Are we there yet?

Does it strike anyone as odd that, during a time when the very solvency of European governments is in question, the ASX goes nowhere for a year and a half? I mean this is the most turmoil in a lifetime and nothing happens in the stock market! Just back and forth.

But the bond markets haven’t been anywhere near as dull. The 10 year yield, which most American mortgage rates are pegged to, jumped the most in years, according to Peter Schiff. He also points out that the EU debt crisis became a problem because interest rates began rising. Now that this is happening in the US, it could be the big hint of sovereign trouble for the US.

The irony is that higher treasury yields imply higher mortgage rates, which implies trouble for the private economy. That usually leads to a flight to safety, which is in turn, Treasuries. It reminds us of the Benny Hill show.

So why are equity markets stuck while bond markets wobble? Well, if you discovered that the Federal Reserve is happy to lend to any (big) company anywhere in the world, what does that do to your downside risk in equities? It takes out a big chunk of your worries. But for bondholders, it means the inflation spectre looms.

Markets and Money Solves the Crisis

Yes, dear reader. Apparently printing money is a solution. Based on that assumption, we have a solution to the EU’s funding crisis and the US states’ funding crisis. Acquire the power to print money … and print it. Ok, so we were inspired by Wayne Madsen and Chris Whalen. As Madsen acknowledges, US states coming up with their own currency would imply dissolution of the American union. The EU would probably go the same way if several of their members broke from the Euro. Whalen reckons it’s only a matter of time before someone does.

And heck, if you have a funding problem, why not print your own money….

Too big to Bail

So Ireland got there in the end. Angela “Teflon” Merkel, as the CIA refer to her, backed down and let the money flow. Germans will wonder why the Irish are protesting on their tab. But relations between the nations have been good since the Germans gave Irish working families jobs at munitions factories.

Even if you didn’t donate to the bailout (Australia provides about 1.5% of the IMF’s funding), it seems rather odd for the Irish to protest now. They should have protested about    the loss of independence when the Euro was being introduced. Instead, the Irish protest against the bailout that is required to clean up the mess of a “one size fits all” monetary policy. In other words, they protest over the conditions attached to a monetary benefit instead of the conditions attached to a loss of independence.

So has the bailout solved Europe’s problems? Nope, the vigilantes have merely moved on to their next victim. The entire Iberian Peninsula, it seems.

“The notion that a rescue package for Ireland would create a firewall and stop the fear of contagion is clearly discredited,” said Preston Keat, director of research at Eurasia Group, a political consultancy, in London. “Portugal and Spain are already facing pressures in the markets.”

Even Germany’s bonds shuddered at the thought of having to bail out Portugal and Spain. Too big to bail? You should feel confident that the ECB will fire up its cylinders if things should get dire. Oh look, it even said so in public. So even if austerity has dawned on Europe, monetary mayhem may not be avoided. It would be a surprise to have the German voter stick around for that experience though. The question is what sort of party might come to power under a policy of abandoning an international treaty which requires Germany paying other countries money. (Sound familiar?)

The ‘flation wars

The Austrian Business Cycle theory contends that inflationary monetary policy leads to a boom, followed by a bust. But what if we don’t start from a “neutral” point. What if the economy is on course for a crash and inflationary monetary policy merely props things up. Do you still get the same kind of distortions, which lead to the bust?

The answer is probably yes. The same distortions that happened under Greenspan’s put era are happening under the Bernanke put era. Only the symptoms aren’t higher prices this time. Instead, the symptoms are in prices that are higher than they would have been without Bernanke’s meddling.

That implies we will have another crash, without even getting a boom. In the 2000s, we got a boom instead of organic growth. This time, we get slow growth instead of a correction. Soon we will have a recession instead of a depression….

In Praise of Bernanke

How is this for a shocker:

“Investors should heed the views of the Federal Reserve on the state of the economy and the need for more debt purchases because “so far they have been right,” according to William O’Donnell of Royal Bank of Scotland Plc.”

Yes, the geniuses who gave you the biggest crisis since 1939, “so far they have been right”. But the morbid hilarity doesn’t stop there:

“The Fed is better informed than anybody else,” O’Donnell continues, to tears from your editor. “They see the picture; they are concerned about it, about the disinflationary trend, and obviously the pernicious nature of unemployment in this country. They are tasked to do something about it and I cheer them on.”

Cheering indeed.

Barney Frank’s Admission

Few earn the disdain of the Markets and Money like Congressman Barney Frank. He might even make it into the top 3 crisis causing meddlers. But every now and again, even Barney does a good deed. Like supporting a smaller military. His latest virtuous move was to make several admissions of what sort of an economy he has conjured up in his tenure as a Congressman.

“We want investors to feel that when they invest they’re totally safe. And if investors get a feeling that the game is rigged, then that’s a problem.”

Yes, Barney admits that investors must be conned, or else the game will be up. If they realise how rigged the markets are, then there will be a problem. And why should investors feel their money is at risk?

Barney continues with a discussion of his latest efforts: “The new laws will prevent the loans that shouldn’t have been made to people who can’t pay them back.”

Frank admits to the blunder his affordable housing policies turned out to be and is now trying to correct his past mistakes. And when asked whether he was concerned 600 billion would fuel a bubble, he pointed out that we shouldn’t worry: “No, a huge amount would. I don’t think the amount they talk about in the context of the global economy is all that significant.”

