Stimulating What?

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Stimulating What?

Its official, “the economy is still on life support.”

“The economy grew 0.5 per cent in the March quarter, driven by a further 11.6 per cent rise in government construction spending, which accounted for more than all of the economic growth offsetting slides in business investment, private housing investment and exports.”

Peter Martin at The Age does quite a good job of outlining just how miserable things really are. His last line is rather out of place:

“Australia’s annual growth rate is still about 2.7 per cent.”

So it turns out stimulus spending works. Governments paying people to dig holes can make GDP jump. Who cares if the real economy is tanking?

Strangely enough, while the government was telling its employees (or contractors) to dig holes, it told the mining industry to stop digging them. More on that below. We’re sticking with the “digging holes for economic stimulus”, not the “digging holes to provide something of value to someone”.

The King of Stimulus was of course Lord John Maynard Keynes. And here is what he had to say about digging holes:

“If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is..”

The problem with all this is that it ruins the economy in the long run. Devoting capital, resources and employment to digging up a finite amount of money hidden in glass bottles can leave you suddenly empty handed and looking very stupid.

So the governments would have to bury more bottles.

Pretty soon, your economy would consist of filling glass bottles with paper (money), burying them, unburying them and paying your paper to the government in tax to be buried again.

Presto, full employment and a great GDP figure.

If the economy tries to revert back to providing something of value, it will notice that capital, resources and employment will have to be reallocated. This is not a fun process. It is called a depression. But if you don’t have the depression, you will continue to misallocate the capital into malinvestments, which turn out to be worthless to the economy in real terms.

To be fair to Keynes, he also mentioned to following:

“It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing”

So, the allocation of resources could be more sensible than digging up dollars. But the issues are the same. If houses aren’t being built by the private sector, it is because this would be a malinvestment; a misallocation of capital, resources and employment that would later be exposed as unsustainable, causing turmoil in that industry. So if the government builds houses anyway, you end up with that malinvestment and the resulting turmoil. A malinvestment remains a malinvestment.

The joyous part in all this is that Keynes advocates government stimulus just when the economy goes into a depression. In other words, just when the malinvestments from previous stimulus are being cleaned out of the system and capital, resources and employment are being allocated to a better cause.

Stimulus doesn’t save an economy. It bashes it back on track to ruin.

The Uncertainty Country

The other way to ruin an economy pretty quickly is to introduce uncertainty. It’s taken Kevin 07 several years to pick up on it, but better late than never. Strangely enough, announcing the Resources Super Profits Tax (RSPT) had a damaging effect, even before Kevin fully understood what it actually is.

So now the miners are reacting and it’s a bluffers game of Russian roulette with dice thrown in for good measure:

Monday: Top miners dig in against resource tax (The Australian)
Tuesday: KPMG predicts investment fallout over tax (ABC)
Wednesday: Miners turn down heat on resources tax (The Age)
Thursday: Rudd not intimidated by Xstrata deferring projects

So how will it end? Nobody knows – which is exactly the problem. Investment doesn’t like uncertainty and the government is giving it plenty. Mining investment is especially sensitive because of the delay in payoffs from the initial investment.

Sadly, political risk has been brought up and is likely to stay. So long, lucky country…

Debt Doom

The steady flow of debt rating downgrades continued last Friday with Spain as the latest victim. But what changed? How come the rating was downgraded after the austerity measures were announced? Surely being thrifty is good for your balance sheet?

Dan explained on Monday that “ratings agency Fitch said [the austerity] measures would damage Spanish growth prospects.”

Harvard’s economics historian Niall Ferguson has a good grasp on certain aspects of the crisis, but on this issue he seems to side with the ratings agency. He uses the sovereign debt racked up during World War 2 in his explanation of the three ways to get out of debt. You can grow out of it, decrease government spending, or raise taxes.

Which do you think is most politically viable?

But sadly, government driven growth gives you fake growth, as explained above. It leads to more of the same problems down the road. The strange thing is that Niall Ferguson is fully aware of this. He “would not be at all surprised to see another crisis in a relatively short time” because all the solutions to the crisis have only made the problems worse. He gives moral hazard as an example. And yet he supports government action to prevent a depression.

So, having a worse depression somewhere down the track is apparently better than having one now.

Ferguson is also a fan of Keynes, but it’s unlikely that the King of Stimulus would have approved of how his theories are interpreted. It seems the mainstream is advocating ruining the long run for the sake of the government statistic known as GDP.

But there may be more important things than GDP for governments to prop up. Themselves for example. If a government can’t borrow enough to keep GDP at the levels it deems appropriate, then the economy could really be in trouble. Even the legitimate services of government would suffer.

