“Global rates policy a dismal failure”
Capital, both debt and equity, is not only plentiful, it’s cheap — perhaps cheaper than it’s ever been. So why is capital expenditure not rising?
Back when the suppliers of equity and debt — that is, savers — demanded returns of more than 10 per cent a year, entrepreneurs lined up to get some and business investment rose year after year. Investment hurdle rates were 15 per cent, and boards were happy with the margin those sort of returns would provide over the cost of capital.
Now savers have been battered into submission, subjugated to the great cause of higher inflation, and have been forced by central banks to lower the price of capital to half what it was.
Yet business — and governments for that matter — have largely kept hurdle rates of return for investment where they were, and are not buying. As the Reserve Bank once again cut the price of credit on Tuesday to the lowest level since it was created in 1960, it referred to the “very large decline in business investment”.
Non-mining investment is not only failing to pick up the slack on the decline in mining investment, it’s falling too! And so is investment by the government. Despite a 10-year bond yield of less than 2 per cent, the government is not borrowing and building.
The only reason the economy is growing at all is because booming house prices have helped maintain consumption, in turn because of the “wealth effect”. But that’s now coming to an end as the housing cycle dies a natural death.
It’s not just Australia: in the US, last week’s GDP report for the June quarter showed that business investment is in recession, while consumption grew 4.2 per cent, and was entirely responsible for the growth in GDP, as anaemic as that was.
There are four reasons, in my view, each of which tends to create a feedback loop:
- Company profits are weak, and naturally businesses invest less when profits are not rising.
- The fact that interest rates are at record lows might be enticing, but it’s also scary: if the RBA is cutting the cash rate to 1.5 per cent, things must be terrible.
- The pressure on boards to pay out the cash to shareholders as dividends or buybacks is becoming more and more intense, so as a result hurdle rates for new capital expenditure are ridiculously high when compared with the cost of capital. To compete for capital against dividends, a new investment has to be compelling.
- Politics is, to say the least, unusually unsettling: first the Australian upheavals, then Brexit and now Trump. It’s a brave board indeed that commits to a 20-year capital works plan.
At some point central banks are going to have to return interest rates to normal without having declared victory in their fight against low inflation and falling investment. It will be one of the greatest failures of public policy in history.
Alan Kohler, Australian 6 August 2016 http://www.theaustralian.com.au/business/opinion/alan-kohler/global-rates-policy-a-dismal-failure/news-story/69ce4a35bad109c00c4edcebe0c66db2