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The Keynesians and declared anti-Keynesians have joined hands in order to promote an intensely Keynesian error: European fiscal austerity as a negative factor. One contributor in Forbes refers to austerity as a death spiral.
The word "austerity," beginning with the Greek government's debt crisis two years ago, has been used by the financial media in one sense, and only one sense: reductions in spending by national governments. The word is not used with respect to the economy as a whole.
More than this: the word has been used to explain the contracting economies of Europe. The reductions in government spending are said to have caused the contracting economies. This explanation is based on textbook Keynesianism.
Keynesians call for increased government spending. This is the heart of Keynesianism. Keynesianism rests on a mantra: "Government spending overcomes recessions." All else is peripheral: monetary inflation, graduated taxation, and free trade. These peripheral issues will always be sacrificed to the supreme economic premise: "Government spending overcomes recessions."
This is where every analysis of Keynesianism should begin. Any economic doctrine, any economic policy, any proposed solution to the present crisis should be assessed in terms of the mantra. Anything that does not begin and end with the mantra is not Keynesianism. Anything that does, is.
It is a mark of the supreme triumph of any ideology when the self-professed critics of the ideology adopt both its conclusions and its rhetoric, and do so unknowingly. This means that the promoters of the ideology have set the terms of public discourse. It is very difficult to replace an ideology or worldview, once its promoters have established the terms of discourse.
It can be done, of course. But to do this, the promoters of a rival outlook must expose both the errors of the existing system and the implicit agreement of its supposed critics. This wins no friends among the hapless troops who think they are scoring significant victories by arguing against peripheral aspects of the enemy ideology, while accepting its central presuppositions and main policy prescriptions lock, stock, and barrel. They have been taken in hook, line, and sinker.
Pharaoh and the FrogsA recent example of a well-meaning but conceptually confused anti-Keynesian was published in Forbes. It had a powerful headline: "Keynesianism Is the New Black Death." It suggested that the great tragedy of Europe today is "austerity."
As I have already said, the financial media universally define austerity as cuts in government spending. I have never seen the word used in any other way over the last two years. Any author who uses the word in any other way owes it to his readers to explain this new usage. The Forbes article offered no such distinction or alternative definition. I therefore take it at its word: austerity.
If austerity is the great evil, then the implication is inescapable: that which restores government spending and therefore overcomes austerity is positive.
This reminds me of the Pharaoh who decided not to let the Israelites journey for a week to sacrifice to God. Moses and Aaron then attempted to persuade him by way of a series of plagues. One of them was frogs. The land filled up with frogs. Everywhere anyone walked, he stepped on frogs.
The court magicians had to do something about this. They responded by a public display of the power of their magic that matched what Moses and Aaron could do. "And the magicians did so with their enchantments, and brought up frogs upon the land of Egypt" (Exodus 8:7).
Somehow, I imagine Pharaoh screaming at them: "No, no, you blockheads: not more frogs! Fewer frogs!" But the text does not record this.
The solution to the frogs of European recession is not increased government spending. Rather, it is the opposite: reduced government spending. In short, the solution is greater austerity.
Austrianism’s MantraThe Austrian economists also have a mantra: "Reduced taxation increases liberty." Liberty is necessary for economic growth.
If a contemporary government cannot reduce taxes without going bankrupt, then it must cut spending if it chooses not to go bankrupt.
Europe's national governments are all going bankrupt. Japan's is, too. So is America's. The solution is to cut taxes and cut spending even more.
"Not more government spending. Less government spending!"
"Not larger government deficits. Reduced government deficits!"
"Not higher taxes. Lower taxes!"
"Not more fiat money. Reduced fiat money!"
In short: "Let my people go!"
With this in mind, let us examine an article that argues that austerity is the great threat to Europe's prosperity.
A Death Spiral?The article begins with a survey of European politics. It points out that voters are tossing out politicians in nation after nation. Sarkozy was number eight over the last year. Why is this happening? Here is the proposed answer:
The voters of Spain, Greece, France, etc., understand that their governing elites have pushed their economies into austerity death spirals, and they have been expressing their unhappiness at the ballot box.
The more fundamental question is this: Why did these elites push their respective economies into this supposed death spiral? Why would faithful Keynesian elites do such a thing?
Let us not be naive. The West has been run at the top by Keynesian elites, or politicians holding Keynesian ideas, ever since 1930 – six years before Keynes offered his unreadable justification of politicians' policies: "The General Theory of Employment, Interest, and Money."
The Keynesian central bank pushed Europe's economies into a boom, 2001 to 2007. The voters loved it. Interest rates were low. There was lots of money to buy houses. The economies of the south – "Club Med" – were booming. So was the honorary member of Club Med: Ireland. Ireland's property values quadrupled. It was all going to last forever. The elites – especially the economists – issued no warnings, except for Austrian economists, who were dismissed, as always, as dinosaurs.
Then came the bust phase. What the European Central Bank did before 2007 – inflate – it has done more aggressively ever since 2008. Governments ran even larger deficits. They all implemented Keynesian stimuli. This did not work. Europe is falling back into a recession.
In the spring of 2010, investors in northern Europe caught on to the fact that Club Med residents could not compete economically. They kept running deficits with the North. Those easy-going populations were living on money borrowed from the North. So were their governments. They had no intention of ever paying back these loans.
Any why not? This is what Keynesianism teaches. Government loans will not be paid off. Ever. Government debt will grow. So will prosperity.
Two years ago, Greece's Socialist Party found out just how far in the debt hole the government was. Interest rates then started to rise in PIIGS nations. PIIGS governments were trapped. They could not run ever-larger deficits, because the cost of loans were rising.
That was when the reality of Keynesianism hit: deficits do matter. Money is not free. Debts must be rolled over at market interest rates. The horror!
That was when governments in the South started cutting back on spending. Not much, you understand. The deficits are still unprecedented: above 6% of GDP.
Keynesians labelled this "austerity."
It is not austerity. It is deficit spending on a massive scale. Austerity is where national governments run surpluses and use excess revenues to pay down the national debt.
There has not been austerity in Europe since approximately 1914.
The gold coin standard enforced austerity, 1815 to 1914. That was its chief function and its great service to mankind. It kept the West's governments austere. This enabled the private sector to dine at an ever-expanding feast.
Keynesians hate the gold coin standard. That is because they believe that high government spending is the basis of high consumer spending, and consumer spending – not private thrift – is the foundation of prosperity.
The public, which prefers consumer spending to the austerity of thrift, cheers on the politics of Keynesianism. Deficits without end, borrowing without pain, growth without ceasing: Keynesians promise, and voters believe.
But the day of reckoning arrived in 2010. The free money got expensive. The party did not stop, but some of the guests were sent home, to join young adults, who have sat and watched TV, because there are no jobs.
The public feels betrayed. Voters believed in the Keynesian dream, which was articulated by the original Keynesian, who said, "If thou be the son of God, command that these stones be turned into bread" (Matthew 4:3). When the target of this challenge refused to rise to the bait, the Keynesian went looking for other takers. In the second half of the twentieth century, he found them. Lots of them. Millions of them. Politicians promised to accomplish the feat. Voters applauded.
But times have changed, the article tells us.
Unfortunately for Europe and the world right now, there are no pro-growth candidates and/or parties on the Continent to offer relief from the austerity programs that are grinding their economies to dust. With no one to vote for, all that European electorates have been able to do is to vote against. They have sought to register their protest by defeating incumbents.
The incumbents over-promised. They had long told the voters that deficits don't matter. Deficits did not matter for as long as banks in northern Europe kept lending to PIIGS at rates associated with German frugality. But then came reality.
Europe as a whole is in recession, and Greece, Spain, and Portugal are in depressions. What are the people supposed to do if the economic chefs on both the political Left and the political Right are offering the same poisonous "austerity" menu?
Balanced budgets remain mirages a far as the eye can see. Token spending cuts, which are made in the name of reducing deficits to about 3% of GDP in ten years, are part of a "poisonous austerity menu." Put in a more familiar terminology, there are too many stones and not enough bread. The voters will not tolerate this.
The reason why there are no economic chefs promoting growth is simple: somebody has to bankroll the growth of government spending. Who will that be? Who wants to trust PIIGS? The louder the voters scream about austerity, the fewer the number of lenders, meaning lenders at rates under 10%.
Plague!The article eventually gets to the point.
So, what happened in Europe? The short answer is, "plague". The Black Death of the 14th century was caused by the Yersinia pestis bacterium, which was spread by rats. Today's plague is the result of Keynesianism, which is being spread by the economics departments of major universities and The New York Times. Unfortunately, unlike Yersinia pestis, Keynesianism does not respond to antibiotics.
How does the article define Keynesianism? Erroneously. It says that Keynesians favour tax increases and spending cuts.
Austerity, as currently being practiced in Europe, is based upon the Keynesian belief that tax increases and government spending cuts have the same effect upon both the government deficit and the economy. In fact, the most virulent strains of Keynesianism cause people to believe that raising top marginal tax rates and increasing government spending can actually boost GDP, because "the rich" have a higher "marginal propensity to save" than do the recipients of government handouts.
Franҫois Hollande, the winner in France, is a Keynesian. He believes that raising France's top marginal tax rate to 75% while hiring 60,000 more unionized teachers will make things better.
Excuse me? What does an avowed socialist politician have to do with Keynesianism? Keynesianism is what Paul Krugman proclaims, which is greater deficit spending, plus sufficient central bank money expansion to finance this expansion.
Which Keynesian economist or politician has come out forthrightly for spending cuts, i.e., austerity? Austrian economists have. Ron Paul has. This is why Austrians and Ron Paul have been marginalized by the Keynesian media as cranks.
To a leader whose mind is infected by Keynesianism, it makes sense to try to close a budget deficit with a combination of tax increases and spending cuts, with the balance between them determined by some combination of political considerations and "fairness".
There are many politicians in Europe who have imposed taxes on the rich. The voters have cheered them on, as always. The voters are outraged by the spending cuts. Spending cuts reduce the flow of funds to government bureaucrats and welfare state clients. This is why Greek union members riot.
Traditional Keynesianism calls for increased spending, more borrowing, and – if private lenders demand high rates of interest – monetary expansion by the central bank to purchase government debt. The article wisely rejects monetization. But it does not call for a gold coin standard. Rather, it defends the euro.
As damaging as tax increases are to an economy, monetary depredation is worse. Only a Keynesian could think that replacing the euro with a new drachma could be a solution for Greece. The result would be a new currency backed by the full faith and credit of a government in which no one has faith and to which no one will extend credit.
In reality, the collapse of the Greek economy would not even wait for the introduction of the new currency. It would not be possible to keep preparations for a new drachma a secret, and even rumours of such a move would be enough to create a cataclysmic run on the Greek banking system. Capital, and people with capital, would flee.
The article suffers from an illusion: that the euro is not just another medium for inflation, that it is anything more than drachmas for Keynesians.
The Keynesian political hierarchy imposed the euro on the voters in 1999. The elite's spokesmen have decried the departure of Greece from the eurozone. The unelected Greek technocrats, like technocrats all over Europe, were either former Goldman Sachs employees or wanna-be's. They are now being tossed out by the voters. The voters are populists and socialists. They are fellow travelers of Keynesians only in the boom phase of the Keynesian welfare state. When the bills come due, they revert to locally issued fiat money, taxation of the rich, trade unionism, and increased government spending.
Conclusion
Keynesianism is in a death spiral. So is populist socialism. So is fiat money fascism. They are all in death spirals because they all reject this premise: "Lower taxes increase liberty."
Liberty will prevail. This is an eschatological affirmation. One of the ways that it will prevail is through the bankruptcy of the Keynesian social order: high taxation, high regulation, high deficit spending, and high inflation.
Let's put government on a diet. Let's have austerity where it belongs: government spending.
That is what Europe's voters do not want. That is what they are going to get.
"Not less austerity. More austerity!"
Regards,
Gary North
for The Daily Reckoning Australia
This article originally appeared in Whiskey and Gunpowder
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
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2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 – Dan Denning
Despite our gloomy headline, today’s Daily Reckoning begins with some excellent news. The European Union won’t be in recession for another six months. Whoopeee!
Buy everything! Stocks, bonds, real estate and yes, even sovereign debt. [Editor’s note: please don’t do this.]
If you’re sceptical about this new-found optimism, here is our impeccable reasoning. First of all, a recession is defined as two consecutive negative quarterly GDP growth figures. Europe had its first in the last quarter of 2011. But the first quarter of 2012 has saved the entire region from economic chaos for sure, because the GDP growth figure wasn’t negative. So there’s no recession. And there can’t be for another six months, because it takes two negative quarters in a row before a recession is declared.
The funny thing is that while the GDP growth figure wasn’t negative, it wasn’t positive either. It was 0. Exactly nothing. But that’s good enough to prevent a recession for a whole half a year according to the rules of GDP. So party on and don’t question the sacred GDP figure. Don’t look closer at the massive divergence between the growing and shrinking economies of the Eurozone. Don’t suspect anything. As sergeant Schultz would say, ‘I see nothing’.
Eurozone GDP Growth
Yes, this is the bizarre world you and your investments live in. Not that the world you inhabited before 2008 was any less ridiculous. How about some inspirational stories from the good old days?
Before the financial crisis, many Greek public servants showed up at work. Once a month. To collect their pay. Others had their salary paid directly to their bank account, so nobody actually knows who they are. Their co-workers who did show up occasionally have never met them.
Not that their employer — the state — was any better. When Greece entered the euro it falsified its debt and deficit figures more than anyone in Europe suspected. And that’s saying something, given they suspected quite a bit. Without the fraud, the Greeks could never have entered the euro. More importantly, it could never have borrowed as much money for such a long time.
The Greek government practiced the basics of a ponzi scheme:
1. Falsify figures to draw in cash from investors.
2. Pay that money out to the stakeholders.
This is clearly a con game. But it’s a satisfying one, and makes perfect economic sense in its own way. A good con satisfies all parties at the beginning. Nobody pays taxes. Plenty of people get money for nothing. Politicians can spend.
It only takes some accounting gimmicks to make an unviable situation viable for quite some time. All governments use these accounting gimmicks. One good example is something called contingent liabilities. These are liabilities taken on but not yet incurred. Another gimmick is the cost of healthcare in coming years. That’s money you know you’ll have to spend, as a government. But with the right accounting, you don’t count the cost.
The main point of a good con game is to steal money. But accounting gimmicks serve another purpose: conceal the debt total as a percentage of GDP. For example, look what happens to US debt-to-GDP ratios when you use the two accounting gimmicks I mentioned above. By stripping out future health-care obligations and ‘contingent liabilities’ you reduce the total debt by half!
Presto!
True Debt to GDP

Without the gimmicks, true debt to GDP figures are more than double their quoted levels. By the way, AUS isn’t Australia on this chart. It’s Austria, which is normally shown as AUT. We couldn’t find comparable Australian figures.
But debt isn’t Europe’s only problem. ‘Nero, Bonaparte and Hitler walk into an economic union’ we wrote five months ago. What could possibly go wrong?
It’s a bad political joke, just like the reality facing Europe and investors.
The hubris and ignorance of the political establishment, to think that binding nations together would create peace, is beyond belief, especially in Europe. A quick tour of history will tell you it’s a bad idea. Anyone who tries, like the three individuals we mentioned, fails.
Just take a look at this video which follows the history of Europe’s borders for 1000 years. It’s like a kaleidoscope. The entire continent completely changed its borders in Napoleon’s lifetime, with whole States disappearing, emerging, and coming back again from the dead.
And then there’s the experience of Yugoslavia. There a small-scale experiment of combining different nations into one ended badly no less than three times in one century. By ‘badly’, we mean with mass graves as ethnic in-fighting tore the unnatural country apart. And who can forget the Soviet Empire? That unnatural agglomeration of different ethnic groups and nationalities resulted in whole scale liquidation of “undesirables”.
Our point? Europe has a history of creating its own problems. Those problems result in wealth destruction and debt at the least...or death and revolution at the worst. We’re somewhere on that continuum right now. The historical tendency to prevent war through greater political unification simply hasn’t worked. It’s always ended in a bloody disaster.
European Parliament politician Nigel Farage pointed all this out to his fellow members in another thrilling speech. He compared the current political unification of different countries to mixing their different cheeses together — a distasteful disaster.
This is probably not just a European problem. Maybe all overly-centralised unions in general are dangerous. That’s what we’ve been pondering all week...whether there is something inherently flawed in currency, fiscal and political unions. The Soviet Union came and went, along with Yugoslavia. Perhaps Europe is next, followed by none other than the United States of America. If they all have similar problems, why not expect similar outcomes?
Californian Governor Jerry Brown posted a YouTube video this week explaining the State’s dire financial position and his solutions. The speech could have been taken straight out of one of Europe’s troubled nations. In fact, many US states began austerity before it became fashionable in Europe.
There are other similar problems between the European, American and Soviet Unions. The NY Times criticises Europe for the same policies it supports at home and that failed in the USSR:
‘What is striking when you compare Europe’s policies on agriculture, monetary union and climate change is the way the Union keeps bolting on patches and extra wiring to try to fix problems created by its own solutions.The default response is always ‘more Europe,’ without insisting upon the most straightforward solution, which is often blocked by the threat of political vetoes.’
Here’s a quick example to tickle your tastebuds:
‘Take the Common Agricultural Policy. Conceived in the 1950s and early 1960s to feed postwar Europe at stable prices for producers and consumers, the system subsidized farmers to overproduce cereals, wine, meat and dairy products. By the early 1980s, it was swallowing 70 percent of the community budget.
‘Surpluses [of cereals, wine, meat and dairy products] grew so large they had to be taken off the market and stored for long periods in giant warehouses at taxpayers’ expense. Some were sold off at subsidized prices to the former Soviet Union and developing countries.
Then farmers were paid to dig up their vines, reduce their herds and leave land fallow. Eventually, the link between subsidies and production was cut, but farmers still receive E.U. payments for maintaining the countryside and producing high-quality food.’
Paying farmers to do nothing is just as stupid as the Greek public sector paying phantom employees. Financial market commentator Marc Faber reckons the Europeans are in a league of their own: ‘I do not have a high opinion of the U.S. government, but the bureaucrats in Brussels make the government in the U.S. look like an organization consisting of geniuses.’ We’re not so sure there’s much of a difference between the American, European and Soviet officials.
If you think it’s a bit of a stretch to say America’s problems are similar to Europe’s, take this comment from the same NY Times article: ‘The euro zone’s one-size-fits-all interest rate provided an irresistible temptation for countries like Spain and Ireland to build homes that people had never been able to afford before.’
How is that different from what happened in certain American states? It’s not.
So here’s our overarching theory. The welfare/warfare state inherently expands. Paying people to do nothing means you get more people doing nothing. Over time, governments run out of tax revenue, so they borrow. When they run out of room on their balance sheet, the only way to borrow more is to join together in a union.
The Americans needed a federal government and its ability to issue credible debt to finance the war of independence. The Europeans now need eurobonds to keep their welfare rort going for a little longer.
If the theory holds, it has an interesting implication. If the Europeans decide to create a fiscal union — to pyramid debt (eurobonds) on an international level like the Americans did on a national level — it might be America that busts first. A eurobond may kick the can down the road further than the American one can be kicked. Indeed, America’s true debt load — including the so called ‘contingent liabilities’ of healthcare and much more — is the worst of any nation relative to GDP.
Except of course Japan's economy, which is a complete basket case.
On the other hand, Europe might come up with their version of the American civil war, where the south tried to break away from the north. Even the geographic references fit here, with the PIIGs nations being southern and the ‘fiscally stable’ nations tending to be northern. Would this mean an actual war?
We have no idea, although dismissing it is probably a mistake. Can you imagine the irony of a union meant to bring about peace, which ends in war? As we pointed out, it’s happened many times before. These situations often end in war. And here’s one big warning of growing aggression: more than half the Greek police force happened to vote for the holocaust-denying neo-Nazi party Golden Dawn in the recent elections.
On the bright side, the website Zerohedge points out that ‘68.8% of Americans are overweight or obese, [so it doesn’t] matter if America has $20 trillion or $1 googol in debt: everyone will be simply too fat to care.’
But here is the big implication you might want to worry about. All this could go on for a heck of a lot longer than you can reasonably expect it to. That’s an odd statement, so we’ll rephrase. What seems unsustainable doesn’t have to end any time soon. We might be looking at a Japanese situation for a Japanese length of time — the lost decade that has so far amounted to two decades.
That kind of scenario has implications for your investments. Sitting out two decades isn’t a viable wealth building strategy. Neither is the German model being implemented in Europe going to work for your portfolio. It’s called ‘Augen zu und durch’. Which means ‘eyes closed and through.’ The Australian version is ‘suck it up princess’ as your editor’s Energy Law professor once put it. No, you need something that works to grow your wealth. But what? We’re working on a range of ideas behind the scenes. Keep an eye on your inbox in coming months.
Until next week,
Nickolai Hubble.
The Daily Reckoning Weekend Edition
ALSO THIS WEEK in The Daily Reckoning Australia...
The Global Monetary Policy of “Three Sheets to the Wind”
By Dan Denning
But here in the late stages of the race we have JP Morgan losing $2 billion in the hunt for yield. And why is JP Morgan hunting for yield and losing money? Because ultra-low interest rates (negative in real terms) force you to speculate and take bigger risks to earn a real return. It's not just mums and dads. Its investment banks too. It's everybody. We are all Jamie Dimon!
When Cash is King: Investing with Risk on the Downside
By Bill Bonner
One of the nice things about being a long-term investor is that you can wait a long time before you make your move. As Warren Buffett says, you don't have to swing at every pitch. And there's no penalty, except missed opportunities, for just waiting for the perfect ball to cross the plate.
That's what's so nice about cash. It's a bat. It's in your hands. And we wouldn't be at all surprised to see Mr. Market toss us a powder puff pitch before too long.
By Dan Amoss
Dodd-Frank was a thin coat of paint over a cracked and broken banking system; since it failed to accurately diagnose the causes of the financial crisis, it was a dud and a nuisance from day one.
More legal complexity, more wasted money and red tape and more lack of regulator accountability is what we got, when in reality, a big part of the problem was regulators not policing activities at the Too Big to Fail banks. Here's an idea - one that banking history expert Jim Grant has been pushing for years: It's called "capitalism."
Why JP Morgan is Playing the Same Old Rigged Game
By Eric Fry
Vibrant economies and civilized societies rely on law and order. And law and order relies on a foundation of fairness — a basic understanding that bad things are bad and good things are good. But when the powers of government begin to affirm that bad things are okay and good things are irrelevant, all hell breaks loose.
By Greg Canavan
China is in all sorts of trouble...and you're seeing the effect of that now in the resource sector. Capital intensive sectors are always the first to feel the effects of an economic contraction. The question you should ask though, is how long China's bust will take to impact Australia's real economy and other areas of the stock market?
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We left off yesterday wondering why the market had turned on gold recently - the supposed "safe haven" metal. But we woke up this morning and saw things had turned again...gold surged 2% overnight as the US markets sank around 1.5%.
No doubt this type of price action will confound many investors...especially those who sold in a panic in the last few weeks. The recent sell-off amongst the gold stocks is up there with 2008 for severity.
In a clear example of how the emotional decisions of investors send price diverging from value, gold stocks have plummeted while the Aussie dollar gold price, which, along with production, determines revenue, is only slightly lower.
The gold price certainly does move in mysterious ways. Today our task is to try and work out why. To do so, we need to look into the mysterious world of the London gold market.
This won't be easy reading. Sometimes you have to look under the hood to work out what the real problem is. If you're not a mechanic, looking under the hood can be daunting. But stick with us, because this could be one of the more important Daily Reckonings we've written for some time.
Trading Physical Gold With PaperLondon is supposedly the home of physical gold trading. But as you'll see, most of the trading that takes place is actually a form of 'paper' gold.
Contrary to what most people think, the gold market is not a small market at all. According to the World Gold Council (WGC), in terms of size it is only behind the US and Japanese debt markets.
The WGC reckons all the gold ever mined is around 170,000 tonnes...or about 6 billion ounces. Of that amount, they estimate that 60,400 tonnes (2.13 billion ounces) represent private investment and official sector holdings. At US$1,600 an ounce, that's a market size of US$3.4 trillion.
That's hardly chump change.
The gold market is massive. It may no longer be officially recognised as money, but gold clearly still plays a hugely important role in the international financial system.
You can see this in other stats too. According to the London Bullion Market Association (LBMA), over the past 12 months average daily turnover in the gold market was 21.2 million ounces. If we adjust this for annualised turnover, an incredible 5.6 billion ounces of gold changed hands last year.
Or did it?
5.6 billion ounces is more than twice the size of the estimated gold investment market, which is 2.13 billion ounces. We didn't sell any of our gold in the last year, and we're sure many others didn't either. So this turnover is clearly not all physical gold. Most of it is paper gold, which is often referred to as 'unallocated' gold.
Unallocated gold is basically gold you think you own but really don't. The bank, or counterparty, promises to get your gold if you want to convert it to allocated, but in the meantime your gold is 'in the system'...more than likely with a number of different claims to it.
Now, here's where things begin to get interesting.
The GOFO and the Gold MarketAlthough the London bullion market predominantly trades paper gold, it needs some physical to give the appearance that the market is a solid one.
In times of market stress, there are two conflicting forces pulling on the gold market. When liquidity tightens (as it is now) financial assets fall in price. Because the gold market is dominated by paper gold trading, including many highly leveraged players, selling prevails and the gold price falls.
But in reality, physical gold becomes even more valuable in times of crisis. How can this be, you ask?
To explain, we need to look at what is called the Gold Forward Offered Rate - the GOFO. GOFO is the rate of interest you pay if you swap your gold (short term) for US dollars. Alternatively, it is the rate of interest you receive for lending US dollars against gold.
Lately, the GOFO rate has been falling. This indicates a few things. Firstly, it tells us that gold's value as security for a US dollar loan has increased. If a bank needs to get US dollars in a hurry (as often happens in a liquidity crisis) then using gold as collateral (security) is the cheapest way to do this. Currently, the GOFO rate is 0.3% for a term of one month, the lowest level since February 2011.
Just as a government bond rises in price as its yield falls, so should the price of gold rise as its implied yield (via GOFO) falls. But this doesn't happen in the gold market.
In fact, it's the opposite. That's because in times of a liquidity crisis or deflationary scare you have leveraged paper gold holders selling, while at the same time increasing fear leads unallocated gold 'owners' to request taking ownership of their gold...and moving it out of the 'system', or out of the London bullion market.
So how do these two contradictory forces play out? Well, let's have a look at two recent periods in the history of the gold market. One that kicked the gold bull market off in September 1999 and the other that looked like ending it in November 2008.
In both these periods the GOFO rate fell below zero. This almost never happens. A negative GOFO rate says banks will pay you to swap US dollars for gold. It suggests they are desperate to get their hands on gold...physical gold.
In late September 1999 the GOFO rate fell to an unprecedented -4%. Look what happened to the price at that point. It exploded higher in a matter of days. The gold market needed a higher price to entice some gold back into the system.
Source: StockCharts
Now let's look at November 2008. On November 20, 21 and 24 the one-month GOFO rate went negative, meaning physical gold was again in high demand in the bullion banking system.
If you look at the chart on those days you'll see that the gold price bottomed right at this time. The stress in the market was so great that a higher price was guaranteed.
After hitting a low of around US$700, gold surged to over US$900 dollars in a matter of months. Paradoxically, the demand for physical gold (within the bullion banking system) seems greatest when the selling of paper gold (which sets the price) is heaviest.
Source: StockCharts
Riding The Gold Bull MarketThat's why this long bull market in gold is so relentless. As the global financial system continues to decay, physical gold flees the 'system'. Rising prices are necessary to bring some of that gold back into the system. This is necessary to keep the US dollar based monetary arrangement going.
If gold wasn't such a crucial part of global finance, it wouldn't be such a huge market. Gold is crucial...regardless of what Warren Buffett or Ben Bernanke say.
The day when physical gold leaves the banking system - for good - is the day when the paper dollar based system dies. The GOFO rate could give us important clues as to when that will happen. As in the past, the gold 'price' may fall at the same time.
But at that point, the value of physical gold will be many multiples of the current price. We wouldn't be surprised to see trading halted and gold repriced much, much higher over the course of a weekend. As it has done throughout history, gold will preserve your wealth. But you must focus on value, not price if you want it to do so.
Holding on Tight to Physical GoldThis current pullback in the gold price has not been as severe as past episodes. The GOFO rate did not go negative. But it is suggesting that physical gold is increasingly in demand. The credit worthiness of the whole system is now coming into question.
Physical gold, the only asset without counterparty risk, increases in value at such a time...regardless of what the price tells you. With gold rising today, it's a sign the 'system' needs a higher price to entice more real bullion into the market.
This is a process that moves gold from the weak hands to the strong. So if you're thinking of selling your gold...be strong. Think about what you're swapping it for. You're going short on 6,000 years of history and long on a 41 year paper and credit based experiment.
As a footnote to this theory about how the gold market actually works, we want to say we are a student of the gold market, not a teacher. Years of reading and study haven't changed that...and we're always willing to learn more.
And finally...we haven't mentioned anything about manipulation being the reason behind the gold price fall. We think governments certainly attempt to control the price of gold (as they do with all currencies). In fact, the US government funded the Exchange Stabilisation Fund with the proceeds from its confiscation of gold from the public in 1934.
But the presence of such a huge paper gold market means that at certain times (liquidity crises) gold will sell off with all financial assets. As we've tried to explain though, a very low gold price is not in a government's interest because physical gold would leave the system and end the paper money game.
So governments simply try to control gold's rise, making sure it doesn't throw off too much of a red alert signal. For the gold price to genuinely fall, we need to see a rise in REAL interest rates. In a world buckling under the weight of debt at all levels, that is just not going to happen.
Regards,
Greg Canavan
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 - Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 - Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 - Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 - Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 - Dan Denning
Run, Saverin! Run!
Were it not for the fact that you’d still have to suffer the eternal torment of actually living with your wicked, miserable little self, life as a willing and active member of The State might be pretty tempting. After all, Team State — operating in direct competition with Team Freedom — enjoys some rather significant advantages, both on and off the field.
For one thing, Team State writes the rules of the game…rules it claims the right to change at any time and for any reason. It can choose to make Team Freedom’s goal the size of a pea, for example, and its own goal the size of…well…whatever it wants. It can recruit a million, steroid-jacked players to wear its own colours, and limit Team Freedom’s membership to a couple of wimpy, though doggedly irreverent, newsletter writers. Who listens to those guys, anyway? Pshhh…
Off the field, Team State may choose to sequester part or all of Team Freedom’s funding. And if Team Freedom doesn’t like it, Team State — reading again from its own rulebook — can choose to simply begin kidnapping members of Team Freedom at gunpoint and locking them up in cages.
More troubling still, Team Freedom suffers the added disadvantage of large scale defection and even of outright collusion with the enemy. In other words, many of Team Freedom’s players are really (whether knowingly or not) playing for the other team…using morally malleable catchphrases like “fair share,” “civic duty” and “social contract” as a way to distract and bamboozle some of Team Freedom’s star players. They read aloud and with unashamed authority from Team State’s own rulebook, exclaiming with sweaty excitement, “But it’s the law! Look, Team State wrote it down, right here!”
