May The Fourth Be With You 2016 Edition

Fighting Deflation In Japan

Here's something from Zero Hedge.

Interestingly, the BoJ’s attempts to achieve its price inflation target continue to end in failure with unwavering regularity. While the central bank’s astonishing ineptness in this respect is a blessing for Japan’s citizens (at least for the moment, their cost of living doesn’t increase further), it harbors the danger that even crazier monetary experiments will eventually be tried. 

While threatening additional easing measures at his press conference (such as driving negative deposit rates further into negative territory) Mr. Kuroda seems to have explicitly ruled out the adoption of “helicopter money” by the BoJ. This is quite funny, since it seems extremely unlikely that the BoJ will ever be able to extricate itself from its balance sheet expansion (which de facto amounts to an “unannounced” case of helicopter money provision)

Of course BOJ boss Haruhiko Kuroda ruled out 'helicopter money' provisions for the way to go about funding the government directly because it would be illegal. Thus it follows that they'll have to think up something else other than the Negative Interest Rates Policy to do in order to reach this 2% inflation goal. 

It's sort of interesting how the Bank of Japan went looking for this 2% inflation rate and did so by massively expanding the monetary base - which inlay man's terms is "printed lots of money" - and somehow still managed to have the Yen go up. From our old high school texts we learned that the Weimar Republic era Germany printed money to pay reparations and this resulted in astronomical inflation. It is therefore interesting that the emir scenario hasn't kicked in at all.

One of the reasons the expanded monetary base hasn't done the trick is because the printed money has gone to the banks who do not lend the money out as planned, and so the money sits there in the banks unspent. The banks for their part complain that there is nothing in which to invest. Thus the great printing press experiment remains stuck in the vaults of the banks. 

The problem is that the inflation would only go up if that money went around the economy chasing assets. To do that, they need consumers to spend, but consumers have all sort of reasons not to spend. Shinzo Abe for his part has been imploring the major corporations to raise their wages. Yet even pay has stayed largely stagnant. 

What this indicates is that the printed money went to the wrong place, pretty much as TARP and QE money went to the wrong places. As objectionable helicopter money is, the BOJ need to figure out how to shove that money into the pockets of the ordinary citizens so they feel they can spend that money. Otherwise all the prince money is going sit in the vaults of banks.

Reserve Bank Of Australia Cuts Rates

So much for the prognostication that the RBA might cut rates around June.
Instead, they were decisive.

Tuesday's historic interest rate reduction coincides with the federal government's third budget, which is expected to be mildly stimulatory despite pressure to narrow the deficit.
Deflation in the headline consumer price index, due mainly to falling oil prices and aggressive retailer discounting, was the first such quarterly contraction in seven years. 

Moderate inflation, the result of demand for goods and services – including labour – just outstripping supply, is usually the mark of a healthy economy. 

However, when prices and wages continue to fall, consumers often hold off on buying and companies on investing. Deflation also pushes up the relative burden of debt.
The cash rate is now easily at its lowest level under the current system of monetary policy setting. 

The latest cut puts Australia into the club of developed economies with ever-falling interest rates and bond yields. Japan, the European Union and parts of Scandinavia now have zero or even negative nominal rates. New Zealand, too, looks likely to keeping cutting from an already-low 2.25 per cent official cash rate.

Let's not kid ourselves. If the economy were actually running well, the RBA wouldn't be cutting interest rates. As the vagaries of politics go, it happened on the same day the Budget was brought down and really gave no scope for the Federal Government to argue it was managing the economy well.

If there's one dumb thing that the Howard Government entrenched in the public consciousness, it was the asinine idea that lower interest rates were a sign of better government. Now that interest rates are at historic lows and set to go even lower, it puts a big lie to the position that the Governments doing any good management of the economy. If this is good management of the economy, for goodness sakes give us the other stuff.

And So The Budget Happened

This year's budget would underline just how ineffective this government is.

Labor has questioned why the government is cutting corporate taxes while the budget is in deficit and only handing income tax relief to Australians on over $80,000 a year even though 75 per cent of Australians earn under that amount. 

In his first interview since Tuesday night's speech by Treasurer Scott Morrison, Mr Turnbull said he believed his first budget - which delivered tax cuts for small and medium businesses, new measures to encourage young people into jobs and cutbacks to superannuation concessions for wealthy Australians - was an "exciting" one.

"A lot of newspapers are saying, 'this is a bit of a dull budget'," Sunrise host David Koch told Mr Turnbull. 

"We all thought you would bring the big excitement and changes."
Mr Turnbull responded: "Scott Morrison was delivering a plan for jobs and growth - I think that's exciting but everyone has their on views on that. 

"The BCA [Business Council of Australia] described the changes to business tax, the biggest changes to business tax in more than a decade. 

"These are substantial tax reforms but these are reforms that are designed not for the short term, not for an election. 

"They are designed for the long-term, to ensure that we continue to get that successful, economic transition from an economy that was fired up by a mining construction boom to one that enables us to live within our means, have a sustainable tax system but above all, drive that economic growth and jobs upon which our futures and those of our children and grandchildren depend." 

Despite the RBA's shock decision to cut the cash rate to a record low of 1.75 per cent on Tuesday, Mr Turnbull said the economy remains fundamentally strong.

I like the insistence that it is an exciting time and that the economy remains fundamentally strong when on the same day the RBA goes and cuts interest rates to historic lows. For reasons and factors totally out of their control, the Australian economy is heading into the ZIRP twilight in the next few years without a plan to get out. It's not even as if Australia has a really matured manufacturing sector or the population growth is stagnating (thanks to immigration it's not) so it can be sheeted home to the massive amounts of money tied up in the Property Bubble together with the world's largest private sector debt per capita. If you want us to get excited about that, you've got another thing coming Mr. Turnbull. 

