The news on the World and Australian stock markets worth paying attention to - and what it might mean for your investments. Our mission is very different to that of newspapers or mainstream financial outlets. Our mission is to look at the investment world and the financial world in a sceptical and contrarian way.
Last week, I asked whether you could vote your way out of a housing bust.
It certainly looks like you tried to.
Bill got banished in spectacular fashion. Australia’s election surprise even made it to the top of the news here in the UK.
But have you been paying attention to Europe’s elections in return? They finish today. And this picture might help you sit up and listen.
It shows a pensioner covered in milkshake after voting and polling for the Brexit Party.
That’s how democracy functions in the UK these days. The elections are milkshake wars.
The victim of the latest attack doesn’t look bothered though.
‘He just told me to watch out for the milkshake on the floor so my children didn’t slip,’ wrote one person at the scene.
After 22 years in the armed forces, I suppose he’s used to people dying for democracy, as he sees it.
The milkshake wars begin
Milkshakes have become the political weapon of choice here in Britain. Uncomfortable enough to intimidate the opposition. Soft enough to ridicule anyone who complains or takes legal action.
Some fast food shops now advertise their milkshakes using political stunts on Twitter. Others ban selling them near political rallies.
The media reported Brexit Party leader Nigel Farage had to hide on his bus when three milkshake-wielding troublemakers were spotted in the vicinity of his event. He claims he was just busy doing interviews on the bus.
While the news focuses on the milkshake wars, politics has taken a back seat. Heck, the UK government hasn’t even bothered campaigning.
The Guardian tried to find out what the Conservatives are up to and concluded they’ve been conducting an ‘invisible campaign’:
‘…as it happens, there has not been a single high-profile Conservative event for these elections…
‘Put simply, the Tory effort for next Thursday’s contest has been the invisible campaign.’
Prime Minister Theresa May went one step further from not campaigning. Apparently, she barricaded herself in her office recently and refused to see Cabinet colleagues. She lives in fear of them serving her with resignation demands.
But it’s no surprise the election isn’t the top news story. Even in the UK, where Brexit has made the EU a hot topic, election turnouts for the EU are low. Despite the fact that the EU controls the UK.
But does the drama unfolding matter to you? Not the milkshake bit — the election?
It certainly could…
You’re not out of the democratic woods yet
Italy’s financial position is downright dangerous. In 2018, it wreaked havoc on global financial markets. We’re talking about the biggest default in history. Bond yields haven’t returned to pre-2018 crisis levels.
The only thing propping up European bond markets is the EU autocracy at the ECB and EU Commission. They managed to calm markets late last year. But the EU elections have an influence on both. So I think you need to pay attention.
Any change at the top of the EU could trigger a quick and severe debt crisis. Most of the mainstream media agree with that. The question is the probability of the various outcomes.
But the tug of war in Europe isn’t in two opposing directions. Even the Eurosceptic camp are at odds with each other in all sorts of different ways.
So the selection of scenarios is an utter mess, making it hard to predict what’ll happen.
But let’s look at some of those scenarios.
By the time you read this, we may know more about what the EU Parliament will look like. And you’ll know what that means.
Understanding the EU standoff
The first possibility is an EU election that delivers the status quo. The only trouble is, Europeans have rejected this at the national level elections. Eurosceptics are in government in a few countries, and opposition in others.
An EU that is at odds with national governments will be nasty. It could mean more exits and more rejections of EU policy. More belligerence, which puts the EU’s credibility into question.
If you’re picturing more Brexits, you haven’t quite grasped it. British PM Theresa May was never a Brexiteer. She never tried to leave the EU. She never asked for a trade deal, as they say here in the UK.
Her deal with the EU was for a pick and mix of EU membership. Which is why it failed — nobody wanted that compromise. And it was never on offer.
An unchanged EU would mean more financial battles over national budgets, more EU rule-breaking and more national governments simply ignoring the EU. As they did over borders during the migrant crisis, and budgets more recently.
