The Cost of Debt Tipping Point

Reddit

Investors are digging at the key levels on U.S. Australian indices. Let’s see if they can defend their territorial gains. Or if they have overshot already and will be forced to retreat.

Enthusiasm for the war on Dow 12,000 was dampened in America when the Labor Department revealed that new jobless claims were up by 24,000 thousand last week. This shows us that the changes in America’s job market are structural, not cyclical. When you off-shore your manufacturing base, Wal-Mart becomes your largest employer and average wages fall (as they have been, in real terms, since 1974).

But Australia doesn’t have anything to worry about, does it? China’s GDP grew by 11.9% in the first quarter, according to figures published yesterday. You can see the immediate local effect of that China boom in Gloucester Coal’s announcement that in secured a 100% rise in coking coal prices from its Asian customers. This theme – coking coal – was one Dr. Alex Cowie recently wrote about in Diggers and Drillers, although Gloucester was not the stock he recommended to take advantage of the high prices.

Is there anything alarming in the China data? Well, maybe. The National Bureau of Statistics reported that real estate prices rose 11.7% in March year-over-year. Hey…that’s not a bad month is it? And it followed February’s year-over-year gain of 10.7%.

Nah….no chance that there’s a real estate and fixed asset bubble in China fuelling demand for Aussie resources is there?

Meanwhile, back in New South Shanghai, Kevin Rudd is doing his best to collaborate with his partners/overlords in Beijing. The Daily Telegraph reports that the Rudd government will offer a savings scheme designed to boost the deposits of the Big Four banks, cutting the need – often cited in this space – of funding new mortgage lending from foreign borrowing.

This would inflate, or at least maintain, the Ruddbubble in Australian housing.

To be fair, the article did not exactly describe the scheme in precisely those terms. It said investors will qualify for a special savings rate if they agree to “lock up” the money for a longer period of time. It’s designed to promote a culture of saving in Australia, which wouldn’t be a bad thing.

But, in theory, locking your money up in a high-yield savings account exposes you to the ravages of inflation. In addition, it negates one of the chief benefits of being in cash to begin with – liquidity. It’s nice to have your own money to do with as you please whenever you choose. Perhaps the simpler reform would be to not tax interest earned on savings at 50%.

Don’t hold your breath, though. Governments everywhere are in money-scrounging mode. How else are they going to pay for $300,000 bar tabs (although, to be fair, if we had to implement the foreign policy of a government that didn’t realise it was bankrupt, we might need a drink too). Keep in mind that when you work for a for profit business, these kinds of expenses are simply verboten in a recession. But if you’re working on the public dime, have another whiskey brother!

Maybe the Feds are toasting their own success in saving the world from itself (or capitalism from itself, as the critique goes). But not so fast! Global curmudgeon and policy fix-it man George Soros says that the old problem – too much corporate and private sector debt – has been replaced by a new problem – too much public sector debt.

In remarks reported by The Economist, Soros told a dinner audience that, “The success in bailing out the system on the previous occasion led to a superbubble, except that in 2008 we used the same methods.” By ‘methods’ we assume he means the process of paying down old debt by taking on new debt (otherwise known as Ponzi finance).

“Unless we learn the lessons, that markets are inherently unstable and that stability needs to be the objective of public policy, we are facing a yet larger bubble….We have added to the leverage by replacing private credit with sovereign credit and increasing national debt by a significant amount.”

It is not just the total amount of debt that presents the long-term problem. It’s the cost of servicing that debt. Returning back to our friends at the Bank of International Settlements we produce a chart from their paper. It shows that adding to the public debt imposes a major burden on the economy and becomes an even larger percentage of GDP the further you go out in time.

Granted, thirty years is a long time. No one even knows what’s going to happen tomorrow. But the issue here is that the reliance on debt (especially short-term, interest rate sensitive debt) makes an economy even more unstable in the way Soros described. This is different, and worse, than the natural state of volatility in free markets. But we’ll get to that in second.

The BIS paper authors write that “When a country starts from an already high level of public debt, the probability that a given shock will trigger unstable debt dynamics is higher. The risk is increased when public debt is already on a steep upward trajectory, as is it is now in several countries.”

