Archive for January, 2009

What will be the impact of government interventions on investing?

Thursday, January 29th, 2009

In our previous article (Are government interventions the first steps towards corruption & inefficiencies?), one of our readers asked,

… I have been wondering what the impact on government interventions will be for investing… What if one was to invest in Blue Chips, with the idea that they are ?too big to fail? (gov. intervention likely) and are therefore very safe?

He had brought a very good point.

Let’s say you have very strong reservations regarding investing in Australian banks (see How safe are Australian banks?). Based on your own assessment of the fundamentals, you make the decision not to invest in banks (if you are a trader, you may decide to short the banks). But then, you receive some tips from banking ‘insiders’ that the recent flight out of bank stocks is a fantastic buying opportunity. You are told that bank shares are so cheap that you will make a lot of money in a few years time if you buy them today. Naturally, you laughed at those ‘insiders.’

But they were right.

A few years later, they end up laughing at you instead. Let’s suppose that your fundamental analyses of the banks are correct. So, what went wrong?

Government intervention.

As we said before in Are government interventions the first steps towards corruption & inefficiencies?,

They [bailouts and rescues] are inherently unfair because the government will have to act as the judge and decide which businesses/industries should live and which ones should die. Unfairness, by its very nature, implies preferential treatment. What is the government?s basis for favouring one business/industry over the other?

So, in your case, the government bailed out the banks (which is happening right now in the US and UK) in such a way that shareholders are protected. If you are a trader, shorting the banks will lead to heavy losses.

From this example, you can see that when government intervenes, the market is no longer completely free. When the market is no longer completely free, it means that the rules change abruptly in the middle of the game. When that happens, those who ought to lose become winners and vice versa. Incompetency is rewarded and competency is punished (indirectly through taxes).

Imagine, what will happen if there’s a soccer match whereby the umpire is allowed to change the rules abruptly any time he wants? In such a world, it’s either that bribery will abound or no one wants to play the game. The same goes for the economy. A half-free market will discourage the capitalists and entrepreneurs and encourage cronyism, corruption and speculation.

That’s one of the reason why in such an environment, the Warren Buffett way is dead. That’s why Marc Faber said this is a traders’ market. It’s possible that we will see Warren Buffet’s long-term track record flounder in the years ahead.

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Posted in Looking Forward | 8 Comments »

Are government interventions the first steps towards corruption & inefficiencies?

Tuesday, January 27th, 2009

The global financial crisis (GFC) has seen governments all over the world engaging in stimulus, special plans, guarantees, rescues, bailouts, nationalisation and other forms of interventions. The Australian government is no different. The first was the guarantee of all Australian bank deposits and loans. Next was the AU$10 billion economic stimulus. Then recently, there was a plan to set up a special purpose fund to help banks refinance as much as AU$75 billion worth of loans. Other plans include help for certain industries (e.g. car, construction, child-care, property sectors) cope with the global shortage of money (credit crisis). In addition, the Reserve Bank of Australia (RBA) is busy cutting interest rates. In the US and Britain, massive banks and GSEs were gobbled up through nationalisations while their limping peers have their incompetence covered by the monetary printing press. As Australia approaches a hard landing (see Realisation of hard landing ahead for Australia), we can expect what happened overseas to happen in Australia.

Among the various forms of government interventions, we have the strongest reservations against bailouts and rescues. While they ease the pain in the short term, they are detrimental to the economy in the long term. While the sting of this GFC may be soothed by each government intervention, there will always be longer term side-effects, many of which will be unintended and initially unforeseen. All these unintended side-effects will eventually accumulate and turn the GFC into a long-term economic malaise that result in a bleak future for the next generation. In other words, anyone who is concerned for the next generation will have strong reservations for today’s bailouts and rescues.

