Financial Markets: We Are Now Entering Turbulence

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We have had neither the time nor the inclination to peruse the Reserve Bank’s new publication on Financial Stability. But we are on the look out for its comments on two particular subjects: the vulnerability of the world financial system to a massive wealth-destroying crash and depression, and the vulnerability of Australian households to a massive debt-induced plunge into crisis, in the midst of a massive wealth-destroying crash and depression in the world’s financial system. They don’t call it the Gloom and Doom beat for nothing.

Seriously, we take no personal pleasure in watching for signs of the financial apocalypse. But shouldn’t somebody be on the lookout these days? From our quick first glance we find the following tidbits, first on the recent “turbulence” in financial markets.

“Whether this turbulence in global financial markets turns out to be temporary, or the start of a broad reversal of the very favourable environment seen over recent years, remains to be seen. It has, however, highlighted the strong inter-linkages between financial markets around the world, and the potential for developments in one part of the global financial system to have significant effects elsewhere. It has also provided a timely reminder to investors that the recent period of strong returns and low volatility is unlikely to continue indefinitely, and has prompted, at least to some extent, greater discrimination between different levels of risk.”

Ah yes, periods of low volatility tend to precede periods of high volatility, the way an infant’s trembling bottom lip and red face tend to precede a lusty wailing cry. And what about households and debt?

“As has been discussed in previous Reviews, the past decade has seen a significant transformation of household balance sheets in Australia, with large increases in the value of both assets and liabilities. On the assets side, the strong rise in house prices between 1996 and 2003 has been followed over the past few years by a significant increase in the value of the household sector’s holdings of financial assets as a result of the buoyant stock market. On the liabilities side, debt has increased significantly, to about 160 per cent of annual income at the end of 2006, more than double the level a decade ago.”

We are often told that there is bad debt and there is good debt. Mortgage debt is good debt because you are also building up equity (unless you are borrowing against it and spending it on new patio furniture.) But even good debt can become bad debt when the market value of your house is less the value of your mortgage. Just a thought. Capital appreciation is not a law of nature.

Dan Denning
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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