Crisis Edition

Since a Tunisian fruit seller lit himself on fire in protest on the 17th of December 2010, the world has gone bananas (not that it wasn’t before):

  • Unrest in Tunisia
  • Unrest in Bahrain
  • Unrest in Libya (including a possible outbreak of civil war)
  • Unrest in Yemen
  • Unrest in Algeria
  • Unrest in Morocco
  • Unrest in Iran
  • Unrest in Jordan
  • Unrest in India
  • Unrest in Greece
  • Unrest in North Korea
  • Iran’s warships on the move
  • Oil to $100 and beyond
  • Record prices in commodities
  • German resistance to bailing out the PIIGS
  • Italian bond default risk jumps, other PIIGS at risk
  • Flooding in Australia
  • Earthquake in Christchurch
  • South Korean bank runs
  • Massive government employee layoffs in various US states (and more to come)
  • Record budget deficits in the US and a budget standoff
  • Unrest in Wisconsin
  • US house prices resume falling
  • US treasury yields rising
  • US dollar falling
  • List of US banks at risk of failing at 18-year highs
  • Even the IMF acknowledging inflation in emerging markets caused by quantitative easing in the US

Yes, it’s been a busy few weeks.

While these events transpired, the S&P500 rose about 5% and the ASX200 rose by about 2%. And that’s all that matters to Chairman Bernanke. He is willing to see the Middle East go up in flames in the name of the wealth effect. So he continues his inflationary ways, conveniently ignoring the effects this has outside the stock market. (Perhaps he will win the Nobel Peace Prize for his efforts.)

But the last few days have seen a reversal of fortunes.

The Arabs have replied to Bernanke’s inflation of food prices with a price hike of their own – in oil. And that’s where it really hurts Americans. Not just in the stock market, either. Much has been said about the American lifestyle’s dependence on oil. Cheap oil.

Of course, Dan Denning has been on top of how unrest in the Middle East and north Africa will impact the world. And he’s found some interesting ways to profit from the energy market’s instability.

But back to Chairman Bernanke’s unintended consequences. The irony of inflation causing a spike in oil prices, which has a deflationary shock, is obvious. Less obvious is just who will win. Inflation or deflation? Markets and Money editor Bill Bonner predicts both. One after the other.

It’s just a question of how bad the deflation will get before Chairman Bernanke comes to the rescue with fresh money – denominated in billions. That state of affairs is a pain in the neck for investors who want to make money in coming months. It means market timing will be the key to successful trades. And when we say market, we mean the announcement of QE3. At that point, the inflation trade can resume until the next external shock hits.

Eventually, the game will come to a climax. History teaches us that banking crises tend to lead to exchange-rate crises, which lead to sovereign defaults. As the US dollar is the world’s reserve currency, the process may be drawn out, but the effects will be worse.

And there won’t be enough money for bailouts. The chips will have to fall as the free market determines. Unlike last time.

Dominique Strauss-Kahn, bailout agent extraordinaire of the IMF, has reaffirmed his ideological leanings:

“Strauss-Kahn reached his two goals during this visit [to France],” said Gerard Grunberg, a professor at the Political Sciences Institute in Paris. “Make sure nobody doubts any more that he will be a candidate for the French presidential race in 2012 while never saying it. And make crystal clear that he is a man of the left, a real socialist.”

Does having a real socialist in charge of one of the world’s most important institutions sound like a good idea to you? But there are more of them. In the US you had George “affordable housing” Bush, who was free market in rhetoric and campaign donations only. Now you have universal healthcare advocate Obama, who wants to “spread the wealth around”. And the Chairman himself, Ben Bernanke at the Federal Reserve.

But it’s not just governments that are into meddling in private affairs. The investment bankers enjoy it too. Aside from being the leading campaign donators for politicians, the investment banks often place their men into government roles. Obama’s Chief of Staff is from JP Morgan (with a fresh 9 million dollar pay day behind him). Bush’s Treasury Secretary was from Goldman Sachs. And the list goes on.

None of these antagonists are remotely free market. And they are all going to discover the same thing: Socialism is too expensive to work. And the money is now gone. From this point on, spending will incur higher and higher interest rates, until the whole thing collapses.

But the Germans are breaking the mould. Sick of bailing out their neighbours once or twice removed, the Germans voted against the ruling party in the wealthy city-state Hamburg. That drove them into the hands of the socialist party. How ironic. Although it is concerning that the socialist party is campaigning on a nationalistic platform of letting Europe deal with its financial mess.

Nationalism, socialism and financial stress – sound familiar?

The always intriguing Ambrose Evans-Pritchard puts it this way: Does Angela Merkel want “fusion of fission” inside the EU? “Her own Bundesbank argued years ago that EMU is unworkable without fiscal union, and it has been vindicated by the events of the past two years.”

But it’s not just the EU sovereigns who are in trouble. The hilarious twist in all this is that, while EU member countries are no longer able to monetise debt, apparently their banks are doing it themselves!

