Archive for November, 2007

Debt stress for Australian businesses

Tuesday, November 13th, 2007

In our previous article, Is Australia facing economic crunch time soon?, we said that,

…, Australia?s frightening high levels of debt makes her highly vulnerable to rising interest rates. Already, as we can see from the political election campaigns in Australian, a frequent theme is often being heard: working families are struggling due to price inflation and debt. Already, there are news reports of soaring bad debts among finance firms. At the fringes, we are seeing signs of the Australian economy under stress (see Investors beware! Signs of economy under stress).

As of right now, with a Federal election underway in a couple of weeks time, reports of housing un-affordability, rental crisis, mortgage stress and escalating living costs receive plenty of high profile coverage in the media (for example, see Interest rates push credit defaults skyward). But what is often neglected is the level of financial stress among Australia’s companies. As this news report, Rates, petrol put 10pc of firms at risk of collapse, says,

AS interest rates continue to rise, petrol prices hit records and the credit crunch worsens, almost 10 per cent of Australian companies – including 100 listed entities – face financial distress or insolvency next year.

According to Dun & Bradstreet, a leading receivables management and credit report company, there is a rising trend of Australian businesses under financial distress since 2005. This is happening in the middle of a period of widely perceived economic boom. As the article continued,

Industries most susceptible to insolvency included transport, communications and utilities, with 8.8 per cent of companies in these sectors in the top-risk category. Agriculture, mining [see our article, Can Australia?s mining boom turn into bust?] and construction followed closely at 8.5 per cent, 8.3 per cent and 8.1 per cent respectively.

As the Reserve Bank of Australia (RBA) had forecasted on their recent statement on monetary policy, inflation rates will exceed the 3% target limit in 2008. Therefore, interest rates will be on the way up again. Given the rising trend of financial stress among businesses and rising interest rates (see Interest rate rise in Australia- be prepared for more to come), what do you think this will do to the solvency of many Australian companies, especially the small businesses? If these businesses become insolvent, what do you think will happen to the solvency of their employees who have mortgage debt? If mortgage debts turn bad en masse, what do you think will happen to the value of houses (see Spectre of deflation on how imputed valuation can affect the value of assets)?

Do not underestimate the destructive power of debt!

Can Australia’s mining boom turn into bust?

Saturday, November 10th, 2007

In our earlier article, Rising metals price=rising mining profits? Think again!, we questioned the conventional thinking that the rise of China will always result in rising profits for Australia’s mining companies. If you understand the concept of the Austrian Business Cycle Theory (ABCT), you will be able to understand how booms can lead to bust.

Today, we will look at this news report through the perspective of the ABCT: Investment pours in: $28bn of new projects:

THE investment boom has built up a new head of steam, with 130 new projects worth a total of $28 billion announced in the September quarter.

There are now projects worth $178 billion either under construction or with firm commitments, while investments totalling a further $351 billion are in various planning stages, according to the consulting firm Access Economics.

In Rising metals price=rising mining profits? Think again!, we mentioned the implication of the peak of business cycle on mining profits. Now, we will put forth this question to you again: Does Australia has adequate resources to ensure the completion of all these hundred of billions of dollars worth of mining projects/investments (even factoring the fact that more projects are on the way)?

As you mull through the answer of this question, pay attention to these paragraphs in the above-mentioned news report:

Mr Richardson said that despite the build-up in the construction workforce, projects were taking longer to complete and costing more than budgeted, because of the shortage of resources.

In the September quarter, there was $10.8 billion in projects completed, however cost blow-outs and upgrades raised the budget on projects under way by a further $15.3 billion.

“Everything is slower because everyone is tripping over everyone else. Completion times have fallen away,” he said.

If the answer is no, we will one day see the mass liquidation of a lot of these projects as they become unprofitable. On that day, you will see news headlines screaming about the mining ‘downturn.’

Website down! Again!

