Your Garden Variety Global Financial Crisis or Something Wilder?

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Watching a giant kettle and tea cup stopped at the light in front on the Prince of Wales this morning, we wondered is it all just a tempest in a tea cup. St. Kilda Festival is on this weekend. So the carnival has come to town. It has put us in a carney mood.

Today’s Daily Reckoning will try to sort out if this is a garden variety global financial crisis or something wilder. We’ll also connect the dots between Ken Henry’s comments on debt yesterday in the Senate, and why Stephen Conroy made sure you couldn’t read those comments.

But first, why are companies hoarding cash? Bloomberg reports that companies in the S&P 500 have increased their cash holdings to an aggregate US$1.18 trillion dollars. The big blue chip multinationals have cut spending, frozen new hires (not literally), and generally kept cautious until more details emerge about the economic landscape.

Here in Australia the landscape doesn’t look all that bad. Rio Tinto followed BHP’s wowser result with a good one of its own. The company said it’s in cautious expansion mode after reducing debt, cutting costs, and posting a $6.29 billion annual profit. Iron ore, debt, and cash all collided on the same balance sheet.

Speaking of which, Diggers and Drillers editor Alex Cowie sent through his February issue for our review last night. Alex and his wife are getting ready to welcome their first baby into the world any day now. But he’s shown admirable focus this week looking at the latest financial statements to figure out which Aussie resource firms have the highest net cash to market cap ratios.

It’s not the first time Alex has used this financial ratio as a lead generator for investment ideas. It’s especially useful if you think credit is going to be tight. You don’t want companies that have little cash and lots of debt to roll over. That makes you vulnerable.

Alex’s list of the top twenty included a fair few energy and gold companies. But near the top of the list were a few iron ore hopefuls. And as Alex has already added gold and energy recommendations in the last six months, he’s tipping some of the ore stocks this month. D&D readers will find out which ones after the market closes on Monday.

Poor old Barnaby Joyce keeps copping it from an establishment determined to diminish worries about Australia’s long-term debt. The Senator asked Treasury Secretary Ken Henry if growing debts and more borrowing would lead to higher interest rates in Australia. The Secretary replied that, “That is a gross over-simplification of economic understanding of these matters… I think we should be … careful not to rush into simplistic relationships between levels of debt and interest rates.”

The full exchange between the two is not available at the moment because hackers have shut down the Australian Parliament site with a Denial of Service attack. More on that in just a second. But in the meantime we’ll just have to guess at what the Treasury Secretary meant by “economic understanding of these matters.”

If he meant the understanding of the economic establishment is that debt is a critical part of the world’s economy, he’s probably right. That is, most of the clods with Ivy League degrees who failed to forecast the GFC have no understanding at all that the world’s financial system is burdened by far too much debt. Most of them appear to have learned nothing from the crisis, except, perhaps, how to make fun of people who understand intuitively that you don’t get rich by spending more money.

Of course it’s true that more debt does not automatically lead to higher interest rates. Suggesting there was such a “simplistic relationship” between too much borrowing and the cost of capital would be…well…simplistic. Simplistic is pejorative. If it were just simpler, or just simple, it would be better.

Therefore a simpler understanding of the relationship between debt and interest rates is this: if you borrow a lot and invest in it unproductively, the debt will be a lifelong financial burden. And if the more short-term your borrowing is, the more interest rate sensitive is. The debt may not lead to rising interest rates directly. But if rates rise anyway, the debt becomes even more burdensome.

It’s not an issue of Australia’s credit-worthiness, at least not yet. Rates aren’t going to rise because international investors view Australia as a greater credit risk than, say, America. But it doesn’t matter. If rates rise globally, Australian borrowers (household, corporate, government) will again find themselves way back in the queue of those with empty pocket and hats in hand. Like everyone one else, they’ll pay more to borrow.

That is the ultimate risk of financing so much of your prosperity with debt (instead of savings). Your continued growth is depending on your access to credit. And if, for any reason, that is cut off, you’re in trouble, not to mention you’ll have to dedicate a larger portion of your national income just to service your debts.

No matter what the Treasury Secretary says, Australia does have a huge net foreign debt figure. The country has chosen to finance its growth with borrowed foreign money. That is what it is. But let’s not pretend than on the face of it, it’s no big deal with no big consequences.