This leads to a standoff where the EU must decide whether to back the belligerent nation with a bailout or not. Any rescue from the European Central Bank is conditional to the EU’s approval these days.
It’s a bit like parents deciding whether they’re on the hook for their children’s financial mistakes. Everyone knows it’s only a matter of time before the backing ends. And when it does, lenders won’t like what they see from the likes of Italy.
The second option is decent performance by Eurosceptic populists at the EU election. This is the most likely outcome. But it’s also the most bizarre.
The EU is run by two large centrist parties in an effective coalition. But under this election scenario, they lose their combined majority. Which means they have to go looking for a third party to form a majority with.
The trouble is, that party is highly likely to be ALDE (Alliance of Liberals and Democrats for Europe) — a left-wing party led by Eurosceptics’ favourite pariah, Guy Verhofstadt.
Consider what’s happened under this scenario. Europe’s electorate has shifted right wing, nationalist and Eurosceptic. But the new alliance ruling the EU would shift the opposite way…
The division within the EU would be severe, leading to a bigger backlash at national elections in coming years. Markets price in the future, so a troubled EU would show up in financial markets very quickly.
Would an increasingly left-wing EU bail out an increasingly right-wing Italy?
The last scenario is a big win for Eurosceptics. Enough to have an influence on how the EU is governed.
This is the ultimate nightmare for the current European leaders. Imagine the populists in control of their project, backed by the legitimacy and power of the EU.
The EU institutions would be used to monetise debt, bail out struggling economies and rob the northern nations.
The EU would become a political and economic warzone, unable to decide anything.
A political union of nations trying to steal from each other.
It would lose legitimacy with those voters currently backing it. And without their backing, the premise falls apart.
The euro would be toast, triggering a major financial crisis.
The wealthy nations can see it coming. It is how all of Europe’s monetary and political unions ended in the past, after all.
The confusing part is that this means northern European Eurosceptics have a very different flavour to southern ones. One Dutch Eurosceptic is polling at the same level as the Dutch Prime Minister. Here’s what he told a TV debate audience:
‘You have to unbundle the entire Eurozone
‘We want a Nexit [Netherlands exit] through a referendum. A number of referenda actually. You could do it all at once. A king of Europe a la carte.
‘What is happening in Britain now clearly shows how treacherous the deep state is. If May had taken Trump’s help, it would have been successful by now.’
What you in Australia still see as fringe views and an impossible future is becoming mainstream in Europe.
You need to wake up fast. And prepare for the implications.
So say the true believers, even with Friday’s flash crash. But there’s less there than meets the eye.
Bitcoin has staged a notable comeback from its 2018 crash.
From a level of about US$4,000 through the month of March, bitcoin had a two-day 23% spike from US$4,135 on 1 April to US$5,102 on 3 April.
Bitcoin then moved sideways in the US$5,000 to US$6,000 range before staging another three-day spike from US$5,932 on 8 May to US$7,255 on 11 May — a 22% surge.
Combining the 1 April and 8 May spikes, the bitcoin price moved from US$4,135 to US$7,255 for a spectacular 75% price rally in six weeks.
By last Thursday morning, it soared even higher, to over US$8,300.
This rally was bitcoin’s best price performance since its 83% collapse from US$20,000 in late December 2017 to US$3,300 in December 2018.
That crash marked the collapse of the greatest asset price bubble in history, larger even than the tulip mania of 1637.
The technical data doesn’t stack up
The questions for crypto investors are: What caused the recent rebound in the price of bitcoin and will it last? Is this the start of a new mega-rally or just another price ramp and manipulation?
Has anything fundamental changed?
If you’re beginning to suspect these are leading questions, you’re right.
Of course, bitcoin technical analysts are out in force, explaining how the 100-day moving average crossed the 200-day moving average — a bullish sign.
They are also quick to add that the 30-day moving average is gaining strength. Another bullish sign.
My view is that technical analysis applied to bitcoin is nonsense.
There are two reasons for this.