So what does Daily Reckoning Editor Dan Denning think about the implications of European nations struggling to fund themselves? He explained on Tuesday that the consequences of a sovereign debt crisis in Europe would hit banks holding that debt hard. And there aren’t many safe assets to sure up your capital base, so what do you do? Hold cash? Not while Bernanke and Trichet are behind the printing presses!

Degrading the Debt Downgraders

The EU has completely misinterpreted the Latin phrase “quis custodiet ipsos custodes?” (Who guards the guards?). Their latest plan is to “create a watchdog to curb credit rating agencies”. There will also be a “review of the way banks are managed”. So after basing bank capital adequacy laws on ratings given by companies paid to give good ratings, the government sees room for more meddling. Paul McCulley from PIMCO agrees with their analysis:

“[The breakdown of our financial system] was about the invisible hand having a party, a non-regulated drinking party, with rating agencies handing out the fake IDs.”

McCulley is right at the top of our least favourite people, so we will keep this short. The party got out of hand because the Federal Reserve was handing out free drinks. Holding the interest rates that bankers borrow at below the rate of inflation is like handing out cocaine at a rehab centre. Free thrills.

Supposedly “financial gain affects the same pleasure centres of the brain that are activated by certain narcotics,” so the metaphor is quite apt.

But of course nothing is free and the hangover had to come around. It didn’t last long, as interest rates went to 0 and the drinks began to flow again. Can you guess how this will end?

One noteworthy aspect of the EU plan to regulate credit ratings agencies is the timing of the announcement. Just as the sovereign debt crisis begins to spread and countries begin to see their bonds getting downgraded, they decide to extend their power over the rating agencies…

Going for Gold … going going gone

According to Zero Hedge, the US mint is out of gold and silver American Eagles (coins). Unprecedented demand happens to be the reasoning.

People all around the world are paying significantly over the spot price of gold for their coin investments, just to get their hands on something. Speaking of which, your editor has been reliably informed by an attractive local “expert” that Argyle Diamonds just happen to be good alternative to gold as an inflation hedge.

Some analysts believe that China is avoiding purchasing gold from the IMF, as this would give the gold price an unstable boost. Instead, their purchases are more covert, but still substantial.

Quotes of the week

Warren Buffet before Congress:

“The entire American public was caught up in a belief that housing prices could not fall dramatically… Rising prices became their own rational.”

Dan Denning, reading the Australian Financial Review, murmured the following:

“There are so many ads for government jobs in here. It’s really depressing.”

Until next week,

Nickolai Hubble.
The Daily Reckoning Week in Review

Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
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Stillgotshoeon
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Quotes of the week

Warren Buffet before Congress:

“The entire American public was caught up in a belief that housing prices could not fall dramatically… Rising prices became their own rational.”

Luckily for us we live in Australia and it’s different…..

Biker Pete
Guest

“Luckily for us we live in Australia and it’s different… .”

And Canada’s different too… . :)

Realist
Guest
Housing has been the catch cry of DR from day one, the general stance is one that is overvalued and going to fall dramatically. This hasn’t happened and in fact in the last 5 years it has grown exponentially to a point that a 3 bedroom 16sq home 43km from the city is $489per week (25 year principal interest loan at 7%) which is about 70% of the average take home wage per week. I can’t get my mind around how the average punter even affords this but with every weekend that passes hundreds of homes come up for sale… Read more »
Biker Pete
Guest

“This sort of mindset will either be down to naivety and we will crash and burn hard, or it will be a confidence (arrogance) that will see us through unscathed.”

Now _surely_ there are other realistic options? ;)

Wish I had ten cents for every time I’ve read those last three little words.
:)

Ned S
Guest
It’s pretty obvious some DR Australia readers would like to see house prices “crash” because they’d like to buy houses? Which seems a bit perverse – Hey you don’t see me hoping gold prices crash because I’d like to buy gold do you??? (And ditto for BHP and CBA shares for that matter!) Anyway, that aside, DRA’s game of let’s belittle the intelligence of all Aussies who own property by pretending they think statements like “ALL Oz house prices ALWAYS go up” are TRUE, has gotten tiresome. And detracts from the site’s credibility for mine. Which is unfortunate, because given… Read more »
Ned S
Guest

Full credit to Sydney for not building a kangaroo shaped island in Botany Bay though! (I can only assume no-one thought of it? :) ) Mine dew (as Biker says), if it was Brissy, we’d probably have built a football shaped island in Moreton Bay; Along with some goalposts and an image of King Wal with his shorts hitched up above his hips! :)