Saturday, November 10th, 2007

Yesterday, our website is down again (see Website down for a while on November 2nd)! If you visited Contrarian Investors’ Journal from 4pm onwards on November 9 (Australian Eastern Standard Time), you will see a “500 Internal Server Error.”

The website is down due to the failure of Yahoo!’s Small Business Web Hosting. This is the second serious failure in the space of 1 week and we are highly disturbed by it. The reason why we left our earlier web hosting provider, Bizland, is due to the high levels of failure and lack of reliability. If this becomes a repeated issue with Yahoo!’s Small Business Web Hosting we will not hesitate to leave this web hosting provider.

If our website is down again, please feel free to contact us so that we will know about it. If it is the fault of our web hosting provider again, we will seriously consider switching to a more reliable one.


P.S. Let’s do some math on Yahoo!’s Small Business Web Hosting’s reliability. It went down at 4pm, November 9th. Right now, it is 8:45pm, November 10 and part of their web hosting service is still down (i.e. partially running at this time of writing). The last time their web hosting service went down was exactly 1 week ago. Therefore, in the space of 1 week, their uptime percentage is only 91.07% at the worst case and 95.8% at the confirmed best case (we were manually monitoring Yahoo!’s Small Business Web Hosting’s service level). Given that the industry standard promises 99.99% uptime reliability, this means that Yahoo!’s Small Business Web Hosting’s reliability is, as of right now, around up to 9% worse than industry standard. Yahoo!’s Small Business Web Hosting have to do better than that!

P.P.S. It’s 12:45pm and other parts of the web site is still reporting an “500 Internal Server error” intermittently. It has now been 21 hours since this issue began. That made Yahoo!’s Small Business Web Hosting reliability statistic to be between 87.5% and 95.8%!

New accounting makes it hard to mark-to-model

Thursday, November 8th, 2007

Yesterday, in How solvent are some of the major US financial institutions?, we paraded the solvency skeletons of major US financial institutions. We provocatively asked what will happen if all these assets are marked-to-market?

Well, November 15 is the day of reckoning because a new accounting rule (FASB 157) will take into effect on that day. Basically, that new accounting regulation will make it harder for companies to mark the value of their illiquid assets to model. The most vulnerable will be Morgan Stanley, with their marked-to-model assets worth 251% of their equity capital (assets minus liability), followed by Goldman Sachs (185%).

According to this news report in Bloomberg, this new accounting rule can result in up to $100 billion of write-downs. Nouriel Roubini reckons that $500 billion is “quite reasonable and likely” (see Credit and Financial Markets Losses: $100 billion or $200 billion? Or most likely $500 billion?).

Obviously, write downs of such magnitude are going to spook the market. Be prepared for a rough ride (a crash is definitely a possibility) ahead!

How solvent are some of the major US financial institutions?

Wednesday, November 7th, 2007

Back in Re-pricing of assets- from ?marked? to model to ?marked? to market, we mentioned about the re-pricing of securitised debt instruments from marked-to-model to marked-to-market. Today, we shall compare the equity capital base against the marked-to-model assets of major US financial institutions, courtesy of this blog article from Nouriel Robini, who is one of the respected contrarians:

  1. Citigroup – 105% ($135 billion of marked-to-model assets divided by $128 billion of equity capital base)
  2. Goldman Sachs – 185%
  3. Morgan Stanley – 251%
  4. Bear Stearns – 154%
  5. Lehman Brothers – 159%
  6. Merrill Lynch – 38%

What happens if all these assets are marked-to-market? We shudder to think of the outcome.

Interest rate rise in Australia- be prepared for more to come

Wednesday, November 7th, 2007

It’s 9:30am in Australia and the Reserve Bank of Australia (RBA) has announced a 0.25% rise in interest rates. As we mentioned before back in February at Have we escaped from the dangers of inflation?, this trend of interest rate rise comes as no surprise to us:

… , we are very sure that as all these liquidity work its way to the rest of the real economy, it will only be a matter of time before price inflation will show its ugly head.