And what can Team Freedom do about all this, other than vote for another member of Team State to act as game referee every four years or so? Nothing. Or so it would seem…
Fellow Reckoners will by now be aware of the latest scheme by Team State to encroach on the lives of those they clearly consider to be “their property.” Sens. Chuck Schumer and Bob Casey, two of the more…er…“active” members of Team State, held a press conference Thursday morning on Capitol Hill where they outlined legislation that would prevent Eduardo Saverin, the Brazilian-born, Singapore residing co-founder of Facebook, from ever returning to the United States.
Now, why would these senators do such a thing, you ask? What do a couple of freeloading, career barnacles have against the entrepreneurial spirits of a go-getting, 30-year-old success story?
Turns out that, back in September of last year, Saverin decided he didn’t want to be considered a US tax slave anymore…a move 1,700 other now-freer people also made during the same year. Abiding by the law, as decreed by members of Schumer and Casey’s Team State, Saverin relinquished his citizenship and moved to Singapore back in 2010, a place where he (and his property) are treated in less of a “gun-in-your-face, gimme-all-your-money” manner.
According to industry estimates, the move should “allow” Saverin to keep about $67 million more of his own money than he would have otherwise been “entitled to” were he still officially a US resident when Facebook makes its IPO, tomorrow.
Of course, the fact that he followed the law, to the letter, wasn’t enough for the senators. Why? Put simply, they didn’t get (what they saw as) their cut. Curiously, Schumer claims Saverin somehow owes “the country” something…beyond the hundreds of millions of dollars he must — and does — already pay.
“Saverin has turned his back on the country that welcomed him and kept him safe, educated him, and helped him become a billionaire,” Schumer said at the conference. “This is a great American success story gone horribly wrong.”
Apparently, helping to found a free product that serves 901 million voluntary users is not enough for Schumer and Casey. Of course, the Senators are not in the business of voluntary transactions, so we can see how this achievement might be lost on them. After all, their own transactions are made not with a handshake, but looking down the barrel of a gun.
So what’s their beef, specifically, this time?
Facebook today serves approximately 180 million people in the US alone…including both Sens. Schumer and Casey. One might think that, if the Senators were so upset with Saverin, as they piously claim, they would take down their own Facebook pages. Since they have not, we encourage Fellow Reckoners to swing by and leave them a warm and fuzzy message.
Clearly not embarrassed to showcase their own conspicuous lack of real world marketing skills, Schumer and Casey are calling their little bill the “Ex-PATRIOT — Expatriation Prevention by Abolishing Tax-Related Incentives for Offshore Tenancy — Act.” Seriously. Who, besides Team State, would even let these guys play for their side?
The proposal targets wealthy Americans who seek to renounce their citizenship — and, along with it, their tax slave status — unless the unfortunate, would be escapee can convince the IRS they are not leaving the country “for tax purposes.”
In other words, individuals looking to protect their property must first convince the thieves that they are seeking to do so for reasons other than protecting their property. Yes, you read that correctly. If the person is unable to prove the “innocence of their intent” to the IRS — just imagine! — they will be subject to a 30% capital gains tax on all future US investments…regardless of where they live…and assuming they still want to invest in their former jailer’s country at all.
Stranger still, the newly emancipated individuals will not be allowed back into their cell. Said Schumer: “They could not set foot in this country again.”
The battle line has been redrawn again, Fellow Reckoner. But as always, where the state exists, freedom does not. And where freedom exists, the state does not.
Choose your team wisely.
Regards,
Joel Bowman
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 – Dan Denning
Similar Posts:
Attention: Our "Crash Alert" flag is flying.
Dow down.
Oil down.
Yields down.
Gold down.
What's going on?
We drove into Washington, DC, to the Argentine embassy. Friends from Salta were hosting a wine-tasting. It seemed strange to see our Argentine friends - who live in a remote corner of the country - in our nation's capital. But it was a pleasure to see them...and taste their very strong, high altitude malbecs.
Washington has largely escaped the financial crisis. There is plenty of money in the city, but hardly anyone in town knows anything about economics or finance. It is politics they care about. That's how they get money, in the old fashioned way - by taking it away from someone else. So, it is only natural that they believe the world of economics should be approached in the same way - by brute force. Command, control, and central planning...that is Washington's method. That's what politics is all about.
Of course, politics and economics are natural enemies, not natural friends. An economy works best when willing buyers and sellers, investors and entrepreneurs, consumers and producers are able to get together on their own terms.
As Adam Smith explained it, they all look out for themselves...and are all guided, as if by an "invisible hand" towards an outcome that is best for the group. Hayek described it in more detail. Willing buyers and sellers set prices freely. Those prices are rich in information. They tell investors where to invest...and shoppers where to shop...and businessmen where to apply themselves.
The more you interfere with this process, the more screwed up things get. Artificial prices - such as the price of credit set by the Fed - send the wrong signal. Investors make mistakes. Resources are misallocated. Bubbles are pumped up...and then, blown up.
But Washington doesn't care. It's not really the gross welfare or wealth of the people it worries about, but the relative wealth. "Fairness" they call it. And relative to the rest of the nation, Washingtonians are getting richer. That's fair, isn't it?
Washington is a bad place to run over a pedestrian. If he is a white male, he is almost certainly a lawyer. So, if you run over him...our advice is to back up quickly and run over him again. Finish him off. Otherwise he'll sue you.
The houses in Georgetown and the Northwest section of the city are handsome. They have carefully-tended lawns and gardens...and a Prius or Volvo parked in front. DC residents - at least those in the Northwest of the city and the Virginia suburbs - are conscious of their 'carbon footprint.' They recycle. They are well-meaning, earnest and public spirited... Just the sort of people you would like to run over, in other words.
Driving on Massachusetts Avenue...then up Wisconsin Avenue...and then along MacArthur Blvd...we passed many of the places we've heard so much about over the years. Fannie Mae's huge headquarters...Homeland Security...the Brookings Institution...SAIS...the White House...the Capitol...the US Treasury...the Eccles Building, where the Fed is headquartered... It's all there.
"It's amazing how much damage has been done from such a little geographic area," Elizabeth remarked.
The question we have been asking ourselves for the last 5 years.
Which way will America go? To Tokyo or Buenos Aires? To deflation...or to inflation? To a long, cold drawn-out slump...or a fiery blow-up?
Mr. Market is pushing the US towards Japan. No question about that. After 60 years of credit expansion we now have a natural credit contraction. Households and businesses are paying down...and defaulting on...debt. They're hoarding cash rather than splashing it around.
For example, young people are driving less...and buying fewer 'starter houses.' Gasoline use in America is going down. So are housing prices.
Part of the reason young people are buying fewer houses is that they can't afford them. The Financial Times reports:
"Young put off buying homes under weight of student debt."
Yes, dear reader, the feds practically force-fed young people student loans. Like shyster subprime lenders, the feds offered students money at low teaser rates. Now, the rates are supposed to double.
Of course, the poor student thought he would be in fat city when he got out of school. He thought he'd have a well-paying job!
Now, he'll be lucky to have any job at all...
It looked for a while as if the US economy really were recovering. At least, that's what everybody said. But now Mr. Market has asserted himself again.
US stocks fell again. Oil, copper, Treasury bond yields...everything is going down.
Truck buyers were canceling orders at the fastest rate in two years.
As to housing prices, the FT continues:
The number of first-time buyers has plunged - they comprised 37 per cent of home purchases in 2011, down from 51 per cent in 2010 - sapping the struggling housing market of a traditional source of vitality.High levels of student debt, along with tighter mortgage requirements and stagnant wages, are forcing young people to delay buying their first homes.
Is there any fed policy that hasn't backfired? Not that we know of. And the biggest fed policy now - aside from world domination - is the attempt to hijack Mr. Market's plane, en route to Tokyo, and force it to Buenos Aires.
The feds have put their hearts and souls into this effort. Too bad they haven't put their brains to it too!
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 - Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 - Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 - Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 - Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 - Dan Denning
There’s a direct connection, Dear Reader, between the trading losses at JP Morgan and the conspicuous non-prosecution of Jon Corzine. In fact, there’s a term for this connection. It’s called “moral hazard.”
Most parents understand the term. They understand that the best way to raise a socially dysfunctional brat is to give him a candy bar every time he whines for something, and to give him a $20 bill every time he bullies a classmate. And yet, incredibly, the Federal Reserve, Treasury and Congress are doing exactly that. They are creating a generation of “spoiled brat” bankers.
Just three years after the depths of the 2008-9 Credit Crisis, Wall Street’s power brokers remain as remorseless as ever, as self-entitled as ever and, therefore, as fearless as ever. That’s not a good thing.
Three years after a crisis that nearly toppled the US financial sector, JP Morgan is playing the same old games…as if nothing had changed. The official chitchat from Washington and Wall Street about “risk” and “regulation” has changed quite a bit since 2008, but Wall Street’s behaviour is just as deplorable and dangerous as ever.
As the chart above shows, the “gross market value” and “gross credit exposure” of global OTC interest rate derivatives has jumped to its highest levels since 2008. If you don’t understand what these data points mean, don’t feel bad, Jamie Dimon doesn’t seem to get it either. (But if you’d like to understand what these data points mean, check out this report from the Bank for International Settlements).
The only thing you really need to know about the global derivatives market is that risk exposures are increasing, not decreasing. JP Morgan’s balance sheet tells the tale. According to Morgan’s latest quarterly report, the firm was a net seller of credit protection — to the tune of about $206 billion, up from $116 billion as of Dec. 31. In other words, it nearly doubled its risk exposure. JP Morgan calls this speculation “hedging.” Unfortunately, it is hedging without a hedge, which is the same thing as speculating.
The newly “retired” Chief Investment Officer of JP Morgan, Ina Drew, was supposed to be hedging other exposures at the firm. But hedging is not supposed to produce billion-dollar losses. That’s why it’s called “hedging.”
“[Ina Drew’s] position over the years has always been around hedging,” explains Dina Dublon, a former JPMorgan CFO who worked with Drew for 22 years, “but hedging for profit as opposed to hedging just to counter losses.”
Ah yes…“hedging for profit”…also known as “speculating.”
“The sheer size of this trade,” says Barry Ritholtz, editor of the Big Picture and recurring speaker at the annual Agora Financial Investment Symposium in Vancouver, “makes it far more accurate to describe this as speculation than hedging. The loss was the tell. A true hedge would have been offset by the underlying position that was being hedged — so any loss should have been insignificant. Even a minor correlation error should not lead to a $2 billion hit.
“If we are going to define this trade as a hedge, then there is no other conclusion to reach except that everything at a huge bank is a hedge. And once you define everything as a hedge, well then, nothing is a hedge.”
In other words, Dear Reader, nothing has changed since 2008. Absolutely nothing. The only reason Dimon is around to lose $2 billion of the shareholder’s capital in 2012 is because the federal government (i.e., we taxpayers) bailed him out in 2008.
Therefore, Dimon understands the rules of this rigged game very well. He knows he can conduct mega-billion-dollar speculations because he knows that JP Morgan could never bankrupt itself, no matter how recklessly it conducts its business.
The US central planners would not allow it. Morgan could build bonfires with $100 bills in front of all its branches every night, and it still would not be able to burn through the federal government’s commitment to keeping it alive.
Jamie Dimon, along with the rest of the coddled Wall Street predators, knows he is just as free to jeopardize the US financial system as he was in 2008. He and his counterparts at Goldman and elsewhere are just as free to place their monstrous heads-I-win-tails-you-lose bets with non-consenting US taxpayers as they were in 2008. No one will stop them.
Vibrant economies and civilized societies rely on law and order. And law and order relies on a foundation of fairness — a basic understanding that bad things are bad and good things are good. But when the powers of government begin to affirm that bad things are okay and good things are irrelevant, all hell breaks loose.
If America is to regain her former glory, she must first regain the integrity to prosecute criminality, no matter how many politicians know the criminals on a first-name basis…and she must regain the courage to let incompetent capitalists fail so that competent capitalists can arise to take their place.
If America is to regain her former glory, she must regain the integrity to prosecute guys like Jon Corzine and the courage to let guys like Jamie Dimon fail.
Regards,
Eric Fry
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy… Booming…or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 – Dan Denning
Similar Posts:
“Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate... it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”
— Andrew Mellon
Down, down, down...
Oil is at a 5-month low. Russian stocks are 20% below their high. Commodities are back to 2010 levels.
Everything is going down. Even gold.
Wait a minute. Since we know from Einstein that all motion is relative, everything CAN’T be going down. If everything were going down, everything would be standing still. Something must be going up as a point of reference.
So what’s going up?
Cash!
Cash is going up against oil, houses, stocks, copper, commodities of all sorts...and just about everything else.
Cash is king.
Why? Because we are in a Great Correction. And in a great correction, prices are corrected. In a bubble, prices tend to go up. This tends to push up animal spirits...encouraging investors and business people to do things that they will later regret. They build houses no one can afford...and shopping centres no one really needs. Then, these things — and the loans against them — appear as “assets” on the books of banks, pension funds, hedge funds, private equity outfits...you name it.
Later, as the correction continues, markets discover that these ‘assets’ are not worth quite as much as they thought. Prices go down. Some ‘assets’ become liabilities. They are underwater, with more debt than equity.
Labor rates fall too. There are fewer projects that “make sense”...and they need fewer workers. Business falls off. Unemployment goes up. Salaries go down.
As prices fall, they must fall against something. So they fall against cash. Cash becomes more valuable. You can buy more real assets with every unit. People who hold their cash through a correction usually do well. They are able to buy quality assets, at the bottom, at large discounts to their previous prices.
That’s why so many people are willing to lend money to the feds for such low interest rates. They figure it’s as good as cash.
All this is obvious and hardly worth mentioning. In a better world, we’d all know what was going on...and we could all predict what would happen next: the mistakes would be written off, defaulted on, foreclosed, and marked down...
... and then, the economy could get up, dust itself off, and get back to work.
That’s what used to happen. The first American depression came in 1819. Cotton prices collapsed. Farms were foreclosed. Banks failed. It was over by 1821 — 2 years later.
Then, there was the Panic of 1837. New York brokerage houses failed. Farm prices collapsed. A bank president committed suicide. But it was over by 1843 — 6 years later.
The Panic of 1857 was triggered by the bankruptcy of Ohio Life Insurance and Trust Company. Railroad speculators were ruined. Stocks plunged. Nearly a thousand companies went broke. The resulting depression was hard...but short. Recovery began two years later.
The Panic of 1873 led to a 5-year depression. And the Panic of 1893 hit even harder — with a crash on Wall Street, 16,000 business failures and a 15% unemployment rate. Four years later, the economy was running hot again.
The aftermath of WWI brought the Depression of 1921. By many measures it was as bad as the Great Depression. But it was quick — two years later it was over.
And then, came the Great Depression itself. What made it so great? The feds! Until the 1930s, the feds let the economy take care of itself. Interest rates? They were set by willing buyers and sellers, not by economists working for the government. Monetary policy? Fiscal policy? There were none.
When it was time for a correction, Mr. Market took out a wrecking ball and knocked down the mistakes of the previous boom. The debris was quickly swept away...and it was off to the races again.
Even as late as the 1930s, Andrew Mellon, then Secretary of the US Treasury, advised president Hoover to “liquidate” everything. His idea was to give the correction a helping hand... Rather than wait for the correction to do its work, he’d swing the wrecking ball himself.
That is just what he did in the 1920s. He was Treasury Secretary in 1921 too. And instead of trying to fight the slump of ’21-’23, he helped it on its way. Instead of “countercyclical stimulus” measures, he gave the nation “pro-cyclical” measures. That is, he didn’t increase government spending in order to provide the economy with fiscal stimulus. He cut government spending in order to leave more money in the hands of consumers, investors, and business people.
And it worked. Scarcely 24 months after the beginning of the depression it was over...with unemployment back to 5%.
But the world changed between ’21 and ’31. By the ’30s, the feds had the bit between their teeth. In Germany, the Nazis were already consolidating power and gathering tinder for the Reichstag. In Italy, Mussolini and his gang were wearing funny outfits and plotting out an empire. Stalin was reorganizing Soviet agriculture — which would result in millions of deaths by starvation. And in the western democracies, the meddlers were taking over too.
Instead of thanking Mellon for his input, the feds tried to impeach him! In a few months, Mellon was gone. And then US economic policy was firmly in the hands of people who thought they could do better.
The gist of the new policy was that corrections must be stopped — at all cost. Depressions must be fought. Bankruptcies must be prevented... Markets must be controlled! By bureaucrats!
This new policy was what made the Great Depression great. Mr. Market may have wanted to correct his mistakes; but the feds wouldn’t let him. The depression continued, off and on, throughout the ’30s...and the ’40s too. It didn’t really end until the 1950s. You might expect the feds would have learned from that experience. Compared to the laissez faire policies of Andrew Mellon their activism was a complete, miserable failure.
Learn? Are you kidding? We’re now in year the 6th year of the crisis that began with the collapse of subprime in April ’07. Does it show any sign of letting up? Any sign of coming to an end?
Nope?
The feds have fought the correction every step of the way...with everything they’ve got. They’ve tried monetary stimulus — taking rates down to zero. They’ve tried fiscal stimulus — with $1 trillion budget deficits for the last 4 years...and no end in sight. They’ve tried “unconventional” measures too — such as QEI, QEII and The Twist.
Last year, the Fed funded more than 60% of the US deficit with printed money. And the Fed has increased its holdings of US debt some 3.5 times since 2008, from $479 billion in September, 2008 to $1.66 trillion in March, 2012.
So, put on your seat belts. Sit back. Relax.
Eventually, the correction will do its work. But it could take a long, long time.
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy… Booming…or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 – Dan Denning
Similar Posts:
When the going gets tough...people turn on each other. BHP Billiton has turned – very publicly – on the government. Jac Nasser, BHP's Chairman, criticised the Fed's industrial relations and taxation policies yesterday. He's right to criticise, of course. This government is one of the most ham-fisted Australia has had for many a year.
But such criticism is almost useless. Politicians meddle. That's what they do. Where we see a temporary credit driven boom pushing up commodity prices, politicians see super profits. They want to tax them. And the 'greedy' companies exploiting their workers (by paying them over $100k for moving dirt around) apparently need tougher industrial relations rules to keep them in line.
Before you think we're being harsh on mining employees, you should know that we think financial sector employees are the most overpaid and under-skilled around. Perhaps 10% of people in the industry deserve what they get. The rest are on the gravy train of central bank credit that first flows through the financial system before spreading to the wider economy.
But it is what it is. Hugh Hendry put it best in his latest letter to investors.
'Rightly or wrongly, the highest return on intellectual capital of any endeavour in the world today comes from the management of other people's money.'
Perhaps by the time this bear market has run its course that won't be the case. Or at least not as flagrantly so as it is today.
Getting back to BHP...and while its Chairman turned on the government yesterday investors turned on the company. As you can see in the chart below, BHP's share price broke through the all-important $34 level yesterday. The last time it passed through this level (on the way down) was back in the turmoil of late 2008.

Does this make BHP a buy? Is it now cheap at these levels? Who knows...it's practically impossible to value resources companies with any accuracy. BHP looks cheap. But it looked cheap over $40 too. The company, along with all other Aussie resource stocks, has benefited from China's historic credit boom.
We've talked about this plenty of times before. China panicked in the 2008 downturn and ordered its banks to lend. So they lent to the big state owned enterprises (SOEs), which are run by all the crony communists, who went and built things like railways, airports and shopping centres irrespective of the actual demand for them.
All this building required raw materials. Australia supplied those raw materials in, well, spades. And while we shipped dirt to the Middle Kingdom, China's economy sent cash our way. You can see the visual representation of the effect of China's credit bubble in Australia's terms of trade chart, below.
Iron ore and coal have contributed most to the increase in the terms of trade since the pullback in 2008. Not surprisingly, RIO and BHP have benefitted handsomely from this. Like all good credit bubbles, the Chinese bubble threw off all sorts of false signals. It caused companies to announce big investment plans to satiate China's supposedly unquenchable thirst.
Not long ago, BHP told investors it planned to invest $80 billion over the next five years. Now, it says that's not going to happen. China's economic boom is turning into a bust. Companies are reassessing expansion plans very quickly.
Check out these statistics on the Chinese housing market, sent to us this morning by our mate, the editor of Slipstream Trader, Murray 'the bear' Dawes:
That should be a wakeup call to anyone who thought China's central planners could manage the downturn. They can't. China's real estate market is in the process of crashing. And it's bringing China's economy down with it.
Consider this Bloomberg report:
'Combined net lending by Industrial & Commercial Bank of China, China Construction Bank Corp., Bank of China and Agricultural Bank of China Ltd. was almost zero in the two weeks through May 13, Shanghai Securities News reported today, citing an unidentified person familiar with the matter. China's central bank and commercial lenders sold 60.6 billion yuan ($9.6 billion) more foreign currency than they bought in April, the first net sell-off this year, according to People's Bank of China data. That indicated capital may have flowed out of the world's second-biggest economy.'
Zero net lending in two weeks? Holy credit crunch, batman. That is not a good sign for a credit dependent economy. If you think lower reserve requirements (RR) will stimulate lending, think again. The last time China cut its RR was in the 2008 downturn.
Interest rate cuts won't work either. Via negative real interest rates, it will just repress China's savers even more. The central planners are trying to rebalance the economy by encouraging consumption. Lower interest rates will not assist in that cause.
China is in all sorts of trouble...and you're seeing the effect of that now in the resource sector. Capital intensive sectors are always the first to feel the effects of an economic contraction. The question you should ask though, is how long China's bust will take to impact Australia's real economy and other areas of the stock market?
My guess is in another three months or so the evaporation of China's credit pool will begin REALLY hurting the property market...and therefore the banks. We explained the link between China and the Aussie property market which we wrote about back in March.
In short, a slowdown in China will hurt national income and impact households' ability to service mortgage debt. Moreover, it will impact people's ability to PAY astronomical prices for property. The property bust has already started in Australia. But it's set to get much worse.
But the market's not seeing that right now. Money is moving from resources to defensive sectors...and the big banks are enjoying their defensive status. Don't make the mistake of thinking a resilient share price means inherent strength. Soon, the market will turn on the banks too.
Perhaps it's already started. The Commonwealth Bank (CBA) provided a trading update today. It contained nothing sinister. But there was no good news either. The share price is down 2%. Investors have turned.
And while we're on the theme of 'turning' today, what about the gold price? Investors (actually, speculators) have abandoned the market. Gold is a whole other story, and one we'll dig very deeply into tomorrow...
Until then...
Regards,
Greg Canavan
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 – Dan Denning
Sometime in the next few weeks we're going to find out if Greece can afford to stay in the euro. We're also going to find out if Spain and Italy can afford to leave the euro. Access to credit markets is the key issue. The stigma of default will lock a country out of capital markets. If you don't have a plan to replace your currency and then devalue it, you're doomed. We'll return to this subject at the end of today's Daily Reckoning.
But first, the crisis in Greece didn't come to a head over night but it can't be far away. Rival political parties have been unable to form a government. New elections are scheduled for the second week in June. The financial has definitely become political. The people have run out of patience with unsound money and the world built on it.
All that said, the Greeks managed to make a €430 million payment to hold-out creditors last night. Nearly 97% of Greek creditors agreed to the restructuring of the country's debt in March. That wiped off over €100 billion in Greek debt and resulted in 70% losses for some of the bondholders who accepted the deal. Not all of them did.
Yesterday, the bondholders who didn't accept the deal got paid in full. There is still about €6 billion worth of debt owed to creditors who refused to participate in the restructuring. You can imagine that the Greek decision to pay the holdouts would anger the creditors who agreed to the deal. They look like schmucks now. Schmucks.
But in the current scheme of things, €430 million is chump change. The real issue is whether the Greeks are going to default on €150 billion worth of government debt. If those bonds are owned by foreign creditors – let's call them other European banks – then the Greek crisis becomes a European crisis. We'll come back to this issue of 'containment' shortly.
For the Greek people, the most alarming aspect of what's going on is that their life savings are at serious risk of a massive, overnight, non-voluntary devaluation. There are a lot of words for the magical process of turning one thing into something else: alchemy, transmutation, and transubstantiation come to mind. But to the Greeks it's going to look a lot like highway robbery.
You'll go to bed one night with your life savings denominated in euros. You'll wake up the next day with them denominated in drachma. And your euro savings will be automatically converted to drachma at an exchange rate not of your choosing. For example, your 1,000 euros will become 100 drachma...or even 10,000 drachma. The nominal amount won't matter. What matters is that the devaluation strips you of 70% or 80% of your purchasing power.
Most people would avoid that kind of value destruction if they could. Maybe that explains why €700 million was withdrawn from Greek banks on Monday, according to remarks made by Greek President Karolos Papoulias and reported in the Wall Street Journal. The Journal reports that between €2 and €3 billion in deposits have been withdrawn from the Greek banking system each month for the past two years. January was a high point, with €5 billion.
A bank run by any other name would look as desperate. And who wouldn't be desperate now? Leaving the euro, devaluing the drachma, and defaulting on debt owed to foreign creditors are Greece's best long-term economic survival strategy. But the unavoidable side-effect is to destroy the savings of the people, not to mention usher in a period of lower standards of living. That won't win you many votes. It may start a revolution.
And how do you prevent the Greek precedent from being imitated by the Spanish and the Italians? To be candid, we don't think it matters much now. Greece can't afford to stay in the euro. The Spanish and the Italians can't afford to leave it.
The economies and banking systems of Spain and Italy are indispensable to Europe. If they leave the euro, there is no euro. The Greeks can leave, devalue, default and use a weaker currency to claw their way back to economic competitiveness. If the Spanish and Italians leave, they lose access to private capital, they lose access to the ECB and they take down Europe's banking system. They can't leave. More importantly, they can't be allowed to leave.
This makes the task of the European Central Bank (ECB) much easier. It simply has to guarantee Greek debt owed to all non-Greek creditors. Or, it could simply buy that debt. This would solve the problem of anyone outside Greece taking losses on Greek debt.
This is what corporatism looks like, when the Big State and Big Finance become the Big Power in the economy. Losses cannot be tolerated. Any loss results in lower equity capital at a financial firm would require selling assets. Since everyone owns a piece of everyone else, and owes to everyone else, any major loss in one place results in losses everywhere.
Of course it's absurd that Europe is moving toward this kind of 'extreme socialism'. The people most responsible for the crisis are not accountable and the people who have saved get punished. The elite are enriched and everyone else is enslaved.
This is why the financial crisis could so quickly become a political and social crisis. When people don't think they can get justice from the courts or the cops, and when they think that cheating is the only way to get ahead in a system, the political and financial order is on borrowed time. The clock is ticking.
Regards,
Dan Denning
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 – Dan Denning
Former Treasury secretary Ken Henry reckons that what's bad for Greece may turn out to be good for Australia. Why? It will make it easier for Australia to finance its current account deficit! Woo hoo!
Capital in flight – and that's what a bank run is, whether it's an individual depositor or a global hedge fund – has to find sanctuary. The easiest (most liquid) place is the US bond market. But Henry likes to think that Australia has developed the reputation as a 'safe haven' for global risk capital. 'The good news side of it is that it is possible, maybe even likely, that any capital flight associated with the euro could make it easier for Australia to finance its current account deficit,' Henry told the ABC last night.
We suspect Henry would like that capital to flow into a new infrastructure bond market. Those bonds would be floated by State governments and finance the infrastructure required for Australia's growing population. We wrote about this new bond market in the most recent issue of Australian Wealth Gameplan. With new exchange traded funds (ETFs) in the fixed income market, it's now possible to fill the 'bond' portion of the Permanent Portfolio with fixed income ETFs.
But back to Henry's point, is Australia a safe haven for capital? Well, we'll see. Obviously we like the place well enough or we wouldn't have been here for seven years. But enjoying the climate and the footy is not the same as deciding to plough your life savings into the share market or the property market.
For a country that managed to run a persistent current account deficit during the greatest ever commodity boom AND managed to stack on about $220 billion in government debt at the same time, the 'safe haven' tag seems misplaced. As we wrote a few weeks ago, the last crisis shows that foreign money flows out of Australia in a crisis, not into it. But maybe this time it will be different.
Maybe what Australia needs is Don Corleone. We bet you didn't know that Australia needs a 'godfather'. As if the disintegration of the euro wasn't enough to wrap your head around, the Chinese have seized on this moment of anxiety to put pressure on Australia geopolitically. A former officer in the People's Liberation Army (PLA) has told Australia that it needs to choose who is going to be its Big Daddy in the Asia-Pacific for the next 100 years.
Song Xiaojun told the Age, 'Australia has to find a godfather sooner or later...Australia always has to depend on somebody else, whether it is to be the 'son' of the US or 'son' of China [It] depends on who is more powerful, and based on the strategic environment.' He inferred that, while Australia has been basking in the glow of record mineral exports to China, it's been lazy about looking after its strategic interests. 'Frankly, it has not done well politically.'
This must be the 'bad cop' part of the interview. It's hard to imagine these kinds of remarks winning you influence and friends in Australia. It's quite possible that Song means 'godfather' in the paternal way, as an older, wiser hand that looks after the interest of a 'son' the way a father might. But he could also mean Don Corleone. Is he making Australia an offer it can't refuse? Hmm.
Assuming this is a two-man job, that means the 'good cop' must be Li Keqiang, the man slated to be China's next Premier. He's meeting in Beijing with new foreign minister Bob Carr. The men are celebrating the 40th anniversary of Australia establishing diplomatic relations with China.
Why would China try to get Australia in line, strategically speaking, right now? Is it because America is weak? Because Australia is vulnerable? Because China is strong? Or because China is weak?
Surprisingly, the last part may be more likely than you think. We don't mean weak in economic terms, although you could make the argument China IS getting weaker. In fact, Li Keqiang made the argument himself to the Financial Times when he cited electricity consumption, rail cargo volumes, and the disbursement of bank loans in the Chinese economy.
Li said these three factors paint a truer picture of China's growth model than do 'man made' GDP figures which are 'for reference only'. Electricity output grew just 0.7% in April, year-over-year. In March, it increased by 7.2%. Rail cargo volumes are growing at half the pace they were this time last year, according to the FT. Banks are extending fewer loans as well.
Let's see...less power used in making goods means fewer rail cars used in transporting them and fewer bank loans taken out purchasing or making them. That all adds up to slower growth. But is it a lot slower? Or is it just a little slower? That's the big question.
And that brings us back to the issue of political strength, not economic strength. The 18th National People's Congress of the Communist Party of China (CPC) will meet later this year. Among other things, the Congress will elect nine new members of the Standing Committee of the Politburo (SCP). This is the most powerful group in China. It's the group that controls Chinese economic and political policy.
In case you've missed it, there's been a power struggle going in the CPC. To make a long story short, we'd suggest it has to do exactly with what kind of 'growth model' keeps the party in power. The 'Chongqing Model' adopted by the ousted Bo Xilai relied heavily on selling land for development and then building massive state-funded housing and infrastructure projects. This investment-led growth has been great for Aussie resources.