Biker
Guest
“It’s pretty obvious some DR Australia readers would like to see house prices “crash” because they’d like to buy houses?” Ned, how could you think such a thing? It implies that inside every goldbug there’s a rampant property bull raging to get out. (The visual imagery makes even ‘Alien’ look tame… . ;) ) But your main point is spot-on. I’ve never wasted a breath wishing gold would crash, so that I could pick up a few kilos for $600/oz. Hell, I don’t even care if it jumps to $6K per ounce! Think of the housing shortage _that_ would create!!… Read more »
Ned S
Guest

In Pharaonic times, four things had value – Gold, ivory, property and slaves. Ivory has fallen from favour. Gold’s likely to go the same way – For mine; For much the same reasons. But property and “slaves” remain sound investments. With the trick being to keep the “slaves” from pinching one’s property!!! ;) DRA’s a hoot! :)

Ned S
Guest

“It implies that inside every goldbug there’s a rampant property bull raging to get out” – I wouldn’t necessarily think that of ALL bullion investors Biker. Some of them live in countries where houses are (comparatively) cheap? But yeh, in Oz, that statement certainly seems to have significant validity! :)

Ned S
Guest

Hey Biker, I’ve come up with some really good ideas – If we do away with neg gearing and CGT; And up stamp duty and bring in a REALLY BIG land tax, PLUS put a 40% Super Tax on all profit made by individuals and tradies and developers and retailers and banks on ALL profits made over the Oz bond rate, we could absolutely CRUSH ALL profit in the Oz housing game … Wat’cha reckon – Ned for PM? :)

Biker
Guest

Hey Ned, check this out. It appears share buyers actually get _better tax concessions_ than property investors:

http://www.perthnow.com.au/money/investing/shares-ahead-of-property-in-tax-treatment/story-e6frg2v3-1225874372015

Since rental homeowners are addressing the second most critical need of the population, tax benefits probably need to be increased… . :)

roy
Guest
US hedge funds dump Australian bank shares AUSTRALIA’S biggest banks have become the victims of aggressive international hedge funds, which are shorting the banks’ stocks after growing concern about the strength of the domestic property market. A New York hedge fund manager, who did not want to be named, said sentiment towards the Australian banks had soured because of doubts that the strength in the national property market would be sustained. “There’s a lot of scepticism in the US regarding the Australian property market,” the hedge fund manager said. “A lot of people have doubts about whether the strength of… Read more »
nv
Guest
Oh no, not austraalia, puuuhleaaaze. Australians live in a spiritual crystalline abode faaaaar from the maddening crowd. There is no bubble of any sort here. Nope. No bubble here. Property always go’s up because it always go’s up here in the wonderful world of oz. True, ask anybody, anyone who’s ever bought a property to live – in. They will tell you that yep we bought back in 1988 and now it’s worth whatever but we’re not selling because want to actually live in it. Why let’s have a double negative gear I say, yep, double negative gearing. Why not?… Read more »
Tar and Feathers
Guest
1. Housing has been the mainstay of all western economies – we should treat building like any other manufacturing ie factory build to sell domestically and sell the surplus overseas alternatively wind back production – if your production is low labour intensive you reduce on the overtime of workers….the building industry is highly inefficient and is locked into the old craft system hung over from the middle ages. But you can see that building has a social impetus to it. 2. Aus is heading south we currently borrow money to carry service industry economy we have very little manufacturing, DR… Read more »
Stillgotshoeson
Guest
Melbourne Auction Clearance rates over the last 6 weeks… 85%, 83%, 81%, 75%, 73%, 70% There was a rumour going around that there was a shortage of properties and that is what has been driving prices.. REAL ESTATE INSTITUTE OF VICTORIA says there has been an unseasonaly high rate of properties available this Autumn.. so there IS plenty of supply… Demand is waning. 300 Auctions scheduled for this long weekend (traditionally a slow weekend for Auctions) the week end after there is 1000 scheduled for Auction. Depending on who’s figures you use the average price of a house in Melbourne… Read more »
Biker
Guest

NV: “Property always go’s up because it always go’s up here in the wonderful world of oz.”

Clearly a brilliant mind at work here… . You don’t have to wonder about his _Mathematics_ either:

“Half is still half so when super funds lost half they still had half.”

