Does QE work?

The RBA Governor says we need to stimulate the economy by continuing to lower interest rates and maybe through QE. Some senior CEO’s advocate for QE. The ex-treasurer says no. So who is right and who is wrong. Well the problem is that they are all correct, it is just that they are all solving different problems. The RBA Governor seems to be fixated on two things keeping inflation and the $A within certain ranges. The CEO’s want pump priming so that their businesses can get some of the money and profit from it and Peter Costello seems to give a damn about what is good for the country.

BACKGROUND.

Let’s start at the beginning, after the GFC the governments of Australia have borrowed around $1trill. Andrew Neil said it eloquently last year. The US, EU and UK went for QE, that is they printed money. Australia borrowed their printed money. So the US, EU and UK can pay themselves back when they like but Australia has to pay them back according to the borrowing contracts. So that was pretty dumb. 

But the dumbest then came next. The $1trill has been used to:

1. Build the non-profitable NBN.
2. Install pink batts and then take them out.
3. Build school halls at inflated costs, that are not used.
4. Employ thousands of public servants that in David Graeber’s words carry out bullshit jobs.
5. Pay international companies billions to not build tunnels.
6. Build roadways to get non-productive employees to work quicker.
7. Build football stadiums so we can all enjoy our ever increasing leisure time.
8. Produce expensive renewable energy.
9. And the dumbest one of all. Australia borrows billions of dollars to buy motor vehicles from other countries. How could anybody think that was a good idea.

And I am sure you have many more.

The point being that none of these expenditures will create income in the future. It is the equivalent of a family borrowing money to purchase and improve a weekend retreat. One that they cannot afford to use. 

That leaves us with the present situation. The country has a $1trill debt to be paid off and no income by which to pay it.

SECTORS OF THE ECONOMY.

Some smart journalist wrote not long ago that if Keynes was alive today his theories would be different. Why is that? Well the economy is very different today than it was 100 years ago, yet economists seem to be stuck in the past.

In the days of Keynes the economy was developing a manufacturing and mining base and coming away from agrarian dominance. Government represented less than 10% of GDP. Hence the majority of the economy produced wealth. Agriculture, mining and manufacturing. Stimulus went into wealth creating activities that returned an income for the investment. Pump priming got people into jobs that created wealth so that more jobs could be created.

Today only 28% of the economy creates wealth. So lets look at the sectors of the economy.

1. Agriculture.

We know that agriculture creates wealth especially when the products are exported. The problem at the moment is the drought and therefore reduced income.

2. Mining.

Mining creates wealth. Much of this goes to government through royalties and tax and shareholders through dividends. It is however a major source of income for the nation.

3. Manufacturing.

Manufacturing was devastated in the 80’s and 90’s through economic rationalisation. These wealth creating jobs were given to emerging nations. Let’s bring this back to the family. My mother knitted my jumpers when I was a child. She made a lot of our clothes. Today the family outsources these activities by throwing out clothes not mending them and buying cheap products from offshore. The family has more expenses.

4. Finance.

For the vast majority of companies the world of high finance is only 70 years old. Look at a P&L for a medium sized company in days gone past and you will find accounting, professional service fees, finance charges all in the expenses section. These used to be inhouse overheads that are now outsourced. They do not create wealth they use wealth because they reduce the gross profit of the company.

The new world has taken this to an extreme where they outsource everything. But the finance industry does not create any wealth it uses it. Now I hear all the M&A people squealing. Sorry people you transfer wealth you do not create it and your fees in the middle destroy wealth.

Remember in 1960 less than 1% of the population owned equities. 

5. Non-Financial Services

Whether it be a barrister, a barista or Uber eats. None of these create wealth they are all expenses. They are family overheads that eat up income. But worse still. You create wealth by growing something. You pay your barrister to defend a frivolous lawsuit, the barrister pays a barista for a coffee on the way to court, the barista pays Uber eats for dinner. Each transaction incurs GST and income tax. The more the money goes around the more the wealth is destroyed.

6. Service paid for from outside the Nation.

International students and tourists bring money into the country creating wealth for the nation. Internal tourism destroys wealth and education not only destroys wealth but steals time from our youth. I could write a whole paper on this alone. I met a builder a couple of days ago. He and his wife are struggling to make a living in regional Queensland. His two children are going to Bond. Yes it is expensive, but they will finish their degree in two years instead of four. Have a loan not much more than their potential HECS debt, and two years of life to get even. Kids at Uni have 10 -20 contact hours a week. Even the smart ones have to take low paid jobs while completing an education that gives them nothing but a piece of paper. Our Education system destroys the wealth of the nation and the fibre of our next generation. (By the way none of these kids should be a Uni they are all doing technical courses.)

