Getting Begotten


And Bear begat Lehman. And Lehman begat Dubai. And Dubai begat Greece. And Greece begat Spain. And Spain begat Italy. And…hold on!

Who begat Hungary? North American markets tanked on Friday on a double barrel of strange and disappointing news. First was a comment from a spokesman for the Hungarian president that the country faced a “grave” economic situation. Debt begat that.

But the 3.15% fall in the Dow Jones Industrials and the 3.44% fall in the S&P 500 were generally blamed on a disappointing U.S. jobs report. That report showed that the U.S. economy added 431,000 jobs in May, which seems like a lot of jobs. But the median forecast from, ahem, economists was for exactly 536,000 shiny new jobs.

The more discouraging news was that the private sector added only 41,000 jobs in the month, and that’s assuming the numbers are accurate and can be trusted. All the other jobs were related to temporary census workers in the U.S. working on the Federal dole. That’s not much cause for encouragement.

The bigger weekend story is that Europe and America are at odds over whether they should continue spending money they don’t have. That is, according to news reports, U.S. Treasury Secretary wants countries like China and Germany – countries with current account surpluses – to unleash private sector demand! Spend money, he says, because we Americans are flagging, and already have too much debt.

The Europeans apparently knocked Geithner back on the suggestion. This prompts the question: has official Europe really chosen the route of austerity?

And if so, will they stick to it? Will their populations let them if it means lower growth and higher unemployment and fewer government services? It will be a very stern test for public finances in a modern democracy. And in the meantime, the Euro is getting sicker against the dollar (which may not bother German exporters too much).

Geithner reportedly told the Europeans that the road back to public sector fiscal sanity is long and winding and that they could put off the journey for a day or two. We didn’t see him anywhere advocating larger public spending and stimulus. But still, in the sense that he sees aggregate demand as the key to a global recovery, Geithner flew the flag of Keynes in South Korea this weekend.

The result is a policy stalemate, at least if you were expecting a coordinated global economic strategy, complete with a tax on banks. Come to think of it, that isn’t a bad result after all, is it? It’s certainly welcome in Australia, where the locals have argued the banking sector is better regulated and capitalised than in the North Atlantic economies.

It looks to us like the global bank tax is the developed world’s way of getting the developing world to pay for bank failures. So it’s no wonder it was opposed by China, Brasil, and Australia. Mind you, we have our own reservations about the quality of bank assets domestically. And it’s clear that no matter how sound Australia’s financial system may be, it would be affected by a capital crisis in Europe.

“Australia’s banks are reliant upon global capital markets to fund a significant share of their balance sheets, including rolling over growing volumes of maturities. In 2009 around two-thirds of bond issues by Australian banks were into the offshore markets,” says’ Westpac’s Chief economist Bill Evans in today’s Australian. Bloomberg reports that cost of insuring Australian corporate bonds from default went up the most in two weeks.

Evans say that, “The inevitable response to an extended tightening of global liquidity will be tighter domestic credit conditions. Proposed new regulations through the G20 on liquidity and term funding must be scaled back considerably if Australia and New Zealand are to avoid a credit crunch.”

Hmm. According to the chart below from CMA Market last week, the next most urgent stage of Europe’s debt and credit crisis is the East. The largest widening spreads, an indication of credit deterioration, were in Austria, Hungary, Slovenia, and Romania.

Crisis on the Eastern Front of the Credit Wars?

But Evans point is well taken. The Australian government correctly argues that in comparison to other countries, the debt and deficit-to-GDP ratios here are small. That’s true. But for the country, the total level of household and private sector debt is large and growing. And a lot of that borrowing is done overseas. Take it away, and what do you have?

You have a much higher cost of capital and another credit crunch. The flow of credit to small businesses and households would be the most affect. Big firms might have trouble selling bonds (hence the higher credit default swap rates). They could, assuming investors are not spooked about sovereign risk, sell equity as they did last year.

But you can see that Australia IS affected both directly and indirectly by what happens in Europe. And that’s just Europe! Ultimately, we reckon the biggest bubble of them all is in the U.S. bond market. But we’ll save that analysis for another day. Until then.

By the way, in the beginning, before the great credit deluge of fiat money, the nature of the business cycle was not boom and then bust. It may not have been a Garden of Eden. But the cost of capital was set by the market, with a natural rate of interest. Bad investments were made and the loan losses were taken by the lenders, with the prudent surviving and the reckless perishing.

In this economic paradise, capital moved from weak and inefficient and wasteful hands into strong ones. Recessions were short and sharp. Growth was slower in the absence of credit above the rate of available savings. But money was sound and investments could be valued.

It’s hard to say if John Law was serpent or merely a scoundrel. But he succeeded in convincing the French regent to open a national bank whose primary capital was government debt. It was the birth of modern central banking, where the government effectively sells the right to print (not coin) money to a private corporation or cartel in exchange for reliable lending at favourable interest rates.

