23/02/2016 - 13:02

Moving backwards in trying times

23/02/2016 - 13:02

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Living life in reverse is an amusing fictional concept that involves being born old and growing young, but if you look at some of the forces at work in the economy today you might imagine that everything is running backwards – starting with the puzzle of negative interest rates.

STUCK: ‘Negative growth’ is starting in the resources world as mines and oilfields close and expansion plans are mothballed.

Living life in reverse is an amusing fictional concept that involves being born old and growing young, but if you look at some of the forces at work in the economy today you might imagine that everything is running backwards – starting with the puzzle of negative interest rates.

What it really means to have a bank charge you a fee on deposits, which is what’s happening in 20 countries (so far) is not fully understood, though it does seem that not much good can come from the reversal of a system on which the global economy is based.

The original story about life reversal involved a character created by the author F Scott Fitzgerald called Benjamin Button, who is born aged 70 and slowly regresses into infancy, and dies.

That 1922 tale made for an interesting 2008 movie, but whether it was amusing or sad is a matter of personal taste.

The same might be said of today’s situation, where much in business and the wider economy is reversing (with interest rates one example), China could potentially slip into recession another, and ‘negative growth’ is starting in the resources world as mines and oilfields close and expansion plans are mothballed.

What appears to have happened is that the world’s central banks have created trillions of dollars in an attempt to shake off the worst effects of the GFC but have failed to actually create the growth and a little bit of inflation they had hoped for.

Anaemic growth, or outright contraction accompanied by deflation, has bankers and finance analysts worried, with one of the world’s most successful fund managers, Ray Dalio, from Bridgewater Associates, suggesting last week that we might now be far away from a phase of ‘helicopter money’.

What Mr Dalio means by that phrase is a large-scale experiment like what happened in Australia at the height of the GFC, when the government showered cash on households in an attempt to stimulate spending and prevent the banking system from freezing.

That proposal reflects concern that most of the money created by central banks remains stuck in commercial and private banks, which have been loath to lend because they have also been forced to increase the cash they keep in reserve, while also worrying about the ability of borrowers to repay their loans, thereby creating a vicious circle of inactivity.

Negative interest rates are one result of the paralysis spreading worldwide, with cash today seen as a cost with potentially serious consequences for important sectors of the economy, including banks, which are losing a source of interest, and insurance companies that have traditionally relied on interest income on spare cash to match premiums paid by customers.

One way of looking at the effect of negative interest rates is to watch the gold price rise as investors slowly appreciate that gold in bullion form has never paid interest, but no interest is better than negative interest.

If the negative rates trend continues to spread, everything will be turned upside down; with early signs evident of significant changes in spending habits, including the appeal of paying bills early just to get rid of cash, which has become a cost rather than a potential source of interest income.

Other events are occurring across the business spectrum which reflect potentially deep-seated changes in the way the world has worked in the past, such as:

• big bets being placed by investment banks and international fund managers on China suffering a hard economic landing, which could lead to a sharp depreciation the value of the country’s currency, the renminbi;

• production of key commodities such as iron ore, coal, nickel and zinc contracting by up to 5 per cent this year as demand slows and production cuts start to compensate for low prices; and

• an amusing calculation by London’s Financial Times newspaper that the “cost of breakfast” is at a six-year low, an estimate based on falling prices for wheat, milk, coffee, orange juice, sugar and bacon.

What all of the events mentioned mean to the Western Australian (and wider Australian) economy are uncertain.

A positive view is that falling mineral production will eventually lead to higher prices, and that a fall in the renminbi will make China an even more competitive exporter, which might increase its demand for WA’s mineral and fuel exports.

A negative view is that a crisis in China will be bad for business, with the potential to ignite a currency and trade war with the US and Japan.

As for negative interest rates, it is impossible to see any good coming from a role reversal that has the potential to severely damage banks, insurance companies and superannuation funds, which have traditionally relied on interest for part of their income.

Perhaps the most startling aspect of negative interest rates is that investors are buying assets such as Swiss government bonds, which ‘yield’ a negative return of 1 per cent, certain in the knowledge that they will lose income on that money while praying that the value of the Swiss franc rises.

Living life in reverse could become very interesting over the next 12 months.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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