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Thought Bubbles from the Deep

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Besides you could argue (leaving aside for a minute the argument that in the current system loans create deposits) that in a healthy/ideal financial system when you deposit (i.e. lend money to) money in the bank that the bank will then on lend that money for mostly productive purposes (I realize the reality is currently different in our modern fractional reserve casino system) thus enriching society in aggregate.

However 90% plus of residential property investment is just people buying existing properties which adds nothing to housing stock or to the productive capacity of the nation. The same for the stock market where 90% plus of share market investments are to buy shares on the secondary market as opposed to participating in IPOs or capital raisings. While the money does provide liquidity to the market, most of the money adds nothing to the productive capacity of society. Therefore I flip your premise on its head and argue that the people "doing nothing" are the stock market and property market investors. The people "doing something" are the savers (owners of savings accounts and term deposits) and small business owners.
 
An economy needs Investment. Savings just facilitates those without capital being able to make investments and those with money but without ideas or risk appetite, to be able to transfer their money through an intermediary. I don’t think this latter group really deserves much return especially if the deposits are gov’t guaranteed.

The economy should be more productive and probably more equitable the more returns are attributable to how money is used in the future rather than money for nothing via a risk free rate on money that has been accumulated in the past.
 
Craft you actually did not fully address my points. Firstly deposits are only government guaranteed up to $250,000 so those with many millions of dollars in savings accounts (there is only so many banks to spread the money to) will not be guaranteed. For example high net worth individuals and companies of a certain size fall into this category.

Secondly there is no guarantee that in a financial crisis the government will be able to honour that promise without destroying the value of the currency. The guarantee is more of a confidence trick than a mathematically viable proposition. If the big four banks in Australia rack up huge record losses the size of the government balance sheet is insufficient to absorb those losses without extreme money printing by the RBA or other emergency measures.

Do you think that the majority of stock market investors who just buy shares on the secondary market or the majority of property investors who buy existing houses are being more productive and are entitled to a higher return than savers?

Please stop using the term risk free rate. Despite it being a commonly used term in finance, there is no such thing as a risk free investment.

Also does not the act of delaying consumption deserve a reward in and of itself separate to the risk factor?

For example in todays environment you could argue for a 5 year term deposit 7% would be fair compensation. For a middle income earner lets say 2% would go to tax leaving 5%. 3% (a reasonable projection) would be to cover inflation. That would leave a 2% real return as a reward to compensate for the combination of delayed gratification and the small risk factor involved.
 
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Value Hunter said:
Also does not the act of delaying consumption deserve a reward in and of itself separate to the risk factor?
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In my opinion, No(inflation compensation at most) . As for addressing the rest to your liking, I can't be bothered having the debate.
 
I thought my arguments were well articulated and reasonable, but i can understand if you don't wish to address them because of the time and effort it would involve.
 
Value Hunter said:
I thought my arguments were well articulated and reasonable, but i can understand if you don't wish to address them because of the time and effort it would involve.
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Nothing wrong with your posts - I have moved a bit out there compared to conventional thinking - Don't really want to go to the efforts that would be required to fully explain where I'm at. Maybe I would discuss further if I saw some posts that sort of resinated but not interested in a debate.
 
I would be interested to eventually hear from Deepstate about my previous posts explaining that fund managers operate in a market with a captive audience and that is a major reason they can charge high fees.
 
Value Hunter said:
I would be interested to eventually hear from Deepstate about my previous posts explaining that fund managers operate in a market with a captive audience and that is a major reason they can charge high fees.
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Fund managers exist to manage funds. Were there no funds to manage, there would not be fund managers.

Compulsory super does create a savings pool. Given the task of investment may not be the way many people want to spend their time, it makes sense to outsource. The vast superannuation funds are essentially conduits to make this as easy as possible. There are a host of others competing heavily for similar things in the SMSF and non-super arena. These entities allow self management of assets or various degrees of outsourcing. At each step, fees are paid.

To the extent that legislation creates the savings pool, a captive audience is created. More fees than would otherwise have flowed to money managers are transferred. True.

Money managers compete heavily. It is an industry with very low barriers to entry and many boutiques are started with two guys in a room with one Bloomberg between them. Further, as is evidenced by the strong growth of ETFs, where fees on vanilla product are measured in a handful of bps, price competition is healthy and alive. If an equity manager charges fees that are too high, there are hundreds more that someone can choose from, including index funds.

A captive audience is not the reason why some fund managers charge high fees. The first hedge funds were 2/20 arrangements in the US (by Aussie Alfred Winslow Jones) where there was no compulsory savings. The first Vanguard fee for their mutual fund was.....

