For the best browsing experience on this site, we recommend you upgrade your browser
AboutSubscribe Your Editors Contact Us RSS

The Dark Side of Profitable Banks

In today’s Daily Reckoning, we’ll set the record straight on whether man is a political animal or not. The kind of featherless biped man is will determine what happens in financial markets. Europe may be preventing the next Lehman Brothers. But the next political crisis (let’s call it the European Spring) could be just around the corner.

But first, the dark side of a profitable banking sector has reared its head in Australia. ANZ and Westpac are going their own way on interest rates. Commonwealth Bank and NAB will probably follow. The Reserve Bank of Australia (RBA) left the cash rate at 4.25% last week. But one by one, the Big Four banks are raising their rates anyway.

Cue community and media outrage. But big bank profits have to come from somewhere, don’t they? Australia’s banks are profitable. The benefit of profitable banks is that they enjoy strong credit ratings globally. Those strong credit ratings make it cheaper for Aussie banks to borrow from foreign lenders. The less they pay to borrow abroad, the less they have to charge you for your mortgage.

The reality is that the RBA doesn’t control the price of money any more. Australia’s house price boom was fuelled by money borrowed abroad. This is the part of the boom everyone likes. The part they don’t like is what happens when the price of borrowing money overseas goes up. It means higher prices here.

The alternative to a highly profitable banking sector is a low-profit, low-risk banking sector. That sounds nice, too. But if you get a low-growth, low-profit banking sector, then who will make the loans to fuel higher housing prices? That’s right…no one.

Speaking of banking sectors in trouble, did you know China’s local governments took out $1.7 trillion in loans during China’s GFC-fighting stimulus of 2009? The local governments spent the money on resource-intensive construction projects. China’s stimulus was good for Australia.

But now the bill is coming due. Nearly 50% of the loans made to local governments mature in the next three years, according to the Financial Times. The tab amounts to 25% of China’s GDP.

The FT article says China’s central government is asking the banks to “roll over” the loans made to local governments. This delays the “reckoning” for local governments that don’t have the money to pay back the loans. They don’t have the money to pay back the loans because some of the projects were never economic to begin with.

Some Sinophiles will argue this is the advantage of a command economy: the government can tell the banking sector what to do. In fact, it wouldn’t surprise us if some people started asking for Australian government control over the banking sector. A lot of bureaucrats and academics have a soft spot for authoritarianism.

But telling the banks what to do in China won’t make the original investments pay off sooner. And of course, the original problem is that the government told the banks to loan the money in the first place. It did this under the misguided belief that any growth at all was better than a period of consolidation. The Australian government followed the same policy.

The virtues and vices of the command economy will surely be one of the topics taken up next month in Sydney at our After America conference. Is it a better alternative to the system we currently have? Is the current system really a free market capitalist system? Or is the whole world wrapped in the cold dead hand of a heartless, totalitarian financial elite?

Why don’t we ask the Greek people? They are being asked to accept cuts to the minimum wage and to the public service, imposed by an unelected banker who’s little more than a puppet for the interests of the European Union and the International Monetary Fund. They’re not very happy about it.

-In fact, they are so unhappy that parts of Athens are burning. ATMs are running low on cash. Zerohedge has a good roundup, including the claim that the Greek police are running out of tear gas to subdue crowds with. It’s going to be a long night in Athens.

This is the next stage of the financial crisis, and it’s largely a political one. It’s clear that the European Union, through the actions of the European Central Bank, refuses to allow a major bank to fail. The Long Term Refinancing Operation scheduled for late this month will allow any and all banks to stockpile more than enough liquidity to withstand a default by Greece. Financial problem solved!

But solving the financial crisis – and we use the term “solving” tongue in cheek – depends on the people of Europe accepting that national sovereignty is a thing of the past. Politicians can be replaced by unelected bankers willing to do the bidding of their masters. But will people accept that this is what modern democracy has come to? A farce?

We’ll see soon enough. Last year’s Arab Spring (which is spreading like wildfire) may just spread itself all the way to Europe and challenge the political order there, as well. Which brings us back to where it all began, ancient democracy and Greece.

The Greek philosopher Aristotle is often misquoted for having written that, “man, by nature, is a political animal.” We’ve had debates with people who use this as a defence for politics. They like to claim that even Aristotle recognised that politics is natural. And if politics is natural, then holding elections so one party can tell everyone else what to do and how to live is natural too, isn’t it?

The more accurate translation of what Aristotle wrote is that man, by nature, is a polis dwelling animal. That is, by nature, men live in cities. Large groups of people with no family connections who live amongst one another will run into problems eventually, like how to resolve disputes, dispense justice, get rid of the sewage, and other matters. Thus, in the rush to organise these matters, we get government.

The Greeks decided that the best way to resolve disputes and settle problems like how to defend the city, or whom to attack, was to have free men vote. Slaves couldn’t vote. Neither could women. It wasn’t perfect. But for a city of a certain size, it amounted to self-determination.

Today, your vote hardly matters. You vote for a party. Or the party establishment produces a candidate it finds suitable for you. Elected officials represent the interests of the banks, the unions, the military contractors, and the donors who fund their campaigns. When a politician starts to think for himself, he’s replaced or defeated.

The financial crisis has now become a political crisis. The legitimacy of so-called democratic governments is being called into question. Are these systems as resilient and adaptive as they used to be? Or could something bigger be in the works? More tomorrow…

Regards,

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning is the Editor-in-Chief of The Daily Reckoning Australia and the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 as a small-cap analyst. From 2000 to 2005 he was the managing editor of Strategic Investment, where he recommended gold and warned of the US housing bubble. Dan has covered financial markets from Baltimore, Paris, London and, beginning in 2005, Melbourne Australia, where he is the Publisher of Port Phillip Publishing. To follow Dan's financial world view more closely 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.

4 Comments

  1. Gees says:

    Good article – can’t be long before the powers to be decide to start a major war to focus the restless masses away from the fraud and corruption

  2. Joe says:

    Sorry for the nit picking, ‘But’ ….

    But the next political crisis (let’s call it the European Spring) could be just around the corner.

    Is that a sentence, should you begin a sentence with ‘But’ Dan?

  3. Joe says:

    But telling the banks what to do in China won’t make the original investments pay off sooner. And of course, the original problem is that the government told the banks to loan the money in the first place.

    The U.S did this too, and it gave us the securitisation market that distributed the risks inherent in doing what the U.S Government told them to do. This then blew up in their faces because a bad investment is a bad investment, irrespective of who shares the risk.

  4. Steve says:

    Given that everyone needs a home, surely it is more desirable for house prices to be lower rather than higher.

Leave a Comment