Bernanke Calls U.S. Economic Recovery “Nascent”


It looks like Kris Sayce will be buying us those three beers after all…

You’ll recall that the wager we made last week with our colleague down the hall was whether or not the Fed would raise the Fed Funds rate in the next three months. Your editor – based on his vast knowledge of the Fed – reckoned no. Kris reckoned so.

So far, it looks like we’re going to win. Ben Bernanke fronted Congress yesterday and called the U.S. economic recovery “nascent.” That seems pretty generous, given that January new home sales fell 11.2% from the month before the lowest-ever level on record. That sounds like a second housing bust, more bank losses, and the increased deleveraging of American households.

Markets didn’t hear any of what we heard though. The S&P 500 was up nearly one percent. And to be honest, we know as much about the future as the next guy: nothing. It could be that the Fed chairman is right and consumer demand will slowly recover and things will be rosy again.

But remember, the central bankers telling us that America’s recovery is “nascent” and that Australia will benefit for many years from a “very big” investment boom in the resources industry are the same blokes who did not give you a single warning about what was coming in 2007 and 2008. Why is that?

They weren’t looking hard enough. The blame for the global bust has fallen on too much leverage and too much speculation. A deeper blame falls on the structure and the ethics of the modern economy itself. It seems to favour debt and speculation and reward money shufflers. But that doesn’t tell the whole story either.

The whole story begins with the manipulation of interest rates. The credit cycle – in this case lowering interest rates to avoid the necessary liquidation of bad investments – is what turned the crisis into an American housing crisis. Securitisation and credit default swaps turned it into a global problem infecting the whole financial system.

But the central bankers refuse to acknowledge that booms and busts are predictable if you study the credit cycle. Maybe they do understand this, of course. They just don’t want anyone else to understand it. How else could Alan Greenspan take himself seriously by telling us this is the worst financial crisis ever – but not acknowledging his indispensable role in making it possible?

However maybe we’ve been couped up in our St. Kilda redoubt for too long. So we’re hitting the air and on our way to freezing, snowy, Baltimore to meet with some colleagues and discuss what to do. We already have a plan.

In the meantime, Australian markets are motoring along contentedly. In fact the economy has recovered so nicely that several investment banks are worried that the government deficits are going to be smaller than expected and that – get this – there won’t be enough government bonds to satisfy market demand.

Quick! Borrow more money so the bond market is happy!

Figures from Deutsche Bank and Citigroup both show the annual fiscal deficits being smaller than expected through 2016. These smaller deficits (they’re not going away entirely) are presumably the result of increased royalty income from the commodity boom, a favourable terms of trade, and solid GDP growth. Spending probably won’t go down much, if at all. But national income will go up. Anyway this is what the banks have looked into the future and seen.

Yesterday’s Financial Review even mentioned the possibility that a shrinking government bond market would be a problem for Australian banks. That’s because a new regulation proposed by the Australian Prudential Regulatory Authority (APRA) would require a certain percentage of bank assets to be made up of high credit quality bonds.

Only government bonds (sovereign debt) would appear to satisfy the requirements. This is convenient for big borrowing governments. A similar rule in the UK is under consideration and it provides the government there with a similar captive market for its bonds. The banks must, by law, own some government debt.

But what if Australia’s government isn’t borrowing enough to meet bank requirements for “safe” government debt. To be honest, we’re not losing any sleep over that problem. Australia’s demographic dilemma is not as acute as other countries. But with an ageing Baby Boomer population, you can surely expect higher aged pension and health care expenses at the federal level. That’s going to take some borrowing.

But yesterday’s article – and we can’t give you a link to it because there isn’t one – said an alternative is being discussed. You’ll never guess what it is…mortgage backed securities!

No kidding. With a straight face, someone has apparently suggested that the best way to improve asset quality for Australian banks is to make them buy mortgage backed securities. Are you kidding?

The banks set up other companies to engage in the non-traditional lending business precisely because they don’t want that stuff on their balance sheets to begin with. It’s hard to imagine you’d improve the quality of bank assets by forcing them to take on more assets that are collateralised by real estate. Remember…that did not work out so well for American banks did it?