By the way, why was the Parliament website under assault from global hackers? Well, who knows? But it could have something to do with the fact Google revealed yesterday it had been asked by the Australian Government to censor certain YouTube videos by putting them into YouTube’s “refused classification” category.

You cannot be serious.

Communications Minister (increasingly an ironic title for a man bent on censoring the Internet) Stephen Conroy apparently asked Google to filter Australia’s YouTube content the way it filters content in China and Thailand. Google, which has recently found a backbone about cooperating with the ‘requests’ of oppressive regimes, said it would not “voluntarily” comply with the request.

So if the Minister wants Google to censor Australia’s YouTube options, he’s going to have to do it the old fashioned way, via legislative coercion. The minister, via the government, appears ready to just that by submitting legislation that would force Aussie ISPs to block websites that were “refused classification.”

Ah yes! The famous black list. No one knows if they’re on it, how they got on it, or how to get off of it. But someone in the government keeps it and if you’re on it, may god and a very good legal team help you. It’s astonishing that after so much opposition, the Minister pushes ahead with his plan. It’s almost like everyone in government thinks you need to be protected from yourself.

Some people will say that reasonable attempts to police the Internet aren’t any different than attempts to police the real world. The distribution of pornography is regulated and limited. The same goes for alcohol and tobacco. Why, the argument goes, should the Internet alone be free of any sensible attempt to determine what people are allowed to consume.

Well, why not let sensible people make that determination in the privacy of their home, as adults? If the government gets to determine what’s sensible for you to see, they will invariably abuse that authority, even if it begins in good faith (protecting kids from sexual predators, for example).

But it’s hard to see you promote a free-thinking and thoughtful society by controlling what people see. That’s paternalistic. What’s worse, it’s a well-dressed up and mild-mannered kind of authoritarianism that should be mocked, resisted, and defeated whenever you get the chance. Don’t worry. They’ll keep coming for you. You just have to keep fighting.

Or have we finally lost the plot? Are we so deeply immersed in the idea that the funding model for the fiscal welfare state is fundamentally broken that we’re being unreasonable? Maybe. But we hope not.

In previous financial crises, the contraction that came with global recession was avoided by either more money or cheaper energy. These kept the whole system growing. Capital and energy are important inputs into any growing system.

But what we’ve seen in the last year is that the flood of capital and credit has gone to prop up fewer and fewer large institutions. The big governments bailed out the big banks and left the little banks to hang. But who is going to bail out the big governments?

They’ve taken on all the risks and bad debts of the private sector. Now all that risk is concentrated in fewer places with a greater strain. These governments aren’t too big to fail either. But their failure will be even more catastrophic for ordinary savers and investors.

That’s what’s different this time, we reckon. For the better part of 200 years, the tides of prosperity have lifted more and more people out of poverty. Mind you there are still billions of people living on less than a dollar a day. But standards of living for more people are higher than they’ve ever been.

We wonder now if the 200-year expansion is due for a contraction. More expensive energy and credit slow the growth of the system. More importantly, globalisation is clearly detrimental to the interests of some nation states, especially in those countries where wages are falling at just the time millions of Boomer’s hope to retire on generous pensions or accumulated financial assets (houses and stocks).

That’s not a tempest in a teacup. That’s a teacup shattering on the kitchen floor when you realise the government is coming for your 401(k) or Superannuation assets to pay for its deficits, which in turn pay for promises it can no longer keep.

Even if Europe finds a cosmetic remedy for the Greek crisis, the real problem is a world that borrowed a lot of its current prosperity. The debt overhang is too great to permit an easy way out of all this. Default in the debtor nations which borrowed in Euros and dollars is inevitable.

For the UK and the US, which largely borrowed in their own currencies, inflation is much more likely. In this scenario, we’d again recommend you sell into rising stock markets when you get the chance. Stocks could rise as investors shun sovereign debt markets. And once the Fed, like the Bank of England, is forced into monetising more government borrowing right away, look out for much higher precious metals prices.

Yep. It’s a carnival of creative destruction. Stay on your toes! Until next week…

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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121 Comments on "Your Garden Variety Global Financial Crisis or Something Wilder?"

