Euphoria Evaporates

  • Lessons not learned
  • Aussie choppers
  • Yesterday, the euphoria.

    Today, the reality.

    Yesterday’s market reaction to the Reserve Bank of Australia’s (RBA) interest rate cut wasn’t surprising.

    For the past seven-plus years, investors should have gotten used to markets acting with wild excitement in response to ostensibly bad news.

    The RBA tries to convince investors that everything is fine.

    Its monetary policy statement tells you that the ‘global economy is continuing to grow’.

    The statement lets you know that ‘Sentiment in financial markets has improved’, and that in Australia, ‘the economy is continuing to rebalance’.

    Yet, despite all this good news, the RBA decides that a further cut in the Cash Rate is in order. Apparently, 2% just isn’t low enough. It needs to be 1.75%. That, the RBA would seem to believe, should be enough to springboard the Aussie economy to new heights.

    Not so fast. As Bloomberg reports:

    Goldman Sachs Asset Management says Australia’s move to a record-low policy rate won’t be enough to weaken the currency as much as the central bank desires and that will spur another reduction by year-end.

    Forget 2%, and you can soon think about forgetting 1.75%.

    For all the criticism we and other dish out to Goldman Sachs, it’s fair to say that they have a pretty good record of anticipating central bank actions.

    A rate cut to 1.5% isn’t so much a possibility as a probability.

    Australian federal government debt currently stands at $424 billion. It’s relatively low compared to many comparably sized economies overseas. However, it’s a lot higher than it was eight years ago, when federal government debt was around $70 billion.

    And based on current projections, the debt pile is only going in one direction — up. In its budget, the government has forecast a budget deficit of $37 billion through June 2017.

    This is a problem, which unfortunately, the folks in the mainstream don’t seem to fully understand.

    When a government runs a deficit, it means that it’s spending more than it takes in through tax revenue. If the government is spending more than it ‘earns’, the only way to cover its expenses is to borrow money.

    When the mainstream talks of a budget deficit, they rarely acknowledge that the deficit necessarily results in higher government debts.

    So even when they acknowledge that the deficit will fall over (say) five years, they don’t point out that each year of deficits means a big increase in debt levels.

    To listen to the mainstream, you’d think that it’s OK if the deficit falls from $37 billion one year, to $32 billion the next, and $28 billion the year after.

    What they don’t mention is that after three years, the government’s debt has increased by $97 billion ($37bn + $32bn + $28bn).

    Furthermore, they don’t explain how the government will ever get around to repaying the debt. After all, is it likely that any government would run up surpluses to the equivalent level in order to repay those debts?

    It doesn’t seem likely to us.

    During the John Howard government, the federal government ran surpluses in most years. Even so, the biggest surplus as a percentage of GDP was 2% in 1999–2000.

    In dollar terms, that was around $8 billion. Is it reasonable to expect that the Australian government would benefit from an economy that boomed so much, that it resulted in a surplus of at least four-times that amount for years on end?

    As I say, it doesn’t seem likely. Not when that same boom would also require the government to not spend the fruits of that boom on vote-buying projects.

    No. I’m sorry to say it, but with a debt level of $424 billion, which will likely be half-a-trillion in less than three years, federal government debt is now firmly institutionalised.

    In our view, it will never be repaid. It will be an ever growing burden for generations of taxpayers in the years to come.

    Maybe that’s why yesterday’s euphoria has been replaced by today’s reality. Folks out there are starting to understand exactly where the Aussie economy is heading.

    Markets

    Overnight, the Dow Jones Industrial Average closed down 140.25 points, or 0.78%.

    The S&P 500 index fell 18.06 points, or 0.87%.

    In Europe, the Euro Stoxx 50 index fell 58.4 points, or 1.93%.

    Meanwhile, the FTSE 100 index fell 0.9%, and the German DAX lost 1.94%.

    In Asian markets, the Hang Seng index is down 0.62%, while the Shanghai Composite index is up a fraction, by 0.01%.

    In Australia, the S&P/ASX 200 index is down 78.44 points, or 1.47%.

    On the commodities markets, West Texas Intermediate crude oil is trading for US$43.75 per barrel. Gold is trading at US$1,281 per ounce.

    The Aussie dollar is worth 74.98 US cents.

    Lessons not learned

    Since 2009, governments, central banks, retail banks, and those on Wall Street and the City of London, have insisted they have all learned their lessons from the past.

    Most have taken that to be a positive thing. They assume that the lessons learned are not to do such foolish things again.

    Unfortunately, they have applied the wrong interpretation to those statements. It’s true that governments, central banks, retail banks, and those on Wall Street and the City of London, have indeed learned lessons from the past.

    Trouble is, what they have learned is that they can get away with ‘blue murder’, knowing that governments and central banks will bail out institutions that are ‘too big to fail’, and that taxpayers are powerless to do anything about it.

    For evidence of this mentality, we need only turn our attention to an article in today’s Financial Times:

    Barclays has become the first high street bank since the financial crisis to launch a 100 per cent mortgage in the latest sign of a return to riskier lending.

    The bank is allowing some buyers to take out a mortgage to 100 per cent of the value of the property, without needing a deposit. Most banks require at least a 5–10 per cent lump sum.

    Barclays said the mortgage only needed to be supported by a family member or guardian, who must set aside 10 per cent of the purchase price in cash for three years in return for interest.

    Aha! Guarantor loans. A product type not unfamiliar to the Australian lending market.

    It’s almost as good a ruse as the no deposit loans, where the financier will lend the borrower money to pay their rent, so the borrower can deposit ‘savings’ into a bank account for the purpose of showing the bank their excellent savings history.

    But why not? What the heck…anything goes if it means helping to prop up house prices.

    Amusingly, the article goes on:

    It said the new mortgage was designed to remove the issue of borrowers drawing from the “bank of Mum and Dad” to stump up a deposit.

    Hmmm. It doesn’t really remove that issue does it? ‘Mum and Dad’ still have to set aside 10% of the purchase price of a property, with no guarantee they’ll get the money back — if the happy homebuyers realise they can’t keep up the 100% mortgage payments and they become forced sellers…selling at a price lower than they paid.

    Because we will remind folks, there is no guarantee that house prices will always rise. Sometimes (turn away if you’re easily shocked) it’s possible for house prices to fall. Really.

    Aussie choppers

    Speaking of not learning lessons and the ridiculousness of the current markets, a recent article in The Economist highlights just how ridiculous mainstream economic analysis has become:

    It would be a good thing if governments began building frameworks for the use of helicopter money. When the next crisis strikes, central banks will almost certainly have little room to reduce interest rates. The ability quickly to credit individual bank accounts with cash, for example, would render shocks more manageable. But there is no way without a will.

    ‘Helicopter money’ is an expression used to describe governments and central banks handing cash directly to individuals. The analogy is that the central bank could just drop cash from a helicopter.

    What most seem to forget is that this policy has already been tried, and was shown to fail miserably. In 2009, Kevin Rudd’s government handed out $900 in cash to every taxpayer.

    The result? A short term boost for furniture, electronics, and whitegoods retailers, but a long term negative for the economy as it helped push Australia towards the $424 billion of debt that it’s in today.

    Surely, the smart folks at the world’s central banks are familiar with Australia’s ‘helicopter money’ experiment. After all, then Treasurer, Wayne Swan, did win the central banker of the year award.

    That was partly due to the Aussie ‘helicopter money’ policy.

    We’re sure the mainstream economists are aware of it, but conveniently choose to ignore it.

    Cheers,

    Kris