How much has Australia’s money supply grown since we begin keeping track of it at Degradation of Australia?s fiat paper money and Increase in Australian M3 in August? In September 2007, the M3 money supply has increased from $897 billion to $910.6 billion, which is an 18.5% increase from September 2006! This means that in monetary terms, every dollar of yours is debased by 18.5% 15.6%.

As the RBA statement says,

… reports of high capacity usage and shortages of suitable labour persist.

If the Australian economy is at full productive capacity (and any increase via investments today will take some time to bear fruit) and money supply growing at 18.5% per annum, what do you think will happen to prices eventually? Furthermore, China is not going to save Australia from price inflation (by keeping prices of manufactured goods down) because they have their own inflation problem to worry about (see China at turning point?).

Will there be more rate rises in Australia?

We would prefer not to give predictions, especially to the timing of central bankers. But given that there are 4 rate rises since August 2006 and the money supply still soared 18.5% in the year to September 2007, what do you think is the answer? This means that given Australia’s appetite for money and credit, the monetary ‘tightening’ of the RBA over the year is nothing but a farce (see What makes monetary policy ?loose? or ?tight??)- debt levels are still soaring and has yet to be curbed. Therefore, we believe this minuscule rate rise alone will have little effect in curbing the profligate ways of Australians.

Is there anything that will stop the RBA from raising interest rates further?

Yes! If the global credit crisis sweeps its way into Australia and tip her into a vicious cycle of debt deflation, then the RBA will do what central banks are meant to do- see Inflation or deflation first?:

Now, faced with the threat of a deflationary recession, what can the Fed do? Politically, it is impossible for them to allow a recession run its full course in order to clean up the prior excesses of the bubble. They will do anything and everything to ?prevent? another recession. The only way for them to do that is to do what they always did?pump even more liquidity into the economy (a.k.a ?print? money).

No one would want the RBA to stop raising interest rates for this reason.

Gisele Bundchen (currently the world’s highest paid supermodel) refuses payment in US dollar

Tuesday, November 6th, 2007

In What should be your fundamental reason for accumulating gold?, we mentioned that:

As we said before, money is fiat if it enjoys legal tender status through the authority of the government instead of through the choice of the free market. This means that fiat money is not backed by anything physically tangible?it derives its value from an elusive intangible called ?confidence.? Simply put, fiat money is backed by nothing!

Today, all currencies (including the US dollar) in the world are fiat. Today, we found this report in Bloomberg:

Gisele Bundchen wants to remain the world’s richest model and is insisting that she be paid in almost any currency but the U.S. dollar.

A fiat currency becomes worthless the moment its elusive intangible quality called ?confidence? is lost. As far as Gisele Bundchen is concerned, she has lost confidence in the US dollar.

This we agree with her. But we see that she has negated this wise decision with a foolish decision?she insisted in being paid in Euros. As we said before in How does the US export inflation?,

That is why when the US opens up their spigot of US dollars and engages in a global spending spree, foreign countries have to follow suit by inflating their own money supply so that their currencies will not be overly expensive relative to the US dollar. The result is worldwide synchronised price inflation and asset bubbles.

The reason for not trusting in the US dollar is also the same reason for not trusting in Euros, Yuan or Australian dollar (see Degradation of Australia?s fiat paper money).

If we were Gisele Bundchen, we would insist on being paid in gold.


How much can we trust the price indices (e.g. CPI)?

Monday, November 5th, 2007

The measurement of the general price level is a very important statistical measurement in economics. Statisticians have reduced all the various prices of various goods and services in the economy into an index number (e.g. CPI). This number in turn is used by central bankers to determine the level of price inflation, which in turn influences monetary policy. This in turn has a great effect on the economy. This number is also used in various economic calculations, from the amount of money in a pension cheque to determining real economic growth.

But this idea of price index is flawed and is easily subject to manipulations. You can be sure that if manipulations can be done, then it will be done to satisfy some other vested interests.

