An Economic Crisis in Reverse Chronological Order

It all started with sub-prime debt in America. Then the trouble crossed the Atlantic, went straight past the rock of Gibraltar, and infected Europe’s Mediterranean nations. Their balance sheets were struck with a bout of sovereign debt crisis. Now, it looks like China could be stumbling. House prices, exports and steel production are clues of the impending disaster popping up in the middle kingdom. Not that the spotlight is off Europe just yet.

At least the gods of economic law are following a logical pattern – they’re going steadily eastwards. Moving in reverse chronological order if you take time zones into account. And that means they’re nearing the land of Oz, the lucky country, the wide brown land of expensive houses.

But what will the gods serve up when they get here? Australia is truly a smorgasbord of accidents waiting to happen. From house prices to personal debt. From resource curse to blissful ignorance about what a recession even feels like. But rather than looking at these, let’s think two steps ahead if things do go bad. What happens to people when the reality of economic law bites? We have plenty of case studies to look at from that other hemisphere.

1. The “risk on” trade

All around the world retirees, and those preparing for retirement, are turning to increasingly risky investments after having been burnt in the 2008 crisis. Sounds rather silly to double down on a losing strategy. But they need to make up lost ground to fund their retirement. According to the academics in the finance departments, the risky assets they are using provide higher returns.

But this exposes people to even more risk, during a crisis that blatantly isn’t over. No government facing a sovereign debt crisis is running a surplus. Banks are even bigger now than they were when ‘too big to fail’ was used as an excuse to save them. Personal debt levels are still stratospheric.

Here at home, we’re already overexposed to risky assets to begin with. Last weekend’s Financial Review said ‘Super funds overloaded with shares’ on the front page. It’s only a matter of time before something brings a recession here. Australians’ investments will take a big hit.

What’s particularly surprising is that fixed income investments are getting a terrible rap in Australia. Nobody seems to favour them in the papers. We’ve read article after article poo pooing their benefits. Meanwhile, British, American and European investors and savers are wishing they had locked in interest rates when they were above zero.

You’d think we’d learn from their suffering and jump on anything paying a decent yield. But the fixed return of fixed interest investments remain a no no with the finance industry. At least as far as the media would have you believe. Instead, stick with the high risk assets, they say. Go on, have a punt! She’ll be right mate!

2. Debt-pression

The Daily Mail has reported on a phenomenon we expect to hit Australia like a ton of bricks: ‘…one in ten [Britons] are turning to gambling or the lottery in a desperate bid to ease their money woes – branded by experts as ‘debt-pression’ – a study has found.’

It may seem like a bad idea to gamble your way out of debt. But it’s a tried and tested Keynesian strategy, just on a small scale. Instead of the government spending more and more money on increasingly ridiculous things, like insulation, people spend that money themselves. Just like with government stimulus, these people are gambling on some sort of magical result which multiplies their spending and somehow turns it into increased income. It’s much the same fallacy.

But what’s worth focusing on is the ‘debt-pression’ part of the story. How many of your children, relatives and friends are in for rough time if things in Australia get difficult? Twenty years without a recession is one heck of a build-up of naivety.

In Argentina, where USA Markets and Money editor Joel Bowman recently lived, things are pleasantly inflationary. People go out and spend their money each night, because it’s not worth as much the next day. That makes for one heck of a nightlife.

But in places like Ireland and Scotland, your editor has seen and heard very different accounts. People are really struggling. And it’s not pretty the way social institutions turn when people begin to realise the pie is shrinking.

The most important preparation for bad economic times is your own psychology. Don’t make your personal life dependent on the performance of your portfolio. Although you probably need to be robust financially to be robust personally.

3. Routing savers by rerouting their savings

ZIRP stands for Zero Interest Rate Policy. It’s also the noise that a central banker’s weapon of mass destruction makes as it turns savings to dust. How? The lower interest rates mean savers get less return on their savings, just when inflation is being primed.

Apart from forcing you to make riskier investments (see 1. above) ZIRP zirps the incentive to save further. That might be fun when it comes to Argentinean nightlife, but it’s not so great if you’re trying to create the capital an economy needs to grow and improve productivity. In their efforts to encourage consumption and borrowing in the face of too much consumption and borrowing, central bankers and their ZIRP rays make things worse.