But outgoing Premier Wen Jiabao – a CPC rival of Bo's – has called this model 'unbalanced, uncoordinated, and unsustainable.' This is a point Dr Paul Monk elaborated on his presentation at our After America conference in Sydney. There's disagreement within the Party over which growth model delivers sustainable benefits to the people, and thus keeps the Party in power.
What's more, China has a lot less 'policy flexibility' to deliver growth on demand than some analysts imagine. Dr Savvas Savouri, the bloke we quoted yesterday, says, 'On practically every measure, such as bank reserve requirements or interest rates, monetary policy is much tighter in China than in the West.' He reckons all the Chinese have to do is lower interest rates here, adjust reserve requirements there, and voila...growth is back at 8.5% a year.
But that entire model of management is under review in China because it's failing globally. It's also under review because it's fake growth...or growth for the sake of politics. All the signs point to the end of this global growth model. And if Li knows this better than anyone, he may be maximising China's political leverage over Australia while it still lasts. Stay tuned for more on this geopolitical game.
Regards,
Dan Denning
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 – Dan Denning
The Dow sinking.
Gold sinking.
Oil sinking.
Copper sinking.
Yields sinking.
We struggled with this, Dear Reader. We meditated. We prayed. We drank heavily.
And finally...we overcame the rank desire to say: "We told you so!"
As you know, Martin Wolf, of the Financial Times, is the voice of The Economics Establishment. All that is great and good in the field – which isn't very much – is given voice by Wolf. Then, it is acceptable for policymakers, Treasury ministers, and central bankers, not to mention the people you talk to at cocktail parties.
And lo! Here cometh the neo-Keynesian economist. What saith he?
He says the world is drifting towards Japan.
Of course, that was the message 10 years ago from a certain feral economist who will not be mentioned. He maintained that Japan was a leader, not a follower...and that the US would follow in Japan's footsteps...with about a 10-year lag.
He even wrote a book on the subject, with Addison Wiggin: Financial Reckoning Day.
Where he got these ideas, we don't recall. What we do recall is that almost everyone laughed at him. "Japan?" they said. "The US is nothing like Japan. We have a dynamic, robust economy. We have Lehman Bros., Bear Stearns and Countrywide 'low doc' mortgages. We have Alan Greenspan. And George W. Bush. We have 'mission accomplished' in Iraq. We have Silicon Valley, Bernie Madoff and a housing boom. Japan has none of those things. Ha. Ha."
But now, the last laugh is on the other foot!
Japan's market topped out in 1990. The US market topped out – in real terms – in 2000. Thereafter, Japan saw on-again, off-again recession...sinking prices, generally...and slumpy conditions. The US economy staged a limp recovery in the '02-'03 period...then gave investors a bubble head-fake. Now, it's back to the slump...
...and now, both Europe and America are looking more Japan-like every day.
Martin Wolf explains:
On May 10, 2012, the yield on the German 10-year bund was 1.44 per cent, on the US 10-year Treasury was 1.85 per cent and on the UK 10-year gilt was 1.9 per cent.
These are extraordinary numbers. They are particularly striking in the cases of the US and UK, which unlike Germany, run very large fiscal deficits and are experiencing very rapid increases in public sector indebtedness.
This combination of falling government bond rates with very rapid rises in public sector indebtedness reminds us, of course, of the experience of Japan since 1990.
At the end of 1990, when its "bubble economy" went pop, the Japanese government's 10-year bond was yielding 6.7 per cent. As the economy subsequently declined, deflation took hold and fiscal deficits and public debt exploded. But yields on 10-year Japanese government bonds (JGBs) fell to close to 2 per cent in 1997 and then, with sizeable fluctuations, to troughs of 0.8 per cent in 1998, 0.4 per cent in 2003 and, recently, to 0.9 per cent. In short, the worse the Japanese government's present and prospective debt position has become, the lower the interest rates on JGBs has also become.
Similarly, in July 2007, just before the beginning of the crisis and consequent explosion in fiscal deficits and debt, the US 10-year Treasury yielded 5.1 per cent. Now, almost five years later, the bonds of this alleged fiscal basket case yield less than 2 per cent. Again, in the UK, another supposed basket case, with huge fiscal deficits and a slipping austerity programme, yields have fallen from 5.5 per cent in July 2007 to below 2 per cent.
What does it mean?
Well, if the US and Europe are following Japan...and Japan is going nowhere...then three of the world's large major areas are dead in the water.
And if that is the case, you can expect the entire world economy to "go Japan."
That will mean lower commodity prices. A lower price of oil. A lower price of gold. Lower interest rates – yes, look for the yield on US 10-year notes to drop below 1%. Bad unemployment figures. Low...or negative growth...falling real estate prices.
...and probably a stock market crash.
Hold onto your hats!
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 – Dan Denning
Well, okay...so the Yahoo! guy 'embellished' his resume a little. Big deal. Really, we're surprised to see people make such a fuss about it. After all, who can honestly say they haven't put a little positive spin on their own achievements. We have!
But let us rush to clean up our credentials before Dear Readers make a federal case of it.
Okay...on our age. It says we were born in 1959. Must be a typo. We were really born in 1953...okay...'48.
And, it says we attended Harvard University. Well, yes...we certainly did 'attend' Harvard... But through some bureaucratic mix-up our name was never on the official student list and our diploma must have gotten lost in the mail.
As for the Pulitzer Prize, we wouldn't say that we were awarded the prize, not exactly. There again, it seems to be a case of a slight mis-wording. "Pulitzer Prize-winning" describes the quality of our work...as widely recognized, at least in the office here.
And we didn't exactly invent the Post-It note. We just invented something like it, with scotch tape and a piece of paper. Same idea.
And, okay, did we really "win" the Nobel Prize in economics? We probably shouldn't have used the word "win." We were nominated...well, mom thought should have been nominated. She was putting us "in the running"...or something like that.
There, we hope that clears up any misunderstandings.
*** How do you like that? A guy comes from Brazil. He makes billions helping Zuckerberg launch Facebook. And then he leaves the country. You'd think he'd be more grateful. Or at least more sentimentally attached to the land that gave him so much loot.
But no. Edouardo Saverin is pulling out of the USA. Bloomberg reports:
Eduardo Saverin, the billionaire co-founder of Facebook Inc. (FB), renounced his US citizenship before an initial public offering that values the social network at as much as $96 billion, a move that may reduce his tax bill.
Facebook plans to raise as much as $11.8 billion through the IPO, the biggest in history for an Internet company. Saverin's stake is about 4 percent, according to the website whoownsfacebook.com. At the high end of the proposed IPO market capitalization, that would be worth about $3.84 billion. His holdings aren't listed in Facebook's regulatory filings.
Saverin, 30, joins a growing number of people giving up US citizenship ahead of a possible increase in tax rates for top earners. The Brazilian-born resident of Singapore is one of several people who helped Mark Zuckerberg start Facebook in a Harvard University dormitory and stand to reap billions of dollars after the world's largest social network holds its IPO.
But the rich are doing it all over the world.
A report from London tells us that the French are moving to town. France's new president has pledged to raise income taxes on the rich to 75%...and to boost France's wealth tax too. Wealthy French people are buying houses in South Kensington to escape.
As for the rich in Argentina, they've been making tracks for many years. As soon as they get some money they buy an apartment, in Miami!
Here in Baltimore, wealthy people have been getting out of town since the top in real estate in 1927.
And now, the rich are leaving Maryland too. Governor O'Malley says "wealthy people can afford to pay a little more in taxes..."
Well, yes, they can afford it. But that doesn't mean they will like it.
"We're moving to Florida," says an old friend.
"Wait for me," says your editor...
Meanwhile, the Irish and Spaniards are leaving their homelands too. Money is the reason. But smaller amounts of it. There are few jobs in Ireland or Spain, so they're leaving to find work.
Even the Chinese are jumping ship. No kidding. Taxes are low in China.
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 – Dan Denning
Having benefitted from the risk management failures of others such as investment bank Bear Stearns and hedge fund Amaranth, JP Morgan (JPM) appears to have made an 'egregious' and 'self-inflicted' hedging error. The bank would have done well to reflect on John Donne's meditation: 'send not to know for whom the bell tolls, it tolls for thee'.
A US$2 Billion Banana Skin...
The losses indicated are US$2 billion and may be higher. JPM's share price fell around 9% (a loss of US$14 billion in market value) when the news was announced via a hastily arranged news conference. The bank also lost considerably more in reputation and franchise value.
The episode has all the usual trappings of a salacious trading disaster. Competitors have christened Bruno Iksil, one of the traders responsible, 'Lord Voldemort' (after the Harry Potter villain). The position, which has been common knowledge in the market since early 2012 at least, was dubbed 'the London whale'.
After the losses were announced, the usual journalistic liberties have been taken – the whale has 'beached' or 'been harpooned'. A sub-editor gleefully coined the headline 'Dimon is a Whale of a Hedge Fund Manager', in reference to Jamie Dimon, the CEO of JPM.
But the losses raise serious issues. As they do not relate to the usual 'rogue trading' incident which is typically dismissed as impossible to detect or control, the episode provides insights into the problems of modern high finance, bank strategies and regulation of markets.
Details are sketchy. The losses relate to a position taken to 'hedge' a US$300+ billion investment portfolio managed by JPM's Central Investment Office ('CIO') overseen by staff including experienced hedge fund investment managers. The portfolio has increased in size from $76 billion in 2007 to $356 billion in 2011.
The objective of the CIO is hedging JPM's loan portfolio and investing excess funds. During a 13 April 2012, conference call, Jamie Dimon referred to the unit as a 'sophisticated' guardian of the bank's funds.
In its statement, the bank advised investors that,
'Since March 31, 2012, CIO has had significant mark-to-market losses in its synthetic credit portfolio, and this portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the Firm previously believed.'
The large investment portfolio is the result of banks needing to maintain high levels of liquidity, dictated by both volatile market conditions and also regulatory pressures to maintain larger cash buffers against contingencies.
Broader monetary policies, such as quantitative easing, have also increased cash held by banks, which must be deployed profitably. Regulatory moves to prevent banks from trading on their own account – the 'Volcker' rule – has encouraged the migration of trading to other areas of the bank, such as liquidity management and portfolio risk management hedging.
Faced with weak revenues in its core operations and low interest rates on cash or secure short term investment, JPM may have been under pressure to increase returns on this portfolio. The bank appears to have invested in a variety of securities including mortgage-backed securities and corporate debt to generate returns above the firm's cost of capital.
In 2011, the CIO portfolio contributed $411 million to JPM's earnings, below its contributions of $1.5 billion in 2008 and $3.7 billion in 2009. JPM's disclosures show that the unit took significant risk. Based on a common measure known as VaR (Value at Risk), the potential statistical loss for a single day was $57 million in 2011, similar to the $58 million of average risk in the bank's larger investment bank and trading business.
The Art of Topiary...
The losses relate to an attempt to hedge the exposure on this portfolio.
As hedging would reduce returns, the strategy adopted appears to have been to buy insurance against default in the short term (to end 2012) and finance the hedge by selling insurance against default in the medium term (to end 2017). The structure took advantage of the difference in pricing of insurance between the two maturities of around 0.60–0.70% per annum. The strategic view was that risk would increase in the near term but abate in the longer term.
The choice of hedge instrument was an older 'off-the-run' credit index – the CDX NA.IG ('North American Investment Grade') Series 9. In all probability, the choice was driven by economic considerations. The constitution of the index may have provided a better match to the exact risk in JPM's books. The pricing of the index may have been more favourable than a more recent 'on-the-run' index. The relative liquidity of alternative hedging instruments would have been a factor.
The choice may also have been motivated by the desire to mask the bank's trading activities from other market participants, to allow the position to be established without moving market prices. The particular contract, originally issued in 2007, was extensively used in a variety of structured products. This meant that trades could be disguised as hedging existing products or client positions rather than on JPM's own account.
It is possible that the hedge could have been 'juiced up', that is, leveraged, by trading in different instruments such as the tranched version of the index to increase sensitivity to changes in market credit spreads.
With the benefit of hindsight, the trades seem to be no more than what Lord Voldemort might view as 'school-boy spells you have up your sleeve!'
Imperfect Hedges...
In the conference call announcing the loss, Mr. Dimon explained that the CIO portfolio was a hedge for the bank's balance-sheet risk. He stated:
'It actually did quite well. It was there to deliver a positive result in a credit-stressed environment. And we feel we can do that and make some net income.'
It is questionable whether the CIO portfolio or the problematic positions could be regarded as a true hedge. It is complex and relies on the correlation between the bank's underlying positions and trades. The effectiveness of the hedge also relies on the changes in credit pricing for different maturities. The simplest way to reduce risk would have been to sell off existing positions or offset the positions exactly.
The bank's assertion that the entire set of transactions was both a hedge and a source of earnings is confusing. The bank should have heeded the warning of the seventeenth-century French author François de La Rochefoucauld:
'We are so accustomed to disguise ourselves to others that in the end we become disguised to ourselves.'
Given JPM's vaunted risk management credentials and boasts of a 'fortress like' balance sheet, it is surprising that the problems of the hedge were not identified earlier. In general, most banks stress test hedges to ensure their efficacy prior to implementation and monitor them closely.
While the US$2 billion loss is grievous, the bank's restatement of its VaR risk from $67 million to $129 million (an increase of 93%) and reinstatement of an older risk model is also significant, suggesting a failure of risk modelling.
During the conference call, Mr. Dimon conceded that the trades were 'flawed, complex, volatile, poorly reviewed and poorly monitored...there are many errors, sloppiness and bad judgment.'
The episode also points to failures on the part of parties other than JPM.
Banks are now obliged to report positions and trades, especially certain credit derivatives. This information is available to regulators in considerable detail. Given that the hedge appears to have been large in size (estimates range from ten to hundreds of billions), regulators should have been aware of the positions. It is not clear whether they knew and what discussions, if any, ensued with the bank.
External auditors and equity analysts who cover the bank also did not pick up the potential problems. Like regulators, they perhaps relied on assurances from the bank's management, without performing the required independent analysis.
Encouraging Pundits...
The losses are complicated by Mr. Dimon's vocal opposition to some aspects of the re-regulation of financial institutions, especially the Volcker Rule which seeks to restrict proprietary trading of banks. Given the fact that JPM survived the financial crisis relatively well and Mr. Dimon's personal high standing within President Obama's administration (he was considered a potential Treasury Secretary), he has held the moral high ground in arguing for less stringent regulations.
In the bank's annual report, Mr. Dimon wrote:
'If the intent of the Volcker Rule was to eliminate pure proprietary trading and to ensure that market making is done in a way that won't jeopardize a financial institution, we agree... We, however, do disagree with some of the proposed specifics because we think they could have huge negative unintended consequences for American competitiveness and economic growth.'
Banks have sought a weaker version of the Volcker Rule with broad remit to undertake 'portfolio hedging'. This would allow banks to view an investment portfolio in its entirety and enter transaction to offset the risks of the entire portfolio, without the necessity of hedging securities or positions on an individual basis as would be required by a narrow definition of hedging. Banks argued that this exemption is essential to allow flexibility in managing risk within a large financial institution.
The JPM episode has helped re-open the debate. During his conference call, Mr. Dimon ruefully observed that the bank's US$2 billion loss 'plays right into the hands of a bunch of pundits out there'.
Legislators and regulators now argue that the rules for portfolio hedging are too wide and effectively impossible to police effectively. In addition, the statutory basis may not support the rule. The legislative intent was intended only to exempt risk-mitigating hedging activity, specifically hedging positions that reduce a bank's risk.
Interestingly, drafters of the portfolio hedging exemption recognized the potential problems, seeking comment on whether portfolio hedging created 'the potential for abuse of the hedging exemption' or made it difficult to distinguish between hedging or prohibited trading.
In a recent Congressional hearing, Former Fed Chairman Paul Volcker, who helped shape the eponymous provision, questioned whether the volume of derivatives traded was 'all directed toward some explicit protection against some explicit risk'.
The pundits have been quick to suggest that the losses point to the need for more stringent regulations. But it is not clear that a prohibition on proprietary trading would have prevented the losses.
In practice, without deep and intimate knowledge of the institution and it activities it is difficult to differentiate between legitimate investment and trading of a firm's surplus cash resources or investment capital.
It is also difficult sometimes to distinguish between hedging and speculation. The JPM positions which caused the problems were predicated on certain market movements – a flattening of the credit margin term structure – which did not occur.
Hedging individual positions is impractical and would be expensive. It would push up the cost of credit to borrowers significantly. All hedging also entail risks. At a minimum, it assumes that the counterparty performs on its hedge. But inability to legitimately hedge also escalates risk of financial institutions. Ultimately no hedging is perfect or, as author Frank Partnoy told Bloomberg, 'The only perfect hedge is in a Japanese garden.'
Additional regulation assumes that the appropriate rules can be drafted and policed. Experience suggests that it will not prevent future problems.
Bankers and regulators have always been seduced by an elegant vision of a scientific and mathematically precise vision of risk. As the English author G.K. Chesterton wrote,
'The real trouble with this world [is that]... It looks just a little more mathematical and regular than it is; its exactitude is obvious but its inexactitude is hidden; its wildness lies in wait.'
Human Sacrifices...
JPM indicated that it is trying to unwind its positions. Given the size, the level of losses may increase as markets may move against the bank as it tries to liquidate its position.
But JPM should survive this loss. The bank was quick to point out that the US$2 billion loss was offset by profits in other parts of the portfolio. According to the bank:
'As of March 31, 2012, the value of CIO's total [available for sale] securities portfolio exceeded its cost by approximately $8 billion.
The fate of specific actors is more difficult to predict. Mr. Dimon's language in describing the losses was expressive:
'... Errors, sloppiness, and bad judgment... Badly executed, badly monitored. I'm not going to repeat it 800 times...I know it was done with the intention to hedge tail risk... it was unbelievably ineffective...'
He seemed to be trying to distance himself and the bank's Board of Directors from the failures, praising the expertise of the individuals involved. 'We added different types of people, talented people and stuff like that.' He was at pains to point out that the CIO had been very successful, until recently.
But human sacrifices will be needed. The question is whether it reaches the executive suite or can be limited to foot soldiers. Mr. Dimon has admitted his credibility is at stake, though not necessarily his job.
What complicates Mr. Dimon's position is that as recently as 13 April 2012, he indicated that the CIO positions were not problematic, dismissing the issue as 'a complete tempest in a teapot'. After the losses were announced, Mr. Dimon admitted on US television that he was 'dead wrong' to have dismissed questions about the issue.
Just Watch This Space...
The episode raises deeper concerns, beyond the issues at JPM.
How many other such problems, in other firms, remain undiscovered? JPM is a major player in credit derivatives and by no means the worst managed or the most aggressive in risk taking. If it curtails its activities then the loss of liquidity may affect other players and result in unrelated losses.
How has earnings pressure in banks affected their risk taking? Clearly, the large cash holdings of banks and the need to generate adequate returns for shareholders is encouraging risk taking.
How do regulatory initiatives and monetary policy action affect bank risk taking? Central bank policies are adding to the problem of banks in terms of large cash balances which must be then invested at a profit. The implementation of the Volcker rule may have had unintended consequences. It encouraged moving risk taking activities from trading desks where the apparatus of risk management may be marginally better established to other parts of banks where there is less scrutiny.
The most important question remains whether any specific action short of banning specific instruments and activities can prevent such episodes in the future. It seems that, as Lord Voldemort observed in Harry Potter and the Deathly Hallows Part 2, 'They never learn. Such a pity'.
Regards,
Satyajit Das
for The Daily Reckoning Australia
Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011)
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 – Dan Denning
Sell first and ask questions later. That was the global investment strategy overnight. Whether it was JP Morgan's $2 billion loss, Greece's possible exit from the euro, or 'Greece of America' California's $16 billion budget deficit, investors found plenty of reasons to sell everything. US dollar cash and US Treasuries rallied.
How soon could Greece exit the euro? Well, it may not be that easy. Remember, back in February we made the argument that Europe's powers that be had to prevent a Greek bond default. They couldn't allow a precedent to be set.
If it was okay for Greece to default, then why not Spain? Why not Italy? Confidence in Europe's entire government bond market would be blown to smithereens, taking the banking system (capitalised by government debt) with it. The European Central Bank (ECB) would be collateral damage.
Mind you, no one in Europe's establishment likes to mention Iceland. There's probably a reason for that. It might give the Greeks ideas. In 2008, Iceland's three largest banks owed foreign creditors more money combined than the size of Iceland's economy. The government couldn't guarantee the banks debts. So it didn't.
The government DID assume the banks' domestic obligations. But it told the foreign creditors to get lost. It defaulted. The currency fell by about 80% against the euro. The default and devaluation put Iceland back in a trade surplus a few years later and earlier this year ratings agency Fitch upgraded the credit rating on Icelandic government debt.
Now, you may be thinking that stiffing your creditor is a less-than-honourable decision. But it was done democratically. Iceland put the question of default to its people and 90% of the people chose default. They put the credit risk right back on the lender, which seems appropriate considering the borrowers were not the people but the banks. The people refused to accept the debt burden taken on by the banks. And the creditors? Too bad for them.
Greece has taken the other path. The politicians thus far have rejected what the people want. Greek politicians are taking their marching orders from Brussels, Berlin, and Paris. The debts of the private sector are now the debts of the people. Maybe this explains why the Greeks are currently unable to form a government. According to some sources, that government may have less than €2 billion cash.
Of course the main difference between Iceland and Greece is that Iceland had its own currency. The default was coupled by the devaluation. That's what made the debt go away. It caused a short, sharp, painful recession. And in GDP terms, the economy is much smaller today than it was in 2008. But the debt was liquidated. That's the important part. It hasn't been preserved as a perpetual burden on taxpayers in order to satisfy creditors (the private banks).
The Greeks can't devalue until they exit the euro, and the Europeans don't want the Greeks to exit just yet. If the Greeks repudiate their foreign creditors, it means they repudiate the debts they owe to French, German, and other European banks. There's no telling what would happen then.
Some people are already speculating that a massive ECB money-printing binge - on the order of hundreds of billions of Euros - would ensue. The intent would be to insulate the rest of Europe from a Greek euro exit. But an unintended consequence would be a devaluation of the euro...back to parity with the US dollar!
Now that would be a shocker. But then, we are in a kind of race to the bottom when it comes to currency values. Every country wants a cheap currency to boost exports. Exports lead to growth. Growth is better than austerity. But obviously, not everyone can have the cheapest currency. If Europe devalues...you can expect QE3 from the Fed soon. Heck, maybe even the Chinese will devalue as well. And the RBA may cut rates again sooner than anyone expected.
You can see the absurdity of the current monetary system in this series of tit-for-tat monetary expansions. The 'race to the bottom' in the competitive currency devaluation has lowered global interest rates. In the early stages, lower rates led to more borrowing - the credit boom. The biggest beneficiaries have probably been countries like Australia and Brazil. You got combined commodity inflation and demand for 'risk' assets like commodity currencies and resource stocks.
Around the middle of the race, you saw the expansion of government deficits. You can thank the Federal Reserve for this. The best example of this is the decline in 10-year US Treasury yields since 2007. You can see below the 10-year yield is once again near all-time lows. This has been a boon for US mortgage rates and, of course, for the US government, whose borrowing costs have gone down as its deficits have blown out.
But here in the late stages of the race we have JP Morgan losing $2 billion in the hunt for yield. And why is JP Morgan hunting for yield and losing money? Because ultra-low interest rates (negative in real terms) force you to speculate and take bigger risks to earn a real return. It's not just mums and dads. Its investment banks too. It's everybody. We are all Jamie Dimon!
Bill Gross, the manager of the world's largest bond fund, reckons we are reaching the end of the race. 'Major changes to our global monetary system lie on a visible horizon,' Gross writes in a Financial Times article. Gross reckons the diffusion of low-interest rate sovereign bonds from the developed world has brought us to a tipping point which may lead to an entirely new monetary order.
He elaborates:
'Now, with dollar reserves widely dispersed in China, Japan, Brazil and other surplus nations, it is fair to assume that there will come a point where 2 per cent negative real interest rates fail to compensate for the advantages heretofore gained in buying sovereign bonds.'There is the potential for both public and private market creditors to effect a change in how credit is funded and dispersed - our global monetary system. What that will look like is a conjecture, but it is likely to be more hard money as opposed to fiat-based, or if still fiat centric, less oriented to a dollar-based reserve currency.
'The developing credit cancer may be metastasised, and the global monetary system fatally flawed by increasingly risky and unacceptably low yields, produced by the debt crisis and policy responses to it. The great white whale lies on the horizon. Investors should sail carefully.'
Investors definitely should sail carefully, especially since the monetary policy response seems to be 'three sheets to the wind'. The old sailing phrase describes the ropes that hold a sail in place, the ropes being sheets. When the ropes are loose, the sails flap and the ship cavorts around on the sea like a drunken sailor (mixed metaphor alert!).
The Fed, the ECB, the Bank of Japan, and the Bank of England are drunken sailors. The world's monetary policy is three sheets to the wind. Insert your favourite nautical disaster metaphor here. Are there any lifeboats on this Love Boat?
Toscafund chief economist Savvas Savouri tells the Australian today that as the US dollar loses its reserve currency status, the Aussie dollar will climb to $1.70 against the greenback! 'China needs to gorge on US Treasury securities at the moment to keep its exchange rate stable, but come 2014 that policy will likely change.'
We're not sure what Dr Savouri is on about. Could it be the IMF's reweighting of its special drawing rights in 2015? In the event, he's not worried about China at all. Yesterday we expressed doubts that China can make the seamless transition from export-driven growth to domestic consumption. It's going to be bumpy.
Dr Savouri disagrees. 'People are naive if they think there'll be any 'landing' in China...On practically every measure, such as bank reserve requirements or interest rates, monetary policy is much tighter in China than in the West.' This reflects the belief that economic growth is just a matter of having the right policy settings.
Ahem.
Savouri says it's all happening now. Or next year. 'Next year will provide more economic fireworks than 2008...If, for instance, Russia or Norway announced that they would only part with their oil in return for a basket of currencies - rather than US dollars alone - many other countries would probably follow suit.'
Is he right? Well, there's no doubt the dollar standard is near the end of its monetary journey. But there's no land in sight. A lot of investors have chosen to maroon themselves on the island of US Treasury bonds. Is there a survival strategy you can use or are we all going down on the same ship?
Regards,
Dan Denning
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 - Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 - Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 - Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 - Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 - Dan Denning
More on US institutions going rogue...
Societies become more complex as they age. Each challenge...or opportunity...is met with a new rig of some sort. A tax. A regulation. An organizational fix.
As time goes by, these fixes act like friction...they slow the machine. They make it hard to move...inflexible and unresponsive. And over time, more people gain access to a fix - each lobbying group and special interest, each with his own bailout or subsidy...and each desperate to hold onto it.
Output is thus shifted to unproductive activities. The real producers are punished - with taxes and regulations - while unproductive activities are rewarded, with bailouts, handouts and sweetheart deals.
The financial industry was 2.5% of the economy when WWII ended. Now, it is 8.5%. How did it get so big? What does it do for all the money?
The answer to the first question is that it grew as the economy became 'financialised.' More and more laws were passed granting more and more special favours and protections to the financial industry. Just read the tax code.
Go ahead, we dare you! You will find special allowances and deals for the insurance industry on almost every page. And there are rules and regulations for pension funds. And pensions themselves. ERISA. 401k. 501C3. SEC. FDIC. Dodd-Frank. CFPB. Everything is regulated...controlled...protected...
And all of this happened on the back of the biggest expansion of financial instruments in world history. The feds transformed the economy from one that made things...at a profit...to one that just made money.
The money supply in the US increased by 1,300% in the 40 years after Richard Nixon 'shut the gold window' at the Treasury. That 'wealth' did not take the form of new factories in New England or new tractors in the Old South. It went mostly into money instruments...funneled through the financial industry to the rich people who owned financial assets.
Every potential new competitor had to comply with such a mountain of rules and regulations that he quickly gave up. Even if approved, he could not hope to provide a new product. Instead, he could only provide the same approved services and products that the big, entrenched players already had in stock.
John Kay, writing in The Financial Times, explains what would have happened had the computer industry been tied in the same knots.
"If you needed a licence to enter the US computer business, you can imagine the Computer Regulation Agency interviewing Bill Gates and Steve Jobs in the 1970s. What dutiful regulator would allow someone who had not even completed his Harvard degree to sell software to the public?"
Protected. Coddled. The financial industry went rogue. It was supposed to match investors with worthy investments, helping to bring genuine growth and prosperity to the US. Instead, it matched up most of the new money with itself.
The typical American was impoverished. Forty years after America's money went rogue, he has not a dime's more earning power per hour. And 4.5 times more debt, adjusted for inflation.
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 - Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 - Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 - Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 - Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 - Dan Denning
Reckoning today from Baltimore, Maryland...
China is falling apart.
Bond yields are falling.
Copper is sinking.
Oil is sliding.
US stocks, too, slipped all last week.
Even gold...that old stalwart friend...turned its back on us last week, closing the week at $1,585.
Oh, dear, dear reader...everything is giving way. What can we hold fast to?
Can we count on the lumpen, dear reader?
As you know, when it comes to investing or politics, the humble masses are our North Star...our guiding light. We can depend on them to be almost always wrong. They fall for jingoes and jackasses every time.
"Stocks for the long run," was a popular appeal back at the end of the '90s...just before the stock market produced its worst returns in 60 years.
"The War on Terror" was another popular flimflam; it helped separate the public from $4 trillion or so of its money.
And don't forget "Change," from the man who changed nothing.
We had given up on stocks. They were too expensive. Besides, as we put it, the stock market had never completed its historic rendezvous with the bottom. Investors hadn't given up. P/E ratios were still over 12 or 15. Dividend yields were below 3%.
We wanted a P/E below 8...and then we'd start to consider them. Or, give us a dividend yield over 5%.
Most important, we'll wait until the public is fed up with stocks...convinced that they are a loser's game.
Well, that day may not be far ahead. USA Today reports:
NEW YORK - On Main Street these days, investing in the stock market is about as popular as watching a scary movie on a 12-inch black- and-white TV.Wall Street's long-running story about how stocks are the best way to build wealth seems tired, dated and less believable to many individual investors. Playing the market isn't as sexy as it used to be. Since the 2008-09 financial crisis, the buy-now mentality has been replaced by a get-me-out, wait-and-see, bonds-are-safer line of thinking.
Stocks remain out of fashion even though the stock market has risen more than 100% since the bear market ended three years ago. It's up 25% since October and 9% this year.
Retail investors have yanked more than $260 billion out of mutual funds that invest in US stocks since the end of 2008, says the Investment Company Institute, a fund trade group. In contrast, they have funneled more than $800 billion into funds that invest in less- volatile bonds.
Investors' chronic mistrust of stocks is reigniting fears that an entire generation is unlikely to stash large chunks of cash in the increasingly unpredictable market as they did in the past.
"Investors have suffered a traumatic shock that has caused severe psychological damage and made them more risk-averse," says Carmine Grigoli, chief investment strategist at Mizuho Securities USA. Current worries, such as the USA's swelling deficit, Europe's unresolved debt crisis and slowing growth in China, have done little to ease their anxiety, he adds.