First, the definition of inflation by mainstream economists’ is flawed. As we said before in Cause of inflation: Shanghai bubble case study,

The mainstream economists? definition of inflation is rise in the general level of prices. However, according to the Austrian School of economic thought, the definition of inflation is the increase in the supply of money [and credit], in which the effect is the rise in the general level of prices. For the sake of discussion, let us call the mainstream definition as ?price inflation? and the Austrian School?s definition as ?monetary inflation.?

In other words, the Austrian School‘s definition of inflation implies the debasement of fiat money, which is a monetary phenomena (unlike the mainstream economics’ view of inflation being either cost-pushed or demand-pulled).

Now, if the mainstream economics’ definition of inflation is flawed, then the whole idea of the price index is flawed too. Therefore, no matter how much ?enhancement? that statisticians and economists can think of to improve the ?accuracy? of the price index, it is an exercise of futility. As Ludwig Von Mises wrote in Section 4, Chapter 12 (Stabilization) of Human Action: A Treatise on Economics,

The pretentious solemnity which statisticians and statistical bureaus display in computing indexes of purchasing power and cost of living is out of place. These index numbers are at best rather crude and inaccurate illustrations of changes which have occurred. In periods of slow alterations in the relation between the supply of and the demand for money they do not convey any information at all. In periods of inflation and consequently of sharp price changes they provide a rough image of events which every individual experiences in his daily life. A judicious housewife knows much more about price changes as far as they affect her own household than the statistical averages can tell. She has little use for computations disregarding changes both in quality and in the amount of goods which she is able or permitted to buy at the prices entering into the computation. If she ?measures? the changes for her personal appreciation by taking the prices of only two or three commodities as a yardstick, she is no less ?scientific? and no more arbitrary than the sophisticated mathematicians in choosing their methods for the manipulation of the data of the market.

So, what is Ludwig Von Mises’s objections to the price index? At the root of the problem, as Mises said,

All methods suggested for a measurement of the changes in the monetary unit?s purchasing power are more or less unwittingly founded on the illusory image of an eternal and immutable being who determines by the application of an immutable standard the quantity of satisfaction which a unit of money conveys to him.

So, for example, if the CPI (or whatever price index) rises by 4%, does it mean that the value of every dollar has fallen by 3.8% for each and every individual in the economy? This is what the idea of price indices implies. But in reality, every individual has his or her own preferences, desires and values that will result in subjective changes to each dollar’s purchasing power due to inflation.

Therefore, what is the implication of this? As Mises said,

People began to devise methods for working up complexes of commodity units to be contrasted to the monetary unit. Eagerness to find indexes for the measurement of purchasing power silenced all scruples. Both the doubtfulness and the incomparability of the price records employed and the arbitrary character of the procedures used for the computation of averages were disregarded.

So, what are our reservations on the validity of price indices?

  1. Price indices cannot account for the differences in quality of goods and services. In the US, attempts have been made to adjust prices according to the ?changes? in the quality of goods and services. For example, if a 1 Ghz computer costs $1000 this year and a 2 Ghz computer costs $1000 next year, the price of the computer can be said to have fallen (i.e. the price level of computers have fallen). But the problem is, who is the judge and arbiter in deciding how to adjust the price according to changes in quality? Remember, the perception of quality is subjective. A person using a computer mainly for emailing and word-processing will much less appreciate the increase in clock-speed of a computer (from 1 Ghz to 2 Ghz) than a person who uses it for high-powered video editing.
  2. Is there such a thing as the average prices of disparate and distinct goods and services? As the late Professor Murray Rothbard wrote in Man, Economy, and State

    Thus, any concept of average price level involves adding or multiplying quantities of completely different units of goods, such as butter, hats, sugar, etc., and is therefore meaningless and illegitimate. Even pounds of sugar and pounds of butter cannot be added together, because they are two different goods and their valuation is completely different

  3. What is the standard used in deciding the various weightings in a price index? Here, Mises wrote,

    As it is impossible to establish the total amount of money spent at a given fraction of time for consumers? goods, statisticians must rely upon the prices paid for individual commodities. This raises two further problems for which there is no apodictic solution. It becomes necessary to attach to the various commodities coefficients of importance. It would be manifestly wrong to let the prices of various commodities enter into the computation without taking into account the different roles they play in the total system of the individuals? households. But the establishment of such proper weighting is again arbitrary.