Stunning… . ;)

Biker
Guest

“End of year should see it sub $500k”

Let me guess. You’ll walk from Melbourne to Mount Fuzzioscko if it’s not.
Love it when a punter is so specific… . :)

Ross
Guest
Well the AUD was the signal that the hot money flow went negative but the XXJ has a long way to run. They are starting to leak now about their early 09 staring insolvency when they had no access to wholesale funding. http://www.bankingday.com/nl06_news_selected.php?act=2&stream=1&selkey=9951&hlc=2&hlw= Trouble is they are going into a bigger 12 month funding need as a total of their balance sheet right now than they had in Nov 08. Westpac has to role +45% of the wholesale bonds in the next year. The bond profile used to be an average of about 7 years. The € has kicked off… Read more »
Steve
Guest

Clearly a brilliant mind at work here… . You don’t have to wonder about his _Mathematics_ either:

Yes Biker thats right you don’t have to worry about his mathematics because the residential property market of the commonwealth of Australia is above mathematics and is SPECIAL, didn’t you know that?
Get with the times!!!

Biker
Guest

Yes, it _go’s_ without saying, Steven. ;)

Mate, I’ve found you a location with cheap property _AND_ a job:

http://www.maplandia.com/spain/airports/moron-airport/

Lachlan
Guest

Hey Ross and Shoes
Great call on the USD rally Ross..you win :) …lucky for me gold is on the safety bus too as hoped for although silver looked a little unhappy at end Friday.
The markets are hovering at/near important support levels. Sayce thinks we’ll get another liquidity rally. I dont know about that but I am hoping to play a bounce, or conversley a short set-up if things break down. What do you reckon? Is it possible for the PPT to save this sham?
I’m looking forward to this week.

Lachlan
Guest

At least the DXY has plenty more to run from what I can see. Not sure if that necessarily bodes anything for the ASX200..or the dow.

Stillgotshoeson
Guest
Comment by Biker on 6 June 2010: “End of year should see it sub $500k” Let me guess. You’ll walk from Melbourne to Mount Fuzzioscko if it’s not. Love it when a punter is so specific… . I can see how it appeals to the 10 year old in you… I am sure you have cpoied and pasted the comment, URL and Thread Topic for future reference… Late Jan/Early Feb next year the December Quarter house prices are out and if I am wrong you will plaster the forum with “hey everyone rememeber when Shoe_son said this” (insert quote) ”… Read more »
Stillgotshoeson
Guest

Comment by Biker on 6 June 2010:

NV: “Property always go’s up because it always go’s up here in the wonderful world of oz.”

Clearly a brilliant mind at work here… . You don’t have to wonder about his _Mathematics_ either:

“Half is still half so when super funds lost half they still had half.”

Stunning..

You must be short Biker Pete… his sarcasm went right over your head it seems..

Stillgotshoeson
Guest
Comment by Lachlan on 6 June 2010: Hey Ross and Shoes The markets are hovering at/near important support levels. Sayce thinks we’ll get another liquidity rally. I dont know about that but I am hoping to play a bounce, or conversley a short set-up if things break down. What do you reckon? Is it possible for the PPT to save this sham? I’m looking forward to this week. Still to early to call either way.. Fear and Greed are the drivers.. Capitulation is not on the horizon yet.. I expect thast to occur when Central Bank money runs out. That… Read more »
Lachlan
Guest

.. I am still heavy in Gold at the moment as I see that as the most promising for upside..

Couldn’t agree more Shoes.
AUD gold is looking great too on the back of weakening AUD.. Hoping cattle prices do well too. A punt on the market index right now is risky as you say.. I’m guessing a liquidity bounce not so much a rally to higher highs but waiting for something to confirm.
Are you an early bird for rural property Shoes or are you looking for discounts?

Biker
Guest
“You must be short Biker Pete… his sarcasm went right over your head it seems..” Coming from a bloke _who is_ still learning English I find that highly amusing, Shoes. No punctuation outside the English language, I know. :) And no, I hadn’t ‘cpoied’ your ‘poore’ post, but thanks for the hint. I’ll copy it now… . Looking forward to seeing your sub-$500K medians in Melbourne, son… and your $5K gold…. by the end of the year. And no, I won’t bother taunting you about it (much)*. “…if gold goes (to) $6000 going to buy me a fancy detector….” You… Read more »
Stillgotshoeson
Guest
Comment by Lachlan on 7 June 2010: Are you an early bird for rural property Shoes or are you looking for discounts? No.. Just had a look, saw it in the paper and thought I would have a look… Comment by Biker on 7 June 2010: Looking forward to seeing your sub-$500K medians in Melbourne, son… and your $5K gold…. by the end of the year. It is $3000AUD for my call on Gold BTW… and not years end.. best clarify that now hey ;) And no, I hadn’t ‘cpoied’ your ‘poore’ post, but thanks for the hint. True to… Read more »
Biker
Guest

“some one touches a nerve in you and it is straight after the typos….”

