We Don’t Expect to See Australian Banks Suddenly Keen to Expand their Loan Books

It seems appropriate that hopes of a further rally in the Aussie stock market are being pinned on the IPO of a retailer. It's like saying a prayer to the god of consumerism for share market salvation. Amen.

The $2.5 billion listing of Myer is expected this week. And what better way to celebrate a six-month reality-defying rally than the listing of a consumer-driven business? Happy days are here again!

Not that we have anything against Myer. It's a good store. We recently bought a sweater there to get us through Melbourne's Antarctic spring. But you know our position here at the Daily Reckoning.

You don't wash out twenty years of mis-allocated credit with a mild recession and then return to the glory days of the stock market. We are still in the middle of a large deflation in credit-backed financial assets. The Myer listing may give the index a boost. But it's not going to change the big picture.

The big picture is that across the Western world consumers are dialing back the spending and turning up the caution. A sea change in attitudes about the future is taking place. For example, the U.S. Commerce Department reported that durable goods orders fell in August by 2.4%. Take away government subsidies for new cars and households are not buying big ticket items.

And then there's housing. Existing home sales fell by 2.4%, the first decline in five months. Here's a warning: watch out for a second massive wave of foreclosures in U.S. housing. U.S. banks, thanks to a relaxation of mark to market accounting rules, have been able to put off the day of reckoning on what to do with millions of non-performing loans. That day, though, is coming.

There are other looming issues like commercial real estate. But we know you must be tired of hearing all that. After all, that is America, not Australia. It would be much easier if we quoted the impossibly smug Kevin Rudd that the government has saved the day. But that just ain't the case.

By our reckoning, the second dip of the global downturn is upon us. Government policy (monetary and fiscal) has merely lured people into believing there is no real cost for decades of bad investments. But the truth is that a lot of stock analysts and economists have simply miscalculated the magnitude and severity of what happens to the real economy when the world's largest ever credit bubble bursts.

Of course we could be wrong. Nobody knows what's going to happen. You hedge your bets and continue to plan for the future. But we're about to find out if we've been living through a modern version of 1930, when a false recovery in the economy was the prelude to the "Great" part of the "Great Depression."

Maybe this will sound like a bunch of whining by the end of the week. After all, three of the big four Aussie banks will report results this week. There will be billion dollar cash profit figures tossed around. But as we said last week, the earnings performance of financial firms in the last six months is a sham.

Cost cutting, government loan guarantees, and an infusion of central bank credit allowed all the big financial players to trade their way to profits for a few quarters. What we don't expect to see is that the Australian banks are suddenly keen to expand their loan books or that their underlying businesses are fundamentally better now than they were twelve months ago. A simple question: just where will the profits come from now?

In the meantime, keep an eye on oil. Sometimes the oil price is driven by speculators. Sometimes it's driven by expectations for the economy. And sometimes it's driven by flat out geopolitical fear. We think now could be one of those times were geopolitics drives crude. Why?

We got a note from a commodities trader in Chicago over the weekend. Up at three a.m. as we're getting over our jet leg we read, "In the big geopolitical dance that has dominated recent headlines there remains one player that all the action seems to swirl around. That player is Iran.

"President Obama's announcement of the discovery of a second 'secret' uranium processing facility with shouting distance of the Shiite holy city of Qum has raised the stakes in what is quickly becoming a very dangerous game. If you read between the lines, nearly all of the geopolitical maneuvering over the past few months has been about the same thing.

"Obama dumps Bush's land-based missile system for a sea-based one that poses far less threat to Russia. Russia - without admitting it, of course - then becomes more accommodating to sanctions against Iran. Israeli Prime Minister Netanyahu goes to Russia without telling anybody and gets caught doing it. Why?

"Certainly not to talk about the weather. We believe Netanyahu was there for a specific purpose: to warn Russia what would happen if Iran did not stop producing bomb-grade uranium. We also believe Obama's controversial move was designed to give Russia political cover to pressure Iran to do just that. Now that a second uranium-producing facility has been found, the stakes have risen again.

"If some sort of political solution to the Iran crisis is not found within the next few months, Israel will strike - with or without the 'permission' of the United States and the price of oil will react accordingly. The global slowdown is currently focusing all the attention on demand, but the biggest bullish factor out there is ultimately, supply. Remove Iranian oil from the market and the old highs of $147 per barrel could be tested quickly.

"Is this going to happen? We hope not. However, our read of the geopolitical events of the past few months makes us think it could be a distinct possibility.

Dan Denning
for The Daily Reckoning Australia

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