Investors are choosing 'safe' bond funds. Hmmm... Is it time to dump bonds and buy stocks? Or dump them both?
We faced this question a few days ago. We got a cheque - the payout on a deal we did long ago and since forgotten about.
What do to with it? Cash? Bonds? Gold? Stocks? Real Estate?
We chose cash!
Our guess is that we'll be on our present path...lagging growth...dragging unemployment...sagging yields...for a while longer. How much longer? Damned if we know...
But Treasury yields are already near or at all-time lows. How much lower can they go? Houses are already down to their most affordable level ever...how much cheaper can they get?
As for stocks, our bet is that they can get a lot cheaper. Mr. Market, should he care to undertake such a mission, could drive the Dow from 12,000 down to 6,000...or even lower. And, if he cared to, he could hold prices at that level for years.
So could he push the 10-year Treasury yield all the way to 1% (now about 1.8%) if he wanted to.
Yes, dear reader, there's still room on the downside. A lot of it.
One of the nice things about being a long-term investor is that you can wait a long time before you make your move. As Warren Buffett says, you don't have to swing at every pitch. And there's no penalty, except missed opportunities, for just waiting for the perfect ball to cross the plate.
That's what's so nice about cash. It's a bat. It's in your hands.
And we wouldn't be at all surprised to see Mr. Market toss us a powder puff pitch before too long.
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 - Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 - Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 - Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 - Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 - Dan Denning
Congratulations, Federal Reserve! Your zero interest rate policy tempted the world's most-sophisticated bank to create its own toxic blend of interest income in the derivatives markets.
JPMorgan made headlines late last week for a $2 billion trading loss that's likely to grow over time. Today, the bank's CIO fell on her sword for the trading gaffe. Ina Drew, a 30-year veteran of the firm decided today was a good day to "retire" from her trading desk.
JP Morgan's costly error was the result of "reaching for yield," just like retirees all over the US are doing. When traditional fixed income securities like Treasuries and CDs provide almost no yield whatsoever, the only remaining option is to reach in to riskier markets to try to find some yield. Reaching for yield - overpaying for income-producing securities in a low-rate environment - usually leads to a painful tumble off the proverbial ladder.
As part of the banking crisis fallout, the Federal Reserve pushed interest rates down close to zero, and is telling investors to expect zero rates until 2014. Savers will have gone six years without interest income, all so the Fed can implement its grand experiment to rebalance portfolios away from cash and US Treasuries.
"We'll buy the Treasuries," the Fed implicitly says to investors, "so you can push up the stock market to create a wealth effect for the economy." This begs the question: What happens if the Fed decides to unwind its gigantic Treasury portfolio? Wouldn't that reverse the stock market wealth effect at warp speed?
The answer is yes, but here's the dirty secret: The Fed is never going to unwind its portfolio. It's going to be forced by investors (and Congress) to keep the reserves it has injected into the banking system intact, so it can keep rates low on the US national debt. That's why we've been looking for short ideas that would suffer in an environment of rising commodity costs.
It's inevitable and unfortunate that retirees starved for yield are overpaying for risky assets like REITs, junk bonds and even financial products that create "synthetic" yield. A synthetic yield means a yield created by derivatives, rather than the underlying security.
These derivatives often cap upside returns in exchange for higher current income. As such, these structured products are essentially a slow return of capital masquerading as income. Some annuity products sold to retirees fit this description.
Back to JPMorgan, and the specifics of its $2 billion trading mishap. This is important, because it's a consequence of our still-broken financial system...
JPMorgan warned in its 10-Q that it's going to take an earnings hit in the second quarter from trades in its Chief Investment Office (CIO). CEO Jamie Dimon felt the need to schedule an impromptu conference call explaining the impending losses from CIO's hedging activities.
JPMorgan's Treasury and CIO department is tasked with investing the bank's excess cash, while hedging the credit risk that exists on the rest of the bank's $2.3 trillion balance sheet. Most people forget that banks are among the biggest fixed-income investors, and are suffering in a low-interest rate environment along with retirees. It's hard to shed a tear, I know.
So JPM decided it was a good idea to play along with the Fed's encouragement to exit low-yielding securities and move out along the risk spectrum to invest its excess cash to enhance shareholder returns.
JPM's $1.1 trillion in deposits exceed its loan portfolio by $407 billion, so it has lots of excess cash looking for a return. At March 31, CIO managed a $374 billion portfolio of securities - presumably in a manner that hedges JPM's credit risk. There is derivative exposure too, as we discover in the 10-Q.
The CIO can create synthetic credit risk by shorting credit default swaps, in which it would collect insurance premiums from underwriting the default risk on a specific entity. The result is synthetic interest income if everything is peachy and default doesn't occur; if not, the result is repeated margin calls and a complete blowup if the reference entity defaults. Think a mini version of AIG in 2008.
Jamie Dimon refused to provide any detail about the derivative trades on the conference call, but we can guess. Here is my guess: JPM owns a boatload of credit risk. Therefore, if CIO were trying to offset this risk, it would probably sell short credit default swap insurance (CDS). Some of the biggest rises in CDS spreads since March 31 were in European banks.
If CIO was short a basket of CDS on European credit indexes that included European banks, then its hedging activities could wind up inflicting large losses. If so, the CIO would have had to post more and more margin with its counterparty as the trade went against it. At some point, Dimon was informed of this unpleasant reality and decided to unwind the losing trade and break the news in the 10-Q.
JPM's conference call was a stark reminder that investing in large derivatives-trading banks (the "Too Big to Fails") is investing in a volatile cocktail of credit risk. Executives manage this credit risk with minimal disclosure about what types of risk they're taking. "Just trust us," is what they say. "We have sophisticated 'Value at Risk' models managed by rocket scientists," they say. As you recall from the financial crisis, this was a formula that blew up spectacularly.
Jamie Dimon was very defensive and combative in response to questions on the call. He couldn't provide specifics about the mark-to-market loss lurking in the CIO trading books - for obvious reasons: Other traders on Wall Street, like sharks smelling the scent of blood, would make JPMorgan's exit from these underwater derivatives positions an even-more painful experience, while pocketing derivatives trading profits.
We won't know any more detail until JPM reports its second quarter, when Dimon promised to provide more detail - presumably after unwinding the losing trades. This episode is one of many flashing signs that the global banking system is more fragile than advertised.
JPM has built a reputation as one of the better risk managers among the world's largest banks. If JPM had this surprise, what derivatives accidents lie in wait at other banks? With the eurozone on the verge of heightened drama and bank restructurings, I don't think stock market bulls want to find out.
Finally, I'd be remiss to not mention our wonderful financial system regulators. Using the logic of the idiots (Dodd and Frank) that supposedly "reformed" Wall Street after the financial crisis, what we need now is another new regulatory agency. Dodd-Frank was a thin coat of paint over a cracked and broken banking system; since it failed to accurately diagnose the causes of the financial crisis, it was a dud and a nuisance from day one.
More legal complexity, more wasted money and red tape and more lack of regulator accountability is what we got, when in reality, a big part of the problem was regulators not policing activities at the Too Big to Fail banks. Here's an idea - one that banking history expert Jim Grant has been pushing for years: It's called "capitalism."
Take away the subsidies and bailouts for banks, along with the regulatory red tape. If they want to blow themselves up, fine - but losses would fall on the risk managers making those decisions and bank shareholders, not taxpayers or depositors. Push to return the investment banking business back to the partnership model that worked much better. Then, with the senior partners' capital on the line, we'll see how many derivatives blowups occur.
Regards,
Dan Amoss
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 - Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 - Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 - Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 - Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-05-07 - Dan Denning
If you haven't yet prepared your portfolio for a world with a lot less economic growth, there's still time. But maybe not as much as you think. The transition from a world led by American consumption to one led by Chinese consumption isn't going to be seamless. And it probably includes an extended stop-over at Deleveragingville, during which time not all stocks will be treated equally.
The good news out of China - the news that the bulls will seize on this morning - is that the People's Bank of China cut reserve requirements at banks and injected $63 billion into the economy over the weekend. The Bank is trying to free up liquidity, lower interest rates and generate economic activity. Which brings us to the bad news.
Economic activity in China is slowing down. The slowdown touches all parts of the economy, too. For example, April industrial production (IP) was 9.3% higher year-over-year. But that was the weakest reading for industrial production in three years. It was also lower than the 11.9% rate in March.
Now, an industrial production of 9.3% doesn't seem like a disaster. It seems pretty solid. It's certainly not the kind of disastrous figure that precedes a big crash. But you do have to wonder how much you can trust any official government numbers these days.
It's not so much that the statistics themselves lie. It's that the people providing the statistics may be lying. They do so in order to inflate their growth numbers to the party higher-ups. High growth is the currency with which you can purchase political advancement. And in any case, the lower IP number had plenty of company in the last week.
April imports in China were up just 0.3% year-over-year. Analysts expected 11% growth. That expectation was based on an average monthly growth rate of 25% in 2011. That string of strong export figures fully supported the idea that China was seamlessly switching from export-led growth to more domestic consumption. Last week's data challenges the narrative.
Last week's retail sales figures also showed slower growth, and so did the fixed asset investment figures. That's the very definition of a statistical double whammy! Both figures represent different growth models.
Retail sales should rise as China's per capita incomes rise and consumption increases in the economy. Fixed asset investment - the resource-intensive building of roads, houses, bridges, and infrastructure - should gradually decline, at least as a portion of over-all GDP. Less investment, more spending. That's the simple explanation of what everyone expects to see in China.
But instead you see this: less investing, less spending, less building, less importing, less exporting, and less lending, despite cheaper credit. What kind of a world is that? That's a world that's not growing as fast, or is even contracting.
Maybe this is all just a gradual moderation in China's growth rate. You can grow your economy at double digit rates when you're coming off a low base, but as GDP creeps up, sustaining that infernal pace becomes impossible. Developing economies grow at double digits. Developed economies don't.
For Aussie investors, this means be on your guard. The Aussie share market is, by definition, a growth-oriented market. China's fixed asset investment binge of the last two decades almost single-handedly accounted for the windfall profits from rising iron ore and coal prices.
That's all changing now. We think it means a shift in the leadership of the commodity sector in Australia. Read that shift correctly and you should be okay. Read it incorrectly and you probably won't be okay.
Even the New York Times is on to the story, reporting that,
'China has been the largest single contributor to global economic growth in recent years, and a sustained slowdown in its economy could pose problems for many other countries. Particularly exposed are countries that export commodities like iron ore and oil and rely on demand from China's steel mills and ever-growing ranks of car owners.'
Hmm. Which 'particularly exposed countries' could the Times possibly mean?
Slipstream Trader Murray Dawes is already trading the 'negative growth' story. He's been sending us versions of the Bloomberg chart below for weeks now. It shows the price of iron ore imports in China. The price has been in a steady distribution since late last year, but now it's turned down.
Source: Bloomberg
Murray's especially interested in this price because he has several short trades on with iron ore producers. One is already in stage-two profit. The others are trending nicely. From a 'big picture' perspective, it's basically a 'negative growth' trade. It's one way to hedge your overall portfolio risk by at least making a little money as things fall apart.
But you don't need to be excessively negative either. We mentioned that we think leadership in the Aussie resource sector is changing. From whom to whom? From the bulk materials producers to the energy miners, that's whom and whom!
On the case is our own Dr Alex Cowie. He's travelled to Adelaide for the annual conference of the Australian Petroleum Production and Exploration Association (APPEA). He's writing notes this week for our sister publication Money Morning. You can see his posts this week at www.moneymorning.com.au
The conference starts today but it's already in the news. 'The head of the world's fifth-largest oil company wants to turn Australia into a global energy hub on a par with the Middle East, Canada and Russia, after a 20-year absence from the local market,' reports Angela Macdonald-Smith in an exclusive interview at the Australian Financial Review.
Hey, that sounds familiar. We told a similar story last year in Revolution in the Desert. We wrote about the new 'energy superhighway' between China and Saudi Arabia and its direct impact on natural gas, both conventional and unconventional. We told our Australian Wealth Gameplan readers about three companies operating in Australia's Cooper Basin that would benefit most from this big global energy shift. It's worked out pretty well so far.
And it could get even better. Christophe de Margerie, the CEO of French oil giant Total, says the company will invest at least $16 billion in Australia over the next five years. Total is already invested in the Santos LNG project in Gladstone and the $34 billion Icthys LNG venture led by Inpex in Darwin. But Christophe de Margerie is ready for more.
'We think it is the right time to see if, on top of those two projects and all the acreage we have off the north-west coast, we can do more with local companies, and to start, with Santos...We have said it already to Santos, we will meet with them and see what we can do from there - and not only be definition on LNG coming from those coal-bed-methane fields. I come with a totally open mind.'
Hmm. That sounds to us like Total might have an interest in shale gas assets in Australia. Despite BHP's cost blowouts on its US ventures, Total is thinking long-term, as a major integrated oil company must. New reserves must replace annual production on a constant basis. That means planning years ahead, so that exploration can yield actual resources that enter into production when you need them (or when your customers need them, to be more accurate).
This is probably the bright spot in an awkward moment in the Aussie share market. The China growth story is evolving. The next ten years on the Aussie market aren't going to look anything like the last ten years. You can't afford to invest as if nothing will change. But what CAN you do?
Well, we'd expect more de-leveraging. JP Morgan's $2 billion trading loss reported last week - admittedly a pittance relative to the size of the company's balance sheet - is more evidence that the world's financial markets are highly leveraged. You have trillions in assets sitting on top of a very small sliver of equity. In fact, the leverage is probably higher and more dangerous than in 2007, when the global financial crisis began.
The world's financial markets are more fragile and interconnected now than they were five years ago. That means commodities, resource stocks, and the Aussie dollar are all in danger of big falls if the 'risk off' mentality leads to more deleveraging in the financial world. You saw what happened in 2008. Now imagine that was just a preview. And it's not something that could happen far off in the future. It's something that could happen now, in 2012.
It's hard to reconcile that gloomy forecast with a bullish forecast on energy, but if you're looking 20-30 years out like Total, it's not as hard. It means a falling Aussie dollar is the perfect opportunity to buy Aussie energy assets on the cheap. You then have a tangible asset that's at the centre of the Asian growth story for the next 30-years - natural gas.
Of course most investors are not investing for the next 30 years. Most investors can't afford another bad three years, or another three years of average returns. So if we're right about the commodity shift AND the deleveraging in the markets, what's the best position to take? More on that tomorrow.
Regards,
Dan Denning
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 - Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 - Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 - Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 - Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-04-07 - Dan Denning
Reckoning today from Baltimore, Maryland...
The new Japan is China. It's an export economy with too much capacity...like Japan in '89.
The new Greece is Spain. It's got mortgage debt up the kazoo...
The new Ireland is the old Ireland. Yes, Ireland is now exporting people again...at the fastest rate since the 19th century.
Our old friend Jim Davidson says the new America is Brazil. But what happened to the old America? It's the new Argentina. Whoa! What a topsy-turvy world! The US is going broke...and going rogue. Just like Argentina in the '80s...
The story on China, from The New York Times:
HONG KONG - China announced Thursday that growth in imports had unexpectedly come to a screeching halt in April - rising just 0.3 percent from the same period a year earlier, compared with expectations for an 11 percent increase. Businesses across the country appeared to lose much of their appetite for products as varied as iron ore and computer chips.China has been the largest single contributor to global economic growth in recent years, and a sustained slowdown in its economy could pose problems for many other countries. Particularly exposed are countries that export commodities like iron ore and oil and depend on demand from China's voracious steel mills and ever-growing ranks of car owners.
Exports, a cornerstone of China's torrid economic growth over the past three decades, grew only 4.9 percent last month - half as fast as economists had expected. And a slump in new orders over the past month at the Canton Fair, China's main marketplace for exporters and foreign buyers, suggests that overseas shipments by the world's second-biggest economy, after that of the United States, may not recover quickly.
Growth in other sectors appears to be slowing, too, particularly in real estate. Soufun Holdings, a Chinese real estate data provider, released figures Monday showing that residential land sales in the country's 20 largest cities had fallen 92 percent last week from the week before, as declining prices for apartments have left developers short of cash and reluctant to start further projects.
There are early signs of a credit crunch, at least among private sector companies. Many seem to be asking their suppliers for more time to pay debts and complaining of cash flow problems. Zhang Jinmei, the sales manager at Qitele Group, a company that makes playground equipment in the coastal city of Wenzhou, said that local investment and lending pools there were starting to charge higher interest rates for loans, a sign of worries about creditworthiness.
"The business environment is getting tougher and tougher," said Tom Zhang, the sales manager at Hebei Haihao High Pressure Flange and Pipe Fitting Group. "Competition is very intense to get more business - our domestic sales are down from last year, though our export sales are more or less stable."
And here's the lowdown on the pain in Spain from Bloomberg:
Spain is underestimating potential losses by its banks, ignoring the cost of souring residential mortgages, as it seeks to avoid an international rescue like the one Ireland needed to shore up its financial system.The government has asked lenders to increase provisions for bad debt by 54 billion euros ($70 billion) to 166 billion euros. That's enough to cover losses of about 50 percent on loans to property developers and construction firms, according to the Bank of Spain. There wouldn't be anything left for defaults on more than 1.4 trillion euros of home loans and corporate debt.
The government, which came to power in December, announced yesterday that it will take control of Bankia with a 45 percent stake by converting 4.5 billion euros of preferred shares into ordinary stock.
Spain's home-loan defaults were 2.7 percent in December, according to the Spanish mortgage association.
Taking those into account, banks would need to increase provisions by as much as five times what the government says, or 270 billion euros, according to estimates by the Centre for European Policy Studies, a Brussels-based research group. Plugging that hole would increase Spain's public debt by almost 50 percent or force it to seek a bailout, following in the footsteps of Ireland, Greece and Portugal.
Spain... is mired in a double-dip recession that has driven unemployment above 24 percent and government borrowing costs to the highest level since the country adopted the euro. Investors are concerned that the Mediterranean nation, Europe's fifth-largest economy with a banking system six times bigger than Ireland's, may be too big to save.
In both countries, loans to real estate developers proved most toxic. Ireland funded a so-called bad bank to take much of that debt off lenders' books, forcing writedowns of 58 percent. The government also required banks to raise capital to cover what was left behind, assuming expected losses of 7 percent for residential mortgages, 15 percent on the debt of small companies and 4 percent on that of larger corporations.
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 - Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 - Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 - Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 - Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-04-07 - Dan Denning
When an organization goes rogue it takes up a new mission, of its own choosing...often in cahoots with the enemy it was supposed to be fighting.
You can see this phenomenon in many different places in many different activities. Poor African nations were supposed to be fighting poverty and hunger. But leaders found that losing the battle was more rewarding than winning it. Famine brought aid. And top-end Mercedes sales went up in the capital cities shortly after new aid programs were announced.
Likewise, US cities such as Baltimore and Detroit largely destroyed their own middle class tax bases. So, they came to depend on federal aid programs with perverse incentives. The outside world saw city governments as corrupt and dysfunctional, but they were really responding, rationally, to the choices before them. The worse off you are the more money you get. They went rogue...because that's where the money was.
The clearest example of this phenomenon is the War on Drugs. The anti-drug warriors went rogue many years ago. They found common cause with drug dealers, both of them now work against the public's interest. The drug fighters gain power and money by putting resources to work against the drug dealers. The drug dealers gain power and money thanks to the drug fighters who, like regulators, create high barriers to entry, keep out competition, push up prices, and protect the dealers' profit margins.
The drug dealers should thank the drug fighters. And here, one did:
"I couldn't have gotten so stinking rich without George Bush, George Bush Jr., Ronald Reagan, even El Presidente Obama, none of them have the cojones to stand up to all the big money that wants to keep this stuff illegal. From the bottom of my heart, I want to say, Gracias amigos, I owe my whole empire to you."- Joaqin "El Chapo" Guzman, head of Mexico's Sinaloa Cartel, as reported by a close confidant (via The Huffington Post)
Colleague Justice Litle explains:
The war on drugs - a war that America has lost - is an excellent example of why the world is so hard to change. Bad laws, bad ideas and bad arrangements persist by the will of stakeholders behind the scenes.It's a "tragedy of the commons": Costs are shouldered by the oblivious many, while profit concentrates in the hands of the few.
There is no way the cartels could have prospered so mightily, for so long, without a symbiotic relationship between criminals, politicians, and the lobbying agents who love them both. If not for the long arm of the law - and the helping hand attached to it - El Chapo and his ilk would have been rubbed out by Fortune 500 corporations (via free competition in a regulated market) quite some time ago.
"Whoever came up with this whole War on Drugs," one of El Chapo's lieutenants reports he said, "I would like to kiss him on the lips and shake his hand and buy him dinner with caviar and champagne. The War on Drugs is the greatest thing that ever happened to me, and the day they decide to end that war, will be a sad one for me and all of my closest friends. And if you don't believe me, ask those guys whose heads showed up in the ice chests."
But the biggest rogue of all is the only one that still retains the faith and respect of the people - the US military. That alone is remarkable, considering that the Pentagon has a record of failure that stretches back over the last 60 years. In Korea, it accepted a draw. In Vietnam, it withdrew, shamefully. In Iraq, we replaced one corrupt government with another, probably just as corrupt and incompetent too. In Afghanistan, it is ready to get out...leaving the country in the hands of its enemies.
Still, instead of sending military personnel to the back of the bus, the airlines board them along with the first class passengers and even move them up to business class if there are seats available. Mother Teresa can stay in economy!
Additional "investments" in security have been arguably the least productive use of capital in American history. From an outsider's perspective, it looks like the US military was suckered into spectacularly bad outlays in Iraq and Afghanistan. The New York Times reported as follows:
Al Qaeda spent roughly half a million dollars to destroy the World Trade Center and cripple the Pentagon. What has been the cost to the US? In a survey of estimates by the New York Times, the answer [is] $3.3 trillion or about $7 million for every dollar Al Qaeda spent planning and executing the attacks.
The insiders knew better. The Pentagon has gone rogue. It no longer protects the US from war; it causes wars. It no longer seeks to win wars; it wants them to go on forever. It no longer avoids wasting US resources; it sucks up all it can get.
Like drug fighters and poverty fighters, the fighters in the military were happy to have an enemy...especially one that couldn't do them any real harm.
Where does this lead? How does it progress? Stay tuned...
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 - Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 - Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 - Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 - Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-04-07 - Dan Denning
"America's national government has moved way beyond a political spoils system," wrote Charles Goyette in his book The Dollar Meltdown. "A spoils system leaves the host alive so that a politician's occasional ne'er-do-well brother-in-law can be put on the payroll."
In contrast, Goyette suggested, "America has become a piñata: Everybody gets a crack at it. Presidents and other elected officials pass the big stick around as a reward to those who help keep them in charge of the piñata party."
Goyette's book came out in 2009. Since then, we have learned that the party is even more debauched, nay demented, than he ever imagined. And you, dear reader, were not invited...
Ms. Lazar's clients, according to The Wall Street Journal, pulled down double-digit returns on 10-year Treasuries between the time of that meeting and the time Operation Twist was unveiled to the public on Sept. 21. Sorry you missed out.
The takeover, in fact, occurred on Sept. 6 - giving the hedge fund managers their own handsome payday in a six-week span. Again, you were excluded.
Before you object too loudly, we daresay you might wish to consider the consequences.
The Repeal of Habeas Corpus? When Free Speech No Longer Matters
On December 31, 2011, President Obama signed the Department of Defense Authorization Act into law. This is normally the routine annual budget for the Pentagon. But inserted into this year's bill is language giving the president the authority to use the military to imprison terrorism suspects - including US citizens - indefinitely, and without charges.
In other words, the "great writ" of habeas corpus is in danger of repeal. No longer would the government have to justify to a judge why it holds someone in custody.
"Take away this great writ," writes The Future of Freedom Foundation's Jacob Hornberger, "and all other rights - such as freedom of speech, freedom of religion, freedom of the press, gun ownership, due process, trial by jury and protection from unreasonable searches and seizures and cruel and unusual punishments - become meaningless."
Without habeas corpus, you could be thrown in prison for the "terrorist" act of criticizing the government and the government would never have to declare the precise reason it hauled you away. And in theory at least, the First Amendment would still be in force!
"This defense bill," says The Rutherford Institute's John Whitehead, "not only decimates the due process of law and habeas corpus for anyone perceived to be an enemy of the United States, but it radically expands the definition of who may be considered the legitimate target of military action."
"This bill will not only ensure that we remain in a perpetual state of war - with this being a war against the American people - but it will also institute de facto martial law in the United States."
135 SWAT Raids per Day: "Life Goes on, But It Is Debased..."
Rampant corruption and the apparatus for wide-scale repression: These are the hallmarks of what military theorist John Robb calls "the hollow state."
"The hollow state has the trappings of a modern nation-state ('leaders,' membership in international organizations, regulations, laws and a bureaucracy), but it lacks any of the legitimacy, services and control of its historical counterpart," Robb wrote in 2008. It is merely a shell that has some influence over the spoils of the economy.
"The real power," Robb continues, "rests in the hands of corporations and criminal/guerrilla groups that vie with each other for control of sectors of wealth production. For the individual living within this state, life goes on, but it is debased in a myriad of ways. The shift from a marginally functional nation-state in manageable decline to a hollow state often comes suddenly, through a financial crisis."
It is in this context that the growing "militarization" of police looks even more ominous than it does on the surface.
The Pentagon has distributed $2.6 billion in military surplus to local police agencies since 1997. Thus do towns of only a few thousand people have their own SWAT teams. Time was their use was limited to hostage-takings and other high-stakes situations. SWAT raids nationwide numbered only 3,000 per year in the early 1980s, according to University of Eastern Kentucky criminologist Peter Kraska.
Nowadays, SWAT teams are used to serve routine warrants. By the time Kraska stopped counting in the mid-2000s, the annual number had exploded to 50,000 - an average of more than 135 per day.
What happens when the tinder-dry combination of piñata-party corruption and a police-state structure meet the spark of violence?
We don't know where all this is going... but we know it makes us uneasy...which is why we are increasingly interested in casting our gaze for investment opportunity far, far away from US shores.
The US remains a land of (some) opportunity, but it has lost its monopoly.
Regards,
Addison Wiggin
for The Daily Reckoning Australia
From the Archives...
Is the Australian Economy... Booming...or Busting?
2012-05-11 - Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 - Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 - Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 - Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-04-07 - Dan Denning
“Economics puts parameters on people’s utopias.”
Yes. That’s exactly it. That’s why the politicians hate economics. That’s why the media are so... selective in which economists they call on to talk about policy.
That’s why the economics departments in colleges are put down by the sociologists, philosophers, literature professors and just about everyone else who has romantic longings for a coerced utopia.
“The teachings of the principles of economics should inform as much on what not to do, perhaps even more than providing a guide to public action.”
That’s it again. Don’t control prices. Don’t socialize medicine. Don’t raise taxes. Don’t inflate the money supply. Don’t put up trade barriers. Don’t go to war. Economists just keep bursting people’s bubbles. And it’s because economists say these things that the ruling class wants them to shut up about.
It’s been going on for hundreds of years. Every generation for the past 500 years has seen the battle wage between those who want to use the power of the state to contort and distort the world to fit some daydream on one hand and the economists who have seen the futility in this manipulation and warn against it on the other.
The man who wrote those above words is Peter Boettke, economics professor at George Mason University. He is one of the nation’s leading producers of economists, having directed several dozen dissertations over 20 years and having spread his students to colleges and universities around the country and the world.
His new book, which ought to be read by every college student who secretly suspects that economics is not as dreary as they say, is Living Economics, just published by the Independent Institute. It’s a big book, but a luxurious read from Page 1 to 450.
The phrase “living economics” means two things: 1) economics is part of life whether we recognize it or not, and 2) economics is a living discipline, rooted in universal principles but always changing in nuance and application.
Professor Boettke’s purpose is to provide a guided tour through the profession as it is now and how he would like to see it changed. He does this by first explaining what got him interested in the science.
It turns out that he remembers the gas lines of the 1970s and recalls being amazed to discover that they were wholly manufactured by Washington policy. It was the price control of oil combined with inflationary pressures from bad monetary policy. Contrary to what the media mavens and politicians were saying at the time, it had nothing to do with producer greed, secret price manipulation or financial speculation.
That’s what did it for him. He realized that economics is woven into every aspect of our lives. It is inescapable. When the market is allowed to work, beauty and growth result. Humanity flourishes. When markets are truncated and hobbled, people suffer.
Then he realized how little public understanding there is of economics. And he realized that he could play a role in changing this. He has. His students are now teaching other students in six different Ph.D.-granting institutions, among dozens more institutions.
Here Boettke reflects on the decision to make economics his vocation. Economics as a reality in our world will exist whether there are people around to study and explain it or not. As a discipline, it was very late in developing, mostly during the High Middle Ages. And it came about precisely to elucidate the way the world works in order to prevent kings and other big shots from using force to interfere with its mechanisms.
As Boettke puts it, “We do not need to understand economics in order to experience the benefits of freedom of exchange and production. But we may very well need to understand economics in order to sustain and maintain the institutional framework that enables us to realize the benefits that flow from freedom of exchange and production.”
What follows this beginning material is a plunge straight into the core of what economics teaches. Boettke chooses a very engaging path. He tells the story through a series of intellectual biographies of the economists he most admires.
We read about his teacher Hans Sennholz, about Ludwig von Mises, F.A. Hayek and Murray Rothbard (his chapter on Rothbard is particularly celebratory). He covers James Buchanan and Gordon Tullock. Perhaps the most- interesting sections are the ones that find “Austrianness” in unusual places — in the work of Kenneth Boulding, for example.
In contrast to most books on economics, this book is very warm and humane. He goes all out to describe economics as the science of human choice in the real world. The prose matches his intellectual sense. We are spared the usual academic pomp and the absurdities of trying to cram people and their spontaneous decisions into mechanical models. He never talks down to his readers. This reader found no showing off, no strutting around, no defensiveness or bickering. The prose and line of thinking are open and generous.
It’s no surprise that the Austrian School is at the core of the narrative. This figures into his choice of biography, of course. And it informs the whole of his worldview, accounts for why he is able to write about real-world problems and explains the failure of planning in such lucid terms.
At the same time, Boettke cautions: “The main thing that makes someone an Austrian is not the willingness to identify one’s work with that label, but the substantive propositions in economics that an economist identifies with.” With this in mind, he shows that Austrian ideas are very more widespread that one might suppose.
In general, Boettke attempts to show that the profession has lost much of the arrogance that it practiced from the 1930s through the 1970s. While methodological positivism and mathematical hubris still exist in form, he attempts to show that the old ways have shifted toward a greater emphasis on institutions and human choice. He detects the rise of a certain humility in the profession, which has made way for a broader and more-eclectic approach that includes even radical libertarians like Boettke himself.
A book like this will provide anyone vast insight into what economics has to offer the world of ideas.
It is an excellent overview about what is great and what is awful in the profession today. But even when he criticizes, there is no anger; instead, there is conviction that openness and frankness is the best path to finding truth. I can’t think of a better good for an economics major to have on hand when the lecture content begins to depart from reality.
Regards,
Jeffrey Tucker
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Similar Posts:
This week, three seemingly unrelated stories hit the news.