With the increased demand for fund manager services came a huge supply of them. It is a functioning market and not a cartel arrangement. Manager fees have come down a long way as scale has increased and the industry is actually more concentrated with the big supers and funds than for fundies. The cartel is at the super fund level. So, I suppose you are going to say that the fees charged at the level of major super funds are too high....and I would have some difficulty arguing against it. In my view, there are conflicts of incentives in there which move towards the direction of creating expensive complexity.
 
craft said:
Why should their be a positive risk free rate? Is there a moral or economic reason that money should make more money for nothing? If anything there are good fairness and resource sustainability reasons why it shouldn't.
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There is no reason the cash rate should be anything in particular. It is an instrument of policy. Certainly, the level at which it is set does have consequences and people can make their own moral judgements about the fairness of a 2% interest rate vs a 1.5% rate. Those same arguments should extend to the moral value of the S&P ASX trading at 5700 vs 3500. In a break from the past, where I believed in the primacy of markets, these questions are reasonable to ask and the outcomes are somewhat the results of societal choices made by leaders entrusted to make these calls....
 

Wait, interest rate on money is just a moral issue now? There's no reason why cash rate should be anything in particular?

I would have thought that when a person or a business borrow other people's money to benefit themselves, they ought to pay a risk-free rate+.

It's just common sense that when you borrow money, it shouldn't cost you nothing.

Why? Because believe it or not, most people work hard to earn their money and often, those with most of their savings in cash or a long term deposit or govt bonds does so because they have very little other assets or in a situation where they cannot afford any risk of loss.

To take people's savings for practically nothing is legalised theft. To take it from the poor and the elderly... Instead of seeing there's something morally corrupt about that, we're justifying why it must be anything else but?

I guess the poor and the elderly weren't doing much good with their savings anyway. I mean, besides paying the ever increasing cost of living and stuff.

But that's the poor's problem so who cares.

What economic implication does low interest have? Driving up property prices; driving up asset prices; giving cheap money to aspiring empire builders to play with... I guess these tend to end well for the economy, eventually.
 
Chaps,

The fundamental problem is that economic theory today has seemingly forgotten what capital actually is. The abstraction of money is so prevalent, not that economists seem to understand money either, that capital and its function has been lost.

Take the mind experiment of Crusoe on the island alone. He has a bright idea to build a boat and a net to catch more fish. He has the idea, now, how to build the boat and net. Both will require time to build/make and both will require materials, which again require time to be gathered.

The time required to gather and manufacture his products, require him to forego time spent gathering food. He decides to gather extra food each day for 3 months and save it. Then when he is manufacturing his product, he can allocate time from gathering food to manufacturing his products, living off of his saved capital, viz. stored/saved food.

The saved food is present value consumption. It is valuable. More valuable than future value consumption. The future haul of food will however be far more using a boat and net than current production of food. The difference or discounted value is the return to capital. Whether this capital be the saved capital goods of stored food, or the capital goods manufactured, capital is critical to actioning an idea.

If however there was a second castaway, and instead of Crusoe ‘saving’ food [capital] he could borrow the food [loan]. The difference or interest rate, will be the future haul of food, which will however be far more using a boat and net than current production of food. The difference or discounted value is the return to capital and is the interest rate charged for the loan [food].

Another way of looking at it is if I want to manufacture a boat and I can borrow money [food] to do so: will the return exceed the cost of interest? If it does, I build the boat. If not, I don’t.

Or,

I manufacture wigits. I can borrow at an interest rate of 5%. My selling profit is 18%. My net profit is 13%. It is worth borrowing the capital.

When the interest rate is low, more projects of production will be profitable, the marginal project. When it’s high, less.

So the only way to manipulate the interest rate is through inflation, creating money to maintain and overcome time preference. So it is more accurate to talk about inflation rather than the interest rate, as the natural rate of interest is not able to be manipulated by Central Bank. The natural rate of interest, eventually, dictates the the trend of the economy.

jog on
duc
 
Deepstate the issue about the morality of interest rates is that its not a free market and the RBA and the whole financial system as a whole is arguably suppressing interest rates. If under a truly free market interest rates were this low I would not pass moral judgement on the level of rates. However I strongly suspect in a free market system interest rates would be higher than they are today.

Yes, there is a cartel at Super fund level. Like I pointed out before because of the complex super system there are people that for one reason or another (tax consequences, union agreements, etc) actually have limited choice, despite the wide array of super funds on offer. Also the scale necessary to run a Super fund tends to lead to a cartel situation.

