Asset Inflation – Herman O’Hermitage takes it to task …

Herman O'Hermitage

Asset Inflation is the twin soul (dark side) of Consumption Inflation – the 21^st century disease, a destabiliser that would make Keynes cringe.

Carl Jung admits that much of his scientific research and thesis on duality was inspired through Norse mythology of twin souls and the rather similar Eastern philosophy of I Ching.

Late last week I came across an article that was explaining using circular flow of money and Keynesian aggregate demand that the Fed Reserve should have been withdrawing funds (money supply) from the system to stop the asset bubbles that were in hindsight so obvious from 1991 to 2007.  Greenspan spoke of excessive exuberance as we approached the millennium.  (Most thought on circular flow is addressed at consumption, not the value of productive assets.  Moreover fiscal policy can be a blunt instrument and why central banks focus so tightly on Money Supply, therefore consumption inflation).

The article was based on the thesis statement that central banks should not just target consumer price inflation but stability of all prices. Therefore the Fed owns the GFC.

I can not see that the Fed acts in isolation. In Australia in 2004 the Howard Government was given control of both houses of parliament as a reward for the illusory wealth effect of asset inflation.  People with substantial assets in property or share investments could finance conspicuous consumption by borrowing against the increased value of their assets, or parlay their gains into further speculation. Even those who were less affluent where feeling increased wealth by the effects of compulsory superannuation. The total euphoria was infectious and contagious.  The masses were hooked and addicted.

As it continued the distributive effect was exposed, where loans where made on property to people who simply could not ever afford those mortgages and sub prime turned into global financial crisis and the rest is history as well.

Yesterday I came across a piece on Australia’s Prime Minister in 1932, Joe Lyons. He was advised by the wise economists of the Melbourne University school of L F Giblin, Douglas Copland and Leslie Melville. Each were adherents to the arcane economics of Adam Smith. Balanced budgets, honour your obligations, and austerity – (somewhat pre industrial revolution and based in agricultural production).

Where the stock market crash of 1929 had seen Australia’s terms of trade washed away in it’s tsunami, they were advocating balanced budgets and government spending to be slashed and taxes raised and greater flexibility in wage demands. In Australia the opposing forces were the Theodore Plan or the Lang Plan, but overseas in Britain there was new economic thought of John Maynard Keynes and business cycles. Keynesian thought arrived in Australia in 1941 under John Curtin and H C Coombs.

As always, such is the parallel of our current treasurer needing to bury his head in the sand, by defending our excessively high asset prices. He too is addicted to the need to maintain the status quo or current stabilisers.

Westpac has a market capitalisation of about $98 billion. Therefore its return of $6.2 billion pa is a low return on risk. Just for one moment imagine it’s market capitalisation was only half, say $48 billion.  Then it’s return on capital would double, a very handsome reward on risk. So what determines capitalisation?  The answer is the aggregate demand and limited supply of Westpac shares.  Very often driven by compulsory superannuation saving.

The same cuts for RIO or BHP or Wesfarmers.  Just stop and look at the multiples that BHP and RIO are selling on. Is it based on assets? No it is based on expected earnings, in the light of current performance.  Any tiny hint of economic malaise sees a 2% downward shift in ASX 200 prices, without any real thought or explanation.  Each night on Lateline Business, various stockbrokers attempt to explain the daily movement in the index, and as a rule there is simply no explanation.

In the last 12 months, 252 trading days, RIO rose by over 5% on 9 days.  Same time frame it rose by over 2% on 41 trading days.  It fell by over 2% on 51 trading days, and fell by over 5% on 8 trading days.  Which is to say on 92 trading days it’s share price changed by plus or minus 2%, or on 17 days its share price change exceeded 5%.  With that level of uncertainty I say that market capitalisation is not a very precise science.  The Chief Executive of CBA recently wanted to equate their return to a return on assets, and he included funds under management. He then surmised that their return was insignificant.

This year BHP is expected to report an after tax profit of $21 billion.  This year the 4 major Australia Trading banks will report collective profits exceeding $22 billion. Both equate to about $1000 per Australian of population.  The CBA earns in excess of $40,000 per staff member.  What is the average wage paid to the CBA employee?

This only highlights the disparity of incomes within our economy.

To conclude I ask what is the growth in market capitalisation over the last decade?

This is why asset inflation is killing and marginalizing the middle classes.  This is why there is so little regard for our leaders.  This is why gambling is debasing our very core of dignity, equity and social justice.  Poker machines, lotteries, horse racing ,and now the emerging sports wagering are the gambling mechanisms encroaching our living rooms – the down trodden and forlorn.  The financial markets are the gambling mechanisms of the educated and well off.

Never the two shall meet.  There is no explanation in Markiewicz Capital Asset Pricing Model.  He assumes only on behalf of the rational investor. When are TAB, or Keno or poker machines rational? When you own those companies or franchises.