But Australia? The May federal budget may show a smaller future debt and deficit than expected, thanks to the rebound in export prices and the strong terms of trade Australia currently enjoys. But as we’ve pointed out, the health of government “revenues” depends to a large degree on property and China. And those are pretty slender reeds to lean on.

What Australia has going for it is that the public debt as a percentage of GDP is small, relatively speaking. What it doesn’t have going for it is that the government is increasing its role in the economy and committing more money to long-term programs on what could be really bad assumptions about the cost of borrowing and the regularity of national income. And to repeat, the country is a net capital importer.

But hey, someone else can figure out what to do about all that in the next election cycle. And somebody else can worry about paying it off later. The Soros emphasis on public policy – and the way in which it is embarrassed at a deep level of belief in Australia – seems sensible. But it’s a kind of well-meaning idiocy.

By the way, ifyou don’t like disussions on liberty and the proper role of government in regulating society, you’ll want to give the rest of today’s DR a miss. But if you’re in for that sort of thing…read on.

We’re going to paint with a broad brush and say most well-meaning government interventions in public and private life are designed to promote equality of outcome, social justice, or reduce the seeming unfairness and volatility of life in market economy.

But have you ever wondered if, in the earnest attempt to eliminate risk in our society (financial, physical, emotional), we’re actually make people less safe and society more inherently risky?

Wear your seat belt. Don’t binge drink. Don’t drive too fast. Be politically correct. Be tolerant. Be diverse. Be multi-cultural. All these commandments coming down from the Nanny State on high are given to use presumably because we are too stupid or unthinking to look out for ourselves, or too unsensitive to the feelings of self-worth held by others.

We won’t eat right unless told what to eat or invest enough to provide for our retirement unless compelled to. And in the world would be better, in the words of principal Skinner, “If nobody was better than anybody else and everybody was the best.”

But what if all this bullying, nonsense, nannying, and government coercion is eroding the very healthy and natural ability to identify and manage risk? We’d argue that in nature, the ability to identify risk promotes survival. The amygdala – that tiny part of our brain that controls the fight or flight instinct – is evolution’s way of keeping us on our toes. It reminds us that in the tens of thousands of years human history, the margin between life and death has been pretty small.

Over most of human history, people haven’t had surplus time or energy to think about what to do with surplus, quantitatively or qualitatively. You spent most of your time surviving and finding food. And this pursuit, knowing what to fear was probably your most important survival skill.

But we live in a world of profound and seemingly endless abundance and surplus today. It’s a product of the division of labour (which has been so successful most people don’t even know what it is), cheap energy, and cheap credit. We’d argue that all of these things have dangerously dulled our sense of risk and exaggerated our expectations of what to expect from life, each other, and our public institutions.

Wealth, material wealth anyway, is a product of surplus. And surplus is another way of saying profit. It means combining raw materials, labour, and your talent to make the whole worth more than the sum of the parts.

In this respect – by communicating accurate prices so people can make informed decisions about what to buy and sell – the free market delivers extraordinary outcomes. It unleashes the sheer productive capacities of millions of people who do completely unpredictable and unplannable things with their life that no central committee could possibly organise.

The trade off for such an open system that produces so much surplus, choice, and income mobility is instability and relative inequality. Unless you are in a rocking chair, you can’t really be moving and staying put at the same time. But for some reason, some people find this instability – a natural feature of a dynamic system – threatening. They want to freeze things and give up growth and change for the sake of predictability and security, which they would choose as personal goals.

To be fair, change freaks some people out. To be ideological, the people (usually in government) opposed to the instability of the free market just don’t like what other people choose to do with their economic liberty. They find prosperity morally vulgar and are offended by obvious inequality – failing to see that free markets have elevated all people everywhere to standards of living that would have been unimaginable even 100 years ago.

One possible explanation is that the meddling central planners of the world are just egomaniacs who get off on telling other people how to live. More worrying is that these people actually believe they are right and that someone should have the role of regulating, with the power of the State to coerce, how people behave in the minutest detail.

