Butter up the pop corn, fluff up the throw pillows, and get yourself three litres of carbonated high-fructose corn syrup! There is lots of good viewing to be had on financial markets this week. The Reserve Bank will decide what the price of money is to be in Australia. But as intriguing as that story is – especially the sub-plot of Joe Hockey leading a popular insurgency featuring support from the Greens against the banks – it’s not the main attraction.
The main attraction is a double feature from America. On Tuesday Americans go to the polls. If they send to Washington several dozen Mr and Mrs. Smiths whom refuse to be cowed/bought off by the Wall Street lobby and entrenched DC interests, financial markets might cheer the possibility of two years of Washington gridlock. The dollar could rally.
In fact, though the systems are different between Australia and the United States, the election there could produce nearly the same result as the election here: a divided government with little ability to mass major policies or reforms. To the extent that less government is better government, limited government is always good for a) political liberty, b) economic liberty.
From the business perspective, no news is good news when it comes to new laws. By the way, that’s why this canard that Australia’s business community is keen for a carbon tax so it can have certainty is rubbish. It’s manufactured manure posing as sensible wisdom.
Australia’s businesses don’t want a carbon tax. What business worth defending does want a new tax? That business should be against the tax is certain. True, the not knowing if there will be a carbon tax is a liability in terms of future planning.
But you don’t exchange a sense of certainty for a clearly negative outcome just to be certain, unless you’re a bad trader. If that logic prevailed, then we’d all wake up tomorrow and shoot ourselves in the head (in places where you can still own guns). Life=uncertain. Death=certain. It’s not a real choice, though, is it?
Back to markets. Will the outcome of the American election really have any influence over Australian markets? Well, it IS possible that a grid-locked Congress might be seen by investors (and U.S. creditors) as the high-water mark for the big spending/big bailout Washington-Wall Street axis of elitists.
However, our view is that the U.S. election merely begins the official countdown on America’s fiscal crisis. For owners of dollar-denominated assets or just currency punters, the dollar’s demise means the forced migration to other stock markets or asset classes, and you should decide son where you want to take your money. Why?
America’s structural deficits are worse than those in Greece, France, and the U.K. Former Clinton Administration economist Laurence Kotlikoff, now with Boston University, says U.S. government debt is not $13.5 trillion. That would be about 100% of US GDP. And although impressively bad, it is not so much worse than other places that it’s a currency breaker.
Kotlikoff reckons, though, that when you figure in the value of the unfunded and off-balance sheet liabilities (Medicare, Social Security, Medicaid), the actual U.S. “fiscal gap” is nearly $200 trillion – or 840% of GDP, which is a lot bigger than 100%. There are two ways to close this gap: cut spending (which no one seems serious about politically) or raise taxes (which would have to be doubled just to grow government tax takings as fast as projected spending increases.”
So THIS is why Nouriel Roubini calls US finances a “fiscal train wreck.” Roubini reckons the best we can hope for is Japanese-style stagflation in the U.S. markets, with occasional Fed cardio pulmonary resuscitation (large scale asset purchases of $100 billion a month) to keep asset markets alive. He reckons the Federal government will be forced to bail out the most fiscally distressed state governments.
By the way, the assumption here is that the U.S. federal government has the resources to do this. It does not, of course. It will require new money. And before that money can ever be created by the Fed, international creditors may have begun their long march/stampede out of the dollar. You’ll get either higher U.S. interest rates or massive inflation. But you may not get the orderly debt-funded bailout the economists expect.
What you will definitely get is a self-evident Ponzi scheme that even establishment players like Bill Gross from Pimco are recoiling from in horror. Gross, unlike mindless shills for the financial establishment, sees that Fed intervention in the markets is not in the interests of savers, bond holders (his clients and himself), or anyone who understands the benefits of sound money and the dangers of inflation.
He wrote to his clients that, “Cheque writing in the trillions is not a bondholder’s friend; it is, in fact, inflationary, and, if truth be told, somewhat of a Ponzi scheme.” And then voicing a concern so obvious that everyone but Paul Krugman seems to realise it, Gross writes, “We are in a ‘liquidity trap’, where [low] interest rates or trillions in asset purchases may not stimulate borrowing or lending because consumer demand is just not there.”
We’ll find out shortly – after the premiere of the second feature in our double feature – whether the rest of the audience in the investment world feels the same way Bill Gross does. The second feature comes on Tuesday, when the Federal Reserve meets to decide what to tell everyone about quantitative easing.
This could be the ultimate cause of “buy the rumour, sell the news.” The Fed has so many people on tenterhooks right now that nearly anything it says will disappoint someone. There’s a good argument that the markets (equity and commodity futures) have already priced in several trillion dollars in QE to “front run” the Fed.
But as Gross points out, fluffing up asset values doesn’t in any way improve consumer or household demand. All the world sees is anemic American GDP growth, persistent household debt (made worse by an intransigent mortgage crisis), political paralysis for two more years, and massive balance sheet expansion by the Fed. So who wants to buy the dollar?
Or who, like your editor on Friday, has concluded the world’s monetary system (based on a dollar standard) has tipped into terminal decline?
Something new is coming. But something old is breaking. Writing for Bloomberg last week, John Hathaway says, “The world’s monetary system is in the process of melting down. We have entered the endgame for the dollar as the dominant reserve currency, but most investors and policy makers are unaware of the implications. The only questions are how long the denouement of the dollar reserve system will last, and how much more damage will be inflicted by new rounds of quantitative easing or more radical monetary measures to prop up the system.”
These are important issues for everyone, including Australian investors. Radical monetary measures are already leading to soaring commodity prices (including food prices, which we reckon will force the final break with dollar pegging). Look for the RBA’s index of commodity prices to confirm this later today.
But do world currency systems simply collapse? Or do they slowly decay like a derelict Victorian mansion on Grey Street here in St. Kilda? The pace of the dissolution matters a lot to investors. And if we’ve learned anything in the last five years, it’s that complex financial systems are capable of falling apart and dis-integrating much faster than computer-based models would predict.
Our speculation, which was admittedly long-winded in the October issue of the Australian Wealth Gameplan, is that the Fed’s QE suicide policy (which it is pursuing solely to protect the interests of the banks which own/make up the Fed) will force the world off of the dollar standard, lest food riots create political crises. But what does that mean?
It means, to make a long story short, that emerging market equities and tangible assets may be the most popular destination in the capital markets for U.S. dollar refugees. Both asset classes may benefit from the short-term benefit of increased Fed asset purchases. But in the longer-run, global capital markets are going to be decoupled from the idea of U.S.-led consumption growth.
Granted, this has been going on for awhile. And Australia’s stock market – to the extent it’s a China proxy and a commodity proxy – could benefit. But orderly migrations of capital in the middle of a currency crisis usually aren’t placid affairs. Don’t be surprised if Wednesday’s blockbuster showing by the Fed leads to an unexpected and wild outcome. More on three possible outcomes tomorrow.
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