Here are some of the issues with bailouts and rescues:

Unfairness

They are inherently unfair because the government will have to act as the judge and decide which businesses/industries should live and which ones should die. Unfairness, by its very nature, implies preferential treatment. What is the government’s basis for favouring one business/industry over the other? Due to the ’emergency’ nature of bailouts and rescues, transparency over such government decisions will be in short supply. This will open the door for corruption as lobby groups and vested interests jostle and fight over the government’s preferential treatment. This is not to say that the current government is corrupt. Instead, our concern is that this will open the door for future governments to be corrupt.

Moral hazards

Bailouts and rescues introduce moral hazards because by not letting the free market punish incompetent, reckless and stupid business behaviours, they are making conditions ripe for more of such nonsense to continue. After all, why bother be good when bad behaviours are not punished?

The whole point of free market capitalism is to let the incompetent businesses be eliminated so that the competent ones can take over the incompetent ones and be rewarded. This competition forces the survival of the fittest and most efficient. By bailing out and rescuing, the government is taking precious economic resources (which is scarce in such a time) from the competent (via taxes) and awarding them to the incompetent. The net result is that the economy as a whole will become more and more inefficient. This is precisely the reason why communism ultimately fails.

Now, there are talks of the need for more government regulations to curb such nonsense in order to prevent future financial crisis. The idea is to bailout and rescue first, then come up with more rules and regulations to ‘prevent’ another global financial hazard from happening again.

The problems with rules and regulations are:

  1. Administering, monitoring and enforcing them are costly. They are a drag on economic growth as they introduce more red tape for businesses to handle.
  2. Rules and regulations may be so effective that while they prevent the bad things from happening, they cab also stifle the good things from bearing fruit too. Those entrepreneurs with brilliant ideas who have to battle government red tape to get their projects moving another step forward can relate to that.
  3. As we said before in Where do we go from here? A journalist?s questions…,

    … at the root of this Global Financial Crisis (GFC) lies the moral failure of humanity. Through this moral failure, the world is allowed to get carried away and believe in what it wants to believe.

    Rules and regulations can only work up to a certain extent because beyond that, it is impossible to legislate morality.

  4. No matter how tight and comprehensive rules and regulations are, there will always be loopholes and gaps to allow circumvention. For example, as Satyajit Das revealed in his book Traders, Guns & Money, derivatives routinely make a mockery out of laws. It has come to a point that poking holes at the legal system via derivatives has become a sport!

As we quoted Jimmy Rogers in Jimmy Rogers: ?Abolish the Fed?,

More regulations? You want Alan Greenspan and Ben Bernanke? These are the guys who got us into this situation. They are supposed to be regulating the banking system for the past 50 years. These are the guys who let it all happen. I don?t want more regulations. Let the market regulate it. If xyz needs to go bankrupt, let them go bankrupt. I promise you, that will send a very straight signal and you will have a lot of self-regulation when these guys start to go bankrupt.

If the Federal Reserve did not bail out LTCM in 1998 and let it go bankrupt instead, it would have sent a very strong signal to the market back then.

****************

One day, the GFC will end. But this generation will leave a legacy of corruption and inefficiency for the next if today’s governments continue to intervene in such an unprecedented scale.

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Posted in Looking Forward, Market Observations | 11 Comments »

Realisation of hard landing ahead for Australia

Sunday, January 25th, 2009

History will look at this week as the turning point in the Australian public’s perception of what is to come for the economy. Before this week, the mainstream assumed that Australia was on track to a soft landing (see Soft landing hope built on faulty framework assumptions). But with the release of much worse than anticipated economic data from China, that perception was changed. Prime Minister Kevin Rudd said that (see After 17 years on the way up, a rush back down)

China has been hit much harder than forecasters had predicted, its slowdown will affect Australia.

Last Friday’s The great stall of China in the Sydney Morning Herald (SMH) made it to the screaming front page headline.

Our readers should not be surprised at this news. 12 months ago, we already warned (based on deductive reasoning) that China was facing a major economic correction in Can China really ?de-couple? from a US recession?,

We may be wrong, but our theory is that this may be an epic boom waiting to be a bust. Note: we are not making a prediction here- we are merely expressing our scepticism on the de-coupling theory.

