Money, what's it worth..

The ongoing thoughts of an SMSF Trustee...

Money doesn't have any inherent value. It is simply pieces of paper or entries in a ledger. A car has value because it can help you get where you need to go. Water has a value because it has a use; if you don’t drink enough of it you will die.

In the past money was in the form of coins, generally composed of precious metals such as gold and silver. The value of the coins was roughly based on the value of the metals they contained, because you could always melt the coins down and use the metal for other purposes, in Australia we have examples where the value of the metal was worth more than the face value of the coins. Until a few decades ago paper money in different countries was based on the gold standard or silver standard or some combination of the two. This meant that you could take some paper money to the government, who would exchange it for some gold or some silver based on an exchange rate set by the government. The gold standard lasted until 1971 when President Nixon announced that the United States would no longer exchange dollars for gold.

Australian is on a system of fiat money (Fiat currency is money that is created by government and given a value by regulation or law), which is not tied to any other commodity. So these pieces of paper,  in your pocket or digits in your bank account are nothing but pieces of paper, or one's and zero's.

Goods and services are what ultimately matter in the economy, and money is a way that allows people to give up goods and services which are less desirable to them, and get ones that are more so. People sell their labor to acquire money now to purchase goods and services in the future. If I believe that money will have a value in the future, I will work towards acquiring some.

Our system of money operates on a mutual set of beliefs; so long as enough of us believe in the future value of money the system will work.

What if we believed our money wouldn’t be nearly as valuable in the future as it is today? This inflation of the currency causes people to want to get rid of their money as quickly as possible. People will not sign into profitable deals which involve future payments because they’ll be unsure what the value of money will be when they get paid. Business activity sharply declines because of this. Inflation causes all sorts of other inefficiencies, from the café changing its prices every few minutes, to people taking a wheelbarrow full of money to the bakery in order to buy a loaf of bread. The belief in money and the steady value of the currency are not innocuous things. If people lose faith in the money supply and believe that money will be worth less in the future economic activity can grind to a halt.

The key cause of inflation is increases in the supply of money. Money has value because people believe that they will be able to exchange their money for goods and services in the future. This belief will persist so long as people do not fear future inflation. To avoid inflation, the government must ensure that the money supply does not increase too quickly.

A bit link our Superannuation, if we don't believe it will be there and have value in the future, we will leave in droves..

Forces on the value of Money?

Increases in American bond prices will have an effect on the global exchange market. Rising American bond prices will cause investors to sell those bonds in exchange for other bonds, such as Australian ones. So an investor will sell his American bond, exchange his American dollars for Australian dollars, and buy a Australian  bond. This causes the supply of American dollars on foreign exchange markets to increase and the supply of Australian dollars on foreign exchange markets to decrease. This causes the U.S. Dollar to become less valuable relative to the Australian Dollar. The lower exchange rate makes American produced goods cheaper in Australian and Australian produced goods more expensive in America, hence American exports will increase and imports will decrease causing the balance of trade to increase.

When the Australian government raises interest rates, this increases the supply of bonds, this reduces the price for bonds. These bonds will be bought up by foreign investors, so the demand for domestic currency will rise and the demand for foreign currency will fall. Thus the domestic currency will appreciate in value relative to the foreign currency. The higher exchange rate makes domestically produced goods more expensive in foreign markets and foreign good cheaper in the domestic market. Since this causes more foreign goods to be sold domestically and less domestic goods sold abroad, the balance of trade decreases. As well, higher interest rates cause the cost of financing capital projects to be higher, so capital investment will be reduced.

Hence today, we have a historically high AUD, and high (compared to the USA and many others) interest rates, It is worth mentioning, that none of the above is caused by "our" activities such as increased productivity, world competitive goods and services.. the above is totally outside of the control of the average SMSF Investor.

Falling Interest rates?

The conventional economic theory is that all segments of the bond market will perform well when prevailing rates are falling, but that’s not necessarily true. Certain sectors tend to benefit more than others, and some may actually be hurt. Longer-term bonds tend to have the highest interest rate risk; i.e., they are more sensitive to rate movements than shorter-term issues. As a result, long-term bonds deliver the best performance when rates fall.The difference in the performance results of long- and short-term bonds can be dramatic.

For example, concerns about the slowing economic growth and the crisis in Europe caused Treasury yields to plunge,but the vast majority of the action was in longer-term issues. The iShares Trust Barclays 20+ Year Treasury Bond Fund (ticker:TLT), an exchange-traded fund that focuses on the longest-term bonds in the U.S. Treasury market, returned a gaudy 16.48% in this time. In contrast, the iShares Trust Barclays 1-3 Year Treasury Bond ETF (SHY) barely budged, gaining just 0.38% in the same period. It helps to think of the price action along the maturity spectrum as similar to the movement of a whip: the section closest to the handle (near-term bonds) moves the least, while the portion furthest away from the handle (longer-term bonds) moves the most.


The declining yields in government bonds are often the result of a “flight to quality” into the safest assets. During these times, investors tend to gravitate away from assets with higher credit risk.
Second, a decline in prevailing rates can be a sign of slowing economic growth. Since many corporate, high yield, and emerging market issuers tend to benefit when growth is robust (since it reduces their credit risk), an economic slowdown tends to have the opposite effect on them as it does government issues.
Third, lower-quality bonds have yields that are well above those on higher-quality issues, so a change in yield has less of an impact on their “yield spread.”

While risk and reward go hand-in-hand, in the bond market it’s the type of risk that counts the most. If you want to take advantage of falling rates, be sure that you’re investing in a security with higher interest-rate risk, not higher credit risk.

