QE+NIR - funky money’s coming back.

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Funky money.

Quantitative easing with negative interest rates, or QE+NIR for short, is coming to an economy near you.

Japan and Sweden’s economies have been running on negative interest rates for many years now. In Europe, the ECB went negative on rates in 2014, however last month Germany sold 30 year bonds on a negative yield.

QE 6 - QE likely to be on again in Europe.

While Sweden has recently indicated it now wants to reverse those pesky and troublesome negative rates, it’s widely expected that in the EU, the deposit rate will be cut from -0.4% to -0.5% and the ECB will announce a restart to QE.

Those predicting this move say it’s to make up for the lack of confidence and negative investment outlook created by the US/China trade war.

But what’s more important is that over time it will weaken the Euro and make EU originated exports cheaper and Europe more competitive - particularly in the cases of Germany, France and Italy.

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Stir up a few animal spirits? Perhaps. Increase business investment and lending? Inconclusive.

But, stack on more central bank paper on top of the 5 trillion stacked up across QE1 to 5, and fuel equities? Absolutely.

Central bank tools have their limits.

The problem with more QE is that attempts to reverse ~US$20 trillion already on central balance sheets have so far been invisible, other than for a small run-off in the US (less than 5% of the total).

The problem with negative interest rates, particularly in economies where a high proportion of the funding mix comes from depositors is that at some point banks will need to pass on the cost of negative rates to depositors.

At the low watermark, depositors will simply take their cash out of banks and store/hoard it, the implication being that banks won’t be able to lend that money. Under that scenario, negative rates will not support lending, but strangle it.

It’s probably the case that Europe with a -0.5% expected deposit rate might be at that point soon, but only time will tell.

Negative rates are not good.

Australia needs to steer well clear of the funk.

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In Australia since the GFC, Australian banks have turned the funding mix on its head. Nowadays, most money lent by Aussie banks has been borrowed from depositors for a (relatively unexciting) interest rate.

Accordingly, the RBA needs to pay close attention to how low it is prepared to see interest rates go.

This may be why the RBA Governor has been calling on a thus far deaf Government to kick-start the fiscal machine.

Our economic malaise can’t be solved with monetary policy alone - but we’re all drunk at the QE punch bowl, so to turn the titanic it’s going to take more than just a few muffled calls of ‘iceberg’ to get the Government to engage the fiscal rudder.

Fiscal policy is the blue pill for Australia.

Tariffs are not fiscal policy! They are blunt protectionist instruments paid by importers of goods originated from countries which are tariffed. They produce income for a while until output declines.

Before the Trump tariffs, the last time they were used in a major way was in the US when the Smoot-Hawley tariffs were introduced just before the Great Depression in 1930. Some say they led to the Great Depression, which we all know didn’t go so well for most people.

And, any tariff mischief that serves to slow down the Chinese and other Asian economies effects all of us here in Australia.

Rather, there are three basic ingredients used to make fiscal Viagra, and they are business taxes, individual taxes and government spending.

We are told the recent personal income tax cuts have not yet flowed through the economy. The corporate tax rate drop to 27.5% for entities with < $25m revenue and >80% passive income is yet to occur.

The experience in the US in relation to the 2018 corporate tax cuts is that it fueled a buy-back boom (not necessarily investment) which has further carried the bull market. That’s created asset inflation, not goods and services price inflation. It’s unclear whether the same would occur in Australia.

What about spending? Infrastructure spending sounds like a good idea - but it depends on what sort of infrastructure - and whether the money gets to the right people.

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Where we’re going, we don’t need roads - so why not spend now to re/up-skill displaced workers.

Building roads and rail is not the only answer.

Sooner or later those tasks will be fully automated (deleting humans) and shredded/reconstituted plastics, graphite/graphene, invisible aluminium and the like may one day displace concrete, asphalt and steel, etc.

As Australia is one of the world’s most compelling renewable energy locations - initiatives which capture, produce and store (for domestic use and export) zero-carbon clean energy might be one good place to start. Re-up-skilling people for the new world should be a no-brainer.

So, it’s likely that a Government spending program which invests in Industry 4.0, modern transport, zero emissions energy, etc., would be a great way to go - however it needs to be done in a way which:

  1. Up-skills workers which have been made and/or will be made redundant as the economy transitions.

  2. Re-skills and brings seniors/retired workers (no longer able to survive on bank interest rates, thanks to QE) back into the economy.

  3. Focuses taxes/borrowings on areas in which Australia can build comparative advantage.

If Mario Draghi gets his full funk on, he will restart the currency war.

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Full funk Draghi (which is not yet certain) would mean:

  1. Deeper negative interest rates.

  2. Tiering, perhaps like the Japanese model where some bank current accounts will have a positive interest rate and others have a zero rate or a negative rate.

  3. Restarting bond purchases.

  4. Potentially renewed calls for a ‘fiscal instrument’ or guarantee which can coexist with the ‘no bail-out’ rules.

Yields are falling, so it looks like the market is pricing in some of the above.

If the above does occur, one of the effects will be cheaper borrowing costs in Europe relative to the US and in time, a lower Euro once the markets have processed the lifeline. This would have a major effect on capital flows and would no doubt restart the currency war.

If this plays out there will be pressure on Switzerland and Japan to consider re-calibrations at their upcoming meetings, and this may spur even further stimulus in China and a lower yuan - but most of all if the EU stimulus does materialise, Fed Reserve Chair Jerome Powell will most likely cop it from the President if he does not lower interest rates further. And, we all know what that means for markets.

Stay tuned.

Mike.


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