Posts Tagged ‘Wayne Swan’

Expectation of US Dollars (USD) printing creates an Australian Dollar (AUD) bubble?

Sunday, October 10th, 2010

Everyone on the streets know that the Australian Dollar (AUD) is rampaging towards parity with the US Dollar (USD). Joining the media circus, some forex pundits are even prophesying that the AUD could reach $1.20 against the USD. The masses in Australia are cheering because it is now cheaper to buy stuffs overseas due to the ?strong? AUD. Politicians (Wayne Swan) are cheering because it is a great excuse to brag about the ?strength? of the Australian economy under the stewardship of their political party. Businesses that has their costs paid directly or indirectly in terms of USD are cheering (e.g. retail import). Businesses that receive their revenue in terms of USD (directly or indirectly) are in pain (e.g. mining, tourism).

We wouldn?t be surprised if the next round of readings for consumer confidence in Australia will show a marked increase. We have no doubt that this in turn will add fuel to more cheering by politicians and the media circus.

But as contrarian investors, you have to understand the context and big picture behind the surging AUD. Do not be like the masses by being caught up with the euphoria. Instead, be prepared and even profit for what is to come.

Firstly, it is not just the AUD that is rising against the USD. The euro, yen, base metals, gold, silver, etc are also rising too. However, the expectation of more interest rate rises by the Reserve Bank of Australia (RBA) is acting like rocket boosters to the already rising AUD (see Return (and potential crash) of the great Aussie carry trade). In other words, it is more of the USD that is deprecating, not the AUD appreciating. As we wrote in What if the US fall into hyperinflation? on April 2008,

Now, in this age of freely fluctuating currencies, the currency?s value is a relative concept. For example, a falling US dollar implies a rising Australian dollar. Therefore, one way to ?maintain? the value of the US dollar relative to the Australian dollar is to devalue the Australian dollar. Perhaps this is the route that central bankers will concertedly take to instil ?confidence? in the US dollar in order to create the illusion that the US dollar is still a reliable store of value? Well, they can try, but growing global inflation and skyrocketing gold price relative to all currencies will be tell-tale signs of such a dirty trick.

Already, the Japanese central bank are cutting interest rates, taking token measures to intervene in the forex market to weaken the yen and even talking about buying government bonds (i.e. ?printing? money). Basically, the Japanese want to devalue the yen. For Australia, we would hazard a guess that one of the major contributing reasons why the RBA did not raise interest rates last week is because of the surging AUD (that was also the suggestion of one of the economists in CommSec).

To put it simply, the depreciating USD is creating a bubble-like conditions for the currencies of foreign countries. That is problematic, not the least because it is making their exports uncompetitive (just ask any Australian mining company). What is the solution for these countries? Devalue their currencies too (if it can be done without the masses being aware, all the better).

The next question is: why is the USD depreciating?

The reason is simply because of the expectation that the Federal Reserve is going to embark on a second round of massive money printing (see Bernanke warming up the printing press). What is the background behind the Federal Reserve?s money printing idea? To answer this question, we would refer to the late Professor Murray Rothbard?s book, Mystery of Banking:

In Phase I of inflation, the government pumps a great deal of new money into the system, so that M increases sharply to M?. Ordinarily, prices would have risen greatly (or PPM fallen
sharply) from 0A to 0C. But deflationary expectations by the public have intervened and have increased the demand for money from D to D?, so that prices will rise and PPM falls much less substantially, from 0A to 0B.

Unfortunately, the relatively small price rise often acts as heady wine to government. Suddenly, the government officials see a new Santa Claus, a cornucopia, a magic elixir. They can increase the money supply to a fare-thee-well, finance their deficits and subsidize favored political groups with cheap credit, and prices will rise only by a little bit!

It is human nature that when you see something work well, you do more of it. If, in its ceaseless quest for revenue, government sees a seemingly harmless method of raising funds without causing much inflation, it will grab on to it. It will continue to pump new money into the system, and, given a high or increasing demand for money, prices, at first, might rise by only a little.

