Posts Tagged ‘Glenn Stevens’

Hidden weak foundations covered by high tide of debt

Thursday, June 17th, 2010

Today, we read this interesting article, Nothing can save Spain,

"Greece is not Spain", has been how European politicians have been trying to reassure the markets. Once analysts had a closer look at the Spanish figures they concluded that this was indeed true ? Spain?s troubles are much worse.


In fact, before the crisis struck the Spanish were seen as Europe?s model citizens. Public debt was low, the economy grew rapidly, and in 2007 the government could still report a healthy budget surplus of 1.9 per cent of GDP. There was no sign of grave economic mismanagement, let alone on a scale comparable to the Greek basket case.

So what turned the Spanish miracle into an economy on the abyss? How can a country be regarded as a role model one day and almost a failed state the next?


But whereas in Greece the lower interest rates were taken as an opportunity to incur greater public deficits, in Spain it was the private sector which accepted the invitation to go deeper into debt.

One sector in particular benefited from this injection of cheap cash thanks to the euro: real estate. For many years, Spanish house prices only knew one way, and that was up. Between 1998 and 2007, property prices increased by about 10 per cent per year on average.

When the global financial crisis struck, the bubble burst. Since 2008, Spanish house prices have declined 15 per cent and there is no end in sight to the correction. Some real estate experts are predicting further falls of up to 35 per cent.

Suddenly, the weak foundations of Spain?s economy are exposed, especially its over-reliance on debt coupled with low productivity.

Consequently, the pristine clean Spanish public debt turned into deficit as unemployment rate soared to 20% and bad debts plagued the banking system.

Note that we highlighted the word ?suddenly? in the final paragraph.

The key to remember is that the economy looked rosy until something suddenly gave way. The high tide of debt kept the weak foundations hidden under the water. Finally, when the debt tide receded, the weak foundations were exposed. With the weak foundations in full view, the financial market reacted in horror accordingly.

Spain?s situation reminds us very much of Australia. As the Reserve Bank of Australia (RBA) governor hinted in a speech last week,

Markets can happily tolerate something for an extended period without much reaction, then suddenly react very strongly as some trigger brings the issue into clearer focus.

Again, we highlighted the word "suddenly.? As we wrote in Serious vulnerability in the Australian banking system, there is a serious weak underbelly in the Australian economy. All we need is a trigger for all eyes to be on its weak foundation (see Will there be an AUD currency crisis?).

However, many pundits in the mainstream media are still putting on Turkey Thinking (see our book, How To Foolproof Yourself Against Salesmen & Media Bias for more information on Turkey Thinking).

Growing structural unemployment in Australia

Thursday, June 10th, 2010

Today, the Australian stock market and the Aussie dollar performed relatively well. Alan Kohler, the financial news commentator in ABC News gave the reason why- China and Germany?s industrial production, Australia?s job ?boom? and so on. Incidentally, this is an example of narrative fallacy and lazy induction as described in our book, How To Foolproof Yourself Against Salesmen & Media Bias. Anyway, we will leave you to follow up on the issue of media bias.

But first, we will look at this news article,

Australian employment jumped a strong 26,900 in May to extend a remarkable run of jobs gains that suggests wage pressure could build earlier than thought and require yet further action on interest rates.

That article was published just before 5 pm. Coincidentally, in the streets of Sydney, another news article reported,

Thousands of protesters marched through the streets of Sydney’s CBD today, waving colourful banners and chanting demands for equal pay for women.

This is the sort of things that the RBA fears and give them a reason to raise interest rates. However, though the falling aggregate unemployment rate looks good, it masks a hidden problem. The problem is of the same nature as we described in Overproduction or mis-configuration of production?,

This is the key insight from the Austrian School of economic thought. Over-production or over-investment is not the problem. Rather, the trouble lies in the mis-configuration of production and mal-investments

In the same way, it is not the aggregate level of unemployment that tells the whole story. Rather, if unemployment is to be a threat to the Australian economy, it will be its configuration that is the cause. Recently, we saw this article, Recovery doesn’t extend to long-term jobless,

LONG-TERM unemployment continues to rise sharply and has increased for 18 straight months, despite the better performance of the economy and the overall improvement in th1e labour market.

A Herald analysis shows that Centrelink payments to people without a job for more than a year have risen by 27 per cent, or nearly 72,000, to 334,244 people in the year to April.


