If the expansion of the Federal Reserve’s balance sheet due to its swaps agreements with Europe is a trip-wire for inflation, consider it trippy. Bloomberg reports that, “The Federal Reserve’s balance sheet rose to $US2.34 trillion, the first increase in a month, as the central bank reopened liquidity swaps with foreign central banks. Assets increased by $US9.93 billion, or 0.4 per cent, in the week ended yesterday, the central bank said today in a statement. The balance sheet reached a record level of $US2.343 trillion April 14.”
The increase in liquidity swaps was US$9.21 billion in the last week. That’s presumably the money headed “over there” to Europe to reinforce the ECB’s efforts to prevent a wider “contagion” in European credit markets. The bigger the Fed’s balance sheet gets the more support you’ll probably see in the gold price.
Speaking of which, JP Morgan analyst Michael Jansen told clients in a note that, “The gold price is being driven by…the rising concern of the ‘exit strategy’ for central banks given that the ECB is the latest agency to join the (quantitative easing) bandwagon…Indeed, the perceived breach of the ECB’s independence…adds to the view that in the long-term monetary and fiscal authorities will be forced to choose between anaemic economic conditions or monetary-driven inflation.”
“Monetary-driven inflation” is, along with good old fashioned fear, behind this week’s move in gold and precious metals. It is easier for governments to lean on central banks to print money than it is to make politically unpopular (and socially destabilising spending cuts). Bond markets will try to hold European governments honest by punishing those that don’t commit to genuine spending cuts and deficit reduction.
But this not just an accounting debate or a fiscal policy debate. Europe’s post-war social contract is being forcibly rewritten by economic circumstances. Markets enjoyed a massive “short squeeze” rally with the announcement of the bailout. But how markets behave now is anyone’s guess.
Our guess is that austerity measures in Greece, Spain, Portugal, and probably Italy will prove so unpopular that governments who agree to them may find it hard to hold onto power. And then? Debt default remains a real possibility, and one not currently priced into equities, if you ask us.
But don’t take our word for it. Yesterday the Australian Mint said it sold more gold coins in the first two weeks of April than in the entire first quarter of the year. Nearly all the buying was coming from Europe. The mint told Reuters that it sold 243,500 ounces of gold coins and bars in the first two weeks of April compared to 205,000 in the first quarter.
Meanwhile, what about China? We concede that all of our information comes second hand, and not from any correspondents on the ground (although some of our colleagues are headed that way next week). In the meantime, there are signs that property prices are already falling in Beijing and some analysts are joining in the prediction of a major credit bubble that’s due for a popping.
Beijing commercial property prices may have fallen by nearly 31% in the last month, if we’re reading this article correctly. “The average transaction price of commercial residential properties in Beijing for the week ended May 9 fell 1,790 yuan per square meter or 9.6 percent week-on-week to 16,898 yuan per square meter, reports The Beijing News, citing statistics released by Beijing Real Estate Information Network. Compared with the week ended April 11, the average transaction price of commercial residential properties in Beijing plunged 31.43 percent or 7,744 yuan per square meter.”
That’s just one source and one market. But if it’s correct, that is…well…that is what it is, isn’t it?
But according to Hong Kong-based hedge fund analyst David Roche, it gets a lot worse. “We’ve got the beginnings of a credit-bubble collapse in China,” Roche told Marketwatch.com. Roche goes on to assert that the Chinese banking sector will face huge loan losses on bad loans made to local governments. And what does that mean for you?
Roche links a credit contraction in China with infrastructure spending, which he reckons accounted for 90% of China’s economic growth last year. So while housing is a clear bubble, Roche says the contraction of bank lending will remove infrastructure investment as one of the key pillars of Chinese growth. He says that’s negative for industrial commodities like iron ore and copper.
As if the news wasn’t bad enough for Aussie mining companies…
Of course no one knows for sure what will happen next. The fact that so many people are talking about a China bubble is itself a disturbing sign. Normally you don’t get that during a bubble, although claiming there is not a bubble in China because people are talking about it a fairly superficial way of dismissing the argument.
But inquiring minds often disagree on the same set of objective facts. That’s what makes a market. Our colleague Dr. Alex Cowie has the full time resource beat here in St. Kilda. Alex is recommending precious metals producers as part of his general strategy, with a particular focus on the inflationary policies of central banks.
However the key debate the rest of this year is how to value the miners. And you have two massive elements of uncertainty now. One is the Rudd Resource Tax. The other is China’s growth. The only upside to all of this is that a great deal of uncertainty can distort valuations, which occasionally gives you a chance to buy something really cheap at a time when everyone else is petrified.
“You know,” a friend said to us the other night over a drink, “sometimes you come off like a know-it-all smart arse. It’s one thing for you to tell the Chinese they’re doing it all wrong and predict a crash. But you’re bagging out our Prime Minister and you’re not even in an Australian. To be honest it’s kind of aggravating and offensive.”
“Good,” we replied.
“How can you say that? Aren’t you worried you’re going to upset your readers? They won’t become customers if they’re angry with you.”
“That’s true. But you probably mis-understand what our business is. I don’t want a customer who’s easily offended by ideas. It’s my job to provoke thought. And you do that by presenting ideas, challenging conventional wisdom, and just thinking harder about things.”