None of those problems are solved. Negative Gearing stayed in place, which was something expected, but you have to wonder about the wisdom of tightening the Superannuation loopholes fr the rich while keeping Negative Gearing going because some people think the money is going to flood into the property market, furthering the Bubble. It strikes one that the Federal Government - regardless of which party is in power - refuses to acknowledge the elephant in the room and keeps trying to talk around it as if there's room to manoeuvre. 

A crackdown on superannuation tax concessions for the rich, coupled with a budget day cut to interest rates, could increase the flow of funds into negatively geared investment property.

Ahead of the 2016-2017 federal budget announcement, two of the country's leading actuaries, Rice Warner chief executive Michael Rice and Mercer senior actuarial partner David Knox, warned that any crackdown on super tax concessions for the rich without any changes to the negative gearing rules could have the unintended consequence of pushing more money into property. 

That is exactly the policy combination that we got on Tuesday night. And to add fuel to the fire, earlier in the day, the Reserve Bank of Australia dropped the benchmark interest rate by 0.25 per cent to a record low 1.75 per cent.

In other words, this Government just fed the elephant in the room while not acknowledging it's there. 

All that being said, it's not as if it's making outlandish forecast projections for growth like WTE Joe Hockey's last budget. There's some difference between a plain old crappy crap sandwich and a double poo sundae. 

Economy As Conundrum

"Modern Money Theory"

Here's something that might surprise people. There's a new theory of modern money and it is going to piss off all the people wanting budget surpluses.

The MMTers claim that in the modern era of floating exchange rates and deregulated financial markets, governments can, and should, run deficits whenever they are needed. There is a strong moral case for this: in a modern economy, there's no good reason to have unemployed labour or capital. For the MMTers mass unemployment is a great evil and its daily, human cost dwarfs other economic challenges. 

They acknowledge there are limits to government spending. Resources in the real economy can be constrained and taxes are an essential tool to ensure demand for the currency and to cool the economy if it overheats. But there's plenty of scope for governments to print and spend money without causing inflation or triggering a financial crisis. MMTers say sophisticated modern economies like the US and Australia are in no danger of the hyper-inflation which plagued Zimbabwe last decade or Germany's Weimar Republic in the 1930s. 

Modern Monetary Theory has an intriguing link to Australia. The term was coined by veteran University of Newcastle economist, Professor Bill Mitchell, and he is a passionate advocate for the theory. 

Mitchell argues that outdated "gold standard-type thinking" – from a time when governments accepted effective constraints on how much currency they could print – is wrongly applied to the modern financial system with fiat currencies, floating exchange rates and deregulated financial markets. 

"The economics that apply now are nothing like the economics that applied under a fixed exchange rate, convertible system," he said. 

Mitchell says a fundamental problem is that most people, including politicians, wrongly equate government finances with managing their own household budget.
"The way mainstream economics is taught plays on that analogy all the time in the sense that the government has a financial constraint just like you and I," he said. 

If fact, says Mitchell, household budgets and government finances have nothing whatsoever in common. He doesn't even like to use the word "budget" to describe the government's finances because it implies they work like a household budget.
"A government that issues its own currency, like the Australian government, has no financial constraint. That's the starting point."

Which goes back to what Taro Aso was saying 5 years ago about the Japanese currency. Naturally, you can see a huge cadre of resistance to this notion of a government printing as much currency it needs. But in Japan, they've been doing this simply to stave off massive deflation that happens when the equivalent money simply sits in the banks. It remains true that printing money leads to inflation - but in the face of massive deflation, it might just be what is needed. After all, interest rates certainly have room to move up should inflation actually become a problem in Japan. 

In Australia, it might be a little trickier because there already is a Property Bubble that shows no signs of abating. If the government printed money, chance are it would get sucked into the property market and simply inflate prices there without ever heading out to where the capital is needed. In fact, it's not as if it's working great in Japan either because even with negative interest rates, the money tends to go from the Central Bank out to the banks and then doesn't get invested. It doesn't get invested because there's no demand. 

Which begs the question about helicopter money and just where this helicopter money is being dropped. For the last seven years, it is banks that have been getting the kid-glove treatment of low interest rates and Quantitative Easing programs to shore up their loan books and bottom line. Naturally the banks have bounced back strongly even as the actual economy has stayed stagnant in the G-20 world. When you think about it, the various QE programs and money printing programs on the whole have been showered upon banks. And there's no reason to think that banks would contribute to aggregate demand in the context where the banks are supposed to offer more credit to the already indebted private sector. Nobody wants more debt in this current context of record private sector debt. 

If the government really wants their helicopter money to work, you need to shove it straight into the pockets of the ordinary citizens to bolster their spending - not hand it banks in the hope the ordinary citizen decides to up their credit card limit when they're already n debut to their eyeballs. The obvious-as-daylight answer is that governments should spend more on welfare payments. Just ramp it up to a living wage and let the people decide how that money should be allocated in the economy. 

You can hear the howls of complaint that this is "rewarding" the 'dole-bludgers', but the point is, you're not going to get more aggregate demand out of a population that has little cashflow and maybe in hock to the eyeballs on credit. Debt relief from the bottom up is likelier to go along way. 

Two From Pleiades

If you want to know why banks aren't particularly helpful, well I've got just the pair of articles for you from Pleiades. 

The first is about how contemporary economic orthodoxy might be a big con job to enrich the 1%. 

The National Income and Product Accounts treat the interest, profits and other revenue that Wall Street extracts – along with that of the rentier sectors it backs (real estate landlordship, natural resource extraction and monopolies) – as if these activities add to Gross Domestic Product. The reality is that they are a subtrahend, a transfer payment from the “real” economy to the Finance, Insurance and Real Estate Sector. I therefore focus on this FIRE sector as the main form of economic overhead that financialized economies have to carry.  