I imagine that with the current situation, you’re the nervous one, son.
It certainly affects your accuracy when you’re in a swinging mood… . :)
I let most of your ‘typos’ go past without comment, Shoes. It’s important to record your wild guesses for posterity, though. As per _your_ suggestion, I’ve now done that… . :)

Stillgotshoeson
Guest

Comment by Biker on 7 June 2010:

Shoes. It’s important to record your wild guesses for posterity,

Difference between you and me… I can handle being wrong… and being more pessimistic.. If I am wrong that’s a good thing ;)

If the words of wisdom that you have spewed forth turn out to be wrong.. Well that will be a bad thing, won’t it? ;)

Biker
Guest
“If the words of wisdom that you have spewed forth turn out to be wrong.. ” This from a bloke who calls another man’s city a ‘sewer’. (Well after he’s left it, of course… and from the safety of the internet. ;) ) Two of your comments did, however, raise a smile: 1.) “Here is our similarity… we both hope I am wrong… reasons are different though, you hope I am wrong for above.” 2.) “Difference between you and me… I can handle being wrong… and being more pessimistic.. ” :) Frankly, I don’t give a toss about our similarities…… Read more »
Ned S
Guest

If I was interested in buying rural property in Oz I think I’d ask Biker and Lachlan their thoughts … They both sound like they have a reasonable amount of knowledge/experience re same? :)

Ant
Guest

So is anyone wondering why everyone is deciding to sell their houses now. Cashing in their profit I presume and getting out of a sinking market? Given that lending to owner/occupiers is continuing to fall, if investors decide that it is not a good time to buy could there be an avalanche on the cards?

Ned S
Guest

Just saw another property over this way that might be reasonable value for money. Under $330K – For what appears to be a pretty respectable and reasonably new little home – In amongst all the other $380K, $480, $580 and higher asks in the Brissy boondocks. (With plenty of stock on the market.) Could be there’ll be a bit of a window of opportunity open up for a year or so like back in 2008?

Ned S
Guest

“If gold reaches the $5K” – I’ll be the fat grey bearded black hatted old b@stard lined up down on the Victorian “Go Line” with his metal detector and spade all ready to get at the underlying nuggets easy as the guv institutes their Burn the Bush and All Rural Housing to Get the Bullion Now policy! :)

Biker
Guest

“I’ll be the fat grey bearded black hatted old b@stard lined up down on the Victorian “Go Line”

http://www.youtube.com/watch_popup?v=NINOxRxze9k

Thought I recognised you _after_ the Gold Rush, Ned… .

Steve
Guest

So Ned is that bad news or good news?

Ned S
Guest

Gold at significantly higher multiples or lower fractions of where it is now in a relatively short period of time – The great majority probably wouldn’t be enjoying it although Bill Bonner would presumably be consoling himself with the thought that in theory this must be a good thing while Goldman Sachs would either be making squillions in profit or lining up for squillions in bailout booty.

Stillgotshoeson
Guest
Comment by Ned S on 7 June 2010: If I was interested in buying rural property in Oz I think I’d ask Biker and Lachlan their thoughts … They both sound like they have a reasonable amount of knowledge/experience re same? Property is not an investment decision for me.. Shelter and security.. I have shelter now, I have security now. My investments have out performed property in its run up… Property is going to go backwards or at best stagnate (go backwards due to inflation) Property does not correct and stagnates, I have 15% pay rise over 3 years.. property… Read more »
Ned S
Guest

I’ve been happy enough with early “retirement” to date – Although the Great Recession has certainly given me a few things to think about. Housing – I see it as shelter and security as well – Plus a hobby and an investment. (Albeit one that some reckon has overperformed of late and could underperform for a while.) Yeh, I know some blokes over Perth way – A Brit, an Indian and an Aussie especially come to mind – They all seem to enjoy a quiet tipple! :)

Stillgotshoeson
Guest

Comment by Biker on 7 June 2010:
You’ve made your predictions. I’m happy to let those ride ’til Christmas.

results probably won’t be in till Feb ;)

Biker
Guest
Ned S
Guest

Maybe the Blues felt miffed by that report? It would appear they have decided to stimulate their residential RE market a bit more:

http://www.businessspectator.com.au/bs.nsf/Article/NSW-stamp-duty-cut-to-zero-for-some-6852Z?opendocument&src=rss

stavros
Guest

A bit late on this thread but i’m stunned the anti stimulus rants such as above still get a run in the modern era. Amazingly ignorant in both terms of capital allocation and understanding of economies not running at full capacity.

I’m sure the author has never read anything by Keynes other than cherry picked quotes from other ideologically like minded sources.

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