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DW Documentary – “The Money Deluge”

July 11, 2017 Leave a comment

Below is a recent documentary from Deutsche Welle (DW – Germany’s international broadcaster) on the impact of exploding real estate prices, zero interest rate (see graph below) and a rising stock market. The higher income groups are benefiting greatly from these conditions but how does it effect middle income earners especially those in retirement. The DW documentary addresses these issues and explains how money deals have become detached from the real economy. Worth a look.

For years, the world’s central banks have been pursuing a policy of cheap money. The first and foremost is the ECB (European Central Bank), which buys bad stocks and bonds to save banks, tries to fuel economic growth and props up states that are in debt. But what relieves state budgets to the tune of hundreds of billions annoys savers: interest rates are close to zero.

The fiscal policies of the central banks are causing an uncontrolled global deluge of money. Experts are warning of new bubbles. In real estate, for example: it’s not just in German cities that prices are shooting up. In London, a one-bed apartment can easily cost more than a million Euro. More and more money is moving away from the real economy and into the speculative field. Highly complex financial bets are taking place in the global casino – gambling without checks and balances. The winners are set from the start: in Germany and around the world, the rich just get richer. Professor Max Otte says: “This flood of money has caused a dangerous redistribution.

ECB Rates.png

Those who have, get more.” But with low interest rates, any money in savings accounts just melts away. Those with debts can be happy. But big companies that want to swallow up others are also happy: they can borrow cheap money for their acquisitions. Coupled with the liberalization of the financial markets, money deals have become detached from the real economy. But it’s not just the banks that need a constant source of new, cheap money today. So do states. They need it to keep a grip on their mountains of debt. It’s a kind of snowball system. What happens to our money? Is a new crisis looming? The film ‘The Money Deluge’ casts a new and surprising light on our money in these times of zero interest rates.

When the NZ Official Cash Rate exceeds the US Fed Rate.

July 1, 2017 Leave a comment

With Janet Yellen increasing the US Fed Rates to 1 – 1.25% and Graeme Wheeler keeping the OCR at 1.75% it is anticipated that the US Fed Rate will eventually become higher than the OCR. What impact might this have on the New Zealand dollar?

With higher rates (or expected higher rates) in the US money flows will be attracted into the US with higher interest rate returns. This is referred to as ‘Hot Money’ and for international investors there are significant amounts of money to be made.

A higher interest rate in the US would mean a higher return from saving in a US bank. Therefore, New Zealand investors may sell NZ dollars and buy US dollars so that they can gain more interest from their savings. This increased demand for US dollars will push up the value of the US dollar against the NZ dollar.

RBNZ v Fed Rates.png

However it is not just interest rates that influence Hot Money. In 2011the Swiss Franc appreciated on the back off the turmoil in the Eurozone as investors saw the currency as a safe haven. The NZ dollar and the AUS dollar appreciated for similar reasons post the Global Financial Crisis.

Problems of hot money flows

Hot money flows can be destabilising. A rapid rise in the currency can harm a countries with exports become more expensive and imports becoming cheaper. However the latter might be favorable depending on the import content.

Hot money flows can create excess liquidity fuelling a future asset boom and creating more long-term problems.

Trump’s tax cuts likely to have limited impact on growth

May 14, 2017 Leave a comment

Donald Trump has indicated that the US economy needs a big tax cut to stimulate some growth and aggregate demand –  C+I+G+(X-M). His rationale is that with consumers having greater income they will spend consume more (C) and businesses keeping more of their profits will invest more (I). He is even so confident that the tax cuts won’t put a dent in the overall tax revenue of the government. However economists are suggesting that the US economy is already growing as fast as it can and in order to improve its growth rate it needs to investment in productivity.

D Pull Inflation.jpegNevertheless, US tax cuts in the 1980’s under Ronald Reagan proved to be very effective in stimulating aggregate demand but the economic environment then was different to that of today. The 1980’s was an era of stagflation with the US experiencing 10% unemployment and inflation reaching 15%. Since the GFC in 2007 growth has been positive and unlike the 1980’s unemployment has been falling  – from 10% in Oct 2009 to 4.4% in April 20178. Tax cuts are all very well when you have high unemployment but with the rate falling to under 5% companies may find it difficult to respond to the greater demand for goods and services by taking on workers to increase supply. Tax cuts would then lead to an increase in inflationary pressure (see graph) which is turn would prompt the US Fed to increase interest rates.

ProductivityTrump’s plan would also increase the Federal deficit and borrowing from the government. This would put upward pressure on interest rates for the private sector which reduces the potential for further growth. As noted earlier the area that needs to be addressed is productivity, with a shift of the LRAS curve to the right – see graph.

Categories: Growth, Inflation, Interest Rates Tags: ,

Global Liquidity Trap

April 4, 2017 Leave a comment

The FT had an excellent article back in April last year that covered many concepts which are a part of Unit 4 of the CIE A2 Economics course. It covers the liquidity trap, deflation, MV=PT, circular flow, Monetary Policy, Quantitative Easing etc.