Have you connected the dots? [Hint: The hidden link is gravity.]
First to the bear, which also featured in Monday's Daily Reckoning. It was tranquilised and fell out of a tree after being judged too close to a student housing complex:
Your editor's short lived career as a trapeze artist was equally elegant, but never received much attention from the global media. In fact, the bear has its own Facebook page and we don't.
Now on to the new drinking game being played in New Zealand. It's called 'Possum' and involves getting very drunk while sitting in a tree. You only stop drinking when you hit the ground. We're not sure how to win the game. Or why the tree is necessary in the activity. But consider it a metaphor for leverage - the use of debt to make things more exciting.
We submit to you that Australia's banks are the next thing to fall out of their tree. At least, the next thing to fall out of a tree that is in your vicinity. The banks are both cornered, like the bear was, and drunk, like the students at Dunedin Park.
Watch out below.
Why do we say that? Well, just like the black bear in Colorado, Australian banks strayed into places they shouldn't have been. And then got drunk on their exploits like the students up the trees. Maiden explains:
'Foreign loans taken out by Australian banks to fund their own lending accounted for 82 per cent of Australia's $521 billion net foreign debt load at the end of 2006.'
In other words, banks borrowed from far away places at low interest rates to lend locally at high rates. And on a large scale.
But one of the joys of banking is that debt has to be rolled over. Banks borrow for short periods of time and lend for long periods of time. That creates what's called a maturity mismatch. And taking on the risk of a maturity mismatch is part of the reason banks make a profit. It's a bet they will be able to find financing at agreeable rates.
But what's important here is that banks have to be able to refinance themselves regularly after committing to long term loans. If they can't source new cash at cheap rates, they become less profitable. If they can't source enough cash, they do a Lehman Brothers. Which causes the global economy to do a global financial crisis. Which causes governments to bail out the banks. Which causes governments to default.
Greece is at the default point in that cycle. Spain just decided to bail out a bank, and has plenty more to go. The US and UK are in between the two, having bailed out banks but not yet entered a sovereign debt crisis. Australia is at the beginning of the cycle - where the banks are about to get into trouble.
That's because the overseas sources of funds that allowed them to grow their lending in the early 2000s are in turmoil. Never mind why for now, we're focusing on what might be lurking in the trees above your head, not on the other side of the world. So those sources of funding aren't there anymore, creating a difficult situation for Australian banks. You've seen the symptoms plastered all over the media with newspaper editors demanding that the big four banks lower their interest rates in lockstep with the central bank.
That's something the banks were happy to play along with while their important sources of funding (from overseas) were low anyway. They created an illusion that banks follow the RBA because they profited from that illusion. Now that the relationship with overseas lenders is no more, and banks are having to finance themselves in the face of tougher funding conditions, it's time to make their customers pay up.
The issue isn't that bank funding has become more expensive. It's that it is normalising. Banks are now funding themselves locally more, and that means the interest rates that they borrow at and the rates they charge at are much closer together. There is less profit. But this change can't be allowed to happen because of what it would do to an economy used to cheap credit imported from overseas by the banks. An economy used to rising house prices and lots of spending. An economy with a housing bubble and massive amounts of private debt.
We'll put this simply because the world of banking is a little odd. Think of it like this. The banks used to import money from overseas, where it was cheap. Then prices there rose, causing banks to look locally for funding. But they are now fighting over a much smaller pool. That means less and more expensive funding, which gets passed on to you.
And that's where we are now. In a world where deposits, hybrid debt issuance and superannuation are the new, more expensive, sources of funding for banks. If the mention of Super made you choke on an orange pip too, get this from Maiden:
'... deposit funding would also require a restructuring of the $1.3 billion superannuation pool, to divert money from it to the banks.'
Do you smell a back door bank bailout in the making? Dan Denning made the case that there are big changes in store for Australia's retirement system in his newsletter Australian Wealth Gameplan. We reckon the powers that be are pondering the idea that governments should require an allocation of your Super to cash at a bank.
To get a window into the mind of those calling the shots, why not take a 30-day trial of AWG?
One last story to round off the metaphors and analogies for today's Daily Reckoning. Your editor lost his keys in the middle of the rather large Fawkner Park a few months ago. On the way home, the world seemed wonderful after a miraculous discovery of the keys in the dark. Then we got the fright of our life as a possum, not the drunk human kind, fell out of a tree right next to us. That's how quickly things can change. One moment everything is wonderful, you've narrowly evaded a global financial crisis because of your supposedly strong balance sheet. You're on top of the world, convinced of your own ability. And then - bam - out of nowhere a possum gives you a heart attack.
This is perhaps the most important lesson the armchair investor can learn. Things can happen very quickly - even if you expect them.
By the way, our three news stories have another similarity - they all end badly. Possum players in New Zealand were required to clean up after themselves by the University of Otago's so called 'Campus Watch'. And the same black bear who took the world by storm was taken out by two cars on a highway recently, two miles away from the university where it was tranquilised...after being relocated 50 miles away. So our question to you is, what are you doing again that you were doing in 2007? And does it involve the banks?
RIP Black Bear.
Until next week,
Nickolai Hubble.
The Daily Reckoning Weekend Edition
ALSO THIS WEEK in The Daily Reckoning Australia...
When Financial Markets Decouple From Reality
By Dan Denning
The cosy relationship between central banks and governments is responsible for this. The financial has become political. And currently, the political is a complete mess in Europe. Central banks used to just be responsible for the stability of the currency, but now they're responsible for the entire financial system. And because the financial crisis has torpedoed government finances and the economy, the entire system of free enterprise in the Western world has finally been supplanted by central planning.
How The US Military Is Sucking The Empire Dry
By Bill Bonner
A common view of what is going on - in order to be commonly shared - has to be stripped so bare of nuance and paradox that it ceases to be an idea at all. It is just a feeling. And sometimes, it becomes a grotesque, simpleminded fantasy that it is actually the opposite of the original thought or desire behind it. It becomes a zombie thought...actually harmful to the group that holds it.
Low Interest Rates Are A Dangerous Addiction!
By Satyajit Das
Low interest rates have become a panacea for economic problems. In part, this reflects the limited flexibility of governments to run budget deficits. This is driven by increasing scrutiny of public finances and the lack of willingness of investors to finance such deficits, as highlighted by the ongoing European debt crisis. But like all addictions, low interest rates are dangerous. They may be also ineffective in addressing the real economic issues.
Could The Revival of U.S. Manufacturing Mean China Has Lost its Edge?
By Chris Mayer
Even though labour costs have surged, one could argue they have not kept pace with the cost of living. "Food prices in China are ridiculous," Scott says. "It's a hell of a lot cheaper to live in the United States than it is in China if you equalize people's incomes. As a percentage of someone's income, the chunk for food is a huge line item there. Land prices have been skyrocketing everywhere. Apartment prices are through the roof. It is cheaper to live in the U.S." Remarkable, isn't it?
How Bailouts Encourage Bad Behavior
By Eric Fry
As we have observed time-after-time since the 2008 crisis, there is no economic downtick that is not simultaneously a call to action - a call to government action. Regrettably, most of these government actions address symptoms rather than the disease itself. They "cure" gangrenous limbs with Lidocaine rather than amputations. As a result, a smattering of politically connected banks and corporations feel better, but the overall economy remains deathly ill.
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They have been charged with the important responsibility of setting monetary policy… yet The Problem With The Reserve Bank is that their decisions are wrong more often than not!
With the Global Financial Crisis (GFC) four years ago has come a constant dribble of opinion and commentary. The more negative the story the more prominent the media features it.
I can put up with the nonsense we have had to listen to from Professor Steve Keen and those prophets of doom like him, but my greatest disappointment has been with the Board of the Reserve Bank of Australia (RBA) who have demonstrated repeatedly how to get monetary policy monumentally wrong.
Flashback to Early 2008In early 2008 the RBA (destructively) raised rates twice. Our economy was already slowing quickly after the rate rises of 2007 and this one caused it to swing too far the other way. Then Lehman Brother’s collapsed in the USA, triggering the GFC and the rest is history. The RBA scrambled to undo the damage by dramatically slashing rates in the latter part of that year; essentially admitting they had got their earlier decisions wrong!
August 2011 to May 2012 Interest Rate Decisions – WRONG!!!Maybe they could be forgiven for the events of 2008; although there were many reputable opinions at the time saying they were going too far… but what has transpired over the past nine months, in my opinion, casts a huge question mark over the role the RBA plays today.
Below is a copy of what I said ahead of the RBA Board meeting in February 2012 to decide whether or not to move interest rates that month. This exact copy is of my newsletter article on January 27th last, titled “February Interest Rate Prediction”.
“On Tuesday week the Reserve Bank of Australia (RBA) will meet for the first time since early December to decide what to do with interest rates. In my opinion it is not a matter of IF they put rates down again… but by how much. As I sit here right now I cannot think of any half-decent argument for keeping rates on hold so I’m predicting another drop. I’ll even go out on a limb and suggest that they should bite the bullet and drop them by 50 basis points (or a full half a percent). BUT… I do not believe the banks will pass the next rate cut on in full; making the argument for an even bigger rate cut (say 60 or 65 basis points) justifiable. What the RBA is more likely to do, however, is go beyond the usual 25 basis points in February (but not more than 50 basis points) and then when the banks don’t pass it all on to consumers… follow it up with another rate cut in March or April.
My disclaimer, however, is that while I have been consistently right with what SHOULD happen (as proved over time)… the RBA board doesn’t always ‘get it‘ at first. So let’s sit back and see what they do. Either way, I am again on the record for you to ‘judge’ over the months ahead.”
Now compare the above with what the RBA Board said after that February 2012 meeting when they left rates unchanged:
“At today’s meeting, the Board noted that interest rates for borrowers have declined to be close to their medium-term average, as a result of the actions at the Board’s previous two meetings. With growth expected to be close to trend and inflation close to target, the Board judged that the setting of monetary policy was appropriate for the moment.”
In my newsletter on 9th March last I was very critical of the RBA Board’s decision (yet again) to leave interest rates unchanged in March. Here are three quotes from their official statement to support their decision:
That reads to me like I was wrong! With the combined experience of the RBA Board members and their access to crucial data that we don’t have it is understandable that they did what they believed to be correct.
I could accept that… except that it was ‘blatantly obvious’ rates needed to come down earlier. You didn’t have to be an economist looking at fancy charts from behind closed doors… you just had to have some ‘economic street smarts’. Anyway, after the RBA Board last met (on 1st May 2012), after having changed course and cut rates by half a percent, they justified that decision by saying that “the economic outlook was not as good as they had thought three months ago”.
The above aren’t their exact words but are exactly what they essentially said.
In short… the RBA Board was wrong not to move on rates earlier in the year; as most economists now agree.
Get The Right InformationIf you and I are going to safely and responsibly navigate our way to prosperity, through the twists and turns that life will throw us along the way, we must be very careful who we allow to influence us. Just because someone has a degree, a fancy title and a fat salary does not make them right!
The seemingly small decision you make today will potentially have huge and lasting outcomes.
Happy Investing,
Nick Lockhart
Our Customer Care Program works for you… because investing is personal!
Convenience! Location, Location, Location!!!
Lutwyche sits on Brisbane’s leafy northern inner city fringe with a uniquely characteristic blend of inner city chic and elevated charm. Residents will take full advantage of walking proximity to the Centro shopping centre, cosmopolitan cafés and boutiques, the Kedron Brook bikeway and parkland sanctuary, and an array of easy transport options.
The Northern Busway is the next link into South East Queensland’s dedicated Translink Busway system which is due to open mid in 2012. This project is around the corner from the ‘state of the art’ new Lutwyche Bus Station which connects to both express and standard bus routes and also provides a safe pedestrian underpass of Lutwyche Road.
Brisbane’s CBD is just 7 minutes or 5 km away, whilst the vibrant artistic and cultural pursuits of Fortitude Valley are even closer. Immediate availability to the Royal Brisbane Hospital, the Clem 7 tunnel, Gold and Sunshine Coast and airport links, simplifies those journeys and enriches multiple options for unlimited leisure and rewarding work or play.
Brisbane’s newly emerging ‘northern inner city precinct’ is undeniably one to watch as a rapidly emerging cosmopolitan and commercial hub producing an inherently aspirational lifestyle.
Happy Investing,
Katrina Lockhart
Our Customer Care Program works for you… because investing is personal!
Conflicting data…what to believe?
Yesterday we received news that the Chinese economy is slowing much faster than expected. But then strong employment data indicated that Australia’s economy is still booming.
Is Australia… booming…or busting?
The boom part is employment. According to the Australian Bureau of Statistics (ABS), the national unemployment rate fell to 4.9%, the lowest level since the GFC. That’s the official version.
According to Roy Morgan research the unemployment rate in April was 9.3%. They say a further 8.2% of the workforce is underemployed.
The reason behind the big difference in unemployment rates comes down to definitions. Roy Morgan defines an unemployed person as one,
‘looking for work, no matter when. The results are not seasonally adjusted and provide an accurate measure of monthly unemployment estimates in Australia.’
The ABS on the other hand,
‘classifies an unemployed person as part of the labour force only if, when surveyed, they have been actively looking for work in the four weeks up to the end of the reference week and if they were available for work in the reference week.’
In other words, the ABS doesn’t count those who have given up looking for work as unemployed. They refer to such people as ‘marginally attached’ to the labour market.
Whatever the case, employment data is a lagging economic indicator. It doesn’t really tell you what’s coming.
Chinese trade data doesn’t tell the future either but yesterday’s numbers were horrible. Year-on-year import growth was just 0.3% for April. The market expected 11% growth. So much for the Chinese consumer coming to save the world.
Of course, it’s only one month’s data. But Chinese households are the most financially repressed in the world. The government has siphoned their wealth by holding down the currency and interest rates. The fruits of their labour have flowed into China’s record FX reserves.
Don’t bet on the Chinese consumer anytime soon.
Things are getting interesting, dear reader. Economic reality is once again triumphing over central banking hubris. Expect the calls for more money printing to grow louder…
Regards,
Greg Canavan
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
US investment bank JP Morgan has dusted $2 billion on synthetic derivative positions since March 31. According to the company, the Chief Investment Office’s ‘hedging’ strategy gone wrong will result in a net income loss of around $800 million for the corporate division.
Back in April, Bloomberg reported that:
‘JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon has transformed the bank’s chief investment office in the past five years, increasing the size and risk of its speculative bets, according to five former executives with direct knowledge of the changes.
‘Achilles Macris, hired in 2006 as the CIO’s top executive in London, led an expansion into corporate and mortgage-debt investments with a mandate to generate profits for the New York-based bank, three of the former employees said. Dimon, 56, closely supervised the shift from the CIO’s previous focus on protecting JPMorgan from risks inherent in its banking business, such as interest-rate and currency movements, they said.
‘Some of Macris’s bets are now so large that JPMorgan probably can’t unwind them without losing money or roiling financial markets, the former executives said, based on knowledge gleaned from people inside the bank and dealers at other firms.’
‘Former employees’ are a great source of information. Their version of events is usually much closer to the truth than the official line trotted out in conference calls. JP Morgan says the role of the Chief Investment Office (the unit responsible for the losses) was to hedge the banks positions. That is, reduce risk. Commenting on the loss, the bank said:
‘This portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the firm previously believed.’
But the hedging explanation doesn’t stack up. There’s much more to this story than meets the eye. When Bloomberg broke the story of JP Morgan’s huge derivative exposure back in April, the bank panicked. Here’s what Bloomberg said back in April:
‘Bruno Iksil, a London-based trader in Macris’s group,’ (Macris is the head of the bank’s Chief Investment Office – Ed) ‘gained attention last week after moving markets with his trades, drawing a comparison to Federal Reserve Chairman Ben S. Bernanke’s power in the government-bond market.
“What Bernanke is to the Treasury market, Iksil is to the derivatives market,” Bonnie Baha, head of the global developed credit group at DoubleLine Capital LP in Los Angeles said…’
It appears that JP Morgan subsequently tried to de-risk the portfolio, with disastrous consequences. Also, volatility has picked up recently, which has probably made matters worse.
The much more likely explanation is that JP Morgan’s ‘Chief Investment Office’ is (or more likely was) a proprietary trading desk for the company. In other words, it punted shareholder funds on derivatives to boost profits. Or maybe it wasn’t using shareholder funds at all…?
All the action occurred out of the London office.
Why London?
London is the place to be if you want to use other people’s money to make money for yourself. Remember MF Global? The source of its problems and the reason behind its eventual bankruptcy stemmed from MF Global’s London office.
How do you use others people’s money for your own benefit? The process is known as ‘re-hypothecation’, and London is the centre of the universe for re-hypothecated trades.
According to Wikipedia:
‘Re-hypothecation occurs when banks or broker-dealers re-use the collateral posted by clients such as hedge funds to back the broker's own trades and borrowing.
‘In the UK, there is no limit on the amount of client assets that can be rehypothecated, except if the client has negotiated an agreement with their broker that includes a limit or prohibition.’
That all sounds a bit heavy for a Friday. But there is something going on here. JP Morgan’s operations straddle the world of banking…and the far murkier world of ‘shadow banking’. Shadow banking is where investment banks, hedge funds, leverage, repos and hypothecated assets all come out to play.
We don’t pretend to understand it all. But it’s crucially important to the global economy. We’ll be digging deeper into the issue in the weeks to come. Stay tuned…
Regards,
Greg Canavan
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
"The only real force that ultimately makes the stock market or any market rise (and to a large extent, fall) over the longer term," writes analyst Kel Kelly, "is simply changes in the quantity of money and the volume of spending in the economy. Stocks rise when there is inflation of the money supply (i.e., more money in the economy and in the markets)."
You'll recall, Dear Reader, that we are getting suspicious of GDP. As we said yesterday, it measures how fast the wheels are spinning; it doesn't tell you if you are getting anywhere.
What happened over the last 30 years in the US? Money...funny money from the feds...was causing the wheels to spin faster and faster. But the economy got nowhere...
...except deeper in debt.
Yes, the phony money caused people (many of them in Japan and China) to produce more stuff.
And, oh yes, it shifted money from the middle classes to the rich, by increasing the relative value of their investments 13 times...while simultaneously holding real wages flat.
Ken Gerbino explains it in another way:
It is the paper money created out of thin air that creates the unfair distribution of wealth that is making the middle class fall more behind and the poor more poor. Newly created money and credit in a paper money system benefits those that can access the money first and buy capital goods and real property...before the new money circulates and makes all prices go up. Wages also do not keep up with the inflation and that creates another squeeze on the middle class...the bottom 90% of our citizens went from owning a big piece of the income gains (65%) in the 1960s to being squashed in the 2002-2007 period to 11%.
Now, the feds have the voters where they want them. Forty-six million on food stamps. And millions more dependent on federal handouts... Most people can't afford to oppose the government. They need it to eat. The Week reports:
"Over the last three decades, annual spending on the top federal programs for the poor and near-poor - such as Medicaid, food stamps and Pell grants - soared from $126 billion (in inflation adjusted 2011 dollars) to $625 billion. Today, the average poor person receives $13,000 in federal aid, up from $4,300 in 1980. Programs that transfer wealth to the middle classes are even more massive, with Social Security consuming $725 billion last year and Medicare $560 billion. All told, the US spends nearly $2.1 trillion on social programs, 60% of all federal spending."
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Reckoning today from Baltimore, Maryland...
Gold down below $1,600! Is the bull market in gold finally over?
Nah...let's change the subject.
Today, our hearts go out to the poor 1%...
Yes, dear reader, they're blamed for the crisis...
They're reviled, calumnied, and criticized...
They're hunted by the tax men...
And now they are being shunned by the very institutions they most wanted to get to know.
Bloomberg:
US Millionaires Told Go Away as Tax Evasion Rule LoomsThat's what some of the world's largest wealth-management firms are saying ahead of Washington's implementation of the Foreign Account Tax Compliance Act, known as Fatca, which seeks to prevent tax evasion by Americans with offshore accounts. HSBC Holdings Plc (HSBA), Deutsche Bank AG, Bank of Singapore Ltd. and DBS Group Holdings Ltd. (DBS) all say they have turned away business.
Renato de Guzman, chief executive officer of Bank of Singapore Ltd., said in industry meetings of private bankers he attends in Singapore, not accepting US clients is "quite a prevailing sentiment".
"I don't open US accounts, period," said Su Shan Tan, head of private banking at Singapore-based DBS, Southeast Asia's largest lender, who described regulatory attitudes toward US clients as "Draconian."
The 2010 law, to be phased in starting Jan. 1, 2013, requires financial institutions based outside the US to obtain and report information about income and interest payments accrued to the accounts of American clients. It means additional compliance costs for banks and fewer investment options and advisers for all US citizens living abroad, which could affect their ability to generate returns.
Most offshore hedge funds will no longer take US clients. Overseas banks don't want their money either.
Why? Because there are over 400 pages of new regulations in the FATCA legislation. Way too much for a sane person.
Everybody wants to tax the rich, investigate them, crucify them...
But what did they do wrong?
In 1970, the top 10% of California's taxpayers paid 28.2% of all the personal income tax in the state. Who complained? They were pulling their weight. Paying their fair share.
Now, 78% of all California's personal income tax comes from these "rich" people.
But what, exactly, happened between 1970 and 2010 that shifted so much wealth and so much tax burden to the top earners? As you can see, it wasn't just cutting their taxes - they're paying more now than ever.
So what happened?
The whole system changed. Richard Nixon cut the dollar loose from gold. He may not have upset the world, but he changed the US economy. Instead of being an economy based on real money where real savings and real production increased real wages and profits, it became a smoke and mirrors economy...with money that you couldn't trust...GDP growth that was largely phony...and zero real growth in wages.
From the '70s to 2012, US stocks - measured by the Dow - rose more than 13 times. From under 1,000 to over 13,000. Here's a question: how could America's companies be so much more valuable...when their customers hadn't gotten a penny richer?
Follow the money. From 1970 to 2008, the US money supply (M-2) grew from $624 billion to $8.2 trillion. Guess how much that is. It's 1,314% - almost the same as the Dow.
The feds have the rich where they want them. They're now pariahs...all over the world. Nobody wants them. Nobody likes them. Banks won't touch their money.
Now, the feds can squeeze them for campaign contributions and tax money as hard as they want.
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Reporting from Buenos Aires, Argentina...
I gave a letter to the postman,
He put it in his sack.
Bright and early next morning,
He brought my letter back.
- "Return to Sender", lyrics by Otis Blackwell and Winfield Scott
This just in: The state still sucks at delivering the mail. Shocker!
According to news across the wire...
(Reuters) The US Postal Service said its loss widened to $3.2 billion in the first three months of 2012 and repeated on Thursday its warning that it will likely default on payments to the federal government unless Congress passes legislation offering some relief.
"Of course sales are down," we hear a few reckoners contest, "nobody uses snail mail anymore. It's all email today. And Tweets and Facebook 'likes' and LinkedIn networking. Sheesh... Get with the times!"
Ah, but we are with the times. You're receiving this in electronic format, aren't you? Besides, FedEx isn't in the email business. It still delivers packages. And its sales for the quarter ending February 29 were, at $521 million ($1.65 per share), more than double sales for the same quarter of last year - $231 million ($0.73 per share). And that, despite the fact that volume in its US express business slumped 4%.
Profits were up for UPS too, though not by as much. Net income for the world's largest package company rose to $970 million, or $1 per share, from $915 million, or 91 cents per share from the same period last year. Revenue rose 4.4% to $13.14 billion.
And yet, the United States Postal Service can't manage to balance a budget. USPS enjoys a "statutory monopoly" on non-urgent First Class Mail and the exclusive right to put mail in private mailboxes. (No joke!) Yet it bleeds money like no privately-owned business ever would...or even could. Why is that?
American individualist anarchist and proud owner of one of history's coolest beards, Lysander Spooner, thought he knew the answer to this question 150 years ago. Put simply: It's the government, stupid!
Postal rates were notoriously high during the 1840s, a direct result, thought Spooner, of the USPS's aforementioned monopoly status. Why charge less when there is no competition? Nobody's going to undercut you...at any price. Similarly, why bother to offer better service? Nobody's going to siphon off your customers. You're the only game in town!
In response to the outrageous rates and abysmal service, Spooner set about opening his American Letter Mail Company. He argued that the constitution (with which he didn't necessarily agree on many issues), granted the government powers to establish mail...but not to exclude others from entering the marketplace too.
"The power given to Congress, is simply 'to establish post-offices and post roads' of their own, not to forbid similar establishments by the States or people," wrote Spooner in his 1844 pamphlet, The Unconstitutionality of the Laws of Congress, prohibiting Private Mails.
Pressing on the issue of unnatural, coercive monopolies, he later continued...
"The idea, that the business of carrying letters is, in its nature, a unit, or monopoly, is derived from the practice of arbitrary governments, who have either made the business a monopoly in the hands of the government, or granted it as a monopoly to individuals. There is nothing in the nature of the business itself, any more than in the business of transporting passengers and merchandise, that should make it a monopoly, either in the hands of the government or of individuals."
Spooner's pamphlet was published the same year his American Letter Mail Company went into business. The company had offices in Baltimore, Philadelphia and New York among other cities.
Of course, Spooner's analysis of the market for mail wasn't restricted solely to ethical grounds. He saw what all good businessmen see when they decide to go into business...an opportunity to profit, in this case born by the dismal service and high prices of USPS mentioned above. The market - defined as the individuals acting within it - was crying out for a competitive alternative to USPS. And Spooner gave it to them.
His mail company significantly reduced the price of stamps, undercutting the government's 12-cent standard, and even offered free local delivery on some routes. Hooray for faster, cheaper mail!
Of course, the government doesn't like competition. It's bad for "business." That's why it maintains and enforces a self-granted monopoly on things like counterfeiting and putting people in cages. (Don't believe us? Try inking your own dollars or kidnapping your neighbor because he didn't give you a portion of his annual income.) And so, after years of fines and state-sponsored assaults on his enterprise, Spooner was finally forced out of business in 1851.
But the story of Spooner and his American Letter Mail Company is not entirely a sad one. True, the government forced him out of business by leveling against him unpayable fines for breaking (fundamentally unconstitutional) "laws." And yes, it forced him to shutter operations before he had the opportunity to fully litigate his own constitutional claims. But the joke is surely on the practically bankrupt USPS, which continues to run at a loss even now, a century and a half on.
Moreover, Spooner's company proved what many at the time already knew: that the government is no match for private enterprise, neither in offering competitive prices and services or for being able to read and respond to the real world demands of the market. (Interestingly, USPS actually ended up offering a 3-cent stamp in direct response to the challenge from the American Letter Mail Company. Though with Spooner out of the way, it was short-lived.)
Perhaps most importantly, Spooner taught us to always question unnatural authority, rather than simply accepting the limits it forever seeks to impose on us. And, thanks to his example, the next time someone trots out that tired old line, "Yes, but who would provide X service (roads, schools, whatever) if not the government?" you can simply answer them, "Anarchists would, my good sir...anarchists just like Lysander Spooner."
Regards,
Joel Bowman
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Whether or not you realise it, You Are The Architect Of Your Life – relationships, health, finances etc.
Your environment matters because it shapes your beliefs and they in turn determine your actions… which ultimately produce the life you are heading towards.
As you would probably advise your kids… be careful about who you listen to and hang out with!
Today we take up the challenge of the art of stock valuation in a world of monetary madness. We’re already a few years into what’s probably going to be a prolonged bear market. As often happens in bear markets, the general consensus is that the ‘rules have changed’. Long term investing — and value investing — apparently don’t work any more. You need to be nimble and trade in and out of markets…ride the momentum…ride the Fed’s liquidity wave.
Maybe that will work for some, but for the vast majority it will end in tears. Trying to second guess the short term moves in the market is a game for pros…and even then it reduces many of them to a nervous wreck after a few years. With increased central planning across the world’s economy, second guessing the timing of the moves of power hungry central bankers and politicians is a tough ask.
Investing in the Value of a BusinessThe beauty of value investing lies in its simplicity. The basic premise starts with the fact that you’re investing in a business…not a stock price. While the stock price responds to a hundred different things — both real and imagined — on a daily basis, the value of a business changes far less rapidly.
The value investor thinks in terms of an operating business, not a stock price.
The Financial and the Real EconomyBefore we move on to the art of valuing a business, we want to address the connection between the financial and the real economy. The financial part of the economy, beginning with central banks and then commercial banks, creates money and credit, which flow like tentacles out through the real economy (operating businesses that employ people).
In a normal, functioning economy, newly created credit increases the money supply. If it flows smoothly, it increases (in aggregate) revenues, wages, profits, taxes etc. Companies, by offering products or services that people want, capture some of this newly created credit via increased revenues…and hopefully profits. The longer a credit boom lasts, the more a company benefits.
This is what happened in the lead up to the 2007 credit bust. Global credit growth was out of control. Many companies were making hay, and analysts thought the boom would go on forever. They believed credit would keep increasing and company profits would keep growing at healthy rates.
In 2007, the global credit bubble burst. Thanks to central banks, the supply of credit remains abundant. But demand, having been brought forward by prolonged low interest rates, is weak. No one wants more debt. Housing booms — and subsequent busts — all over the developed world helped to diminish demand for more household credit. And while banks still lend to the ‘real economy’ they do so at high rates.
So the flow of credit has slowed. This means revenues, wages, profits and taxes will not grow anywhere near the rates you were accustomed to in the credit boom era. And it means slower earnings growth for most companies…and lower profitability.
That explanation is all in the ‘aggregate’. The ‘aggregate’ works for economists trying to fit a complex world into a model, but it masks reality. The reality is that there are winners and losers in credit booms and busts. And obviously in a credit depression there are many more losers.
So what does this mean for company valuation? In very basic terms it means you can expect the market to trade on a price to earnings ratio closer to 10 or 12 times rather than the often quoted ‘normal’ level of 14 to 15 times. In other words, for a given level of earnings the market will trade 20-30% lower than ‘normal’ because of low growth expectations. This is how a bear market works.
But when looking at individual securities, valuation is not as simple as picking stocks with low price–to–earnings ratios and high dividend yields…or stocks trading at a discount to book value. Many cheap stocks deserve to trade ‘cheaply’ because they are bad companies. And when you really look into it, they might not be cheap at all.
Value Investing the Warren Buffet Way
This is where Warren Buffett and Charlie Munger have probably made the greatest contribution to value investing since Ben Graham. Through the many years of writing annual letters to Berkshire Hathaway shareholders, they have provided value investors with a logical framework to calculate the intrinsic value of a business.
Armed with this knowledge and Ben Graham’s concepts of Mr Market (the bloke who turns up every day and offers you a price — completely unrelated to the value of the company — for your shares) and a Margin of Safety, Buffett and Munger have compounded their way to astronomical wealth.
So how do they go about valuing a business? They look at just a few things. The return on equity (ROE) that the business generates, the equity value of the business, and the discount rate, or required rate of return. If you have these variables you can basically value a business.
Breaking Down Value InvestingLet’s look at each of these things in turn. The equity value of a business is the capital injected into the business by its owners. You can find the equity amount of any listed company by looking at the bottom of a balance sheet. The equity is what’s left over after you deduct liabilities from assets. This is also known as ‘book value’.