  4. Who is the judge and arbiter in deciding how to calculate the price index? Here, Mises continues,

    Secondly, it becomes necessary to compute averages out of the data collected and adjusted. But there exist different methods for the computation of averages. There are the arithmetic, the geometric, the harmonic averages, there is the quasi-average known as the median. Each of them leads to different results. None of them can be recognized as the unique way to attain a logically unassailable answer. The decision in favor of one of these methods of computation is arbitrary.

  5. What is the basis of deciding what is to be included into the basket of goods and services used in the calculation of the price index? Again, this is subjective and arbitrary. The exclusion and inclusion of various goods and services can affect the outcome of the calculation.
    • For example, central bankers see the difference between ?headline? and ?core? (or ?underlying? in Australia) inflations. The latter, which excludes the more volatile food and fuel prices, affects monetary policy. But in reality, which human being in this world does not consume food and fuel? Furthermore, the changes in the prices of goods and services do not occur independently and in isolation from changes in prices of fuel. As we all know, oil is an crucial ingredient of the modern economy. Any change in the price of oil will affect the prices of everything else to different extent and different time lags. Therefore, the concept of ?core? inflation is flawed.
    • Another example: As we said before in Epic, unprecedented inflation, the world is experiencing unprecedented asset price inflation. In Australia, it is the housing price bubble (see The Bubble Economy). Since the Reserve Bank of Australia (RBA) does not have the mandate to prick asset price bubbles, then can we give them such a mandate by merely redefining houses as consumer durable goods and include them in the basket of goods in the price index calculation?
  6. Changes in purchasing power of money affect goods and services differently and to different extent. Here, Mises continues,

    As will be shown later, changes in the purchasing power of money must necessarily affect the prices of different commodities and services at different times and to different extents; they must consequently bring about changes in demand and supply, in production and consumption. The idea implied in the inappropriate term level of prices, as if ?other things being equal?all prices could rise or drop evenly, is untenable. Other things cannot remain equal if the purchasing power of money changes.

    Let’s say the CPI index increases by by 4% but the price of rent increases by 6%, does it imply that something unethical or unjustified has happened to the price of rent?

  7. Changes in the methods of price indices calcuation invalidate economic calculation. If you use the 1970s’ method of calculating CPI and apply it today, you will get a far higher readings of price inflation. The excuse is that today’s method of calculation is far more ?accurate? than in the past. But that would also mean that comparisons of real economic growth between time periods have become invalid. That in turn will derange economic calculations unless there is a way to reapply comprehensively and accurately past price data using today’s method.

Therefore, beware of price indices! It is not as ?scientific? as you think!

Result of Chinese price controls

Friday, November 2nd, 2007

In Counter-productive way of dealing with inflation?price control, we mentioned the foolishness of the Chinese authorities in trying to control price inflation with price controls:

How can you possible control price inflation by imposing price controls when you are, at the same time, printing money like there?s no tomorrow? We believe such folly will end up doing more harm than good.

Today, we found this news report, China raises fuel prices by 10%:

China has raised fuel prices by almost 10% in an effort to ease the country’s worsening supply crisis.

Officials hope the extra revenue will make refiners increase production, easing the long queues and rationing at filling stations.

The rise is a reversal of policy. In September the government promised to keep fuel prices at current levels.

Oil prices have been sky rocketing, but Chinese refiners cannot pass those rises on to consumers and so they are losing money.

Many have already cut their supplies to limit losses.

Website down for a while

Friday, November 2nd, 2007

We are sorry that our site had been down for a few hours. It turns out that our web hosting provider had bungled. The problem is now rectified.