600 billion isn’t significant to a man of stature like Barney…

What authority is backing the public authority with authority?

Central bankers around the world have been doing some serious soul searching. The result; they couldn’t find them. Most likely, it is too difficult a task for econometricians. No data to look at, so no trend line to draw. They don’t know much else. So they pull at straws, making statements as though they had any credibility left to discount.

Jean Claude Trichet reckons that markets “are tending to underestimate the determination of governments.” Yes, apparently governments are determined enough to bring back their balance sheets from the brink. We can’t think of an example in history where this was the outcome. Usually political pressure became too much and central bankers began printing money to fund the government deficits. Hence Trichet’s hint at more QE.

“We have to reinforce the authority of the public authority,” Trichet said. “It is on the authority of the public authority that we can continue the resistance to an environment which is very demanding and will continue to be demanding for a period of time.”

Trichet can “authority” all he likes. In the end, governments must fund their deficits and roll over their debt. And the money to do so is in the hands of greedy bankers who don’t want to go the way of their comrades at Lehman Brothers. So if the sovereigns are a losing trade, then they will not be bought.

“To some extent the ECB is being held hostage by financial markets,” one of those greedy bankers reckons.

The big four get Fitched

“Australia’s banks and insurers would find the fallout following a 30 per cent tumble in house prices ”manageable”, Fitch Ratings said yesterday.” Who? Fitch! For Gods sake, those geniuses are still at work? Yes, after missing the biggest bubble of the past few generations, they claim to know what they’re doing.

Apparently the Australian people at large are no better than Fitch though: “The report by the Australia Institute shows about 70 per cent of Australians make irrational decisions about money… More than 40 per cent of Australians cannot name their electricity company, don’t know what their mortgage interest rate is…” So don’t go sending complaints to about “stagnant incomes”.

But wait, the article kind of loses its message:

“Irrational behaviour includes devoting accounts to special purposes such as a wedding or holiday, when the consumer is paying 20 per cent interest on a credit card.”

What’s irrational about that? People saving up for something specific was supposed to be prudent. If you are willing to raid your savings at the whim of a credit card bill, you might as well not save. Here is the flaw: “Orthodox economics is based on the assumption that people act rationally, like human calculators. The survey paints a different picture.” Why on earth anyone has faith in so called “orthodox economics” has been beyond our understanding for a long time. But assuming people are calculators and that calculators are rational is a farce. Money is only a part of people’s decisions. That is painfully obvious, unless you studied economics.

So when someone doesn’t raid their savings to pay off their credit card, that shows long term wisdom overruling a temporary glitch in virtue. The interest rate you pay is the price.

But back to Fitch’s declaration that the banks could survive a 30% decline in prices, you have to wonder, could Australian households?

Has the RBA gone too far?

With Australia posting a disappointing growth figure for the third quarter, there is much whispering about whether the RBA has raised rates too far. But it’s a trick question. If it hasn’t gone too far, then it hasn’t gone far enough. That’s because the chances of a bunch of central bankers guessing the correct rate is pretty … impossible. Only the free market could do that.

Consider the following imaginary scenario: The RBA has raised rates repeatedly to slow down the economy and its inflation rate. But what if interest rates would have risen even more during that period if the market for money wasn’t price controlled by the central bank? In that scenario, the RBA would still be stimulating the economy – despite raising rates. It’s all relative, not absolute.

And it’s all real, not nominal. Consider the second scenario: If inflation increased more than central bank decreed rates did during a period, then the real interest rate has fallen, which means stimulus is being added, despite increasing rates.

So don’t go thinking that central bankers know what they are doing or could possibly know what they are doing. There are too many moving parts. But that doesn’t mean you can ignore their blunders. 2008 was a lesson on that count.

For the time your portfolio isn’t plunging because some academic at the helm of the world economy decided to inflate a bubble, it is fun to laugh at just how clueless central bankers are by their own measures. Michael Pascoe does a good job of it here.

Did the Fed feature on your Christmas card list?

So transparency won out and the Fed got outed. Revealed are the beneficiaries of the unlimited credit lines that were opened during the crisis. Among them the known unknowns – banks and investment banks – along with a few surprises.

Michael Dell of Dell Computers is on the list! And obesity itself, in the form of McDonalds, was bailed out too. Poor old Lehman Brothers employees must be really grumpy now. But among the clarity, there remain some questions. Like whether JP Morgan holds $4 billion of Washington Mutual securities or not. They can’t figure it out!

One rather amusing side to the bailouts, which never dawned on us before, was that the wealthy, after paying disproportionate taxes for decades, simply got the money back. If they hadn’t been taxed, government might not have had the financial clout to mess in the mortgage market and the boom would be found only in an alternate dimension.

Civil wrongs?

Here is an interesting thought to round off this week: As discrimination laws have grown more and more intrusive, more and more employers are having to discriminate. That’s because discrimination laws are a cost of hiring someone who can sue under them.

Here is an example. You can choose between hiring a black or a white, who are otherwise the same. Under the law, if you fire the black person, they have a significantly better chance of suing you successfully. Who do you hire? If you can’t work it out, ask your lawyer. Apparently, it is the norm for lawyers to advise people (off the record) that they should avoid hiring minorities!

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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Here’s a message for Barry O’Farrell.

He doesn’t have to just worry about losing the shrinking pot of GST he has to look at the other side of the ledger and the inability to fund all his poilce state mates.

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