“Are you one of those American finance guys from Lehman Brothers or something?”
Your editor was eating pizza at a café on St. Kilda Road last night with a friend who works in the mainstream financial media. The owner knew our friend, but not us. And once he picked up on our accent, he had a few questions like, “What is wrong with all those people in Greece?”
We’ll get back to that story in a moment. But this week’s markets make for compelling reading – and the week is barely half over! In today’s Daily Reckoning, we confess the things we don’t know, look at the routine rigging of the global financial system, and discuss whether the People’s Liberation Army of China is about to drop the big one on the United States of America.
Let’s quickly dispel a rumour. There was a rumour on the Internet of secret emergency meeting in Sydney of the world’s central bankers. We’ve been assured by sources that it was just a regularly planned retreat by the Bank of International Settlements. Rather than some extraordinary rigging of the world’s financial markets, it was just regularly scheduled, ordinary rigging.
In the not so mundane world of markets, today is looking pleasant, if not totally rigged. The futures were up overnight, so Aussie stocks will probably follow New York’s lead and have a big day out. The big report today is the half-year earnings for the Commonwealth Bank of Australia. And the big question: have bad debts peaked?
“Yes!”, says CBA chief Ralph Norris. Last year the bank reported nearly $2 billion in charges for “bad and doubtful debts.” This year, it’s just $1.39 billion. The bank also reported a 13% increase in first half profit to $2.91 billion. Yep, doing it tough is the old CBA.
There’s no doubt that the reduction in bad debt charges is a good sign for the banks. The “operating environment” (the real economy) appears to be less threatening. We’ll see how it goes, but the rest of the market could take the CBA numbers as a sign the debt problem has well and truly peaked. A re-rating of the bank shares might take place and you’d see a mini rally.
Mind you it’s not a rally we’d care to go to. There was another interesting note in the CBA’s media release about the last six months. It reported a 49% increase in home loans to $1.19 billion. The CBA said the home loan growth was, “mainly as a result of increased market share and significant growth in outstanding home loan balances.”
In other words, CBA had less of a bad debt problem in the last six months. But just you wait. It rode the FHOG to higher loan values and volumes and market share. If those borrowers struggle with higher interest rates or – horror of horrors – Aussie house prices grow less fast (or even fall) – we’d expect to see the bad debt problem again affect earnings growth and, ultimately, the valuations on Australian bank stocks.
But there is a lot about the world we don’t understand. As our old friend Thom Hickling used to say when he visited us in France, “Je sais rien…I know nothing Dan. That’s my motto.” It’s more or less our motto as well. That’s why we ask a lot of questions.
And it’s also why you’ll find apparently contradictory statements and advice in the Daily Reckoning. Your editor thinks you should use any rallies in the market to gradually liquidate your stock portfolios. In other words, retire now before the government seizes your super assets or the market crashes.
Yet we work with experienced traders and analysts who’ve spent years in the markets finding great investments. We publish and sell their research and that contains buy recommendations on all sorts of Australian stocks. We publish that because fundamentally, we have no idea what will happen. It’s what we’re all trying to figure out.
The best strategy in that case is to surround yourself with people who are thinking hard and working hard to figure things out. And ultimately, you get to choose the ideas and editors you agree with or whose thinking you’re interested in and whose track record impresses you. And even if you never take a punt on any of those publications, we’ll keep reckoning every day for free! How good is that?
While we’re still on the subject of debt, three cheers for Senator Barnaby Joyce! The finance spokesman for the opposition is copping it from all sides for suggesting that Australia is in hock “to our eyeballs to people overseas.” He also said, “You have got to ask the question, how far into debt do you want to go? We are getting to a point where we can’t repay it.”
Even members of his own coalition have turned on him for suggesting Australia may not be able to repay its sovereign debts. But we say if Barnaby Joyce is fiscally incompetent, we need more men like him in government. He couldn’t do much worse than the debt-first mentality of the establishment.
You can also judge a man by his enemies. In an article titled “Credit experts line up to rebuff Joyce” published by the ABC, we learn that experts from Fitch, Standard and Poor’s, and Citigroup assure us that Australia is in no danger of defaulting on its sovereign debt obligations. Yes, the same people that nearly brought the global financial system to its knees and didn’t see it coming are telling us there is nothing to worry about.
Irony aside, it’s true that Australia’s fiscal position at the sovereign level is better than a lot of other countries. As Michelle Grattan points out in today’s Age, “Australian net debt is expected to peak at 9.6 per cent of GDP, or $153 billion, in 2013-14. In contrast, debt in 2014 in the US is estimated to be nearly 85 per cent of GDP. It will be nearly 92 per cent in the United Kingdom, 143.5 per cent in Japan and 93 per cent for the major advanced economies collectively.”
