Archive for August, 2010

Bernanke warming up the printing press

Sunday, August 29th, 2010

Last month, we wrote in Prepare to pull the trigger on speculating! about the signs to watch out for the timing to speculate. Well, the sign arrived over the weekend.

Last Friday, Ben Bernanke gave the strongest hint about money printing. As this article reported,

Federal Reserve chairman Ben Bernanke has laid out four "unconventional" policy options to boost the US economy.

Top of the list is more "quantitative easing" – mass purchases of debt.

"Quantitative easing? sounds technical, but it basically means printing money. In another article, Bernanke is talking tough against deflation,

Federal Reserve Board Chairman Ben Bernanke said Friday that the central bank would not sit idly and let the U.S. economy sink into a period of deflation.

"The Federal Open Market Committee will strongly resist deviations from price stability in the downward direction," Bernanke said in a speech opening the Fed’s annual summer policy retreat.

The Fed would be "vigilant and proactive" if inflation falls by a significant amount, he said, though he downplayed concern that the economy would fall back into another downturn, or a double-dip recession.

As we wrote in our book, How to buy and invest in physical gold and silver bullion,

The United States, with ?helicopter? Ben Bernanke at the helm of the Federal Reserve, is committed to money printing to solve America?s economic woes. To the extent that the US dollar is the world reserve currency, it will affect the rest of the world.

In essence, for investors who still believe in deflation, Bernanke is saying, ?Try me. I dare you.?

More political instability for Australia ahead

Sunday, August 22nd, 2010

Now that the election is over, Australia has a first hung parliament in 70 years. What this means that no political party has an outright majority to form a government. However, what can happen is that either the Labor or Coalition party can form a minority government by dealing with the minor parties and independents.

Regardless which party forms the government, it can be easily toppled with a vote of no-confidence in parliament. When that happens, either the people have to go back to the polls again or the other party form the next government.

If the global macroeconomic headwinds of deflation comes and puts the Australian economy under enormous stress in the months to come, we can expect more political instability as blame shifting, polarisation of views and strife increases. This is an environment that is hardly conducive for sound economic policies and doing business.

Watch this space.

What if Australia?s banking system needs a Government bailout?

Tuesday, August 17th, 2010

As most of us are aware, Australia has the ?four pillars? ? four large banks that provide the majority of Australia?s local banking credit. Over the last few decades, these four banks have increased their exposure to residential mortgages, even in the face of what appears to be a large housing bubble.

Mark Joiner, NAB?s finance director is confirms in this article:

[CBA and Westpac] ?with mortgages accounting for more than 60 per cent of the Sydney banks’ balance sheets?

“Australia should have a balanced economy; not a big skew to mortgage or business lending”

Each of these four banks lends money to each other and has enough influence on the economy to be considered ?too big to fail? by most – the failure of one bank potentially triggering the collapse of another and so on.

Popular opinion suggests that if such a scenario were to occur, the Australian Government would step in to bail out the banks and prevent them from collapsing. This would require the Government to acquire money, either by borrowing it, selling bonds or ?printing? it.

If we make the assumption that the Government would be forced to act in this way, the repercussions of such action could be that borrowing or bond sales increase the Government?s financial liability. This increases the risk of lending to the Government, possibly even our AAA debt rating. Such increased risk will:

  • increase the cost of borrowing for the Government and local companies including banks
  • decrease the amount of credit easily available
  • increase the Government deficit and annual interest payable
  • increase local interest rates, making it more expensive for the public to service debt or take on new debt, possibly reducing the ability of the public to purchase property

If the Government resorted to money printing (or equivalent), it is likely that the value of the Australian dollar would depreciate, causing credit problems similar to the ones mentioned above. And if such problems persist, they would form part of a feedback loop that amplified them over time (see Serious vulnerability in the Australian banking system).

However, this does not mean that the problems would be inescapable. Strong fiscal policy, increased taxes, reduced spending ? all of these could contribute to bringing Australia back into healthy financial territory.

But what are we missing? Even now, people are crying out for spending on infrastructure in NSW, VIC and QLD by the state and federal governments. How will the Australian Government have the funding to pay for any of this if it is trying to pay down debt, or if the cost of debt is increasing? Every dollar of government spending sourced through taxes, services, bond sales or borrowing has been labelled to be spent on something. If the Government allocates money to bail out banks, it is taking it away from spending on other items. From this we get a mis-allocation of spending, which will create market distortion and potentially hamper the economy at a time when Australia can least afford it.

