A downside risk you should embrace

Tuesday, 29 October 2019
Adelaide, Australia
By Bernd Struben

  • All hail our pricey fruit!
  • Enter the RBA

If you say something often enough, it becomes the truth.

Or at least the masses come to accept it as such.

Nowhere is this more apparent than with the great inflation myth.

We’re told…over and over again…that the ‘ideal’ level of inflation is 2–3%. This is the level that’s meant to deliver the best playing field for economic growth. It’s meant to spur investment and consumer spending. And it’s a target the Reserve Bank of Australia (RBA) is hell bent on achieving, no matter the cost.

When inflation is running at 3%, you’re supposed to feel good about your 3.5% nominal pay rise. Never mind that your real income only went up by 0.5%. And never mind that the value of the dollar in your pocket will be cut in half every 24 years.

We’re also told that without inflation, the economy will grind to a halt. Hence the frequent lamentations from mainstream economists over Australia’s ‘stubbornly low’ inflation rate.

Dare to raise your voice against them, and they’ll be quick to trot out the dreaded deflationary beast.

This is where they warn you that consumers will stop spending if they know they can get the same items cheaper by delaying their purchases.

That’s nonsense, of course. We all still need to eat, pay our monthly bills, and yes, even splurge on luxury items.

Computers and TVs are a great example. Not only do they keep getting better each year, they keep getting cheaper. Yet that hasn’t seen the industry come to a crashing halt. Quite the opposite.

Ask yourself this. If Australia had a deflation rate of 1.0%, meaning the dollar in your wallet would be worth $1.01 by next year, would it change your purchasing decisions at all?

I’m guessing not.

So why the manic efforts to stoke inflation across the developed world?

It all comes down to debt, folks.

Here’s another no-brainer question…

If you were a trillion dollars in debt, would you rather see the value of that debt inch up by 1% each year? Or would you prefer to see inflation cut it in half every 24 years?

Which brings us to the latest inflation data, due out tomorrow.

More, after the markets…

Markets

Yesterday I noted US markets should hit new record highs this week. That’s off the expectation of another interest rate cut from the Fed on Wednesday, which would mark three cuts in a row. As well as more positive noises from Donald Trump on US–China trade negotiations.

Indeed, both the S&P 500 and the NASDAQ closed on Monday posting new records, though the Dow Jones didn’t quite get there…yet.

Overnight, the Dow Jones Industrial Average closed up 132.66 points, or 0.49%.

The S&P 500 closed up 16.87 points, or 0.56%.

In Europe the Euro Stoxx 50 index closed up 1.01 points, or 0.03%. Meanwhile, the FTSE 100 gained 0.09% and Germany’s DAX closed up 47.20 points, or 0.37%.

In Asian markets Japan’s Nikkei 225 is up 96.67 points, or 0.42%. China’s CSI 300 is down 0.07%.

In Australia, the S&P/ASX 200 is up 10.09 points, or 0.15%.

West Texas Intermediate crude oil is US$55.82 per barrel. Brent crude is US$61.68 per barrel.

As you can see on the chart below, both crude benchmarks retreated overnight, the first price fall in a week. Why?

Bulging US inventories, of course.



chart image
Source: NYMEX / Bloomberg
Click to enlarge

As I’ve written here before…more than once…this picture is highly unlikely to change. US production is at record levels. And the shale revolution has years to run yet, with new record production forecast out of the US in 2020 and 2021.

Without the current production cuts from OPEC+, crude would already be trading far lower. And as I’ve also banged on about here, I expect OPEC+ will struggle to extend those cuts into 2020. I still believe that Russia, the ‘plus’ member of the cartel, will be the first to bolt.

Here’s a neat summary from Bloomberg:

Data provider Genscape Inc. said oil stored at a key Oklahoma storage hub expanded by 1.5 million barrels last week, reviving concerns about sluggish demand and ample inventories. Meanwhile, Russia threw cold water on expectations a new round of major supply curbs are imminent.’

Barring a full scale war with Iran, crude prices are likely to head far lower into 2020 before finding a floor.

Turning to gold, the yellow metal is trading for US$1,492.34 (AU$2,181.78) per troy ounce. Silver is US$17.83 (AU$26.07) per troy ounce.

One bitcoin is worth US$9,471.54.

The Aussie dollar is worth 68.40 US cents.

All hail our pricey fruit!