But then, Australian house prices never fall. So perhaps collateral securitised by Aussie houses is, well, safe as houses. But you wouldn’t want to be the solvency of the banking system on it, would you?

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 then, Australian house prices never fall.” I do assume that is sarcasm meant to make all Aussies who have property sound like idiots Mr Denning?

    How about “Sometimes in severe recessions Oz house prices have fallen by as much as 20%” ? Or “When Aussies have been really concerned the baddies might invade, plus in the two full-on depressions we’ve had, some Oz house prices have gone down a LOT!”

    Followed up by “What do you think is happening in the Oz economy right now?”

  2. Property fell an average of 5.5% across Australia. It’s worth remembering that the ASX fell nearly eleven times that amount. In some locations housing prices may have fallen by as much as 20%; in others virtually zero.

    As interest rates rise, it’s predictable that construction of new housing will slow. It’s likely too, that rents will rise. As population rises in QLD and WA, accommodation will become scarcer… and more expensive. Labour costs are part of that expense. Our builder’s quote for building a new house, identical to that currently being completed, is already 6% higher.

    From extensive travel in the last four years, it’s our belief that property and banking are more secure in Australia than in any other country we’ve visited. That’s not to say we won’t experience some plateaus and minor corrections.

    Remember that those old adages ‘As safe as shares’ and ‘As safe as gold’ were both coined for good reason… . ;)

  3. The Oz economy has significant risks – “If” (or more reasonably “when”) China has a flat spot (with the timing being China’s choice whilst they’ve still got cash), then Oz is very likely to have an even nastier flat spot. During which the Oz guv will borrow and spend against future earnings to tide us over.

    But given those “risks” I mentioned, I surely do accept that Oz could do it a bit tough at some unknown time in the future. Which probably makes it really important to try and profit from all and any purple patches. IMO.

  4. Ned, Ned… where’s ya faith, son?! We’re “As safe as Super!~” ;)

  5. The “safety” comes from having taken advantage of the good years to be prepared for if/when the not so good years come Biker – Just in case! ;)

    But, Yep, there’s some good things happening in WA and even QLD right now from what I can read. So it probably really isn’t a good time to be spending too much time gazing into gift horses’ mouths is about all I’m saying. (But HAVING said same, I’m still a hedge me bets regardless kind of bloke.)

    And Yes, I do recall that the last time you mentioned super, you said you were moving away from it … :)

  6. Ned: “I do recall that the last time you mentioned super, you said you were moving away from it … :)”

    To clarify: 1.) We stopped sal-packing when we realised our property claims had already got us down to sub-zero… there was no advantage in Super, tax-wise any more; 2.) I’m now about to commit a large sum to Super… then pull it all out, except for $150K; in less than two months. (Sooner, if there’s a double dissolution threatened!”) That sum can stay in, to move between cash (high ASX) and shares (low ASX). That has paid off twice. It _may_ work again.

    I guess I’m ‘hedging me bets’ with that indexed-funds-style-strategy. ‘Lucky’ so far… . You can enjoy a good laugh if I crash-and-burn… :)

  7. Don’t like to see anyone crash ‘n burn Biker – Sends shivers up my spine along the lines of “There but by the grace of go I” perhaps?

    I’ve been looking into Transition to Retirement. Earnings on Capital in super become tax free? 15% tax rebate against other income (I think???). $150k Low some-bloody-thing-or-other tax free threshold on drawdowns. Then upon further geriatricancy the Senior Australians Tax Offset etc, etc.

    So Yes, fully suspect I’ll have way more tax credits than I can burn also?

  8. Ned: “So Yes, fully suspect I’ll have way more tax credits than I can burn also?”

    It depends, Ned. For years the maximum tax we’ve paid is 15%… but remember that our scenario was based on quite a few rentals PLUS maximum sal-pack.

    Last year’s completion and rental of five more houses actually caught us out. We’d got our sums _slightly_ wrong. We had far more write-offs than we needed. It could have been ‘worse’. Our goal had been six houses… !