From this we can deduce that there must be a limit to how much money the Government would realistically allocate to a bank bailout. At some point the risk of bank failure to the economy will become less than the risk of removing Government spending from the economy. Whether from this point the banks will actually fail or not cannot be known at this point.

And a final point to consider is that after bank bailouts, will the banks be very cautious lenders who have learned valuable lessons about asset risk and reserve requirements, or will they have an increased risk appetite due to a feeling of assurance that the Government will always step in and save them from ruin?

Tip for politicians: how to win voters’ hearts

Sunday, August 15th, 2010

There was this story about two men being chased by a bear. As both of them were running for their lives, one man told the other,

There’s no way we can outrun the bear. Why don’t we play dead instead?

The other man replied,

No, I don’t have to outrun the bear. All I need is to outrun YOU!

Alas! This is the current state of affairs for Australian politics. Political parties don’t have to come up with good policies. All they need is to be less bad than the next viable alternative. Next Saturday, as Australians go to the polls to vote for the next government, they will have to choose between bad alternatives. We find both major political parties have much to be desired. Both of them are almost indistinguishable from each other as they steer their policies to optimise their re-election prospects. As for the minor parties, some of their policies are based on good principles. However, they also have some other wacky (or extreme) ideologies mixed in as well.

So, the winner of this Saturday’s Federal election will go to the party that is least bad in the eyes of voters. Our guess is that the Labor Party will win the election. So far, the punts from betting agencies are agreeing with us.

The important question is, why would Labor be more likely to win?

The answer (as we will reveal later), reminds us of this simple phrase borrowed from Bill Clinton’s campaign:

It’s the economy, stupid.

Back in 1992, George H W Bush’s approval rating fell from 90% in March 1991 to 36% in the space of 15 months. He lost because he was perceived to have failed to address the economy adequately.

In Australia, we think the phrase should be:

It’s the jobs, stupid.

Back in 2007, the NSW Labor Party government won the election despite being one of the most incompetent governments in the world. We have no doubt that the electorate despised the NSW Labor Party. As this Wikipedia article wrote,

The newspaper editorials on the eve of the election held little cheer for either party. The Australian, The Sydney Morning Herald and The Daily Telegraph had each endorsed Labor at the 2003 election. Though each newspaper expressed misgivings about Debnam’s campaigning ability and called the result in Labor’s favour, they were unanimous in their attack on Iemma’s record.

If this election campaign has proved anything, it is this: Labor has completely lost its way on policy ? and the Liberals are no good at politics … However, after 12 years, Labor’s sustained policy failures should count for more than five weeks’ incompetent Liberal campaigning. If anything, the fact that spin-driven Labor has shown that it is vastly better at politics is of itself a reason to chuck them out.

So, how did they win the election? Our opinion is that the voters feared that the NSW Liberals would hand industrial relations powers to the Federal Government (under Liberal-National coalition at that time), which was pushing through the highly controversial WorkChoice legislation.

In late 2007, the Australian economy was still doing well and had an uninterrupted economic growth for more than a decade under the Liberal-National coalition. Since the status quo was good enough (or at least not bad enough), why did voters risk with the largely unknown Kevin Rudd and gave the Liberal-National coalition the sack in the 2007 Federal election? Again, the issue was because John Howard pushed his luck too far with the WorkChoice legislation.

Fast forward to early 2010. Why was Kevin Rudd’s mining super-profit tax very unpopular among the mining states of Queensland and Western Australia? Again, the idea was that the mining tax will kill mining investment projects and by implication, threaten jobs.

Today, with less than a week to the election, the Federal Labor had turned the tables against the perception that the Coalition is better at economic management and successfully painted the idea that Tony Abott (as Prime Minister) is a risk to the economy. With the economic crisis still unfolding in the US and Europe, voters could easily see what a bad economy can do to job security. To plunge the nail further into the coffin, some of Labor’s campaign commercials seek to fan suspicion of Tony Abott’s future intention with WorkChoice.

In Australia, it seemed to us that the way to the voters’ heart is through his/her job. If our theory is right, why do you think job security is so sacred for the average Australian voter?

Free pass to a trading education web TV

Sunday, August 15th, 2010

Every once in a while, our friends at INO (aka Market Club) come up with an amazing offer for those who are into trading the financial markets. For this month only, they are launching a trading education program and is giving away FREE access to it.

They are launching Trend TV! What is it? A little bit of background…

Before the Internet…

When TV was first invented by John Logie Baird (1888-1946) back in 1925, it revolutionized communication. Shortly afterward it became a mainstay of popular culture. TV changed the world and how we view information, not unlike what is happening on the Internet today.

But do you know what TV was supposed to do?

