Posted on August - 21 - 2010

Economic outlook – look out (take 2)

Double dippers are on the rise.

Nouriel Roubini: “Risk of a double dip recession in advanced economies (US, Japan, Eurozone) has now risen to 40%.”

Robert Schiller: “… also said last week that there’s a greater than a 50 percent chance of falling into another downturn.”

San Francisco Fed: “put the odds of a second recession in the next 10 months at “no greater than a coin toss.”

Mohamed El-Erian (PIMCO): “… said earlier this month that the U.S. faces a 25 percent chance of a double dip and deflation.”

David Rosenberg: “higher than 50-50,” and “If You Don’t Believe In A Double Dip, It’s Because The First Recession Never Ended”.

Thursday and Friday began with the markets’ reaction to data concurring with the double dippers.

It’s the mainstream, stupid

Poor Mr. Hoenig is the lone dissenter at the Fed. The New York Times tugs at the rug under his feet, not realising he stands on a bedrock of logic:

“I wish free money was really free and that there was a painless way to move from severe recession and high leverage to robust and sustainable economic growth, but there is no shortcut.”

While Mr. Hoenig’s view is far from the mainstream …

Poor guy. Opposing the Chairman of the Federal Reserve means anything you say is no longer mainstream. Even if it is blatantly obvious and true, it’s not mainstream, so it’s wrong. Hoenig continues with more comments, which are not only self evident, but vindicated by the recent financial crisis:

“Monetary policy is a useful tool, but it cannot solve every problem faced by the United States,” Mr. Hoenig told local Chamber of Commerce members in a speech at the University of Nebraska, Lincoln. “In trying to use policy as a cure-all, we will repeat the cycle of severe recession and unemployment in a few short years by keeping rates too low for too long.”

“In judging how we approach this recovery, it seems to me that we need to be careful not to repeat those policy patterns that followed the recessions of 1990-91 and 2001,” Mr. Hoenig said. “If we again leave rates too low, too long, out of our uneasiness over the strength of the recovery and our intense desire to avoid recession at all costs, we are risking a repeat of past errors and the consequences they bring.”

Remember though, he’s not mainstream, so ignore him. (Why are you reading this?)

It’s pretty rare for a central banker to forecast boom, doom and gloom. It’s also rare for central bankers to accurately and concisely point out the causes of financial crises. But whether the phrase “too low for too long” will ever make it into mainstream economics textbooks is unlikely.

If you want to find out just how competent the mainstream is, this is one of the best articles around.

Our favourite central banker

Perhaps the rarest of all central banking achievements is to forecast, pinpoint the causes of and make provisions for an incoming financial disaster, all in a timely manner. Who you ask? Glenn Stevens? Nope. Ben Bernanke? Nope. Maestro Greenspan? Certainly not. Not even the mentor of all of the above, Zimbabwe’s Gideon Gono, saw the crisis coming. But one central banker did.

Governor Riad Salameh, of Lebanon!

“… in 2007 [Riad] ordered the country’s private banks to exit all mortgage-backed securities and brace for the financial crash he saw looming.”You could have thought [he] had a crystal ball,” said Edward Gardner of the International Monetary Fund (IMF) regarding Salameh’s actions.”

Never again shall it be said that nobody saw the crisis coming. Even a central banker saw it coming.

We won’t go into the IMF’s track record again. Instead, check out this link, which features more than 20 articles by Austrian economists predicting the crisis, or various elements of it. Riad doesn’t belong to the Austrian school. No central banker does. And we don’t endorse Riad. He is simply the only competent forecaster when it comes to central bankers. That is of concern considering their responsibilities.

(Dan points out that financial crisis guru Nassim Taleb is also from Lebanon.)

Keynes needs a bailout

The most delightfully ironic news comes, as always, from the bailout and stimulus arena. Now remember that the idea of stimulus is to stimulate demand, which then has a multiplier effect. The idea of a bailout is to avoid a similar implosion from a reversed multiplier effect. At least that was the Keynesian idea.

But once again Keynesians have come up short. That’s not a surprise for those possessing some logic.

David Stockman, President Regan’s Budget Director, points out how well stimulus has performed in the land of stimulus itself:

“Nominal GDP is only $100 billion higher than it was back in the third quarter of 2008. That means it has been growing at only $4 billion per month, while new federal debt has been accumulating at around $100 billion per month.

“Yes, this period represents the worst of the so-called Great Recession, but never in history has the federal debt grown at a rate of 25 times GDP for two years running!”

What is surprising is that even the stimulus applied directly by the state doesn’t stimulate, let alone have a multiplier effect.

US state governments, despite their pathetic budget management of the past years, have had a financial epiphany on the matter. They have decided to use much of the $26 billion handed to them by the federal government by not using it… yet. Why?

“We’re a little wary about hiring people if we only have money for a year,” Clark County Las Vegas CFO Jeff Weiler said in The New York Times.

So it takes a government CFO to figure out the flaws of stimulus. A once off injection will withdraw any stimulus effect it had as soon as it ends. Which is why they tend not to end, or, when administered by people who have figured this out, there is no initial stimulus in the first place.

Agora’s 5 Minute Forecast elaborates:

“But haven’t we been through this already? Recall 2008, when a $160 billion stimulus gave every middle-class American a check for $300… and what did they do with it? A few months later, banks get $700 billion… and didn’t lend a penny of it. GM got $57 billion, then went bankrupt. AIG… we don’t even keep track anymore.”

