The end of financial year meeting of the Basil and Sybil Cheeseparer Superannuation Fund was going well until the Trustees (a) found that their investment strategy was out of sync with reality and (b) failed to find a fixed interest investment that would return more than 2.50% over five years.
“We should stick it under the mattress,” said Sybil.
“Your side or mine?” quipped Basil.
As you should know, even if economics is not your forte, the Reserve Bank of Australia this week cut official rates for the second month in a row to a new low of 1.0%. They could have heeded this warning from Sydney’s University of Technology Professor Warren Hogan, but the RBA is not often swayed by commentary.
The RBA continues to be driven by persistently low inflation (1.3% in the March 2019 quarter). The theory is that if the RBA cuts rates low enough, business and consumer confidence will return and inflation will resume its normal trajectory (2% to 3%). This in itself should build a case to raise interest rates, albeit gradually.
This current cycle of record low economic growth, inflation and interest rates is best explained by the graph ‘household consumption’.
It clearly shows consumption/spending falling off, concurrent with a decline in disposable income. Note the 10-year decline in our savings habit. Not much point saving if you are only going to get 2% or less in a bank and then pay a fee for the privilege, eh? (a nod to Canada Day).
An official interest rate of 0.1% is not as dire as that of Japan, Switzerland, Sweden or Denmark which have negative interest rates. Actually, since the onset of the Global Financial Crisis in 2007, many countries drastically cut interest rates in an attempt to stimulate growth (production and jobs). A blog by the International Monetary Fund (IMF) reasoned that while, the global economy has been recovering, and future downturns are inevitable:
“Severe recessions have historically required 3–6 percentage points cut in policy rates,” authors Ruchir Agarwal and Signe Krogstrup observe.
“If another crisis happens, few countries would have that kind of room for monetary policy to respond.”
IMF staffers periodically write blogs where they test models and theories (the IMF disclaimer says they do not represent the IMF’s views).
In this context, Agarawai and Krogstrup construct an argument for countries to survive financial crises by using negative interest.
The authors posit that, in a cashless world, there would be no lower bound on interest rates.
“A central bank could reduce the policy rate from, say, 2% to minus 4% to counter a severe recession. The interest rate cut would transmit to bank deposits, loans, and bonds.”
“Depositors would have to pay the negative interest rate to keep their money with the bank, making consumption and investment more attractive. This would jolt lending, boost demand, and stimulate the economy.”
Yes, but how do retirees like Basil and Sybil, who have surplus cash to invest, fit into this system? When the B&S Cheeseparer Superannuation Fund was formed, the cash rate was still climbing to its peak of 7.25% in 2009. That made it possible to invest cash in term deposits paying 5% or more, an attractive option for older people who wanted a safe haven.
Now, the return for risk-averse investors barely covers the cost of self-managed super fund administration. And to think that Labor were talking about taking away much-needed dividend credit refunds! (The fact that this would only affect a small number of wealthy individuals was a fact not well explained by Labor and gleefully misinterpreted by the government).
Continuing low inflation is the main reason Australia’s central bank keeps cutting interest rates. Inflation dropped to 1.3% in March – the cost of living as represented by the Consumer Price Index (CPI) minus ‘volatile items’ like home purchase costs. However, Commonwealth Bank senior economist Gareth Aird argues that adding housing costs could add 0.55 percentage points to the CPI, giving the RBA less reason to lower interest rates.
Warren Hogan writes that ‘Australia is in a new environment where tinkering with interest rates may not be as relevant as it once was.’ Inflation is subdued around the world, he notes, yet the global economy is growing and unemployment is low.
Likewise in Australia, unemployment is low, although wages growth has stalled. As Hogan says, it isn’t at all clear that even lower interest rates would have a meaningful effect on inflation.
Australia has not plunged into a recession for 28 years, yet some commentators have used the R word when talking about the latest round of retail closures. (I should point out that uttering the R word is regarded in some circles as akin to walking under a ladder, breaking a mirror, toppling a salt shaker or seeing a priest in the street).
Retail closures included Maggie, T, Roger David, The Gap, Esprit and Laura Ashley. National retailers planning to downsize include Big W, Target, Myer and David Jones.
While some retail closures involved inevitable job losses, there will be more jobs to go as the big national chains roll out their smaller formats.
For the benefit of those aged under 28, an ‘R’ sets in after two consecutive quarters of negative GDP growth.
As we can see, the GDP result over nine months (+0.3%, +0.4% and +0.4%), means we are in dangerous territory.
The Gross Domestic Product (GDP) number is the one that measures whether the economy is growing or retracting. Safe to say at this point that a 0.4% increase in the March 2019 quarter (published this week) is not what the market or the government was looking for. The annualised GDP is 1.8% − the lowest since the GFC. Some pundits are calling it a GDP-per-capita-R, that is, population growth is overtaking economic growth.
The low interest rate scenario (and the data implies more cuts to come), is good for young people buying houses, but has a detrimental impact on retirees. Most people in retirement mode take a conservative view, preserving their remaining capital as long as possible. Bucket-list advocates would say what the hell and head off to Antarctica while there are still icebergs, glaciers and penguins.
Retirees typically have 60% to 70% of their super fund/savings in fixed interest products, with the balance in income-producing shares. But when faced with returns of 2.45% and less, it is difficult to stick to this formula. Shares or investment housing offer riskier but more attractive returns, though not as risky as spending all your cash on travel adventures or stashing it under her side of the mattress.
What to do? I have no answers, nor, I suspect, does the central bank, or the government, which is seemingly obsessed with the notion of stimulating the economy via $158 billion in tax cuts over 10 years.
Everyone under 30 needs to be across this subject because, as Herbert Hoover once said: “Blessed are the young, for they will inherit the national debt.”
We’ll leave you with some insights from Clarke & Dawe about banks, the debt crisis and interest.