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Ross
Guest
DD is on it today. I may have mentioned it some time in the past, but I am reminded by two pieces read today of the German “rentenversicherung” (super) system. The two pieces today was one from Kohler where he too ate his weeties about unfunded govt liabilities and just how underwater the overgenerous greek pension is, and the other was the announcement by the UK conservatives that they are going with the death tax. I didn’t get alot of ticks when talking about death duties as possibly the only way out in terms of servcing the over the odds… Read more »
Roy
Guest
I never stopped being amazed by officials that dismiss the level of private debt in this country. Then I’m astounded why people can’t see the link between increased debt and ballooning asset (house) prices. Give people more credit they spend more, they spend more asset prices rise so they get more credit, the cycle continues until the debt burden can no longer be serviced and/or the lines of credit are reduced. That is the trouble with using debt to speculate on prices, its all good until it isn’t. Like any ponzi scheme its those that hang on and don’t take… Read more »
Ross
Guest

The trick Roy is to make them feel richer, then they borrow more, and they consume more, and they generate more consumption tax. And when it all goes poof Henry will hide with his wombats.

Dan
Guest
I can think of a few points to add. Firstly, the debt trail leads to who owns what, but owning and controlling are different matters. If you own land, but don’t control the military, you ultimately do not control the land and _ultimately_ don’t own it but depend on the good will of the military guy. But within countries, the debt equation predicts who will be rich and poor in a short while – depending of course on the good will of the military guy. Those in debt will find themselves poor. ie: they that have not, what little they… Read more »
Biker Pete
Guest

Ross: “The trick Roy is to make them feel richer, then they borrow more, and they consume more, and they generate more consumption tax.”

No question that the Brit banks exploited this human weakness, Ross.
The difference between Oz and the UK is that they _have_ so little to make them feel good about themselves… and their situation… and are far more susceptible to the equity drip feed.

We very much take for granted our Australian way of life, but I also suspect our cultural and personal morale is far more resilient… .

Rip
Guest

Just want to add a big quick NO on the internet censoring/filtering or what ever they want to call it ! !

Justin
Guest

While I think it’s good that Barnaby Joyce is stirring the pot, it is simplistic to equate rising debt levels with rising interest rates.

Debt levels have been rising for many years yet interest rates have been falling. In fact debt levels are as high as they’ve ever been yet interest rates are close to Great Depression levels.

Sambo
Guest
You sure that you are not being simplistic Justin? High debt levels = higher risk = higher interest rates (and higher interest rates ironically increase the risk) But it does depend on whether you are talking about private or sovereign debt. High private debt is better understood by the ability of borrowers to service that debt in the future – which relates to the current and future state of an economy. Sovereign debt should be thought of in the same way, just from a more global perspective. However I believe it takes a bit more time for the lenders to… Read more »
Justin
Guest

So why are government 10yr bond yields are currently at around 5.5% with government debt issuance at a record $120 billion & M3 (one of the broadest measures of ‘money’) at $1.2 trillion?

In 1990 the same 10yr yields were nearly 14%, with government debt at around $40 billion, while M3 was a mere $225 billion.

There is no absolute correlation between debt levels & interest rates.

Sambo
Guest
Perhaps there is just no correlation between now and 1990… I’m not saying that I am right and you are wrong. But it ‘makes sense’ that the more debt any entity has, the harder it will be to service that debt. For that reason, the risk for providing further debt increases. Oversimplified analogy: Bob earns $10K a year. He borrows $50K at 5% interest. It costs him $2.5K to pay the interest each year. Would you lend him another $50K at 5%? What about another $50K at 5%? I am oversimiplifying too, but the risk of problems paying off the… Read more »
Biker Pete
Guest

Sambo: “Who will get the credit? The lowest risk entities first. The higher risk entities will only be able to compete for the credit by offering higher returns (rates) on borrowing.”

Already happening… .

Dan
Guest

Just for a bit of healthy alarmism:

“Yes, your enemy is that “Happy Conspiracy:” It has degraded into a pseudo-capitalism with no conscience, no sense of the public good, hell-bent on controlling America’s mind, your money and the global markets for its own selfish ends. And eventually it will trigger the game-changing global-debt bomb, the third global meltdown of the century that finally ignites the Great Depression II, plunging us into an era of anarchy.”

