What a difference a day does not really make. The back-story to the markets – the slow-motion insolvency of the Welfare States – was ignored by rested U.S. investors yesterday. They came back to the floor and bought stocks like it was old times.
Both the S&P 500 and the Dow Jones Industrials finished up over 1.5%. There were two drivers of the feel good vibe. First was New York’s Empire Manufacturing Survey. It concluded that “conditions” were improving.
As far as we can tell, that doesn’t mean anyone actually made and sold more stuff in New York State. But it does mean the state of mind – how people feel about things – appeared to improve. Hooray! It’s nice people feel better about things. But things are still pretty bad anyway.
The bigger story is that Greece hasn’t been abandoned by the rest of Europe…yet. Europe could probably leave Greece behind and preserve the integrity (such as it is) of the euro as a sound currency. But 50 years of harping on about social justice and economic harmony and humane capitalism is going to make it hard for policymakers to leave Greece to its own devices.
This means the debt crisis is consolidating itself into ever fewer and larger entities…the European Union…the U.S. government…and the U.K. government to name a few. In order to save Greece, historians may write, it was necessary to destroy the Euro.
But investors don’t have time machines. In the modern era of central banking, new lines of credit and public assumption of large liabilities – plus more credit creation – has always been the way out of a pinch. Below, we’ll tell you why this makes the inevitable disaster that much worse.
Here in Australia, it looks like the financial crisis is receding. We have our doubts. But according to Gail Kelly and the good people at Westpac, bad debts were down even more than expected in the first quarter. That’s the good news. The bad news is that, “the average cost of funding is going up.”
The strategic weakness of the Australian banking sector – and perhaps the whole economy – is that it’s a capital importer. That’s why even when Aussie banks didn’t have boatloads of U.S. subprime debt; they still faced higher capital costs when the global cost of capital went up. So what?
If Greece goes down or sovereign debt default spreads go up, it’s going to make importing money into Australia more expensive. And that will probably slow credit growth in the economy. Aussie banks will get jealous of their capital and stingier with their lending. Maybe even house prices – contrary to the laws of Australian financial gravity – will fall.
And if you think that’s gloomy, then you won’t want to read what Albert Edwards from Societe Generale has to say about the status quo. Writing earlier this week, Edwards says, “My own view on this is that obviously we should never have got into this wholly avoidable mess in the first place. But having got here, there really is no way out that does not trigger a major market-moving upheaval.“
“Ultimately economic prosperity over the past decade has been a sham: a totally unsustainable Ponzi scheme built on a mountain of private sector debt. GDP has simply been brought forward from the future and now it’s payback time. The trouble is that, as the private sector debt unwinds, there is no political appetite to allow GDP to decline to its ‘correct’ level as this would involve a depression. So burgeoning public sector deficits and Quantitative Easing are required to maintain the fig-leaf of continued prosperity.”
This what we meant above about the inevitability of the disaster that approaches. When the government “brings forward” demand for housing via the FHOG or for consumer goods via stimulus, it’s stealing growth from the future in order to maintain current living standards. In our view, this just perpetuates the misallocation of resources that took place in the credit boom and keeps the money in the weak hands (the financial sector) that took so many bad risks in the first place.
A real free market punishes financial failure with bankruptcy or insolvency. By not allowing a recession to take its natural course, monetary and fiscal policy prevent the conditions for the next growth phase. What’s worse, they’re doubling down on the debt-backed model of prosperity and piling up more liabilities on the public sector balance sheet.
That’s the stage we’re at now. And one insignificant survey on manufacturing sentiment in New York State doesn’t change much. And by the way, the more important news yesterday is that demand for U.S. bonds by foreign investors fell by its largest amount ever. Strong dollar?
Foreign holdings of U.S. Treasury securities fell by $53 billion December. China reduced its holdings by $34.2 billion. The end game is beginning in the Chimerica relationship of vendor financing (China buys U.S. bonds to help keep U.S. rates low so Americans can buy what China makes).
What China doesn’t buy, you can get the Fed will have to monetise – unless the Congress and the President suddenly cut American spending. You can see from the chart below that Japan is now a larger holder of long-term U.S. securities than China.
The long-term trade on this is to get the heck out of U.S. assets. Whether “risk assets” like commodity currencies or commodities are the ultimate refuge is yet to be seen. But oil, gold, and resource stocks are certainly getting a big today on greenback weakness.
for Markets and Money