Chaos No Longer a Theory

What a Horridious Week!

Things are heating up around the world and it’s not looking good.

A bunch of market glitches on Thursday caused some panic in the US. Apparently they amounted to the biggest intraday drop ever for the Dow, but it wasn’t genuine and didn’t last.

Bloomberg reports on how the Greek bailout has calmed nerves in the European bond market – or not:

European Central Bank council member Axel Weber said Greece’s fiscal crisis is threatening “grave contagion effects” in the euro area as stocks fell around the world and riots in Athens left three people dead.

Axel is the guy who should have Jean-Claude Trichet’s job at the European Central Bank (ECB). He is the German representative and thus the resident inflation hawk.

“The legitimate aim of preventing contagion effects in Europe’s financial system doesn’t justify using every means,” Weber said. “Measures that damage the fundamental principles of the currency union and the trust of the people would be mistaken and more expensive for the economy in the longer term.”

The ECB is likely to be the battleground for Europe’s future. Monetary policy is one of the things major powers in Europe still differ on. It isn’t unlikely the Germans will simply tell Europe to get stuffed if they get pressured into printing. Financial market prophet Nouriel Roubini sees it happening soon. More on this below.

A sure sign that contagion is spreading rapidly, apart from the fact that this is by definition undeniable based on increasing bond yields, is the following quote:

“Spanish Prime Minister Jose Luis Rodriguez Zapatero yesterday dismissed as “complete madness” speculation that his government would need a Greek-style bailout.”

Complete madness indeed. Rumours are spreading that Spain is already in bailout discussions with the IMF.

The real crisis measuring stick, gold, reached recent highs in several currencies – especially in AUD.

Reviewing Henry

The Henry Tax Review released by the government on Sunday has caused quite a fuss. The share market didn’t like it at all. It took a 1% plunge in the first 10 minutes of Monday – which has since been eclipsed by European woes. According to financial theory taught at universities, the market should have priced in the Henry Review. Theory forgot that the government doesn’t follow advice. It just pays for reviews. Then comes up with its own crackpot ideas.

But it could be an honest mistake – perhaps Kevin Rudd just forgot to read the Review. According to Michael Pascoe at The Age, he didn’t even get to the executive summary! What a shame – all that work.

Pascoe also comments on what Kevin did come up with…

“The main superannuation change of increasing the super levy went specifically against the Henry recommendations. The business tax rate trimming and small business write-off sweetener were mere shadows of Henry’s suggested improvements.”

So why bother with a review in the first place? Well, if nobody reads the thing, it makes the suggested reforms look a lot more intelligent, no matter what the review actually said.

The only people who bother to read these reviews are ones with a vested interest (i.e. mining executives and their accountants) and they thus cannot be trusted for their opinions.

So goeth the political game. Tax one industry at a time and you only encounter resistance from a small number of people, who are easy to discredit, because they are the ones being taxed.

But if the Henry Review isn’t particularly important, and the legislation hasn’t even been drafted, nor is it likely to be before the election, why all this hubbub?

Well, Kevin has come up with a very clever scam. He proposes to increase compulsory super contributions, while making the Australian mining industry the most taxed in the world. Sounds great if you’re a socialist, right?

Dan Denning pointed out otherwise on Monday: “If you had to summarise it in a sentence you might say it increases the exposure of Australians to equities while reducing the return on those equities at the same time.”

Talk about a bait and switch! The government gets a power grab on both corporate and private Australia, and the citizen loses money twice over. Hurrah for Rudd!

Super Profits

The argument that the resources tax will ensure that Australians now get their fair share of their resource ownership is as deeply flawed as it is intuitive. Sounds like a great idea, but ends as a shemozzle, as most Government initiatives do. Dan discussed the fallacy and what it means for our future here.

The fact that Australians who have given up time and money to invest in an ore body extraction should pay Australians who haven’t done either is just silly. If you want a stake in Australia’s resources, buy a BHP share. Don’t allow the government to force you to do it though. Some of us might think it is a really, really bad idea right now.

One of those is our technical analyst, Murray Dawes. He managed to pick the top for one of the troubled mining giants, as well as locking in profits moments before the stock managed a minor (and temporary) bounce.

But even he couldn’t foresee the speed and intensity of the backlash in store:

“MINING giant Rio Tinto has shelved plans to spend $11 billion expanding its massive iron ore operations in Western Australia…

“Chinese companies have reacted to the proposed tax by shelving plans for investment in Australia’s resources sector and looking instead to Africa, Asia and South America…

“The Australian has learnt that at least one major fundraising by a Chinese company for investment in an Australian mining company has been put on hold as analysts branded the country risky…

“It is understood there are concerns within Rio that its Argyle diamond mine in the Kimberley region of WA could also become a casualty of the new tax. The mine is a major employer of indigenous people in the region and has been used by the Rudd government as a model for engagement between the mining industry and Aboriginal communities…

“Origin Energy said yesterday the proposed 40 per cent “resource super-profit tax” would push up “retail energy prices” by making gas and coal to drive power plants more expensive.”


Oppose What Exactly?

So where is the Opposition in all this?

Pascoe reckons he has picked it:

“And make no mistake in thinking that the current Liberal and National Parties are any less gormless. The main difference between the two sides is that Abbott wouldn’t have been politically silly enough to commission the review in the first place.”

But shadow Treasurer Joe Hockey, who we quite like, as long as he stays in opposition, seems to have picked up on the weak spot in all this as well.

At the moment, Kevin’s claim is that the Australian welfare state needs some extra funding to get back on its feet – and then grow a hell of a lot. So, the natural place to look for such funding is the resource boom that mining executives have been spruiking about so carelessly. Cap and trade didn’t work out, so Kevin has found a more direct way to get at their “super profits”.

