10 years ago The Daily Reckoning launched in Australia. We had one mission: to give you an alternative analysis of the finance news and to give you alternative strategies to profit and protect your wealth.
The underlying philosophy of The Daily Reckoning has been and always will be this: ideas matter. Recently, I sat down with DR Managing Editor Dan Denning to discuss on very important idea for Australian investors: that the economy is in deep trouble.
It was a long chat. You can read it in parts over the next three days, including the first instalment below. Comments and feedback are welcome to email@example.com. But please, no birthday cards.
Callum Newman: Hi Dan. First off, has it really been ten years since the Daily Reckoning Australia was created?
Dan Denning: Hi Cal. Yeah, amazingly, it has been ten years since the whole project kicked off. It was actually Bill Bonner’s idea. I was working with him in London at the time. I’d passed through Perth and Sydney in 2004 when I was doing research for my book The Bull Hunter. When I got back to London I told Bill that Perth was booming, house prices in Australia were expensive, and that with compulsory superannuation and rubbish investment advice, it might be a good place for a publisher to start a business.
CN: What happened next?
DD: Well, Bill’s basic idea behind any publishing business is that it comes down to people and ideas. The ideas come from people who are independent thinkers that actually have something useful to say. By useful, I mean that they have ideas they believe can make your life better by making you richer, smarter, healthier or just better prepared for risks. The ‘people’ are the readers. You have to be in a place where there’s a market for alternative ideas and insight. People don’t have to agree with the ideas even. They just have to find them a valuable addition to their investment decision making process.
CN: And you thought Australia was that kind of market?
DD: Absolutely. We did some basic research and found that there were two major media companies. That meant that most economic issues and investment stories were going to be covered from more or less the same perspective. We also found that with compulsory superannuation, the money managers and stock brokers didn’t have to work that hard. Imagine a business where your customer had no choice but to send you 9% of his salary every month! And imagine that what you did with that money, your performance, didn’t matter either. The money, by law, HAS to keep coming?!
CN: That’s a great business.
DD: It IS a great business. That’s why all four big banks have what they call ‘wealth management’ arms. Commonwealth Bank owns Colonial First State. NAB owns MLC. Westpac owns BT Financial. And ANZ owns what used to be ING. The financial planners in the banks can sell the products produced by the ‘wealth management’ firms. That’s great for a bank if it’s having trouble making money from mortgages or regular loans. It’s not always great for customers though.
CN: But what did any of that have to do with your decision to start the Daily Reckoning in Australia?
DD: Oh yeah! Well, Bill started the Daily Reckoning in the United States back in 1999. It was at the height of the tech mania. And everyone said the Internet was going to kill the publishing business. Bill pointed out that it didn’t necessarily have to be so. The Internet is really just a medium for communicating ideas. In other words, it ought to be a huge opportunity for people who have ideas that the mainstream won’t publish.
You don’t need to get a job with an investment bank or a newspaper and toe the party line. You can take your ideas directly to the public. And if they like what you do, or find value in it, they’ll pay you. The Daily Reckoning was started to showcase those ideas on a daily basis. Bill would write about the markets. It was a great time for it.
Remember, it was a mania. People were buying the IPOs of stocks with no business plans and no products! Bill would bring his knowledge of history, his sense of humour, and his experience as a businessman and investor into play and write about how stupid people were being.
Or, he’d write about what you OUGHT to be doing if you want to build long-term wealth and not get burned by a stock boom. You’d learn how to judge a business and decide if it’s good. You’d learn how to value that business and what to pay for it. Most of all, I think what he wanted to do is produce something every day that made people think. You do that by trying to present a genuine and well-thought out alternative perspective.
Like I said, people don’t always agree with that. But it’s free! You get what you pay for. We also knew that if you expect people to spend money buying serious financial advice from you, they have to know how you think, where your ideas come from, and that you’re not just some kook on the Internet with a fast modem. You have to build up trust by building up a relationship. And you do that the way you would any other place in life, by communicating and getting to know each other.
CN: So about Australia….
DD: Oh yeah! Sorry Cal. By 2004 the Daily Reckoning had US and UK versions. I was based in London at the time, working on a macro-economic/big picture newsletter called ‘Strategic Investment.’ Bill was there at the time too. When I got back to London after my big trip in 2004, we started making plans to see if we could launch the Daily Reckoning in Australia. That was in July of 2004.