In reaction to this bad news from China, Treasurer Wayne Swan promised bold action from the government. The Prime Minister warned that the tests for Australians are yet to come. On another issue, the government also announced that they will organise a fund to help businesses roll over AU$75 billion of loans should foreign banks pull out of Australia. Again, we had covered that issue in November last year at Effects of retreating foreign banks in Australia.

You can see that the rhetoric from government are shifting from (1) denial to (2) underplaying the gravity of the situation to finally, (3) warning of hard times ahead. Denial, for whatever reasons, is the typical reactions of governments. In China, the government denied the truth to save face. In South Korea, the government even went as far as arresting a blogger whose forecasts of doom were disturbingly accurate. In the US, Ben Bernanke was forced to confess that he was completely wrong on his assessment of the US economy. The captains of the finance industry (including their armies of economists, analysts and forecasters) were deep in their denials too (e.g. see Aussie household debt not as bad as it seems?).

So, our dear readers, how can we trust ‘them?’

Is it too late to avoid a hard landing? We’re afraid the answer is a categorical “No!” As we said in Aussie household debt not as bad as it seems?,

A severe downturn to the Australian economy may or may not be statistically likely, but given the level of unprecedented leverage, you can be sure the impact will not be small. Be sure to understand the concept of Black Swans (see Failure to understand Black Swan leads to fallacious thinking).

The question is, how long and severe that hard landing will be. Our view is that since this hard landing is unavoidably long and severe, the best thing the government can do is to do nothing and let the bottom of the economic cycle come as soon as possible, clearing out the years of mal-investments and structural damage. Any intervention will drag out the pain for longer and postpone the day of sustainable recovery.

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Posted in Market Observations | 12 Comments »

Where do we go from here? A journalist’s questions…

Wednesday, January 21st, 2009

We were asked for comments by a journalist. Here are the questions and our answers…

Is this the intellectual failure of mainstream economics, as some have argued?

We believe that at the root of this Global Financial Crisis (GFC) lies the moral failure of humanity. Through this moral failure, the world is allowed to get carried away and believe in what it wants to believe. Mainstream economics provide the intellectual framework for this belief. Strip away this faulty intellectual framework and one will be able to see clearly how humanity is magnificently capable of self-deception. As we wrote in Is this the beginning of the loss of confidence in fiat money?,

Is this crisis a surprise? If you listen to the mainstream economic schools of thought, central bankers, mainstream financial media, captains of the financial industry and so on, it looked as if this looming financial disaster is something that no one can see coming. The common underlying excuse (that was un-said, un-written but implied) goes something like this: ?No one could ever foresee this! It?s impossible! Only hindsight can tell!?

Now, we would like to make it clear that this is completely false. Please note that we are not accusing individuals of lying. Instead, our point is that this excuse is a sign of collective mass delusion. If you look at the 6000 years worth of the history of human civilisation, you will find that humanity is repeatedly capable of mass delusions.

Has the global financial crisis brought to a head a growing dissatisfaction with the corruption of money, as is also being argued in some quarters?

Let recall a story as mentioned in Understanding the big picture in the inflation-deflation debate,

In one of the movies about Marco Polo, it showed a scene whereby Marco Polo was astonished to see his Chinese slave exchanging goods for pieces of paper:

He ask, ?What are you doing??!!!??

His slave replied, ?I am buying something.?

?But money is gold and silver! How can a piece of paper be money?!?!?

If you lived back then, it was obvious why money should not be pieces of paper backed by nothing. Firstly, such money is vulnerable to forgery. Secondly, it can be re-produced at almost no cost. Thirdly, as we said before in Recipe for hyperinflation, the integrity of such money depends on the integrity of the authority that issues it.

