Good news everyone! The end of the world has been postponed indefinitely. You may now carry on as if another credit bubble is blowing (which it is, in China).
It’s a truly bullish way to wrap up the week. China has reported a 7.9% rise second in quarter GDP, driven mostly by a 15% surge in June consumption and a huge boom in bank lending and government stimulus. Aussie stocks felt the warm glow and rallied just below 4,000 on the ASX/200 yesterday. Aussie stocks are now up nearly 7% for the week.
But the even better news from the bullish camp is that perma-bear Nouriel Roubini has defected! Yes, Roubini told a conference that the “free fall” in financial losses is over and the U.S. may exit its recession by the end of the year. This was enough sweet talk to send the Dow up nearly one percent.
And then there was an upgrade to second half U.S. GDP forecasts from the U.S. Federal Reserve. In April, the Fed said second half U.S. GDP would shrink by 1.3% to 2.0%. The revised forecast released yesterday now says U.S. GDP will only shrink by 1.0% to 1.5%. A stunning upgrade!
The Fed’s revised projections also show that the U.S. economy will grow faster than it first thought in 2010, once the much-anticipated recovery takes hold. In April the Fed thought the U.S. would grow by 2.0% to 3%. But in the revised forecast now says the growth rate should soar from 2.1% to 3.3%. A stunning upgrade!
The only negative note in the Fed’s forecast is that it reckons U.S. unemployment will keep growing to over 10%. That, presumably, is a drag on the economy. But if credit conditions improve, maybe all the people who’ve lost jobs because the U.S. economy is not producing and not competitive can, you know, get a credit card and live off of that.
But putting on our serious face, and while we are giving valuable publishing space to the optimists, we should point out that some people think the worst case scenario for the U.S. Housing market is already priced in to financial stocks. This leaves said stocks all clear to lead the market higher, along with tech, resources, bonds, and cash!
For example, Jim Cramer reckons that if you assume a 50% total write-off rate on the 14 million mortgages written between 2005 and 2007 in the U.S., you are only talking US$1.4 trillion in losses (7 million homes X $200,000 per home. ) Cramer says the banks have already written off that amount and that the banks stocks are priced for a worst-case scenario that may not materialise.
And if it doesn’t, it would lead to a faster recovery in bank balance sheets, which in turn would lead to a recovery in bank lending, which would not lead to inflation because the Fed has a plan to remove liquidity from the system and everything thing will be fine!
And you thought Neverland was a ranch in California.
Whether Cramer is right depends on which vintage of mortgages have accounted for the losses in the financial sector so far and which are still going bad. The chart below from the Cleveland branch of the Federal Reserve suggests to us that there are more losses to come than have been accounted for. Why do we say that? First the chart…
What does the chart tell us? Well, it shows that in 2003 and 2004, Fannie Mae and Freddie Mac led the surge into subprime lending. This is the vintage of loans that went bad in the last year as interest rates moved up and house prices moved down, putting many new buyers and speculators underwater. This is where the first $1.4 trillion in losses came from.
But the real issue is the quality and quantity of mortgages that were packaged up and securitised from 2005 to 2007. As the GSE’s reduced their originations, banks stepped in-often haven acquired non-traditional lenders for just this purpose-to keep feeding the boom. The banks wrote the loans and sold them to either other, purchasing default insurance on the securitised loans from AIG.
These loans are not subprime but supposedly higher credit quality Option ARM and Alt-A loans. And these are the loans the banks, we’d suggest, are carrying at elevated values. We’d also suggest the banks are not adequately capitalised to realise losses on these loans should the housing market get swamped again by another wave of defaults and foreclosures. This is where the second $1.4 trillion in losses will come from.
But of course it’s wacky to suggest all that. We might as well say that aliens crashed at Roswell and that the moon landing was faked (it probably was). There’s just no way it could get any worse than it did in 2007. Could it?
We’ll take up that question next week. And we’ll also take up the China question. While all the focus is on the cloak-and-dagger between Rio Tinto and Beijing, another Aussie industry may already be rising to replace iron ore as Australia’s most valuable export commodity. Stay tuned for details.
In the meantime, some reader mail for the weekend….
It’s a lovely warm but overcast morn here in Oxford (visiting family) yet I still find time to read your column (though I rarely get past just your part).
A recent conversation with a colleague of mine highlighted to me an important point regarding superannuation I had never considered. She commented on the fact that super was originally intended to replace the pension. Knowing this then how did we suddenly succumb to the idea we didn’t need savings as well?