The plans took shape and actually it was Kris Sayce who put his hand up to be the first Australian-based editor of the Daily Reckoning. He responded to an advertisement I published in the UK version of the Daily Reckoning. For about three months, we worked together remotely, writing trial versions of a daily e-letter for the Aussie market. Then, in early 2005 we launched it. It’s been going strong ever since.
CN: In fact it’s gone so well that Kris split off and started doing his own thing a few years later and now there’s two daily e-letters. And now you find yourself on the opposite side of many investment issues.
DD: Yes and no. The Daily Reckoning Australia reached over 100,000 readers by 2009. We got lucky with the timing. That is, by 2009 a lot of people were looking for an explanation of what was going on the world’s financial system. It’s something we’d been writing about for years. We had an alternative explanation that you couldn’t find in the papers or from your broker.
And that explanation came with specific investment strategies (mostly sell stocks and buy gold at the time). Kris was an integral part of that strategy. But based on reader feedback, we knew what some readers didn’t want to read about history, philosophy, or the morals of markets every day. They just wanted alternative ideas about what to buy and sell. So Kris broke off and started an Australian version of Money Morning.
That’s more market focused, although it would be wrong to say Kris doesn’t have his own ideas and philosophies. He publishes those in another free e-letter called the Pursuit of Happiness. I’d say that today, the Daily Reckoning Australia is still doing what we set out to do in 2004: give Aussie investors something to think about by really challenging mainstream ideas and strategies. Kris is doing the same at Money Morning.
Where we probably differ the most right now is that he’s quite bullish and picking lots of stocks in the newsletters he publishes, whereas, as you know, the boys in the Daily Reckoning group have a much different and much more bearish view of markets. That obviously leads to a totally different strategy.
CN: Let’s get to that strategy in a second. But first, readers of both Money Morning and Daily Reckoning find it confusing that different people working for the same business often have completely opposite views on what to do in the market. Can you explain how that works?
DD: Yeah I think some readers DO find it confusing. But you’d only find it confusing if you’re the sort of person who’s looking to be told exactly what to do with your money. That’s something a broker or a financial planner would do for you. But once people see what we’re trying to do, they tend to like it and stick around. And those that don’t like it don’t have to pay for it or unsubscribe if it’s not for them.
CN: Can you explain what you’re trying to do?
DD: Well as I said, we’re trying to give people ideas, to make them think, to challenge conventional wisdom, and to entertain as well. The type of reader who enjoys the Daily Reckoning is someone who already thinks for himself, but recognises that you might be able to gain an advantage by getting an informed and alternative point of view. He’s already got a plan for his money and his retirement. But he’s always looking for ways to improve that plan, or ideas he can plug into it.
CN: Right. Well let’s shift gears and talk about a specific prediction you made in October of 2013 and see how a reader could fit that it into his plan. You went on the record and said Australia would have its first recession in 23 years this year. Why did you say that? Is it happening? And what kind of plan did you give readers based on your prediction?
DD: Yeah okay. That’s three questions by the way! But, yes, I did go out on a limb a bit last year and predict a recession this year. Keep in mind, a recession is defined as two consecutive quarters in which GDP shrinks. It’s not slower growth, or ‘negative growth’ which are useless terms. It means the economy is getting smaller.
There’ve only been two quarters of negative growth in the last twenty four quarters if you go back to 2008. It happened in the fourth quarter of 2008, when the economy shrunk by 0.7%. And it happened again in the first quarter of 2011 when the economy shrunk by half a percentage point.
CN: Well given that there’s only been two negative quarters of growth—in total—in the last six years, and there haven’t been two consecutive quarters of negative growth in 23 years, doesn’t it seem unlikely it will happen this year just because you say so?
DD: It’s not going to happen just because I say so. But if it does happen, people need to know what’s at stake. GDP is just a number that measures the quantity of spending in the economy. It doesn’t measure the quality of that spending. Or the quality of that growth. Australia just had a once-in-century resources boom.
That boom is over. And yet the government is running a record deficit, interest rates are at ‘crisis’ lows, households have record debt, and the big things that drove the boom are now working against us. That means you’re going to see rising unemployment, lower wages, and more and more industries struggling to make a profit. All of this has big consequences for investors. But more than that, it has big consequences for every single Australian. That’s why I issued the warning.
CN: That’s a lot to digest. Can we break that up into bite size pieces and chew on them one at a time? Maybe start with what GDP measures and then get to what it’s telling us about the health of the economy?