The first is that there is nothing to analyse except the price itself.
When you look at technical analysis applied to stocks, bonds, commodities, foreign exchange or other tradeable goods, there is an underlying asset or story embedded in the price.
Oil prices might move on geopolitical fears related to Iran.
Bond prices might move on disinflation fears related to demographics. In both cases (and many others), the price reflects real-world factors.
Technical analysis is simply an effort to digest price movements into comprehensible predictive analytics.
With bitcoin (to paraphrase Gertrude Stein), ‘there is no “there” there.’ Bitcoin is a digital record.
Some argue that it’s money (I’m highly sceptical it meets the basic definition of money).
Either way, bitcoin does not reflect corporate assets, national economic strength, terms of trade, energy demand or any of the myriad factors by which other asset prices are judged.
Technical analysis is meaningless when the price itself is meaningless in relation to any goods, services, assets or other claims.
My other reason for rejecting the utility of technical analysis is that it has low predictive value when applied to substantial assets and no predictive value at all when applied to bitcoin.
If you follow technical analysis, you’ll see that every ‘incorrect’ prediction is followed immediately by a new analysis in which a ‘double top’ merely presages a ‘triple top’ and so on.
Technical analysis can help clarify where the price has been and help with relative value analysis.
But its predictive analytic value is low, except to the extent the technical analysis itself produces self-fulfilling prophecies through herd behaviour.
Is manipulation driving bitcoin higher?
That said, what can we take away from the recent bitcoin price rally, putting aside its flash crash for the moment?
The first relevant fact is that no one knows why it happened.
There was no new technological breakthrough in bitcoin mining.
None of the scalability and sustainability challenges have been solved.
Frauds and hacks continue to be revealed on an almost daily basis.
In short, it’s business as usual in the bitcoin space, with no new reasons for optimism or pessimism.
The second relevant fact is that the bitcoin price has been the target of rampant manipulation by miners in recent years.
Bitcoin miners have rising costs of production due to the increasing complexity of the maths problems that must be solved to validate a new block on the blockchain.
Bitcoin miners also have large inventories of coins mined in the past that have not been released on the market through exchanges or otherwise.
As a result, miners have huge incentives to pump up prices, both to cover costs of production and to create demand for undistributed coins.
These price ramps are conducted through wash sales, ‘painting the tape’, joint action, low volume price pumps and other classic manipulations.
The evidence is strong that this kind of activity has taken place in the past and there is no reason to believe it is not taking place now.
As mentioned above, JP Morgan & Chase has estimated bitcoin’s intrinsic value at about US$2,400.
The last potential contributor to the bitcoin price spike is simple speculation.
Bitcoin buyers who missed their chance to reap fortunes when the price went to US$20,000 may see another chance to ride a wave of much higher prices.
New wave coins the future of crypto
Since nothing fundamental has changed about bitcoin for better or worse, some combination of miner manipulation and naive speculation is the most likely explanation for the price action we’ve seen lately.
This means the price could just as well crash as rally further.
Nothing has changed in the bitcoin blockchain technology.
A use case for bitcoin has yet to emerge (and probably never will).
Bitcoin is still unsuitable as an investment, although it may work fine for those who just like to roll the dice. Count me out.
A second wave or new generation of cryptocurrencies is now emerging, with better governance models, more security and vastly improved ease of use.
These new wave coins represent the future of the cryptocurrency technology.
These cryptos have much greater potential to disrupt and disintermediate established payment systems, and financial intermediaries such as banks, brokers and exchanges.
On the one hand, mature cryptocurrencies such as bitcoin, Ripple and Ethereum are showing their inherent limitations and non-sustainability.
These cryptocurrencies all have major flaws in terms of investor safety and ease of use.
The solutions proposed invariably involve backing away from the original promise of safe, anonymous transactions.
Government authorities are converging from all sides looking for tax evasion, securities fraud, evasion of capital controls and other improprieties.
