We Do Not Live in Normal Times

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On a normal day in a normal market on a normal planet in a normal universe, you might spend your Monday going about your normal business. Buy low. Sell high. Digest the data. Drink some coffee.

We do not live in normal times, which is too bad, because it seems like a pretty nice first working day of March here in Melbourne. Later this week the Reserve Bank of Australia meets on interest rates. It will have to decide if bad news in the rest of the world (a revised 6.5% contraction in fourth quarter U.S. GDP, for example) is enough to lower rates for 3.25%–or if it has time to wait and see.

Later in the week, we’ll all learn how Australia’s economy did in the fourth quarter. By then, though, it could be old news. “Dozens of freighters carrying Australian iron ore are stalled outside Chinese ports amid a collapse in demand for steel, dashing hopes that Chinese industrial demand will protect Australia from the worst of the global recession,” reports David Uren in today’s Australian.

“Australian market teeters on precipice,” adds Susannah Moran, also from today’s Oz. Friday’s action on Wall Street sent U.S. stocks back down to twelve-year lows. It was the worst February since 1933. That’s sent the Aussie futures even lower. It now looks like a dead cinch that the ASX/200 it is going to bust below 3,300 and explore what lies below.

Yeah. That’s a hefty dose of bad news to start the week. In fact, it’s so bad, it’s exactly the sort of thing that would make us start to wonder if stocks are going to make a bottom soon. The point of maximum anxiety/pessimism is usually the bottom. But maybe we aren’t quite there yet.

Warren Buffet doesn’t think so. In his annual letter to Berkshire Hathaway shareholders, he wrote that, the U.S. “economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.”

Nope. The market can bottom even as the economy free falls. That doesn’t mean the market will take off like a rocket. But it does mean the best time to buy stocks will be when no one wants anything to do with them. We reckon that time could be later this year-given just how bad things will get in the real economy.

The ban on short-selling of financial stocks in Australia is set to expire this Friday. Will ASIC and the ASX extend it? As ugly as it might be, lifting the ban might allow the market to reach the bottom more swiftly, wherever that might be. Shorts would come in and target whatever firms they view as most exposed. What then?

You’d see a big fall in the banks and listed property trusts (though they’ve both already had a horrid twelve months). Then you might see the shorts cover. This would be the bottom.

Perhaps it’s not that neat and tidy. But we would say that without shorting, you can’t have a short covering rally. Instead, you shamble on to lower lows.

Here’s some good news, though. The RBA reports that personal borrowing levels fell by 0.2 percent in January. It was the eighth month in a row that personal credit is contracted in Australia. A return to living beneath your means? Hmm. Maybe it’s becoming fashionable to be thrifty!

“It’s not realistic when you say that failure must be allowed,” a friend told us this weekend.

“Why not?”

“Because everyone will fail. It’s not as if there are just a handful of bad apples in the barrel. The whole thing is interconnected. It’s like an apple pie really, where all the apples are mixed in the same filling.”

“Uh…you’re going to have to explain.”

“Okay look. If a firm makes a bad bet on a product, like, say, vegemite flavoured toothpaste, and it doesn’t fly off the shelves, that’s a fairly contained risk. If the firm fails then its creditors, shareholders, and employees are out of work. But it doesn’t spread.”

“Okay. But that sounds like awful toothpaste. Doesn’t it deserve to fail?”

“That’s not the point. The point is with the banking system, everybody is counterparty. One default by one firm becomes a systemic problem because everybody owes everybody. Take AIG.”

“You take them. I don’t want anything to do with them.”

“That’s too bad. Because you’re going to own them before this is all over. You keep bashing AIG for hoovering up government capital. But the Feds saw what happened with Lehman. AIG sold insurance against bond defaults. But it’s in big trouble on its credit default swap portfolio. And if AIG gets downgraded or becomes insolvent, then its counterparties face billions in worthless insurance policies against default in other credit risks.”

