Below are the titles of the last 7 posts we have shared with newsletter subscribers (not posted to the website):

  • Sep 17 – Gold, US Dollar, Aussie Dollar & Bitcoin in Charts
  • Sep 16 – Another Strong Week for Markets
  • Sep 15 – Why I’m Resolute the RBA Won’t Move in 2017
  • Sep 14 – One Crypto I Really Like (It’s Not Bitcoin)
  • Sep 13 – Jamie Dimon Selling Bitcoin Fear
  • Sep 12 – Broken Window Parable – Hurricane Irma
  • Sep 11 – Why Things Can End Badly

I am getting a lot of great feedback on the crypto posts… thank you!

With Bitcoin taking a real bashing  – it’s easy to explain why.

Here’s my basic theory:

Those who have most to lose (eg power, money etc) will make the most noise.

We talked to this at length with today’s newsletter (Sept 17) – providing two examples: (1) the invention of the car and disruption to the railroad and carriage industries; and (b) the invention of the printing press in 1440 (as governments and religious leaders alike feared people becoming too educated).

I see the revolution happening in cryptocurrency as no different.

Now we sent out a technical chart on Bitcoin – showing readers what I expect (and where to buy).

This week, I am going to share the post Why Things Can End Badly (from Sept 11th)

To enjoy all my posts – simply subscribe the newsletter. It’s free… 

Preface 

  • RBA Optimistic on Growth and Rates
  • Business Investment Remains Weak
  • Speculation Remains High

In a financial world where the lowest currency wins – our central bank cannot afford the AUD to run too high.

At present, it’s trading a hair below 80.0c.

As was expected, the RBA didn’t move on rates last week — keeping them at a record low of 1.5 per cent.

My view is they are not going up anytime soon but on this occasion – would be very happy if proven wrong.

Most economists felt Captain Lowe would try and talk down the currency — trading some 11 per cent higher against the greenback this year and 6 per cent higher since the monetary policy setting committee last met in July.

That’s not helpful… but make sense when you consider the recent improvements in our Terms of Trade:

A rebound in the iron ore price to above US$70/t has seen things improve (for now).

In short, what this represents is a “pay rise” in terms of our national income. And with an economy so geared towards mining – when the prices of commodities rally – naturally our income goes higher.

Iron ore is  up around 40% since June… we will see how long it lasts.

But let’s get back to the RBA and their choice of language:

An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast”. Previous statements have said a that “an appreciating exchange rate would complicate” the economy’s transition from a once-in-a-generation mining boom.

There you go… but let’s dig a bit deeper.

Business Investment Sags

Perhaps what surprised me most was the RBA talking up growth prospects.

For example, they seem very confident growth will rebound to around 2.75% to 3.0% plus over the coming couple of years – but I am wondering from what platform?

More housing? Higher commodity prices? Another credit boom from China?

When it comes to looking at future growth – below is one of my favourite metrics – the level of business investment:

Business Investment Falls

As a share of nominal GDP – it’s falling.

The only sector holding ‘water’ is buildings (surprise surprise). But look at machinery, equipment and engineering… they are trending lower.

But what about credit? Where is that flowing?

Credit Growth

From mine, this is more troubling.

As we have been commenting for the past few years – more capital is flowing into speculative (non-productive) housing that it is productive investment.

Here’s the thing:

Housing is a place to live. It’s important and we need shelter. But it’s not a productive asset.

When people borrow against housing – they are typically speculating on that asset rising in value.

This does absolutely nothing for a country’s economic output (ie GDP) and its income.

Bottom line:

Capital (or credit) flows into housing is having a direct impact on what capital can be made productive (ie business investment).

And with the average borrower taking on excessive debt (relative to their incomes) – this in turn implies they are more likely to spend less (which is now showing up in retail data) – reducing demand – in turn meaning businesses are less likely to respond.

And with businesses not responding (ie investing) – what happens to wage growth? You got it – it’s likely to fall opposite lower productivity.

Wage Growth

But let’s toggle back to the higher Terms of Trade for moment…

You see this is important.

From the RBA’s perspective, they are hoping that our “pay rise” will find it’s way back into higher wages. For now, that is not happening. As such, before they make any move on rates — this is what they will be watching.

If you connect the dotes – we have (in no particular order): 

  • declining business investment
  • over-inflated house prices (in two cities)
  • excessive personal debt relative to GDP (and income); and
  • falling wages… 

Why I should be so optimistic on our economic growth the next few years? A small bump in the Terms of Trade due to higher commodity prices?

What am I missing Mr. Lowe?

Is it more Chinese credit on the horizon? The next commodity boom? Another billion tonnes of iron ore? And if that’s the case – then where is the business investment which will drive the productivity?  

Putting it All Together

It’s 10:45pm and I am about to fly to Singapore from Melbourne.

Hopefully I will catch some sleep on the plane.

I am curious as to how this “debt drive economic script” will end for Australian when (not if) rates rise.

Are we prepared?

Let’s be clear – I don’t think we have to worry too much in the near-term (eg 2-3 years) about rates rising too much.

However, always keep your eye on long-term bond prices. If they fall, then longer-term rates will rise regardless of what the RBA does.

As always, I am always curious as to what others think…

For example, are we in better economic shape than what I believe?

Let me know… keen to hear the metrics / rationale

Regards
Adrian Tout

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