So not only is the intention of stimulus flawed, but its execution doesn’t work either.

The terminator has taken all this rather badly. 150,000 Californian workers have been furloughed by the other kind of Austrian. That means taking a compulsory holiday without pay. So working for the government no longer means job security. Another lesson learned the hard way.

The cost of costing

The costing debate rages on. The only conclusion drawable is that both sides are chronic hypocrites. And it’s not like costing estimates are remotely accurate:

Public Transport Minister Martin “Pakula has admitted in a statement to Parliament that the average expected cost of stations the government promised in 2006 at Lynbrook, Williams Landing and Cardinia Road in Pakenham had almost tripled.”

On the national level, one comment does stand out. The much publicised efforts of the parties to pay off the debt have lead to some concerning guarantees for Keynesians. Gillard says she will not budge on returning to surplus by 2013. She won’t even answer hypotheticals on the issue. So, we take it that the onset of another economic crisis will leave the Australian stimulus story dead in the water.

If Julia could be trusted to stand fast, we might even vote Labor. The Australian tells us to do a donkey vote after doing its questionnaire. Strangely enough, the Greens and the Liberals tied in terms of matching you editor’s preferences. That would suggest your editor is an Ass more than a Donkey.

Abbott bonding with the taxpayer

“The Opposition has unveiled a scheme to fund infrastructure development through bonds rather than through government borrowing.”

In Australian academic speak, “bonds” are government borrowing. (Private bonds are referred to as debentures.)

Could someone explain this whole thing please? Here are 1, 2, 3 articles on the topic. None seem to say anywhere how those bonds will be repaid. It just mentions a tax benefit on holding the bonds. Will the completed infrastructure projects charge people, or will the government pay off the bonds through tax revenue? Either way, it seems Tony may have pulled off quite a hoax.

Regardless, long term Daily Reckoning and Money Morning readers will recall Dan and Kris’ warnings about the government’s upcoming efforts to tap the super industry’s funds. Well, this bonds thing is another development:

“The key is the tax benefit, which doesn’t have to be large and would make them very attractive to superannuation funds.”

One step closer to having super funds funding government projects.

Is long term investing dead?

“High priests of investing have always held one tenet above all. That tenet was to invest for the long term, through the thick and thin of business cycles to emerge wealthier at the other end. Not anymore.”

Apparently, fund managers seeking “alpha” (returns above the broader market’s performance) are now in fashion. Here at Port Phillip Publishing, we wouldn’t know if there is anything to this new idea. It’s not like it has been our business model from the beginning… (being fashionable).

Even the super funds are catching on. But the amusing thing is that managed funds will of course incur higher fees (all else equal). And they can’t all beat the market. So will greed defeat Aussie egalitarianism? Only one of the two is common sense when it comes to making money. At least based on the past few years of range bound markets.

But if the bottom falls out of this basic concept of investing, what will financial advisers tell their clients? After years of claiming stock pickers are jerks, there seems little else to fill the void.

One thing they won’t mention is something Michael Evans at The Age has pointed out:

“… a report found nearly half of the money raised in the aftermath of the financial crisis did not give existing shareholders the chance to take part.

“A review of the near $100 billion in capital injections made in 2008-09 questioned the fairness and transparency of the process, finding existing shareholders suffered an extraordinary transfer of wealth to other investors picked by company management and their investment bank advisers.”

“Extraordinary wealth transfer”. If you are a blind buy and hold investor, someone is laughing at your expense.

Deutschland ueber alles

The Germans are making themselves unpopular with their stellar economic growth:

“The German economy ministry has pencilled in around 3.0 per cent growth this year, more than double the previous estimate, following the strong expansion seen in the second quarter, reports said on Sunday. Der Spiegel weekly and the Welt am Sonntag said that unlike in the past, growth in Europe’s biggest economy was being driven by domestic demand and not just by exports, making it more resilient to weaker conditions elsewhere. Preliminary data from the statistics office on Friday showed that German gross domestic product (GDP) grew 2.2 per cent quarter-on-quarter in the period April to June, the fastest expansion since reunification in 1990.”

A reader sent us an article about debt levels, which pointed out that Germany isn’t exactly debt free. But what people tend to forget is that debt can be a very good thing, if it is invested in assets that provide a return. Germany’s export success requires this kind of debt. American consumption levels required a different kind. Guess where Aussies sit…

Burn and churn baby

The outrage over banking profits has exposed another hypocrisy in the Aussie property mania psyche.

“According to the REIV, as of last week, 18,294 properties had been put up for auction in 2010 – the highest number recorded for that period of the year. The year-to-date clearance rate is 76 per cent, with real estate transactions worth a record $18.8 billion, $5.3 billion more than at this time in 2009. This week there were 535 reported auctions and a clearance rate of 68 per cent.”

Who makes money on all this? Banks and lawyers do. And plenty of it. (We can vouch that many of both do so in dangerously incompetent fashion).

The editor of our sister publication Money Morning wrote a fantastic article on the state of the property industry on Wednesday.

We can’t remember where we read or heard it, but the following point struck a chord:

Rising house prices don’t benefit Australia. They are merely a transfer of wealth from the property buyers to the property sellers. And yet, rising prices are one of Australia’s most celebrated news items.

Until next week,

Nickolai Hubble.
The Daily Reckoning Week in Review

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