Greek tragedy postponed (so far) for Oz

Economists got smashed in the financial crisis, with their models failing to predict the consequences.

Historians, in contrast, won out – Ultimately historians are not as constrained by the rigidities of models and can view the world through a long-term macro lense (I realise this is an over-simplified view, but this is one of the general differences between historians and economists).

Niall Ferguson, a historian of finance, has today written a sobering piece in the FT of the mess in Greece and the coming day of reckoning for most Western economies.

“What we in the western world are about to learn is that there is no such thing as a Keynesian free lunch. Deficits did not “save” us half so much as monetary policy – zero interest rates plus quantitative easing – did. First, the impact of government spending (the hallowed “multiplier”) has been much less than the proponents of stimulus hoped. Second, there is a good deal of “leakage” from open economies in a globalised world. Last, crucially, explosions of public debt incur bills that fall due much sooner than we expect.”

We in Oz tend to take comfort from the fact that our budget deficit is much lower than other OECD countries. But if you look at charts of household debt, it’s a completely different picture.  While government debt is relatively low, household debt is through the roof and higher than that of the UK and the US.  Rather than teach us a lesson, the financial crisis just saw Oz continue it’s love affair with credit.

What worries me is the lack of understanding by the Oz populace of this consumer debt addiction.  Many thought the GFC would result in Oz’s day of reckoning, but it’s merely been postponed by the massive amount of stimulus pumped into the system.

And with the resumption of the commodities boom, Oz is once again back to a 2-speed economy: The high-growth mining states on the one hand and the poorly-governed, large eastern states on the other.

This presents the RBA with a real conundrum.  The RBA knows that households are now much more sensitive to interest rate increases, despite rates still being at near to 50-year lows (this in itself is quite a ridiculous situation).  But with concerns over potential wage and cost inflation in WA, the RBA will be increasing rates in the future.  And this will result in more “mortgage stress” for those that borrowed crazy large loans at record-low rates.

When and how will this addiction to credit end?  It’s hard to see our day of reckoning in the short term.  The Oz economy will continue to ride the perfect wave of China and India’s voracious commodities demand.  But when it does arrive, it ain’t going to be pretty.

5 surprises for China in 2010

I would be surprised if:

1) Prominent leaders stop using hair dye – Insecurity, insecurity.  Can they overcome their insecurity and show their natural grey?

2) No conflict in the Oz-China relationship – Unfortunately, there will continue to be more flare-ups.  The Oz population has NFI about China’s rise and this provides ample fuel for crazies like Barnaby Joyce to run scare campaigns.  Not to mention the sensationalist way Oz media reports on China.  On the flipside, the Oz government has not really articulated a clear China policy and this leaves the “China story” as fodder for the Tories.

3) Oz articulates a clear China policy – This would be a pleasant surprise.  But it’s unlikely to eventuate, particularly in an election year.  Disappointingly, the Oz population is way too absorbed in house prices, how to get into Ivy bar and Princess Mary’s latest hair style, to care about the future make-up of the world.

4) One-off  10-15% appreciation in the RMB – This would shock the world.  It would preempt hot money speculators from flooding China with liquidity in anticipation of appreciation.  It would be a good way to combat increasing inflation (which I think will surprise on the upside, and which requires a very delicate response to avoid crashing the economy), as imports would be cheaper.  The Chinese consumer would suddenly have a much higher purchasing power and most hotel operators around the world would have to start intensive Mandarin learning for the flood of Chinese tourists.  Though it’s unlikely given the government is still way too scared about nuking the export sector.

5) No unrest – That’s right.  In a country with 56 ethnic minorities, increasing NIMBYism from rising property prices, constant food quality scandals, corrupt officials and suffocating social pressure from ultra-fierce competition, this would be a major surprise.  And one the government would love to see.

Taxing Wall Street down to size

David Stockman, Ronald Reagan’s director of the Office of Management and Budget, writing about the Volcker bank tax.

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“The baleful reality is that the big banks, the freakish offspring of the Fed’s easy money, are dangerous institutions, deeply embedded in a bull market culture of entitlement and greed. This is why the Obama tax is welcome: its underlying policy message is that big banking must get smaller because it does too little that is useful, productive or efficient.

To argue, as some conservatives surely will, that a policy-directed shrinking of big banking is an inappropriate interference in the marketplace is to miss a crucial point: the big Wall Street banks are wards of the state, not private enterprises. During recent quarters, for instance, the preponderant share of Goldman Sachs’ revenues came from trading in bonds, currencies and commodities.

But these profits were not evidence of Mr. Market doing God’s work, greasing the wheels of commerce and trade by facilitating productive financial transactions. In fact, they represented the fruits of hyperactive gambling in the Fed’s monetary casino — a place where the inside players obtain their chips at no cost from the Fed-controlled money markets, and are warned well in advance, by obscure wording changes in the Fed’s policy statements, about any pending shift in the gambling odds.”

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While more details are needed, at face value the Volcker tax is to be welcomed.  The repeal of the Glass-Steagall Act resulted in the formation of the mega banking conglomerates, like Citigroup, which almost destroyed the global economy.  There is a real need to separate casino banking (proprietary trading, hedge funds etc), from utility banking (taking deposits and lending money).  Banks should never have been allowed to gear up 20-30x on the back of deposits from mum and dads.  Moreover, the taxpayer should never have been put in a position to socialise the losses from casino banking.

What’s even more galling is that the banks were given a license to print money as a result of the policy response to the GFC.  It’s not very hard to make good coin when the cost of money is zero – borrow money at zero rates, and then punt to one’s content in a system swimming with liquidity.

An interesting aspect of the bank regulation debate is that there is strong agreement from both sides of politics.  Bank-bashing has always appealed to Democrats, while to Republicans – there’s nothing free market about bailing out banks with taxpayers’ hard-earned.

Bloody brilliant

A dark privatised social security story – This is a brilliant post by John Hempton about how he blew the whistle on a dodgy brothers investment shop, which could have morphed into Australia’s very-own Madoff.

Quite an amazing story.