Importantly, the equity is what you as a shareholder buy when you purchase a company’s shares. You are buying a small portion of the company’s equity — hence the term equity market.
Once you know the equity value of the business, you need to know how profitable it is. That is, you want to know what the return on that equity is. There are a few ways of calculating this, but to keep it simple it’s just net profit divided by the equity value.
Now the discount rate or required rate of return comes into play. This might sound a bit arcane, but the discount rate underpins the whole discipline of corporate finance and company valuation. It’s the interest rate used to ‘discount’ a company’s future cashflows or profits back to a present value.
In practical terms, it’s the interest rate you require to invest in a company or asset. If you demand a high rate of return, you must pay a very low price to achieve that return. If you’re happy with a low rate of return you implicitly accept paying a higher price.
Most investors don’t understand this relationship. That’s why ‘buying high’ always generates a poor long term return. Buying low implicitly says you have a high required rate of return.
Now let’s put it all together. If a company’s ROE is 50% and your discount rate is 10%, you can pay up to five times the company’s equity (or book) value to achieve your required rate of return (50/10).
So in this case the company’s intrinsic value is 5x book value. If the market price is 10x book, then you’re implicitly accepting a return of 5% from the investment. If the market value is 2.5x book, then you’re implicitly accepting a 20% return on your investment. In the words of Ben Graham, at this price you’d be buying with a ‘margin of safety’.
There are a few things to note though. This example assumes the company pays out all earnings as dividends. The calculation is a little different for companies that retain (and therefore compound) earnings. It also assumes the company can sustain a 50% ROE. Not many companies can do that.
That’s why Buffett buys stocks that have extremely reliable earnings. It means that the ROE variable won’t change too much and his estimate of intrinsic value will be sound. Changes in a company’s ROE have a big impact on value.
The other thing to note is that the required rate of return has nothing to do with the stock market. It’s the return the business will generate for you over the long term if you have correctly estimated its profitability. Over the long term the market should deliver the same return as the business. But in the short term — as you know — the market can do anything.
Regards,
Greg Canavan
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Reckoning today from Baltimore, Maryland...
No panic on Wall Street - yet.
But watch out. Our hunch is that when people come to their senses...they will run for the exits.
Europe's shifting from austerity to "growth"...which really means more debt.
US GDP growth is phony - with fewer US jobs today than when the '08 recession began.
More people are below the poverty line. More people on food stamps. And more people so broke they can't even go broke. CNN Money reports:
This year, hundreds of thousands of Americans are expected to be too broke to file for bankruptcy. The average cost to file for Chapter 7 bankruptcy protection, the most common form of consumer bankruptcy, is more than $1,500, according to recent research submitted to the National Bureau of Economic Research.As a result, anywhere between 200,000 and one million consumers are estimated to be unable to afford that steep cost this year.
The research, conducted by a group of professors from Columbia University, the University of Chicago and Washington University in St. Louis, examined how bankruptcy filings spiked after people received their tax rebates in previous years. They estimate that another 200,000 consumers, who would otherwise not have enough money to file, will use their tax refunds to pay for bankruptcy this year.
"For lots of people, bankruptcy has been taken off the table as an option because of the severe fees involved," said Jialan Wang, co- author of the report.
And here comes the critical insight:
"It becomes harder and harder to pay off the debt as interest payments get higher, so your debt grows larger and larger," she said.
Hey, somebody should mention this to the world's central banks. And to Paul Krugman. And Larry Summers. And Ben Bernanke himself.
They think the key to solving the world's financial problems is more spending...more debt and more "growth." But you know they can't really give the world more growth. Real growth requires real investment, real output, real risk, skills...customers with money...and all the rest. All they can really give the world for sure is more debt. Which is exactly what the plan is.
More debt is certain. Growth is unlikely...except in the ersatz version.
Thanks to LTRO, QE and the Twist the feds are really not borrowing money at all. They're printing it. So, you might say that printing money is a debt-free approach to growth. Except that even dollar bills are debt instruments. They are "notes" from a bank of zero maturity. You can cash them in at any time. Of course, all you'll get are more paper notes. Which just goes to show how silly the whole system is.
The trouble with the folks who are too broke to go broke is that they don't have enough of those paper notes. If they were a major bank...or a national government...they could get more of them, just by asking. The Fed would print them up "out of thin air."
They might as well do the same for the small deadbeats too. Why not? The paper money doesn't cost them anything.
But today we've got more important things on our mind that the problems of America's poor people. We're thinking about growth itself...
The guy who drives out to the neighbourhood bar, spends all night drinking, and then drives back home...stimulates GDP growth. Better yet, he crashes his car on the way home. Then, he is a real hero to the economy. He has to buy another car.
The poor sap who stays at home is a drag on growth.
The fellow who goes to McDonald's night after night rather than cooking his own burgers...the fellow who leaves his window open with the air-conditioning running...the fellow who hires a lawn service company rather than cutting his own grass...the man who borrows money to finance a house or a vacation - all of them add to the GDP growth.
Want to increase GDP? Want growth? Let's cut each other's lawns. Let's get others to wash our clothes...and clean our houses. Let's make gadgets, geegaws and other worthless paraphernalia and sell them to each other! Get the housewives into the labor force. Give jobs to teenagers. Don't do anything for yourself.
The guy who plants his own garden...who cuts his own firewood...who fixes his own roof - he is a traitor to the economy. He needs to get another job...borrow money...burn more gasoline...to buy more stuff...!
Doesn't he know the US needs growth?
The trouble with GDP growth is that it only tells you how fast the wheels are spinning. It doesn't tell you if you're getting anywhere.
Turns out, more and more people are shirking their patriotic duty to waste money; they're betraying the economy that supports them.
A report a few weeks ago told us that young people have fallen out of love with the automobile. They buy fewer of them. They drive less. They consume less fuel, less oil, less gasoline.
That certainly won't help growth. And neither will people without jobs. There are, officially, 13.3 million of them. And 29% of them have been unemployed for a year or more. Can't get much growth that way.
And what happens after you've been jobless for a year or more?
The Washington Post calls it the "incredible shrinking labor force." People in the work pool are drowning before they are rescued.
If the same percentage of adults were in the workforce today as when Barack Obama took office, the unemployment rate would be 11.1 percent. If the percentage was where it was when George W. Bush took office, the unemployment rate would be 13.1 percent.That helps explain a seeming contradiction in the unemployment numbers - the rate keeps dropping even though job creation has been soft.
In April, the US economy added a mere 115,000 jobs, according to Bureau of Labor Statistics data released Friday. In a normal month, that would not even be enough to keep up with new entrants into the labor market. But in this economy, it was enough to drive unemployment from 8.2 percent down to 8.1 percent, the lowest point since January 2009.
The explanation is a little-watched measure known as the "labor force participation rate." That tracks the number of working-age Americans who are holding a job or looking for one. Between March and April, it dropped by 342,000. But because the official unemployment rate counts only those workers who are actively seeking work, that actually made the unemployment rate go down.
In February, the Republican National Committee released a research note on "The Missing Worker," arguing that "over 3 million unemployed workers have called it quits due to Obamanomics."
Economists say the story is considerably more complicated. For one thing, the trend predates President Obama. And while part of the story is clearly that the labor force is shrinking because the bad economy is driving workers out, another significant factor is that baby boomers are beginning to retire early - a trend that has worrying implications for future growth.
A smaller workforce means less growth!
We added the exclamation point. Less growth. The wheels are slowing down. This could be a disaster, right?
So, fewer people working means less GDP...less growth. So what?
More tomorrow...and more on the Pentagon going rogue, too.
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Nothing excites Australians like house prices and mortgage rates. It is no surprise, therefore, that the recent decision by major banks to increase interest rates 'outside the cycle' - that is independently of the Reserve Bank of Australia (RBA) - has led to hyperventilation among consumers and politicians.
The major driver is the rising of the banks' own funding costs, which have increasingly become decoupled from the RBA-set official cash rate.
According to the RBA, the cost of senior unsecured bank debt has risen by around 1.85% per annum over inter-bank money market rates, up from an average of 1.27% per annum in June 2011. The cost has eased somewhat from its recent high of 2.23% per annum in late December 2011 and early January 2012. The banks' cost of secured borrowings, such as covered bonds (collateralised by residential mortgages) is also high; between 1.70% and 2.20% per annum over the relevant money market rates, depending on whether it is issued in the domestic or international market.
Current borrowing rates compare to average margins of around 0.15-0.25 % per annum paid by the banks prior to the commencement of the global financial crisis (GFC) in 2007.
The higher rates reflect tighter global liquidity conditions, a structural change likely to persist.
High borrowing costs reflect general risk aversion where investors demand and receive higher compensation for bank risk. It also reflects the higher costs of hedging foreign currency borrowing into Australian dollars. These factors may also persist for some time.
Bank borrowing costs are also affected by regulations introduced in the aftermath of the GFC to improve the solvency of the banking system.
New liquidity controls, being phased in by global banking regulators, including the Australian Prudential Regulatory Authority, require banks to hold more liquid assets such as government bonds to minimise liquidity risk - an inability to raise money to meet sudden withdrawals or repay maturing borrowings. In addition, the new regulations favour banks with a higher level of retail deposits as a proportion of their funding.
This has led to aggressive competition among Australian banks for retail deposits, forcing up the cost. The average term deposit rate for major Australian banks has not fallen in line with decreases in the official cash rate and remains above that for equivalent wholesale funding.
The new regulations also require banks to hold higher levels of shareholder's funds, further increasing their costs. Compliance costs, under new regulations, will also increase.
Given that the cost of funding has gone up as a result of largely uncontrollable external factors, the real question is how these additional input costs are to be allocated. Increasing borrowing rates to pass on the higher cost of funding, penalises borrowers but rewards depositors and shareholders. Absorbing the higher cost of funding by maintaining or reducing lending rates rewards borrowers but punishes depositors and shareholders.
As many Australians are simultaneously borrowers, depositors and bank shareholders (either directly or indirectly through their superannuation savings), the appropriate allocation is unclear.
Australian banks could maintain mortgage rates but increase business lending rates to preserve profits. They could ration mortgage lending to minimise the effect of lower margins on their profitability. These actions may decrease business profitability and investment or reduce the supply of housing finance. In turn, this may reduce economic growth and employment opportunities, indirectly leading to lower house prices.
Critics point to the profitability of Australian banks. Absolute profitability levels are misleading as banks require substantial amounts of capital to operate. Measured using a more appropriate metric such as return on capital invested, Australian banks earn around 15% per annum. This is among the highest in the developed world, although down from the peak levels above 20% prior to the GFC.
Martin Wolf of the Financial Times described banking as 'a risk-loving industry guaranteed as a public utility'. As evidenced by government support during the GFC, this is as true of Australian banks as their overseas peers. If society and governments wish to control banks and limit profitability, then it requires a different debate and extensive re-regulation of the banking system rather than arbitrary interference in the process of setting rates.
The high level of angst is disproportionate to the modest nature of the increases. It highlights a different problem - high levels of consumer debt and their vulnerability.
Between 1991 and 2011, Australian household debt rose from around 49% to 156% of disposable income. In 1989, when mortgage rates were 17%, the ratio of interest payments to disposable income was 9%. Currently, despite the fact that mortgage rates are around 7.5%, the ratio has increased to around 12%, making borrowers sensitive to small changes in borrowing costs.
Australian housing is already heavily subsidised, through direct transfers (the first home buyers schemes), stamp duty exemptions, preferential taxation treatment of capital gains and favourable banking regulations which encourage mortgage lending via lower capital charges. Further assistance by artificially manipulating mortgage rates is difficult to justify.
Regards,
Satyajit Das
for The Daily Reckoning Australia
© 2012 Satyajit Das All Rights reserved.
Satyajit Das is the author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011)
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
“You know the trouble with your writing lately is that you take everything so seriously. You should relax. You've been in Australia what...almost seven years now? Get in the spirit of things. Lighten up. Nobody really cares about this stuff. And besides...it's the same as it ever was...people are greedy...politicians lie and cheat...the rich are selfish...everyone wants a free lunch. Blah blah blah. That's just life. There's no story there. It's definitely not news. I'll buy you a beer and you can forget all about it.'
That's the advice we received from a friend last night. We were discussing Wayne Swan's budget. It's a subject we've deliberately avoided in the Daily Reckoning owing to the utter tragedy and absurdity of the whole premise. But we'll give in today and provide you with our very own budget analysis.
To be honest we can hardly bring ourselves to say anything about it. The surplus will only be real if GDP growth hits the right targets, commodity prices fall at the expected rates and unemployment remains at the projected levels. Change any of those assumptions and chances are the surplus will vanish.
No matter how good the beer is, we find it hard to relax about this.
But really, that's not what's demoralising about the whole thing. There are several demoralising aspects, if we're honest. The first is how much media attention it receives. 'The budget' is a big deal. That shows you what life is like in a cradle-to-grave Welfare State where everyone gets a handout. The Statist mind finds it impossible to believe that some people could get along in life without the ham-fisted intrusions of the government telling us what to do.
By far the most demoralising aspect, though, is the sheer lack of imagination and faux moral outrage of the people wanting to distribute other people's money more 'fairly' in the name of compassion. This is always the ultimate justification for the expansion of the State in your life: because it's the right thing to do and anyone who disagrees is greedy, selfish, and less compassionate. Harrumph.
What a bunch of moral grandstanding.
It's possible to imagine a world in which the disadvantaged and the vulnerable are taken care of by neighbours, families, charitable institutions and the communities in which they live. Just because you don't support higher taxes and wealth re-distribution doesn't mean you're FOR human suffering and misery.
But oh well. You can't fight City Hall, and apparently you can't fight the ceaseless expansion of the Welfare State. We seem to live in a culture where we're all happy to get something for nothing as long as someone else is paying for it. Sooner or later we're all going to find out that nothing's ever free. In the meantime, we're going to take our mate up on that beer.
Regards,
Dan Denning
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Before you continue with today's Reckoning, do yourself a favour and watch Murray's stock market updateon YouTube from yesterday. The Slipstream Trader points out that the ASX/200 staged a 'false break out' on Friday around the 4416 level. If you're unfamiliar with his theory of price action, that means the new high isn't a bullish signal but a 'false' signal.
Murray reckons the first stop on the correction to the point of control at 4200 is the 50-day moving average at 4300. That's been taken out with this morning's opening. Next stop, 4200. And if things get really bearish, look out for the bottom of the distribution at 4050. For the full story watch the 14 minute analysis here.
That's the price action. What happened overnight to confirm the trend? Well, the Greeks are at it again. The €197 billion Greek bailout negotiated between the 'troika' of the IMF, the EU, the ECB and the major Greek parties should be 'null and void,' according to 37-year old Alexi Tsipras, the leader of the Coalition for the Radical Left that did so well in the weekend parliamentary elections.
Cue more political uncertainty for financial markets. But to be honest, it's getting harder to tell the difference between politics and finances these days. The cosy relationship between central banks and governments is responsible for this. The financial has become political. And currently, the political is a complete mess in Europe.
Central banks used to just be responsible for the stability of the currency, but now they're responsible for the entire financial system. And because the financial crisis has torpedoed government finances and the economy, the entire system of free enterprise in the Western world has finally been supplanted by central planning. All the resources of the nation get directed to the State where they are to be taxed, allocated, or otherwise redistributed by the very smart people we elect.
What a great racket this whole deal turns out to be for financial institutions. You can borrow from virtually any global central bank at near-zero rates and then buy government bonds yielding, say, 2%. It's free money!
It's also the trade you make if you're a big firm terrified of the euro. The chart below shows what we mean. Yields on 10-year US Treasury notes are trading just above their record lows from September of last year. In other words, investors are so nervous about what's going on in Europe that they're willing to loan money to the US government for 10 years at 1.88% interest! What kind of rational person or firm would do this?!
The consolidation of global liquidity in the coming bond market Stalingrad
Well, obviously the concentration of cash in Treasuries makes sense if you don't want to be in cash and don't want to be in Europe. But let's call it what it is: a massive concentration of assets in a dwindling number of asset classes. To us, it's akin to capital being conscripted in the US government instead of being free to go do other work, like start a business.
If anything, this is a reminder of one of the biggest drawbacks to being a debtor country. When you borrow short term (the maturity schedule of your debt shifts to the short end of the yield curve) it becomes very interest rate sensitive. For now, this is great news for the United States government. It can run $1.5 trillion annual deficits...and investors can't get enough of the stuff being issued by the Treasury Department!
But at higher rates, the interest on the debt becomes an albatross on the economy. Interest rates do move up, from time to time. But that is another story for another day.
For today, we want to make the point that financial markets have all but decoupled from reality. The manipulation of interest rates has completely distorted prices. If prices don't communicate useful information anymore, markets aren't markets. They're just...vehicles for transferring money from one party to another...from the suckers to the Madoffs.
Getting back to yesterday's topic of barbaric gold vs. Charlie Munger's productive businesses, how is it possible to invest in productive businesses when the financial system has been completely compromised and overtaken by a dynamic which doesn't allocate capital but only funds deficits and profitable trades for investment banks? This isn't just a dysfunctional market. It's a complete farce.
It all goes back to what Benjamin Graham, the godfather of value investing, wrote about buying stocks with a 'margin of safety'. Graham wrote that when a stock's price is below the intrinsic (book) value of the shares, the difference is your 'margin of safety'. You're getting the liquidation value of the business at a discount. It doesn't guarantee you won't lose money on the shares (price and value being different things being a good start).
Warren Buffet and Charlie Munger took this one step further and said you can look beyond book value to a return on equity. They looked for book value. But the real goal was a business that could sustain high returns on equity over time.
When it comes to that, some businesses are better than others. Some managers are better than others. And some investors are better at spotting good businesses run by good managers than others - at least that is the proposition behind Berkshire Hathaway, as far we understand it.
The trouble today, as we see it, is that share prices have been hijacked by this evolution in the relationship between the financial sector, central banks, and governments. You might think you're buying a good business at a good price, but if we don't live in very enterprising times with real markets, what good is it to do the hard work of valuation?
This is a question we'll leave with our colleague Greg Canavan to take up tomorrow. He's the value investing expert in the bunch, and we've been discussing it with him over the last few days anyway. Stay tuned.
Regards,
Dan Denning
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
The financial news was dominated by alarming reports from Europe.
"Backlash," said The Financial Times...referring to an "anti-austerity wave" that washed over Europe in weekend voting.
If the FT doesn't mind mixing metaphors, we don't either. But our metaphors are a bit different. What has happened is not a backlash but a wake-up call. It comes as voters realize that the placebo medicine - phony, half-hearted austerity measures peddled by the Euro elite - don't work. They want an elixir with more of a kick to it. That's why the leftists are gaining so much ground.
In Greece, support for leftwing parties has trebled since the last elections. But what do you expect? The typical family has lost almost a third of its real income since the recession (which continues) began. Youth unemployment is at 50%. Young Greeks fear being a 'lost generation' that must emigrate in order to find jobs.
In France, Francois Hollande promises to be reasonable. But he won the election by attacking Sarkozy's austerity moves. He won't make Sarkozy's mistake. Instead, he'll go after the rich with a top marginal tax rate of 75%...and promise 'growth,' not 'austerity.'
The trouble with the austerity proponents is that they didn't go far enough. Budgets were cut. But not enough. The average deficit is still about 5% - well above the Maastricht 3% limit. This left the deficit nations in tough spots. They cut spending, which angered the leftists and the layabouts. But they still were beholden to lenders to cover their deficits. And whenever their unemployment rates rose...or the GDP growth rate fell...they had to pay more for their borrowed money.
Real austerity - with deep cuts and balanced budgets - could work. But it contradicts the whole idea of government, which is to transfer as much wealth from the outsiders to the insiders as possible. Besides, such deep cutbacks would probably trigger a zombie revolution.
And by the way, 'austerity' is coming to the US too - if Congress doesn't stop it. Economists are calling it the "fiscal cliff." The nation is scheduled to run off the edge on Dec. 31st... Mohammed El-Erian explains:
Economists are rightly starting to warn that the United States faces a worrisome "fiscal cliff" at year's end. The blunt spending cuts mandated by the 2011 compromise on the debt ceiling - and the failure of the "supercommittee" that followed - along with across-the-board tax increases would derail the US recovery and undermine the well-being of the global economy. We should be avoiding the edge of this cliff - and politicians should not believe that they have until the end of this year to act.The sequestration mandated by the Budget Control Act of 2011 and the reversal of the Bush-era and payroll tax cuts would essentially mean withdrawing from the economy some 4 percent of the national income in one blunt go - and this doesn't factor in possible knock-on effects. The importance of this issue cannot be overstated. A fiscal contraction of this magnitude and composition would stop dead in its tracks the economy's nascent healing and job creation. Consumption and investment would be harmed. Foreigners would become more cautious about buying our ever-increasing debt issuance. And with our internal growth momentum weakened, the headwinds from the European debt crisis could prove overwhelming.
The austerity show has been playing in Europe for the last two years. That's why half of Europe is in recession...with the other half not far behind. Europeans are tired of it.
So, now the Europeans seem to be giving up on phony austerity and turning to phony growth. They are going to spend more borrowed and printed money. This will look vaguely like "growth." There will be more jobs and more incomes. But there will be precious little real prosperity going on.
Of course, going for growth is precisely what got the developed world into such a jam in the first place. Too many people spent too much money they didn't have on too many things they didn't need.
In America, the Fed encouraged it with low rates...then after the private sector debt bubble blew up, the feds made up for the missing spending by spending more themselves.
In Europe, the euro-feds made a debt bubble possible by establishing a single currency bloc...with harmonized interest rates. All of a sudden Greece and Ireland could borrow as easily and cheaply as France and Germany. And so they did; they borrowed their way to the brink of bankruptcy.
Now, Francois Hollande has a plan. He wants to make Europe more like America...with a central bank that lends to government directly and "mutualization" of credit risk. In other words, he wants to do what Alexander Hamilton did to the US in 1791: make the states collectively responsible for each other's debt. And then he'll let the ECB print the money to buy sovereign bonds directly.
Yes, dear reader, the trend towards centralization continues...with central financial planning...central bank counterfeiting...and everybody going broke together.
In Europe, as in America, it's one for all...and all for one...
...and every man for himself.
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Greece returned to Europe's center stage...and almost no one was happy about it. Most investors were pretty content when this "Debbie Downer-opoulos" of the European financial markets disappeared behind the curtains for a while.
But Debbie took the stage again Sunday when the left-wing Syriza party gained a surprisingly large number of seats in Parliament. The leftists hope to form a coalition government that would nationalize banks, repeal recent labor reforms and immediately cancel the bailout accords with the European Union and the IMF.
In other words, these politicians are threatening to undo the very austerity measures that the EU and the IMF adore. Whether or not such "leftist reforms" would benefit Greece, the idea that the Greeks would unhinge their EU shackles is worrying investors.
The major European stock markets dropped about 2% - pushing several stock indices on Europe's periphery deeper into the red for the year. The Spanish, Italian, Portuguese and Greek stocks markets are all showing losses for 2012. Looking back over the last 12 months, all four of these markets have tumbled at least 33% in dollar terms.
For a fleeting moment earlier this year, many investors placed the Eurozone crisis in the past tense. But now it appears that the crisis is very much in the present and future tense. "Euro Near Three-Month Low on Greek Leadership Concern," a Bloomberg News headline declares. "Alexis Tsipras, whose Syriza party placed second in Greek elections on May 6...said he wouldn't agree to join forces with New Democracy and Pasok, the two Greek parties that have supported austerity measures in return for international funds."
"When you have the guy who's supposed to form the coalition saying that there's a moratorium on debt limits," a currency strategist tells Bloomberg, "that the bailout is not necessarily in place - stuff like that is getting people a little skittish,"
Indeed...and the skittishness is rippling across the Atlantic. Here in the US, the "risk-off" trade is back on. Stocks and commodities down; bonds and the dollar up. Although the major US stock indices are still clinging to gains for 2012, the S&P 500 is off about 4% since early April.
These modest signs of investor distress will no doubt inspire renewed bailout/austerity/manipulation efforts by the European and US governments' financial meddlers. As we have observed time-after-time since the 2008 crisis, there is no economic downtick that is not simultaneously a call to action - a call to government action.
Regrettably, most of these government actions address symptoms rather than the disease itself. They "cure" gangrenous limbs with Lidocaine rather than amputations. As a result, a smattering of politically connected banks and corporations feel better, but the overall economy remains deathly ill.
The European interventions of the last two years tell the tale. Northern European taxpayers have sent hundreds of billions of euros to their southern neighbors, while the European Central Bank has printed more than €1 trillion and funneled most of that money to large European banks. As a result of all of these shenanigans, many large European banks feel much better. But millions of taxpayers are poorer... and the Greeks themselves are no better off.
In 2010, before the first bailout, the Greek government owed about €310 billion, all of it to banks and other members of the private sector. Today, a whopping 73 percent of Greek debt sits on the books of the European Central Bank, euro-area governments and the IMF. And by the time the EU and the IMF finish sending their bailout euros to Greece in 2015, Greek debt will total about €316 billion, close to 100% of which will be held by the ECB and other government agencies.
In other words, the Greek's monstrous government debt load would be just as large in 2015 as it was in 2010. But government agencies would be on the hook for those debts instead of European banks and other private investors.
Is this really a remedy? If so, for whom?
This sort of remedy rewards imprudent banks, punishes taxpayers and condemns the Greeks to years of indentured servitude. And it probably condemns the entire European economy to a sustained period of slow-to-negative growth.
Unfortunately, while such governmental "do-gooding" almost always fails to restore health and viability to a sickly economy, it almost always succeeds in nourishing a lot of "do-badding." By rewarding imprudence - over and over - government-sponsored bailouts encourage bad behavior...over and over.
Regards,
Eric Fry
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Charlie Munger, Warren Buffett's partner in crime at Berkshire Hathaway, told CNBC earlier this week,
'I think gold is a great thing to sew into your garments if you're a Jewish family in Vienna in 1939, but I think civilised people don't buy gold. They invest in productive businesses.'
The easiest way to dismiss this statement is to say that maybe it's 1939 again and maybe this time we're all Jewish. But we don't wish to dismiss the statement. We wish to 'unpack it' in the words of our tutors at St John's College in Santa Fe, New Mexico. To 'unpack it' we need to focus on two key words in Charlie's statement: 'productive' and 'civilised.'
Charlie might be right if the world were civilised. But maybe the modern world isn't as civilised as he thinks. Part of what made the world so uncivilised in 1939 was unsound money. The abandonment of the gold standard made the expansion of the Warfare state possible in 1914. The equally unsound system that emerged out of the war - including the Treaty of Versailles - virtually guaranteed that monetary and fiscal instability would lead to political instability. Radical parties like the Nazis flourished.
Yet it's hard to argue with Charlie's implied criticism of gold, namely that it's not an investment. Certainly that's true of gold bullion. We view gold bullion as money. You are not buying it for a capital gain. You are buying it, by our reckoning, as way of preserving purchasing power. You extract paper from the fiat money system and turn it into something (bullion) you can later exchange for whatever currency emerges when the financial system becomes more civilised.
That said, gold shares are certainly an investment, and to that extent Munger is wrong. Gold shares can be productive too, if they profitably extract the metal from the ground. And if you were a value investor now, gold shares would probably be worth a look. They've underperformed gold badly.
Speaking of which, Berkshire's own B-class shares have also underperformed gold. This shows you that maybe Berkshire's historic performance has more to do with the expansion of the US monetary base over time than underlying profit growth in productive businesses. But let's look at the chart before we make the conclusion.
The chart tells you the number of Berkshire B shares it would take to buy you an ounce of gold denominated in US dollars. The low ratio in 1998 and 1999 is a reflection of gold's 20-year bottom and Berkshire's generally solid performance. The spike in the ratio in 2000 coincided with the height of the Internet bubble, in which everyone thought Buffett had become an irrelevant and doddering old fool. They were wrong.
But as you can see, since 2001 Berkshire's shares have declined relative to gold. That is, it takes you more and more shares of Berkshire to buy an ounce of gold. This may explain Buffett and Munger's vocal and public hostility to gold. Or maybe that's just a function of both men living most of their adult lives in an era where the monetary system was not disintegrating. They are unable to imagine it.
In the event, a superficial technical analysis of the chart shows you that the B shares have rallied against gold since late 2011. This is a combination of gold's 14% fall from its all-time high of $1900 and of the boost to stocks from the various liquidity programs from the Federal Reserve and the European Central Bank (QE2, Operation Twist, LTRO 1, and LTRO 2).
There's no doubt about the general trend of the ratio since 2000. It's taking you more and more Berkshire shares to buy an ounce of gold. No wonder Charlie is so cranky!
But this isn't an indictment of the investment acumen of Buffett and Munger. It's an indictment of the world! A civilised society with civilised people has sound money. An economy with sound money has price stability. This stability allows for long-term planning and accurate valuation of what a business is worth. Investors are rewarded for identifying which businesses are the most productive and efficient users of shareholder capital.
In an uncivilised society where the value of your labour is stolen through inflation (made possible by an unsound money system) does it pay to invest in productive businesses? Does it even pay to be personally productive at all when a progressive tax system confiscates your wealth in order to be redistributed to the unproductive?
Wouldn't it be a lot easier to be a rent-seeking capitalist that benefits from the government perversion of money, not to mention the perversion of the tax system in which members of the elite corporate class can escape the predations of the State? Hmm.
If you accept that we live in civilised monetary times where productive labour is actually rewarded, your brain has been tranquilised by the Big Lie of our times. Your brain (and your portfolio) are in danger of falling gracefully out of a tree, like that bear we pictured yesterday.
Munger wants you right where you are. The less you think about how civilised the current monetary system is, the less likely you are to question it or disrupt it (which would be inconvenient for Charlie). We highly recommend movement and adaptation to fit the monetary reality.
But if you live an era that subverts accurate valuation of productive businesses - an era that subverts the productivity of the economy itself by encouraging debt and consumption - how on earth can you get by? Stay tuned...
Regards,
Dan Denning
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Did you see the bit in yesterday's Australian Financial Review about who owns Australian government debt? Amy Auster, the chief of staff for the CEO of Institutional Banking at ANZ wrote the following (emphasis added is ours):
'...[There has been ] a big increase in holdings in Australia's bond and foreign exchange markets by overseas investors, specifically official investors such as central banks and sovereign wealth funds in Asia, the Middle East, Europe and Latin America...They are by far the biggest holders of Australian government bonds, with an 85 per cent share of the $220 billion stock of commonwealth government bonds. Foreign investors' holdings of bonds issued by the states - the $195 billion 'semi-government' bond market - is nearly 40 per cent, and the consensus is that official investors comprise a big share of these holdings.'
Hmm...if we've done our maths correctly, that means that commonwealth and state debt combined is around $415 billion, or around 27 per cent of GDP. Remember, a few years ago commonwealth debt was negligible both in nominal terms and as a percentage of GDP. The figures also show that 63% of government debt in Australia is owned by foreign creditors.
If you're a debt optimist, these figures show that there's plenty of demand for Australian debt. If you're a debt pessimist, these figures show that Australia owes foreigners a lot more money now than it did three years ago. The government stimulus alleged to have prevented the GFC impacting in Australia wasn't free after all.