The Irish Times reports:

Irish Banks are issuing bonds to themselves under the Government guarantee to borrow cheaply from the European Central Bank and to avoid drawing more heavily on emergency lending from the Irish Central Bank.
Four banks issued bonds worth €17 billion to themselves last month under the Government’s extended guarantee, the Eligible Liabilities Guarantee, to use as collateral to borrow from the ECB.

“What you have here is micro-quantitative easing, or money printing,” said Cathal O’Leary, head of fixed-income sales at NCB Stockbrokers. “The banks are issuing unsecured loans to themselves.”

And sure enough, collateral popped up at the ECB in exchange for emergency funding. Repeatedly, such borrowing has been at remarkable highs. But the ECB Executive Board member Juergen Stark is diverting attention to inflation, just as it seems deflation might re-emerge:

“Stark Says ECB Will Raise Interest Rates If Needed to Contain Inflation.” Yes, the ECB remains hawkish, while banks raid its emergency war chest with money created from thin air.

Surviving survivorship bias

While the world descends into chaos, Australian investors have survival issues of their own. Go ahead and look at this chart of the All Ords going back to 1985 (courtesy of Yahoo Finance).

All Ordinaries
Click here to enlarge

You might be thinking “Yahoo, look at my stocks go”. But remember, indices are subject to a little sleight of hand. Finance professionals call it “survivorship bias”.

In order to be included in an index, shares have to exhibit certain qualities. For All Ords membership, you have to be one of the top 500 shares by market capitalisation on the ASX. Now, market cap is the price of shares multiplied by the amount of shares.

And that’s where the fraud comes in. If a company grows and is successful, it will at some point join the All Ords and push it up. But failing companies, whose share price falls, will drop out of the index and their decline doesn’t show up in the chart above.

Of course, your portfolio consists of shares and not a bet on the All Ords figure, which you will hear quoted on the news tonight. Unless you’re using derivatives or ETFs that is.

So, if your portfolio had included one or more of the likes of Allco Finance, ABC Learning, HIH Insurance, One Tel, Ansett Airlines, Storm Financial, etc, you would have watched your portfolio plunge while the All Ords kept onwards and upwards.

From 720 in 1985 to around 5000 today, the All Ords has provided a return of 594% in 26 years. $1000 dollars invested in the All Ords in 1985 would be at around $7000 now, but around $2400 adjusted for inflation.

Say you had owned one or more of the collapsed companies mentioned and your portfolio took a 10% hit. Your return would fall to pieces compared to the index.

Considering Australia has been comparatively calm when it comes to corporate collapses, diversification doesn’t look all too bad a strategy for the ASX. Over in the US, survivorship bias is a much bigger factor.

But that doesn’t matter anymore. The place is beginning to fall apart like northern Africa would with record food prices. While Obama discussed investment in education, Michigan closed half its schools and the Rhode Island district (ironically name Providence) issued dismissal notices to all of its teachers. A Democrat has called for unions to begin making their protests a little bloody and a government official encouraged police to shoot at protesters. Also, flash mobs have gone from dancing to looting. We hope those Australian investors who recently bought properties in the US are up for a turbulent ride.

Some reader mail on last weekend’s DR:


With regards the statement that …”The Environmental Protection Agency set the value of a life at $9.1 million last year in proposing tighter restrictions on air pollution. The agency used numbers as low as $6.8 million during the George W. Bush administration.

“The Food and Drug Administration declared that life was worth $7.9 million last year, up from $5 million in 2008…”

It begs the question …assuming that those figures are relative to U.S. civilian lives, what price do they put on non U.S. citizens lives?

If we can indeed assume that those figures are the same for all peoples (re – American Christianity – all men are created equal’), it would be fascinating to do a head count, and add up the figures …Hiroshima and Nagasaki, Vietnam, all the Central and South American wars/murders, Afghanistan, Iraq, etc); see what the U.S. is up for in terms of ‘retribution’ . Given the latest figures from on Iraq and Afghanistan alone….

Number Of Iraqis Slaughtered In US War And Occupation Of Iraq “1,421,933”

Number of U.S. Military Personnel Sacrificed (Officially acknowledged) In U.S. War And Occupation Of Iraq 4,754

Number Of International Occupation Force Troops Slaughtered In Afghanistan : 2,330

Cost of War in Iraq & Afghanistan

So there you have it. Obama’s budget deficit is more than the value of lives lost in America’s current wars.

Nick Hubble
For Markets and Money Australia

Nick Hubble
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.

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3 Comments on "Crisis Edition"

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Nick, great data and commentary as always on this site.

If one is not looking to watch like a hawk to ‘profit’ per se but rather wants to maintain the value of their holdings as people realise Libyan Oil cannot be substituted for Saudi oil and price climbs to $120, Helicopter Ben launches further QE and rounds of POMO etc what would you do?

Oil ETF? Certian tech stocks? Short airlines and steel makers?


The table on the right should include:
– australia house prices commence falling

Who cares anyway. The world is in full socialism mode and socialists are only good for one thing, spending other peoples money.

Europeans (UK is not in EU Gold Bloc) own half the worlds gold.

Gold bitchez! and Euro for reserve currency status, bitchez!

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