What this means in the most general economic terms is that finance and property ownership claims are not “factors of production.” They are external to the production process. But they extract income from the “real” economy.

They also extract property ownership. In the sphere of public infrastructure – roads, bridges and so forth – finance is moving into the foreclosure phase. Creditors are trying to privatize what remains in the public domains of debtor economies. Buyers of these assets – usually on credit – build interest and high monopoly rents into the prices they charge.

In case you were wondering, the whole QE thing didn't really help people on Main Street; it basically fluffed the pillow for Wall Street so it could continue to exploit the real economy. That extract there also points out the folly of the Gillard Government when it wanted the post-mining-boom economy to be led by housing and construction. It was a dumb idea because houses aren't really capital investments in the sense that factories or even shop-fitting might be. A house is much moe like infrastructure. Once it is built, it does no provide production. Just like roads and public transports and utilities, it serves a vital function of providing shelter, but a house in of itself does not become a production centre in the economy. 

In fact, this great muddling of infrastructure and capital investment has become worse in the context of privatisation and Private Public Partnership projects whereby a project like WestConnex is deemed worth doing even though it will have zero positive effect, simply because it costs $18billion. The logic of the government is that if it pumps 18billion through the economy, something's bound to stick. It completely ignores the fact that if you spend $18billion and the outcome is zero effect, then you've wasted the time and money.

The reason the big end of town and especially banks like deals like WestConnex is because they profit first, and all the money that goes through their system somehow sticks into their profit structure through fees. But I digress.  

This brings me to the second article which posits that the global financial markets are a great big Ponzi scheme:

HUDSON: Here’s what happened. Marx traumatized classical economics by taking the concepts of Adam Smith and John Stuart Mill and others, and pushing them to their logical conclusion.

Progressive capitalist advocates – Ricardian socialists such as John Stuart Mill – wanted to tax away the land or nationalize it. Marx wanted governments to take over heavy industry and build infrastructure to provide low-cost and ultimately free basic services. This was traumatizing the landlord class and the One Percent. And they fought back. They wanted to make everything part of “the market,” which functioned on credit supplied by them and paid rent to them.

None of the classical economists imagined how the feudal interests – these great vested interests that had all the land and money – actually would fight back and succeed. They thought that the future was going to belong to capital and labor. But by the late 19th century, certainly in America, people like John Bates Clark came out with a completely different theory, rejecting the classical economics of Adam Smith, the Physiocrats and John Stuart Mill.

HEDGES: Physiocrats are, you’ve tried to explain, the enlightened French economists.

HUDSON: The common denominator among all these classical economists was the distinction between earned income and unearned income. Unearned income was rent and interest. Earned incomes were wages and profits. But John Bates Clark came and said that there’s no such thing as unearned income. He said that the landlord actually earns his rent by taking the effort to provide a house and land to renters, while banks provide credit to earn their interest. Every kind of income is thus “earned,” and everybody earns their income. So everybody who accumulates wealth, by definition, according to his formulas, get rich by adding to what is now called Gross Domestic Product (GDP).

And there, lies the trick. 

The dirty big secret is that banks are not a productive part of the real economy. They have never lent to business as stated in the current economic theory. When you think back to medieval banking, they sure didn't lend to businesses. The Medicis lent to governments and sovereigns - as did the Rothschild banks in the 18th and 19th century. Historically, and traditionally, banks simply don't lend to businesses if they can get away with not having to do so.  Thus we begin to understand why all the helicopter money thrown about from the successive Quantitative Easing regimens have done so little to add to aggregate demand. The banks simply used that money to shore up their bottom line and handed the profits to the rentier classes. All that money created in the USA and Japan, ended up in the vaults of banks with no intention of being actually utilised. But you be your bottom dollar it got counted towards GDP when they paid themselves. 

The rebound of the Big Four banks and Macquarie Bank in Australia tells a story where the historic low interest rates have  allowed the flow of money to the rentier class as well. House prices have stayed inflated, but everybody is up to their eyeballs in debt. Even if interest rates were cut to zero, it's not going to help the ordinary citizen, but it will add fuel to the rush of money heading to the 1% -  money which will stay unproductive and mostly locked into more rentier activity.

If you don't believe me, just today there's something on Macquarie Bank.

There are no flies on those Macbankers. No sooner had they tapped taxpayers for help during the global financial crisis than they raised $25 billion on global bond markets with a sovereign guarantee. It saved their bacon, then, with breathtaking flair, they doubled down. 

Until now, it was common knowledge that the bank merely lent out its cheap government-guaranteed money again at higher rates and pocketed the difference. 

What we didn't know is the quality and quantity of the loans. Revelations by the Australian Financial Review's this week however established the bank has since ploughed $33 billion into junk loans.

It is the biggest junk bond binge in the nation's history, a sub-prime tour de force.
Unlike other famous gamblers such as Wild Bill Hickok and Nick The Greek, who punted their own money, the Macbankers – newly monikered the Junk Yard Dogs – have gambled everybody else's, after blithely leveraging it 10 times.

The upshot is that the bank now has more junk debt than it has equity and its default rate is five times that of the major banks. 

It poses the question, should taxpayers be subsidising, not just Macquarie's garish executive bonuses, but standing behind what appears to be more of a leveraged hedge fund than a bank?

How the hell are those junk bonds going to help aggregate demand? Clearly the helicopter money went to the wrong part of town to shore up aggregate demand. The better thing to do would be to hand the welfare recipients more money and raise interest rates, and stop pretending going back to surplus is something noble (It's not - it shrinks the real economy). We might even get back the semblance of the real economy we once knew. Heck, it might even grow at 5%. All the same, you don't even see the ALP advocating this because they too have drunk the 'Budget Surplus Is Good' Kool-Aid as well. It's a real shame the lobbyists keep winning in Canberra as they do in Washington D.C. and Tokyo. 

