A Mal-Adjusted Global Economy


Before we begin the next ten years, let’s briefly review the last 30. Americans bought stuff they couldn’t afford and the Chinese sold it to them at prices that weren’t sustainable. That was the gentleman’s agreement between the world’s fading and rising economic superpowers for the last, oh, twenty years or so. But now that the cosy relationship has broken down, what will happen in 2010?

We start the year by thinking about adjustments and indexes. Aussie stocks were down 32% in 2008. The first three months of 2009 were even worse. On Wall Street, the Dow found itself down 25% for the year by March 9th, nearly 54% off from its all-time high. And then the great bogus recovery began.

Thanks to fiscal and monetary stimulus, Western policy makers did the Bear’s work for him. They suckered people back into stocks by creating a bull market. It beat cash. In fact, it beat just about everything. Aussie stocks finished up 31% in 2009 but were up 55% from the March lows. The Dow, not including re-invested dividends, finished up 18.8% for the year and the S&P 500 up 23.5%.

You look at an annual reckoning like that and you’d say the stock markets of the Western world are just fine. They’d be telling you that the financial sector cleaned up its act from 2007 and 2008. They’d be telling you the underlying economies of the U.S., U.K., Europe, and Japan were primed for growth, even if the shares were a bit pricey. And they’d be telling you not to worry about the sustainability of public debt levels.

Trouble is, we’re not convinced at all that the monetary and fiscal measures taken by Ben Bernanke et al in the last two years have really improved things. It’s the trendy thing to say the Feds figured it out and saved the day. But bell bottoms were trendy too, at one time, and think how ridiculous they look now.

In fact, fashion trends change. But sound money must obey certain principles. And there aren’t too many governments running sound money policies in the world. That explains gold’s strength last year and its prospects this year.

The other trouble aspect of the Western world’s economic situation is that households and businesses seem to have adjusted to a new world of less debt but governments have not. That, faced with declining net worth and falling asset values (homes and stocks) households did the prudent thing and reduced spending. You might even say they resigned themselves to a long period of rebuilding the household balance sheet and lowering expectations about stock market returns.

This adjustment-psychologically and financially-is exactly what the world economy needed. But it hasn’t been fully made because the crooks in Washington, London, and Canberra are fighting it. They apparently did not get the memo that you don’t build a great nation by going into more debt.

But if Australia is going to be blindsided by events in 2010, it will probably come from China. China is the other partner in the great rebalancing of global growth. And it is cooperating with maximum resistance. For example, China’s currency ought to be stronger. But Chinese authorities have left it pegged to the U.S. dollar for the last two years in order to sustain China’s export machine, which sustains jobs and employment.

In fact, data last week showed that China’s purchasing manager index-a gauge of manufacturing activity-expanded for the tenth month in a row. Chinese officials are counting on 8% to 9% GDP growth this year. These are all bullish signs for Australia’s resource industry, which feeds the Chinese industrial production machine.

But it looks to use like China’s currency policy has fuelled its speculative bubbles in real estate and shares. For political reasons, Chinese leaders pour money into fixed asset investment. This sustains demand for Aussie resources like coking coal and iron ore. But what happens when China’s bubble pops too?

That’s the event we’re watching for this year. Australia managed to dodge the worst effects of the GFC because Aussie banks didn’t own a lot of subprime CDOs. The credit crunch raised the cost of capital. But it didn’t wipe out Aussie banks.

Australia can’t avoid an involuntary collapse in Chinese resource demand. There is no faking GDP growth with cash splashes when your major trading partner has an asset bubble pop. That is Australia’s big risk this year, and the biggest risk investors must reckon with. We’ll be on the case.

Not that this situation is necessarily knew. Our friend Ron Manners-a real hero of the libertarian movement in Australia-recently published his memoirs. You can them here. And if you’re at all interested in how libertarians have fared in Australia over the last 40 years, you have to read Ron’s book.

Ron points out that the policy mistakes of the 1970s cost Australian jobs and led to unsound monetary policy. The economy recovered with a burst of deregulation and entrepreneurial spirit. But now we are back to the 1970s with bad policy and real economic damage. Where to from here?

Well, literally speaking, to lunch! But tomorrow, and for the rest of this year, we’ll look at the big structural changes that are forced on a country that goes into debt. What happens to China is the biggest factor in Aussie share prices. But what’s bad for shares might, just might, be good for housing.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. “But what’s bad for shares might, just might, be good for housing.” ‘Good’and ‘housing’ in the same sentence! And from Dan Denning!

  2. L Bullock,

    I too am surprised. It is as if Dan is defaulting his investment plans to housing because he cannot think of any other asset class that is safe/worthy of recommendation.
    Global Housing has been saved only by very (exceptionally/emergency) low rates. When the inflation pressure pushes on economies (as they will) and rates have to rise, then housing will be seen as a liability as supply and demand are constrained by lack of funding and more importantly a lack of affordability.
    Would you want your money invested in something likely to decline in value in real terms when you could have it invested in an asset that either maintains its value or appreciates?

