Smack! Stocks have really copped it in the last two days.
Now we’re going to find out just how much of this rally is momentum and liquidity from the Robinhoodies — or not.
If you have a watchlist of stocks, the next day or two is the time to be watching to see if they catch a bid or not under the pressure.
But we must return to yesterday’s Profit Watch. We’re making the case that 2020 is not like 2008.
Quantitative Easing or QE is in play, The US central bank is running riot printing money, with consequences for all. But is this even a bad thing?
The Profit Watch inbox contains a gentle rebuke from reader Lisle. Let me reproduce it in full…
‘Hi Callum and friends…
‘There seems to be a lot of criticism of the US Fed for their QE program, printing of money, etc. The aim as I understand it is to put more cash into people’s hands and into the hands of business, to encourage people to borrow more and to create inflation.
‘As this happens the value of US dollars or fiat currencies in general decreases. Our RBA has a target for inflation in the 2-3 percent band, which means they, like the US Fed…WANT the currencies to lessen in value.
‘Personally I have no problem with this. You just have to have some assets that increase in value at a higher rate than inflation which isn’t that hard, is it?
‘So what I want to know is…why is this a problem when it solves some problems during a recession and particularly the current virus situation? And perhaps more importantly, I hear criticism of these really smart, informed people, but I don’t hear any alternative actions. If not doing what they’re doing, what SHOULD they be doing that would give us all a better outcome?’
Thank you, Lisle. You raise some good points. Where to begin?
The very heart of the financial system lies in the power to create money.
Very few people understand this process. It’s certainly not broadcast or taught in a clear way.
The private banking system creates money when they grant loans. They do this out of nothing, and at interest. This is called ‘credit creation’.
Many reformers over the centuries have argued, quite rightly, that this power could rest with the government and be issued debt and interest free.
The early American colonies harnessed this power when the English gold standard system restricted their output for want of gold and silver.
However, the system today is what it is. The key question becomes: where is this new money going?
If it is created and used to fund productive business, any economy will experience prodigious and healthy growth.
This is the secret sauce behind Japan and Germany over the 20th century, and now harnessed effectively by China.
However, here in Australia the private banking system is biased to create credit to fund real estate transactions.
The same is true in the UK. This money creation is part of why property prices inflate, and why Australia’s private debt levels are so high.
It’s also why Australia’s economy has the diversity level of economic lightweights like Bangladesh.
Margin loans in the stock market and property loans are, in an economic sense, extremely unproductive and inequitable. This type of credit creation is also dangerous.
The story behind the greatest collapses in history — the Mississippi Bubble, the Great Depression, the Japanese 1990 bubble, 2008 — are all linked through rampant money creation for speculation in financial assets. Read this book for more on that.
These bubbles crash because there’s no rational or sustained economic activity behind most of it. It’s a game of hot potato with ownership certificates.
It’s why here in Australia the regulators were forced to step in and restrict investment and interest-only property loans a few years ago, before the property boom went completely over the top.
How Fragile is the Monetary System?
COVID-19 revealed one thing. It’s how fragile this system is.
As soon as renters and leveraged homeowners were at risk of not paying, or losing their source of income, it threatened to crash the banking system.
That’s because COVID threatened to stop the flow of income to service the loans held against the ‘investment’ properties and property market in general.
Banks only have about 10% equity. A big impairment in their loan books can send them kaput!
This is also why the federal government is taking Australia’s ‘national’ debt to epic levels.
They have to prop up the shaky foundation of the whole thing.
The interest bill from this debt will remain for generations.
It doesn’t look so bad now because our trade is relatively strong. But the iron ore boom won’t last forever. Too bad future Australians!
Nevertheless, Lisle is quite right. The central bank could use their power — or demand the private banks do it — to fund investment in new technology and business. However, that is not what they do.
Lisle’s letter contains the idea that the Fed bailout in 2008 and 2020 is designed to help the real economy. It is not.
It’s designed to save the Wall Street banks and trading houses from going broke.
That means the Fed has created US$9 trillion dollars to preserve the asset values of the US’ richest 10%.
Those are the ones that mostly own the stocks, junk bonds and mortgage debt reflating right now.
It would be far more equitable to let the free market write down the value of these assets to their true value — whatever it is — and have the Fed create $9 trillion to fund genuine investment that increases production and creates high paying jobs in the US.
The average standard of living in the US is on long-run decline. The riots happening now are hardly coincidental.
The original idea of QE was to prevent a broken banking system from going bust, and sending the economy into a long recession as happened in 1930 onwards from a contraction in the money supply.
However, this situation only arises because we allow private, profit-seeking banks to create money for financial transactions in the first place.
What should happen is this credit creation should serve the common good via investment in productive enterprise.
The best way to do this is the German way: small, local, not for profit banks that lend to small- to medium-sized businesses in their area.
Germany notably did not collapse in 2008 and maintained stable real estate prices for a long time.
Fat chance of that happening here. So the cycle of boom and bust rolls on.
The name of the game is to ride these debt/credit cycles on the way up, then get your money out before they collapse.
Too bad for the unwary, unsophisticated and just unlucky members of society who get left to eat the losses.
The only question is: How long can the whole shebang last before it falls in a heap?
PS: Australian real estate expert, Catherine Cashmore, reveals why she thinks we could see the biggest property boom of our lifetimes — over the next five years. Click here to learn more.