Quick Shots - 09/Feb/2016

Hard Landing In China - "We Crash, You Die!"

Pleiades sent me an article in the AFR today outlining the retreat of bank shares this year. it's not exactly joyous reading. Pleiades thinks this is the shit hitting the fan. He is probably right.

So far this year, European bank stocks have dropped more than 20 per cent, and this pattern continued overnight, with both Deutsche Bank and Commerzbank shedding more than 7.4 per cent. The shares in three big Greek banks all slumped more than 27 per cent on Monday night. 

At the same time, worries about tighter financial conditions weighed on US bank stocks, with Morgan Stanley dropping 6.4 per cent, while Goldman Sachs falling 4.8 per cent.
At the weekend, China said its foreign exchange reserves dropped nearly $US$100 billion ($141 billion) last month to the lowest level in more than three years as Beijing further sells dollars to prop up the yuan. 

China's foreign exchange reserves now stand at $US3.23 trillion, about 20 per cent below the peak of nearly $US4 trillion reached in mid-2014.

Capital flight out of China is accelerating not slowing down.  There's really no sugarcoating the fact that China is slowing down towards a hard landing. Nobody really manages 'soft landings' but on the scale of measuring just how hard a landing this is going to be, it looks like it's gong to be solidly hard.

Abenomics Is Reaching The End in Japan

The latest news out of Japan with its NIRP (yes, negative interest rates policy) is that Abenomimcs has failed. Stocks, USD/JPY trade and Bond yields have collapsed. Naturally, banks are taking a hammering over in Japan as well. The markets are indicating Abenomics simply is not working.

The market's reaction is getting duller day by day. The negative interest rates boosted the market only for two days," said Norihiro Fujito, senior investment analyst at Mitsubishi UFJ Morgan Stanley Securities, and trading data shows even that was down to short-term "gamblers", he added. 

A week later, even those gains are gone, as foreign investors withdrew a net 207 billion yen from the market, taking their total for 2016 to more than 1 trillion yen. U.S.-based Japanese stock funds also saw an outflow in the week ended Feb 3.

Curiously, the Yen rose against the US dollar, even as foreign investors pulled out of Japanese markets.

So, even if the US is doing much better now, with interest rates going up, two out of three of Australia's trading partners are going through what can only really be described as bad times.

Deutsche Bank is now issuing statements defending its liquidity, which is like a throwback right to the GFC. At this point the scuttlebutt is that DB might be the new Lehmann. This is not surprising because Deutsche Bank is neck deep in derivatives that have gone sour, and for a long time it was speculated that any movement of US interest rates would blow up positions taken by those derivatives and adversely affect Deutsche Bank.

Judging from the headlines, it's clear we've entered a new phase in the repercussions from the GFC. It may just be the point at which all the Quantitative Easing and money printing is now coming back with consequences to roost. The Central Banks can't very well spend even more in an attempt to spend their way out of the woods.

Bloody Monday - 2015 Edition

Well, What Goes Up, Must Come Down

It's been this growing disquiet all year around China. The cracks were showing but maybe the market was in denial. Or maybe they convinced themselves all was well in the face of the share market rises in Shanghai. After all, if the shares are rocketing up, something must be going right in the market, people figured. But slowly we kept hearing things that belied that simple understanding. We heard that the growth figures were not something measured, but more like aspirational targets expressed by the Communist central government, which would prompt everybody to chip in and hit the target. We had read reports of ghost cities built on borrowed money with price tags too high; and then of course there was this notion that China would simply move to a consumer-consumption driven economy.

This must be the month where it all went out the window because fear has gripped international markets and everybody's selling out their positions. They're not even going to wait for October, they're going, getting right out. And so we're seeing the entire worlds' markets all retreating at once, one retreat feeding on to the next in the timezone domino of market collapses. It hasn't been quite like this since 2012, and quite honestly, it's sharing hallmarks of the 2007 collapse. It's all very ugly because the problems of 2007 haven't been solved enough to make us weather these moments better than 2007. And of course 2007 turned to the bailouts of 2008 and the rest fit has been about kicking cans down the road, which of course includes the Greek situation which is tethered to the rest of the PIIGS.

In short, we're on a clock of about 12 to 14 months before the Lehman Moment gets a sequel and people will scramble for bail outs - on the eve of a Presidential election. All the same, the most important notion is that this time, there's nowhere to go. They can't go below ZIRP to stimulate more credit growth; they can't cut taxes even more to stimulate consumption - that trick's already hit its limit; and none of the creditors can afford to let the debts go bad because it would blow up their own position - which last time prompted Quantitative Easing so people could get over the hump. "Moral Hazards" - and I say that with irony because you know it turned out that it was more important to save everybody's bacon than encouraging "Moral Hazards".

So depending on how badly this drop affects Australia and its consumer sentiment, you can count on the RBA to go to ZIRP, just to support asset prices. There's not much more they could do as the perfect storm hits for the second time in a decade.

AUD $60 Billion In A Day

Just how crappy was the All Ords today? Take a look at this:

Ouch. A few weeks ago, the ASX was hovering closer to 6000 than 5500. There was talk of a secular Bull Market forming, even though the earnings were not exactly like for what people had hoped. The splatting sounds you're hearing are leveraged investors leaping off the ledge. At least, it used to be in the 1929 crash. It's early days yet as investors will go on a big purge of companies carrying too much debt. The four major banks have beaten a retreat of 20% off their highs this year, just in this month, so this could transmogrify into something a bit scarier quickly. If you cast your mind back to 2008, when global credit totally seized up, there was talk that banks would fail and there would be a big run on banks. At the time Kevin Rudd stepped in by guaranteeing deposits and backing the banks to the hilt. He took lightning fast action to stave off the GFC induced collapse of banks.