  3. Would you please explain that last sentence! Good for housing because prices go up, or good for housing because prices will go down. The way it is left hanging seems contrary to what I have been reading the last few years. Thanks

  4. We can expect housing will retain its value whilst other assett classes dip because the fundamental requirement for the way the system expands and creates artificial value is through housing. The bubble can continue for a long long time because there’s endless support for emergency measures when it comes to not only saving housing value but continue it’s upward spiral. Only a complete and total collapse of any possible way to keep the party going will any Australian government concede their long term failing policies. The property bubble will just rob other productive sectors into the beaucracy and policy will follow maintaining the delerious faith in western politics and poser democracies.

    Drew Weeks
    January 4, 2010
  5. Will the market(s) will allow inflation to execute the necessary adjustments (relatively quietly) or will the market(s) also demand volatility and periodic downward corrections? I don’t know and neither do economists form any fixed school of thought (Austrians, Keynesians, Monetarists whatever).

    I assume that Dan is not spruiking property but is simply being bearish, cautious and uncertain as to where it will all lead. Many would agree with Dan that markets (global and national) now contain significant misalignments and that government stimulus strategies have exacerbated these misalignments. Without the stimulus we would IMO had a worse global recession but we have now traded a shorter sharper downturn for a more prolonged (though arguably weaker variety).

    Money has to go somewhere (banks, bonds, equities, property) and it has to circulate somewhere be it pure consumerism, business development activity or property development. Circulation (or velocity) is I guess just another expression for human economic activity. Long term economic output may simply be lessened by the extent of the stimulus misalignment and (perhaps more importantly) fiscal misalignment (near zero interest rates).

    OK I’m not even following my own prattle very well so what happens next? My guess is that artificially low (global) interest rates have to rise by about mid year. This (if it happens) will hit property valuations IMO but it may hit equities even more.

    The AUD carry trade can reverse quickly if “real” interest rates rise in major economies (this would be good for some of D&D picks other things being equal but my crystal ball goes hazy at this point. .

    It’s a traders market and timing is critical of you are to have a good chance of mailing money this year. D&D and SCI need to take the timing issue up with subscribers separately. For the most part I’m sticking to some junior oilers but each to their own.

    Happy New Year to All!

    Coffee Addict
    January 4, 2010
  6. What exactly do you mean by good for housing?
    If values go up, one group of people are happier (good for them). if they go down, then another are happier (good for me).

    Unpopular Truth
    January 4, 2010
  7. George Soros has been talking about the misalignment of the world’s markets for over a year…did anyone actually believe that global trade etc. was in a state of perfect harmony?

    How many times do we have to go though the same boom-bust cycle before people realise that the economy moves in a cycle whether we like it or not. You can delay a recession, soften the downside even but eventually any imbalance will be worked out.

    Like I said many times last year, the GFC was a nasty economic bubble that went “pop”. In the years ahead some economies will come out winners and others will struggle and I guessing the U.S will be one economy that will struggle. But what DR can’t seem to get their heads around is that the U.S. is not the centre of the world anymore…global trade will go on even if the U.S economy remains flat for years ahead.

  8. “Good for housing” reflects the possibility if prices coming down, and hence, becoming more affordable. IMO.

    Mick Duxton
    January 4, 2010
  9. “We can expect housing will retain its value whilst other assett classes dip because the fundamental requirement for the way the system expands and creates artificial value is through housing.”

    A good comment, except that housing has natural value. It ranks among food and clothing as a necessity. Houses may be overpriced, so might food be, but nobody can change their value. While the population grows, the necessities will find growing demand. Perhaps the population is the ‘bubble’ .. it’s a bloody burst when it pops!

  10. …i think she’s a need a bigger mortgage to wrap around her big fat australian assets and have you noticed how much more work the bigger better houses do?…oops…houses don’t work, not even at all…they just sit, butt at least they appreciate waiting for a date with the next mortgagee…

  11. Bigger Mortgages… bigger houses debate: news.com.au, 29/11/09: ”

    “AUSTRALIANS have the world’s largest houses, beating traditional champion the US, however the cost of renting is similarly expanding.

    Data commissioned by CommSec shows the Australian house has grown on average by 10 per cent in the past decade to a record high of 214sq m, three times the size of the average British house.”

    Bigger houses do actually ‘work’ harder. A family of ten rented our beach house for five years straight, paying off nearly a third of the mortgage for us.

    Property ‘works’ _at least_ as hard as gold ingots buried in the back yard… or in a vault… . Each to his own.
    Agree with Dan’s comment: “…housing has natural value. It ranks among food and clothing as a necessity.”
    Rising population and reduced construction will determine future property values… .

  12. mike, well of course the only reason people (except for _us_, of course) are alive is so we can make slaves of them, right? In which case all they need is a 2x1x1 metre box to sleep in, and anything else is an excess. They will still work, right? Just as hard, and be happy and peaceful, right?