“So you’re saying you can’t let any single firm like AIG, Citi, or Bank of America fail because if one fails we all fail?”

“Yes. The failure wouldn’t just punish the bad banks, it would punish everyone. Credit would lock up. The economy would cease to function.”

“How do you know that’s what would happen?”

“Well, I don’t. But that is the nature of the system we have. We are all dependent on one another. We can’t allow anyone to fail or we’ll all fail.”

“So what you’re saying is that we must at all costs preserve a system that’s brought us to the brink of financial ruin, because the alternative is financial ruin?”

“Well, no. I wouldn’t put it that way.”

“How would you put it then?”

“Well what would you do? What’s your big plan? You just want to let things fall apart and see what happens? That would be a disaster. We can’t afford that risk.”

“There are a lot of things we can’t afford at the moment. But that doesn’t seem to be stopping anyone from spending anyway…”

To be continued…

Dan Denning
for 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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10 Comments on "We Do Not Live in Normal Times"

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beyondtool
Guest
Interesting conversation to end. A pity most don’t see this as a golden opportunity to put the current financial system down, and focus on developing in the infrastructure needed for a changing world. The sooner we all realise that paper money is not a tangible asset the better. Than we can focus on the bigger picture stuff without saying “we can’t afford it”. Thank god GM is going bankrupt, out of all the auto makers they surely have had the most impact on pushing oversized SUVs onto the world market. These companies should be going broke. It is a tragedy… Read more »
kathy
Guest

Minus the banks? aren’t you taking any notice of what’s happening here, After the banks have taken our money selling us investments that don’t exist, the government is giving them the rest of our money to save us all, and when we are poorer still they’ll take our childrens money and their childrens money as well. The banks are the only winners here.

beyondtool
Guest

What I was alluding to was the removal of the banking system in it’s present form. Banks should be banks, that is hold money, not hold a highly volatile risk portfolio. As they were saying on Radio National today “banking should be boring”. At the very least the line between everyday banking and investment banking should be more clearly defined.

kathy
Guest

agreed!!!

Ronnie
Guest
1976..the only capitalist student at Aedlaide Uni. Predicted the collapse of Soviet Union…could’nt believe it happened so fast. Predicted the collapse of capitalism in its present form when Ford and GM go bust. Never believed it could really happen. Read your WEB PAGE..sold all shares moved into gold bullion now in silver bullion, before, things went bad. PREDICTING now… global domestic street violence. US attacks Iran, Israel flattens Syria. South Korea attacked by north. World wide religious war ending in the total destruction of Islam as a functioning religion. As normal millions of innocent people die mainly from hunger and… Read more »
Pete
Guest

It seems most of the younger people seem to want socialism nowdays. I guess they might be getting used to government welfare, without understanding how one actually comes by enough money to support it.

When we are all suffering in Oz from the Depression, I suspect more and more people will cry out with socialistic expectations.

Sometimes I wonder if the system of government is cyclical…what follows democracy? Socialism? Communism? Facist dictatorship?

Maybe the Queen can save us.

Gary
Guest

Ronnie, now you have told us the good news how about the bad news?

watcher7
Guest
“Cycles of economic fashion are as old as business cycles” Big government is back The economic wheel has turned once more and a new cycle of intervention and regulation will soon begin Robert Skidelsky, guardian.co.uk, September 17, 2008: The bankruptcy of Lehman Brothers and the forced sale of Merrill Lynch, two of the greatest names in finance, mark the end of an era. But what will come next? Cycles of economic fashion are as old as business cycles, and are usually caused by deep business disturbances. “Liberal” cycles are followed by “conservative” cycles, which give way to new “liberal” cycles,… Read more »
Doctor Alex
Guest

Vegemite toothpaste? Sounds great to me!

I’m going to liquidate my gold stock portfolio, and trade Vegemite futures!

Thanks for the tip.

rick e
Guest

watcher7 is this an 8000 words

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