That’s not to say – and we’re winding up our rant here – that you can’t have good government. But we’d say it would be much smaller and less morally ambitious than today’s institution. Today’s big government exists for the sake of perpetuating itself. It’s finding that harder and harder to do as it sucks up – and eventually kills – the lifeblood of the productive economy, taxes in the form of suplus on personal and corporate incomes.

Mind you none of this is in defence of the predatory financial capitalism run by Washington and Wall Street oligarchs that’s been masquerading as the free market. As Ron Paul correctly pointed out last week, the current system is more accurately described as “corporatist” in which the banks, the defence contractors and corporations of size (to use a PC term) lobby, cajole, and generally purchase favourable laws from legislators (on the right and left) that are themselves bought and paid for.

Frankly, the whole thing could use a little creative destruction. And no matter how badly its defenders (like Bernanke) fight for it, the system is inherently fraudulent and wasteful of resources and capital.

And in addition to that, it’s just ethically offensive. We won’t miss it or mourn it when it’s gone. As we mentioned last week, we don’t encourage people to get involved with that political system at all. It’s like snogging with a vampire. We’d urge you to deprive that system of your time, talents, and creative energies.

The best defence of liberty begins with financial independence. And taking care of your own money and your own life is something you don’t need to go to the ballot box to do. And you don’t have to take anyone else’s money either. It also puts you in the position of helping people you really can help – your friends, family, and neighbours.

So why isn’t financial independence the highest calling in public life? Hmmn. Granted, a high material standard of living is not the same thing as a high quality of life. And we’d even say that spiritually, there are more important things. But it’s something to think about over the weekend.

Returning to the markets, for investors, we’d continue to sound the warning: be ‘ware the lofty indices. Be vigilant with your trailing stops and stop losses. And enjoy the weekend!

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.
Reddit

Leave a Reply

33 Comments on "The Cost of Debt Tipping Point"

Notify of
avatar
Sort by:   newest | oldest | most voted
Sambo
Guest

11/10 Dan, great article.

Ross
Guest

We wholeheartedly agree, and with Sambo’s rating, if financially independent we might watch the show in the manner of the queen of England …. but we are not the queen and likely we will be drawn into or otherwise be consumed by events. So I’m now not sure that sitting on the fence is defencible.

Claudius
Guest

I would caution everyone looking for information from foreign economic data especially of communist countries such as China.
A short reflective peak into recent history demonstrates they are not to be believed.
Until 1989 ALL communist countries were considered by themselves and some western economists to be perfect economic entities with robust productivity and full employment. To paraphrase, the locomotives of industry, unstoppable and perfect in every way and every day.

ruckrover
Guest
there is a benefit to all from much “nanny state” intervention – especially around tolerance of others, the reduction in racism and homophobia over recent decades is one example, reducing exposure to the toxic overload of tobacco smoke is another benefit. A safety net to stop the sort of poverty seen in the USA is a benefit of social democracies. good to see you reference Soros – that “Corporatism” is wrong and damaging – Unfettered Capitalism it may be called but really it is not – it is oligarchism. Good govt is interventionist on social fronts and on regulation to… Read more »
Ross
Guest

After SEC’s announcement on GS “incomplete advertising of known facts” styled prosecution over $1bn cds profit to Paulson and $1bn loss to Goldman facilitated investors …..

precious metals, energy, and hard commodities generally down hard while soft commodities all bounced.

Singing my own book yes, but there are believers on my side. Looking at where these little runs take us may just inform us for the bigger deleveraging events.

Ross
Guest
ruckover huh? On racism & homophobia you obviously have no experience of post Soviet Eastern Europe or the latent neo nazism that festered and flourished under socialism. As soon as the big nanny state walls came down it came out to play and it still won’t be put back in the box any time soon. It doesn’t matter if it is the Stazi or the sneaky crony Fabian henpecking state, they both grow hate crime rather than vanquish it. I could tell you some stories about how the Vietnamese (refugees of their war) from East Berlin got treated, they “saved”… Read more »
Ross
Guest

I really like the visual of the 52 week meter in these commodity charts, potential rise and falls are clearer … not to say things can’t keep soaring or plunging but still usefull.