Getting back to the great inflation myth…

Consensus forecasts point to an inflation rate of 1.7%, year-on-year, for the September quarter. Some, like Citi economist Josh Williamson, believe it will be even lower, at 1.6%.

If you’re for a stable currency, you might think that’s 1.7%…or 1.6%…too high. But with the oft repeated inflation myth lending it the element of truth, you won’t find many mainstream economists standing beside you.

Take NAB economist Kaixin Owyong, for example, apparently concerned about the drop in energy costs.

From the Australian Financial Review (AFR):

“There is a sizable degree of uncertainty about the extent that the default market offer reduced energy prices, it’s possible the effect is greater than the 2 per cent fall we have estimated,” Ms Owyong said.

“We see downside risk here.”

Pardon me? Falling energy costs represent a ‘downside risk’ for Australians?

But that’s not the extent of the peril facing our economy. Kaixin also warns of the falling cost of childcare:

“Changes to childcare subsidy took place on July 1, increasing the subsidy available to an estimated 1 million families.

“When the childcare subsidy was first created in the third quarter of 2018 child care costs fell 12 per cent in that quarter. Again there could be downside risk here.”

I hate to step out of line — well, not really — but as someone with a young daughter, and an energy hungry house and property, I say bring on those downside risks! Times 10.

God forbid our food bill goes down too.

Which it won’t, by the way. Food is one of the ‘silver linings’ in the inflation forecast. You can thank the drought for that.

Here’s ANZ’s Hayden Dimes:

Wholesale prices suggest fruit prices are up sharply, more than offsetting the fall in vegetable prices. With the ongoing drought, there is some upside risk to food inflation.’

Thanks heavens for expensive fruit delivering a much needed ‘upside risk’.

But pricey bananas alone won’t be enough to combat out stubbornly low inflation.

Enter the RBA

Also from the AFR:

September will mark the 15th straight quarter of below-target core inflation necessitating an extended easing cycle and the expectation of at least a further interest rate cut in February 2020, futures indicate.’

Whether the RBA does cut rates from the current historic low 0.75% to a new low 0.5% remains to be seen. Though I’d agree it’s more likely than not.

But that will almost certainly not stoke inflation.

Just look at Japan. The Japanese have been toying with low and even negative interest rates for years. And the latest year-on-year October inflation figure (quoted by Reuters) comes in at 0.5%.

What lower rates will do is temporarily boost the Australian housing market. This is a boon for current owners. Especially if they choose to sell before the housing bubble truly pops. (It will. The only question is when.)

Higher home prices will also see state governments take in more revenue from stamp duties forked over by those same home owners.

New buyers may think they’re getting a gift with ultra-low interest rates too. But the reality is buyers will need to pile on more debt for the same house that was cheaper with higher rates.

Lower rates will also temporarily send stocks higher. Equities love nothing more than easy money.

As with the housing market this will benefit existing stock holders and government coffers when investors sell and have to pay their capital gains taxes.

Folks sitting on the sidelines and jumping into stocks trading at record highs, however, might not like the outcome so much.

That’s not to say the whole dog and pony show will come to an end this year. Or next even.

Though it could.

And when it does, ‘stubbornly low’ inflation won’t be to blame. Instead it will be the tools used in pursuit of governments’ arbitrary inflation targets that help bring it all down.

Our wealth preservation expert Vern Gowdie has been tracking this disaster in the making closely. And he’s less than impressed that the S&P 500 just hit a new record high.

Here’s Vern:

When it comes to American stocks, this is the most expensive market in history.

The good times have been had, now it’s time for the not-so-good times…deflating this bubble.

The US market is a disaster waiting to happen. The Fed — with its targeted, irresponsible policies — have blown an asset bubble that’s without peer.

A market cannot go steeper, steeper and almost vertical for years on end without some kind of “reversion to the mean”.

To be clear, by ‘reversion to the mean’ Vern is talking about a financial crack-up that will put the 2008 global financial meltdown to shame.

But Vern isn’t cowering in fear. He’s prepared for what’s to come. And he wants you to be prepared as well.

That’s why his latest book not only details how the crash is likely to eventuate. But it gives you five valuable steps you can take now to protect your wealth. And even potentially profit from freefalling housing and stock markets.

Get all the details here.

That’s all for today. Be sure to check back in with us tomorrow.

Cheers,
Bernd