Everybody run for the hills! (At least the real estate up that way is half decent!)

http://www.marketwatch.com/story/how-to-invest-for-the-debt-bomb-explosion-2010-02-09

Biker Pete
Guest
In which city would you buy realty, Dan? The grass is always greener… well, not always… . Son # 2, drafted into a ‘reality TV show’, probably to add some Aussie flavour, found himself housed with a group of young blokes (with a host of young lovelies brought in to lounge around the pools) in a mansion previously on sale for $7 mil, now on sale for $2 mil. Las Vegas? He was totally unimpressed… . In our US travels, we’ve never once been tempted to buy in the US or the UK. Canada, perhaps. But unless you like forty… Read more »
Dan
Guest

Which city? An undersized, under-developed one. The only way is up for those places, by definition. But quite importantly, the grass is greener where it rains, and that’s actually not a bad place to buy land.

Justin
Guest

Sambo, What if the asset/s Bob holds return 10%?

There is also is issue of the issue of maturity matching; Is Bob borrowing short to lend long?

Borrowing short to lend long is one of the main reasons for the GFC. That & ludicrously inflated asset values i.e Bob’s assets don’t return 10%, or his (borrowed) capital.

Ross
Guest
Justin/Sambo, the difference between now and 1990 on interest rates is for now the funny money and the supply side. If you look at that video i posted with Stiglitz … watch his twitches as he says it is ludicrous to suggest Greece should have to pay current rates, and that they are bred only of panic. But Stiglitz is also saying that his market has no risk price no matter how ill disciplined the sovereign or the private sector sponsored by the sovereign’s tax man. Thats what you get from one whose base is the 19th century romantic socialist… Read more »
Biker Pete
Guest
BHP seems fairly optimistic: http://www.watoday.com.au/business/bhp-hints-at-ore-price-surge-20100214-nyzb.html Meanwhile…. … driving south from Vancouver, through the states and down into Mexico in my M-I-L’s convertible a few years back, we were looking for that “…undersized, under-developed…” city, Dan. Never did find it. What we found was over-priced beach suburbs which had us scurrying back to Oz to buy land fronting vastly-superior beaches in WA! Really, instead of just talking about buying over there, many Aussies need a year or two actually living there. Wages are, for most, pretty poor; and while high rainfall may occur most months of the year, much of the… Read more »
Sambo
Guest

Justin: Since when do Australians borrow money to make more money?

The private sector and Government are consumers.

Yes, some people borrow to make money. Big business, small business and speculators. Business rates are through the roof, but speculators are doing okay for now.

Justin
Guest

Sambo: They borrow money to buy real estate maybe?

Benchmark 10yr yields have been, more or less, falling since they peaked in August 1982 at 16.5%. I don’t have exact data but corporate yields have also fallen, yet debt levels have increased exponentially since then.

Debt levels were, at the time, at extreme levels prior to & during the Great Depression yet interest rates were very low.

The notion that rising debt levels means rising interest rates is simplistic.

Ross
Guest

Heat on central bankers, the source of Justin’s simplistic – here’s one where they kept rates up – http://www.zerohedge.com/article/exclusive-bank-england-engaged-flagrant-gold-manipulation-interwar-period-new-york-fed-does-

Matto
Guest

“The notion that rising debt levels means rising interest rates is simplistic.”

the notion hinges on the question – are available funds finite?

Stillgotshoeson
Guest

“the notion hinges on the question – are available funds finite? ”

No they are not as has been proven… the giant ponzi scheme that is capitalism runs out of money it collapses….

Biker Pete
Guest

finite/infinite

For CS, look up the difference. Here’s an example that may help you, son:

“Gawd, the ignorance here is infinite…”

Stillgotshoeson
Guest

That’s the difference.. I can read what was written and understand what was meant… you however. with your can’t think outside the box mentality can not, this is why your ignorance is bliss to the state of the economy ;-)

Biker Pete
Guest
How can I put this kindly? You know even less about your native language than you do about property. No, that seems a little unkind. Let’s _try_ to help you. Find something you know about… and, when an opportunity presents, show off online… if that’s what you desperately need, Shoe-son, or whoever you are. (Probably Steven, whose mental prowess rivals your own.) You said, in answer to the question: “…are available funds finite? ” “No they are not (so funds are _infinite_ )as has been proven… the giant ponzi scheme that is capitalism runs out of money it collapses…. ”… Read more »
Stillgotshoeson
Guest
Sorry, your the smug and self assured one here. I just tell it as it is, call a spade a spade, the economy has not recovered, the stimulus was a band aid on an artery and we are in line for a correction both in the share market and real estate. My investments are exposed to both, real estate, I have shares in Goodman Group and GPT, together 300000 of them. I currently rent as it is better value to me and invest the difference. My take on people like yourself is described in a scene from Saving Private Ryan… Read more »
Biker Pete
Guest

Infinitely funny, Shoe-son.