    The TTR is ‘icing-on-the-gingerbread’. We pull the minimum, simply because we don’t need really it. Hard to resist those extra tax-free bucks, though!

    In _our_ situation, our super in TTR has _already_ paid its tax. It now works in an entirely tax-free environment. We’ve created an exact balance, in which earnings match TTR payments. No tax on the money while it’s working; no tax on monthly payments to us. Got that one right.

    I was kidding about ‘crash-n-burn’, mate. It’s fun money… . :)

  9. Ned: “Then upon further geriatricancy the Senior Australians Tax Offset etc, etc.”

    Yes, sorry Ned. Missed that. Yes, it clicks in at 55.

    Didn’t need it. As I mentioned earlier, we could also have been writing-off interest on vacant lots, for which we had building plans drawn. Didn’t need those claims, either. Wish some canny old bustard had clued-me-in on all this when I was twenty.

    But here I am… throwing PBS… and earning a star… and minus three thumbs. Gotta laff…! :)

  10. My only concern with super is the governments (all) insistence on meddling with the rules. I am only 42 so I am some way away from being able to take even a transition to retirement position and have a sneaking suspicion that as I approach the 55 year point the rules will have changed.. again… We are, imho, heading to a point in time where you will only be able to draw a pension from your super to stop people taking lump sums..

    February 25, 2010
  11. Shoes: “We are, imho, heading to a point in time where you will only be able to draw a pension from your super to stop people taking lump sums…”

    Hence my fear of a double-diss!~ :)

  12. Shoes – surely you don’t think that if the government is saddled with several hundred billion in debt it will start to look longingly at the trillion or so in super holdings? I am confident that it wont make up some silly scheme where they will “hold” your lump sump and index a pension from it. Nah – no chance of that! Bet on form mate, always bet on form :) oh wait that means…..

    Jokes aside I am like you, 40 this year and I believe your assessment is bang on the money. Pension coupons for premium cat food is about all I am expecting from the government for my retirement, all the more reason to not rely on them :)

  13. Don: “I believe your assessment is bang on the money.” No doubt there…

    Being much younger, my missus may actually be caught. Her super is only 71% of mine, but I’d talk her into retiring _the very day_ they announced any significant change to the system. Already our capacity to write-off CGT via Super has been reduced to $900K every three years, ie., $150K each per year.

    We can live with that. All we really want from our investments is a comfortable independence.

  14. Judging from past form the annexation of super will happen because of a crisis of some kind, enough to cause panic and then the government will make like those roulette staff at the $2 tables – sweep out its arms and rake it all into the hole :(

    I hope I get some prior notice, I will withdraw the lot from my SMSF, buy a truckload of bees and release them into parliament house. It wont delay the vote by much but I can’t think of a better use of the funds.

  15. Don, you’ve just given yourself prior notice :) But quite right, the Government waits for opportunity to strike to carry out its plans. Sometimes it ‘creates’ its own opportunities. Problem/reaction/solution.

  16. I have to admit it is very tempting to “let slip the bees of war” now Dan, but I want to wait for the right time to get maximum value for my investment :)

  17. Don: “I want to wait for the right time…”

    So hard to get the timing exactly right, Don. Too many Bs already in there…

    I’m thinking it’s time to pull my super now… well, in 48 days, anyway.
    KRH is a factor, age is a factor, next week’s probable rate rise is a third.

    We’re about to create another ‘tier’ of offset accounts. We’ve been told we’re actually one over the max allowed in our ANZ package. They’ve been flexible, but wouldn’t extend that discretion. We get another free credit card thrown in, anyway…! :)

  18. I recall John Stewart explaining on Inside Business about 4 months before he departed as to honcho at the NAB that no one could have foreseen that the triple A rated CDO’s his bank had brought would turn out to be next to valueless. Bye Bye $1,000,000,000 …

    I watched and listened that quiet Sunday morning not believing what I was witnessing …. Write off $1 Billion and no one batts an eye lid …

    So how on Earth is the government, the rating agencies, and the banks going to value securitised real estate .. They’ve already demonstrated most perfectly that they cannot manage the job.


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