As of Friday morning, the second most important piece of economic thought ever has been released. Please make sure you watch both:
Fight of the Century (new)
Back to the present
So which European state got bailed out this week?
Surprised dear reader? Isn’t that a sign of the times?
Instead, the action was far more interesting.
Bond markets, well, credit default swap markets to be precise, have long considered Greek restructuring likely. But for God’s sake, don’t tell anyone. If you do, you may find Interpol knocking at your door. The Guardian is reporting that a London trader learned this the hard way. After emailing his clients that the Greeks may default, or do something of the like, he was interrogated by the international police.
Would a Gestapo reference be entirely out of place here?And since when do Interpol handle securities law? Oh wait, a sovereign nation is at stake.
And, perhaps more importantly, banks are at stake too.
The Telegraph reports:
‘On Saturday Jurgen Stark, an executive board member of the ECB, warned that a restructuring of debt in any of the troubled eurozone countries could trigger a banking crisis even worse than that of 2008.
‘A restructuring would be short-sighted and bring considerable drawbacks,’ he told ZDF, the German broadcaster. ‘In the worst case, the restructuring of a member state could overshadow the effects of the Lehman bankruptcy.’
Yes, there they are again – the threats of chaos. Bail us out or else…
But who is left to do the bailing this time around is a mystery. A Business Intelligence article mentions a ‘new report from Deutsche Bank ranks the US government as the world’s fourth riskiest sovereign borrower, behind Greece, Ireland and Portugal, and just ahead of Italy.’ (Wait, wasn’t Deutsche right on top of the list of Federal Reserve rescues?) The Telegraph points out that the UK is much like Japan and also has the deficit to match the PIIGS.
So who is left to let the dollars flow?
*** crickets chirp ***
If you think that the governments of the world will look to their money printers for help, you are probably right. But a few days ago, your editor floated a theory that may upset that sequence of events. What if the Fed and the ECB refused to go along with their respective deficit indulging countries?
It seems like a laughable stretch of the imagination. But the law actually requires it. Price stability is part of the Fed’s mandate and the full mandate of the ECB.
If you believe, as Markets and Money faithful probably would, that all the money printing to date will unleash inflation eventually, there won’t be much room for more money printing.
Of course any genuine austerity measures would be deflationary, which might create room to print some more. But the amount of monetisation required to fund the deficits of nations around the world would be massive, even under austerity. And the more monetisation and inflation, the higher rates will go, leading to even more monetisation and inflation.
Unless the Fed and the ECB hit the brakes early.
Put it this way: If you were Chairman of the Fed or President of the ECB, would you want to be forever known as the one who let the inflation genie out of the bottle? Or would you prefer to let the politicians take the heat for their irresponsible deficits which they expect you to obediently monetise? Why share the blame when it rests squarely on their shoulders?
We’d like to think that Bernanke and Trichet’s successor will stand up to the pressure put on them by their governments. You may laugh at the idea, but remember that a bureaucratic organisation’s goal is to perpetuate itself and blame other bureaucratic organisations for its mistakes. The central banks can’t do that by siding with their doomed governments.
And here’s another bold prediction for you: The US will be the first major casualty when it comes to the debt crisis. Whether it’s some form of restructuring, or inflation because of massive monetisation of debts by the Fed.
MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES
(in billions of dollars)
Before nations restructure their debt, you’d think they’ll sell off their treasury holdings, right? Adding up the holdings of countries we consider to be in fiscal trouble, you get about $1.25 trillion of treasuries. Selling them would mean added pressure on US fiscal stability.
It’s not all doom and gloom though. Even one of the many ‘Dr Dooms’ has a cheerful note:
‘Gasoline has never been so cheap’ quips Peter Schiff on CNBC. You just need to find an American coin minted before 1964. The silver in that coin will buy you more gasoline than it ever has!
But we poor Aussies are missing out on much of the recent fun. Metal prices in Australian dollar terms aren’t matching the American’s parabolic rise. Even the stock market is giving up the US’s strong leads to a jumping Aussie dollar. Each time you think the ASX200 will go up, the AUD rises instead.
On the bright side, if the Aussie crashes, all our assets will go up, right?
Unfortunately no. Having cake and eating it too is something only the world’s super power has got covered. It comes with being the world’s reserve currency. Here’s how it works:
When the US dollar falls, as it has been doing, American assets tend to go up in dollar terms. Money is worth less, so prices rise. Simple. And win/win. Either the US dollar is the stellar performer or the Dow Jones is rallying.
The over-optimistic American media loves it.
But for an ASX-listed stock, life is different. Each time Wall Street seems to signal a great day, the Aussie dollar eats into the gains. That’s because, of late, the Wall Street rallies have been predominantly US dollar falls in disguise. And the Aussie dollar’s rise is the giveaway. Any real stock market rally would hold water against currencies around the world. The US market’s gains don’t. So the ASX stays put. Were the Aussie dollar to fall, that would indicate a flight away from risky assets, causing the ASX 200 to fall.
