Over the last five years the GFC has triggered a significant loosening of monetary policy settings in regions such as the US and Europe, as authorities have sought to reflate their ailing economies.
This approach represents an orthodox macroeconomic response to cyclical weakness, but unfortunately it has had little impact, leading to more drastic action, including “quantitative easing” (a euphemistic term for effectively printing money in order to avoid deflation by encouraging greater levels of consumption and investment).
After a respite caused by the impact of favourable terms of trade, Australia seems to be following a similar path, with progressive reductions in the RBA’s cash rate in response to weak economic indicators.
However these policy responses have ignored the fact that the context is more structural than cyclical.
Pre-GFC Drivers for Growth
In the 15 years leading up to 2007 the world economy – and particularly Australia – benefitted from macroeconomic outcomes well above trend line, driven primarily by rapid growth in credit.
This debt-fuelled boom saw increases in incomes and asset prices well above long-run GDP growth.
But it is important to understand that:
DEBT IS JUST FUTURE CONSUMPTION BROUGHT FORWARD
Current worldwide debt levels (approx US$70 trillion) now represent not a cyclical event, but a long term drag on macroeconomic activity – a structural downward shift in the demand curve caused by the fact that:
- A portion of future consumption has already been ‘consumed’
- Notwithstanding loose monetary policy settings, debt servicing takes precedence to current consumption (and as witnessed in Europe, failure to do so risks wholesale collapse of the monetary system)
Peak Debt and the Effectiveness Monetary Policy
So why has monetary policy become ineffective?
The answer is deceptively simple.
Loose monetary policy is designed to encourage consumption and investment by making current period consumption and riskier assets more attractive, and has historically been an effective tool in this regard.
This is no longer the case because we have collectively reached ‘peak debt’ (at least in most western countries, including Australia).
Whether an individual, organisation or nation state, for any given level of income there is a maximum level of debt that can be accumulated without triggering a repricing of risk. Beyond ‘peak debt’ any further increase leads to a repricing of credit risk – the price that must be paid for that debt.
If you can’t increase income, you can’t increase the debt level. The monetary authorities are trying to send one signal about the pricing of credit, but at a national level the markets are sending exactly the opposite signal – the two just cancel each other out. (There is some increase in consumption because of the cash savings in interest cost, but at a national level this tends to be neutralised because one person’s interest expense is another person’s income).
This is the fundamental cause of Europe’s woes – countries like Greece, Spain and Portugal went past their ‘peak debt’ levels, and their creditors started to re-price their debt because doubts emerged about their credit-worthiness.
The RBA will continue to cut interest rates, but their efforts will be in vain, because we have already borrowed as much as we can for our current level of income (and having spent much of the money on non-productive real estate assets, have little in the way of options for driving the improvements in productivity which are a fundamental pre-requisite for increasing the size of the Aussie pie).
Not surprisingly credit rating agencies and other commentators have started to join the dots on Australia’s external debt position, and the risk of a feedback loop (where the repricing of risk triggers a crisis of confidence amongst lenders: http://www.macrobusiness.com.au/2012/11/sp-australia-is-spain-in-waiting/.
There is No “C” in the “GFC”
In the above context the use of the term ‘crisis’ is a misnomer, as it implies a discrete event or time period, when in fact what we are dealing with is a ‘new normal’ – a Japanese-style lost-decade (or more) of low growth, and even lower yields.
Monetary Policy Settings and The Yield Curve
Another affect of loose monatery policy is to push the yield curve for all assets down, regardless of risk profile, (as investors chase better yields, asset prices rise and yields fall).
This impact can be seen in the overall market response to cuts in the cash rate, but also individual stocks.
Telstra is a classic example, as interest rates have fallen over the last 2 years, its share price has gone up (and the dividend yield has correspondingly gone down.)
Implications for SMSF Trustees
An understandable response from SMSF Trustees to the volatilty of the last few years has been to migrate their asset allocation from higher risk ‘growth’ assets to ‘beta’ assets such as cash, fixed interest and bonds.
At the time many of these decisions on asset allocation were made, they represented a trade off between risk and return.
However the very clear implication of the above analysis is that SMSF Trustees now find themselves in a fundamentally lower yield environment, where for a given level of risk they will see a lower return.
Trustees must therefore recalibrate their expectations about gross returns, and hence the retirement income that is likely to be generated from a given portfolio.
Implications for the Australian Funds Management Industry
As mentioned above, in the 15 years leading up to 2007 the Australian funds management industry benefited from a very positive macro environment including:
- Mandated superannuation
- Benign inflationary outcomes
- Favourable tax treatment
- Strong population growth
- Favourable terms of trade
- Credit growth well in excess of GDP growth
- Asset price inflation contributing to high levels of consumption
This context contributed to relatively high net returns and allowed the cost structure of the industry to grow and solidify without strong competitive pressures.
This trend was reinforced by:
- A lack of transparency to costs across the value chain
- Relatively low levels of client engagement
- Cost / value calculations requiring analysis over long time periods
The total cost of the industry is now roughly $20 billion per annum, which represents a significant proportion of the gross income that can be generated from the $1.4 trillion in superannuation assets under management. It is difficult to calculate, but if one assumes (generously) a weighted average gross return of 6% across all asset classes, the industry-wide costs absorb more than 20c in every dollar of income generated.
The cost structure of the industry now represents a huge drag on net returns, and is arguably unsustainable in a low yield environment.
Mclowd was established with the goal of improving net returns for investors by driving per unit cost savings of 70-90% across the funds management value chain. (Launching a free SMSF accounting platform is just the first step in a long journey).
This vision will be achieved through two levers:
As a technology platform Mclowd is designed to support direct ownership of assets at scale. (By reducing the costs of accounting and tax compliance, reliance on the managed funds model will be significantly reduced).
As has been seen in other vertical markets (such as IT, marketing, design and analytics) the crowdsourcing of related services drives rapid per unit price deflation, as tasks are undertaken at a new, globally-defined marginal cost (typically 70-90% below those charged by professional services firms in Australia).
Crowdsourced services marketplaces like Mclowd are also inherently transparent as to both quality and cost.
While still in its infancy, the response to Mclowd from SMSF Trustees has confirmed the need for a new funds management paradigm.