I’ll rephrase:

“In rabbiting your simple-minded rhetoric, gleaned avidly in a local cinema, you fail to even realise that most here are _capitalists_; that we speak and understand English; and that that’s your mum, right now, yelling to get off her computer… .”

What is the language usually spoken in your home, BTW?

Claytonator
Guest
I read the DR, say 5 times a week. It’s fantastic – have been doing so since 2005. Sadly, around a year or so ago – Tricycle Pete showed up. It’s hard for Biker Pete to listen to what other people have to say. I think it may have something to do with the fact that he often forgets to take his helmet off. Secretly – I think he chooses to leave it on to save black eyes and broken jaws in public. Seems to know alot about Australia – although there are alot of pretty pictures available on the… Read more »
Fiscal Phil
Guest

There goes the monopoly board!!!!!!

Biker Pete
Guest
Prefer your allegations of paedophilia, do you, Clay? Slime thrown up from gutter level splatters back on the upchucker, sport. Now I realise it must be difficult for those who’d like to see property crash, when it’s rising _infinitely_ faster than your Centrelink payment, but neither a headshot or a mudsh*t will make that happen, son. Let’s sit back and watch the _specific predictions_ of your fellow bears, shall we? Let’s see: 1 – 2 months; 4 – 6 months; 12 – 18 months, for the 40% crash, wasn’t it? (With Steve Keen’s 200km trek in April, as a minor… Read more »
Claytonator
Guest
I can’t believe your still licking those festy old wounds? To be honest I can’t even recall any of your lame comebacks. I work full time and my (real – not imaginary) wife works part time. We owe around $200k on a property we bought in 2005. I wouldn’t exactly call myself a bear, although I do have concerns. I’m fairly confident that I will weather the storm (if there is one). I guess though if the RBA cash rate hits something like 9% and wages are still stagnant I might have a problem. If I do, a whole heap… Read more »
Matto
Guest
id like to take a moment to clarify my 1-2months prediction while its being quoted. im not interested in winning an argument on the economic future, i am interested in finding the most likely scenario and will happily accept any economic insights from where ever they come from, whether they debunk my ‘predictions’ or whatever. i think we are facing a market adjustment due to the current macro risks in the global system – take your pick but Alt-A resets are one i think we cant avoid, whether it comes later in the year or sooner but i suspect that… Read more »
Biker Pete
Guest

The hapless followers of Keen
in Canberra will soon convene
to consecrate their guru who’ll
become our _best-known_ April Fool…

John
Guest

While Clayton may have feet of Clay, he did apologise!
“I’d take it back, but words I lack to make amends here, guys.”

Fiscal Phil
Guest

Here’s to Pete, he’s now moved to rhymes, what a treat.
Propertay’s his thang, it’s having a good time, bow at his feet.

I hope he does not have to eat his words, because most of them have been sheeeet.

Enjoy the meal Bikey.

Biker Pete
Guest

Needs work, Prozak. I’d advise you not to leave your day job, but I see you’re still shaking hands with the unemployed… .

Claytonator
Guest
Just to clarify for our new readers’ sake there was no allegations of paedophilia on my behalf. Postman Pete used to specify his location when posting and it would differ from post to post, sometimes several times in one day. I simply suggested that he was a transient internet cafe hopper unless his bike has wireless roaming broadband which I doubt. I merely suggested there was a correlation between his habits and that of paedophiles. Since then Postman Pete no longer posts his location. Biker is renowned for taking people’s words out of context and avoiding questions such as have… Read more »
Ned S
Guest

Do believe I found it – To be interpreted as ??? :) :

“… Alot of transient creatures bouncing between internet cafes are child porn addicts and paedophiles – maybe this is not you – maybe you have to shift towns regularly (several in one day) because you saturate your ego and profound intellect onto the locals …”

http://www.dailyreckoning.com.au/total-meltdown-of-the-aussie-housing-market/2009/08/28/

Biker Pete
Guest

Whose side are you on Ned?