Luckily for the politicians, the ZIRP ray that central bankers use is aimed at government bonds first and foremost. That has the effect of making government borrowing cheaper. But, as this video shows, that can be a trap.

First, consider that US government interest expense on debt at around 3% is more than three times as expensive as running the Iraq and Afghan wars put together. Every percentage increase in interest adds the cost of another Iraq and Afghan war to the US budget. At 6% interest, the US would have interest expenditure at the same level of cost as World War 2.

Remembering that ZIRP ignites inflation, and it takes rising interest rates to slow inflation, you can surely expect higher rates to come.

ZIRP has led the public and their politicians into a trap not seen since the Greek tragedies of … this year. Are you prepared for what a high interest rate environment could do to your financial position? Don’t be tricked into loading up on debt while ZIRP comes to Australia.

4. Crime

We really don’t know whether to laugh or cry about this one. Japan is experiencing a crime wave in response to its continuously sagging economy. What’s new is that these criminals are the elderly. Prisons are being turned into retirement villages. We’ve quoted from the Guardian at length because this is just such a bizarre situation.

‘Pills and porridge: prisons in crisis as struggling pensioners turn to crime’

‘Charts on their cell doors stipulate special dietary requirements and medication regimes. A handrail runs the length of the corridor, and makeshift wheelchair ramps are kept at the entrance to the communal baths.

‘But the most common condition afflicting these men is loneliness. Some serve their sentences without seeing a single visitor. Their relatives are either dead, live too far away or, unable to cope with the shame of having a criminal in their midst, have ceased all contact.’

The rise of the superannuated criminal is only partly explained by Japan’s rapidly ageing population. While the number of Japanese aged 60 and over grew by 17% between 2000 and 2006, the number of prisoners in the same age bracket soared by 87%.

The prisoners repay their debt by performing six hours a day of light manual labour, two less than Onomichi’s younger prisoners. Every few minutes, one of the men lays down his tools and shuffles to a makeshift pharmacy set up in the corner of the room, where the prison doctor dispenses pills that must be washed down on the spot with tiny cups of water.

As many as 80% of the inmates here have high blood pressure or diabetes. There is a portable mattress on hand in case anyone feels faint, along with a wheelchair and, placed discreetly behind a desk, boxes of incontinence pads.

Japan, the country of the rising sun, paradoxically came first in the reverse chronological order of crises. It has been suffering for around 20 years now – a similar amount of time to Australia’s unbroken run of prosperity. That’s ironic considering Australia’s future was once tied to Japan according to all the leading intellectuals and politicians.

That’s why, we’re guessing, Australian state schools teach so much Japanese. Now there is a move to teach Mandarin instead. Our bet is that the same economic story will be repeated with China, just to make those intellectuals and politicians look stupid again. Perhaps Australian schools should teach better English instead.

But what’s important about Japan is that has shown the world one version of what the future could look like. And we haven’t deviated from that path yet.

As for what to do about that … well we’re working on it.

Until next week,

Nickolai Hubble.
Markets and Money Weekend Edition

ALSO THIS WEEK in Markets and Money

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Dividends: How to Milk the Stock Market’s Cash Cows
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As miserable as this situation is for the economy, it means there should be a premium out there for those with a vision for the future and the fortitude to save for it; for the savers, lenders and investors of Australia. They should be able to do well for themselves while their spendthrift neighbours try to keep up with the Jones’s.

Greg Smith – A Former Goldman Sachs Insider Finally Speaks Out
By Eric Fry

But your editor is just a guy who’s trying to peek over the hedgerows…an outsider…a “Muppet,” according to the Goldman lexicon. He assailed Goldman’s moral bankruptcy from the outside looking in, because that was the only option available. But now comes Greg Smith to assail the firm’s moral bankruptcy from the inside looking out.

Hilarious Reasons for Why We Need the Government
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Your editor nearly spat his Burger Rings into the next aisle when he read that one. “A caring state.” Ha! The favourable personification of a non-human entity. The slavish, drooling adoration of one’s own keeper. This had to be one of the most poorly disguised cases of political Stockholm Syndrome we’d ever come across. But there’s more.

Nick Hubble
Nick Hubble is a feature editor of Markets and Money and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about Markets and Money, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails.

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