If you're a realist - you note the Australian debt is bigger than it once was and likely to get bigger still. And with people like Ken Henry, David Murray, and Jeremy Cooper advocating for a bigger, stronger, more liquid corporate bond market (one accessible to individual investors and superannuation funds) the debt market might even become accessible through the share market. This is the development we explored in the latest issue of Australian Wealth Gameplan.
It's a shame that we have to talk about corporate bonds instead of equities. Corporate bonds are generally about capital preservation and risk aversion. Equities are about growth and capital appreciation. The fact that we're talking about a retail corporate bond market tells you that attitudes toward risk are changing with performance of the stock market and with natural demographics (the retirement of the baby boomers).
And we're talking about income investing because genuinely productive businesses are harder to buy in a stock market rigged by financial intervention.
Regards,
Dan Denning
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Let’s have a look at yesterday's market action. And more importantly, the price action…
Our own Slipstream Trader, Murray Dawes, is back in the public eye with another YouTube broadcast. The European and North American markets digested the election of a socialist as President of France with calm, unlike the Aussie market. You can watch this morning's stock market update here. Murray says:
'Last Friday's employment numbers ignited a sharp fall in markets worldwide. US markets are poised on the edge of some very important technical levels, with further weakness confirming a false break of last April's high and creating a potential double top. The ASX 200 has also confirmed a false break of last October's high which points to the potential for substantial downside from here.'
Speaking of Francois Hollande, he put markets on notice yesterday. Hollande said, 'My real enemy is the world of finance.' He may be right, although markets didn't care one bit. But once he gets a look at France's books and the real state of the European banking system, he'll probably end up pursuing the same policies as his predecessor.
There is increasingly little difference between major political parties these days. They are custodians of a system where bankrupt governments are depending on the central banks which exist to finance governments as a matter of last resort. This is the last resort.
Besides, all incumbent and mainstream politicians have one thing in common: they seek power and self-preservation. That means defending the current monetary system, despite its obvious flaws and irreparability. It also explains the rise of fringe and radical political parties.
Unsound money undermines civil society and provokes social instability. Fiat money allows unlimited deficit spending at the government level and massive credit creation in the financial sector. The people who get to use this money first in the financial sector (investment bankers, bankers, financial firms) benefit enormously, as do the people who administer the system.
But if you're not in a privileged position, you end up with higher inflation and reduced purchasing power. Not everyone can be an investment banker, either. When you throw in the globalisation of the labour market, you get a perfect recipe for huge income inequality. The resentment this inequality breeds can be exploited by radical political parties.
It's a little like Europe around 1939. Of course by then, the radical political parties (the National Socialists) were no longer fringe parties. They were in power. We're not there yet. But are we headed there?
We don't know the answer. But you can't separate political instability from a flawed monetary system. This is another way of saying that nothing in life is free. Decades of welfare state promises have led to unsustainable debts for the public sector. Meanwhile the private sector deleverages. The two forces cancel each other out and leave financial markets treading water...for now.
Regards,
Dan Denning
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
The Pentagon goes rogue...
Yesterday, we were thinking about how democracy...or any government...operates on the basis of shared emotions, or feelings, rather than real ideas. We explored the public's contemporary narrative on the financial crisis. What we saw is that a common view of what is going on - in order to be commonly shared - has to be stripped so bare of nuance and paradox that it ceases to be an idea at all. It is just a feeling.
And sometimes, it becomes a grotesque, simpleminded fantasy that it is actually the opposite of the original thought or desire behind it. It becomes a zombie thought...actually harmful to the group that holds it.
If you follow the popular media, for example, you would think that the US is engaged in a war against "terrorists"...bad people, who for a reason never explained, aim to do harm to Americans. These terrorists are so evil they must be stopped...at all costs.
"It's a war," says US Attorney General, Eric Holder. So, he explains, we can set aside the Constitution and the Bill of Rights - the very things we're supposed to be defending - to fight it.
Thus is the US military industry set to the task of protecting against "terrorists"...with the solid support of the American people. An announcement at the Ft. Lauderdale airport on Friday told us that "military personnel can board at their leisure."
They got the treatment normally given to paying business class passengers! On one plane, a stewardess invited military personnel to take the vacant seats in the business class section. And it was reported last week that of all America's public and private institutions only the US military retains the confidence of the general population.
But if you bother to study the situation at all you quickly realize that it is not terrorists who pose a threat to the US, it is the US military itself. The Pentagon has gone rogue...now it is a danger to the nation.
Terrorists are insignificant. Trivial. You could fit all of them in a mid-sized movie theatre. And half of them - like Osama bin Laden himself - are so infirm, insane or incompetent that they are completely incapable of doing any real damage to the world's only super-power.
The US military - along with its suppliers, security agencies and all the rest of the lethal establishment meant to protect America - is big. And very expensive. Like a parasite, it drains energy and resources from its host - the productive US economy. The total cost, fully loaded, is about 8% of GDP.
America is, of course, no normal nation. It is an empire. The cost of running an empire is high. But empire is supposed to be a paying enterprise. An empire takes tribute from its vassal states in exchange for providing protection. That's how all empires worked.
The US empire, on the other hand, loses money. It conquers foreign nations...but it fails to make money at it. Instead of sucking resources from its vassal states, it takes resources from the American public. It is no longer protecting the nation; it is endangering it.
More to come...
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
The pentagon goes rogue...
"Jobs engine sputters again in April," reports the weekend Wall Street Journal.
What kind of humbug recovery is this? Bloomberg adds:
Estimates for the jobless rate, derived from a separate survey of households, ranged from 8.1 percent to 8.3 percent. Unemployment has exceeded 8 percent since February 2009, the longest such stretch since monthly records began in 1948.
Of course, it's much worse than that. John Williams puts the real US unemployment rate - the people who want jobs and can't find them - at 22%...the same as the unemployment rate in Spain. And just 3% points lower than in the Great Depression.
And what kind of humbug response is this? Reuters:
(Reuters) - The White House pledged on Wednesday to help lower- income youth find summer jobs in a move likely to appeal to younger voters crucial to President Barack Obama's re-election campaign.The initiative is in partnership with the cities of Philadelphia, Chicago and San Francisco and is meant to add 110,000 jobs, internships and mentorships to the 180,000 summer work opportunities for 16-24 year olds that Obama has promised to create for 2012.
Under the new program, companies such as Blue Cross and Blue Shield Association, Johnson & Johnson, and UBS, as well as non-profits and federal agencies such as the Department of Education will offer paying jobs as well as mentorships and other training programs.
Every year from April to July, the size of the youth labor force swells as high school and college students nationwide look for summer jobs. But summer employment for young job seekers has hit record lows in recent years as more of them are unable to find work, according to data from the US Bureau of Labor Statistics.
"There's no replacement for the dignity that comes with earning your first paycheck," said Secretary of Labor Hilda Solis in a statement.
Yes, dear reader, now the feds are turning young people into zombies too...with make-believe jobs, many of them in zombie industries.
The report went on to tell us that the initiative does not require congressional approval. Which leads us to another question:
What kind of crackpot system do we have...where the president can create jobs...like the Fed creates money...out of thin air? Of course, we know the answer, the new jobs are just like the new money; they're not real.
The program, phony as it is, will not be examined carefully by anyone. Instead, it will "feel good" to the voters. Obama is doing something. His heart is in the right place. Don't think about it anymore.
His initiative is right out of Franklin Roosevelt's playbook. Back in the '30s, our own father participated in something called the CCC, the Civilian Conservation Corps. He was a poor boy. His father was dead. He needed a way to support himself. So he joined the CCC.
"It was like the army," he recalled years later. "It was like a junior version of the Army Corps of Engineers. And it was hard work. I helped dig irrigation ditches in New Mexico."
Make work, perhaps. It may not have been a real job, but at least it was real work. A whole lot less phony than hanging out with mid- level bureaucrats in an air-conditioned office at the Department of Education.
And more views on jobs and education...Did you see our rant about education yesterday? Education, along with health care, finance, and the military are the big zombie industries of the late, degenerate imperial period (as future historians will describe it). They drain resources out of the productive economy...and waste them.
To give you an idea of the scale of the waste, the 2009 Program for International Student Assessment gave tests to 15-year-olds in 65 different countries. The US spends far more than most countries on education, so you'd expect that it would come out on top, right? But nooo.
Instead, China-Shanghai came in first. China-Hong Kong second. Finland was third. In terms of educational "investment" per student, the US spends 15 times as much as China. Even at the state level, educational "investment" has little to do with educational return. Idaho spends only about $10,000 per student. Washington, DC spends nearly 4 times as much. Which has better test results? Idaho, of course.
So, what do the zombies say? We need to "invest" more in education!
*** We're always trying to connect the dots. Unfortunately, the dots won't stand still!
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Singer Robert Palmer was "addicted to love". The world is now addicted to low interest rates.
In Australia, businesses and unions, in a rare show of unity, urged the Reserve Bank of Australia ("RBA") to cut interest rates aggressively. In early May 2012, the RBA cut the interest rate 0.50% per annum to 3.75%, with more cuts forecast by the pundits.
Following the global financial crisis, policy interest rates in the USA, Europe, UK and Japan were reduced sharply. The US Federal Reserve has committed to holding rates around zero for the foreseeable future. Faced with deep-seated economic problems, other central banks are following a similar strategy. Where interest rates are zero and cannot be lowered further, novel forms of monetary accommodation, quantitative easing (a politically correct expression for printing money), are in vogue.
Low interest rates have become a panacea for economic problems. In part, this reflects the limited flexibility of governments to run budget deficits. This is driven by increasing scrutiny of public finances and the lack of willingness of investors to finance such deficits, as highlighted by the ongoing European debt crisis.
But like all addictions, low interest rates are dangerous. They may be also ineffective in addressing the real economic issues.
Financial markets have generally reacted positively to low rates, pushing up stock prices. But low rates point to a worrying lack of growth. In announcing the cut, the RBA's press release noted:
"This decision is based on information received over the past few months that suggests that economic conditions have been somewhat weaker than expected, while inflation has moderated."
Low rates also highlight the increasing risk of deflation and a severe contraction in economic activity. Given that growth and inflation are among the primary requirements for a relatively painless reduction in elevated debt levels globally, the enthusiasm amongst investors and citizens is curious.
The clear hope is that low rates will revive the "animal spirits" of the economy. The Australian Industry Group, whose former head is now a member of the RBA Board, provided extravagant praise for the decision:
"Today's rate cut accurately reflects the state of the Australian economy and it is most welcome. It's not a silver bullet but it will help industries on the wrong side of the resources boom. The size of this reduction is particularly important for non-mining trade exposed businesses in industries such as manufacturing and construction who are currently facing very difficult trading conditions...A full pass-on of the cut by banks to business and household borrowers is essential if the move is to play a part in lifting the economy from its slump."
But the ability of low rates to boost real economic activity is unclear. The cost of funds is only one factor in the complex drivers of demand.
In the housing market, demand depends on many factors - the level of required deposit, existing home equity (price of house received less outstanding debt), the ability to sell a current property, income levels and employment security. Low rates do little, in themselves, to address these issues.
In the absence of growing demand for their products, businesses are unlikely to borrow to invest in new capacity based purely on the low cost of debt.
Low rates also decrease income of retirees with fixed interest investments, reducing demand.
In Australia, Reserve Bank research indicates that the savings from lower mortgage rates are simply being used to retire debt, rather than consumption. While the reduction in debt levels is necessary, a lower rate will, of itself, do little to boost demand and economic activity.
Stimulus from low interest rates is also temporary, with demand likely to revert to normal levels once rates increase.
Low interest rates can distort economic activity, especially where real interest rates (nominal rates adjusted for inflation) are low or negative.
Low cost of debt encourages substitution of labour with capital in the production process. Given 60-70% of activity in developed economies is driven by consumption, this reduces aggregate demand as employment and income levels decrease.
Low rates favour borrowing, encouraging substitution of debt for equity in financing structures, increasing financial risk. Where companies and nations are over-extended, this decreases incentives to reduce debt. In fact, low interest rates are economically identical to a disguised reduction of the principal amount of the loan.
Low rates discourage savings, creating a disincentive for capital accumulation which would reduce overall debt levels. Lower earning on savings should encourage spending stimulating economic activity but may perversely encourage greater saving to provide for future needs reducing consumption and demand. Low rates also increase the funding gap for defined benefit pension funds.
Low rates encourage mispricing of risk, creating asset bubbles.
Low costs of borrowing encourage investors to seek investments with income, feeding recent demand for high dividend paying shares and low-grade debt. Driven by low rates, Australian investors have increased investment in complex capital securities issued by banks and corporations, taking on additional risk, which they do not fully understand, to generate higher income.
Low rates also feed asset price inflation. Minimal opportunity costs allow investors to hold assets that pay no income in the hope of price increases, evidenced in demand for commodities and alternative investments such as art works. Money tied up in non-productive investments driven by artificial low rates reduces the flow of capital and economic activity.
Low rates do not necessarily increase the supply of credit as risk aversion and higher returns on capital encourage banks to invest in government securities, eschewing loans. Low interest rates also provide an artificial subsidy to financial institutions, allowing them to borrow cheaply and then invest in higher yielding safe assets such as governments bonds.
Internationally, low interest rates distort currency values and encourage volatile, short term, cross-border capital flows as investors.
Low interest rates and quantitative easing has led to a significant shift of money into emerging countries. This has created destabilising asset bubbles and inflationary pressures. Higher commodity prices, driven by low rates, exacerbate inflation pressures requiring higher rates and reducing growth in emerging nations.
Low interest rates and quantitative easing have driven down the value of the US dollar, euro and yen. As currency reserves are invested in these currencies, emerging nations have suffered losses on their savings.
In Australia, advocates of low rates argue that it would assist in bringing down the value of the Australian dollar. In reality, currency values are affected by a variety of factors including relative growth rates, inflation levels and interest rates. In addition, trading the Australian dollar is a proxy for commodity prices and Chinese growth. Most of these factors are outside the control of Australian policy makers.
Even if rates in Australia are cut further the differential between local rates and foreign rates would be significant. There is no assurance that lower rates would have the desired effect of the value of the local currency.
Central banks believe that they will be able to exit from a policy of low rates when appropriate. It is reminiscent of Ashly Lorenzana's definition of addiction in her journal Sex, Drugs & Being an Escort:
"When you can give up something any time, as long as it's next Tuesday."
A sustained period of low rates, like the one the world is experiencing, makes it difficult to increase the cost of borrowing. Levels of debt encouraged by low rates would become rapidly unsustainable at higher rates. In effect, the policy compounds existing issues, making the problems ever more intractable.
In addition, as global economic conditions remain fragile, in expending its ammunition now, the RBA may be reducing its options for the real battles that may lie ahead.
Low rates do not address the real issues but central banks and investors seem to believe that there is no alternative. They are relying on the advice of celebrity Russell Brand:
"The priority of any addict is to anaesthetise the pain of living to ease the passage of day with some purchased relief."
Regards,
Satyajit Das
for The Daily Reckoning Australia
© 2012 Satyajit Das All Rights Reserved.
Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011)
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
'Sometimes you eat the bear and sometimes, well...he eats you.'
That's what Sam Elliott's character says to the Dude in The Big Lebowski. He didn't say anything about those times when the bear climbs up a tree, is tranquilised, and then falls gracefully to the ground. They don't ring a bell at the top. Do they shoot a bear at the bottom?
A tranquilised black bear falls from a tree in Boulder, Colorado
Reports of the bear's demise may be greatly exaggerated, to paraphrase Samuel Langhorne Clemens. The Australian stock market has opened up in the red. It follows Friday's loss on the Dow Jones Industrials. The Dow had been trading near a four-year high.
It's going to be a tough week for Aussie assets. The financial crisis in Europe has become political. The results of weekend elections in France and Greece make it hard to figure out what the end-game for Europe's debt crisis is. This kind of uncertainty makes 'risk' assets like the Aussie dollar less attractive.
Speaking of the Australian dollar, does it look like a 'safe haven' currency to you? We made the argument over the weekend that the Aussie dollar is anything but a 'safe haven'. It's a proxy for commodities, it's a proxy for China, and it's a proxy for risk. All of those things make it a dangerous currency at the moment.
The argument we made over the weekend is that the next 'crisis' could trigger a major correction in the Australian dollar. We'll get to the trigger event in a moment. But what could a major correction entail?
Well, Slipstream Trader Editor Murray Dawes showed us a long-term chart of the Aussie dollar this morning. The crucial item on the chart was that the short-term moving average has moved below the long-term moving average. Murray says this is long-term bearish. He reckons if the Aussie dollar breaches a certain level, look out below.
Of course the point of such a warning/forecast isn't to abandon hope and panic. For Murray, it's to prepare and trade. He has several shorts trades on at the moment. Individual stocks can often track the performance of a currency or index. Such is the case with the Australian dollar. If Murray is right and the Aussie dollar falls, then so too should some of the stocks he's short.
It all depends on the 'trigger' event. There are several candidates in Europe. Take the French and Greek elections, for example. The French have elected their first socialist President since Francois Mitterrand. Francois Hollande is in, Nickolas Sarkozy is out.
If the election results are a rejection of the current austerity measures imposed by the European Union and the European Central Bank, it's not going to make things better in Europe. Mind you, the austerity isn't making things better either. You can't blame the French for rejecting a system which makes taxpayers foot the bill for the ongoing bailout of the European banking system.
But if the socialist answer is bigger government and more spending, well then that's hardly a solution to the debt problem either, is it?
While the French turn left, the Greeks turn right. Actually they seem to have turned away from the centre, more than anything. The anti-bailout Left Coalition is on track to win 16.1% of the vote in Parliamentary elections. The centre-right New Democracy party came in first at 20%. The socialist Pasok party came in third.
Both elections see a rejection of the status quo in Europe. For example, both Pasok and New Democracy - supposedly on opposite sides of the political spectrum - supported the austerity measures imposed on Greece by the 'troika' from the EU, the ECB, and the IMF. If you ask us, it looks like voters are rejecting political elites who do the bidding of banking elites. If they had their way, they'd probably throw the whole Euro baby out with all the European Union bathwater.
But then again, it's hard to know what the Greeks and the French want. Do they want something for nothing? Or are they rejecting elites? Do they want less pain and more free money? Or do they want a decentralised Europe free from the micro-managing bureaucratic tyranny of the EU? Are they headed down the path of more debt, more spending, and bigger government...or the total breakup of the European Union and the Euro currency?
Or maybe none of the extremes are likely. Maybe the 'elite' strategy is to paper over the financial crisis with debt refinancing and money printing. If so, that strategy has just run headlong into the buzz saw of righteous democracy. Maybe, in time, when confronted with the realities of the situation, the new elites will be compromised just like the old elites. In the meantime, it's not a good environment for 'risk assets'.
You don't have tell that to Albert Edwards. Dylan Grice's colleague at Societe Generale told clients last week that in Australia, 'We see a credit bubble built on a commodity bull market based on a much bigger Chinese credit bubble...Of all the bubbles I have seen over the last 30 years in this industry, this one is even more obvious.'
We feel partly to blame for Edwards' conclusion. Dylan wrote a piece on Australia a few weeks ago. That piece was derived from his trip down here for our After America conference in March. He concluded that there were some pretty obvious signs of a bubble, including a household debt-to-GDP ratio of 150%.
Incidentally, the After America DVD ships later this week. It includes six discs from the three days of presentations in Sydney. We reviewed a lot of it last week and found the analysis to still be timely. Many of the presentations look at the long-term case for and against different Australian assets.
There isn't a better time to be thinking about this, either. The government debt bubble in Europe grows more unstable by the day. The situation is not much better in America, nor in Japan's economy. If these bubbles pop or even just deflate as they did in 2008, it could be devastating for growth stocks and growth assets. That puts Aussie assets right in the crosshairs, just where the bear wants them.
More on how to avoid being tranquilised tomorrow.
Regards,
Dan Denning
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
In The Wall Street Journal (!) this week, was another editorial explaining why education is necessary to GDP growth.
“Education is the key to a healthy economy,” say George Schultz and Eric Hanushek. They show that societies with the highest test scores in math — notably Taiwan and Singapore — also have had the highest GDP growth rates. Well, surprise, surprise. Math is the common language of engineering and science. And engineering and science are what it takes to make the stuff of GDP growth. Little wonder, that the people who work the hardest at math are also those who make the most stuff.
The authors didn’t mention that when people from Taiwan and Singapore come to the US, they continue to work harder at math than native born Americans. Whatever the defects of the school system, it doesn’t keep them from getting advanced degrees in science and engineering and going on to earn a lot of money.
And they don’t mention that the US already spends much more per student on education than either one of them.
So, the reasonable question is not what’s wrong with US education...but what’s wrong with Americans.
Are they lazy? Or just stupid?
But instead of really analyzing why the US spends so much on education and gets, relatively, so little...
...or even wondering why anyone should give a damn...
...the authors call for “reforming” our K-12 system. What do they mean by that? How would it make anyone any better off? And if it were such a good idea, why haven’t people already “reformed” the schools?
The typical reader doesn’t think about it. He merely feels it is the right thing.
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
Feelings...
Whoa whoa whoa...feelings...
— Morris Albert
Our plane got delayed. This left us in a small waiting room for longer than we wanted to be there. The two large TV screens were inescapable.
Who watches this stuff? Poor schmucks.
The more they inform themselves by watching TV news, the less they really know. If they watch long enough, their brains must become like a zombie city, populated by zombie characters they’ve seen on TV...animated by the zombies’ fictions...and dominated by zombie emotions from their two-dimensional personages on the LCD screen.
The most important event in the Atlanta area was the death — apparently by suicide — of a well-known football player. We never met the man; we had no particular reaction one way or another. But the tube requires feelings. One reporter after another...one interview following another...all zap the reader with easy emotions. After a while, if you are still unmoved, you think there must be something wrong with you.
But it’s probably always been that way. The popular media stirs group feelings and mob emotions. The crowds at the arena...the thousands at the coliseum and those in the stalls at the theatre — they need heroes and villains, not complex ideas and ambiguity.
Of course, ideas can be made accessible by the masses. But only by stripping out the complexity and nuance, making them so barren and so remote from the whole story that they are rarely more than collective fantasies, shared as feelings...
The masses don’t want to think. They just feel. Every flack...and hack politician knows that feelings sell. Not ideas.
That’s why Ron Paul...an idea guy...is trailing Mitt Romney at such a distance.
The masses form their opinions...choose their candidates...and spend their money on the basis of feelings. Real thoughts are banished.
The presidential race is really little more than a contest to which line of guff most voters will take...that is, how they will feel about the candidates and their themes.
If you watch TV you’re tempted to believe that...
...the US was hit by some kind of economic firestorm. Maybe it was caused by Wall Street greed. Maybe the regulators made mistakes. Or maybe it was just a natural thing, the way things work.
Thanks to the wise decisions of its leaders, the US economy is now recovering. Europe is having a rougher time; its leaders are not fully in charge of the situation.
But even in America the damage was so severe that recovery will be difficult. More help from the federal government may be needed. Perhaps more legislation — targeted tax favors, aid to young people, more spending on education...and so forth.
When it comes to the US ‘recovery’...a typical ‘news’ consumer would also believe that the Fed plays a vital role too. Ben Bernanke looks like the kind of guy who might know something about economics. He was head of Princeton’s Economics Department after all. So, if the US recovery doesn’t continue, the Fed will probably put in more money.
Everybody knows that money is what makes the economy go!
But is it?
The only presidential candidate with his thinking cap on, says no.
The Financial Times allowed Ron Paul to voice his thoughts on central banks. They are “intellectually bankrupt,” he says.
His argument will be very familiar to Dear Readers:
The gist of it is that central banking is a fraud. Honest economists...and thoughtful people with real jobs...know that central planning is an ineffective way to add wealth. If you could get rich by printing money, every central bank on the planet would run the printing presses night and day.
But they don’t. Because it doesn’t work that way. You only know what real wealth is by allowing buyers and sellers to set prices. The prices tell you what things are worth...providing a measure of the goods and services that people actually want. Real money represents real savings. It — and the interest rates people ask for lending it out — tell investors how much capital is available, and at what price. You can print up all the pieces of green paper you want. It will only distort the picture, mislead investors, and cause them to misuse capital. The more central planning, the more mistakes.
The Fed determines the quantity of money available to the market...and the price of it (at least for short term loans). It creates “money” apparently out of nothing...that is, counterfeit money...money with no resources or savings behind it. Then, it dictates interest rates. Investors err; that is how they created the housing bubble in ’05-’07, for example.
And now the Fed is compounding its failures of the past...leading to even bigger errors...even bigger bubbles...and even bigger blow-ups.
“Printing unlimited amounts of money does not lead to unlimited prosperity,” says the congressman.
Regards,
Bill Bonner
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
There was lots of scepticism about a piece in March called "U.S. Manufacturing - The Great Comeback No One Will Believe" about the revival of U.S. manufacturing as China loses its cost advantage. But I continue to find evidence that the piece was spot on.
I had a good talk with Scott Huff, a principal at Innovate International, which does product development work and contract manufacturing for several industries. Scott's story is worth passing on because the arc of his career in the last 10 years tells the story better than any set of statistics.
Scott is a design engineer. He started going to China in the mid-1990s to do work for clients. Huff was living in Chicago at the time. Every year, the travel got heavier as more and more clients manufactured in China. "So in 2004, after spending three months in the country in two-week blocks in the first half of the year, I figured maybe I ought to just move here," Scott recalled. "My wife is pretty adventurous. So we moved lock, stock and barrel to Shenzhen and started rebuilding the business there."
There were tons of opportunities, and the business grew. Things went well. Then, last year, it started to change.
'In the middle of last year,' Scott said:
'I realized it when I was getting price quotes for some injection-moulded plastics. Chicago used to be a centre of excellence for this, and it's since been decimated by overseas competition. But there were a handful of the old hands that survived. They kept up with the technology and got very lean and efficient, using electric presses and things like that that reduce cycle times and labour.'
He continued:
'Suddenly, prices from them weren't that different from what you could get in China when you factored in transportation costs. It looked better and better as we took another big labour increase in China in the third quarter of last year. Of the last four out of five jobs I quoted for injection moulding in the U.S. versus moulding in China, the U.S. won. Most people don't believe me when I tell them I'm getting better prices in the U.S. The first instinct people have, the paradigm that they've learned to live with, has been to bid work in China.'
Your editor sympathizes with this. I've had a lot of people shake their head in disbelief and call me crazy when I tell them it is (sometimes) cheaper to manufacture in the U.S. now. But here you have a real-world tale from a man on the ground seeing this new trend unfold in real time.
"Things are getting expensive in China, pure and simple," Scott told me. "Labour costs have gone up substantially in China. That's not a mystery to anybody. The amount of labour available at any price for some jobs is just not there. If you want to polish a piece of stainless steel for the kitchen industry or tie rawhide pet treats, you're going to have a tough time finding people. People have options. They'd rather put together an iPad now."
Even though labour costs have surged, one could argue they have not kept pace with the cost of living. "Food prices in China are ridiculous," Scott says. "It's a hell of a lot cheaper to live in the United States than it is in China if you equalize people's incomes. As a percentage of someone's income, the chunk for food is a huge line item there. Land prices have been skyrocketing everywhere. Apartment prices are through the roof. It is cheaper to live in the U.S."
Remarkable, isn't it?
So business is just starting to move away from China. Manufacturers are seeking out cheaper markets in Southeast Asia. Scott has a new plant there already, in Cambodia. "Cambodia is small but in a good location," Scott says. "Right in the middle of everything, really."
His company is also moving business to the States. When I caught up with Scott, he was in Knoxville, Tenn. He is still a resident of Shenzhen, China. That's where he officially lives. But his kids are going to school in Tennessee, and he is looking to build a business back in the States. It's a complete reversal of what happened eight years ago.
"I don't think anybody has any idea that's happening," I said.
"It's sneaking up on people, but they're going to realize it. The handfuls of survivors in the moulding industry in the U.S. are busy as hell right now. It's not just the plastics industry. Anybody that was left here with manufacturing intact is getting extremely busy."
"So it seems there would be an opportunity in U.S. manufacturing," I said. Scott agreed, with a caveat.
"There is an issue that we're battling. The U.S. lost an entire generation of toolmakers. They're just not there. The old Polish toolmakers I used to work with in Chicago have all retired, or if not, they are more gray-headed than I am. And there aren't the apprentices ready to step in. You can't find a good toolmaker in Chicago right now. It's hard to come up with. And the skill set you can't just turn it on and off like a faucet."
This is something people especially political types -- overlook. It's not just a matter of bringing back the jobs. The skill set has to be there, and that takes time to build.
"Technology changes, too," Scott added, "so it is extra hard to find someone who's kept up with it all. You can still cherry-pick and pull out a tool in Asia and bring it to the U.S. You just have to figure out a way to maintain it without a toolmaker."
"Wow," I said, "that's a complete reversal of what went on before where people would take machines from the U.S., disassemble them and ship them to China."
"I was one of them," Scott said. "Now I'm designing products from China and carrying them to Chicago for production. Touch base with me in a couple of months and I'll let you know how it went."
I said I would. In the meantime, we'll continue to watch this story. China losing its once-formidable cost edge would have a sweeping impact on manufacturers everywhere. Stay tuned...
Regards,
Chris Mayer
for The Daily Reckoning Australia
From the Archives...
Markets and the Aurelius Vision
2012-05-04 - Greg Canavan
How the RBA's Interest Rate Cuts Cause a Housing Bubble
2012-05-03 - Nick Hubble
How a Cashless Society Promotes Tyranny
2012-05-02 - Dan Denning
Gleichschaltung
2012-05-01 - Dan Denning
Risky Investments in a Market Full of Conmen
2012-04-30 - Bill Bonner
"So what do you think should be done?"
I often get this question after I presented my case against our fiat money system, and I sense there is a trace of frustration in it, a bit along the lines of, you are telling us that we are in quite a mess but you offer no policy prescriptions. That is a fair point, I guess. Most writers who lament the economic ills of our time usually have a bag of policy advice on offer. Indeed, whispering new policy ideas into the ears of those in power is what most of these writers aspire to. I reckon what separates them from me is that they believe in government and I don't.
The mess we are in is the result of policy, of the very idea - the silly idea - that the field of money and finance would work better if it were supervised, managed, guided and controlled by the state; that if we had clever, powerful and astute policymakers, consulted by economist philosopher kings, we could enjoy a smoother, better functioning economy. And if ever things were not running so smoothly, we would change the policy.
"So what is your policy, Mr. Schlichter? Could you not be a bit more...constructive?"
My conclusion is straightforward. There should be no policy. The existence of policy is already the problem. What we need is proper capitalism in money and finance. We do not have that now. What we have is limitless state fiat money, quantitative easing, systematic market manipulation, bailouts, regulations, the IMF, the World Bank, the FSA, FDIC, TARP and LTRO. We need proper markets, not more policy, not more manipulation, and not more bureaucracy. And not more fiat money. We need the state to exit the field of money and banking. Completely.
The main problem with monetary policy is that there is such a thing as monetary policy.
The state is the problem. It will not be part of the solution.