7. Government.

When GDP was brought in as a measure there was a significant debate as to whether Government expenditure should be a part of the measure. I think it is clear Government creates no wealth and everything it does destroys wealth. Effectively if the nation was a small business we would have expensed $1trill and the corresponding transaction would have been to increase non-current liabilities.

8. Construction.

If construction produces income it is wealth creating otherwise it just uses wealth. If the family builds a weekender this does not increase their wealth it increases their costs. 

A new building of apartments is built and sold to people selling out of existing homes. This does not create wealth. It uses the wealth of the family to purchase a property for their lifestyle. So what about the home they sold. More often than not the money goes to help kids by a house. The bank of mum and dad. No wealth creation. Or if they are smart they will buy shares in emerging nations. No wealth creation until the shares are sold and the money repatriated.

Meriton builds a new building and sells it all to Chinese buyers. This is wealth creation as the funds to buy are coming from offshore. HOWEVER, the problem is that it is a one off sugar fix. Once the building is up it no longer provides an income in fact it becomes an expense.

Building non-incoming producing capital projects is wealth destruction. 

I understand that we could debate what produces wealth and what destroys wealth, however this is not the point. 

If you borrow money and put it to work to produce an ongoing income that works.

If you borrow to build lifestyle capital that gives the economy a short term sugar fix at the expense of the balance sheet.

If you borrow and use the funds to prop up the P&L you are the road to bankruptcy. 

CONCLUSION.

Keynesian economic works when consumer spending is on goods and services that come from wealth production. It does not work when the expenditure is on imported goods and wealth destroying services. Therefore QE works well in economies like the present one in the US where red tape is being put to one side so that people like Anthony Pratt and Robert Millner can build wealth creating factories. It has not and will not work where there is no wealth creation.

A LOOK AT THE WORLD IN RELATION TO WEALTH CREATION.

Japan was the rising superstar of the world economies in the 80’s. Its wealth was being created by manufacturing goods that were being sold to the world therefore creating wealth for a resource poor nation. Then came the Reagan trade wars. Japan was still highly productive but without the ability to receive massive income from the developed world their economy slowed. I believe at the time $3trill was written off the value of real estate in Japan, the combined wealth of all the world’s equity markets at the time. Property had to be sold around the world to pay off loans. With wealth creation hamstrung Japan never recovered. 

Over the last two decades China has had 10% growth because its base domestic consumption has been very low. It built huge wealth creating industries that sold goods all around the world amassing a huge trade surplus. Now the proportion of its income going to domestic consumption is increasing the growth rate is slowing because it is consuming its own wealth. 

Australia has had nearly three decades of growth due to immigration and the resources boom. It has used its wealth to build lifestyle capital that does not and will not earn it an income in the future. Australia’s wealth has been destroyed, and replaced by a $1trill liability, which will take 10 years of all our fuel exports or 100 years of our agricultural exports to pay off.

Europe is going down the same path. They are all slowly moving from net creators of wealth to net destroyers of wealth. Some have gone down that road and are being propped up, others are waiting for judgement day. How long has it been since France had a surplus? 

WAGE GROWTH.

Wages cannot continue to grow in an environment of wealth destruction. At present Australia is borrowing money to pay public servants wages that are rising more than the average. Wages have risen in wealth creation industries such as mining. Small business cannot afford the minimum wage, or the red tape hence our investment levels are the lowest for 50 years. 

Pay careful attention to the finance industry over the next five years. When I wrote TPU there were over 6,000 managed funds in Australia paying an average of 4% in total fees and charges. That money is moving into ETF’s. Even the major LIC’s with an MER of <1% are struggling with discounts between 3 – 20%. Hundreds of thousands of jobs will be lost, so don’t look for any wage hikes in the near future. The government pushed towards home care a few years ago. There are 160,000 unfilled jobs in that area, so there will be a movement from one wealth destructive sector to another.

SUMMARY.

1. The present method of measuring the economy is not appropriate for the modern economy.
2. Borrowings need to be used for building assets not for enhancing lifestyles.
3. We need to have an economy that creates more wealth then it destroys.
4. Most developed nations are no longer net wealth creators.
5. Wages cannot rise in an economy that is building liabilities.
6. The finance industry is in the process of being “rationalised” we need a better plan than we had for the manufacturing industry.