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A strange financial circus



An oft-quoted phrase from the preamble to the United States constitution that is used to describe where power lies in a democracy is: ‘We the people’. In finance, an equivalent designation might be: ‘We the savers’. In non-communist financial systems, especially those with large stock markets, power finally resides with the masses who save, not the super-rich predators who exploit them.

One of the odd side effects of the global pandemic is that it was pretty good for savings. Trouble is, it has been largely based on a financial fiction, money printing. (Please note that the definition of ‘savings’ used here is my own and would no doubt offend many economists. What is meant is the various ways that money is stored, not just what people hold in their bank accounts. The reason for looking at it this way is to get a snapshot of the ‘capital’ part of capitalism, as opposed to the ‘ism’ part of ‘capitalism’ on which commentators mainly focus.)

In Australia, the biggest pool of savings is the $3 trillion in superannuation funds, which have transformed the financial structure of the nation. The super funds have done well during the pandemic, with the pool of funds now one of the highest levels in the world, equating with 132 per cent of GDP according to the OECD. Only the Netherlands, Switzerland and Iceland are higher and Australia has about four times New Zealand’s level and 65 per cent more than the level in the United States.

Unlike other countries’ pension funds, especially Europe’s, there is no risk that the Australian super pool is unfunded (a situation where the government promises to pay the pensions but ultimately does not have the money). Each individual owns the money in their super so it is, by definition, fully funded.

The COVID-19 crisis led to another positive for saving, a sharp rise in bank deposits. Australia’s total bank deposits were $US2.54 trillion in June, about 24 per cent higher than the average level over the last 17 years. Similar increases were seen around the world, with people stockpiling an extra $US5.4 trillion of savings since the coronavirus pandemic began. That extra saving very much benefited Australia’s domestic banks, which now get about 60 per cent of their funding from domestic deposits on which they pay almost no interest.

It has been a strange financial circus, just what critics of ‘fiat money’, who support a return to the gold standard or using Bitcoin, like to attack. They have a point, although there is no easy way to fix such an entrenched problem. The government increased government debt to pay for programs like JobKeeper, funding it in the usual way by issuing government bonds. Meanwhile, the Reserve Bank undertook a program of Quantitative Easing, whereby it bought back some government bonds, a sort of recycled money printing.


'Financial markets are a bit like a spinning top trying to stay ahead of inflation and other costs. If the top does not spin fast enough, or stops spinning altogether by incurring losses, collapse becomes inevitable.'


Next the Australians who received the extra money during lockdowns shovelled much of it into their bank accounts rather than spending it. That extra money sloshing around in the system, especially the cheap money provided to the banks, turbo charged the domestic property market, causing prices to soar. The resultant merry-go-round has been more like something out of Alice in Wonderland than any finance textbook.

Australia is hardly exceptional. Similar kinds of things have been going on across the world, and to a more extreme degree. The global savings pool is being propped up by a magic trick, money produced out of nothing.

One of the biggest slices of global savings is the $US103 trillion of assets under management in the world. About a third of that is pension funds, saving for people’s old age, and another third insurance company funds (insurance is not usually thought of as savings but it is a form of collective saving against adverse events). That pool of money managed by institutions is where most of the mobile investment capital comes from and it rose by over 11 per cent in 2020.

It all looks well and good, money in abundance. But here’s the catch: Where is the return on that capital going to come from in an economic environment looking increasingly bleak after the economic damage caused by COVID? Without sound returns, capital quickly starts to evaporate. Financial trickery can only last so long.

Financial markets are a bit like a spinning top trying to stay ahead of inflation and other costs. If the top does not spin fast enough, or stops spinning altogether by incurring losses, collapse becomes inevitable.

To get a sense of what can happen, witness China. The Evergrande collapse, which is likely to set off a chain reaction in China’s heavily indebted property market, came about because the banks were not getting a sound return on their investment. China’s property sector is valued at $US62 trillion, making it the world’s largest asset. Property contributes 29 per cent of that country’s GDP and 62 per cent of the household wealth. 

Chinese banks are state-owned so the government can continue to bail them out with money printing, unlike in Western economies where banks are mainly private. But the looming implosion is a pointer to what happens when returns are inadequate or non-existent.

Over the last two years, money printing has created the illusion of strength in savings. But when reality resurfaces, and actual returns are required from actual economic and business activity, the global financial system will come under extreme stress. And when financial markets implode, then the savings implode with them. And even if there is not a collapse, inflation eats away at the savings’ value. ‘We the savers’ will be the casualties.




David JamesDavid James is the managing editor of personalsuperinvestor.com.au. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.

Main image: An aerial view from a drone of the Evergrande City on September 24,2021 in Wuhan, Hubei Province, China. (Getty Images)

Topic tags: David James, savings, money, banks, inflation, global debt, economics, financial markets, Evergrande



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Existing comments

Shakespeare's head must be spinning in his grave with all this; I just hope it doesn't "implode".

Daniel O'CONNELL | 12 October 2021  

Predictions of China’s economic stalling are mostly self-consoling illusions of a lazy Western elite who have overseen the erosion of Western manufacturing, educational and technological advantages. A lazy elite with no answers. This week, Pentagon software chief, Nicholas Chaillan, resigned saying the US cannot compete with China in the tech war, and that the bureaucracy was all talk and no action.
China has a problem with an over-leveraged real estate sector, but it has a large current surplus and huge savings. It will simply reorganize.
But the West seems unwilling to curb spending. Just keep interest rates low so that borrowing trillions allows the government to make people feel there is plenty for everyone at no cost.
This fantasy land of financial irresponsibility is demonstrated by Joe Biden who claimed his new proposed five trillion spending spree will cost “nothing”—the same Biden who claimed America’s disastrous Afghanistan withdrawal was an “extraordinary success.”
America now has runaway inflation, which hurts the poor and middle classes the most. These deficits are nation-destroying and will undermine the financial bedrock upon with democracy stands.
China is serious and strives for meritocracy. The US has rejected meritocracy and focuses on “diversity.”

Ross Howard | 13 October 2021  

A very sane, insightful article, David. The only other Australian economic commentators I would put in your class are Satyajit Das, Ross Gittins and possibly my old schoolfellow, Terry McCrann. Terry does often take a rather different tack to you, but that's diversity.

Edward Fido | 19 October 2021  

David when budgetary implosion seems plausible, the Superpowers ramp up their spending on Defence, or Preparatory Offence in the case of China and USA.
These figures are all post pandemic: SIPRI estimated that Chinese defense-related expenditure actually reached $240 billion in 2019—nearly 40 percent higher than the official budget ($183.5 billion). Similarly, the International Institute for Strategic Studies put the 2019 figure at $234 billion. The U.S. Department of Defense has stated that China’s actual spending could be higher than $200 billion. This does not include what China spends on its military by accounting for expenditure outside the official budget eg their ubiquitous Coast Guard which polices the SCS, or for example their new bases in PNG and Vanuatu.
In 2020 US military expenditure reached an estimated $778 billion, representing an increase of 4.4 per cent over 2019. As the world's largest military spender, the USA accounted for 39 per cent of total military expenditure in 2020.
Australia? This year, the consolidated defence funding line (including both the Department of Defence and the Australian Signals Directorate) is $44.6 billion, which is real growth of 4.1%. It's the ninth straight year of real growth, and, according to the DSU's funding model, that will continue until the end of the decade. (Wikipedia).

Francis Armstrong | 19 October 2021