RBA holds rates steady again, and the once-in-a-lifetime end to the Petrodollar

Posted by Gavin Chau

Despite rising prices, property market sentiment has been the worst I can remember. While it is nice to see the numbers continuing to climb across my portfolio, there has been a seemingly never-ending onslaught of articles that see-saw between the housing affordability crisis, the rental crisis, rising insolvencies, and the rising cost of living. Doesn’t help that as I drive past the servos, I get constant reminders when I see the price of 95 octane fuel at $2.50.

This is the effect of monetary debasement playing out in real time. The 180 litres of petrol I put into my car at $2.50 isn’t 166% more valuable than the 180 litres of petrol that cost $1.50 since I can’t drive 166% further or faster. It simply costs 166% more. There’s an important difference between price and value.

The purchasing power of money is visibly eroding, as evidenced by the cost of living (such as fuel prices) rising faster than wages. On the other hand, asset prices rise even faster, which not only protects us against monetary debasement but also allows us to run against the tide and become wealthier.

The secret is that as the purchasing power of money declines, it also erodes the value of debt. That is to say that if you borrow money to buy an asset (like a house) and never pay it off, the debt falls in real terms. In other words, while the dollar number of your debt doesn’t actually go down, the value of the debt does. It falls at the same rate that the Australian dollar loses its purchasing power. It’s the Aikido* of money.

Ok, onto other semi-related matters.

Last week, Saudi Arabia decided not to renew the 50-year petrodollar agreement…. I don’t know if this means they’ll have to get a taste of ‘American freedom’ yet. Coverage has been conspicuously absent in the mainstream media even though it should be front-page news.

The topic probably deserves its own blog. It’s a fascinating story of the intersection of geopolitics, economics, and oil. Put simply, after 1971, the US abandoned the gold standard, which allowed the USD to be redeemed at any time for a set amount of physical gold. This effectively meant that the US dollar was backed by nothing, as there wasn’t enough gold in Fort Knox to cover the number of USD in existence.

Shortly after, the US government struck an agreement with Saudi Arabia (the world’s leading oil exporter) that any oil purchased from them had to be made with US dollars. This led to the rise of the petrodollar, effectively backing the value of the USD against oil rather than gold and ensuring the continued demand for USD globally. This agreement was not renewed, meaning Saudi Arabia will now accept other currencies such as the Yuan, Yen, and the Ruble for oil in addition to the USD. This is a clear sign of the declining dominance of the USD and the US Empire beginning to fray at the edges. These periods of history occur every 100 years or so, making them once-in-a-lifetime events, and it will no doubt be called a ‘black swan event that nobody foresaw’ when it happens. This is typically marked by accelerated monetary debasement as the reserve currency loses its strength, meaning that owning hard assets is more important than ever.

Ok, the RBA.

Today, the RBA decided to hold rates steady again despite a few calls from crazy people saying there would be a hike. The truth is that the RBA is stuck between a rock and a hard place. It wants CPI to drop into its 2-3% target band while maintaining full employment. At the same time, the house is burning down around it.

The economy is in the doldrums, having effectively been in recession for five quarters, and all the forward indicators point to a rapidly weakening jobs market. Construction companies are dropping like flies, with insolvencies up by 140%, and in accommodation and food services, insolvencies are up by 130%. So, we’re faced with no building supply, and household spending (60% of the economy) has contracted to the point where people don’t want to go on holidays or eat out.

At the same time, the immigration floodgates have been opened, further suppressing wage growth and putting additional strain on the already strained property market. This drives up rents, which then adds to rent inflation. Annualized GDP growth in Q1 2024 was extremely weak, falling to 0.8%, while the population increased by 2.4%, meaning that in per capita terms, we’ve gone backward. It’s like trying to fill a leaky bucket.

Holding interest rates here for too long (let alone raising them) is a game of brinksmanship and puts Australia at risk of falling into a deep recession. Inflation has continued to fall, unemployment and underemployment continue to rise, job ads are down, household disposable income is the weakest in the developed world, and the economy is in reverse. Our best estimates remain that we will see a rate cut in H2 this year. This will provide a much-needed boost to consumer confidence and take some of the strain out of household budgets.

*Aikido is a martial art designed to redirect the opponent’s force against them. I have to say that it doesn’t work in many real-life situations (unlike using debt to buy income-generating assets)

Posted by Gavin Chau, on 18th Jun 2024