The STUART Effect – The irrational effect on economic rationality

By Graham Andersen

Many things that occur in society defy rational or logical explanation. Society does not behave like the universe where science continues to unravel the workings through theory, experiment and testing. The universe is rationally predictable through the laws of science. Society or people are not. Collectives of humans influence their own outcome and that is the problem with economic rationality. Some things that occur in society seem irrational but are so STUpid, they are smART for a collective of humans for a time, and that is the STUART effect.

Unaffordable housing markets, overblown debt levels, loose lending criteria and negative interest rates are a few examples of current STUART Effects.

Australia’s housing market is seriously distorting economic activity. What some call strong I call stupid. Not only does housing costs inflate the cost of doing business and employing staff on an internationally competitive basis but the costs of capital projects like infrastructure are also greatly inflated. It may be cheap to borrow but it’s expensive to build.
You may feel smart if you’ve been in the housing market long enough but cashing out for retirement and investing at negative yields may not be the smart that was envisaged, even if STUART rules. The unearned income generated by cashing out of the housing market simply transfers debt to future generations of buyers who’ll need to be bailed out by future generations of taxpayers.

We’ll come back to STUART, but let’s review the signals and why Australia is heading for negative interest rates for a long time.
•    At over 125% of GDP, Australia’s household debt is the largest in the world.
•    Australia’s Public and Private foreign debt has reached astronomical height of 140% of GDP. This debt is growing and can only be repaid by selling the country
•    Debt creates money and if there’s too much debt, there is too much money
•    Australia’s economy is bar belled in that household debt is held by a group of borrowers and another group of depositors hold the money.
•    Australia’s private debt binge over the last 30 years has allowed house prices to rise to massive levels relative to median incomes all over the country.
•    Australia’s foreign debt binge over the last 30 years has allowed Australians to increase living standards and wealth in older generations whilst also ensuring that the current account deficit is paid for.
•    During the 30 year cycle Australia managed to transfer public debt to the private household sector but for the last 7 years has rebooted public debt in order to maintain growth in the economy whilst putting the AAA rating on the locked in path of downgrade.

Through the last 30 years did we have the policy debate that Australia was going to borrow itself to prosperity and eventually force interest rates to practically zero and beyond? Would we have thought that was a stupid or smart idea? Ask an individual and I’m sure most would call stupid. But let the humans act as a collective, then it’s very smart. I’m calling STUART on that. Enriching much of a generation or two with little effort and with the fall-out to be dealt with by future generations who’ve yet to wake up to their plight is not new, but it works, for a time.

Under current settings, a continuation of the debt to prosperity policies is all but impossible. So some things must give in order to reboot the economy to improve standards of living for existing and future generations. This cannot again be done by pushing up debt levels to create money rather we must increase productivity to generate wealth. Maintaining and increasing debt levels will only saddle future generations with lower living standards and reducing incomes plus the cost of bailing out the economy.

Simply put there is too much debt in the wrong hands and too much money in the opposite hands but this does not counter balance. In modern times, the rebalancing is usually done by having a financial crisis which results in loan losses, a destruction of money through equity and deposit losses and the resultant fall-out to employment. More recently, globalisation and the financialisation of almost everything, may mean that there is another yet stupid way of achieving the same thing.
Central banks around the world and our own RBA, have decreased interest rates to record lows on the basis of stimulating borrowing to keep our debt to prosperity model pumped. It has worked but not the way that was planned. Borrowing increased but mostly in non-productive assets like housing which had the effect of creating money and increasing asset prices but at the expense of productive investment. Not only that but the collective of humans worked on the basis that the RBA would keep decreasing  interest rates to avoid at all costs any rebalancing and a change to the debt to prosperity policy. To date that’s exactly what the RBA has done. So taking on massive debt amounts to buy overpriced assets, is not only low risk but is hugely profitable. I’m calling STUART.

As interest rates continue to decrease and move strongly into negative territory, asset prices and debt levels may still increase, but a funny thing happens, debt and money destruction starts to occur and the slow rebalancing of the economy commences without necessarily having a crisis. However, once the collective of humans is convinced that interest rates have hit bottom and the RBA cannot possibly lower further but must raise rates for fear of destroying too much money through negative rates, then the whole STUART process goes into REverse Gear (REG) and asset prices decrease in anticipation of higher rates and deleveraging. At this point the crisis hits with many losers through asset losses and income loss.
REG is not all bad however, the other thing that occurs at this point is that incentives now change considerably. The collective of humans, no longer wants assets decreasing in value but are incentivised, at the risk of losing a lot of capital, to invest in future productive cash flows. This may be hard for some to conceive but when the cycle turns, even when interest rates may be significantly negative, there will be little incentive to leverage assets because as asset values fall the cost of that debt rises to wipe out any notion of cheap debt. This is the point we must reach to reboot the economy, at the very least for the benefit of future generations. Whilst rebooting will create many relative losers, the balance is that the process creates even more future winners relative to the shocking effects of having to rescue an even bigger debt monster.
Perhaps there are numerous reasons why rates will not go heavily negative, the best of which is that it’s politically unacceptable to have depositors losing money on deposits. Nevertheless, the resulting outcome when STUART meets REG will still be the same regardless of where rates bottom. There is too much money and debt in the wrong hands for continued financial stability and as the list grows of those locked into massive mortgages and those locked out of the housing market, the political will starts to sway away from protecting those with unearned gains to those wanting opportunities of their own.
Although many events could happen internationally to bring on our rebooting crisis earlier, as we are very vulnerable, the collective of us humans that don’t want our children and grandchildren to pay for current excesses, want the economy rebooted. Those who want a more sustainable distribution of wealth across both society and generations should be creating their own STUART effect through a push for serious negative rates. Get on board and drive those rates down. Stupid hey, to believe that decreasing rates will cause the crisis? No, I call STUART. How low can they go before REG arrives and the reboot happens?

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