The Recession We Have to Have

Today is the 11th day of the 11th month. It’s Remembrance Day…the day the guns fell silent on the Western Front in the Great War.

The date neatly closes the chapter on the hostilities…but for many the war never left. Among millions of others, it killed and maimed a generation of Australians. Those left physically untouched didn’t escape psychologically.

And if you survived the war, you still had to deal with the Spanish Influenza breakout of 1918, which ended up killing more people than the war did. Yet the world managed to recover. By 1920, the global economy was healthy again. It suffered a sharp downturn in 1921, and an equally strong recovery.

All this happened with a minimum of government interference. The Federal Reserve was only a few years old and hadn’t quite worked out how to ruin the economy yet. It quickly got the hang of it though. The Fed mistook productivity driven price deflation (good deflation) for something else and kept monetary policy looser than it should’ve been.

This resulted in a booming economy and a stock market blow out in the late 1920s. Then the Fed bungled the rescue. They remembered they were running an economy on the principles of sound money, and they let thousands of banks go bust.

If only they remembered these principles earlier, there would have been no need for such an aftermath. And what if the Fed decided ‘reflate’ the financial system instead of letting it go bust? Yes, they would’ve avoided the Depression…in 1932/33. More than likely though, they would have just pushed some kind of economic calamity further into the future. Just like they are doing now.

Today’s an apt day to remember that central banks and governments don’t make things better for you. They make things worse. Not out of design, but out of ignorance. For example, in an effort to prop up the banks and financial system in general, they make it weaker and more susceptible to random events.

In Australia, the government’s efforts to get everyone on the housing gravy train over the years has produced a market where the speculators are now pricing out the people the government originally intended to help.

Now, Aussie property is just a sinkhole of vested interests holding the government to ransom. The government no longer cares about first home owners. And nor should they. It’s not their job to ‘care’ about any vested interest. It’s their job to leave everyone alone and do less…and less…and less.

But they can’t help themselves. Governments around the world have managed to hoodwink everyone. Apart from a small minority (and I’m including you in that minority), most people still think the government is there to ‘make things better’, right wrongs, and dispense with social justice.

Rubbish. They’re there to impose their ideological views on everyone else…whether we like it or not. And they don’t really care who they hurt to do so…as long as it isn’t a large enough demographic to get them voted out of office.

Which is why politics and politicians are so dodgy. They know full well that ‘we can’t handle the truth’, so they twist it, beat it and turn it upside down before delivering it with a smile.

Where am I going with this? I don’t really know. I guess I’m wondering where the outrage is. Australia’s politicians are selling our country out (citizenship for cash…money dirty or clean…properties to the highest bidder…money dirty or clean) and mortgaging our kids’ future, and there’s nary a whisper from the population. Or if there is, it’s quietly muffled.

That’s because there’s a lot of people on the gravy train. There’s no need to complain. Australia is now one of the wealthiest countries on earth. But that wealth has come with a loss of dignity and integrity.

Where this ‘wealth’ takes us is anyone’s guess. That’s because much of this wealth is the product of record debt levels. Household debt as a percentage of disposable income is at a record 137%, according to the RBA. One person’s debt is another’s asset. And assets = wealth.

That’s all well and good while the money continues to flow and the economy can service the debt. But, thanks to tanking iron ore prices, Australia now faces an ‘income recession’. In the next few years, our economy will produce much lower income growth, making it harder for the economy to sustain its debts.

This situation will make it harder for the government to keep its debts low too.

In early December, just in time for Christmas, Treasurer Joe Hockey will release a confidence sapping mid-year budget and economic update. And it will be worse than what most people expected just a few months ago.

Well, not entirely. You knew the budget was in trouble. And anyone keeping an eye on the iron ore price knew the budget forecasts would be in tatters by now, too. According to analysis today on the Australian Financial Review website, the deficit has blown out by $10 billion halfway through the financial year. Independent forecaster Macroeconomics reckons you’ll see budget deficits persist for another decade.

But…but…Joe promised a balanced budget by 2017/18. What can I say? Politician + promise = oxymoron.

What Joe was really saying was this: ‘Based on my pipedream budget measures, which disproportionately punish the less well-off and favour the speculating rich, the budget will in a few years’ time arrive on my desk, nicely balanced, accompanied by rainbows and unicorns.’

In other words, it’s not happening. With household debt at record levels, the credit rating agencies won’t look upon rising government debt levels too kindly. There is a real threat that Australia will lose its AAA credit rating in a few years’ time.

And if iron ore prices head down into the US$50/$60 a tonne region (as I expect they will) without a massive decline in the Aussie dollar, you can almost pencil the loss of AAA in around the same time that Joe pencilled in his unicorn inspired break-even budget.

In other words, it’s all starting to go pear-shaped for the once lucky country. I hate to say it, but there really is a recession (in our future) that we have to have.

Greg Canavan+
For Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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