This time, we're stuck with captain Snaily Failure in the Lodge, so we may not get a Decisive bit of action out of this idiot government until it's too late and even then it will likely be too little. Some ideologue - I'd guess Cory Bernardi or Eric Abetz - will bang on about moral hazard as Sydney and Melbourne property markets descend into carnage. Remember, we've got record private sector debt. A lot of positions are ready to burst if the margin calls are made. Hold on to your hats!

You Know What's Weird? Gold

Gold is a commodity as well as the metal by which currency used to be measured. Of course, none of the major currencies have the God Standard going, and it's been this way since Richard Nixon shocked the world and took the US Dollar of the gold standard. You'd think with this crisis brewing for the last few weeks that Gold would go up as people lost faith in equities and bonds and fiat currency notes. But no - it's been going down.

...which is weird.
So, in 2008, they start QE and you can understand the impulse to buy gold because, hey, they're "printing money". We would expect to see the sort of inflation that broke out in Germany between the war as it printed money to pay off the reparations for World War I. Now, inflation an the measurement thereof is a separate bugbear, but there simply hasn't been that kind of inflation going on. Instead the Central Banks have worried about deflationary pressures and so interest rates have plummeted to zero or near-zero in many advanced economies. Gold peaked at 2011, but has been sliding ever since - which I suppose suggests the inflation expectation is less than zero, and has been for a long time.

When you include the fact that gold actually has commercial uses beyond just being precious, then it makes sense that the Commodities collapse as well as the ongoing deflationary pressures has pushed gold down to this level we see today. What's weird is that if fear was really running around the globe, you would expect that gold price to jump.

News That's Fit To Punt - 01/Apr/2015

If A Fool In April, Perhaps A Fool All Year Around

This isn't a prank. Our treasurer really is the Worst Treasurer Ever. He's only waking up to it in his second year at the helm.

With the budget reeling from that external shock, the latest NAB quarterly consumer anxiety index has, for the first time, put consumers' concerns over government policy higher than the usual pre-occupations with the cost of living and worries over job security.

"Government policy is now the single biggest cause of anxiety for consumers, just ahead of cost of living, while job security continues to cause the least stress," said NAB's group chief economist Alan Oster.
"What it basically says is that the consumer is still scared, that's basically the bottom line."

The bank has warned that the sense of anxiousness is prompting consumers to eschew "non-essential" spending in favour of either saving or paying off non-discretionary commitments such as utilities and medical bills. 

Asked what concerns consumers identified and what they intended to spend on, Mr Oster said: "It's very much a picture of consumer who is doing what they have to do and who is not feeling happy."

How dumb is that? They ran an election campaign on scares, and now that they're in power they've sunk the economy with the very same scares. People believed them. Then they cut the budget hard, and so the people believed them more. If you lie to the people enough, they believe your lies and do the things that come back to bite you.

The Customer Is Always The Patsy

During the GFC, all the banks were found out; by found out, I mean, the world found out that the banks didn't carry enough liquidity to cover all the extreme positions. In Australia, the government guaranteed the deposits and basically backed the 4 major banks and Macquarie Bank, declaring them "too big to fail" (Also known as TBTF). Since then there's been BASEL, I, II and III agreements demanding that banks carry more capital.

Here's the response to the rise in demand to raise and preserve capital:

Two of Australia's largest banks are warning that interest rates on loans could rise if they are made to carry more capital, suggesting they will favour shareholders over customers as global regulators consider creating larger equity buffers in banks to protect the financial system from future crises.

In a dialling-up of resistance to being forced to increase capital carried against mortgages, as recommended by David Murray's financial system inquiry, the Commonwealth Bank of Australia said higher mortgage risk weights, which determine the riskiness of a loan and how much capital must be set aside, would "restrict the cost-efficient provision of credit to consumers". A consequence would be "that costs for home loans increase on average across the economy", the bank said.

You gotta laugh. Of course they would argue that  - but they're taking the piss.
That's exactly how we got into trouble in the first place when big banks in America started handing out cheap loans to inappropriate people, and then divvied up the debt positions and turned them into mortgage bonds. When the inappropriate loans customers defaulted, the whole edifice came to a stop and the whole financial sector gagged on the shit sandwich that we have lovingly come to remember as the subprime loans crisis.

Yes, all those stupid 'subprime' loans all blowing up at once! The banks are misremembering the sequence of events that nearly destroyed them. If banks need to store more capital to be safe, then they should. If that means a couple of points higher on the interest rates, so be it. If this scares off some of the customers, well heck, you probably don't want those subprime-y customers. This is not a bad thing.

Iron Ore Hits Rock Bottom, Could Even Go Much Lower 

Yeah, let's see now. In the 6years we've been able to see the spot precision iron, it's never been so bad for iron ore prices.

Iron ore started the year at $US68 after losing half its value in 2014, but the fallout has accelerated with a fresh record low of almost $US51 a tonne hit on Wednesday.

The question has changed quickly from whether the price would have a five in front of it in 2015 to whether the price start would start with a four. 

A flood of new supply from the majors - BHP, Rio, Brazil's Vale and Fortescue Metals Group - and stalling Chinese steel demand growth have together crushed the price.
Despite the cries of protest from Fortescue, which is the highest cost producer of the majors, as well as smaller industry players, and the state and federal governments whose budgets have been smashed by the price collapse, Rio and BHP are sticking firmly to their expansion targets.

UBS mining analyst Glyn Lawcock said the iron ore price could soon fall into the $US40s but that would not push Rio and BHP to review their strategies.

"Having a four in front of the price is not far away and is entirely possible given what we've seen in the past few days," Mr Lawcock told Fairfax Media.

