With Creditors Like These

This week we collected ridiculous statements found in the media’s daily garble. Here are some of the highlights:

‘When it becomes serious, you have to lie’ – Chairman of the Eurogroup, Jean Claude Juncker

‘… I don’t think we’ll ever have a [housing] boom and bust cycle in this country again.’ – Australian Property Monitors economist Andrew Wilson

‘Reach for the sky: housing market rockets’ – Tim Colebatch at The Age (What he means here is that supply is rocketing. There is no mention of prices in the article.)

‘What we are working on is a plan, that if things go well in terms of economic growth, is clearly something that will bring debt on a sustainable path… If things don’t go well, it will be much more difficult. In that case, there will be a problem.’ – Irish central bank Governor Patrick Honohan (as only an Irishman could put it.)

‘Portuguese authorities have opened a criminal inquiry into three international credit rating agencies’ Associated Press

‘Australia’s Budget Will Make “Substantial” Savings, Swan Says … Swan, who delivers the budget to Parliament tomorrow, said yesterday the deficit in the government’s finances will widen in the fiscal year ending June 30′ – Bloomberg [emphasis added]

‘Assistant Treasurer Bill Shorten overnight moved in parliament to extend the Australian government’s debt ceiling to A$250 billion from A$200 billion. The move comes as the government’s gross debt is forecast to rise to A$239.1 billion in 2013-14.’ – Marketwatch

‘A floor price should be implemented for domestic drinking milk supply as an urgent interim measure’ – Senator Xenophon

‘U.S. Will Urge China to Boost Interest Rates in Washington Talks’ – Bloomberg

Some of the quotes don’t need an explanation. They are that ridiculous. For others, the irony can be a little more elusive.

Let’s tackle the last one first. For those of you who don’t know, the Federal Reserve has interest rates at about 0%. The Chinese have them at about 6%. The Chinese have been increasing theirs and have clear plans to continue doing so, while the Fed has been printing like mad to suppress theirs.

And the US is urging the Chinese to boost rates!

But the reasoning behind their demands is the real story. Having adamantly denied that currency depreciation and price inflation are the same thing and brought on by the same phenomenon (money printing), the Americans now use that very argument against others.

This is an admission of epic proportions. If currency exchange rates give away the inflation rate, what does that say about the US dollar over the last 10 years?

US Dollar Index 2001-2011
US Dollar Index 2001-2011

Source: Marketwatch

The next time you hear the denials about a falling dollar exposing the inflation being created, remember the hypocrisy.

The Americans’ demands for the Chinese to revalue their currency may also be an iconic case of ‘careful what you wish for’. As we pondered in a Markets and Money past; what would happen to the US dollar index if the Yuan were revalued? The chart above might just collapse. And the US dollar would be ‘relegated to a “museum”‘ according to Global currency expert Savvas Savouri.

And of course, precious metals would go ballistic. But we can’t have precious metals giving the game away. That would make the inflationists very uncomfortable.

The rapid decline in the price of silver went contagious last week. If you were wondering what had happened, Greg Canavan covered it on Friday:

— One silver contract represents 5,000 ounces. At say, $40 an ounce, this represents a position of $200,000. But you don’t need to pay that upfront. You put down a ‘margin’ instead. Back in January, the margin set by the CME Group (the owner of the futures exchanges in the US) was $11,138. So to get exposure to $200k of silver, you need to come up with just over $11k. That’s leverage.

— Since late March, the CME has continually increased margin requirements. That’s fine in a rising market because it wants to make sure it’s not encouraging more leverage as the price of the metal rises. Fair enough.

— But what is truly strange is the CME’s actions over the past few days. It has continued raising margin requirements even as the price falls! Effective 5 May, the initial margin requirement to buy a silver contract is now $18,900, up from $16,200 just a few days before. Then, from 9 May, the margin requirement will increase again – to $21,000!

— At the current silver price of around $35, that represents a margin of 12 per cent. This compares to a margin requirement back in November of just 6.5 per cent.

So if you double the cost of holding a position in silver, the price falls? What a surprise. The same trick was then pulled on crude oil contracts. (Seeing as it worked so well for silver…) To be fair, the CME was probably just responding to political pressure, like all good businessmen. Several senators happen to be campaigning on this particular issue at the moment.

Of course the speculators will simply move elsewhere. And that’s what the CME and its customers (the investment banks) want. Silver was getting far too much attention and oil was hampering the imaginary recovery.

The whole episode reads like a chapter out of Atlas Shrugged. If the powerful and their friends don’t like what’s going on, they simply change the rules. Slipstream Trader Murray Dawes explained in Monday’s DR how this has worked in the past.

The Australian version of precious metals manipulation is the Silver Florin. Sound familiar? The Silver Florin was an Australian coin. Before 1945, it was 92.5% silver. Then the rules were changed by the authorities and the silver content went to half. When Australia moved to the decimal system of currency, the coins were declared to be 20 cents.