Today, the world runs on a fiat monetary system in which money enjoys legal tender status through the authority of the government instead of through the choice of the free market. In today’s credit system, money has become intangible, imaginary and hard to define, to the point that its supply (‘quantity’) can be inflated and deflated from thin air by central banks and the financial system. Currently, the global financial system (private sector), through debt defaults, de-leveraging and so on, is contracting the quantity of ‘money’ (deflation) while governments and central bankers are trying to do the opposite (inflation). The result of such government intervention is extreme volatility in prices. Once this happen, money can no longer function as a yardstick for unit of accounting and store of value. For example, take a look at oil prices from July 2008 till today. Such extreme volatility cannot be simply explained with traditional economic model of supply and demand, which assumes that the integrity of ‘money’ trusted. Once this integrity is broken, prices can no longer convey vital information to the free market. Without this information, the free market breaks down and no long-term planning can be performed (see Real economy suffers while financial markets stuff around with prices).

As long as governments keep on intervening, the situation will get worse and the dissatisfaction will grow.

Will things ultimately stay in the same after some adjusting, or will  the global economy (and the Australian economy) look dramatically different in 12 (24) months time?

We doubt the status quo can be maintained. The genie is already out of the bottle. In due time, we believe the global economy will be very different. The only thing we are not sure is the time-frame. Today’s GFC is the accumulation of decades of unsound monetary system, starting from the severing of the final link between the US dollar and gold in 1971. That breakdown was accelerated after 2001, with Alan Greenspan’s unsound monetary policy.

If it?s true that laissez faire capitalism was given its head to a dangerous degree, what needs to be done now – and can we trust governments and central banking systems to get it right?

Firstly, the laissez faire capitalism was not really laissez fair in the first place. As we explained in What cause booms and busts? Introduction to the Austrian Business Cycle Theory,

If we generally let market forces set the price of things (e.g. stocks, consumer goods, bonds, real estates, etc), then why is it that the price of money (interest rates) should not be chosen by the market? Does the central bank know better than the market to set the ?right? price of money?

We have a centralised command economy (for the price of money) in the midst of a laissez faire free market. True laissez faire will not give so much power to one man (Alan Greenspan) to mismanage. The worst thing we can do is to give more power to the government. Alan Greenspan set the price of money to be too cheap for too long. Credit became too cheap and too easy to get. Obviously, supply more cheap credit is the wrong medicine. The GFC is a correction to what had been distorted for too long. Government interventions to prevent this distortion will prolong the agony and cause other unintended side-effects.

How do you regulate better?

Today, there is one country totally unaffected by the GFC. That country has the most stringent regulation in the world. That country is North Korea.

How does bailing out banks and businesses make sense?

In a free market, the incompetent businesses will go bankcrupt and cede control to the competent. By bailing out businesses and banks, the government is giving an unfair advantage to the incompetent. This introduces moral hazard by rewarding incompetency. As we all know the rest of the story, communism became a failed experiment.

What happens when the bailout money runs out?

Remember, the world is running on a fiat monetary system. ‘Money’ will not run out as long as governments are willing to do whatever it takes to destroy its integrity. Already, Bernanke and company have already thought of what it means by “whatever it takes” (see Bernankeism and hyper-inflation). He once said this,

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning.

…

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

And what happens to those in the finance world who have done nothing but take risks and do the deals that make the money…how will they cope?

As we questioned before in The myth of financial asset ?investments? as savings,

Can the printing of money, which spawns the growth of an industry to shuffle it, cause a nation to be richer in the long run?

Real prosperity lies in real capital formation and the accumulation of capital goods. Shuffling of ‘money’ is not the path to long-term sustainable wealth. The GFC clearly shows it. It’s time the world gets back to the honest basics.

Who?s MAKING money now (apart from those running insolvency practices)?

There will be bound to be some smart (or lucky) short-term traders who profit from all these volatility. But look at the big picture, no one benefits in a depression- everyone’s standard of living will decline. In such a day, ‘money’ becomes meaningless.

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Posted in Economics/Finance, Looking Forward, Market Observations | 4 Comments »

Baltic Dry Index indicates a collapse in global trade

Tuesday, January 20th, 2009

Today, we will introduce to you a new economic indicator- the Baltic Dry Index (BDI). According to the Wikipedia, the BDI is a

… number issued daily by the London-based Baltic Exchange. The index provides “an assessment of the price of moving the major raw materials by sea. Taking in 26 shipping routes measured on a timecharter and voyage basis, the index covers Handymax, Panamax, and Capesize dry bulk carriers carrying a range of commodities including coal, iron ore and grain.”