http://money.cnn.com/data/commodities/

Lachlan
Guest
“So come over from the dark side, to where traditional freely chosen conservative and Australian values of tolerance prevail, where you rely on a persons good nature and them feeling good about expressing it rather than try to impose your will upon them through a chauvinistic elite.” What I respect about DR and some other blogs is the level of freedom from censorship in the forum. They let people have their bitches, sometimes people (not in position of power) try to diffuse said…sometimes it helps sometimes not much but all up people are free to sought out their own stuff… Read more »
Lachlan
Guest

What I like there Ross is the way every consolidation posts a sharp shake out before going higher. I suppose somebody needs the cash to balance the books.

Ross
Guest
Lachlan, hope you don’t think I was running a censure motion on ruckover. I agree with the free expression view. Most people in Australia have cut over to his idea from the 70’s onwards that “social democracy” with pins and sticks enforcement should fight their personal corner but I feel they are unable to see the pit they have fallen into. I argue my corner hard but expect no quarter. I also believe in the basic de-incentivised safety net which might set me aside from some (I don’t think we miss the mark by way too far on that already).
JMR Norton
Guest

Er, its ruck-rover as in aussie rules

Lachlan
Guest

Sorry Ross. Funny I thought my post was open to that interpretation ie a censure on ruckover, but not what I intended. I got the gist and I agreed so used your quote to push the theme further. I prefer to live under a minimal level of social or economic intervention from any controlling body though I except that laissez faire desireable but unstable for extended periods due to human nature. I’ll just have to make do with some John Wayne movies ;)

Ross
Guest

Ta JMR Norton, being a New South Welshman I follow leaugue and a little rugby … and it sounds like you that would be rucking over a bit differently. Lachlan, I have been posting continuously for some time and am sensitive and aware that it could become problematic. I might take a break like Greg did at some point soon.

Lachlan
Guest

Ross, your posts will be missed for sure. I cant stay but if I dont catch you round then I wish you the very best with everything and hope we see you back some day :)

Biker Pete
Guest

No doubt about it, Ross. While our viewpoints differ in some key respects, you’re the most informed voice here*, over the widest range of economic subjects. I doubt that you’ve offered any opinion here, from which I haven’t gained a new insight, wider perspective, or enhanced knowledge. This site will be poorer without your views and opinions, which have sometimes provided me with days of reflection… and, at times, wonder… .

* Apart from Greg, who has become a tourist, perhaps frustrated at times by the tone and rhetoric… self included!~ :)

Stillgotshoeson
Guest

I too will be taking a break.. I have said what I wish to say, stated my position on where I think we are headed, the economy is in a state of play..

To All
Go raibh tú daibhir i mí-áidh
Agus saibhir i mbeannachtaí
Go mall ag déanamh namhaid, go luath a déanamh carad,
Ach saibhir nó daibhir, go mall nó go luath,
Nach raibh ach áthas agat
Ón lá seo amach.

Steve
Guest

Australian Football pfft, we had that on at work today for a while cause there was nothing else on.

All the boys were watching it and were like this sh!t is so boring haha

Lachlan
Guest

Great post Biker and I share your sentiments.

Lachlan
Guest

Now lets get back to bitch’n ;)

Chunkton
Guest
I heard a psychologist on the radio talking about risk, her belief was that we need it in our lives as it is essential to our development. By trying to create a risk free society we are actually stunting our full development into beings that cannot deal properly with stress or danger. A fearful and compliant society. Australia has enormous potential and inherent advantages, if we managed it well we could be an extremely affluent society. However it seems that most Australians prefer the Nanny State/Big Government/Big Spending model, a model that has proved to be one that bankrupts countries.… Read more »
Dan
Guest
Risk is essential to our development only in the Darwinistic sense in that risk allows the weak to perish and the strong to take advantage – our society is rightly and deliberately against this principle. Prosperity comes from rewarding merit and managing risk for everyone. Opportunity comes from fairness. Without prosperity, words like safety or freedom are empty promises. Seat belts reduce risk – how is this impeding social development? The problem psychologists is that their behavioural and psychoanalytical theories do not generalize to the whole of society. There is nothing scientific about doing this, it is merely someone giving… Read more »
Nirvan
Guest

Chunkton
You need to refresh your economics a bit. Without government spending and a country that has a trade deficit , the only way aggregate demand can be maintained is by credit creation in the private sector which means debt!!.