While the economic stimulus package has been credited with saving Australia from a deep recession, there remain pockets of deep disadvantage.

This mis-configuration between surplus supply of unemployable labour and shortage of employed labour is what economists call ?structural unemployment.? Also, according to the ABS, the youth unemployment rate in Australia is 3 times the national average. This is another large pool of structural unemployment.

As that article continued,

A senior analyst at the University of Sydney’s Workplace Research Centre, Mike Rafferty, said it appeared that as the economy had improved it was people moving jobs or within jobs that had benefited.

”The people who are benefiting first are perhaps those that already have jobs and are able to move into better jobs or perhaps from part-time to full-time work,” he said. ”It’s not the same picture for the people not in the labour market.”

Since the official unemployment is based on a sample of surveys whereas Centrelink payments is based on the actual number of people seeking welfare, we can argue that the latter presents a more accurate picture of the unemployment situation in Australia.

A rising structural unemployment will increase the drag in the economy as government welfare payment will have to be increased. If this growing trend is not arrested, then this growing pocket of disadvantage will increase, resulting in social problems down the track. Unfortunately, these structural unemployed do not make it to the aggregate figures.

Putting the politicians on notice

Sunday, October 18th, 2009

Over the weekend, the Reserve Bank of Australia (RBA) governor, Glenn Stevens, surprised the financial markets with his unusually hawkish stand on interest rates. In response, as this news article reported,

Financial markets responded by pricing in the most rapid series of interest rate rises Australia has seen for 15 years. Markets now predict that the Reserve board will raise rates at seven consecutive meetings, lifting its cash rate from 3 per cent 10 days ago to 4.75 per cent by May and 5 per cent by July.

As we wrote back in July (see How are central bankers going to deal with asset bubbles?), under the influence of William White of the Bank for International Settlements (which is dubbed as the central bankers’ central bank), there’s a sea-change in central bankers’ thinking. Glenn Steven’s aggressiveness is the result of such a sea-change. Our long-time readers should not be caught by surprise at this, unlike the financial markets.

Economists like Professor Steve Keen reckons that if the RBA really carry through its threat that way, it will be a big mistake. The problem with monetary policy is that it is an extremely blunt instrument. Though rising interest rates can put a brake onto the growth of dangerous debt-fuelled asset bubbles, it will also constrict other sectors of the productive economy as well. The risk is that the productive sectors of the economy may be crippled, bringing down the rest of the economy along with it, and as a result, burst the existing asset bubbles in a spectacular way.

Therefore, what is needed is a very precise tool that can target asset bubbles specifically while leaving the rest of the economy alone. Unfortunately, the RBA do not have the power to to enact such a precise policy tool- they can only change the interest rates lever. On the other hand, the arm of the government that are controlled by politicians has the power to formulate such a tool. Very unfortunately, we have politicians who are unwilling to attack asset price bubbles (and worse still, inflate the bubble even more), due in part to control of vested interests and fear of losing elections.

The outcome is that we will have politicians (both at the State and Federal level) and the central bank engaging in policies that are uncoordinated and mutually incompatible. Unless that change, there’s a significant risk of loss of control of the economy by the government. Should this happen, the most convenient scapegoat will be Glenn Stevens as he will be accused as the man who bust up the Australian economy. But for us, we will point the finger at the Rudd government because they understood what the root cause of the GFC (see the essay written by Kevin Rudd here) but instead, not only did nothing to deal with Australia’s towering debt levels, but also introduced policies that increase the risk of a home-grown credit crisis in Australia (the most notorious is the FHOG). The State governments are not any better either.

The politicians must be put on notice.

Government taking tougher line on debt and bubbles

Tuesday, July 28th, 2009

To be a successful investor, one must be be aware of the sea-changes that are happening in the economy and financial markets. One of the sea-changes is in the line of central bank thinking. As we wrote in How are central bankers going to deal with asset bubbles?, central bankers are now more ready to deal with asset price bubbles than before. Previously, central bankers were targeting price inflation rate with their monetary policy while they stood idly by to let house prices form a bubble. As Glenn Stevens, governor of the RBA said today as reported in this mainstream news article,

Not only would it confirm that there are serious supply-side impediments to producing one of the things that previous generations of Australians have taken for granted, namely affordable shelter, it would also pose elevated risks of problems of over-leverage and asset price deflation down the track.