It was going to educate the world; that was the whole purpose of TV back then. Somehow the message got twisted and the educational aspect of TV was quickly forgotten and lost forever.

Now, for the good news…

Educational TV and has been reborn on the web and presents some marvelous opportunities to get back to TV’s original roots. Now you can educate yourself and learn valuable insights on subjects that you would have missed out on had it not been for TV on the web.

Here is a question for you:

Have you ever been to one of those expensive trading seminars? You know the ones I mean. They normally cost several thousand dollars, plus the cost of a hotel room and airfare. Thousands and thousands of folks attended them because they wanted to expand their knowledge of the markets and learn new trading techniques.

We have some great news for you…

Even if you’ve never attended a trading seminar before, you know the value of knowledge and education, that is why this offer will appeal to your interest.

Announcing Trend TV…

This is like the perfect marriage of TV and the web. Now you can attend online trading seminars that you have an interest in. It is so easy. If you are reading this email, you are online and therefore have everything you need to get started. You can attend all 4 trading seminars, or just the ones that interest you. There are four world class trading instructors that will help improve your trading. Best of all, it’s all online and it’s on TREND TV now.

Click here to sign up (FREE) to Trend TV now!

Now for the good news…

You’re not going to have to spend thousands of dollars like before to attend all four of these seminars. You’re not even going to spend $100 to attend one of these online trading seminars. In fact, you can put your credit card and wallet away because these online seminars are offered at no cost from a well known, world class company.

In fact, if you jump over to this web address right now, you will have instant access to these four online trading seminars with our compliments. But hurry, we’re not sure how long this is offer is going to last.

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World Class Company

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What do overseas property investors see that Australian property investors don?t?

Thursday, August 12th, 2010

Foreign investors are getting spooked by the ?perky? Australian property market, according to this article:

Overseas bank investors are becoming increasingly jittery about Australia’s housing market. Bank analysts are fielding calls from overseas-fund managers about the sustainability of a surge in prices over the past year.

So while Australian property investors celebrate increasing prices, overseas investors are getting wary of an overheated market.

In Australia we have been inundated with theories regarding restricted supply, immigration, lack of land release, low interest rates and any number of other ?fundamentals? to explain the continued rise, and possible sustainability of Australia?s property market.

But are we exposed more than we realise?

According to this article, Australian banks are increasingly exposed to the cost of foreign sourced credit:

Australian banks now finance much of their lending from offshore because our national thirst for credit outstrips our collective ability to fund it.


The nightmare scenario goes something like this: International investors refuse to extend our banks credit at a reasonable price. This forces the banks to pass on additional costs to their customers and, in some cases, refuse credit. These tight credit conditions could squeeze property developers and highly-geared property investors alike. Many developers would be forced to offload housing stock quickly- by reducing sale prices – to raise cash to repay their loans as they fell due and/or cover the increasing costs of their debt.

Overseas property investors will be acutely aware of the value of the Australian dollar, as their investment will be bought and sold at a relative exchange rate. They will need to understand the current and future Australian dollar trends and risks.

But local investors are not encouraged to look into global economics. In fact, the level of financial education in Australia (and perhaps a large portion of the world) is unfortunately weak. Instead of being a ?smart country?, perhaps we are only the ?lucky country? after all. Will an external shock end our run of luck?

So, what do you think will happen to the Australian property market? Vote below and tell us what you think!

How the Consumer Price Index (CPI) could indicate false inflation?

Tuesday, August 10th, 2010

The Consumer Price Index (CPI) is one of the price indices used by the RBA to calculate the inflation figures felt by ordinary Australians. In fact, some of our pensions, wages and other payments are indexed to match the CPI.

However, sometimes the CPI really doesn?t seem to reflect the actual increase in the cost of living. According to this article, price inflation is close to 3.1%, however experts say that the increase in the cost of living feels closer to 5-6%:

There’s a disconnect between the high frequency items, which people regard as driving their cost of living and the broader measure of inflation, which includes less frequent purchases

We potentially have a scenario whereby cost of living is actually higher that is reflected in the CPI. However, the RBA will attempt to ‘manage’ inflation at the CPI rate (see Why central bankers are obsessed with inflation not breaching a certain band?), which means that they may mismanage their response to inflation.

The RBA?s response does not immediately hurt everyday Australians as much as it could. Increasing rates by small increments to fight 3% price inflation is not as bad as the increments required to fight 6% price inflation, especially if you?re heavily in debt. So let?s reverse that idea ? what about if cost of living increase is less than the CPI indicates? Suppose cost of living is increasing at a rate of 3% and the CPI was running at 6%. The RBA is vigorously increasing interest rates, whilst inflation is well ?under control?.