And yes, it could very well get there soon.
Here's a quick question. How is it possible for China to be growing its GDP at 8.7% in 2009, 10.1% in 2010  and 7.5% this year, while iron ore fluctuates this much in-between? If anything makes you suspicious of Chinese GDP numbers, it's the relative stability of the GDP figure sin thecae of such fluctuating costs of raw materials. It's basically more evidence that the GDP figures from China are made up 'aspirational targets' and not actually measured values.

The current drop in spot prices has been credited to the explosion in the supply side for iron ore, but it seems more pertinent to ask why the demand side for why iron ore is dropping so much.

View From The Couch - 19/Sep/2014

I Was Wrong (Again!)

Some time ago before Tony Abbott came to power, I made the awful observation that a Tony Abbott Prime Ministership may well be a DLP government with all kinds of BA Santamaria-like notions making their way in to the Liberal Party position. That, even if Abbot had own, in some ways the Labor party in one guise or another would leave an imprint on things.

One year along, I have to admit, that was totally hopeful, wishful ,idiotically optimistic blather; clearly it was one of those stages of grief called negotiation. During the process of moving the blog back here, I had to confront the reality that as awful as the Gillard ALP government got, nothing could have prepared us for the ongoing enormous clusterfuck that is the Abbott government. For that I cannot apologise to my readers enough.

It was always going to be bad; it is bad, and it's not going to get better - just worse.

No Such Thing As An Energy Superpower

Pleiades sent in this article about how this notion of an energy superpower is misguided.

Former Treasury secretary Ken Henry gave a speech on Tuesday outlining the danger that we have fallen under the spell of a narrative which says the route to economic prosperity is built on exports above all else. 

Henry pointed out that a focus on improving the competitiveness of our exporters was a good thing, but this was part of achieving the final end-game – improving both present and future Australians’ overall quality of life. Henry noted that this focus on exporters was very useful in helping the general public to see the value in a range of economic reforms which unfolded over the 1980s. Yet these reforms were, in fact, great for the economy as a whole – not just exporters. However, he was worried this heavy emphasis on export competitiveness was now acting to distort public debate in ways which distracted us from the final end-game. 

Unfortunately, this government is in real danger of falling for a sub-narrative related to this, one that has its roots in the 1970s but doesn’t make sense today. 

A range of statements from this government seem to suggest it believes that Australia’s economic prosperity and competitive advantage rides upon the availability of cheap energy for domestic use.

Because the Abbott government is basically a mouthpiece for the corporate control of this country and wants to do the bidding of the rich mining magnates - except Clive who went into politics instead of simply buying it - we keep getting this distorted view that somehow mining and its support industries are somehow the most important thing in the Australian economy. Hence the twin repeals of Carbon Pricing and Mining Rent Resources Tax can be made to look like important planks of an imaginary tax reform agenda when in fact all it does is absolve the same mining magnates from having to pay tax for their polluting ways and pay less on their excess royalties.

Be that is it may, the whole point of having energy in proximity to other resources for doing things as a benefit, has been shot out of the water. We certainly don't do steel any more, and this is in spite of iron ore being as abundant as coal. We don't do chemicals and chemicals is intensive on gas - and we sell what we have already and it's over-priced. Building materials is the third plank but of course this stuff weighs too much to be shipped around the globe - so as with steel it's not really going to be an export winner.

Therefore it's worth noting this bit:

Even if Australia’s major competitive advantage is cheap energy and, particularly, cheap electricity for domestic use – it ain’t worth much. What does seem to be far more valuable is the exporting of energy to others. 

If Abbott and Macfarlane think we’re going to get rich on the back of being an affordable energy superpower they’re fooling themselves. So time to abandon that narrative.

And that just about sums it up. This illustrates yet another way in which this current government really has no idea what it is doing with industrial policy.

How Risks Layer Up

There was a bit of argy-bargy this week about whether Australia's banking sector is in fact healthy. It's implicitly tied up with whether the big 4 banks are borrowing too much, and further still, whether they are lending out to the wrong areas, feeding a bubble in property (although the worst-treasurer-ever Joe Hockey says it's not a bubble, it's just a shortness of supply). I'm no economist so it's hard to go to charts and demonstrate how the risks are layering up, but I think I can offer up some issues that might make people a little more concerned.

The news this week included reports that house prices are up in Sydney and Melbourne, but the majority of buying was done by investors. First time buyers have declined to historic lows. This suggests - no let's be more blunt - this underlines the fact that the worst-treasuer-ever Joe Hockey is entirely wrong in his statement that it is a shortness of supply. Again, going back to the definition where price inflation is too much money chasing too few assets, it's easier to explain that the ordinary dwelling-buyer has receded to give ground to speculators who are chasing the short supply, pushing up prices. Whether one calls this price inflation a bubble or not is academic next to the rampant speculation going on in the property market.

Amazingly, banks want to be in this market rather than in the business of lending to businesses. So instead of lending to a business that might want to invest in capital and ratchet up production, banks have lined up to lend money to people who are flipping houses. Not only are they doing it as fast as they can, they're doing it as big as they can. It has the net effect of making banks look bigger because they're lending out more money to cover the same few positions. Once again, you see the definition of inflation right there. It's a misallocation of capital.

Here's the thing. If people are using their self-manage super funds to be in property to speculate, that's one thing. But ordinary people have superannuation in funds, which in most part are exposed to equities and indexed, so they too would be exposed to banks. The ordinary folks might even be exposed to REITs who also borrow heavily and put money into property. And every week/month/quarter, the super money keeps going into these funds and gets dispersed and invested, which largely goes to chasing the ever-diminishing pool of assets, pushing up prices even more.