Please note that we are not endorsing the economic literacy level of that news article. Rather, we are quoting Glenn Stevens to show you what is going on inside his mind. The RBA is also hinting repeatedly that the next move in interest rates is up. Basically, the RBA is telling Australians this: you better wake up from your old ways and get serious about repaying your debts because the party is over.

This line of thinking is in sharp contrast to China’s central bankers, who are allowing a debt bubble to grow (see Is China setting itself up for a credit bust?) and spill over into asset prices (e.g. property and stocks).

The next sea-change is the change in the line of thinking from our dear Prime Minister, Kevin Rudd. He wrote in his essay published a few days ago,

The roots of the crisis lie in the preceding decade of excess. In it the world enjoyed an extraordinary boom… However, as we later learnt, the global boom was built in large part on a three-layered house of cards.

First, in many Western countries the boom was created on a pile of debt held by consumers, corporations and some governments. As the global financier George Soros put it: ?For 25 years [the West] has been consuming more than we have been producing … living beyond our means.”

Second, these debts were racked up on the back of sky-rocketing asset prices. In several countries, stock prices and house values soared far above their true long-term worth, creating paper wealth that millions of households used as collateral for their growing debts.

This crisis has shown we have reached the limits of a purely debt-fuelled global growth strategy. Not only will the neo-liberal model of the past not provide growth for the future, its after-effects will make recovery more difficult. Mountains of global public and private debt, global imbalances, and a weakened global financial system will drag on global growth for a long time. As the renowned financial columnist Martin Wolf has written: “Those who expect a swift return to the business-as-usual of 2006 are fantasists. A slow and difficult recovery, dominated by de-leveraging and deflationary risks, is the most likely prospect.

This had been what we were arguing for a few years already (see Aussie household debt not as bad as it seems? on January 2008 and The Bubble Economy in October 2006). Kevin Rudd has finally understood the root cause of the GFC- spendthrift ways financed by rising debt using bubbly asset prices as collaterals. Now, he acknowledges that de-leveraging (repayment of debts) will be the fashion for a long time, in contrast to the past few decades of increasing debts. For many Generation Xs and Ys, the change from profligate to more frugal ways will be alien to them.

Unfortunately, as the mainstream always do, both the RBA and government is one-step behind.

The global economy is like a heart-attack patient on a life-support system. He faced a near-death experience in the second half of last year. Today, his condition has stabilised. But it will be a long time before he will fully recover and be fit enough to run again as in 2007. What the government is doing today is to inject more steroids (targeted stimulus spending financed by public debt) in the hope to see the patient running as soon as possible. The result is a walking zombie on life-support system (massive liquidity injections via ‘printing’ money).

As we wrote in Marc Faber vs Steve Keen in inflation/deflation debate- Part 2: Marc Faber?s view, the government is in danger of painting itself into a corner with no exit strategy (even though they’re talking a lot about it). If the exit strategy fails, we know the result is very high inflation (maybe even hyper-inflation).

How are central bankers going to deal with asset bubbles?

Sunday, July 12th, 2009

Prior to the Global Financial Crisis (GFC), central bankers tend to adopt the ostrich’s mentality to asset price bubbles. Alan Greenspan, the chief architect of this school of thought believes that central bankers should only target price stability and price inflation with their interest rate levers. Greenspan argued that since it is impossible to know when bubbles will burst, it is impossible to intervene at the right moment (we heard of another twist to Greenspan’s argument- one can never know whether it’s a bubble until it bursts).

What about Australia? As we reported in What should the RBA do?, the RBA, regardless of whether it believes asset price bubbles are dangerous or not, do not have the mandate to prick them,

The masses have not given the RBA the mandate to spoil the asset price inflation party. Although, Ian Macfarlane acknowledged that asset price bubbles can be very dangerous for the economy, his hands were tied. Elsewhere, Coalition opposition politicians were toeing the populist line by demanding that Glen Stevens (the current head of the RBA) be grilled more frequently in order to pressure him against hiking interest rates.

This ostrich mentality of central bankers is strongly criticised by the Bank for International Settlement (BIS). As we wrote before in Bank for International Settlements (BIS) warning on stimulus spendings, the BIS is the

… only international body that had correctly anticipated the global financial crisis (GFC) and warned of another great depression back in June 2007, when they released their 77th annual report (see Bank for International Settlements warns of another Great Depression).

The BIS is dubbed as the central banker of central banks. Its chief-economist, William White, whom we believe is from the Austrian School of economic thought, warned central bankers repeatedly of impending global financial disaster and implored them to re-think their strategy as early as 2003.

