The Fed’s doing an ‘Italian job’ on us all

With the Fed bus hanging over a money cliff, we can only hope Yellen doesn’t tip us over the edge.

When the Federal Reserve announced an end to quantitative easing last week, it seemed the catastrophic risk of debasing global currencies was to be averted.

It was a bit like the bus teetering on the edge of a cliff in the Michael Caine version of The Italian Job.

In the cliff-hanger ending to the 1969 film, the gold thief played by Caine was stuck at one end of the bus with the gold bars, while his gang were at the other end hoping their weight would stop the whole thing lurching into the abyss.

In the last moment of the film, when all seems lost, Caine says optimistically: “Hang on a minute lads. I’ve got a great idea.” The film cut to the credits before the audience found out what he meant.

And so it was when Fed chair Janet Yellen effectively said “Hang on, global markets, I’ve got a great idea.”

That idea was to stop increasing the narrow measure of US dollar money supply before borrowers and lenders around the world realised money was no longer worth anything.

As explained by Adam Carr previously, the Fed has trebled narrow money in the past six years, but banks have not been able to leverage that up through the credit system to turn it into ‘broad money’ spending and investment, because nobody wants to borrow it for productive purposes (though plenty want to gamble with it).

In that respect, it’s like Caine’s bus – as long as nobody heads towards the gold, everything stays balanced.

However, if there were to be a sudden surge of confidence and borrowing increased, there could quickly be too much broad money, too much demand, global hyperinflation and pretty much the end of fiat currencies as we know them.

That’s why the Bank of Japan’s decision to start printing yen, just after Uncle Sam shut his presses down, was so troubling. Central bankers around the world are playing with the value of money as they’ve never done before – the Weimar Republic experiment notwithstanding.

Or put another way, central bankers are treating us all like fools -- for that is what we are when we cheer asset prices rising in response to the artificial fluctuations in global money supply.

Alan Kohler suggested yesterday that financial markets are so hooked on an ever-expanding money supply that the Fed will have no choice but to resume money printing at some point.

He’s probably right, but it’s also pushing more gold bars to the wrong end of the bus. While ultra-low interest rates persist, and if QE is resumed, we’ll see more artificial inflation of asset markets around the globe – and, as Rupert Murdoch and others pointed out last week, that will mean growing inequality in developed economies and entrenched poverty in less developed ones.

Trying to model, or even imagine, this on a global scale is mind-boggling, but the way it plays out in Australia is easier to understand.

The growing problem here is the disparity between the average Australian’s wages, the cost of their day-to-day living, and the cost of assets -- primarily property and shares -- they previously expected to own to fund their retirement.

Asset prices have gone up, fuelled by global capital flows that result not from a ‘free market’, but from the actions of public servants called ‘central bankers’.

Meanwhile, the components of the consumer price index (CPI), which includes rents but not house prices, tells a story of benign inflation. And wages are flat or declining in real terms.

So in Australia, as elsewhere, if you’ve owned an investment property and shares for some time you’re laughing -- their value continues to increase faster than the wages of working Australians, who happen to be the ones who live in the houses and work for the companies whose shares you own. Those people are getting poorer.

Some characterise this as an erasing of the middle class, suggesting that we’ll end up with an asset-rich super class, lording it over an asset-poor mass of workers -- a bit like the simple ‘stratified’ economy on the 19th century.

But things are not that simple now. In most cases, ‘asset-rich’ and ‘asset-poor’ are just Australians of different ages – the older retirees sitting on ballooning wealth, but the younger generations unable to get on the investment ladder because prices (relative to yields) are so high.

It’s not the ‘middle class’ that’s being erased, so much as a strange and unproductive misallocation of capital that will be redistributed in chaotic ways when the younger generations inherit the wealth of the older generations.

And for Australia, there is the added risk of being much more of a currency casino than the bigger economies printing the money -- while money can rush in and out of the US, Eurozone and Japan, its relative effect on their economies is less. Australia is more of an ‘Iceland’ than the big boys.

If, as Callam Pickering suggests, there is no resumption of QE in the US and an interest rate increase there earlier than markets predict, asset prices here will be knocked around in the opposite direction.

The cheering then will be from younger Australians looking to buy into long-term investments at reasonable valuations.

None of us should be cheering really. Generations forced to bet against one another in this way is a sign of a debauched, unstable financial system manipulated from afar by the same people who brought us the GFC.

If we’re lucky, Australia will ride out the current turbulent period, begin to price assets for their yield rather than artificially pumped-up future prices, and see a convergence between the growth rates of wages, the cost of living and the assets Australian would like to own.

Or we could go the way Michael Caine’s bus went -- over the cliff. In 2008 he revealed that they’d filmed that scene too, but decided they didn’t want audiences to know what happened next. Just like our central bankers, really.

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