Let’s take a break from the great housing debate today and return to markets. What a day it was! Gordon Brown is ridiculed in the European Parliament as a U.K. bond auction fails. The U.S. Treasury Secretary is forced to consider a Chinese proposal for a new reserve currency that is not the greenback. And Australia ponders its Chinese future.
You get the sense that investors are of two minds, both probably subconscious. On the left shoulder, a little devil whispers into their ear that there is still at least another US$1 trillion in losses to be taken by the global financial sector. It warns that asset deflation can last for years and resist quantitative easing.
“Look at Japan puny human. Its exports fell 50% year-over-year in February. GDP is shrinking at an annualised pace of 12.1%. Global demand for Japanese goods has collapsed. And it’s not just the exporters. It’s the consumers too. European and American Banks will need more capital. There will be even more bailouts. The economy won’t recover this year. Banks can’t resume lending and consumers spending until losses have been taken and debts written off. How can stocks rally? This is not the bottom. Not yet.”
In the right ear another devil whispers. “Yes yes, asset deflation is a big worry. But inflation. It has to happen. You can’t expand the money supply without causing a rise in prices. It will come when the new money is released from banks into the economy. Watch for it. Prepare. The Fed will create trillions more to buy U.S. bonds. The Chinese will stop buying them. The dollar will crash. Sometime in 2010 prices will begin to soar.”
Which devil is right? The devil warning of more asset deflation or the one who has studied monetary history and concludes it has to be inflation? More on that in a moment.
U.S markets dithered with the data on Wednesday. Stocks weren’t the story. Bonds were. The bond market tells all. And what’s it telling you? Lenders to the U.S. government are demanding higher yields.
The Federal Reserve bought $7.5 billion in U.S. Treasuries. But yields on U.S. ten-year notes rose anyway. Recall that when the Fed announced its plan to begin buying U.S. debt, ten-year yields fell 47 basis points. Since then, though, they’ve risen by 24 points in five days.
What does that mean? Well, the U.S. Treasury auctioned $34 billion in five-year notes today. Tomorrow, it auctions another $24 billion in lucky seven-year notes. For the whole week, the U.S. is hawking a whopping $98 billion in new debt to finance its old and new spending.
If you’re scoring at home, that’s a lot of new supply coming on to the market. Just as in any other market, an increase in supply leads to lower prices. With bonds, lower prices mean higher yields. That’s bad news for the U.S. government because higher yields mean higher borrowing costs, and the U.S. government has world-class borrowing plans.
So in steps the Fed to try and cap yields, which also keeps other rates that are pegged to the ten-year low, like mortgage rates. The only problem?
Today’s action in the bond market suggests that investors are not going to play along. If the Fed wants to keep yields down, it may have to buy a lot more U.S. bonds than it expected. There may be a lot more sellers than it expected. And a lot fewer buyers.
Take the U.K. Today, for the first time in seven years, the U.K. failed to attract enough bids at an auction of £1.75 billion in 40-year bonds. That’s right, investors turned their back on sovereign British debt.
It’s not so surprising given the economic situation in the U.K. Britain is again the poor man of Europe (unless you count Iceland, which is really the destitute man of Europe). In Britain, you have crashing house prices, a banking sector in disarray, public finances in an absolute mess, and a Prime Minister who wants to borrow even more money for a bigger stimulus (does this sound familiar?)
By the way, do you get the feeling the G20 meeting in London next week is going to be a circus? Stay tuned on that. Markets may not like it one bit.
The demise of British financial capitalism prompted a British member of the European Parliament to rather publicly take Prime Minister Gordon Brown to the woodshed. It was great! He called him the “devalued Prime Minister of a devalued nation.” You can watch the whole thing here. Opposition parties in the U.S. and Australia should take notes.
If you get the feeling that the world’s modern financial architecture is buckling, you are not alone. It is. With the U.S. and the U.K. facing massive deficits and Japan joining them in a policy of quantitative easing, basic assumptions about how the world economy works (like whether the dollar is a good long term reserve currency and how much debt a nation can sustain) are being called into question.
Czech Republic Prime Minister Mirek Topolanek hold’s the EU’s rotating six-month presidency. He used his bully pulpit to cause a diplomatic stir yesterday by saying that the, “The US Treasury secretary [Tim Geithner] talks about permanent action and we, at our spring council, were quite alarmed at that.”