How Law turned the debt of the French government into the equity of the Mississippi Company is also a story for another day. But in his ability to convince the investing public that liabilities and promises to pay are the same thing as real money, Law Begat Greenspan and Greenspan Begat Bernanke. And to channel the Mogambo Guru, we’re all begatted now.

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. Maybe Rachel was the begatting counterparty. Someone had alot of fun anyway.

  2. Dan also forgot the record of the Australian treasury in lecturing the US and elsewhere just how totally integrated and tuned our tax system was to harvesting tax receipts from consumption. Consumption driven by debt. Debt goes backwards, consumption goes backwards, and that fine tuning has us with the world’s finest economic cliff to jump off.

  3. A ring, a ring o’ roses…

  4. A VAT just could be the US’s ace in the hole re collecting more taxes. Most other countries have already played that card I gather.

  5. Treasury debt hit another record in May; $143 billion!, almost entirely bonds.

    Yet bond yields fell, somebody is buying up big.

  6. Yep Justin which is why I happily paid 1511 yesterday for my last oz aussie gold.
    “Ohh ,the dearer it gets the more people are buying” says the receptionist.

    Its 2.51am..wake up and smell the rally :)
    Will I ever get any sleep?
    When its over I can sleep….ahhh
    In 5 years.

  7. Same oz at 1563 this morning. Both prices include premiums (approx $30).
    AUD bumped resistence at just over 82 last now and now breaking support sub 81

    Our Aussie gold at around $2000 is coming into sight.
    Actual Aus price is around 1530 now almost matching high in Jan 09 at around 1550. AUD looks bearish and US gold chart is mighty bullish with cup and handle.

  8. Comment by Lachlan on 8 June 2010:

    AUD looks bearish and US gold chart is mighty bullish with cup and handle.

    Won’t be surprised to see another 20% drop in the dollar in the near term .65USD
    Gold at current USD/Oz puts it at over $1800AUD if that does occur, Goldbugs more bullish than bearish, we may see that $2000AUD/Oz fairly soon.

    June 8, 2010
  9. There was a sharp turn up in the Dow futures just after ASX open this morning and the ASX has taken the ride and the AUD is responding. Plunge protection team at work in the NY dark hours. Mind how you go.

  10. Its PPT or goodnight now but yep the aud holds support so far..ominous. Waiting games now…everyones feeling bearish..pretty good shakeout if thats how it turns out. Maybe that Ozzie oz will be a way dear one at least short term.

  11. But then we count our wealths in ozs’ here..and cows :)

  12. I was hoping for a drop under $1400 before I bought more of the noble metal.

    Wishful thinking. Sugar is looking a buy though!

    Found some interesting data in the RBA annual reports. Gold loans by the RBA dropped drastically in 2007-08 financial year and again in 2008-09. In the midst of a liquidity crisis? From their (or should I say our) entire stock for many years to now only 20%.

    I suspect they may have lost the lot, probably when Lehman Bros went bust. Don’t be surprised if the government ‘sells’ some more gold soon, though in reality it’s already gone.

  13. Justin I figure if AUD gold consolidates a little and breaks for 2000 from here that 1500 gold will still be a fair thing probably making a good support price in future times.
    I’m not ready to buy sugar quite yet although it’s sporting a hefty discount… I dont know yet what investment vehicle to use either.
    Soft commodities seem appealing. Makes me wonder if the ol hat factory could make room for regular columns/advice on some such.

  14. China considers doubling average wages over 5 years from 2011:

  15. Must admit, I’d be vaguely interested to know if commentors here are dealing in a few tens of thousands, of 100s of thousands, or even multiple millions – (Those who talk in Billions presumably chat elsewhere!?) :) :) :)

  16. SON: “What should I become when I grow up Daddy? A scientist? An engineer? A doctor?” DAD: “Don’t be silly son. If you really want to get ahead, you should strive to use other people’s money to set yourself up as a taxpayer-subsidised, credit-bingeing, balance-of-payments-destroying leach on Australian society.”

    This IS NOT MY QUOTE I found it on the smh website that a blogger posted and thought it was good

  17. So dad advised son to enter an area of the public service where he could obtain an understanding of economics and banking with the eventual goal being to become a socialist politician I gather? :)

  18. Off Topic.. However, ASX run a share game a couple of times a year.. latest one has just finished. It is a good way to get to get a feel of the share market without doing your dough..
    You start with an imaginary $50000 and trade from a list of 100 companies.. my results were this
    Your current portfolio (live)
    Portfolio total $55,096.50
    >> See details
    National performance (at close 02/06)
    National leader $66,265.10
    National average $47,849.73
    Your ranking (at close 02/06)
    National ranking 172 of 13386
    State ranking 40 of 3009
    >> see details

    Less than 20% of players finished positive this time around.
    I did not take it too seriously and did not check it daily.. I was at one point 13th for state that I did see..
    game can be found on the asx website Share Game

    June 10, 2010

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