Second-generation cryptocurrencies have a much greater chance of competing successfully with existing payment channels such as Visa, Mastercard, PayPal and the traditional banking system.
The potential value of these new wave cryptos can be measured by the current franchise value of the institutions that will be disrupted.
If these cryptocurrencies can disintermediate centralised financial behemoths like Citibank and the New York Stock Exchange, their value can be measured in the trillions of dollars.
If bitcoin is still unsuitable (despite a recent price rally), where do the opportunities lie in the cryptocurrency space?
The answer is that the blockchain is growing up, and new tokens and use cases are emerging all the time.
These new opportunities are in permissioned distributed ledgers, such as JP Morgan’s payment token and synthetic world money proposed by the IMF.
This means that the companies who will benefit most from the rise of new cryptocurrencies are not garage band start-ups, but technology giants such as IBM, Intel and Nvidia, as well as financial giants such as JP Morgan and Citi.
Crypto has a bright future. But bitcoin doesn’t.
All the best,
Strategist, The Daily Reckoning Australia
The homelessness problem was worse in major cities after the subprime crisis left thousands without a house…
It was tough.
Unless, of course, you were an Aussie.
Because for once, walking into the US with a bunch of Aussie dollars made you feel rich…
From parity to half
Nine years ago this month, the Aussie dollar was trading at 90 US cents.
And a year after that, the Aussie dollar was actually worth more than the US dollar. One Aussie dollar was equal to US$1.05.
It was a confusing time for analysts. We’ve spent out entire careers looking at the currency pair in a certain way. So to see the Aussie dollar as the higher valued figure was, well, odd.
Of course, it didn’t last. By 2012, the days of parity with the US dollar were over…and the Aussie dollar began its long slide down to today’s 68 US cents.
And today, I’m here to tell you that things are about to get a whole lot worse for the Aussie dollar.
In fact, I think there’s a chance the Aussie dollar is going to sink all the way down to 50 US cents…
Sounds mad, right?
The Aussie dollar dipping all the way down to financial crisis lows.
Well, not only is it possible but also probable.
Let me show you why.
Red dirt drives the Aussie dollar
Currency movements are complex.
But when it comes to the Aussie dollar, we can simplify it somewhat.
You see, the Aussie dollar is a commodity-based currency.
Because Australia is a major exporter of commodities, changes in the value of commodities affect the value of the Aussie dollar.
The most notable one is iron ore. We predominantly export iron ore to the world, and for that reason the Aussie dollar tends to track the movements in iron ore quite closely.
Have a look:
Iron ore price in US dollars (left axis) versus Aussie dollar (right axis)
Source: Trading Economics
While it’s not a lockstep movement, this chart shows us that the Aussie dollar (black dotted line) tends to follow the overall trend of the iron ore price (blue line).
Why is that?
Mostly because iron ore is Australia’s largest export. When iron ore prices are high, it generates a high income for the Aussie economy. In fact, iron ore prices have the biggest effect on Australia’s national income.
So when the price of iron ore rises, it stands to reason that Australia will ‘earn’ more money, and the Aussie dollar goes up as a result.
However, when iron ore falls, it means our income will fall too. So the Aussie dollar falls to reflect the reduction in national income.
To boot, a lower iron ore price means that our government will receive less income through tax. Meaning the government may need to increase debt in order to maintain the government budget.
This relationship shows us just how important iron ore is to the Aussie economy.
But our red dirt isn’t the only factor when it comes to the Aussie dollar. The other crucial component is interest rates.
Cash rate supports it
Think of it like this.
The value of iron ore prices may drive the Aussie dollar.
But the cash rate, as set by the Reserve Bank of Australia, supports the Aussie dollar.
And right now, the Aussie dollar is about to have this support whipped out from underneath it.
You see, a high Aussie cash rate means we are likely to attract foreign capital to our shores. Companies and people park their money here as it is likely to earn more interest compared to other countries.
In turn, the higher dollar value helps bring more investment into the country.