Also you did not address my argument that artificially low rates are pushing more money into equities and property from inexperienced investors leading to fund managers having more FUM than otherwise. Another bow in the captive audience argument. Many of these investors are too in-experienced and lack the financial literacy to find themselves a good deal. We are pushing these people into riskier assets then they would otherwise be in, yet they lack the knowledge to make good choices. Under free market arguably higher interest rates many of these people would invest in cash or term deposits.

Yet another bow in the captive audience argument is the four pillars banking policy. This has made the big banks enormously large and powerful. The banks then use this power and scale to successfully cross-sell garbage products with high fees and poor performance to their customers under the guise of "financial advice". The poor financially illiterate customers thinking they are getting advice are actually just getting a product sales pitch.
 
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Its morally wrong that banks can call some of their employees financial advisors, financial planners, etc. If by law they had to name these people "bank product salesmen" instead and they had to verbally explain to the client the conflict of interest, sales targets, and the commission/fee structure etc (many people don't have the skill to make sense of a PDS written in legalese) in simple language, I bet a lot of people would stop using financial planners. Are you telling me a 75 year old widow with a Commbank savings account knows what she is getting herself into when she visits a Commbank "financial planner"?

Another point that has not been mentioned is that the government and the RBA actually creates a lot of the need for financial products and financial advice, not only by suppressing interest rates but by complex superannuation regulations, complex tax law, complex inheritance law, complex divorce law, etc. So the government is actually creating a need for all sorts of products and advice, where that need would not exist without such a big and bloated and intrusive government.

Deepstate are you telling me that this system (as described above) does not affect the fees service providers can charge? If the tax system was incredibly simple, how many people would need an accountant? The ones that still did use an accountant would be paying much less because it would not take as much time or technical knowledge to submit a tax return. Under a more free market system of no compulsory super and high real interest rates (after taking into account tax and inflation) then fewer financially illiterate people would invest in property, shares, alternative assets, etc and would instead invest in cash and term deposits, where you do not need to pay high fees to fund managers. The remaining people that did invest with fund managers would be more likely to be financially literate/savvy and thus the whole fee structure would come down.
 
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craft said:
The economy should be more productive and probably more equitable the more returns are attributable to how money is used in the future rather than money for nothing via a risk free rate on money that has been accumulated in the past.
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I've had this argument with myself many times (I'm sane, I promise). If you look at the effect of this through generations of wealth accumulation, those who hold significant assets simply in terms deposits/government bonds were (not so much now) receiving a real return that just increases the class divide. Negative interest rates go a long way to address this. The alternative to this (or perhaps we do both) is have some form of taxes on inheritance.

Assuming one goes down this path of ensuring positive real return (i.e. after inflation) through negative rates, the problem then becomes how one maintains a stable economy (i.e. avoid hyperinflation).
Do you artificially ensure that 'savings' that are essentially risk-free (govt bonds) receive no real-return through a constant negative cash rate? It sort of breaks the model that we currently work with (not that we haven't done that before - removal of Bretton Woods is a great example).

Interest rates are currently set to maintain stability in the economy, but perhaps this is not the only tool we need. Perhaps further limiting creation of money by adjusting capital requirements can deal with inflation, rather than using interest rates...

I didn't really get much further than that TBH. Some more thought required.


On a side note - one could argue that doing this ensures no-one will save, but that's not the case. If the alternatives were far riskier, but had only a slightly higher return, which would one take? The choice of returns are not taken by the absolute figure, rather they're chosen by the return relative to other opportunities, or the opportunity cost. (Assuming a rational decision maker... which, of course, is also flawed, but that's another discussion).
 
VH: Would a free market result in a higher IR?

Don't know. But, what would happen is that wealth and means of production would be heavily concentrated in the hands of the few and they dictate the terms. So the natural end point of a free market is a market which is not free, but controlled by a small number of borderless citizens. Depending on what they feel like doing to the masses, they might want to make access to capital more or less easy. It becomes a command economy.

VH: Morality of low IR in that it forces savings in to property and equities where FMs get more fees.

Low IR hurts those with existing liquid savers much more than those who are paying down debt and seeking to build a nest egg. Low IRs help the majority of super fund investors in the real economy. It is people holding debt investments who pay for this in a direct sense...rich savers.

Super fund members can opt out by choosing a cash option if they want.

If it is optimal, given the sitn to move to more growth assets, demand for these services increases but so does supply. Prices have come down a lot, but more fees have flowed to FMs it is true.

If interest rates were higher, those people in REST would be collecting welfare cheques or even more underemployed. So, if you have a moral concern for paying an extra 10bps on the investment, you need to balance that out with the moral outcome of peristent 8% unemployment and even more stagnant wages. I would vote for lower interest rates. These same people have seen their wealth grow considerably faster bank deposits would have, even if they were at some notion of a natural interest rate of, say, 3-4% pa.