That’s the ridiculous situation we find ourselves in. There is no prosperity growth in much of the world. The fake prosperity engineered by Bernanke in the US is exposed as a lie by every asset not measured in US dollars.
All this is why Slipstream Trader Murray Dawes has been starting many of his weekly videos with analysis of the currencies. They are where the action is. Other assets are priced in terms of those currencies, so it stands to reason.
And according to the latest of those videos, released only to Slipstream subscribers, the US dollar has recently fallen below a key level. Only Slipstream subscribers will know what it means though.
But why is the US dollar falling? It’s basic supply and demand really. Chairman Ben Bernanke prints more dollars… they become worth less.
And here is the bit you need to put your thinking caps on for: If the US stock market’s gains are illusory, or based on a falling dollar, does that make the stock market a bad place to be?
Well, would you rather be in cash?
Of course there is a third option. One which the Markets and Money has been harping on about since its inception. Gold.
But we won’t go there today. Instead, ponder this: What would the US dollar index look like if the Chinese allowed their currency to appreciate? In our mind, the drowning anchor of the dollar hasn’t even been dropped on the deck of the USS Titanic. And when it does, the US dollar will really fall.
Petrol will go through the roof for Americans. Suddenly, there will be 9 million bicycles in Washington. And the Chinese will be able to afford the cars they make. The politicians calling for an end to the pegged exchange rate will be in for a shock.
In other topsy turvy news, it turns out that the poor have been getting richer too, not just the rich. All those academic studies which ended in the cry ‘the rich get richer while the poor get poorer’ conveniently left out certain types of income. We won’t comment on this further because it makes our blood boil to see how manipulative these types of studies are. Yet they set the political agenda of the day. Maybe the two are linked.
Before you think we’ve avoided talk of housing bubbles for a whole Markets and Money, consider this rather odd claim from Bloomberg regarding the outlook for US real estate: ‘Residential real-estate prices dropped in the 12 months to February by the most in more than a year, putting the market on the verge of eclipsing the nadir reached during the U.S. recession.’
It should be of no surprise that the falls in price in a year were the most in a year, as that would be the same year.
Anyway, Aussie investors who went on a house purchasing holiday to the US probably don’t want to hear about the double dip in US house prices. Nor would they enjoy the look of the USD/AUD exchange rate, which only adds to their worries.
Closer to home, the homeless who are included in the housing shortage figures must be getting excited at the thought of falling house prices. Perhaps they will be able to afford something soon. Like in Noosa, where prices have plummeted.
Markets and Money reader Paul has come up with a reason for pricking the housing bubble that your editor never considered:
Ok a lot has been said about negative gearing via real-estate and the property bubble
Now it’s time to do some lateral thinking. The government wants property price to fall; why
If prices start to fall investors will bail out (sell) that means they will have to pay Capital Gains
How much will the government reap if half the investors sell their properties?
Hopefully more than it will cost the government to shore up the banks afterwards…
But why are Australian properties so overvalued in the first place? Our theories for the US housing market boom and bust rely on irresponsible monetary and fiscal policy. Was it the same here?
The evidence is not as obvious. But it’s still there. Low interest rates, tax incentives and the biggest factor of all – rising house prices. What we mean is that a house price increase, once it gets off the ground, can be self-sustaining… for a while
First people are pleasantly surprised when their house goes up in value. Then they realise they can make a packet by buying another house. Pretty soon, rental returns are no longer a consideration – and losses can even be a benefit for your tax bill. What makes housing affordable is the capital appreciation. Even first-home buyers can enter the market at ridiculous prices, as they can simply sell at a higher price later. Again, the expected capital gain is a part of the justification for the price.
But when the trend ends, the whole process is reversed. People can expect to begin losing the value of their deposit from the moment they sign the contract. (Please don’t start telling us about the cooling-off period.) This makes housing unaffordable in the same way as appreciation made it affordable. Soon, purchasers and bankers will want significant down payments to avoid being underwater.
And the RBA has gone about demonstrating yet another way central banks create instability. If, as they claim, the inflation Australia is experiencing is caused by the likes of cyclone Yasi, how does increasing interest rates help? Surely it just makes life more difficult for those struggling with the inflation.
The RBA has got itself in a muddle over what inflation really is. If a cyclone causes increased prices because supply is wiped out, that is a supply and demand issue. It is not inflation. Increasing interest rates in the face of a damaged economy is a stupid thing to do.
But Ian Verrender at The Age has other ideas:
‘Prices are determined by supply and demand. That means you can have two types of inflation, price rises caused by excess demand or price hikes resulting from restricted supplies.’
This is painfully incorrect. Real inflation is ‘everywhere and always a monetary phenomenon’ – an increase in the money supply – according to Nobel Laureate Milton Friedman. This usually leads to rising prices. The solution to that is to stop the money supply from increasing. It really is that simple. And if the RBA adhered to that definition of inflation, it wouldn’t be putting the squeeze on Australians already suffering from a cyclone.
To believe that all price changes are inflation or deflation makes the concept completely useless.
Markets and Money Weekend Australia