The problem with digital money

So, the Reserve Bank of Australia (RBA) cuts interest rates again.

Australia now has a new record low Cash Rate of 1.5%.

Congratulations Australia, you can be proud of that record.

But what more can we say?

Not much more than we’ve already said.

Should we analyse the RBA’s statement? That’s a little boring, don’t you think?

So no, we don’t have anything further to add. All we can say is that Australia’s interest rates are low and are likely heading much lower.

How do you fancy a dose of negative interest rates here in Australia? It could happen sooner than most folks think…


Overnight, the Dow Jones Industrial Average closed down 27.73 points, or 0.15%.

The S&P 500 fell 2.76 points, or 0.13%.

In Europe, the Euro Stoxx 50 index lost 23.45 points, or 0.78%. Meanwhile, the FTSE 100 closed down 0.45%, and Germany’s DAX index lost 0.07%.

In Asian markets, Japan’s Nikkei 225 index is down 149.41 points, or 0.9%. China’s CSI 300 index is down 0.07%.

In Australia, the S&P/ASX 200 index is down 31.49 points, or 0.56%.

On the commodities markets, West Texas Intermediate crude oil is trading for US$40.13 per barrel. Brent crude is US$42.33 per barrel.

Gold is US$1,349 (AU$1,794) per troy ounce. Silver is US$20.37 (AU$27.09) per troy ounce.

The Aussie dollar is worth 75.19 US cents.

We’re sorry!

In a world of digital money, the following webpage could become more common:

chart image

This is the page that greeted me when I tried to log into my Commonwealth Bank online account yesterday afternoon.

The message says, ‘We’re Sorry!’ It explains, ‘Netbank and our CommBank app are temporarily unavailable.’

That’s fine. When I checked again a couple of hours later, everything was in order.

But what if it wasn’t?

What if the only money available to you was digital money that was under the direct control of the government and central bank?

What if the government and central bank decided when and how much money you could access on any given day?

Today the RBA cut interest rates by 0.25%. The new Cash Rate is 1.5%, a record low.

But think about why the RBA did that. The RBA believes that by cutting interest rates it will convince folks to spend more money.

The RBA (like all central banks) is trying to guide, prod, and steer the economy in a particular direction.

If it doesn’t like where the economy is heading, it will try to shift its course. To do this, the RBA uses interest rates. If it feels the economy is growing too much, it will raise interest rates.

If it feels the economy isn’t growing fast enough, it will cut interest rates.

But interest rates in Australia and around the world are at record lows. In some countries, interest rates are negative. As a means to attempt to control the economy, interest rates are becoming less and less effective.

So, what’s the central banks’ alternative?

You may very well ask.

Central banking used to be a discreet business. Central bankers (and bankers in general) weren’t really celebrities.

You could argue that James Pierpont Morgan and Andrew Mellon were celebrities, but that was just as much about their business acumen as it was their banking skills.

But that has changed.

Arguably, Dr Alan Greenspan was the first real central bank celebrity. Not because he had a particularly engaging personality, but because he happened to be in the role of US Federal Reserve chairman during the big growth spurt of 24-hour cable TV in the 1980s and 1990s.

When a cable news channel has to fill 24 hours with content, it’s no wonder that they took to deciphering every word that Greenspan wrote or spoke. Or tried to guess interest rate moves based on which hand he used to carry his briefcase!

But with the rise of the celebrity central banker, there has also been an increase in the transparency (for want of a better word) in what central banks actually do.

It really wasn’t that long ago that central banks would deny that they have any influence on an economy. They would say that the ups and downs of the economy or markets aren’t relevant to them.

They would claim their only focus is achieving full employment and providing a stable currency — even though central banks are the least stable thing for any currency.

But now, they’re completely open about their aims. When markets rise or fall, the central bankers will openly comment about how the market has overdone or underplayed their intentions.

They’ll openly and aggressively intervene in the market in ways other than moving interest rates. The obvious example is the monetisation of debt through money-printing programs.

The US Federal Reserve is now among the biggest (if not the biggest) holder of US government debt. The European Union is among the biggest owners of European sovereign debt. The Bank of Japan now routinely buys Japanese stocks as it attempts to boost its economy.

Is there no boundary the world’s central banks won’t cross in order to do what they believe is best for their national economies?

There’s no need to answer the question.

But it brings us neatly back to our point on digital money. Central banks and governments are now pushing the cause for the abolition of physical cash.

It’s plain to see why. If you’re able to withdraw money from a bank, or hold money in alternative forms, such as gold, you have greater control of your money.