Murray Rothbard wrote this book more than 25 years ago. Yet, it is pertinently relevant for today?s context. The US government?s budget is in great deficit. It will get worse as they have to spend even more money to prop up and stimulate the economy. The current environment of deflationary expectations is providing an excellent cover for Bernanke to print money (see Bernankeism and hyper-inflation).

But as Murray Rothbard continued,

But let the process continue for a length of time, and the public?s response will gradually, but inevitably, change. In Germany, after the war was over, prices still kept rising; and then the postwar years went by, and inflation continued in force. Slowly, but surely, the public began to realize: ?We have been waiting for a return to the good old days and a fall of prices back to 1914. But prices have been steadily increasing. So it looks as if there will be no return to the good old days. Prices will not fall; in fact, they will probably keep going up.? As this psychology takes hold, the public?s thinking in Phase I changes into that of Phase II: ?Prices will keep going up, instead of going down. Therefore, I know in my heart that prices will be higher next year.? The public?s deflationary expectations have been superseded by inflationary ones. Rather than hold on to its money to wait for price declines, the public will spend its money faster, will draw down cash balances to make purchases ahead of price increases. In Phase II of inflation, instead of a rising demand for money moderating price increases, a falling demand for money will intensify the inflation.

Given the large and exponentially growing debt of the US government, monetary inflation is the only path they can take as far as the eye can see.

There is a lot more in Professor Murray Rothbard?s Mystery of Banking if you want to learn how money and credit are related to each other through the banking system work. You can read a sample of this book here (at the right of that page, click on the ?Read First Chapter Free? button).

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.

Do sentiments make the economy or the economy makes the sentiments?

Thursday, September 4th, 2008

Not long ago, we had lunch with one of our friends. Invariable, the conversation turned into the economy. Judging from the quantity of bad news (e.g. sub-prime, credit crisis, inflation, recession threats, oil prices, falling stock prices, etc.) from the media lately, our friend remarked that “I can tell something is wrong with the economy.” Indeed, we believe large segments of the population are thinking the same too. That’s why surveys are reporting falling business and consumer confidence.

Clearly, sentiments are turning for the worse.

In the midst of economic uncertainties, it is very easy to blame the cause of worsening economic conditions on sentiments. Politicians are fond of using this myth (whether deliberately or out of ignorance). For example, Malcolm Turnbull (Australia’s shadow Treasurer) accused Wayne Swan (Australia’s Treasurer) for “talking up” inflation, as if the tongue of Wayne Swan has the power to move economic forces. But is sentiment so powerful that it can move economic mountains? On Tuesday’s ABC 7:30 Report, Malcolm Turnbull stated in an interview that had it not been Wayne Swan’s talk, consumer confidence confidence would not be so low and the RBA would not have to raise interest rates that much.

But do sentiments make the economy or the economy makes the sentiments?

We do not subscribe to the theory that sentiments alone are the root cause of the business cycle. In fact, as we explained in What causes economic booms and busts?, the business cycle has its roots on human decisions and actions. It is not swayed by the cyclical tide of sentiments. But having said that, sentiments can accentuate the effects of the underlying root causes.

This remind us of a story by Marc Faber,

It was autumn, and the Red Indians on the remote reservation asked their new chief if the winter was going to be cold or mild. Since he was a Red Indian chief in a modern society, he couldn?t tell what the weather was going to be. Nevertheless, to be on the safe side, he told his tribe that the winter was indeed going to be cold and that the members of the village should collect wood to be prepared.

But, being a practical leader, after several days he got an idea. He went to the phone booth, called the National Weather Service and asked, ?Is the coming winter going to be cold??

?It looks like this winter is going to be quite cold indeed,? the meteorologist at the weather service responded.

So the chief went back to his people and told them to collect even more wood. A week later, he called the National Weather Service again.

?Is it going to be a very cold winter??

?Yes,? the man at the National Weather Service again replied, ?It?s definitely going to be a very cold winter.?

The chief again went back to his people and ordered them to collect every scrap of wood they could find. Two weeks later, he called the National Weather Service again.

?Are you absolutely sure that the winter is going to be very cold??

?Absolutely,? the man replied.

?It?s going to be one of the coldest winters ever.?

?How can you be so sure?? the chief asked.

The weatherman replied, ?The Red Indians are collecting wood like crazy.?