Before I tell you what I think should be done, let me give you another reason why I have been so reluctant to offer policy advice. The aim of my book Paper Money Collapse was to expose widespread fallacies and debunk erroneous common wisdom concerning money. It was not to provide a program for reform. The book is meant to be an eye-opener.
Almost the entire discussion on money and banking today is based on deeply flawed theories. This is true of the financial markets industry where I worked for 19 years. It is equally true of most of the discussion in the media and, as far as I can see, academia. The book was meant to debunk a lot of this misinformation.
My intention was to challenge the present consensus and the established orthodoxy. I think this is what needs to happen before we can even talk about the drastic changes that our system requires. Any policy debate of the type you read in The Economist or The Financial Times occurs within the boundaries of the established consensus. Questions of a more fundamental nature cannot be addressed in the context of policy debates.
But I am not going to evade the question about policy. So let me talk a bit about policy and reform.
The big mistake has already been made. The gold standard was abandoned, in a step-by-step process that began around the time of World War I and that culminated in Nixon's closing of the gold window in August 1971. For more than 40 years, gold has played no official role in global monetary affairs. State paper money ruled. Everywhere.
This was the era of the central banker, the monetary bureaucrat, of artificially cheap credit, of stimulus, of big equity rallies, of bigger real estate bubbles, of constant debasement, of the quick buck and the big bonus, of growing banks and of ever more sovereign debt. The global financial system got unhinged.
After four decades of persistent inflationism we have an overstretched finance industry gravely addicted to the constant drip-feed of cheap money and an out-of-control public sector constantly issuing debt that will never get repaid. Capital misallocations and asset mispricing are gargantuan. The establishment prescribes itself ever more easy money to keep the show on the road.
So the first conclusion is, there is no painless exit. The cleansing crisis is inevitable. Simply being honest about the mess we are in would not be a bad starting point for policymakers.
And to acknowledge that this can't go on forever. Because it certainly won't go on forever.
Okay, but what next? If you could design policy, what would it be? What is the number one thing that we need to change to restore financial sanity?
Fiat money critics have floated a whole range of policy proposals. There is the return to some form of gold standard. Also, there is the rather fiercely contested debate about whether fractional-reserve banking should be banned or at least restricted.
Recently, colleagues of mine at the Cobden Centre in London have introduced a bill to Parliament that would make board members of banks personally liable for bank losses, which is supposed to reduce or eliminate moral hazard. Thus we are already faced with a range of policy proposals. What is my position on them?
I think we can have it much easier. My proposal is more effective and more easily communicated: Let us separate state and money completely. That is the one thing that needs to change. Capitalism is the only economic system that works in the real world. But what we have today is monetary socialism, albeit a socialism predominantly to the benefit of the rich and well-connected.
We need to get the state out of the economy completely. To achieve this we must get the state out of ALL monetary affairs. The monetary sphere of society should be a no-go area for politicians and bureaucrats. State involvement in finance is the problem. Let us get the state out. Period. That is the one goal we should have. That is the one policy I recommend.
My enthusiasm for any other policy proposal varies considerably and is dependent on how much state intervention the policy still allows or in some cases even requires.
As an opponent of fiat money I am naturally positively inclined to a return to a gold standard. I believe that Mises was right when he wrote:
"If in the coming years or decades our civilization is not to collapse completely the gold standard will be restored."
But what type of gold standard should be implemented? Would there still be central banks that would 'administer' that gold standard? Under any form of gold standard, the central bank would most certainly be more confined in its monetary operations than central banks are today but there could still be considerable room for manipulation.
The US Fed was founded in 1913 under what was officially still the Classical Gold Standard but that didn't stop it from funding the US government's military spending in World War I and from initiating credit bubbles and business cycles.
By 1933, the dislocations introduced by cheap money were so big that their dissolution - mandatory and normally automatic under a gold standard and indeed inconceivable under a proper gold standard - had become politically unacceptable. The Fed's mission was accomplished and the gold standard was abandoned. The rest is history as they say.
An official, government-directed return to a gold standard also raises a lot of questions about implementation that would invite lobbying and horse-trading by various pressure groups.
* How much of the existing money stock - obscenely inflated after decades of money printing and fiat money debasement - should be backed by gold, or to put the same question in a different way, what should the new exchange rate between the money in circulation and gold be?
* How much should the existing money stock be devalued? Should banks be allowed to create deposits that are not backed by gold? Should fractional-reserve banking be permitted?
Questions over questions, and the room for political maneuvering and for political abuse are massive. Do we really want politicians, central bankers, bureaucrats, and their economic advisors make all these decisions? I don't think so.
I know somebody who is best equipped to make all these decisions.
Mr. Market.
We may not all agree on the merits or demerits of fractional-reserve banking but as capitalists we should agree on the benefits, indeed the necessity, of free competition.
So how do we get from A to B? How do we get from the present system of finance socialism, of interest rates fixed by the central bank and asset prices manipulated by the central bank, of nominally private banks operating with the protection of a lender-of-last resort, to a system that again deserves the label capitalist?
Step 1: Privatize the central bank.
Do not even introduce a gold standard. Just transfer ownership of the central bank officially to the banks that have an account with the central bank. This is the first step for the state to exit the sphere of money. The central bank is no longer a public institution run by bureaucrats and politicians but an entirely private undertaking. It is owned and operated by the banks.
The central bank administers bank reserves and provides certain clearing functions. The banks need this, for now at least. Shutting the central bank down is not that easy. But its most pernicious aspect is that it is a policy tool. This would end abruptly with its privatization.
Step 2: The state revokes with immediate effect ALL laws and policies that relate specifically to banking and money.
From this moment on, banks are capitalist enterprises just like any other normal business. There is no lender of last resort (at least not one run by the state), there is no inflation target or other official monetary policy for which the banks function as conduits, which under the present system puts them in the strange position of being profit-seeking enterprises and policy-transmission mechanisms simultaneously.
But equally, there is no backstop for the banks from the state any longer. No guarantees, no deposit insurance or taxpayer bailouts. If a deposit insurance institution exists, it is handed over to the banks, similar to the central bank. Again, the state has exited the business of regulating, supervising, licensing, subsidizing and backstopping the banking industry.
Entry into the field of banking is now free. You do not need a license. You do not need an account with the now privately owned central bank (although without such an account clearing with other banks might be difficult). There are no legal tender laws anymore, so if anybody has any bright new ideas about money (Liberty Dollars, bitcoin) they are most welcome to try them. The consumer alone will decide over success and failure.
Monetary policy has ended. Bernanke testimonies on TV will be replaced with reruns of old Simpson episodes. Senators and congressmen will have to find new soapboxes from which to propound their personal economic theories.
Step 3: The state's gold hoard is handed over to the banks.
What? A gift to the bankers? - I do not consider this a gift to the banks but more a return of property to the bank depositors. The bank depositors are the ones that should benefit from this transfer most.
The present monetary system could only have come about because it was once based on gold. Deposit banking spread at a time when banks still promised to repay deposits or banknotes in specie, and when all banks were thus required to hold (some) gold reserves - reserves that no political entity could create at will. Only slowly and gradually was the gold backing removed and replaced with various implicit or explicit state guarantees, all of which are now practically failing.
Of course, just like investment genius Warren Buffett, the bankers may not know what to do with a pile of gold and may thus be tempted to simply put it on a big heap. I suspect, however, that the bankers will have a very good use for the gold. Their customers - the holders of bank deposits - may be very unsettled by the exit of the state and thus the taxpayer from the business of underwriting the banking industry.
Most people only consider their bank deposits safe because they believe the state would not allow Bank XYZ to default, not because they have any confidence that Bank XYZ is run prudently. Now that the state has exited the field of money and banking, the banks are likely to use the gold as additional backing for their balance sheets. They will use the gold as it has been used for thousands of years - to gain trust. And to avoid bank runs.
Will the gold hoard be sufficient?
I don't know.
Presently, the US government sits on 260 million ounces of gold. At the present gold price of $1,655 per ounce, we are talking $430 billion. The monetary base is presently $2,673 billion; M1 is $2,220 billion and M2 minus money market funds is $9,163 billion. The gold hoard is thus only 16%, 19%, and 5% of these money stocks, respectively.
Hardly a proper gold standard but it could be a start. Through proper balance sheet deleveraging and through additional gold purchases the private banks are obviously free to improve these ratios. (Again it is not for bureaucrats or economists to decide what is appropriate. This is the role of the banking entrepreneur.)
But now that the private banks own the central bank, would they not put the printing press into overdrive and create inflation?
I don't think so. Through quantitative easing the central bank accumulates assets from the banking sector and expands the money supply. The central bank leverages its own balance sheet in the process. The Fed is already levered more than 50 to one, which is more than Lehman and Bear Stearns were when they collapsed. But now the banks own the capital of the Fed. They foot the bill, not the taxpayer. The banks can no longer dump unwanted assets on the central bank. They own the central bank. They cannot transfer risk to it.
Additionally, the public will be very suspicious of an overtly expansionary central bank. They know it is operated by the private banks and entirely for their own benefit. Any inflation concerns will translate into higher interest rates and that is detrimental to the highly leveraged banking sector. I would expect the private banks, now operating without any safety net from the state but under the suspicious gaze of their own customers, to be very cautious about how much money they print.
Easy money is great for the banks for as long as they can lower reserve and capital ratios. That was much easier when they could rely on government backstops or when meeting official regulatory requirements already gave their balance sheet policy an official seal of approval. Now that they are on their own, monetary expansion and thus debt accumulation and leverage are a double-edged sword. It will pay again to run a bank prudently and even advertise your higher capital and reserve ratios.
Furthermore, the relatively sounder banks (if we assume for a moment that those indeed exist) have little interest in running the jointly owned central bank for the benefit of the weakest banks. To the contrary, it is in the interest of the stronger banks to see weaker banks fail and exit the market. At the same time, it is not in the interest of even the strongest banks to see widespread bank runs or a general distrust in banks as that could quickly come to haunt them, too.
I think it is very reasonable to assume that under my plan of complete privatization the key challenge of allowing corporate failure in banking on the one hand but avoiding a complete collapse of the banking system on the other will be managed much better.
The reason is that this task is now given to bankers as entrepreneurs who have a keen interest in getting that balance right. As long as banking is under the protection of the state, monetary and banking policy will be conducted for the benefit of the weakest banks, and the strongest banks will simply reap windfall profits.
Does the state get off too lightly?
The state no longer has any responsibility for the banks or money. No more setting of policy, no big hearings in Washington, no bailouts, no IMF, no World Bank. A lot of money will be saved and many explicit and implicit claims on the taxpayer will be eliminated. But also, the state can no longer tell the banks that government bonds are safe and encourage the banks through bank regulation and official capital requirements to invest in them.
There is no longer any bank regulation from the state. Banks will be regulated by the market, which means ultimately by the consumer. The state also loses the central bank and can thus no longer create an artificial demand for its securities. Remember, last year 61% of new Treasuries were placed with the Fed. Why should the banks, which now own the central bank, continue to accept this?
Government bonds everywhere benefit from the idea that states can't go bankrupt because they can always print the money. This idea is fundamentally wrong as I have argued repeatedly. Once the debt load reaches a certain level, it can no longer be inflated away. If this is still tried, currency disaster will ensue.
Be that as it may, with the state officially separated from the field of money and banking, it would have to manage its finances like any other entity, like a private corporation or a household (or almost like any other entity as it still benefits from the privilege of taxation). We would certainly see higher state borrowing costs, lower levels of spending and smaller deficits. This would be an important step to what Doug Casey calls "starving the beast".
Of course, in such an environment we would not have to worry at all about how the banks arrange their executive pay, how their bonus schemes work, or if bank shareholders hold their board members at all responsible for their mistakes and failures.
These are internal affairs of entirely private and capitalist enterprises. If bank shareholders get this wrong and set the wrong incentives, only they will bear the consequences. The idea that banking is a public service for which a specific set of rules and regulations must be designed and administered by the state does no longer apply.
Come to think of it, this proposal looks much better in terms of consistency and clarity than any other, in my humble opinion. Those who argue for an official gold standard are asking the state to design and implement a new monetary order.
Those who ask for a ban on fractional-reserve banking ask the state to define what constitutes legitimate banking business and then enforce it. Those who want to introduce new legislation in response to executive pay and bonus schemes, ask the state to interfere in the relationship between shareholder (principal) and manager (agent).
I ask the state to do just one thing: Get the hell out of money and banking! Now!
Regards,
Detlev Schlichter
for The Daily Reckoning Australia.
Ed Note: Detlev Schlichter is the author of Paper Money Collapse. This article originally appeared in Whiskey & Gunpowder.
From the Archives...
How to Use Preference Shares to Become an Absolutist Investor
2012-04-27 - Nick Hubble
Why Politicians Can't Solve Economic Problems
2012-04-26 - Bill Bonner
Pozieres
2012-04-25 - Greg Canavan
Investor Choices - Do You Have a Lifeboat or a Bottle of Brandy?
2012-04-24 - Tim Price
A Bankrupt Idea Whose Time Has Gone
2012-04-23 - Dan Denning
On Thursday we predicted doom and gloom for the Australian housing market. More doom and gloom than we've seen already.
'On a 12 month basis capital city dwelling values have fallen by 4.5 per cent, with the weak conditions in Melbourne (-7.0 per cent) and Brisbane (-6.4 per cent) dragging the weighted average down,' RP Data property analyst Tim Lawless said in The Age.
But today we're going to suggest buying houses, for two reasons. Capital gains and income. The catch is, it's not Australia we're on about. But, just so you don't think we're serial doomers and gloomers when it comes to housing, here is why you should flip a house in the land of beer and sausages, and invest for income in the land of peanut butter and jelly sandwiches.
The Eurozone has a one-size-fits-all monetary policy. This sounds like a bad idea, because different regions surely need different monetary policy, right? Well, the United States of America only have one policy, and their collective GDP isn't much smaller than Europe's. So if it works there, why doesn't it work in Europe? Perhaps because Europe doesn't have a fiscal union - a government spending union. But the American states have their own fiscal sovereignty too, on many matters, and they issue their own debt.
We're not sure why the EU's monetary union is somehow inherently doomed. The economic arguments just don't make sense to us, because they apply within countries like the US as well. But what does make sense is the opportunities the monetary union creates for you. And the one we want to uncover today is squarely in our 'policy profiteering' category of how to make money. You see, the government's misguided policy of manipulating interest rates never has the effect they want it to. Just like all other government policies. (The exception is when they want something really stupid, like a housing bubble - then they get it.)
But the predictable mistakes that governments make create opportunities - policy profiteering opportunities. In this case, they are creating a housing bubble in one of the few countries to avoid the 2007 episode. Just think about it for a quick second and you'll see the point we're making. Low interest rates created housing bubbles in places like Spain and Ireland.
Now rates are even lower. So where is the next housing bubble forming? Germany is our bet. Although you might discover the same phenomenon in countries we're less familiar with like the Netherlands and Austria. Anywhere that didn't have a bubble in 2007 might have one forming now.
The monetary policy that is keeping Greece, Spain and their fellow PIIGS on life support is not necessarily finding its way to Greece, Spain and the rest. At least not all of it. That's because central bankers can't control where the money goes once they create it. Funds are fungible. This is a very important point to understand, but we can only get it to make sense with an example…
Imagine a charity with admin expenses of $50,000 and regular donations of about $500,000 dollars. You, the local billionaire, decide to give the charity $1 million. But, being a suspicious and astute Daily Reckoning reader, you insist on the condition that your money is only to be used for the cause, and not to line the pockets of charity employees. None of the million is to go to admin expenses, you agree with the charity. A year goes by and the charity employees overtake you on the highway in their new Bentley, eating Häagen-Dazs ice cream in the back. You discover that admin expenses of the charity have grown by exactly $500,000.
Storming into the charity office, you demand an explanation as to why your money was spent on the Bentley and over-priced ice cream. The answer you get is 'funds are fungible'. The charity employees didn't spend any of your donation on the Bentley and ice cream, they did it with other people's donations.
The ECB faces the same problem. Actually, all money faces the same problem. You cannot connect one flow of money with another because all money is the same. Money can be redirected, manipulated, reclassified, and moved around. With the ECB's efforts to prop up Greek, Spanish and other PIIGS debts, part of the money will inevitably flow into other parts of the European economy. And we reckon German property is a big recipient.
The reasons are fairly obvious. Housing is sensitive to interest rates, and rates are low. The German economy is one of the few that Europeans probably feel like investing in. And the German politicians aren't likely to do as many stupid things as their fellow Europeans (short memory, we know), so foreigners will park their money there. That makes more money available for loans in Germany.
So anyway, all this is leading to a boom in German house prices. It's already underway according to your editor's Grandmother (in the interests of disclosure, we do have an indirect interest in the German property market). But our bet is that it will continue until interest rates normalise or prices go through the roof completely.
But if you're not interested in capital gains in Germany, how about a nice income play in the US of A?
Our colleague Chris Mayer and Daily Reckoning founder, Bill Bonner outlined the opportunity in US housing on Wednesday. As you read it, keep in mind that property prices may continue falling in the US. In fact, they are falling now. But that doesn't mean they can't earn a pretty impressive rate of income:
"US housing is the best value play in America," says colleague Chris Mayer. "If you own a house then look to buy and rent another."
Here's the idea. You can now buy a decent house for $60,000 to $80,000 depending on where you are. You spend a little to put it into rentable condition. Then, you can rent it for $1,000 a month...maybe $1,500. At $1,200 a month on a $60,000 house you have a gross rental yield of nearly 20%. Assume you spend half of that on taxes, maintenance, etc. That leaves you with 10% net. Not bad.
Better yet, mortgage it for 30 years. Say you put up cash of $20,000...and mortgage the rest. Your mortgage payments should be a good deal less than $250 a month. So, after expenses (assuming they are 50% of your gross rent) you are netting $250 a month, which works out to a 15% yield on your cash.
And what happens to that $40,000 mortgage? Could be that it is a burden for years...and you pay it off with no gain or loss. More likely, it gets cheaper, year after year. Inflation knocks it down. Perhaps slowly at first - 3%...5%...
But we wouldn't be at all surprised to see it get knocked away completely in a few years. Most likely, within 10 years a $40,000 mortgage...at today's fixed rates...will be worth less than half of what it is today. So, you'll make another $20,000 over 10 years...giving you a real yield on your investment over 20%...
This seems to us like the perfect investment for a retired person with time on his hands. Put $60,000 of savings into a money fund and you'll get...what...$100 a month?
Instead, buy 3 houses for $60,000 each...mortgaging $40,000 on each one. You'll have to work to fix them up and find the right tenants. But you'll end up with positive cashflow of about $750 a month...plus, maybe a bonus of $60,000 more over 10 years as your mortgages get whittled down by inflation.
All of that sounds like quite a good proposition. Imagine the look on your friends' faces when you tell them you're making a fortune in the housing market while their investment properties here in Australia plunge.
Until next week,
Nickolai Hubble.
The Daily Reckoning Weekend Edition
ALSO THIS WEEK in The Daily Reckoning Australia...
Gleichschaltung
By Dan Denning
According to Roger Kimball, gleichschaltung means two things, 'First, bringing all aspects of life into conformity with a given political line. And second, as a prerequisite for realizing that goal, the obliteration or at least marginalization of all opposition.' This, then, is the politicization of all discussions and then kind of an enforced sameness in the discussion. It sounds pretty contemporary, actually, doesn't it?
Stagflation: The Consequence of Printing Money That Nobody Wants
By Tim Price
Moreover, an outbreak of serious stagflation will decimate conventionally managed debt and equity portfolios. And given that most people invest with the crowd, with conventional investments or conventionally managed portfolios, stagflation will wipe the savings and livelihoods from untold masses. But, we live in strange times - times, for example, that reward bankers handsomely for bankrupting the economy.
The Fake Money From The Fed That Goes "Nowhere"
By Bill Bonner
Let's start with the money. When a fix is needed, the feds come up with money. But everyone knows the feds are broke. So where does the money come from? "Out of thin air," was an expression used by John Maynard Keynes. But how could that be? How can you get cash...money...out of nowhere? And what kind of money could it be...if you could get it at no expense? It must be a "funny" money...a zombie money...It must be worthless, right? But it's not. That's the crazy thing...
Examining the Long-Term Benefits of Gold Investing
By Joel Bowman
Does that make gold cheap, or expensive? A buy, or a sell? It depends on your perspective. We've all wished we could go back in time and buy '90s shares of Apple, acres of unpopulated beachfront and unloved ounces of gold. Alas, time marches in one direction and one direction only. So where will gold be tomorrow...a year from now...next decade?
A Growing Ageing Population… Catastrophically Successful Life Extension
By Patrick Cox
Even those who have no personal interest in life-extension strategies, beyond those supplied by conventional medical networks, will have to deal with the social and economic problems they cause. Our lives will be profoundly affected by emerging biotechnologies that will push maximum healthy life spans up much faster and further than ever before. Typically, when I say that life extension brings problems, the default assumption is that I'm referring to traditional fears of resource depletion and overpopulation. I'm not.
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Don’t visit your neighbours’ homes too often, or they will begin to hate you!
That’s a proverb… as well as common sense. Relationships generally fall into one of two categories; replenishing relationships or draining relationships. I bet when you answer a knock at your door from a friend, it could be either one you are excited to see and invite inside… or one who when you see him/her standing there you think “Oh no… there goes my afternoon and everything I had planned”.
Some people have a knack of lighting up any room they enter. We feel better about life and ourselves for having been with them. Others unfortunately only light up a room by leaving it. I’m sure you make time for all your friends… perhaps just a little more for those that refresh and replenish you.
So what about you… think about it; you’re the person that you spend more time listening to than anyone else. Does your self talk leave you replenished or drained?
Maybe there’s a bit of self talk going on right now… ha, ha. You may be asking “What has any of this to do with investing in property”? Great question and the answer is… EVERYTHING – if you want to have success!
Let me explain…
Attitude And Gratitude – Life’s Fertile Breeding GroundProblems (or challenges as I prefer to call them) are synonymous with life. The day all life’s challenges are at an end… so is your life. How you deal with challenges will play a bigger role in your ability to do well than anything else. As an employer I much prefer having people around me who, when a challenge arises, either take the initiative to solve it or bring both the challenge and their suggested solution to me.
I don’t like my mind being used as a dumping ground for negativity any more than you do yours… and we can easily be our own worst enemies in that regard.
Regardless of how bad things seem you have so much more to be grateful for. Stop for a moment and reflect on 20 things that you can give gratitude for. It’s amazingly true that when we get our attitudes right circumstances around us start to fall into place.
I barrack for the Gold Coast Titans in the NRL… who haven’t been travelling so well since the beginning of the 2011 season. I was saying to my brother last night that it’s frustrating how when a team is playing badly, making lots of simple errors, even the referee’s calls seem to unfairly go against them.
Attitude produces momentum – for better or worse. The ‘trick’ is to maintain a positive attitude so the momentum produced is like a tail wind propelling you forward rather than a head wind pushing you backwards. In the case of the Titans, I watched their game last week where many silly errors seemed to affect their attitudes and before long ‘everything’ seemed to go against them.
Not everyone reading this is a property investor… but no doubt you are a spouse or parent, employer or employee and the principle is exactly the same. Your attitude will determine your success in raising kids or in your performance at work. Likewise it will play a huge impact on your success (or otherwise) as a property investor.
Many companies selling investment property opt for a push system. That is, they work hard to get in people’s faces. Perhaps someone has tele-marketed you after you filled in a coupon for some competition promoted at a shopping centre. At mrd we prefer what is referred to as a ‘pull system’. That is, we let you know about the services we offer and invite those interested to respond and request our support.
Uniquely IndividualI can’t possibly know where individual mrd clients are at… but undoubtedly some may be struggling due to a business downturn while others, earning big bucks, are losing way too much in tax. There would be those ready and eager to take immediate action to keep their dream for financial security moving forward. Others may feel paralysed with fear, uncertain who to listen to and trust. There simply isn’t ‘one size that fits all’… we are all individuals with uniquely different circumstances.
My Invitation To YouI invite you to respond if you think there may be a way for us to add value to your situation at this time. Whether it’s help with debt consolidation, having your existing financial arrangements assessed, furthering your knowledge or securing your next investment property… my team are very capable of delivering you a level of service that you will be extremely pleased with. Interest rates are on the way down and perhaps now is a good time to have us see if you are getting the best deal going.
I’d like to direct you to what we call a “My Starting Point” assessment form which (as the name indicates) we use to gather an accurate snapshot of your current position. Only after we understand your unique ‘starting point’ can we assist you to take the next step. After help in defining your goals your focus should be on making measurable progress in reasonable time.
The antidote for confusion, anxiety and fear is right knowledge and putting an end to the negative self talk that keeps the potential before you… out of reach. I encourage you to ‘put your hand up’ and request a Property Strategy Blueprint session with one of our property mentors. We can do this with you over the internet (no technical knowledge is required, by the way) and assist you to create a personalised workable plan. Remember, it’s always the squeaky hinge that gets the oil… so ‘squeak up’ and let us know how you’d like us to help you.
Happy Investing,
Nick Lockhart
Our Customer Care Program works for you… because investing is personal!
In Australia there are approximately 1,600 postcodes with 30% of these showing Rental Vacancy Rates less than 1%, according to property analyst Michael Matusik. He went on to say that 70% of postcodes had a vacancy rate below 2% and 87% were under 3%.
Nationally, the average vacancy rate sits at just 1.7% with Victoria at 3% showing the only capital city to buck the trend.
The Australian Bureau of Statistics CPI rental index reports that weekly rents have been rising by 5.7% nationally since the middle of 2008; with Brisbane at 6% and Melbourne at 4.8%. Rental yields in many parts of Queensland reflect that State’s housing shortfall with the State’s average yield being in excess of 6%.
Median rents over the past 12 months have grown significantly higher in the Queensland’s Hot Spots… with Gladstone up by 45%, Emerald 25%, Mackay 15% and 10% in Brisbane’s inner west.
For those with a capacity to capitalise on the opportunities that currently exist… 2012 is definitely shaping up as the turning point from Queensland’s time ‘flat-lining’.
Opportunity is certainly knocking… (metaphorically speaking) don’t get caught ‘hiding indoors with the TV turned down and the curtains drawn – this guest is worth opening your doors to and embracing with open arms’.
Yes Please Nick… I would like to have my situation assessed to determine if I would qualify to take advantage of the opportunities around at this time >>>here
Happy Investing,
Nick Lockhart
Our Customer Care Program works for you… because investing is personal!
An American tourist in London decides to skip his tour group and explore the city on his own.
He wanders around, seeing the sights and stops at a quaint pub to soak up the local culture, chat with the lads and have a pint.
After he sets out again, he finds himself in a very high-class neighbourhood – big, stately residences, no pubs, no shops, no restaurants and, worst of all, no public toilets.
Desperate, after all those pints, he consults a London bobby, who says: “Just follow me.”
He leads him to a back delivery alley, then along a wall to a gate, which he opens.
“In there,” points the bobby. ”Whiz away sir, anywhere you want.”
The fellow enters and finds himself in the most beautiful garden he has ever seen. Manicured grass lawns, statuary, fountains, sculpted hedges and huge beds of gorgeous flowers, all in perfect bloom.
Since he has the cop’s blessing, he unburdens himself and is greatly relieved.
As he goes back through the gate, he says to the bobby: “That was really decent of you, is that what you call ‘English hospitality’?”
“No, sir,” replies the bobby. “That is what we call the French embassy.”
We've spent the past week moving house and family from Sydney to Melbourne.
We don't recommend the experience.
You spend weeks packing all your belongings. Then some blokes come along and squeeze it all into a shipping container in a matter of hours. A few days later some other blokes unload the container in even less time, leaving you swamped with boxes and stuff you forgot you even had...and can't find any room for.
Our wife and daughter flew down yesterday. Melbourne welcomed them with a pleasant blast of Antarctic air and persistent rain. We welcomed them with a wall of boxes and a lounge room that looked like a Picasso painting.
As much as we wanted to continue to find space for things we don't need and don't use, we couldn't neglect our Daily Reckoning duties any longer.
So we came into DR headquarters in St Kilda this morning to reckon. But about what? We've had no time to keep up with the world this past week. We've slipped into ignorance.
And, as the saying goes, ignorance is bliss. We have worried less about the world this week. Everything seems fine when you're not looking too hard. Sound bites and headlines only make you think you know what is happening. They provide no context, no details.
Here's our impression of the world following a week of ignorance.
Of course these points tell you nothing. They're simply statements. That's the problem with living in a world that fires information at you 24/7 at 360 degrees.
Which is where the Daily Reckoning comes into your life. We aim to piece the absurd and nonsensical together and give you some context. You may not always agree with what we say, but if we make you think each day then we've done at least part of our job.
Because the informed and thinking investor is much better equipped than the ignorant investor. Ignorance breeds complacency. Complacency leads you to put off making important decisions about your finances. And you generally remain complacent until it's too late.
Back in late 2006, we moved our parents' superannuation portfolio into cash. That was after speaking to their financial adviser whom we concluded was ignorant about the market and therefore complacent.
We didn't want him advising our parents in what we saw was a highly riskly environment. So we sold and moved into cash. The trick is to panic before everyone else...or at least before the complacent investor.
So, what is going on in the world? Financial markets are grinding higher...feeding the complacency.
Well, nothing has really changed, dear reader. Put simply, too much unproductive debt is weighing on the global economy. It's 'unproductive' because the projects the debt helped to finance don't generate enough cashflow to even service the interest repayments, let alone repay the principle.
It is 'bad' debt. Instead of recognising this and liquidating these 'bad' investments, governments and central banks prop up the system through the creation of even more debt. It is a policy based on hope. We would suggest it's a policy bordering on insanity.
Which brings us to Marcus Aurelius. He was Emperor of Rome from 161 to 180AD. According to Edward Gibbon, author of the Decline and Fall of the Roman Empire, the decline started following Marcus Aurelius' death and the ascension of his son, Commodus.
We bring up Marcus Aurelius because we stumbled upon some of his writings when unpacking. And instead of getting on with the job, we sat on a box and flicked through them. The following quotes from Aurelius are worth pondering in today's complacent environment.
They serve as a reminder that wisdom is not evolutionary. It is timeless. Despite all the 'progress' humans have made over the centuries, we are just as dumb as we've ever been.
'The object of life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane.'
When really pressed to think about it, even the ignorant observer would acknowledge that the creation of ever greater amounts of debt to solve a crisis caused by too much debt is insane.
'Everything we hear is an opinion, not a fact. Everything we see is a perspective, not the truth.'
Truth, like beauty, is in the eye of the beholder. There really is no such thing as the truth in financial markets. There are lies aplenty...but the truth?
'Look back over the past, with its changing empires that rose and fell, and you can foresee the future too.'
This is practically our mantra at the Daily Reckoning. We look to the past to give us a guide to the future. Without knowledge of history you're flying blind in today's investment world.
Armed with just a little history, a few things are certain. That is, today's policymakers will continue to make the same mistakes made in the past - just under a different guise. And gold will continue to fulfil its role as the ultimate form of money.
Until next week...
Regards,
Greg Canavan
for The Daily Reckoning Australia