DD: Sure. And health is the right word. You can think of GDP as a plate of food. The foods on the plate have different caloric and nutritional values. For example, nutritionists will tell you about ‘good carbohydrates’ and ‘bad carbohydrates.’ Good carbs come from fruits, vegetables, and whole grains. When you eat them, your blood sugar levels don’t spike.
And because they have lots of fibre, they’re good for your digestion. Bad carbs come from things like chips and beer. Don’t get me wrong. I love beer. But those carbs get stored in your body and turn to fat. It’s the same thing with fats. You can get good, low cholesterol fats from things like nuts, avocados, and olive oil. But if you’re eating lots of processed food, you tend to get bad fats that raise your cholesterol levels and can lead to high blood pressure.
CN: What does that have to do with GDP?
DD: I was getting to that. Not all economic growth is healthy. It depends on where it’s coming from. GDP is like having a plate full of calories. If you want to know how healthy it is, you have to know where the calories are coming from. The headline number—the one the papers report or that you see on the news at night—just tells you the total number of calories. It doesn’t tell you whether the patient (the economy) is healthy or is headed for a massive heart attack.
CN: I take it you believe the Australian economy is headed for a massive heart attack?
DD: It’s certainly possible. But at the very least, I’m talking about high blood pressure, shortness of breath, and obesity. Here’s why. You have to break it down into the components that make up GDP. They’re not all equally healthy. The formula itself is actually really easy. It goes like this: GDP= C + I + G + (X – M). The ‘C’ is for consumption, which is mostly consumer spending. The ‘I’ is for investment, which is mostly business spending. The ‘G’ is government spending. And (X – M) is the difference between exports (X) and imports (M). And trade surplus adds to GDP. A trade deficit subtracts from it.
CN: That’s all pretty straight forward. But you said not all components of GDP are equally healthy. Can you elaborate on that?
DD: A healthy economy is one where you have low unemployment, growth in per capita wages, strong investment that creates new jobs, low government and personal debt, and strong productivity growth. Productivity means you’re increasing output per person without increasing costs.
That’s an economy that creates jobs, encourages the formation of new businesses, delivers new goods and services to consumers, and allows families to enjoy a high quality of life without resorting to credit cards or a second job or a second mortgage. What I’m saying is that you get that kind of healthy GDP from espousing some basic economic principles. One of those principles, for example, is called ‘Say’s’ Law.’
It’s named after the French economist Jean-Baptiste Say. He said that ‘products are paid for with products.’ Today economists would say that ‘supply creates its own demand.’ But what it all means is that a healthy economy gets wealthier through production. If you produce goods and services, then you earn an income that allows you to buy the things you want and need.
CN: That seems pretty obvious, though. Why would you call that a basic economic principle?
DD: It DOES seem pretty obvious. But think about what GDP measures. Remember, everybody takes GDP to measure the health of the economy. But the ‘C’ in GDP measures how much people spend. It doesn’t measure how much they’re producing. That matters a lot these days because so much of consumption is financed by credit.
Another way of thinking about credit is that it’s spending without previous production. If you can buy things with borrowed money, it means you don’t have to produce anything to earn an income in the first place.
When an economy relies on consumption for growth, and that consumption is financed by credit, you basically have a whole country that’s chosen to live above its means. You have a country that consumes more than it produces. Yet the GDP measure would indicate that everything is healthy.
CN: But Australia does produce a lot.
DD: It does. And I’ll get to that in a second when we look at exports. But back to the debt that’s financing consumption. The Reserve Bank of Australia keeps track of the ratio between household debt and disposable income. They keep track of it because it tells them when Australians are cautious, which is a low debt-to-disposable income ratio, and when they are speculating, which is obviously a high debt-to-disposable income ratio.
The current household-debt-to-disposable income ratio is almost 149. That means for every dollar in spendable income an Australian household has, it has a $1.50 in debt. This really tells you how far people are living beyond their means. That’s important because right now, with the cash rate at 2.5%, the cost of paying interest on variable rate debt is low. But if it goes up, or if someone in the household loses a job, disposable income goes down, while the cost of the debt could go up. In other words you have a lot less margin for error when the ratio is this high.
CN: How does the current ratio compare to other periods or other countries?
DD: That’s a good question. According to the RBA figures, the ratio hit an all-time peak in September of 2006. It was around 153. It fell a bit during the GFC. But here’s the thing that’s unique about Australia: during the GFC, households in the UK and the US actually took a cautious view of the economy and paid down their debts.