Greenspan and White stood at opposing sides. It seemed that Greenspan’s views held sway among the central bankers. He was dubbed as the “Maestro” and was celebrated as the world’s greatest central banker. No one in the world of central banking dared to openly criticised Greenspan, except for William White of the BIS. Since Greenspan was a member of the board of directors of the BIS, he was technically White’s superior. Greenspan had the upper hand until…

… until the GFC erupted and the financial world order came close to collapse in 2008. And so, Greenspan is dis-credited today. White’s theory gained ascendency. As this article reported,

The group of the 20 most important industrialized and emerging nations, which is now left with the task of cleaning up the wreckage of the crisis, apparently faces less academic problems. At the London G-20 summit in April, the group decided to promote a crisis-prevention model based on White’s theories.

They want to introduce what might be called his hoarding model, which calls for banks to build up reserves in good times so that they can be more flexible in bad times. The central banks, according to White, must actively counteract bubbles and exert stronger control over the financial industry, including hedge funds and insurance companies.

As an adviser to German Chancellor Angela Merkel’s group of experts, White helped to shape the basic tenets of the new order. And the 79th annual report of the BIS, published in Basel last week, also reads like pure White. It lists, as the causes of the crisis, extensive global imbalances, a lengthy phase of low real interest rates, distorted incentive systems and underestimated risks. In addition to improved regulation, the BIS argues that “asset prices and credit growth must be more directly integrated into monetary policy frameworks.”

What does this imply for investors?

It means that any investments and investment strategy that depends on ever rising asset prices to work will no longer work in this new global financial order. To put it bluntly, in this new financial order, the Reserve Bank of Australia (RBA) will not let property prices balloon as it did over the past 10 years. As the RBA governor Glenn Stevens said (as reported in this Bloomberg article),

 Australian central bank Governor Glenn Stevens said policy makers must be cautious about cutting interest rates too far because that may encourage some borrowers into debt they can?t afford.

?It is the intention of current monetary policy settings to lower debt-servicing costs, assist efforts to reduce leverage and support demand,? Stevens told a conference in Townsville, Australia, today. ?It would be counterproductive, though, if further reductions in interest rates induced a large number of marginal borrowers into debts they could service only at unusually low interest rates.?

This is just an example of a sea-change in thinking among central bankers.

Too eager for an interest rate cut?

Sunday, July 20th, 2008

Ever since the governor of the Reserve Bank of Australia (RBA) made the speech last week, the mainstream media has been catching on to the idea that interest rates in Australia is at the peak and the next move will be a cut. For example, The Age came up with a highly misleading and sensationalising headline: RBA chief throws borrowers a bone. We are sure that such headlines will give some property ‘investors’ (read: speculators) the wrong idea that the property bubble will re-inflate when such a day arrives.

First, let us understand the context of what Glenn Stevens said. In Australia, our central bank has a policy of targeting inflation within a band of 2% to 3%. Note: If you want to know the long story about how inflation targeting come about as a policy, take a read at our earlier article, Why should central banks be independent from the government? which contains a link to the RBA’s web site. There are some who fear that with the credit crisis and rampaging oil prices, any rigid and inflexible adherence to the inflation target band through monetary policy will result in a serious crisis for Australia. In other words, the belief is that the RBA should be flexible enough to let inflation veer off the course. We believe it is in this context that Glenn Stevens reportedly said that he will not “wait until inflation has retreated below 3 % before cutting interest rates.”

Second, though it may be true that the next interest rate move in Australia will be down, it may not be imminent. In fact, it may be quite a while before it happens. So, those who are waiting for an interest rate cut to do wonders to their asset speculation should not be too hopeful yet.

Third, should interest rates be cut sooner than expected, it will probably happen in the context of a credit deflation, which is hardly good for asset prices. In other words, you will not want to see the day when the RBA is forced to cut interest rates desperately because it will be a day when the economy is slowing too dangerously. As we said before in Can lower interest rates re-inflate the property price bubble?,

But what if the economy slows down too much for the RBA?s liking? In that case, given the high levels of debt of Australians, if the economy slows down too much, the Australian economy can tip into a dangerous downward deflationary spiral.

Fourth, an interest rate cut by the RBA need not necessary mean a cut in the mortgage rate. In fact, the opposite can occur. How? Why? We will discuss more about this in our next article. Keep in tune!