The BDI is a price index. As we all know, prices are determined by the supply and demand for shipping. The supply of shipping is fixed and not easily susceptible to price change (i.e. inelastic in economics jargon) because

… it takes two years to build a new ship, and ships are too expensive to take out of circulation the way airlines park unneeded jets in the California desert.

Therefore, prices of shipping are mainly affected by its demand in the short term. So, what happened to the BDI over the past several months? Take a look at this graph:

Baltic Dry Index chart


As you can see, in May 2008, the BDI fell from a record high of 11,793 to a low of 663 since 1986. It has been said that such low reading means that shipping costs is very close to the “combined operating costs of vessels, fuel and crew.”

As the Wikipedia article explained,

Because dry bulk primarily consists of materials that function as raw material inputs to the production of intermediate or finished goods, such as concrete, electricity, steel, and food, the index is also seen as an efficient economic indicator of future economic growth and production. The BDI is termed a leading economic indicator because it predicts future economic activity.

The BDI is a leading economic indicator in the sense that changes to it will occur prior to what will happen in the global real economy. Therefore, any recovery in the global economy should not precede a recovery in the BDI.

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Posted in Economics/Finance, Market Observations | 2 Comments »

Photos of Shanghai

Sunday, January 18th, 2009

If you are on Facebook, you may want to join our Facebook community here. It is a great place to interact, communicate, network, discuss and befriend other readers. Recently, we have uploaded several photos of some of our recent visit to Shanghai in that Facebook group.

What do you think of Shanghai?

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Will China succeed in navigating its way out of the Global Financial Crisis (GFC)?

Thursday, January 15th, 2009

In our previous article, Global Financial Crisis (GFC) is real in China, we mentioned an interesting conversation with a retiree in China regarding his opinion on whether China can succeed in navigating its way out of the GFC. He believes that this local Chinese perspective on that matter is not well appreciated and understood by those outside China.

Firstly, we will introduce some background understanding. With the Chinese export industry declining significantly, its economy is facing a major crisis. Therefore, it is generally accepted that the way forward for the Chinese economy will be for it to develop its own internal consumption demand instead of relying on the over-indebted US consumers.

Here comes one problem.

The majority of the Chinese are still very poor (we add that the vast majority is poor when measured in terms of Australian dollar purchasing power). For example, we were told that some families in the nearby Anhui province are so poor that each member of the family takes turn to wear a trouser. As we mentioned before in Two faces of the China growth story,

Then there?s the other face of ?China?- the backwater rural regions. They have yet to experience much of the benefits of the prior economic growth. These rural regions still form the majority of China?s population. In other words, the majority of Chinese has yet to fully benefit from the two decades of economic boom.

How can China ramp up its own internal consumption when there are still vast numbers of poor among themselves? For these people to consume, the government has to at least somehow put cash on their hands.

Then, even if the government succeed in doing so, there’s another problem. Unlike all of us here who live in the Lucky Country, there’s hardly any safety net (e.g. Medicare, unemployment benefits, etc) in life for these people. Even in the major cities like Shanghai, their ‘medicare’ still has a lot more to be desired. Put it simply, if you are poor in China, you cannot afford to be sick.

As a result, unlike the perennially spendthrift Americans (and British, Australians, etc), the average Chinese tend to save as much as they can, just in case the proverbial rainy day comes. Given the recent history of wars, civil wars, revolutions, invasions, civil unrests, hare-brained programs and natural disasters of the past couple of centuries, this prepare-for-rainy-day idea is probably deep in the psyche of many Chinese. That explains the high savings rate of China. Therefore, stuffing cash into the pockets of the poor rural Chinese will not be enough to persuade them to spend and consume.

Then, even if the government overcome these two problems, there’s a third one- corruption. There’s where it gets interesting.

