In today’s Markets and Money, we bring you the story of the Zombie war. On one side, a whole army of bankers, politicians, and economists fighting for a system based on debt and counterfeit money. On the other, the un-dead legion of bad loans in investments created by the credit boom. More on the war in a moment. But first, to the markets…
The markets are actually pretty quiet today. After battling for the better part of three months to get back in the black for the year, the Dow Jones Industrials fell 186 points in New York. We’re not saying the Dow can’t hold the ground it’s gained. But consolidating those gains against the onslaught of more asset deflation is going to take a lot of defence.
And there’s a twist today. You may be surprised with this twist, given how we’ve been pounding the table about the risk in U.S. Treasury bonds. We think that risk is very real and not likely to go away anytime soon, given the $3.25 trillion the U.S. will have to borrow this year. But you should pay close attention to this twist because it may explain the action in the markets for the next few months.
The twist is this: you may soon see RISING U.S. bond prices and a stronger U.S. dollar accompanied by FALLING stock and commodity prices. Yes yes, it’s a complete reversal of recent trends. And it doesn’t mean we are reversing ourselves about the long-term trends. But you cannot remain Orthodox if the facts change. So allow us to explain why this might happen.
Russia’s Finance Minister Alexei Kudrin told journalists yesterday that the U.S. dollar is in “good shape.” He added that, “It’s too early to speak of an alternative [to the U.S. dollar].” These remarks came after Chinese and Russian officials have quite publicly suggested that the world’s financial system would benefit from using a currency that wasn’t being run by a bunch of inflationistas in America.
But the dilemma for the large dollar holders of the world-Japan, Russia, and China to name a few-is how frankly they should speak in public what everyone knows in private. By blowing the whistle on the Fed’s inflationary monetary policy, dollar holders penalise themselves. After all, the rise in oil this year and the fall in U.S. bond prices are both directly related to the perceived weakness of the U.S. dollar-a face pointed out quite publicly by officials in Japan, Russia, and China.
The lesson? There’s a price to pay for rightly pointing out that a huge supply of Treasury bonds threatens the credit rating of the U.S. That price is paid by owners of dollar denominated assets. Yesterday’s remarks by Kudrin, then, should be seen for what they are: a hasty retreat by dollar holders to stem the fall in their investments by reassuring other investors that everything is fine.
In the meantime, you can bet that those same dollar holders are working behind the scenes to find alternatives to the greenback and, of course, to diversify their currency reserves into other currencies or tangible assets. It’s just that you don’t want to precipitate a crisis until you’re good and ready to profit from it with a well-planned trade. Goldman Sachs would never make this kind of mistake.
A fall in stocks and commodities and a rise in U.S. bond prices are also consistent with the technical trends on the major indices we highlighted yesterday. The big bullish moves since the March lows have exhausted most of their momentum. You will now see the secondary trend, a counter rally in bonds as stocks consolidate (perhaps to be blindsided by more financial system issues later, but who knows?)
Does this mean Aussie investors ought to rush out of equities and back into property? Well, if you ask BIS Shrapnel, the answer is probably yes! Yesterday, the firm released a study that concluded Australian house prices will go up an average of 20% over the next three years. We’re not making that up.
“We expect rising confidence in the prospects for an economic recovery in 2010, so investors are likely to return in greater numbers, attracted by increased rental returns and low interest rates,” says BIS Shrapnel senior project manager Angie Zigomanis, who was apparently not informed that Australian banks have begun raising home loan rates.
Blah blah blah. Yammer yammer yammer. Lies lies lies.
Well, okay. Maybe not lies. And to be fair, the BIS report actually admitted that the inflation adjusted gains in Aussie house prices, should they actually materialise, would actually be about half the nominal figure. You’d have something more like a 9%-11% gain over three years, or about 3% compounded after inflation-which is about seventeen percent smaller than twenty.
Even three percent a year seems generous to us, given that Aussie unemployment is still rising. More importantly, the low point of the interest rate cycle has been reached. It’s hard to see how that’s bullish for housing-unless BIS is right and investors dump shares and try to lock in new financing before interest rates rise even further (double digits by 2011, we reckon).
And let us not forget that first home buyers accounted for 28% of all new housing finance in April, according to the Australian Bureau of Statistics. That’s the highest percentage since 1991, the ABS added. The first home buyers aren’t just a marginal force in the market any longer. The lure of government grants has sucked them into the residential property market at a peak in prices and a low point in interest rates. They may be propping up the market now. But when their financial strength fails, it could crush them AND the rest of the market too.