Just for the sake of the argument, even if there isn't a bubble in property, that's a lot of risks lining up onto property. Consider for a moment the mining construction boom is over, manufacturing is beating a retreat under the Abbott government; retail is hurting thanks to competition from on-line merchants,; agriculture is getting bought out by overseas entities in an ever increasing rate; just why should finance and property be so far ahead of the curve when the rest of economy is crawling along? If the whole of Australia is growing at around 3%, wages aren't growing at all, why should property be growing at a 15-18% clip, if not but for a misallocation of capital?

Not only that, what happens when there is a crisis to the banks? A lot of debt positions are going to be wound up and a lot of it is going to happen in the property market first. Not only will property prices be hit, banks will look insecure, the stock market will crash and take people's superannuation with it. The Australian government will probably do everything it can to keep prices inflated, but that's essentially where we are at in Europe and Japan. Nobody wants to take a hit on their major asset, so everybody agrees to socialise the losses and cut welfare.

Do people really think the worst-treasuer-ever Joe Hockey is credible when he says there isn't a property bubble in Australia? Oh, and by the way, we've gone to war now.

Where QE Has Taken Us

The Central Bank Conundrum

In the past week, Mario Draghi put through the policy of negative interest rates. He said the idea was to push savings out and into investment. This has had scribes scribbling around the world as to exactly what it means, but parsing through the writing it appears the most dreaded thing for central banks is asset deflation. It appears that we've hit a point in history where we just can't let asset prices fall because too many things are tied into the prices as they stand, even if they are bubble prices. In other words, the whole Zero Interest - and now Negative Interest policy has been a desperate attempt to keep everything in their leveraged positions.

To this end, central banks around the world have been running what amounts to a price-keeping-operation, partly through printing money, partly through bluff, but also by buying equities. It turns out central banks have bought 29trillion in equities around the globe. 'Abenomics' in Japan has been running a gambit where pension funds have been buying equities at the behest of the government. 29 trillion is a lot of money when you consider the size of the US economy is 17trillion. No wonder investors around the world have looked at prices of shares and said a bust is due. Yet amazingly share prices of blue chips have kept soaring. Well,they would if Central Banks are buying them with printed money.

Now I'm not one of those people that bangs on about the failing of the fiat currency but any way you look at that situation and you have to ask, should equities be a one-way bet? But the Central Banks do this because they need share prices to stay high.

Zero Interest rates have been in place for many countries and the effect of that has been to amplify the carry trade where the US Dollar has surged out to 'emerging economies' in search of yield as well as re-inflate the property bubble in places like California and London. Once again, asset prices are getting supported over just about any other consideration. So much so that a hypothetical interest rate rise of 0.5%would jeopardise US$13trillion worth of derivative products. Again, we're not talking chump change here.

The problems of falling asset prices would be the banks being unable to cover all the positions. Take Deutsche Bank, which has  200trillion dollars worth of exposure to derivatives as an example. If asset prices deflate even a little, there will be massive movements in those derivatives and would easily wipe out Deutsche Bank. And if Deutsche Bank should fail, the fallout form that would be a whole bunch of banks going down with it.

And so we're stuck with Central Banks busily trying to re-inflate asset prices whether they be shares or property or bonds. They're printing money to do it, which means inflation is going on pretty hard out there somewhere. The proper analytical explanation of inflation is going to be too much money chasing around too few things. If you print enough money there are too few things by definition. If the printed money is then used to buy the share market, it seems the inflationary effect will be amplified. Similarly if money is  printed to buy the bad debt derivatives from the subprime loans crisis, there will be too much money chasing around too few proper investment vehicles. What happens i the things that are affected the most are not houses and fancy commodities but things like grain and foodstuff? Doesn't that sort of destroy the purchasing power of people living in the third world? Won't this bring massive social stability around the globe? And still the Central Bankers are trying to re-inflate the asset bubbles.

It's not the speculation that is the problem; it's the process of simultaneously destroying value while preserving prices.

When the GFC came about, there was much discussion about moral hazard and the US TARP bill which was an emergency loan to banks to shore up their bottom lines. We threw precaution to the wind and supported TARP because without it, our banking and our  superannuation accounts would have been shot. Since then banks have received the mos support from Central Banks in order to set their books straight. The bankers even drew up  Basel II and Basel III agreements so that banks could be held to a standard to lessen systemic risk - or so the argument went. And yet the net effect of all this has bee the destruction of the middle class in America (with the possibility looming for Australia yet), with the super-rich getting ever richer. The guy on Main Street got taught a lesson moral hazard at his own expense, after having his life savings taken hostage. The guy on Wall Street simply got a green light to continue doing the stupid things that got all of us into such a sticky strait.

So 6years-going-on-7, I think it's a good time as any to ask just how well all of this is working out. The debt of the world combined sits at 720trillion dollars. The world economy combined is somewhere around 70trillion. We're not easily going to pay off that mountain any time soon. That being the case you wonder how long the whole charade is going to go on. We might have kicked the can down the road nicely back in 2008, but we're running out of road.

Discounting Inflation

One of the more pernicious things that has happened since sometime in the 1970s is that governments have changed the way they measure inflation. The net result of doing so has been to under-measure the real inflation out in the market place and claim inflation has been tamed. Again, this was particularly true in Clintonian America of the 1990s, where they invented some strange practices, which have since been adopted by the rest of the world as a 'standard'. The basket of goods used to measure CPI has changed so much since the 1970s that it really bears no relationship to the figures that have come before. It's been made to look more palatable by adding in luxury goods as well as items imported from overseas instead of items produced in the first world, which of course means we're importing the deflationary pressure from the third world.

Obviously it works out much better for Central Banks and governments if they can turn around and point at lower inflation figures. The problem is that we are printing money in an awful hurry in many parts of the world, and at the same time China is running out of cheap labour which meas there won't be a whole lot more deflationary force to be imported from China, the world's second largest economy. In fact the Australian Financial Review had a headline in the last week saying just that; that the RBA has erred on the side of too low an official interest rate.