There’s more. “The US,” he said, “is repeating mistakes from the 1930s, such as wide-ranging stimuluses [sic], protectionist tendencies and appeals, the Buy American campaign, and so on…All these steps, their combination and their permanency, are the road to hell.”
We reckon our asset deflation devil and our inflation devil would both like that. All roads lead to the same place now apparently. And it isn’t Rome.
Meanwhile, back in Australia, regulators and politicians face a moment of truth about Australia’s economic future and how much if it is going to be determined by Australians. The Australian Competition and Consumer Commission (ACCC) has ruled in favour of Chinalco’s $28 billion bid for Rio Tinto. Now all that’s left is for the Foreign Investment Review Board (FIRB) and Treasurer Wayne Swan to sign off on the deal.
But according to today’s Australian, the ACCC ruling was based on an assumption the commission made. That assumption is that the Chinese government is the ultimate bidder for Aussie assets and that Chinese companies are all subsidiaries of the government.
This leaves the door open for Kevin Rudd to make a deal with his friends in Beijing in the style of Thomas Jefferson’s Louisiana Purchase. We’ll get to that in a second. But before we do, can someone please explain Australia’s policy with respect to investment from Chinese state owned enterprises? The clock is ticking…
The FIRB has three bids in front of it at the moment and it’s neither approved nor denied any of them. Hunan Valin Iron and Steel Group wants to buy 17.6% stake in Fortescue Metals (ASX:FMG) for $644.8 million. Fortescue wants to sell. The FIRB wants another thirty days from March 25th to think things over. Meanwhile, Macquarie Group says Fortescue faces a $731 million shortfall to fund its expansion plans.
Next, China Minmetals has made a $2.6 billion bid for distressed miner OZ Minerals (ASX:OZL). But on Tuesday shares of OZL (already in the pits, much to our chagrin) fell as much as 15% when the FIRB announced it was delaying its decision on the Minmetals bid by another 90 days. OZ has $1.3 billion in debt and desperately needs more capital before March 31st.
So now the FIRB must deal with Chinalco’s bid too. Will it delay that decision too? On March 18th, the Senate Standing Committee on Economics began a Parliamentary inquiry into foreign investments by state owned entities. It’s reviewing how to deal with Chinese Investment. You could also call it stalling.
The trouble is, the inquiry isn’t scheduled to report back to the Parliament until June 17th. The FIRB has knocked back the OZ-Minmetals ruling until June 22nd. And it’s knocked back the FMG-Hunan ruling until June 14th.
What will the FIRB know by the second week of June that it does not know now? Further, how can it be so sure that credit markets will roll over Oz’s debt, or that Rio’s share price won’t again decline as investors worry about how it’s going to finance the massive debt it used to finance the Alcan acquisition?
Markets are moving pretty fast these days. June is a long way away. And here’s the important point: Australian firms need capital badly.
The government seems happy to give money away to people who want to drink, buy TVs, and gamble. And it’s happy to subsidise commercial property development (because falling property prices would be a national and electoral disaster). But it seems like it’s doing everything it can to make life miserable for the miners who make up such a large part of the national economy.
But the Chinese are here to help. They have trillions of U.S. dollars. They would like to get rid of them. A trade of dollars for tangible assets is in order. So shouldn’t a deal be made?
After all, let’s be candid. Even though there is a lot of engineering and expertise required to be a world-class low-cost commodity producer or miner, extractive industries are low on the value-added chain in economic terms. The raw materials command a certain price. But the finished consumer and manufacturing goods they are turned into command a higher price with a larger profit margin for the manufacturer or the ultimate retailer.
If Australia is trying to figure out how to maximise the value of its natural resources, certain facts about the economy should be put on the table. It’s a two tier economy. On one tier you have the banks and the finance sector. On the other you have the resource industry.
We all know it’s a bear market in credit. The Aussie banks may or may not suffer more losses on their loan books. But the era of finance as a generator of outsize profits for shareholders is probably well and truly over for awhile. You can’t build a national economy on banking (unless you’re Switzerland, which cops it for being a tax haven).
That leaves the Aussie economy with resources. It has a willing long-term partner in China. And there’s no doubt China will be Australia’s principal resource customer for decades to come.
The Parliament, then, has to make a deal or craft a policy that maximise the value Australia gets for its resources. And it has to do so acknowledging that Chinese capital is critical to the development and expansion of the industry as a whole.
So here is our plan: sell China a 50-year lease to Australian resource projects. Demand an annual royalty or excise tax. Distribute the profits from the lease sale to regular Aussies. Presto!