Except over the past couple of years, the US Federal Reserve has been increasing rates. And it now offers a higher interest rate than Australia’s 1.5%, making it more attractive to put money into the US than here.
Furthermore, the lower interest rate reduces the appeal of the Aussie dollar, and subsequently the demand for it. In other words, the value of the Aussie dollar falls.
And this is about to get a whole lot worse.
The markets ad most punters are widely expecting a rate cut in a couple of weeks. That will bring our cash rate down to 1.25%.
However, another rate cut is expected to follow in the next 12 months.
Meaning Aussies could be looking at a cash rate of 1% by as early as Christmas this year.
Two interest rate cuts from the RBA are actually a bad sign. And that will flow into the Aussie dollar and see it fall dramatically.
Exactly how quickly the Aussie dollar tanks is anyone’s guess.
Free fall to 50 cents?
In addition to wondering how quickly the Aussie dollar will fall, the other question to ask is: How low can it go?
To be honest, 50 US cents is a guess. But it’s not impossible. It happened before in the peak of the financial crisis. It also happened during the dotcom bust.
It could potentially drop into that range again.
Already, the Aussie dollar has dipped to 68 US cents. A tumble to 65 US cents after the first rate move isn’t out of the question.
The point is, interest rate decisions support the Aussie dollar. And the RBA is essentially removing that support by reducing the value of interest rates.
Yes, the iron price remains high.
In truth, that’s possibly the only thing keeping the Aussie dollar where it is for now.
What remains to be seen is how long the iron ore price can prevent the Aussie dollar from falling.
Because once the Aussie dollar is in freefall, there’s a whole other bunch of problems coming our way.
More on that next week.
Until next time,
Editor, The Daily Reckoning Australia
You mess with one little computer program and it looks like all hell is about to break loose.
The US-China trade war just stepped up a notch.
Although this time, Trump didn’t escalate the trade war. Google did.
The US has gone from lobbing taxes at the Middle Kingdom to forcing US companies to completely change global trade arrangements.
The trade war has shifted from bare-fisted bar fight into a brass-knuckle street riot.
Except in this case, I don’t think China brought its knuckle dusters…
It’s amazing how quickly tensions can rise.
Just two days ago, Trump added Huawei Technologies Co. Ltd. to the trade no-no list.
This comes shortly after smartphone chip makers Intel, Qualcomm, Broadcom and Xilinx said they’ll stop supplying products to Huawei.
Within a day, Google took it one step further. The tech behemoth will no longer offer software and services to Huawei smartphones. There’s only 2.5 billion in use globally… Yikes.
That doesn’t make the phones useless.
For now, Huawei users will still have access to the publicly available version of Google’s Android software. It’s just the fun stuff — like Google’s Play Store, Gmail and YouTube — that Huawei phone users will lose access to.
But the move from Google makes the Huawei smartphone pretty useless outside of China.
The dollar value damage to the brand isn’t obvious yet. Nonetheless, it makes it pretty hard for a company claiming to have a tech-leading product to sell it when it’s not supported by any software.
This spat is a clear step up in the trade war.
The US has shifted from simple tax increases to make Chinese products unattractive to consumers.
Now, the US has moved to openly disrupt Chinese business models.
The question is, what’s China’s next move?
China controls what we need
Tit-for-tat taxes are gone.
It’s time to bring out the big weapons now.
From here on in, the Sino trade war is all about disrupting, and possibly bankrupting, companies.
China can’t tax the US any more than it already is. And dumping its US$1 trillion worth of US-dollar reserves isn’t an option (China only ends up losing out on that one).
This leaves China with few options.
Perhaps one of the few retaliations from China may be a rare earth ban.
Rare earths are 17 chemically related elements found in the earth’s crust. Their composition makes them ideal for making electronic devices light and more efficient.
One commodities trader, Daniel Cordier, called them the ‘vitamins of chemistry’, saying, ‘They help everything perform better, and they have their own unique characteristics. Particularly in terms of magnetism, temperature resistance and resistance to corrosion.’