At 0.1818 troy ounces of silver, the post-1945 Silver Florin would now be worth around $6.18. And pre-1945 Silver Florins would be $12.36. (At $34 silver.) A quick Ebay search will verify these calculations.

It needs to be said, this is slightly more than 20 cents. But don’t go looking to the government’s inflation stat’s for an explanation.

Inspired by MIT’s Billion Prices Project, we have decided to monitor inflation ourselves. No longer will we rely on the ABS’s fudged figures. Let us know at dr@marketsandmoney.com.au if you witness any of the following and we will add it to our data set:

  • McDonalds announces it is freezing the price of its most popular burger, but renaming it the ‘Quarter Ouncer’.
  • People with silver fillings are afraid to smile.
  • Street beggars start demanding coins with silver in them instead of just ‘silver’ coins.
  • Airlines begin requiring that passengers bring their own jet fuel. [Compliance edited out the airline we named.]
  • The RBA announces it is going to base policy on a new price index, called ‘Core Core Inflation’. This one excludes food, petrol and everything else.
  • Australian current affairs shows cover the way packaging is being used to hide inflation.

For the source of our inspiration and the American version of our list, check out this blog at Forbes.

It is said that inflation favours debtors, because it makes their debts easier to pay. The fact that creditors are fully aware of this and adjust interest rates to compensate seems lost in the analysis. Inflation benefits creditors too. Apart from charging a higher rate, foreclosing on a house that has gone up in price is less painful for the repossessing party.

But outside the insidious effects of inflation, the world is about to make mincemeat out of creditors. Not since Shylock have lenders been in for such a rough time. And it’s not just banks. Bond holders generally are in the line of fire.

Across Europe, restructuring is looking more and more likely for the sovereigns. (CDSs imply a 68% probability of default for Greece.) In the US, banks can’t foreclose on people not paying their mortgage, they may be required to reduce mortgage balances and they face continued falls in house prices with 28% of homeowners already owing more than the value of their house. The Big Four Australian banks are suffering under higher delinquencies than during the GFC and a housing market teetering on the edge.

You have to wonder what will crack first.

Does it matter? Philosophically speaking it does. Whichever issue triggers the crisis will receive the blame for the problems that ensue. Even though sub-prime wasn’t a humongous market, it will forever be blamed for the debacle of 2008. The fact that it was the straw that broke the camel’s back is forgotten.

A Eurozone collapse would render the great European experiment a failure. We can’t think of a similar experiment off the top of our head. A shared currency with separate fiscal policies, some of which are headed for default – this promises to be interesting. How are the politicians to react? What policy prescriptions should they adhere to? ‘When it becomes serious, you have to lie,’ according to Eurogroup Chairman and Luxembourg Prime Minister Juncker.

We’re not so sure whether history repeats itself because people don’t learn or because they simply follow precedent when things get too complicated. In this case, there’s no precedent to follow. And things are looking very complicated. While bailouts and austerity are negotiated, the ECB looks set to continue increasing rates. What a shemozzle!

Warren Buffet Are you a Warren Buffet fan?

Find out how much you really know about the Oracle from Omaha by taking the Warren Buffet Quiz.


Back to the quotes listed above. One that cannot remain unaddressed is Nick Xenophon’s comment. Here it is again in all its blood curdling glory:

‘A floor price should be implemented for domestic drinking milk supply as an urgent interim measure.’

Accessories to the lunacy were Liberal senator Bill Heffernan, Nationals senator John Williams and Greens senator Christine Milne.

Have we really gone back to the era of price controls? How stupid are these people? If they set a minimum price, milk production will go through the roof. How will they allocate who produces what and who gets to sell their milk at the price decided on? What will happen to the surplus milk?

Price controls cannot work and have, coincidentally, never worked.

Nick Hubble
Markets and Money Australia

Nick Hubble
Nick Hubble is a feature editor of Markets and Money and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about Markets and Money, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails.

Leave a Reply

4 Comments on "With Creditors Like These"

Notify of
Sort by:   newest | oldest | most voted

Looking at the Australian budget and getting back to surplus, an “easy” way to boost mining revenue is to devalue the AUD by 50%. What are the chances of this happening?


I actually wonder if the RBA is keeping the AUD high in order to protect Australian assets from being bought up by China.

Not that it would work particularly well, they’ll just buy the assets anyway.

Also I think I am giving way too much credit to the RBA by thinking that.

Tim Colebatch
Nick Don’t you bother to read the articles you comment on? This is just sloppy work. 1) My article was not about ”rocketing”housing supply. It was about the shift in the composition of Victorian approvals, from single houses to units and apartments, especially high-rises, which have made up 1 in every 4 homes approved this financial year. 2) Newspaper headlines are written by sub-editors, not reporters. I claim no credit for the headline on my article, but I thought the first half of it ”Reach for the sky” was pretty good. But I suggest next time you read the article,… Read more »

Pete, I think we both give the RBA and their masters to much credit!

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au