That retiree told us that in the area where he lives, the district chief was caught for corruption. That district is a very low-level one, which we understood to be equivalent to the level of a village. The amount of money involved was in the amount of around 100 million yuan, which is around AU$20 million.

Guess how did that chief hide his dirty money? The accounts clearly showed that he stole the money. But that money could never be found. Then one day, someone noticed that the floor in his house was suspiciously high. It turned out that this corrupt chief hid the money as thick sealed stacks of physical cash underneath the floorboards!

Now, here comes a crucial question: If corruption in such tiny low-level district involves so much money (100 million yuan), then how much corrupt money is still floating around in the entire country? This is a very critical question because the effects of any Chinese economic stimulus will be dampened by corruption. As stimulus money flows down from the central government to the provinces, counties and districts, corruption will siphon it away. How much will be left for the poor masses? If corruption at just the district level involves $100 million yuan, how much more is involved at the higher levels?

That retiree told us that this is the perspective of China not well understood by foreigners. He also added that the future prospect of the Chinese economy will depend on the outcome of 2009. If signs of recovery can be seen in 2009, then there’s hope.

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Posted in Looking Forward, Market Observations | 14 Comments »

Global Financial Crisis (GFC) is real in China

Tuesday, January 13th, 2009

In our previous article, Visit to Shanghai- observations, we promised to reveal more about the insights on the Chinese economy from the conversations we have with the locals in Shanghai.

In all the meaningful conversations we had with the locals, we were asked whether Australia is affected by the Global Financial Crisis (GFC). Those people whom we talked to are just normal everyday folks across different walks of life. Chinese President, Hu Jintao, in his new year speech, mentioned about the challenge China faces with the GFC. The local newspaper talked about the Great Depression of the 1930s. Indeed, there are real concerns about the GFC among the Chinese people.

There are anecdotal evidences that the GFC is hitting the real economy in China. We learnt that freshly graduated university graduates in China are having trouble finding jobs. Although the government is encouraging them to start business enterprises, we doubt many can make it through successfully without any experience. One career woman even had to put her ambitious career plans on hold due to the GFC. Another expressed her opinion that this GFC is not one that can be over in just a few years- i.e. it is so serious that it can drag on for much longer than that.

Although the GFC is hitting the Chinese economy hard, we could feel from the streets that economic activity was still much ‘hotter’ than Australia. The reason is because of the sheer size of the population in China. We were told that the number of registered residents of Shanghai is 17 million. We guess if you include the unregistered residents, the population of Shanghai could easily exceed 20 million. Imagine cramming the entire population of Australia into one city! Thus, the colossal size of the population in China means that there will always be colossal amount of economic activity relative to tiny countries like Australia. On the flip, this means that any problems will be colossal as well.

The most interesting conversation we had was with a retiree. The question was, will China succeed in navigating its way out of this economic crisis? That retiree had his own opinion which he reckoned many foreigners have yet to fully appreciate. This insight will require another piece of article. So, keep in tune for the next one!

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Visit to Shanghai- observations

Sunday, January 11th, 2009

Over the past couple of weeks, some of us visited Shanghai, China. Shanghai is a vibrant, rich and cosmopolitan city. People, especially the young, generally dress well.

In comparison to Australian roads, the roads over there were chaotic and dangerous. Cars, motor-bikes, scooters, bicycles, trucks, buses and pedestrians crisscrossed haphazardly among each other. Drivers tooted their car horns indiscriminately and continuously. We wondered, if the car horns were so arbitrarily misused and drivers get used to such noises, then wouldn?t its original purpose (warning of danger) be nullified? More alarmingly to us, pedestrians in China have to give way to cars. Danger lurks when you cross the roads even when the pedestrian traffic lights shows green. We encountered a few near misses already. The other few foreigners whom we observed seemed more nonchalant than us on such dangerous living.