And this scenario could happen. The CPI is prone to overstatement of single items. The most recent CPI values for the year to June are heavily weighed down by a nearly 20% drop in Computers/Audio and a 6% drop in men?s clothes (single female technophobes must be doing it tough). A 50% rise in the cost of cigarettes could easily tip the CPI into high territory, whilst the non-smokers of Australia enjoy a lower level of inflation. Therefore, the RBA has to use other statistical hacks like “trimmed mean” and “weighted median” to smooth away the effects of once-off, seasonal or volatile price changes to arrive at an ‘underlying’ price index.

Yet, statistical hacks, regardless of how sophisticated the math is underneath them, are still not good enough. As we quoted Ludwig Von Mises in How much can we trust the price indices (e.g. CPI)?,

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.

At the root of the problem with any price indices is that, 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.

Basically, price indices, regardless of the level of sophistication, are not as ‘scientific’ as it seems. Central banks, however, have no choice but to rely on them to target price inflation with their monetary policy.

So, how much is the increase in your cost of living reflected by the CPI figures? Vote below!

Credit problems in China

Sunday, August 8th, 2010

Last Friday, we asked our readers: Do you think China will crash soon? The results are pretty interesting. Almost 29% of you reckon that China will crash in a few years time. Almost the same number reckon that China will not crash as far as the eye can see. The rest are scattered throughout the other response. From what we can see, most of you do not think that China will crash anytime soon.

Today, we will talk about credit in China?s banking system.

In Western countries, central banks cannot force the private sector to borrow.  As we wrote in What makes monetary policy ?loose? or ?tight??,

To understand why, we have to remember that the central bank cannot control the demand for money and credit. It can supply whatever amount of them that it wants, but it cannot force business and people to desire them. Put it simply, you can lead a horse to the water, but you cannot force it to drink.

Apparently, this is not so in China. The Chinese government, which has greater administrative powers than Western governments, can force feed credit into the economy. The result: bad debts.

Professor Patrick Chovanec, professor at Tsinghua University’s School of Economics and Management in Beijing, has concerns about the Chinese banking system. He wrote two articles detailing its weaknesses:

Chinese Banks At Risk, Part 1
Chinese Banks at Risk, Part 2

The question is, can there be a Western-style credit crisis in China?

Do you think China will crash soon?

Thursday, August 5th, 2010

Today, we will be doing something a little different. Instead of us doing the talking, we will let you discuss and brainstorm this question.

A little background about this question. In many of the interviews with Marc Faber, he correctly predicted that China will slow down. Furthermore, he suggested that there’s a possibility that China may crash, though he stressed that he’s not predicting that it will happen. Interestingly, he mentioned about “loan-sharking” creating credit problems in China:

Well, I?m not sure. Because if [the Chinese government]? ease off again, the speculation [of property] will go on. But we have credit problems in the property market undoubtedly. We have Ponzi schemes like of loan sharking operations all over China. That?s a very dangerous, and so forth.

We find the word “loan sharking” very interesting. It seems to imply something about the Chinese credit market that is by definition, underground. That is where Black Swans lie.

On the other hand, one of our readers, Paul, who lives in Beijing, has different views about China (see Concerns about China?s slowdown):

It takes years to understand the Chinese psyche, and it’s virtually impossible to get even close from outside the country. Yes, there’s a correction going on, but it’s controlled at the core. Outcomes and reactions will of course be wild and woolly, such as the steel production slowdown.

As for ghost cities, well of course, if you don’t understand how the chinese work, you will think they are ghost cities. But that’s how they do things here – they build the whole damn thing, then move the people in. As I said, you have to understand the Chinese way of thinking.

Put this in your diary. The restrictions will last until November. By December this year, production of key items such as steel and cement will be returning to full pelt.

So, do you think China will crash soon? Please vote below and feel free to contribute your opinions.

Interview with Marc Faber (inflationist) and Michael Shedlock (deflationist)

Wednesday, August 4th, 2010

A few months ago, we found this interview with Marc Faber and Michael Shedlock (aka “Mish”). Faber once said in an interview that he was “100% sure” that the US will fall into hyperinflation. Mish, on the other hand, is a very staunch deflationist (see Are deflationists missing the elephant in the room? Or are they believing in something more sinister?).

What if you put the two together in an interview? Will they clash? Surprisingly not, as you can see…

In particular, pay attention to what Mish said in the final moments of this video.

The takeaway lesson is this: the unfolding train wreck will be something the world has never seen before (as one of our reader, DavidL said). Whatever ‘flation it is, it would not follow the script of the past.