Like it or not, the Aussie share market still takes its marching orders from the U.S. action. It hasn’t decoupled yet – even though what drives the respective economies of Australia and America is somewhat different. Australia has resource demand for its raw materials from emerging markets. America does not. But both countries have debt (especially household debt), and plenty of it.

Here in Australia, what will investors think of the new powers being sought by the Federal government on behalf the corporate regulator, ASIC? ASIC would have the power to tap phone lines, impose fines of $500,000 on insider traders, and double jail terms for insider traders from five to ten years. Hmmn.

Better yet, what will corporate insiders think? We’ve seen some strange share price activity since moving to Australia four years ago. Shares move on no news and volume spikes. Then a few days or weeks later some important announcement comes out. And frankly, the disclosure rules for insider buying (or selling), or at least the enforcement of those rules, seem fairly voluntary.

Not that it’s any better in America or anywhere else. But perhaps because of the smaller financial community and the underpowered regulator, the insiders have a better time of it here than they might other places. Ahem.

But the power to tap telephones? Yikes. That sounds draconian. But it’s fully in line with the encroachment of government power into private life, so it’s no big surprise.

Outside Australia, more trouble is piling up for the world’s most debt-addled nations. “We no longer classify the United Kingdom (AAA/Negative/A-1+) among the most stable and low-risk banking systems globally,” said ratings agency Standard and Poor’s. The FTSE finished lower on that cheery note.

This is the big back story to today’s financial markets. The debt problem has not gone away. Banks have recapitalised, making up for some of their losses from 2008 and 2009. But you still have a financial system addicted to debt and leverage. Investors have bought into the recovery story, though, and taken a punt on shares at just the time they ought to be reducing their allocation to shares (in our estimate). Why?

The deleveraging that kicked off in 2008 still had a long way to run. The banks know this, which is why they’ve decreased risk by being stingier with lending. Shareholders, on the other hand, have done the opposite. And that could cost them.

“Any discussion about the response to the crisis,” reports Peter Larsen at Reuters “must acknowledge the need to reduce the levels of debt that have been built up. A study by McKinsey, the consultancy, found that previous deleveraging episodes have generally taken four forms: a period of belt-tightening, in which credit growth lags behind economic growth for many years; massive defaults; high inflation; or a period of rapid GDP growth as a result of a war effort or an oil boom.”

So which will it be? The RBA releases its report today on financial aggregates. We’ll see if credit growth is lagging the economy. Not likely, we reckon. Massive defaults? High inflation (higher than the RBA is comfortable with)? Or war and an oil boom?

None of them are particularly attractive. But none have really happened yet either. That’s why we think 2010 will have more fireworks. Perhaps a debt default by a sovereign government or two. And then you have fewer and fewer surviving financial firms all deemed too-big-to-fail by the government. Not good.

This just in…the U.S. Senate has voted to raise America’s statutory debt ceiling to $14.3 trillion. This will allow the Treasury to borrow more money to both service existing debt and pay for this year’s $1.3 trillion annual deficit. Ben Bernanke was also confirmed for another for another four-year term as destroyer in chief of the U.S. dollar by a 70-30 vote.

Prediction: at some point the American people are going to turn on the clowns ruining their money and their financial future, piling up debt that will take decades to pay off, if it’s ever paid off at all. The Congressional Budget Office reckons that interest on that debt will more than double as a percentage of GDP. In nominal terms, it will triple from $202 billion to $723 billion.

That’s just interest. That is the price of living above your means as a nation. That is the price (really just part of the price) for making promises you can’t keep. It’s a big price. And in the meantime, we’d take U.S. dollar rallies with a lick of salt. And though we read this morning that George Soros thinks everything is in a bubble – including gold – we’d keep an eye on old yeller and look to buy more on dollar strength.

Regards,
Dan Denning
The Daily Reckoning, Australia

February 1, 2010

The Debt Problem Has Not Gone Away was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Early though it may be, however, it’s not too early to come right out and say what needs to be said: when it comes to the steps being taken to address the current crisis, Obama has no clothes.

Both President Obama and Timothy Geithner, the latest recipient of the Goldman Sachs Chair for Managing the Treasury, are on record as saying that the Japanese experiment in quantitative easing didn’t work. They say much the same about FDR’s New Deal. In both instances, they correctly point out that massive doses of government stimulus had no lasting effect.

If the history lesson stopped there, we could all nod our heads in agreement and go about our business.

