Equity Shareholders Are Wiped Out As Financial Shares Plummet

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Calamity averted! At least for a day or so.

Markets did not self-immolate over night. But the S&P Banking sector had its worst day out in nineteen years.  It was led—or dragged—by a 34% decline in the shares of mortgage lender Washington Mutual, after an analyst said the company would have to raise capital to offset some US$28 billion in loan losses.

Now the wealth destruction is advancing on two fronts. Equity shareholders are wiped out as financial shares plummet. Meanwhile, assets are being revalued or in some cases, written off. Bondholders will be next.

Here in Australia the credit noose tightened on the economy last month. Gasp. The Australian Bureau of Statistics reported that total lending finance fell by a seasonally adjusted 13.3% in May.  It was the steepest fall in 16 years. “Total lending” includes all kinds of borrowing, personal, business, housing, and leasing.  The only bright news, perhaps, was that business borrowing grew by 3.2% after last month’s 15% drop.

Not all debt is bad. It just depends on what you do with it. If you buy an asset that produces income over time, we’d call it good debt. If you use borrowed money to buy financial assets that are falling in value, we’d call it bad debt.

Yesterday we mentioned how much exposure Chinese official investors have to mortgage debt issued by the GSEs. Today, we read that Chinese firm CITIC has upped its stake in Macarthur Coal (ASX:MCC) to 20.39%. It surpasses steel giant Arcelor Mittal (19.9% stake) as Macarthur’s largest shareholder.

Rock that burns beats paper.

Macarthur does not have a balance sheet full of mortgages, or a vault full of IOUs. It has a mine full of coal. Two mines actually. Between the Coppabella and Moorvale mines, the company supplies nearly a third of the world’s pulverized coal used to generate electric power, according to today’s Australian.

Is energy a better way to store your capital than financial assets? Well, shares in energy companies (and we consider coal and energy commodity, although it is also a steel-making commodity) are still just financial claims on a company’s earnings. But those earnings are derived from a real asset with real demand.

This is why—as bad as this grinding deflating of the financial asset bubble is—you need to keep your eyes open for quality resource assets. They are in demand more than ever, both economically (driven by Peak Oil and Urban China) and as investment alternatives to the slow-motion train wreck that is the American mortgage market.

And then there is the huge construction boom in the Middle East. This has to be a bubble of sorts as well. Soaring oil prices have sent billions of dollars into the Middle East. That money is turning into gaudy construction projects. But at least some Aussie firms are making out like bandits.

Leighton Holding’s (ASX:LEI) Middle East Operation—Al Habtoor Leighton—has landed $1.7 billion worth of projects in the last three weeks. Yesterday the company announced it won the contract for the Al Bustan mixed development complex in Abu Dhabi. The complex will include five 17-story residential towers and a five-story car park. And also a stairway to heaven.

Dubai, the new Babel?

Do you think Dubai will be around in 50 years? Or will it be a giant desert ghost town, and a monument to misallocated capital? If so, it will resemble the empty cul-de-sacs of Suburbistan in Southern California.

The Romans left roads and stadia and aqueducts and walls as visible signs of their Empire. America’s Empire of Debt just leaves busted real estate developments in its wake all over the world. Great for scavengers of copper and wire. Bad for investors.

Hey did you see that inflation in New Zealand is running at an 18-year high? Second quarter consumer price inflation clocked in at 1.6% on the other side of the Tasman. The culprits? Food and fuel. We’ll ask our colleague Mike Graham, who’s filling in this week at Money Morning for Al Robinson, what’s going on.

“Gold Jumps to Highest in Three Months on Risk of Attack on Iran,” reports a Bloomberg story.

Don’t you think gold’s recent strong showing has more to do with the colossal risk to the U.S. dollar posed by Henry Paulson’s plan to save the GSEs? The U.S. government already has US$7 trillion in debt outstanding. What’s another US$5 trillion at this point?

Well, not to be too obvious, but it’s US$5 trillion. Adding that to the balance sheet of the USA puts enormous pressure on the greenback. It should, in the long-run, drive up borrowing costs for the U.S. And you know what that means…higher taxes under McBama.

The Aussie dollar traded at another 25-year high overnight.  Send us your best guess for when the Aussie hits parity with the Greenback. The winner gets a complimentary subscription to both the Australian Small Cap Investigator and Diggers and Drillers. Entries can be e-mailed to dr@dailyreckoning.com.au

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.
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Comments

  1. So the Chinese are selling their $US and using them to buy up Australian assets? No doubt the reserve bank is using those same $US to back the $AUS, since Howard and Co. sold our gold reserves. I can’t help thinking that we’re f****d, can anyone tell me otherwise? Maybe I should start learning Chinese.

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  2. Im my humble view, the world is about to taste some severe economic pain as it realises its been swindled by America. Its clear, in the absence of some miracle, that the US is longer able to pay back its gigantic debt to the rest of the world. If people think the US government will step in and save the day, they should think again, it itself is hugely indebted and technically insolvent. If the US economy begins defaulting, watch the US dollar become nearly valueless and then watch OPEC stop selling oil exlusively in $US and switch to a currency that has some value. OPEC discussed this god-forbidden notion at a recent meeting, so its on the agenda. The $US will have no value if its not the exlusive currency in which oil is traded. Any joker wanting to buy oil from OPEC must swap their currenty into $US, thus given the american currency some power. If OPEC abandons the $US, America will become desperate and will use its military to force mainly middle eastern OPEC countries to stick with the $US. The US has an inglorious and dishonourable history of using its military might on anyone who threatens them or they percieve threatens them. Saddam was selling oil in whatever currency he could get his hands on in the end, thus destablising the cosy arrangement the US has with OPEC and look what happended to him and thousands of innocent Iraqis. A desperate America, a threatened Israel, a biligerent Iran and an arrogant Russia and China. God help us all.

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  3. Justin, the Chinese AUD buying you mention might spike it there faster than a Japanese housewife’s hot money so go short with Dan. In current account terms we have to sell off plenty of commodity producing assets to fund the foreign RMBS borrowing we took back so it is all upside momentarily. We could sell off other assets but only an idiot or a Chinese banker would buy a long term AUD asset liability exchangeable only within our urban services economy.

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  4. Ross look at the trade weighted exchange rate, this is not about the AUD, it’s about the US dollar.

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  5. I think there is too much “excess liquidity” common ground in the stories surrounding both currencies Charles. We got ours from foreigners but like the 1890’s it can run away fast.

    The Chinese are flush with junk USD and need to buy assets that have some value long term. But if Australia goes too far selling commodity producing assets we run the risk of producers controlled by foreign users starting to transfer price (like the shopfront multinational importers do to us on the flipside).

    The reason the USD is trashed is their current account deficit and the long term gap between the cash rate and core inflation (producing excess liquidity and asset price inflation). Our CAD was & is bad and the big control lever we used called “CPI interest rate setting” allowed core inflation to get away on the strength of countervailing import price deflation courtesy of the Chinese and the screwing of our farmers by subsidisers elsewhere.

    Services economies like ours won’t go backward nicely and we have that in common with the US & UK.

    The strength and relative weight (vs others) in the core economy is the other thing needed to support currency. The AUD is not different enough from the USD and being labelled “the battler” has always been appropriate.

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