative bond market into a casino. As JP Morgan analyst Oksana Aronov writes, quoted in Bloomberg:
‘As the amount of negative-yielding debt now exceeds $10 trillion globally, bonds increasingly cease to trade based on fundamentals, such as yield, and trade instead on what someone else might be willing to pay for them in the future. Bonds are effectively commodities, and investors are using the greater fool theory as an investing strategy.’
Everyone knows that central bankers are the greater fools. They are the ones bidding up prices to ridiculous levels. And, given central bankers are the managers of their national currencies, it is ultimately we, the people, who will suffer from their idiocy via currency devaluation.
Speaking of currencies, what about the Aussie dollar?
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Two weeks after the RBA cut interest rates to another record low, in an attempt to weaken the currency, the dollar has simply snubbed its nose.
As you can see in the chart below, on the day of the announcement, the dollar briefly sank to around 75 US cents. But ever since it’s moved higher, and is now just above 77 US cents.
[Click to enlarge]
I don’t think the rally will last for much longer. At least, I don’t see any fundamental reasons for the rally to last.
For example, as I pointed out earlier this week, in the month of June, Australia posted a trade deficit of $3.2 billion. Annualised, that’s about $40 billion a year. Add on the interest expense we must pay on our $1 trillion foreign debt pile, and the current account deficit is getting up there into alarm bell territory.
But judging by the performance of the currency, we’re getting enough capital inflows to compensate for the current account outflows. Since May (see chart above) we’ve been getting more than enough, because when more capital comes in than goes out, the currency rises.
Just why foreigners are so keen to shove money into the Aussie economy right now is a bit of a mystery. The economy is about as attractive as a mangy, three legged dog. Or a one legged dog, actually — the one leg being the housing market and everything attached to it.
Of course, it could continue to hold up for longer than anyone thinks possible, with foreigners continuing to invest here for longer than anyone thinks possible. That is the nature of bubbles.
But the longer Australia takes to find another source of sustainable economic growth, the tougher it’s going to be for us.
Outgoing RBA boss Glenn Stevens touched on this in a speech yesterday. While he said he has reservations about the ability of monetary policy to boost growth (it hasn’t stopped him trying though), he then suggested the government could do more to increase debt and spending to boost the economy.
Here’s an important excerpt from the speech…
‘…the most powerful domestic expansionary impetus that comes from low interest rates surely comes when someone, somewhere, has both the balance sheet capacity and the willingness to take on more debt and spend. The problem now is that there is a limit to how much we can expect to achieve by relying on already indebted entities taking on more debt. So for policymakers looking to use low interest rates to boost growth, the question is: which entities, if any, in the economy can accept higher leverage safely?
‘In some countries there may be no safe way of borrowing and spending because debt, both public and private, is just too high. In Australia, gross public debt, for all levels of government, adds up to about 40 per cent of GDP. We are rightly concerned about the future trajectory of this ratio. But gross household debt is three times larger — about 125 per cent of GDP. That is not unmanageable — but nor is it a low number. It’s an interesting question which sector would have the greater capacity to take on more debt, in the event that we were to need a big demand stimulus.’
Will someone, somewhere, step up to the plate and take on more debt?
Stevens suggests the government is that ‘someone’. Their balance sheet is much better than highly leveraged households, and if we were to need a ‘big demand stimulus’, the government is the go-to guy.
This is just monetary policy advocacy in a different guise. Stevens is more or less stating that households are close to being maxed out, so the government should take up the slack by taking advantage of ultra-low interest rates.
This is the same old hit and hope strategy that central banks the world over have been employing for years. It tells you that the global monetary system absolutely relies on more debt and credit to survive.
Like a shark that must constantly keep moving to avoid death, our modern credit based monetary system must constantly keep increasing debt in order to survive. Glenn Stevens knows it, which is why he’s now trying to change the debate, encouraging governments to take on more debt.
‘The point I am trying to inject here is simply that popular debate in Australia about government debt and how we limit or reduce it seems so often to be conducted while largely ignoring the size of private debt.’
In other words, the private sector is maxed out. It’s time for the government to increase debt levels for the good of everyone. Sadly, in a debt-based financial system, there is no other alternative.
For The Daily Reckoning