When we hear monetary policy news, it's usually of the form "today the RBA decided to raise/lower interest rates by X%." We currently live in a capitalistic enough society that interest rates are determined by the forces of supply and demand, so it's not like the RBA can just directly dictate what they are. Instead, the RBA has a number of indirect tools at its disposal. The most commonly used tool is open market operations, which is just a fancy term for "buying and selling government bonds." When the RBA buys bonds, it takes in a bond and puts money out into the system. When it sells bonds, it gives out a bond and takes money out of the system. Therefore, buying bonds increases the money supply and selling bonds reduces it.
As it turns out, an increase in the money supply lowers interest rates, and a reduction in the money supply raises them.

In the past, a form of social contract existed to tighten the link between the RBA and the interest rates changed by Tier one banks. As Australian banks become more dependent on the global bond markets, and less on Australian Government bond issues, the linkage between RBA rates and the bank interest rates will become less coupled. Additionally most Australian banks ( such as CBA Perls IV) and large corporates have been issuing their own long term financing instruments, that have rates well in excess of RBA rates.

SMSF trustees, need to consider how to maintain the current value, and future purchasing power of their assets.



Disclaimer The contents of this site should not be understood to be accounting, taxation or investment advice but rather as general product related educational information that may or may not meet your specific requirements.

Wealth, an illusion?

An SMSF trustee perspective...
Those providing the resources through paying taxes, earning profits and efficiently producing goods and services see their capital being squandered or devalued. After all, why work when someone else can do it for you. Why resort to free market competition when you can lobby for assistance?

Unfortunately, decades of slowly increasing government intervention and paternal policies, which allow government control of money and credit, will not be permitted to recede easily. One must therefore ponder the potential actions of policymakers and the response these actions are likely to elicit from those impacted, as it is certain they will dominate the landscape for years to come.

Industries such as steel and aluminium are suffering from Chinese policies, which encourage new capacity to be built until profits disappear totally. They are proving successful in this profit elimination. Banking thrives on volume growth dictated by the extent to which central banks make credit available. Airlines are subsidised and manipulated the world over in the name of tourism.

Regulators set prices for utilities and telecommunications companies while governments allow toll roads to shut and prevent alternate routes to allow high tolls and upfront payments to governments. Land prices are influenced by government regulation on land release and house prices are distorted by credit availability, first home owners grants and negative gearing policies.

Lately we have artificial carbon tax policies making us uncompetitive versus countries without them and handouts back to those impacted by them. The idea is no-one feels the pain, how could this possible work.

So how should one invest in an environment of such intervention? Probably the first step is to ascertain where intervention has caused prices to divorce most significantly from fundamentals. There is little doubt that bond markets should be the centre of attention in this regard.

Regulatory reforms are forcing banks and insurers to become buyers of sovereign bonds, central banks using their own balance sheets in an effort to manipulate prices and the europeans desperately trying to create artificial buyers of government bonds to salvage insolvent governments, this has caused fundamental buyers to disappear, crowding instead into the corporate bond market. There has been a steady additional supply in this area, as corporates seek to dis-intermediate banks and secure longer-term funding, this process has prevented prices from reaching the ridiculous levels seen in sovereign bond markets.

Investors, quite rationally, are responding to a consistently reinforced message that they will not be offered the same protection as bondholders. Consistent outflows are the order of the day, and when any pool of assets sees the pool of money seeking to buy them contract, they fall.

What about gold?
Valuing gold is almost impossible. It has value only in so far as others accept as it having value in exchange. In this function it is obviously similar to money, but the fundamental issue with gold, is that it does not "generate" wealth.

If investors lose faith in the ability for wealth to be sustained with available assets, they will seek refuge elsewhere. Gold is looking like one of these "elsewheres".  But many see the gold as being manipulated just like the bond market, to ensure it does not become a "currency" outside of sovereign control.

Another outcome of tougher economic times which is causing many investors consternation is the strategy and remuneration in the face of mediocre operating performance.

When businesses generate unacceptably low returns on capital for extended periods, management and employees must take steps to improve inadequate performance. Similarly, the concept of resetting remuneration hurdles for highly paid management personnel that have cost shareholders large amounts of money through ill-considered acquisitions. When shareholder losses are permanent, financial costs for those responsible should not be fleeting.

Australia, via its forced superannuation "tax" has accumulated significant wealth, the concern is that governments are seeing this wealth as a means to support government policy. The continual tinkering with superannuation is growing, to a point where one must wonder at the ability for any trustee to make any long term decisions.

"Suggestions that the Federal Government intends tapping the superannuation industry and, particularly self-managed superannuation funds (SMSFs), to bolster its promised Budget surplus, have raised the ire of the Self-Managed Super Fund Professionals' Association (SPAA)."

To date, investors have seen intervention in the form of monetary policy and stimulus as the panacea for improving market performance. As Mitt Romney noted in a CBS interview in relation to US stimulus, it "did not put Americans back to work, did not raise our home values, did not bring jobs back to this country or encourage small businesses to open their doors".

Within Australia, as individuals we have reduced debt, and moved our wealth to as low a rik as possible. See the effect of the Government bank guarantee, it decimated CMT's within Australia. During this time governments have accumulated significant debt for the next 20 years in our names.

The only tangable result of the Australian stimulas, almost every school has a new "shed", and most homes have a solar power station or pink bats. Would like to see the ROI for these investments.

So where do we go from here?



Disclaimer The contents of this site should not be understood to be accounting, taxation or investment advice but rather as general product related educational information, the persoanl views of the author, that may or may not relate to your specific requirements.