Australians did the opposite. They actually took on more debt. The household-debt-to-income ratio went up. Or, in economic terms, Australians levered up. To me that’s a sure sign that you now have people speculating on higher house prices. And that’s very dangerous.
CN: You point out countries like the US and the UK. But I can think of two big differences between those countries and Australia. First, they both had housing crashes. That put households in trouble and it put banks in trouble. Second, they both had recessions. People lost jobs and their incomes fell. Neither of those things has happened in Australia. And even after that big fall in GDP growth in the fourth quarter of 2008, the economy bounced back in the first quarter of 2009 and grew by almost one per cent.
DD: It was 0.9% in the first quarter of 2009. But I’m glad you mentioned it because it brings me to another point about GDP. It can be easily distorted by government spending. In February of 2009, the government passed an emergency stimulus bill. It contained $42.5 billion in spending (money the government had to borrow and pay interest on, by the way) designed to prevent the economy from having a second negative quarter and entering a technical recession. Remember, this was after the government has already spent $10.9 billion in the famous ‘cash splash.’
CN: Are you going to tell us how bad the Rudd government was now?
DD: Not at all. My analysis of the GDP figures is non-political. My point is that no matter who’s in government, if they decide to spend money they don’t have, it can give Australians a false sense of economic security by distorting the GDP figure. The Rudd government stimulus added up to over $95 billion, or about 4.6% of GDP. In terms of size, Australia’s stimulus was bigger than Germany’s and the UKs. Not all the money was spent at once, mind you. But the interest alone on that borrowed money is over $4 billion a year.
CN: Keynesian economists would argue it kept us out of recession.
DD: The government stimulus fuelled household consumption. That boosted GDP in the first quarter of 2009. But by the second quarter of 2009, GDP growth as was back to 0.1% In other words, people blew the money. It made GDP look better. But conditions in the underlying economy weren’t any better.
In fact, they were worse. Both government and household debt began to rise again. If the government had let well enough alone, people would have seen the fourth quarter GDP figure for what it was: a signal that it was time to be more cautious, to pay down debt, to live within your means, and to wait for the economic cycle to improve. Besides, the Australia stimulus had a lot less effect on the economy that what China did in 2009. China’s stimulus was 4 trillion Yuan! That was over 13% of Chinese GDP.
The Chinese freaked out because their fourth quarter 2008 GDP growth was around 6.8%. That meant the Chinese economy wasn’t creating enough jobs to absorb the supply of migrant labour coming to big cities.
So they pulled the trigger on a massive stimulus. It amounted to just under $600 billion—or 50% of Aussie GDP if you like! If you look at the figures, more than half that, or around $300 billion, was infrastructure spending. That’s what created a huge surge in demand for iron ore and coal. And that’s why export prices and earnings spiked that year, which also helped GDP.
CN: So you’re saying the stimulus in Australia added to household and government debt, contributed short-term bogus GDP growth, and that Australia could have spent that time paying down debt and waiting for China to deliver a far bigger benefit to GDP later in the year?
DD: Exactly. Government spending always delivers a short-term boost to GDP. But what you don’t see are the costs of paying interest on the debt. That’s because the government doesn’t have a surplus anymore. If it wants to spend money it can only get it two ways. It can raise taxes on you or on a corporation. But if it does that, it lowers the ‘C’ and ‘I’ in the GDP equation because it takes money out of your wallet or money a business might invest. The other option is to borrow money. That’s what it’s been doing. Total government debt is now over $300 billion.
CN: Some people might be wondering, wasn’t that worth it?
DD: You’ll have to ask the people who are going to be paying for it for years to come. They get the interest bill on the debt without the plasma screen TV. The way I see it, recessions are like medicine. They cure the disease of too much debt or speculation and bad investment decisions. Recessions are the economy healing itself and preparing for another phase of growth based on savings and production. You can avoid technical recessions by boosting GDP through government spending. But the cost has to be paid later.
And what’s worse, because so many people misunderstand GDP, they took the ‘no recession’ signal as a sign that it was okay to borrow. That’s why you have house prices soaring in the capital cities. And that’s why you have us approaching record household-debt-disposable-income levels.
Stay tuned tomorrow for why Australia is still heading for ‘Recession 2014’
for The Daily Reckoning Australia