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The Irish Diaspora

–There’s a fungus among us. But is it the banks? Or is it a caterpillar fungus that boosts sex drive and is soaring in price as China imports Ben Bernanke’s inflation virus? The task of today’s Daily Reckoning is to figure out where the fungus is coming from and how it will affect Aussie share prices.

–But first, you didn’t have to know there was more trouble coming from Ireland. Just have a pint at any of the pubs here in St. Kilda and you’ll hear a veritable symphony of Irish accents. Most of the girls are behind the bar serving drinks. Most of the boys are at the bar drinking drinks. All of them seem to be having a pretty good time, even if they are a long way from home.

–Meanwhile, back in Ireland, a European drama is playing out. It’s putting pressure on the Euro and just like back in may, that word “contagion” is being thrown around again. The U.S. dollar is moving ahead while commodities cool off.

–But what about the Irish? The government has a deficit equal to 32% of GDP which it’s rapidly trying to bring down through spending cuts. And if interest rates on sovereign Irish debt weren’t rising (they are) the government doesn’t appear to be in any kind of immediate funding crisis.

–Down the track though, investors are looking at the Irish banks and realising the Irish banks are still stuffed with heaps of toxic assets. Irish banks have been borrowing from the European Central Bank in order to refinance their obligations to other lenders. But ultimately, Ireland’s government is on the hook for bailing out the banks (again). And if Ireland’s government doesn’t have the money to do it (it doesn’t) then the task falls to the ECB.

–Of course it’s possible the Irish government finally stops the madness and says to its banks, get stuffed. Based on the number of punch ups we’ve seen at pubs in the last year, we know the Irish aren’t afraid of a fight or a little rebellion now and then. But the rest of Europe—especially Greece, Spain and Portugal—are keen for Ireland to agree to an ECB plan and halt an investor run on the euro and on European sovereign debt.

–Does any of this really matter to Australia? Well, aside from expecting even more Irish to invade St. Kilda if the Irish banks fold, the weaker euro is leading to a relatively stronger dollar. That’s causing carry traders who borrowed in cheap USD to take profits on their “risk” trades in higher yielding assets like the Aussie dollar, which you can now buy for ninety six US cents.

–Ireland “matters” in the larger sense that it’s also a test of popular tolerance for socialising the losses of the banks. No one knows what the consequence of allowing major Irish (or any other) banks to fail. But we are told, mostly by the bankers, that it would be such a disaster for the economy that the government simply must assume those bad debts and the central bank must print more money to recapitalise the banks.

–The problem is really the same now as it was two years ago—way too much bad debt that cannot be cancelled out by issuing more debt. The “solution” offered by the authorities doesn’t really seem like a solution. It just seems like a get out of jail free card for the bankers and endless more debt as far as the eye can see.

–There’s no doubt there’d be some real havoc in financial markets and the economy with a real reckoning in the banking sector. But the situation we have right now is pretty lousy too. Could allowing the banks to fail be much worse? At some point the debt is going to have to be liquidated or restructured.

–Closer to home here in Australia is the news that China is trying to choke down inflation by reducing loans to property developers. Bloomberg reports that China’s four biggest banks–Industrial & Commercial Bank of China Ltd., China Construction Bank Corp, Bank of China Ltd. and Agricultural Bank of China Ltd.—have all met their lending targets this year and won’t be making any more loans. China’s M2 measure of money supply rose 19.3% over the last year, according to figures released last month.

–That kind of lending boom leads to 15-story hotels allegedly being built in six days. It also leads to politically destabilising inflation in the goods people buy every day. For instance prices in Shenzhen are now growing much faster than prices in Hong Kong, which is a reversal of the traditional relationship. “Shoppers report that certain food and grocery items can be to 40% cheaper in Hong Kong,” reports Colleen Ryan in yesterday’s Australian Financial Review.

–“It is not just fresh fruit and vegetables. Even items like Dove soap, which is manufactured in Anhui province in China, is 25% cheaper in Hong Kong…The increase has been more than 300% for a small group of herbs. Caterpillar fungus, said to slow down the ageing process and boost sex drive, has been one of the top performers.”

–The other obvious inflation China is in the share market. The chart below shows how it’s turned down in the last two days, dropping over 4% yesterday, with metals producers and property developers hit the hardest. Note also that the Aussie market (the All Ords in the gold line) has pretty much tracked the Shanghai Stock Exchange. The Aussie dollar (green line) looks pretty elevated compared to the two indices, doesn’t it?

All Ords and Shanghai Composite Apparently like Hanging out with Each Other

(Click to Enlarge)

–When you consider that the ASX/S&P 200 closed yesterday exactly at Murray’s point of control for the price action (4,700) you can see the market is now poised for a move. Will it be a post-Ireland bailout melt up? Or will it will be a post-China tightening inflation watch meltdown? We’re going to see what Murray says. And then later, we’ll be having a drink with the Irish. Maybe two, just to be sure.

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