The article focuses on the liquidity trap with Monetary Policy being the favoured policy of central banks. However by pushing rates into negative territory they are actually encouraging a deflationary environment, stronger currencies and slower growth.  The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.

Liquidity Trap

Normally lower interest rates lead to:

  • savers spending more
  • capital being moved into riskier investments
  • cheaper borrowing costs for business and consumers
  • a weaker currency which encourages exports

But when interest rates go negative the speed at which money goes around the circular flow (Velocity of Circulation) slows which adds to deflationary problems. Policymakers pump more money into the circular flow to try to stimulate growth but as price fall consumer delay purchases, reducing consumption and growth.

The article concludes by saying Monetary Policy addresses cyclical economic problems, not structural ones. Click below to read the article.

The global liquidity trap turns more treacherous.

China and the exodus of cash

March 5, 2017 Leave a comment

Another very good video from PunkFT. As the Chinese economy starts to slowdown by its standards (even at 6% growth) the Chinese are sending their money overseas in search of safer investments. In doing this they are often violating currency controls which are there to keep money inside China. The housing market in many countries have been driven up by the flood of cash from China – Vancover, Sydney, Hong Kong, New York and Auckland. Chinese spent almost $30 billion on U.S. homes in 2015.

How will authorities stop the outflow? One way is to increase domestic interest rates to encourage people to deposit their money in local banks. However this impacts those Chinese companies that borrow money and could prompt some debt-laden companies into deleveraging. Worth a look and great animations.

RBNZ cut OCR but little mention of Trump

November 10, 2016 Leave a comment

Although the attention this morning was on the election of Donald Trump as US President the RBNZ cut the OCR to 1.75% with a mild easing bias of “numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly”. nz-cpi-nov-16

It is expected that the OCR will remain at this level in the near future with inflation expected to be back within the 1-3% Policy Target Agreement (PTA) by the end of January next year – see graph from ASB Bank. The reason for this is that:

  • Dairy prices have recovered considerably.
  • The labour market is tightening.
  • Growth is running at an above-trend pace.
  • The OCR is already at an expansionary rate and the economy.

Could there be another cut in the OCR? There would be pressure if the following eventuated:

  • there is a strengthening of the NZ dollar,
  • increasing bank funding costs,
  • any further weakness in inflation expectations,
  • any deterioration in the global growth outlook.

The change of US Presidency will also be a wildcard over the longer term, with its mix of potential fiscal stimulus and trade protectionism. Trump has already signaled that he is not keen to sign TPP and he wants to reopen the NAFTA – North America Free Trade Agreement. Furthermore, he might take umbrage on the Chinese with their manipulation of the Yuan to advantage its exports and put a large tariff on its goods coming into the US. For New Zealand it may mean that they have to go down the bi-lateral agreement option in order to increase trade.

Other than the US election, Graeme Wheeler needs to be aware of the following:

  • Theresa May has indicated she wants to trigger Article 50 by May 2017 – it is very unclear what the process will be and the negotiating strategy of both the UK and the EU. This could have implications for NZ trade.
  • In China the increasing of centalised  power of the President.
  • China has a huge amount of corporate debt relative to GDP – see graph below.
  • Brazil is still in recession
  • Russia still has issues in the Middle East

China Corporate debt.png

Monetary policy – not too tight in New Zealand?

October 26, 2016 Leave a comment

Brian Fallow of the New Zealand Herald wrote a very informative article on the inflationary target that the Reserve Bank of New Zealand keeps missing – the CPI has been below the bottom of the bank’s 1 to 3% target band. Some will say that the RBNZ has been too tight with its monetary policy stance – maintaining high interest rates for too long. Assistant Governor John McDermott has defended the bank’s position for the following reasons:

  1. Nearly half the CPI consists of tradables where the price of goods is impacted by competition from outside New Zealand. For the last four years the global economy has been in a disinflationary environment caused by excess supply and in particular low commodity prices especially oil. Year ending September 2016 Tradables = -2.1%. This offset almost all of the +2.1% rise in non-tradables prices. See graph below.
  2. The recovery form the GFC has been quite weak and with the NZ$ strengthening (imports cheaper) accompanied by lower world prices has meant that import prices have been very low.
  3. The growth of the supply-side of the economy has been particularly prevalent which again has led to less scarcity and lower prices.
  4. Recent years has seen immigration boost the demand side of the economy but because the age composition is between 15-29 rather than 30-40 in previous years, the former has a much less impact on demand as they don’t tend to have the accumulated cash for spending.
  5. The RBNZ reckon that the output gap is now in positive territory (actual growth being higher than potential growth) which will start to put pressure on prices as capacity constraints become more prominent.
  6. Statistically with a weak inflation rate in the December 2015 quarter the December 2016 quarter is most likely to be higher as the percentage change is taken on the CPI of the previous year.

nz-cpi-2004-2016

The spectre of deflation hitting the New Zealand economy does not seem to be a concern at this stage especially with the longer-term inflationary expectations being in the mid range of the target bank i.e. 2%.

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