The choice of IR is one very blunt instrument with which to balance these things out. If you consider the counterfactual, it seems likely that those renting a house on a 2% net rental yield wondering how they will afford a house would, instead, be in their parents' house wondering how to get a job or get enough hours to rent in a place with a net 3% yield.

Based on what I observe, of all the possible evils, low IR is not amongst the most heinous. Amongst the most heinous would be not to intervene in a clear market failure. In doing so, there will be relative winners and losers. In society, what abt the aggregate. We are better off as a whole...and FMs were amongst the winners. As were builders and renters, those in economically sensitive sectors, anyone who cared about maintaining a stock of skilled workers...and so on.

There seems to be some moral outrage at wealth flowing to FMs. There is no law which prevents to from trying to be one. There is no school tie boundary. The market for funds management is utterly savage and highly competitive. For all the glass walled offices, inside is very little job security and a bunch of highly motivated, smart, people generally doing the best they can.

Are you also upset at home builders? Because the primary motivation for lower front end interest rates is not to push more savings in to products with higher FM fees. It is to stimulate housing development. This is the most direct impact of low interest rates for the real economy.
 
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Perhaps we should also force hair stylists to be called barbers once again. Real estate agents should have Shark in Suit under their names on business cards and tradesmen should caveat appointment times with...subject to change without notice. Caveat Emptor has always been a principle in commerce and there is only so much you can do to stop someone from making a stupid decision.

Financial planners, I feel, should be moved towards a fiduciary mentality. I think commission based sales is fine for a salesman but not fine for a fiduciary. Anyone who reads the first paragraph of the engagement letter should see that "I get paid to sell you stuff" makes you a salesman rather than an independent advisor. If you for the CBA, you aren't independent. It was like this with life insurance salesmen in the 1980s and snake oil salesmen in the 1800s. Just to be clear, fund managers are fiduciaries.

In an environment with no compulsory super, tax and financial arrangements for most people would be simpler. Mainly because they'd have no savings to speak of. The financial industry would be smaller and, given that much of wealth is held in liquid assets, there would also be a lower standard of living for all. Then we'd be back in to the welfare state and unsustainable debt trajectories given the moves in demographics. No.

If you have an issue with an overcomplicated system, that's fine. I agree. It is overbuilt but there are all sorts of things being done to streamline the experience. Yet, you seem to be inferring that this is largely done for the benefit of financial advisors, accountants and fund managers. Really? I am uncertain whether Paul Keating was in the pocket of BlackRock and E&Y when deciding to negotiate the Accords in a far-sighted way. Actually, scratch that. I am certain they didn't. Partly because BlackRock didn't exist then.

Were you to look back at how money was invested in the, say, mid 1990s, not so long after the Recession We Had To Have and high interest rates, you would find that the dominant fund managers of the time had about the same amount in equities then as the key investment options in major super funds today. So that angle, of low interest rates forcing higher exposures to equities, is outright wrong. It forced money out of fixed income for sure, but it went to other things. As for more sophisticated investments, they are only accessible to 'sophisticated investors'. The illiterate have to choose who to entrust with their finances. Hopefully they are competent enough to make those decision on their behalf. Being unsophisticated, I would not normally go in for a cartilage repair using XYZ sophisticated surgical instrument, but I hired a knee surgeon to do it and he made those choices for me. So it is with investment.

As to this low fee in deposits stuff, let's look at it. The difference between the return you get as a direct investor holding a pile of stocks and bonds and one intermediated by fund managers and super funds with their army of accountants is about 60bps per annum. Cost of doing business.

A deposit in the CBA ultimately finds its way to a mortgage (interest at around 4.5% or a small business loan at around 6%). Your deposit interest rate is, what, 2.2%? So that would make bank fees...what? And who is the moral beneficiary of high interest rates??

Nothing stops you from moving your holdings to cash....please do if that works for you.
 
Deepstate I concede the caveat emptor point you made. Its totally true and correct. Its just that after all the banking, financial planning and insurance scandals of the past 5-10 years its hard to not feel outraged at the fat cats in the financial industry. Do you not feel any sense of outage? Especially given how poor the performance of the funds management and financial planning industry as a whole has been? Are their any other sectors of the economy that you are aware of where poor performance is so common and so readily accepted and highly remunerated? Perhaps, the government, legal, insurance and building sectors come somewhat close (but not quite as bad). Building used to be a proud profession once upon a time but building standards have slipped greatly over time. Compare the quality of a newly built off the plan apartments to 50 year old double brick homes which are still going strong.