This is of course kind of ironic because on the one hand central banks the world over are fighting to have more inflation and no deflation on asset prices. If they simply went back to measuring the CPI the old way, they can probably see just how much inflation there exist sin the current system. Also, by under-measuring inflation, they're setting themselves up for lower interest rates and thus looser monetary policy which of course does lead to more inflation. The longer the low interest rate regime runs, in a sense we're making real a greater inflation without having the means to measure it. We're already way too comfortable with the low interest rates. Even without the discussion on moral hazards, you'd think the central banks have got to figure they have one on their hands.

Moral Hazard Spectacular

Stop(ped) Making Sense

Pleiades wanted me to write a bit about this today. He's sent me a couple of interesting links behind the AFR paywall. I can't link to them a a result but I can offer my opinion on a few things.

You have to hand it to Central Banks. They'll jawbone anything and everything to get the economy to roughly go in a direction. Usually, what the Central Banks want is for asset prices to be stable and go up, while an inflation of about 2-3% eats away at cash so people have to do something with their money apart from shove it under the mattress. You can put them in equities, bonds, commodities, property, but the 2-3% is there to eat away at your pile of cash if you keep it stationary.

Of course, that's why interest rates move the way they do, which is to say whenever the equity markets sag, the Central Banks cut interest rates and every time they hit new highs, they take some points off. We've been watching this game for something like 30years since the RBA went independent of the Federal government, and since the days when Paul Volcker as the head of the US Fed set about taming inflation.

...but what if all this was a crock?

Share markets in the USA are at an all time high, but interest rates are close to zero, and Quantitative Easing is, while being tapered back, still pumping liquidity into the market in exchange of bad debts. You'd have to look at all this and say that the narrative we've been led to believe is broken. It's also been 7years since the GFC broke, 6 since liquidity got pumped into he market, and QE is still continuing. The American markets are talking about a 'Recovery', but the mere fact that interest rates are at zero and QE is still going on should tell you we're nowhere near any kind of recovery.

If there were a 'Recovery', how could there be stories like this?:

Driven by economic necessity — Rohr has been chronically unemployed and her husband lost his job last year — she moved her family back home with her 77-year-old mother.

At a time when the still sluggish economy has sent a flood of jobless young adults back home, older people are quietly moving in with their parents at twice the rate of their younger counterparts.

For seven years through 2012, the number of Californians aged 50 to 64 who live in their parents' homes swelled 67.6% to about 194,000, according to the UCLA Center for Health Policy Research and the Insight Center for Community Economic Development.

The jump is almost exclusively the result of financial hardship caused by the recession rather than for other reasons, such as the need to care for aging parents, said Steven P. Wallace, a UCLA professor of public health who crunched the data.

"The numbers are pretty amazing," Wallace said. "It's an age group that you normally think of as pretty financially stable. They're mid-career. They may be thinking ahead toward retirement. They've got a nest egg going. And then all of a sudden you see this huge push back into their parents' homes."

I'm sort of lost for words when I read that because that's a surefire sign that the economy has not made any kind of credible recovery - but for some miraculous reason US equity prices have punched through the previous highs from prior to the GFC meltdown. What QE has accomplished is to reinflate all the asset bubbles, up to and including the housing bubble in America. If you think this is somehow not true then hey presto, subprime mortgages are back. Maybe these people in California living in their parents' houses can score one of those loans that only need 3% upfront.

The point is, Ben Bernanke said the whole QE thing and TARP thing was to shore up banks so they would keep lending and that liquidity would not dry up and businesses would stay open. What's happened instead is that the money got sent out of America on financial markets to places with high risk and high yields - affectionately known as emerging markets - and has subsequently inflated commodity prices and real estate prices around the globe. More to the point it didn't exactly save jobs.

We're Really Going To Fight For The Grey Zone On The Eastern Front?

This is nuts. The US is sending 600 troops for an exercise in eastern Europe. Airborne troops are allegedly going to Poland, Lithuania, Latvia and Estonia. All of it in response to the crisis in Crimea. There are a few things I am not convinced about America's willingness to follow through and fight a war in Ukraine.

First of all is how willing the NATO allies are, in supporting America. Germany in particular makes me doubt NATO's resolve. Are the Dutch and Spaniards and Belgians and Italians willing to send troops out to Ukraine and shed blood for Ukrainians, even though they're not even a member of NATO or the Euro zone? It seems incredibly unlikely the commitment is there. Germany in particular might still be culturally traumatised by the World War II campaign in Ukraine and the political fall out ever since. Do they want to send troops there? I'd hazard a guess and say no.

Secondly, Europe still relies on Russian gas supplies from the pipeline that runs through Ukraine. They're not in a position to bite the hand that feeds it. And contrary to opinions flying around that America's shale gas boom is big enough to fill in the gap it has two giant hurdles to getting to Europe: the gas has to be liquefied and then shipped across the sea. It's not economically viable to be doing so.

Which brings me to the third conceptual bump in seeing the West fight in the Ukraine against the dark forces of Mordor Putin's Russia is that there's no money in the coffers to sustain this war effort. A lot of the Eurozone and the USA are simply carrying too much debt to finance yet another war (after the squandered expenses of the Iraq misadventure and the mismanaged Afghan misadventure). The Central Banks are tapped out printing money to buy back the crappy subprime debt that needs to get written off. Who are the idiots who are going to line up and buy war bonds to fund this misadventure into the grey zone of history where mighty empires go to die as they dash themselves upon the borders of Russia?

Putin must know all this. So this has to be a bluff. Right? Of course one imagines this is exactly how people felt in the 1930s in the aftermath of the 1929 bust as the world marched to World War II. I can't believe I'm even writing of this on an ANZAC Day weekend. You'd be worried if you're the Baltic states and Poland.