Is Australia up to scratch? Diversify with peer to peer lending

 A look at how the 2008 financial crisis changed the way policy-makers use monetary and fiscal policies.

It’s a bold statement to say that Governments always learn from their mistakes. But, for the most part, they at least attempt to learn from their mistakes and the outcome is generally positive. However, what if a Government got off scot-free and they didn’t really have to learn anything?  This is the case for Australia, but it is not that simple.

Pre-crisis monetary policy was heavily based on one target, inflation, and one policy instrument, the policy rate. It was a heavily one-dimensional and naïve approach to the nuanced and dynamic 21st century economies that exist today. The assumption being that the policy rate could be manipulated to ensure a stable inflation rate. The stable inflation rate would then lead to a stable output gap. However, after the crisis occurred in 2008, policy-makers realized that this was not enough.  Firstly, they realized the relationship between the policy-rate and the output gap was not as strong as they initially expected. Secondly, a stable inflation rate and output rate does not necessarily ensure that the financial sector is stable.

This has resulted in a global rejuvenated focus on macro-prudential policies in order to stabilize the financial sector. This regulation can take many forms, there is no instrument to stabilize the financial sector. In Australia, we have already seen this with the enforcement of higher capital to credit ratios in the larger banks.

However, is this enough to control the credit market?

Credit is an aspect of the economy that is often over-looked. It was an excess of credit that created a bubble that eventually burst and caused the 2008 financial crisis. Basic macro-prudential policies can prevent this, but is it enough? Is it possible to efficiently enforce regulation on “too big to fail” banks? This was another lesson learned in the crisis; private banks act in self-interest and cannot be trusted to act responsibly with regards to the national and global economy. Post GFC, we have seen the banks focus on residential mortgage lending with little to none in the small to medium enterprise (SME) lending. A large question mark looming over many heads is whether Governments who were not heavily affected by the GFC will learn from these mistakes.

What does this mean for you, the investor?

I think a basic investing principle to decrease risk is the concept of diversification. It is never a wise concept to invest in shares, or property  or both and say I am diversified and protected from any downturn.

Fixed income, either securities, loans e.g. peer to peer lending or corporate debt, is another way to diversify. For many, investing in fixed income is complex and at times hard to understand, but it doesn’t need to be. The simple concept of lending to a SME or a person by participating in peer to peer lending platform, Marketlend, and Ratesetter to name a few that are available to all investors and that are accompanied with loss protection, will give you that diversity. With the added benefit, at least you know where you are invested.

Under the current government, we are heavily reliant on the Chinese economy, we haven’t really diversified and the economic complexity of our exports are low. We also lack the lessons learned in the GFC, and our policy-makers are scared to enforce a set of fiscal policies that include macro-prudency. This raises some questions.  Is our economy stable enough to withstand a recession? A steadily inflating credit market in both China and Australia is beginning to loom over us; are we up to scratch? Is your investment portfolio exposed to China, and if so, how much? Comically, there is a suggestion in the press that we should begin exporting baby milk and this will in some way compensate for the reduction of mining exports. Ask yourself, is this a real solution and is it long lasting? Can’t the Chinese make their own high quality milk formula in the future? It is not like Iron, it doesn’t come from the ground.

Ironically, one of the largest peer to peer lending markets is China, maybe we should import more of their ideas and technology than export our natural resources.