–It’s good to be back in rainy, carbon-tax obsessed Australia. Your editor is back at his St Kilda command centre after nearly three weeks away in America, where everything is cheaper, bigger, and louder. So world, how are you doing?
–Europe’s sovereign-debt crisis is reaching critical mass again. By “critical mass”, we mean that even Europe’s leaders can no longer pretend that Greece will repay its debts on time and that much of Europe’s banking sector (private and public) is insolvent. The yield on 10-year Greek government bonds is 15.8%. On a two-year bond, the yield is 25%. The European Commission estimates that Greek public debt is 166% of Greek GDP.
–Greece is scheduled to receive another €12 billion in bail-out money by the end of June. A Swiss journal cites a Greek newspaper in reporting that Greece has enough cash to get by on until about July 18th, give or take a few days. If that June money isn’t there, it could be curtains for Greek bondholders.
–You can probably repeat that sentiment for bondholders across Europe. Insolvent banks have been extended credit by insolvent sovereigns. The situation has not improved in the last year. Now, as we wrote last year in the Australian Wealth Gameplan, the debt must be paid off, restructured, defaulted on, or inflated away (where possible).
–However, one lesson we’ve learned in the last three years is to not underestimate the ability of central bankers and central planners to kick the can down the road. Banking rules can be changed willy nilly so that assets are suddenly eligible as collateral for new loans. Or, assets can be carried on the balance sheet at some theoretical value (not market value). Or, certain liabilities can be moved off the balance sheet.
–In other words, there are lots of regulatory ways to pretend that assets are worth more than they are. There are also lots of ways to pretend that liabilities (government bonds) are actually assets, even those assets are based on the ability of unpopular governments to raise taxes and cut spending. Even an inevitable day of reckoning can be postponed if enough people believe in the same fiction.
–Mind you, it’s not just Europe that’s burdened by a left-over debt burden from the 2003–2007 credit boom. America and China have their own version of the problem. The private sector debt crisis of 2007 has become a public sector debt crisis in Europe. You can’t afford to bail out the banks and pay for an overly generous, completely unrealistic social welfare state.
–Something has to give. In America, it should be defence spending. But that is not yet a serious part of the political discussion. Meanwhile, China’s fixed-asset boom has been fed by epic private and public sector credit growth. Which brings us to Australia.
–While the rest of the world struggles under mountains of debt and the inability to repay it, restructure it, or stop adding to it, Australia is still having a furious debate over what price to pay for carbon dioxide. Observing from afar, we’d think the government would be more worried about the housing market or the resource industry.
–But as climate change is a problem the government’s experts have admitted they can’t really do anything about, it’s the perfect problem for the government to take on. You can have action without accountability. Yet it does seem like an almost obsessive sideshow for a country that has bigger immediate worries.
–Like what? Well, the banks for one. S&P, Moody’s, and Fitch have all rated the Aussie banks AA. This isn’t so bad, on the surface. What IS bad is that all the ratings agencies have pointed out how dependent Aussie banks are on foreign borrowing to fund their domestic lending.
–That’s not news to anyone who’s been reading the Markets and Money for the last few years. But more people are starting to realise Australia’s property boom was achieved with borrowed money. The more expensive that money gets, the harder it is to keep money flowing into the property market and prices rising (which they’re not).
–Incidentally, the ability to borrow cheaply abroad and loan in the Aussie mortgage market has been the engine of bank profit growth. And as you know, banks are widely held by super funds. If bank profits fall because the global cost of capital goes up, then super investors will feel it too.
–Oh…and what about the race to replace Dominique Strauss-Kahn at the International Monetary Fund (IMF)? The head of the IMF is, by agreement between the US and Europe, a European. America gets to pick the head of the World Bank.
–This arrangement made sense when Europe and America were the world’s bankers and creditors and had the largest economies with the fastest growth. But Brazil, China, India and others are asking if it still makes sense. They may have a point.
–How long can the world’s biggest debtor nations continue to be in charge of the global financial system? When will creditors assert their influence? Doesn’t he who owns the gold make the rules? Oh, and if that’s true, Europe and America still own—officially at least—a lot of gold. Hmm.
–We’re warming up to the task of answering these questions as we get back behind the keyboard. We’ll also sprinkle in a few observations from our trip to America. The first one is this: wealth comes and goes in cycles, as it always has. No era of prosperity is permanent.
–This observation came to us during an hour-long boat tour of the fresh-water lakes in Winter Park, Florida. Winter Park became a popular refuge for frost-bitten Mid-Westerners (mostly from Chicago) back in the 1920s. It was one of Florida’s many cyclical land booms.
–Many of the tasteful homes built on the lakes during the 1920s (the modern homes are ostentatious) were financed by first-generation immigrant fortunes. Europeans with multi-syllabic, Polish-sounding names came to America, got into business, and made a fortune on the expanding continent. They had enough surplus capital to luxuriate in lake-side mansions in old Florida orange groves.
–Most of them probably lost money speculating on house prices, Florida land, or the stock market. The 1920s credit bubble eventually burst. But many Americans did not neglect to get land rich during the boom. And still others built up family fortunes by starting or owning businesses that produced real goods and services.
–This is unlike today, where the biggest fortunes are made by the money-shuffling class. Back then, debt didn’t do it. And consumption didn’t make people wealthier either (it never has). Neither was government spending or stimulus thought to be the way to make everyone prosperous.
–So what was the secret to wealth? It wasn’t so secret. It was good old-fashioned opportunistic entrepreneurship. We took heart from that observation. Tomorrow, we’ll tell you why.
Markets and Money Australia