Claytonator
Guest

Biker says:
“Needs work, Prozak. I’d advise you not to leave your day job, but I see you’re still shaking hands with the unemployed… .”

Are you employed by anyone Biker?

Ned S
Guest
Let’s all have a vote now: Who warms to “transient creatures bouncing between internet cafes” who may or may not be “child porn addicts and paedophiles” – But if they aren’t rock spiders, “saturate” their “ego and profound intellect onto the locals” … :) :) :) Jeez I love this site! :) Claytonator, if you don’t see it as being in any way personal to ask, just how exactly DID you get so clued up on the habits of “child porn addicts and paedophiles”? – From one of those in depth academic analyses like what Steve Keen dun on Oz… Read more »
Biker Pete
Guest

Claytonator’s slimy apology, later retracted, was the classic, Ned. Enjoyed your contribution, John! :)

Claytonator
Guest
Ned, the top bit is a bit convoluted. Lets keep things in context in future. Those that follow the link from your previous post and read the entire battle will judge for themselves. I don’t recall siding with Steve Keen directly in any of my posts either.. Now – I am not offended by your personal question and am not treating it as an allegation either. So here is my explanation – basically anyone with a bit of networking knowledge would understand that by WAR driving or using Internet cafes you cannot be directly identified by your IP address. This… Read more »
Biker Pete
Guest

Hmmm…

Here’s the next part of the saga:

“Comment by Claytonator on 2 September 2009:

My apologies Rob, Biker Pete and others – DR is a rarity and should stay that way – If I were able I would edit my post – so sorry again and I will keep my shots above the belt in future.”

Claytonator
Guest

Biker – can you enlighten me as to where my apology was retracted?

Are you unemployed?

Ned S
Guest
G’day Claytonator – “top bit is a bit convoluted” ? – If I was being represented in a court of law, I’d kind of hope my barrister might say something like “Prejudicial your honour!” And that the beak might even agree with him!!! :) But that aside, it’s got to be better fun than than chatting about Oz house prices! And for what little value it may or may not be, I can’t see the RBA rate getting to the sorts of levels that you indicate could cause you concern anytime soon at all. BUT even IF they did, they’ll… Read more »
Biker Pete
Guest
Don’t ya hate it when the past comes back… and bites you, Claytonator? Here’s a tip which may help you in life: If you speak the truth, you’ll never be caught out like that again… . How did you choose the strange tag, son? Were you perhaps influenced: http://www.lightstalkers.org/images/show/594022 Your interest in my welfare is amusing, considering your numerous, continuing bad guesses in the past. (A few more today, by the way… .) To answer your personal question(s): I’m semi-retired, on a tax-free TTR (look it up). Managing a dozen properties is enough to keep me busy, even when travelling… Read more »
Claytonator
Guest
I don’t feel like I’ve been bitten by my past at all Biker. I feel as though you are losing relevance with every post. Plastic valves? I don’t understand. This is just lame now. I see your realing scratching for comebacks if your googling my tag digging for dirt. For someone with all that wealth why would you waste so much time on the “slimy” likes of me. For the record my household has no debts other than our mortgage. I worked in a financial institution for six years doing loans, cashier work and I.T. – I know of the… Read more »
Ned S
Guest

You’re not a bloody Kanuk are you Biker? Jeez, have I got some “dead leaf” jokes for you! :)

Biker Pete
Guest
Claytonator: “I see your realing (sic) scratching for comebacks if your (sic) googling my tag digging for dirt.” Nah, I suddenly remembered that the Yanks had manufactured a landmine under that patent… and wondered if you might be going to blow up. I’ll help you here: “Pleased to learn you’ve upgraded to a “(real – not imaginary) wife” (Your post 16/02/2010). Those plastic valves are a real nuisance, aren’t they?!~” Blow up… get it? Nah? OK. You sure someone actually employed you? Loans? Finance? IT?! No wonder there’s a GFC out there! M-a-t-e… . Borrow money?! Let’s put it this… Read more »
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