But what happens if the central bank and government abolish physical cash? What happens if the only form of money available to you is the central bank’s digital money held in your online bank account?

Instead of the central bank fiddling with interest rates, they could simply control the flow of money in and out of (supposedly) private bank accounts.

In a central bank digital-money world, there would actually be no need for interest rates. The concept of earning money on deposits and paying interest on debts would disappear.

In its place, the central bank would simply increase or decrease your bank balance according to whether the central bank wanted you to save or spend.

Your employer may pay wages into your account today, and by lunchtime your account balance could be higher or lower, depending on the central bank’s whim.

In other words, bank accounts wouldn’t be the relatively static thing that they are today. They would behave more like the stock market — rising and falling according to central bank instructions.

I know, it sounds crazy. Or, it may seem too intangible and improbable. Folks will say, ‘It could never happen, the public wouldn’t allow it. Any government trying it would be voted out of office in a flash.’

Our answer is, really? You think so? Supposing voters did vote them out of office, who would take their place? Another government, sympathetic to or under the spell of central banking, that’s what.

One true money

And if you think I’m a Luddite for opposing electronic money, then you miss the point. I’m all in favour of a private system of electronic money. That could work well. Competition between private electronic money providers would limit the risks inherent in such a system.

Of course, when it comes to money, we do retain the stance we have held for a number of years. Boiled down, only one system of money has proven to work time after time. That’s a money system backed by gold.

Cash Calendar can help combat low rates

When it comes to interest rates and the impact they have on investors, I like to turn to my old buddy, Matt Hibbard. Here’s the note he sent me this afternoon, after the RBA rate cut:

The RBA announced at 2.30pm this afternoon yet another cut in the cash rate — to 1.5%. It signals that the RBA is running out of ammunition, and also out of ideas.

And what did the stock market do off the news? It fell over 40 points, as it became obvious that the RBA is more worried about the economy than the government or market is. Now it’s the market’s turn to worry.

It’s not the RBA’s fault. Trying to run an economy on just monetary policy is never going to work — something it’s been forced to do for close to a decade now. What’s needed is a big dose of fiscal policy — things like tax reform and reviewing government expenditure. But don’t hold your breath on that one.

If you went through the various term deposits available from the big four banks this morning, you would have seen that an investor could get around 2% if they invested $100,000 for 10 or 11 months. Invest it over 12 months, and the rate improves to 2.45%. Still a pittance, and that was before the latest cut.

As the global hunt for yield accelerates, a big chunk of money is finding its way to our shores to access our relatively higher interest rates. And it’s just that — relative. While the yield on an Aussie 10-year bond is hovering around 1.84%, the equivalent bond in Japan is on a yield of -0.11%. So an international investor is 2% better off putting their money in Australia.

And therein lies the problem — this impact on our exchange rate. Before overseas investors can invest their money here, they need to change their own currency into Australian dollars. The RBA is no doubt worried that if our exchange rate gets too high, it could put a handbrake on our already insipid economy.

And no doubt that’s why the RBA moved on rates this afternoon.

Monetary policy is always going to have its limitations; interest rates can only do so much. The real impact, though, is on the millions of savers and retirees, and the ever growing need to find other ways to supplement their income.

It’s also why more money will continue to find its way into the stock market as investors are forced to find other ways to eke out an income.

That can be a risky gamble. Too often you’ll see investors pile into a stock for the high yield it’s offering…only to see that stock tumble in value. Losing 30% of your capital in exchange for a 7% yield isn’t exactly the deal of the century.

That’s one of the reasons I like options so much. With my advisory service, Options Trader, I use a range of strategies to help investors as they try to secure extra income from some of Australia’s largest listed companies. And usually without ever having to purchase a single share.

I know Kris wrote about this quite a bit last week. But I genuinely believe these are among the best income generating strategies available today. And with interest rates now at new record lows, and likely only heading lower, there’s never been a better time to learn how to use them.

You can find out more about my service by clicking here.

Matt’s right. Now, more than ever, investors need to look for new ways to earn an income. Matt’s ‘Cash Calendar’ strategy is — in my view — one of the best ways for experienced investors to source a new income stream.

It won’t be for every investor. But I’m convinced every experienced investor should at least find out what it’s all about. For details, go here.

That record again

Check out this picture. It’s the Australian government two-year bond hitting a new record low:

chart image

Source: Bloomberg
Click to enlarge

As I write, the Australian government can finance its debt for two years at a record low interest rate of 1.427% per year.

It’s no wonder the government’s debt continues to grow. At the last count as of 29 July, Australian federal government debt stood at $429.7 billion.

By this time next year, it will be half a trillion. Again, congratulations Australia.