Why do you think Australians are carrying record debt levels and the government was in surplus when Rudd took over.

Government spends and then taxes not
Tax and then spend (as our economic books would describe).

Read about it here .
http://bilbo.economicoutlook.net/blog/?cat=11

Finally if the free market was unfettered , you dont get thriving individualism pursuing what the mind sees fit but huge monopolies.

smallcap
Guest
I have to say gentlemen, I have been a fan and frequent reader of this web site ever since i found it about 14 months ago and agreed with just about all of the opinions made by the authors on the site. The constant trumpeting of the real estate ‘get rich now’ bandwagon by reader ‘biker pete’ was at first amusing and then slightly irritating. I come from a different area of real estate and would love to see the roof blow off and speculators get burned. I must say, a made a little on Oil shares and a bit… Read more »
Biker Pete
Guest

“I come from a different area of real estate and would love to see the roof blow off and speculators get burned.”

If you live by the blowtorch, you die by the blowtorch, son.
You speculated that your waterfront block would be cheaper this year…
and were very lightly toasted. You really lost _nothing_ and you may have broadened your knowledge of realty.

“…’get rich now’…? It has taken 32 years of continual investment, most of it managed without realtors, smallcap. Appreciate your Canute analogy, though… .

Justin
Guest

“and if house prices halve even in 5 yrs time, they will have doubled by then anyway”

huh?

The only way this statement makes any sense at all is if you are using a metric other than the dollar to value houses.

There is truly no understanding of the nature of money. Which is just the way the money managers like it; more for them, less for you.

Biker Pete
Guest
“and if house prices halve even in 5 yrs time, they will have doubled by then anyway” Silly to cling to any dream of a 50% fall in house prices. There will be some plateaus, even a few troughs, but values will steadily rise during the next decade. If this prospect is disheartening, get in at the low end, as most of your fellow Aussies have had to… . If you can’t build it (contributing your own labour to reduce costs) as cheaply as you can buy it as an established home, you’re reasonably safe. Or go the route Keen… Read more »
89peterg
Guest
memo to: the daily reckoning subject: free markets please take a day off staring at the screens and go and read some Dickens (that is Charles…, 19th century). memo to : self subject : commenting whilst drunk please continue drinking, but dont post any more comments on provocative economic rationalist rants, what with all the ” the GFC proves how wonderful a hands-off capitalist takes-all system works” but ” if only we lived in a utopian global, but Local, village situation where perfect knowledge works fab, just like it doesnt in the insect world (less so in the dog eat… Read more »
Biker Pete
Guest

“memo to : self
subject : commenting whilst drunk”

memo to : peteG
subject : leave some of that Voyager Shiraz for deprived DRA bloggers!

Biker Pete
Guest

Further memo to : peteG
subject : …or if it has the words EXOTIC (in caps) spicy (lower case) on the label, snort it all down rapidly… and Save The RestavUs… !!~ :)

89peterg
Guest

BP, I’d have to get drunk again to make sense of any of what I wrote there, or try sorting some gold dust perhaps. sour grapes I suppose.

89peterg
Guest

edir snorting, not sorting (every tried sorting out the gold dust from the bull dust?)

Biker Pete
Guest

“…edit snorting, not sorting… ”

Just don’t inhale*, Peter!

* Blowing wine outa ya nose is NOT a good look, mate!~

Rahm
Guest
It’s interesting to read a good article and all comments. I have seen feudalism in India in the past 50 years in some parts. The priviledged class took away land and education from some classes of society. Those states have a phenomenal rise in People’s war group and subsequently communist party came to power. Mind you, communist party in India is far better than labour party in Australia or NZ. I bet the people who support real estate prices rising will also be losers in long run as their sibblings in subsequent generations will also can’t afford a small piece… Read more »
wpDiscuz
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au