Past history should have alerted most of us to the fact that the pension has never been sufficient enough to retire well on and the invention of superannuation therefore should never realistically have been expected to be one’s only source of income in retirement.
Of course, government has had a hand in perpetuating this myth, perhaps because they felt some need to make people dependent on a system which is based on an idea, never before tried in history and bound to fail for reasons that now seem obvious to many of us except the government.
–Attn: Dan Denning
From the tenor of your piece today denigrating the suggestion that mandatory super contributions should be increased, I suppose you are a Yank. It should be self-evident if you look a bit closer that the Australian super regime is away ahead of that of most countries, certainly the USA.
As a CFO for a private Australian company until recently, (and an ex-banker) I have seen first-hand the tremendous transformation which has built up in this country since mandatory super was gradually introduced. 9% will not however provide adequately for anyone’s retirement. (The figure is at least 14%).
While John Brogden might be talking his own book, it does not mean he is wrong. Australians broadly speaking are yobs, just as Americans are or any number of lumpen anywhere.
In this country, everyone, without discrimination, is entitled to draw a pension in old age, (if they have failed to provide sufficient means themselves) and is then also entitled to free medical and hospital care. (Hence some long waiting lists).
It is obvious that it is in everyone’s interest to ensure that the maximum number are self-sufficient and not endure the shame of being a burden on their fellow man/woman/taxpayer. In this context we have to recognise that in the last year, Australian yobs (out of a total of just over 20 million people, a good percentage of whom are children) squandered $1,860,000,000 on gaming machines.
Some of these people might have been rich and able to afford this, but as an ex-bank manager I can tell you that the vast majority of people cannot. Most are immediately in trouble if they lose just one fortnight’s pay. They have nothing saved for the rainy day, and depend on credit cards. (Although there is nominally also a high percentage of home ownership here, in fact the banks own the biggest portion of most homes).
With the Superannuation Guarantee regime, increasing numbers are becoming able to at least reduce their dependence on the public purse in old age, and vast sums will continue to be marshalled for investment through funds which have a strong motivation to invest prudently.
Individuals (contrary to the inference you make) have full freedom to choose which superannuation fund their money goes through, and the Industry funds have a good strong record in this country. They also can choose to run their own super fund if they wish.
See ABC Radio National program Rear Vision found at:
You can read a transcript, listen on-line or download a podcast. I found it enlightening having been immersed in your constant criticism of “fiat” money. Aspects as to why gold was cast off came over which you have been silent about.
The Austrian School was described by one of the commentators as a “relatively fringe group”.
I remain interested in listening to your views particularly investment views because you have such a “fringe” position but your silence about factors that don’t support your position places a big grain of salt warning to be very careful of what I read from you.
You should always be careful of everything you read Victor. It’s a good idea! As for the criticisms in the piece of the gold standard, they miss the point entirely. The main criticisms are that the gold standard did not give governments enough flexibility to borrow money to pay for wars or spend their way out recessions. The standard was abandoned because of the fiscal discipline it imposed on nations.
We’d argue that the European nations chose to squander their accumulated capital on destroying each other. The gold flowed to the U.S. as a result. That’s the price you may for redirecting economic production in the service of the Warfare/Welfare state. There is no scenario in which you can escape the long-term consequences of how you divert production away from creation and toward destruction.
It doesn’t bother us at all to be in the fringe. It’s cool here (shaded). The company is eclectic and interesting. And most of the people we know here don’t confuse causes with effects. The fiat money standard leads to a permanent welfare state because the government can tax to pay interest on its borrowings.
This makes its borrowings theoretically unlimited, which is why governments relentlessly expand their intrusion into commercial and private life, nosing around to get in the way, boss people around, and clip tickets to pay for bloated bureaucracies.
A gold standard is an impartial negative feedback loop. If an economy produces and sells, it accumulates capital and attracts investment too. If it borrows, spends, and consumes, it does not accumulate capital. It accumulates debts and the ownership of its gold and its assets its gradually transferred to creditors.
A version of that is happening today anyway, with creditor nations holding the whip hand over debtors. Only the illusion that fiat money is worth something and that governments can actively manage the economy prevent people from realising a money and power migration is happening, and the English-speaking nations are not on the winning end of it. Australia is, of course, an English-speaking nation. But it’s also a resource rich land not far from China and India, where the demand of the future is coming from. It’s the country’s saving grace.
Meanwhile, we believe the huge increase in liabilities coming from the Western world will inevitably lead to either devaluation of those currencies or the preferred method of reducing huge outstanding debts, money printing. This is going to be very good for gold, no matter what a few economists in the mainstream may say.
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