    The problem with the industrial revolution was that it took people out of their ancestral homes and comfort (farmland, albeit with frequently short life expectancy) and shoved them into smoking cities and socialistic/capitalistic dog-box housing and suburbia, in order to make a select few rich. Nice homes in the city reflects the fighting back against this phenomenon by the working man by trying to eke out some kind of meaningful life out of the empty and meaningless one into which their forefathers were coerced.

    People generally don’t have much left to hold onto in life (they’ve forgotten most of it) – their material possessions, (ie: house, car, etc) are one of the few things left.

  13. @ Pete

    We compare apples to pears here.

    In squaremeters it might be true – but then again I can assure you – if GB had more landmass e.g the size of Australia – they would built the same kind of houses!
    So the only comparison valid is with a country having approximately the same ratio landmass/population – you probably won’t find it!

  14. Dan that is an amazingly bleak outlook on life you have there.
    What exactly stops you from having more than the bare minimum? For a lot of people, it’s because it’s not handed to them on a platter.

    If you honestly think people were all better off being farmers then I suggest you do some more reading on those time periods in human history. It sucked pretty hard.

    Unpopular Truth
    January 5, 2010
  15. I do wonder why we try to compare house prices between countries when there are so, so, many variables. We struggle to get meaningful data for the real estate market in Australia let alone trying to then compare our house prices with say the U.K.

    Also why do most people only ever compare house prices in English speaking countries? Do we have some shared housing preference or style? I don’t think so.

    And just to make things more complicated we need to factor in climate. That’s right, housing styles are affected by climate so it no use comparing a house in one country to another unless they are in a similar climatic zone.

    All this before we even get to building codes, labour costs, government charges, taxes, available infrastructure, desirability etc.

  16. Stan,

    If GB had the same land mass .. They would build the same kind of houses!
    Not really now would they. The climate in GB is significantly different to anywhere in OZ. For example, in the U.K it is now standard practice to have double glazing. All lofts are tiled and lagged. Each UK house is many times more fuel efficient than an OZ house. Please take care make generalised statements as a house in the UK costs much more (not just land) to build than here because the quality materials required (double brick and not wooden frame).

  17. Stan, that’s one of the issues, I agree. But even rural properties at which we stayed, with large acreages, generally had smaller homes. We covered a lot of distance in England and Scotland. Most homes were much smaller than any we build, so it’s not just simply a smaller land mass issue. It may have a lot more to do with the age of the homes, despite the fact that our forebears had larger families. An immense number were built before the invention of the motor car, so private garages are a rarity in many towns and villages. What remains surprising is that sellers are still asking prices which seem extraordinarily high to us, compared to Australia. Perhaps your rationale is that less land means every block will have greater demand(?); and I agree, that’s a likely explanation. Another explanation is that heating a large(r) home in the UK is prohibitively expensive… as it is becoming right across the northern hemisphere.

    My reading of the article, however, was that in terms of house size, Aussie homes _are_ now the biggest.

  18. Smaller homes = easier to heat. Ever seen a big igloo? :)

  19. Interesting to see three simultaneous responses to the same blog. Joe, we’d agree that newer houses were heated more efficiently. Many were heated no more efficiently than our own main property in West Oz… four fire places. We experienced double _and_ single glazing. We stayed in homes which were insulated… and some that weren’t… but we’d agree completely with all respondents that climate issues are critical.

    Greg, we experienced total extremes in Mexico…. one apartment sweltering… poorly designed; another casa beautifully designed (took a lot of pictures!) and air-conditioned efficiently. Unfortunately most homes we visited were generally the former; mainly due to cost considerations and lack of efficient environmental design. What’s the current situation in Japan?!~

  20. The styles/design in Japan vary depending on the climate as I mentioned above since people tend not to want a nice open tropical style home in areas you get a few metres of snow in Winter! Tends to be the case wherever you go in the world. Of course modern homes are built to be energy efficient.

    Not sure I have ever visited a country where there was anything close to a “standard” house apart from maybe some of the smaller European countries.

  21. Funny you should mention “…a few metres of snow…” Greg. We just arrived home after climbing much of Mount Washington with snowshoes!! Strange to see just the tips of 7m pines and firs sticking out of the snow around us.

    The ‘standard home’ is becoming more common in WA. It tends to be 4BR, 2BR, Cin, Open Plan, large covered patio, DG. We are breaking away from that design, ourselves. This may be in response to a ‘downsizing’ trend we sense coming. News item from the US today. For the first time in history, _single-person homes_ outnumber all other forms of residence in the US(!) It’s not that trend we’ve anticipated. (We were surprised by the US data!) We sense that many BBs, unprepared for retirement, may downsize. We’re also preparing to accommodate DINKs who want five years in an easy-care 3BR rental under $400 pw, close to the beach.

    Our experiment with a three-garage home will still be interesting! Nothing ventured, nothing gained… .

  22. 76 m2 average for a UK home.
    In Brisbane 70 m2 is called a secondary dwelling (ie granny flat.)
    Although UK homes are the smallest in Europe apparently.


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