Enter Hockey, the forward thinker: What happens when the mining boom is over? Australia will be stuck with the deficits from Kevin’s government expansion and won’t have a way to fund it. Keeping in mind that Dan reckons the resources boom is already a duck on its way to Peking, this is particularly concerning for Markets and Money readers. Hockey also points out that competition from around the world is going to jump at the opportunity to get a foothold in the lucrative resources business, which won’t be lucrative for Australians any longer.

Hockey even managed some brilliant eloquent language to describe the situation: “…standing the Government Budget on quicksand.”

Again, Dan reckons we may be in too deep already.

Interesting Rates

Even the RBA is buying into the mining boom – not literally we hope. Only idiotic central bankers would consider creating funds out of thin air to then use those funds to purchase assets from the real economy. As the Germans and Zimbabweans will tell you, it doesn’t end well.

But wait, what is this we hear from Bloomberg?

“The central bank may have to …, renew a program of lending unlimited cash to banks for a year, and even start buying government debt if the 110 billion-euro ($146 billion) bailout plan for Greece fails to stem the euro’s slide, economists said.”

Admittedly, it was “economists” who said this. In the same article, ECB President Trichet assures us that, “at this stage, we have absolutely no decision on the purchase of government bonds.” What that really means is one thing, but it’s not like the Frenchman feels bound to stick by the rules anyway. “Trichet yesterday diluted rules for the second time in a month to guarantee the ECB will keep taking Greek government bonds as collateral for loans.”

So what is stopping him from diluting the Euro, along with the rules?

The Germans!

Surprise, surprise, they haven’t forgotten the hyperinflations of the past. Using the printing press is a “red line which the German government would not allow to be crossed,” said Marco Annunziata, chief economist at UniCredit. “Purchases of government bonds would be a straight monetary financing of excessive fiscal deficits, which is anathema to the Bundesbank and German government.”

An anathema is an abhorrence, or abomination, according to trusty Microsoft word. But there are those who differ. Among them is another anathema, only a personified one. Paul Krugman, esteemed former Enron advisor, has picked up on some rather obvious facts regarding the Euro’s future. His conclusion is about as useful as his economic advice: “I think I’ll go hide under the table now.” The rest of the article is too sickening to quote, so check it out yourself. His point is that the politicians may end up having little say when it comes to a breakup of the Euro. The market could dictate that decision for them. (Surprise!)

French Prime Minister Francois Fillon thinks otherwise:

“This is not an attack on Greece but on the euro, and it will fail, for two reasons. Firstly, because the euro zone is solid … and then because we have demonstrated solid solidarity in favour of Greece”

Dan reported on Monday that “The Greeks have agreed to cap public sector debt at 140% of GDP.” But they haven’t. Their Prime Minister has. The Greeks don’t like the idea at all. In fact, Reuters reports that one in two Greeks will be taking to the streets in protest. One in two! Protesting against their own bailout!

Now that the deal is done, the protests are beginning. With three dead already (and an unborn baby), things are looking pretty morbid.

A German reporter with a very poor, or very excellent, sense of humour has been handing out the old Greek currency (Drachma) to Greeks on the streets of Athens, just to record their reaction. He obviously didn’t expect to get the worthless paper torn from his hands – literally.

Super Contributions

Kevin has indicated he would like to increase compulsory super by 3%. Where would that 3% come from? One of two places, the Austrian School of Economics tells us. Firstly, from business budgets, resulting in less employment, and secondly from disposable income, resulting in less discretionary spending. In what proportion this cost is carried by the two is something up for debate.

As we are true capitalists and care about the wellbeing of the poor more than the rich (because there are more of them), let’s examine the effect on those who struggle to make ends meet.

If 3% of your their income suddenly disappears, and you were only just making ends meet, what happens to you? And consider the rates on mortgages are rising as well. The sickening thing about this is that Super’s return thus far is so bad that you would be better off taking your Super contribution and paying down the mortgage.

Brown Knows

Gordon Brown’s last ditch effort at persuading the British public he represents change comes after his ten years as Chancellor of the Exchequer (Treasurer) and three as PM. But that wasn’t the problematic part of his speech.

Those tea partiers in the US who think Obama is a socialist would have been shaking in their boots if they listened to Gordon’s speech to the Citizens UK organisation.

“Inequality should not be woven into the fabric of our lives” he said.

Considering inequality is woven into the fabric of our DNA, let alone our lives, equality might be something rather unattainable. This discussion featured in a previous weekly edition, so let’s move on to an even better topic.

Gordon’s heralded achievements include introducing the minimum wage to the UK. “Justice for the low paid” and all that. But what was the actual effect of this?

Nobel Laureate Milton Friedman explained long ago that “There are no positive objectives achieved my minimum wages.” In fact, classical economists going back a very long way agree.

“The well intentioned ‘do-gooders’ think that raising the minimum wage helps low wage earners. According to Friedman, the opposite occurs. What you do when you raise the minimum wage is to ensure that those whose skills are not up to the new rate will become unemployed.”

Higher prices lead to less supply being utilised. Even Krugman wouldn’t deny that – except he does. Caroline Baum of Bloomberg’s opinion column comes up with the decisive solution to the debate:

“There is never a good time to raise the minimum wage. Just ask the people working in low-skilled jobs that are laid off as a result.”

I.M.F.’ed Take 2

If you would like to know more about the IMF’s track record, check out this article, which features recent “successful” bailouts of European countries. The market’s dismal reaction to Greece’s bailout will suddenly seem a whole lot clearer.

Have a great weekend.

Nickolai Hubble.
Markets and Money Week in Review

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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