If I came across as implying that low interest rates and financial complexity, etc were solely to benefit the financial industry that is certainly not what I meant. I agree completely that there are many other beneficiaries including the construction industry, existing homeowners, etc. Low interest rates benefit existing home owners not first home buyers, because in practice the lower interest rates push house prices up so far that the total debt servicing burden does not go down in the long run. You only need to go look at graphs of mortgage payments as a percentage of income to see that its not that far from previous record highs. And what happens to those people when the interest rate cycle reverses and heads higher?

Looking at fund manager holdings in the 90s when interest rates were high is misisng th point. You have to look at the retail investor level and see how much retail investors hold in equities, in property and in cash now compared to the 90s. Because the funds management pie has grown as a whole.

Also if you look at the growth of the banking and financial services industry over the past 30 years in any developed country its been absolutely gargantuan and well in excess of nominal GDP growth. A fractional reserve banking system with a controlled interest rates and a monopoly on currency creation and an oligopoly on credit creation feeds the parasites. Hedge fund managers, getting paid billions of dollars just to shuffle assets around, and banks making obscene profits on the back of lending more and more against the same pieces of land (simply pushing the price of land higher without adding productive capacity into the system) is hardly a productive system.

I don't know where you get 60 basis points for the funds management industry from? Maybe at the wholesale level but at the retail level just look at managed funds open to retail investors and listed investment companies. The base fee is typically 1 to 1.5% plus some sort of outrageous performance fee on top. Which by the way I never understood the concept of a performance fee, isn't their whole reason for existence and the base fee meant to be for them to outperform? In my opinion a fund manager that under-performs the index should charge zero (no base fees even) because they cost you money.

What makes you think I want to move my holdings into cash? I have enough knowledge about the stock and property markets to buy individual properties and shares successfully (at least so far) thank you very much.

The banking system as a whole is mainly focused on grabbing maximum share of the economic rent as opposed to adding productive capacity to the economy. Yes there is productive activity in Australia's banking system but the majority of the lending is unproductive. This is due to our system of enclosing the economic rent i.e. land price. The majority of the lending activity will go towards chasing economic rent higher. The economist Phil Anderson has a lot of good research on this topic of land price and economic rent.
 
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In theory there is nothing to stop somebody from becoming a fund manager but the licensing/regulation, scale requirements (at least to be decently profitable) and the fact that the industry is run like a boys club act as deterrents. Otherwise there are so many investors on Aussie stockforums that are thrashing the market returns (and the returns of the majority of overpaid fat cat professionals) yet cannot or would not open a funds management business (true that some on the forums manage capital for family and friends, etc and charge a small fee).

Eternal growth partners https://egpcapital.com.au/ is a typical example of what might happen if lets a skilled investor from lets say this forum decided to open a funds management business. With his minuscule level of FUM do you really think he makes much money from being a fund manager? And that his despite his relatively strong performance track record. There are a lot of things other than performance that dictate how well a funds management business will do.
 
Deepstate tell me do you think its a coincidence that the financial industry took off like a rocket after the final link to gold was severed in the monetary system (in the 1970s)? And that low interest rates and high credit creation at the same time are also a coincidence and that the financial industry and credit both vastly outgrew the economy at the same time? We both know that all these things are linked. What do you think of the views of Austrian economists that the whole fiat, fractional reserve, banking cartel system is a sham to benefit certain elites at the expense of the rest of society? Of course even the Austrian economists don't put it so bluntly but that is what they hint at if you read between the lines. You speak as of the current system were the world is awash in debt was/is somehow good for society.

p.s. I left out the point before that while industry super funds have relatively low fees many retail super funds are charging 1%+
 
"Most of the funds management industry is full of unscrupulous fat cats. An example of a fund manager doing things right is EGP which I mentioned before. here is a quote from their website:

The funds management industry is fundamentally flawed. EGP Capital is here to change this. EGP Capital charges no management fee. We charge a performance fee which is set against a high benchmark. And if you don’t make money then neither do we.

On average, fund managers charge clients around 1.67%p.a. for the privilege of managing their money, regardless of how they perform. History shows around 80% of funds fail to beat their benchmark over a five-year period, there are a lot of investors paying a lot of money for nothing, or in some cases, less than nothing."

Not to mention all the rants people like Warren Buffett and Charlie Munger have had against the fat cats in the funds management industry. Deepstate for somebody as knowledgeable as you not to feel some sort of outage is disappointing. I am not saying funds management should be illegal or that fees should be capped via regulation but at the very least it needs to be decried and denounced in bold fashion by investors, financial advisors (assuming they are independent and not conflicted) and the media. Its morally wrong.
 
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