As foreigners from Australia, we were not accustomed to the dirty and dusty air in Shanghai. There?s always a haze in the air. A newly cleaned window pane will collect dust within a day. Apartment blocks built a couple of years ago look ?old? and dirty today. A layer of dust seemed to cover every vehicle. We wondered, if you stay in such an environment over an extended period of time, how much dust will accumulate in your lungs?

We tried to seek refuge from the unhealthy and dirty air inside air-conditioned restaurants, cafes, shops, banks and other buildings. But we were totally disappointed. There were almost always smokers (who were usually males) lighting up indoors. We wondered, is it healthier to breathe dusty car-exhaust-filled air or second-hand cigarette smoke? What a tough choice! Maybe we should follow the example of a few cyclists, motor-cyclists and pedestrians wearing surgical masks outdoors. It seemed to us that smoking is the bad habit of the Chinese in the way drinking is for young Australians. Perhaps fighting lung cancer will be good businesses to invest in the decades to come?

On the plus side, the transport infrastructure is very efficient in Shanghai. Taxis are plentiful and cheap (in Australian dollars), buses run frequently and the trains (metro) arrive every few minutes. Shops, restaurants, convenience stores, services and department stores are everywhere. It is very convenient to get anything anytime. Compared to Sydney, Shanghai is bustling with activity. In Australian dollars, food, clothing and transport are cheap. But electronics and branded luxury goods can be more expensive. But relative to their local income, we can imagine Shanghai to be a very expensive city to live in. If housing is unaffordable in Australia, it is more so in Shanghai. But on the other hand, the cost of labour is much cheaper in China.

Compared to Australia, we feel that Shanghai (and perhaps, by extension, the rest of China?s major cities) to be more ?capitalistic.? If you feel that there?s no such thing as a free lunch in Australia, then you can include breakfast, dinner, tea and supper in Shanghai. It is much easier to bleed your savings over there. Businesses are more adept at profiting at your expense. Conversely, for those of you who are business-oriented, this is an opportunity, although it is likely that you will find greater challenge in ethics over there?also, watch out for predators.

Tomorrow, we will talk more the Chinese economy from the interesting insights we learnt from conversations with the locals and the observations we made. Keep in tune!

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Soft landing hope built on faulty framework assumptions

Sunday, January 4th, 2009

Looking forward, what will happen to Australia’s economy in 2009? Currently, the mainstream economic forecast is for a soft landing. As Shane Oliver was quoted in this article,

But with the economy on track for a mild recession…

Shane Oliver’s opinion is fairly representative of the mainstream economists, which include those bureaucrats in the Reserve Bank of Australia (RBA). Why are the mainstream economists’ forecasts so tame and mild? As Professor Steve Keen criticised their neo-classical economic thinking here,

This is not a prediction by the model as such, but a product of its structure, which assumes that the economy will always return to a supply-side driven equilibrium in a relatively short time frame.

Built into the blinkers of the mainstream neo-classical economic framework, the assumption is that the economy is like an elastic band that will spring back to its previous un-stretched state of ‘equilibrium’ after being stretched by external ‘shocks’ (e.g. global financial crisis). For those who studied economics at university, you will realise that the phrase “external shock” is often used in the text-books to describe phenomena that are beyond the scope of economic model. Furthermore, you will find that your text-book are full of simultaneous equations, which implies some sort of ‘equilibrium’ has to unquestionably happen.

But this is a very erroneous assumption built into the framework of mainstream neo-classical economic thinking. Does the economy always have to return to equilibrium the way an elastic band spring back into its previous relaxed state? Can there be other forces that can pull the economy further and further out of equilibrium until a breakdown occurs? Can there be snowball effects? Mainstream economics do not entertain those questions seriously. They consign the answers to those questions (that they do not understand) as an excuse called “external shocks.” As a result, their forecasts are next to useless, especially during turning points (see our guide, Why are the majority so wrong at the same time and in the same ways?).

Thus, we are very sceptical of the mainstream economic opinion that Australia is on track towards a soft landing. Such thinking is more of a reassuring, good-feeling hope and less of serious analysis.

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Posted in Economics/Finance, Looking Forward | 8 Comments »