Debt and Deficits Do Matter

Just a quick note that there are, in fact, only 139 copies of our Australia in the Red DVD left. We only had 500 made up and most of them have been snapped up. If you want one, you’d better claim one soon. You’ll also get a 28-page PDF transcript of the entire panel discussion with your order too.

We were thumbing through the transcript last night over some sashimi and a beer and highlighted this passage from Dr. Steve Keen: We are told that for example debt doesn’t matter because if a company takes out a certain level of debt, say a very low level of say 10% debt to equity, that’s irrelevant to the company’s value because the person buying shares in that company can take out 90% debt to equity ratio.”

“Therefore you’re told the Modigliani-Miller proposition, after the two morons who got the Nobel prize for it, was that the level of debt that a company takes out does not affect its value. And those sorts of propositions are strewn through conventional economic theory, and of course people like Alan Greenspan and Ben Bernanke are experts in that very same theory.”

See? Bernanke…Greenspan…morons, all of them! Debt does matter. And so do deficits. Just this morning we read that U.S. President Barack Obama will ask the Senate to lift America’s statutory debt limit to $13 trillion. It’s at $12.1 trillion at the moment.

The lower legislative body of the Congress, the U.S. House of Representatives, passed a measure lifting the debt ceiling earlier this year. But it used a parliamentary trick to do it in a manner which did not require a roll call vote. No jack asses had to go on the record.

The Senate is different. There are just 100 of the grumpy old men and women. And to increase the debt ceiling to accommodate annual deficits of over $1 trillion for the next ten years (it’s $1.6 trillion this year) the Senator will have to go on record. Spending other people’s money is generally easy (and probably kind of fun). But not when you have to publicly commit to it and “own” the debt. No one wants to own it, even though everyone wants to benefit politically from the spending (sound familiar?)

The investment fallout from the record U.S. debt and deficits is continued pressure on the dollar and $1,000 gold. Old yeller metal dragged itself up $2.50 in the futures markets to close over the $1k in New York trading last night. Gold has done this despite a 50% rally in stocks. We reckon once the punters catch a little gold fever – which they will if it can hold the line at $1,000 for a few days – higher highs will follow.

And let’s not forget large owners of dollar-denominated assets like stocks and U.S. Treasury bonds. Do you reckon they’re getting a touch nervous? Cheng Siwei, a Chinese official attending a conference at Lake Como in Italy, said he was worried about the Fed’s indefinite policy of credit easing.

“If they keep printing money to buy bonds it will lead to inflation,” Chen said. “And after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies… Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets.”

In the meantime, why not try iron ore and uranium? Reuters reports that, “Chinese state-owned firms expanded their footprint in Australia’s mining industry on Tuesday, agreeing to help fund two iron ore explorers in return for supply contracts and taking a controlling stake in a uranium prospector.” The iron firms involved were FerrAus United Minerals both of which formed relationships with China Railways Materials Commercial Corporation. The uranium deal was between China Guangdong Nuclear Power Holding Co. Ltd and uranium prospector Energy Metals.

These deals are probably both operational and strategic. They’re operational to the extent that in exchange for capital, Chinese firms get long-term supply contracts (price certainty) for key minerals and bulk commodities. They’re strategic to the extent that State-owned firms can channel U.S. dollar reserves into tangible assets. This slightly reduces China’s risk to the inevitable devaluation of U.S. debt securities through inflation.

Getting back to Cheng, he seems to understand exactly what happened over the last five years. Loose credit is the problem. “This is where Greenspan went wrong from 2000 to 2004,” he said. “He thought everything was alright because inflation was low, but assets absorbed the liquidity.” He’s talking about real estate and stock markets.

He’s also talking about the psychological and moral attitude in a country that’s obsessively focuses on preserving its immediate lifestyle at the expense of future investment and growth. “The US spends tomorrow’s money today…We Chinese spend today’s money tomorrow. That’s why we have this financial crisis.”

Of course whether your Chinese, American, or Australian, it’s everybody’s crisis now. So what should you do?

Inflation has yet to really rip through the commodities sector. As Bill pointed out yesterday, the U.S. dollar has yet to really crash. It may do so only gradually. U.S. creditors are not exactly easy to cause a run on the dollar. They have a lot to lose. And we know the Fed and Tim Geithner and Barack Obama want a gradual devaluation, not a dollar crisis.

Will they get what they want? We don’t know. But we reckon the Law of Perverse Outcomes applies here: people get not what they expect, but what they deserve.

For investors, we’d say again that markets are priced for earnings growth that we think won’t materialise. It’s wishful, almost nostalgic thinking. That means you should be on your guard for locking in paper gains since March with trailing stops. We’re pleased that Gabriel Andre is just about ready to debut his new ASX 200 blue-chip timing service this week. The aim is to track the chart patterns and technical trends on the biggest Aussie stocks in order to avoid buying at the top.

But the big benefits – he hopes to prove – are the ability to take profits on long-term holdings and avoid the big declines we’ve seen over the last two years. Then, using the same analysis, Gabriel believes you can time your entry back into the same stocks. It’s quite a proposition.

Of course, anything that looks or sounds like market timing probably makes a buy-and-hold investor really nervous. But it’s time to question the conventional wisdom that buying and holding blue chip stocks is a guaranteed retirement strategy. It’s not.

If we’ve learned one thing in the last two years, it’s that the stock market is not a retirement machine. The name of the game is to generate gains. And we are at least open to the idea that it may be possible to make better gains as a medium-term trader of ASX 200 stocks than simply buying and holding for grim death.

On the other hand, there are some very exciting disruptive energy technologies that have a huge upside if you can stomach the risk. Woodside Petroleum Don Voelte took a swipe at those technologies in a recent article published locally. And for good reason. He’s got a bit to worry about. More on disruptive energy technologies tomorrow…

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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I think Dan might extend this to mean that the patrons of Greenspan and his reserve bank board and the academic institutions that backed them “absorbed the liquidity”. It was a heist taken in ticket clipping and the “derivative” salaries and bonuses.


GreenSPAM actually

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