Alas, the lips of Mssrs. Obama and Geithner keep moving… telling us with great confidence that the reason the fiscal exertions of Japan and FDR failed was only because in each case government didn’t act quickly enough, or with enough monetary vigor.

Having thus explained the shortcomings in prior adventures in stimuli, the administration promises that “this time it will be different” and wholeheartedly commits itself to acting decisively, quickly, and with stunning amounts of cash. By doing so, we are told, they will shock the economy back to life.

But this argument simply doesn’t hold water — there is zero historical precedent for the notion that applying blunt-force government stimulus will somehow mechanically “shock” an economy back into productivity. A couple of bullet points:

• When FDR came into power in 1933, unemployment in the U.S. had reached a high of about 25%. Despite tripling federal spending on the much heralded New Deal, the best unemployment number achieved was 14%, in 1937. By 1939, however, unemployment was back up to 19%. Now, there is some nuance in those numbers, because the calculations include some number of people on the payrolls of the New Deal’s many make-work programs. Yet, given the fact that those make-work jobs would have come to a quick end if the government had stopped its New Deal spending, the poor results of the FDR stimulus hold up.

• In the Japanese crash, the government spent hundreds of billions supporting banks and businesses, buying U.S. Treasuries in an attempt to keep the yen cheap and so their manufacturing sector at work. As the economic morass dragged on, the government cut interest rates to zero, then eventually accelerated spending in a five-year experiment in “quantitative easing,” which involved funding all manner of public works projects and other targeted infusions of government spending into the economy.

Using the equity market as a proxy for the broader economy, the Nikkei fell from around 38,000 at the height of the bubble in the late 1980s, down to around 7,000. During the five-year period of quantitative easing, 2001 to 2006, the Nikkei rebounded by about 100%, moving back to the 14,000 neighborhood. Importantly, however, the minute the Japanese government stopped the spending, the stock market came tumbling back down to around 7,500, near where it hovers today. Note that at no point did it get anywhere near the bubble high of over 38,000.

In sum, the evidence strongly suggests that there is no permanent benefit to be gained from throwing a lot of money at an economy, though there is one clear negative: a steep ratcheting up in government debt. Of course, because the government doesn’t actually make anything, what we’re really talking about is a steep ratcheting up of your debt… and that of your children… and their children.

So, what’s going on? Don’t you think all the Obama’s horses and all the Obama’s men know this?

Maybe they do.

In earlier editions of this missive, I have commented that President Obama may be the best politician in U.S. history. How else to explain how a virtually unknown black man could, in just a few short years, become president. And do so despite a foreign father and two given names eerily reminiscent of two of the most vilified individuals in the current American ethos? Impossible, most would have said, if asked a few years ago. But here he is… undeniable proof of his political skills.

Not to be cynical, but what if, on surveying the landscape, Obama and his inner circle came to the following conclusions about the possible paths they could take in regard to the dismal economy:

Path One: Stand aside and let Mr. Market put on the leather gloves, pick up the truncheon, and get to work pounding the economic dislocations out of the economy. Or…

Path Two: Observe that, during the period of Japan’s quantitative easing, the economy actually did pick up, albeit on a cushion of growing government debt. Using the same approach, one might push the worst of the economic problems past the next presidential election. Given his political skills, that approach syncs up nicely with what is almost certainly Obama’s most pressing personal goal: to avoid at all costs the ignominy of being a one-term president.

Besides, Team Obama could rationalize, even though the quantitative easing will have no lasting effect other than sending government deficits through the roof (a fact that Obama has been very candid about), it will at least buy the new administration some time to come up with another plan that might actually work.

I sincerely believe that just this sort of calculation has been made, and not for practical economic reasons – but almost entirely political ones. Supporting that contention, a large part of the spending in the latest stimulus bill is slated for 2011, the year before the next presidential election is held. Coincidence?

Then there is the $2 billion earmarked for ACORN in that same stimulus bill. While I tend to dismiss the allegations about ACORN’s purported voter fraud as desperate measures on the part of the failing McCain campaign, what we do know about ACORN is that their primary mission is voter registration, and that they are very friendly to President Obama.

It’s all a big win-win… as in “yes we can” win-win the next presidential election.

The way the current mess will actually get cleaned up is through the adoption of measures that support, or at least don’t hinder, entrepreneurs running or starting businesses and expanding into new markets. What we have instead is yet another experiment in more government.

In this matter, at least, Obama has no clothes.

Regards,
David Galland
Managing Editor, The Casey Report

February 23, 2009

Stimulus, Deficit and Elections: Obama Has No Clothes was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.