Based on these numbers, it’s looking pretty grim for the Senator isn’t it? He does look a bit alarmist for warning of an imminent crisis in servicing Australia’s sovereign debt. What’s interesting is how vigorous the attacks on him are. What’s going on there?
Well, there are certain interests in government and finance who want the debt to go higher. It’s the business they’re in and it supports their livelihoods and lifestyles. Some of the people criticising the Senator benefit tremendously from larger and larger government borrowing in Australia – whether it’s the politicians who spend it or the bankers who arrange it or the ratings agencies who get paid to slap a triple A on it.
And in case these folks haven’t noticed, the funding model for the welfare state is breaking down all over the world. It will catch up to Australia eventually. Indeed the very premise of the welfare state – that society can enjoy less risk higher standards of living through progressive taxation on a tax base that’s getting smaller and less productive by the day and faces global wage deflation – is being exposed as bogus and fraudulent. That’s why you should expect more measures that punish you for withdrawing your money from super or the banks – or restrict it outright.
But on this issue of debt, if only the Senator had spoken about Australia’s net foreign debt as a nation, he would have made a better point. The net foreign debt is the sum total of how much Australians have borrowed from the rest of the world, minus what Australians have lent or own in equity. According to the ABS, “Net foreign debt is equal to gross foreign debt less non-equity assets such as foreign reserves held by the Reserve Bank and lending by residents of Australia to non-residents.”
A simpler way of thinking about it is “how much of the world do we own and how much do we owe to the rest of the world.” The facts on this matter clearly support the Senator’s position. According to research published last year by the Statistics and Mapping section of the Parliament of Australia’s Parliament, Australia’s foreign debt was just $3 billion in 1976. According to the ABS, it’s now $637.5 billion – or about 63% of GDP. That’s a lot higher than the sovereign debt-to-GDP level of 9%.
Even without knowing how this compares to other countries, it’s safe to say that number is alarming. Australia has $1.1 trillion in foreign assets. Half are in equities and half in debt securities. As always, there’s the risk that asset values, especially equities, can fall.
On the debt side, Australia has $1.8 trillion in foreign liabilities. Nearly $700 billion of that is foreign equity ownership of Aussie stocks. The other $1.2 trillion is debt owed to foreigners by Australians. The odds are that if there’s a double dip global recession this figure will increase. Domestic consumption of imports will rise with more stimulus while exports would presumably fall in a global slowdown.
But so what? Who cares if Australians firms and households borrow abroad to finance their consumption and investment? Isn’t that a private or market-driven decision? Well, yes. But we think it exposes the country to several big risks.
First, the lenders might not always be so forthcoming. With massive borrowing needs in places like Japan, the US, and the UK, it’s probably not safe to assume a ready supply of foreign capital. Even with a great credit rating, in a credit depression capital is going to be scarcer and the cost of it will inevitably go up.
The big risk, of course, is that you build an economy based on debt which isn’t sustainable when the creditors turn you down. You have long-term liabilities you racked up when the currency was strong. But if they’re denominated in foreign currencies and the Aussie crashes again (as it might in a global W shaped depression) paying back your debts gets more expensive.
Ultimately, it comes down to what you’ve down with your borrowed money. Have you invested in wisely? An increase in debt – or even net foreign debt as a permanent feature of Australia’s economic landscape – wouldn’t be so bad if it translated into an increase in productive assets. You’d be a capital importer. But you’d use it to build your asset base.
Those assets – especially capital equipment in the resource sector – would lead to higher exports, lower current account deficits (also as a % of GDP) and generally more investment led growth instead of consumption led growth. It would be a responsible use of debt.
But if the debt – as we believe the numbers show – has been taken on to finance a housing boom, or worse, to finance speculation by Aussie banks and financial firms in asset markets abroad, then it’s not going to be what we call productive debt. So we’ll see, won’t we?
Tomorrow, we’ll show you why borrowing your way to prosperity is not only a sure fire bet to national servitude, but also a recipe for political instability. Our case in point will be the United States of America and its main creditor, the People’s Republic of China.
Finally, our waiter last night asked us, “What’s wrong with those Greeks? Is there some sort of crisis or something? Is it like that Lehman thing you guys caused?”
“What’s wrong with Greece? They can’t pay their bills. Nobody wants to admit it. But they’re living beyond their means. All of Europe is.”
“So what will happen?”
“Probably some fake bail out. The bigger countries in Northern Europe will guarantee emergency borrowing by the Greeks. No one wants to admit that standards of living have to fall and government spending has to fall too. They’re going to fight it…but it’s like fighting the orbits of the planets.”
“Hmm. Imagine that. Even in antiquity the Greeks were bad with money. But the Romans figured it out didn’t they? They were good at collecting taxes. Not the Greeks. They had all the good ideas though.”
for The Daily Reckoning Australia