Warming up to our task, and perhaps inspired by a sip of Maker’s Mark, we continued, “When I see someone say something idiotic – or, if you prefer – something I think is totally wrong, I feel compelled to point it out. You have to challenge that stuff when you see it, or else people start to believe it. And once they start to believe it without really thinking about it, the game is up. You become a servile, passive, brain-dead whip dogged to be kicked around and cuffed about the ears by the Welfare State. You’ll be lucky to get a bone.”
The discussion came up because of this quote by the Prime Minister earlier in the week on the radio. He said:
The core element of conservative economic management, in which I believe, is expanding the role of government in the economy when the private sector is in retreat.
Had we not done that we would have had a quarter of a million more Australians out of work, many small business [sic] collapsing.
Now that the economy globally is on a pathway to recovery it’s time for the role of government to retreat. That’s what conservative economic management is all about. That’s what I believe in.
You have to give the Prime Minister credit. He says what he believes. But what he believes is all wrong. And we wish he’d stop using the phrase “the business of government.” It’s an insult to businesspeople. Government is not a business. It does not take risks with its own capital to create value and jobs. The Prime Minister is not an entrepreneur.
He is, however, by his own admission, a manager. And in that respect, his hubris and his error are revealed. It is not “conservative economic management” for the government to massively intervene in the private sector. It is Socialism.
You might agree with it or believe in the moral rightness of that intervention, mind you. But let’s at least call things by their right names. It’s one of the surrealities of the modern world that things are often given names that are in direct opposition to what they actually are. Examples include the Democratic People’s Republic of Korea, which is neither Democratic nor a Republic, and Britain’s Liberal Democratic Party, which is neither Liberal nor Democratic either. We would add to the list Kevin Rudd as a “conservative economic manager” of the economy.
In any case, the Prime Minister’s error (shared by many members of the opposition who fail to rebuke him), is that he does not understand the inherent impossibility of managing a complex system like the economy. The second order error is probably just a disagreement about the government’s role in the economy. But you can’t have the second error without the first. And the first one is a fundamental question about the limits of human knowledge.
No human being, economist, and philosopher made this point more clearly than Friedrich Hayek. One of Hayek’s great achievements – picked up today we think by Nassim Taleb – is forming a clearer picture about the quality of knowledge and what we can say that we really know. What does that mean?
Hayek simply pointed out that in a complex system like an economy, no single person can have enough information or even know what information is required to correctly allocate and direct the use of society’s resources. To believe otherwise is to have an exalted sense of your own abilities as a micro-manager.
Hayek’s critique of central planning – what he called the fatal conceit of socialism – was, and remains, the most sensible criticism of centralised economic authority. It can’t work because human action is too complex and unpredictable and ultimately unknowable in a strict cognitive sense. You cannot plan and organise for what you do not know and cannot understand.
Market prices, on the other hand, are the sum total of human action. Those prices contain information and help maintain the relationship between supply and demand. That is the essential triumph of a free market: it allows people to be free and choose their own path and, at the same time, manages the most efficient allocation of resources.
It does this based on what people want as expressed through their own choices, not what government tells them they should or should not want. It produces this kind of peaceful and prosperous order – most of the time – without being organised by a smart man in an expensive suit serving on the public payroll.
But the basic idea simple. Individuals and firms know better how to plan their own future than the government. If you believe otherwise, you believe the government has the right and the obligation to make plans on behalf of people who are not fit to govern themselves. Proper names for that include: Nanny State, coercion, tyranny and more!
The Prime Minister is a planner and a world improver. That is the “business” he is in. And perhaps his motives are building a better world. But the way to do that is to sweep your own doorstep and tend your own garden, we’d submit. His belief about the proper role of government in the management in the economy is based on an overweening pride in the knowledge and skill of government ministers and career bureaucrats.
How else can you explain a piece of tax law like the Resource Rent Tax which effectively makes the government a silent partner in the profit and the losses of the resource industry without the consent of shareholders? Only a man who believed government had the right and the ability to insinuate itself into private business relationships would so pridefully propose a scheme like that.
That’s not to say that the government doesn’t have a role in civilised society. It most certainly does. Its role is to guarantee and enforce clear rules that establish and protect the ownership of private property and enforce contract, as well as punish people who take what is not theirs. The Law – transparent, providing equal justice, and impartially administered – is as important an institution to civilised society as the free market, which itself is could be described as a mechanism for communicating prices.
By those standards – which are, of course debatable – this government has done the exact opposite of conservative economic management. It has changed the rules in mid-stream, proposed to enforce them retroactively, and demanded equity in private enterprise without paying for it like the rest of us.
To be fair, that is “business” of a kind. Monkey business perhaps. Or “business” in the same way organising payments through the threat of violence is a “business.” Or less threateningly, it’s just meddlesome troublesome “business” that gets in the way of real people doing real business.
As the economist and thinker Henry George wrote, “It is not the business of government to make men virtuous or religious, or to preserve the fool from the consequences of his own folly. Government should be repressive no further than is necessary to secure liberty by protecting the equal rights of each from aggression on the part of others, and the moment governmental prohibitions extend beyond this line they are in danger of defeating the very ends they are intended to serve.”
The world is complicated enough. Europe’s sovereign debt crisis will eventually migrate its way to America and the super cycle in fiat money will end in either a debt deflation or massive inflation or both. Real wealth will be destroyed. Meanwhile, China faces a property and credit bubble of its own.
These are big enough worries for Australia without having to worry that its own government is unwittingly sabotaging the country’s success. Sound economic management would have been to leave well enough alone. But that is not what the government has done. And it’s going to reap the whirlwind, both in the markets and, perhaps, at the polls.
for Markets and Money