This is simply a disaster waiting to happen for the unlucky first homebuyers, as we’ve said before. Nor does it bode well for the rest of the residential property market. Real estate agents always tell you that the sooner you get on the housing ladder the sooner you can move on up. Buy a house, sell it. Buy a bigger house, sell it. Buy an even bigger house, and so on. There are many mansions in Australia’s property market.
What happens, though, if the lowest rung on the ladder is violently ripped off? If you bring forward years of demand by first home buyers and concentrate all that demand into a thirteen-month period (October of 2008 through the end of this year) what will happen? Hmm.
Well, for one, you will have structurally altered demand for housing finance for years to come. Eventually there’s going to be a drought of new buyers who cannot get credit or cannot afford to get on the ladder without a $30k boost from the politicians. But even that is an optimistic view.
The more negative view is that a large percentage of the FHBs who’ve come in on the current grant package are going to get wiped out. They will be renters for a long time to come. This removes them from future demand for housing finance too.
And so who will investors low on the ladder sell to? Who will people on the second rung of the property ladder sell to if there’s no one from the first rung looking to climb up? And if people in the middle of the housing market can’t sell to trade up, where will demand and the top end come from?
Maybe we’re wrong. We often are, and will be again (and again). But we suspect that the government’s policy to bring demand forward at the bottom end of the market will destroy future demand at ALL levels of the market. And one more point about housing. Quit sending in e-mails telling us it doubles every ten years.
Seriously. Stop it. We’re tired of reading them. Housing does not double every ten years. That is simply not true.
To get the doubling time for any investment you divide the interest rate you’re getting by 72. This is known as “The Rule of 72”. For example, an investment earning seven percent per year compounded would double in 10.3 years (72/7=10.28). You can see how absurd it is to suggest that it’s possible for housing (or any investment really) to grow infinitely at a rate of 7%.
By the way, if you want to see more on inherent possibility of exponential growth-and you are not easily bored-give this video a try. And after reading it, tell us if you agree or disagree with the following statement: a fiat money system accelerates the depletion of resources and the misallocation of capital.
Hey did you see the government of New South Wales has come up with a nifty new policy of buy Australian? The Rees government has said that NSW government departments and agencies have to give preference to Australian-made products when buying uniforms, cars and even trains, according to Sydney’s Daily Telegraph.
It’s not exactly a Smoot-Hawley tariff war to kick off the next Great Depression. But in principle, this is an equally stupid policy. It’s again a case of what is seen versus what is unseen. What will be seen? The jobs that go to Australian companies that make these things.
What is unseen? The cost to NSW taxpayers will most certainly be higher to “buy Australian.” The government will pay more for these things, leaving it with less money to pay for other things. Or, it will raise taxes in order to pay for the higher spending, and the higher taxes leave New South Welshmen with that much less to spend on other products.
Either way, someone always pays the price when the government favours one group over the large group. About the only compelling argument for this kind of policy, in our opinion, is that competition for these goods or services from China (and that’s who this targets) is “unfair.”
That is, if the Chinese-or any other labour market for that matter-are using slave labour to produce goods, it’s a sound principle not to buy those goods. But if it’s not a moral issue and is just an issue of economics, the relevant question is whether these goods and services can be produced in Australia at competitive prices.
We suspect that for industries like textiles, the answer is simply no. Australia, like so many other Western countries, can’t compete on labour or raw material costs with lower-cost manufacturers. Where Western post-industrial economies ought to be able to compete is on quality.
Consumers will always pay more for superior quality for certain goods (textiles, electronics, and manufactured goods). In fact, Japanese and Chinese consumers seem to love French luxury goods, as we recall from our time dodging them outside the shops on the Rue de Rivoli in Paris.
The point is that Western firms can carve out a niche in high-margin manufactured goods and even textiles, provided the quality is excellent. But it’s not something you can do simply be changing a government policy. You have to compete. In the meantime, while we’re measuring how many jobs the NSW policy saves, can we also measure what the higher costs mean to everyone else in NSW?
Finally, we were going to tell you about the Zombie war today. But we’ve run on too long already. More on that from our friend Shawn Cownah tomorrow.
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