No more need for government borrowing. Nor more stimulus plans. No more hand wringing. Just make a deal with your inevitable partner and guarantee the national cash flow for years. You can even call WA “New South Shanghai.”
It might not be popular at first. But just do the maths. Let’s say the price of the 50-year lease is US$1 trillion, or about A$1.43 trillion. You might even raise the price, to account for inflation. But even if you leave it at $1.43 trillion that amounts to around $28.6 billion a year for the next fifty years.
You could, if you liked, simply cut everyone in the country a check for $1,361 each year. It would be the Chinese Dividend. Imagine how much stimulating it would do!
There are problems, of course. A mere $28.6 billion a year is admittedly less than the current total value of Australian resource exports. So the lease price might have to be raised. But it’s a beginning…
Of course we’re joking. But we are serious about one point. The Chinese have capital and need Australia’s resources. Australian firms have debt and need capital. It’s a global bear market in credit. Australia and China are destined to be long term partners. The Prime Minister speaks Mandarin. Will it really take until June 17th to figure out how this is going to end?
Lots of reader mail on housing came in. So much so, in fact, that we’ll deal with it in a special essay tomorrow. Until then, here’s some reader mail.
You wrote, “”This alleged shortage is often alluded to but never proven…”
Rising rents are proof.
Regarding the housing shortage, I own a block of 12 units. About 5 or 6 years ago when a tenant vacated the unit, it would take several weeks to re let the unit. These days when a unit is vacated it is filled within a few days.
We may not have a chronic housing shortage to the point where people are sleeping in their cars, but I do think we have one. And if you are wondering why aren’t developers developing than consider this (1) construction costs are still very high compared to resale value, thanks to a lack of competition is steel, concrete, copper piping, copper wiring and other material pricing (2) the GST is a killer for developers, if the govt is serious about getting the construction industry going all they have to do is get rid of the GST and it will boom (3) to a lesser extent bank financing, but the reason this is an issue is because 1 and 2 make most projects barely viable.
You write “The number of first home buyer commitments as a percentage of total owner occupied housing finance commitments increased from 25.7% in December 2008 to 26.5% in January 2009. This is the highest level recorded since the series commenced in 1991” – but you omit to state what the annual levels or average level has been since 1991.
If it has always been around the 20-30% mark then it would look like you are sensationalising. If however the figure has risen substantially in recent years from a much lower average then that would be something.
For the record, the AFG mortgage survey we cited yesterday showed that first home buyers accounted for just 12.1% of new mortgages in January of 2008 compared to 26.1% in February of 2009. That’s an increase of 115%, and very subprime-esque in our view.
But the Reserve Bank provides a little clarity on this matte too. The RBA’s Head of Economic Analysis, Anthony Richards, gave a speech yesterday about Australian housing in which he said, “First-home buyer demand is also expanding following the boost to grants for these buyers. We can see this from the increase in the number of grant payments made in recent months and the rise in the share of first-home buyers in loan approvals to the highest on record.”
He also provided this handy little chart. More on his report and housing in the essay section tomorrow.
First Home Buyers Surge Into Housing
Source: Reserve Bank of Australia
Hi Ho Dan,
Love you site, great direct no bull info. I have one nagging question that has been testing my “grey matter” for months.
Let’s say 20% of the Milky Bar Kid’s “working families” lose their bread winner. We still have 80% of the “working serfs” paying their 9% into super funds. That is a huge lot of paper that must go somewhere safe.
Will the keepers of the cash invest locally in mortgages? Will the Banks soak this up in place of imported funds?
Good questions. The banks could fund local lending from local deposits. The question is whether Super fund managers risk putting Super contributions in cash rather than shares or mortgage and property funds (not guaranteed by the government). After all, who wants to pay a Super fund manager to put you in cash? You do that yourself in a self managed fund.
The giant ponzi scheme is really heating up with that news from the Fed. Perhaps we could call it a Fonzi scheme?
So Freddie and Fannie, who are essentially bankrupt, are raising debt capital from the Fed. This is used to make new loans, which are then securitised and sold into the open market, trading as agency MBS.
Actual market players are no longer keen to buy these at low interest rates, so the Fed has to step in as the marginal buyer to affect the price. The Fed prints money to buy agency debt and prints money to buy the securitised asset…itself the product of the debt it created out of thin air.
Then I read some clown who says, ‘this action will help everybody, maybe the Fed can put humpty dumpty back together again’. The animals are now well in charge of the zoo. This is not going to turn out well.
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