Their usefulness means they are used in everything from smartphones to MRI machines to satellites to wind turbines and even glass.
And in spite of the global reliance on them, China controls the supply of the minerals. Roughly 80% of the world’s rare earths come from China.
But it doesn’t have to be that way.
Rare earths are more abundant than gold and silver. The United States Geological Survey even considers these minerals ‘moderately abundant’.
In fact, they can be found all over the world, including Australia, Brazil, India, Malaysia, Russia, Thailand and even Vietnam. Global reserve deposits are estimated to be 120 million tonnes…and China is believed to have 99 million tonnes.
So why did we leave China to control the market?
Getting these minerals out of the dirt is the hard part.
Unlike other minerals, rare earths ‘bond’ themselves to the other metals they are surrounded by.
This makes the whole process ‘expensive, difficult and dangerous’, according to former rare earths trader Tim Worstall.
Also, the process of extracting rare earths is incredibly damaging to the environment.
Removing rare earths from the ore means they are basically washed in various acidic mixes hundreds and hundreds of times over. Oh, and most of the time, the mix used is radioactive.
So most companies and governments have happily left the rare earth gig to the country with the lowest labour costs and the weakest environmental concerns.
China could do it cheaply, and didn’t set off the greenies.
Better their lakes and rivers than ours, right?
Next step: Rare earth ban 2.0?
China is essentially the world’s hub for a small group of metals that almost every tech-based device relies on.
This no doubt crossed Chinese President Xi Jinping’s mind as he toured a rare earths facility only two days ago.
Xi’s tour of the processing plant could be seen as a ‘warning’ of what might happen next. Although China’s foreign ministry spokesman dismissed that fear and said Xi’s visit was normal, and shouldn’t be ‘over interpreted’.
But the problem is, Xi’s visit and a rare earths ban may just be noise.
Because supply chains around the world learned lessons from the last rare earths ban.
Back in 2010, the Middle Kingdom banned sales of the minerals to Japan over a ship collision.
And while geopolitical tensions between the two countries increased for a short period, the rare earths ban was short-lived.
Yes, the prices of rare earths made triple-digit gains inside 12 months.
But the high costs and short supply saw Japanese companies Hitachi and Mitsubishi alter products to require less of the minerals.
Furthermore, the ban meant other companies realised the long-term value of their own rare earth reserves.
Countries like Australia, Brazil, Russia, India and Vietnam have the ability to ‘speed up’ the process to increasing the supply of rare earths.
This means that while China could go ahead and ban rare earth sales to US companies, there’s every chance half a dozen other countries will step up and pick up the slack.
The reality is that rare earths aren’t the economic super weapon China might be hoping for.
It won’t cripple the US; the US will simply go elsewhere for these minerals.
The market learned that the first time around.
Until next time,
Shae Russell, Editor, The Daily Reckoning Australia
To be fair, I would have written that sentence no matter which of the two major political parties won the election over the weekend.
While they desperately try to appear different to each other, they tend to have the same problem: The people in the party are far more interested in themselves than the actual people they pretend to serve.
Nonetheless, it means our Prime Minister Scott Morrison gets to stay in Kirribilli for the next few years (or until the next leadership coup).
And what will this government’s focus be?
Ensuring absolutely nothing changes…
Markets rally on nothing changing
Apparently, something like $33 billion in value was added to the Australian stock market on Monday.
Although, I never liked that terminology — ‘adding value’. Talking about the market gaining or losing billions of dollars is often a clever little soundbite to push a storyline.
A much more effective method is to follow the percentage gains.
Take this from the ABC, for example:
‘The ASX 200 share index closed 1.7 per cent higher at 6,476 — its highest level since late-2007, when the global financial crisis was brewing, and just below its record high.’
See? Far more informative.
Sure, percentages aren’t as scary-sounding or as exciting as the word ‘billions’ is. But you get a far more accurate picture of what happened this way.
Why were the markets rallying? Simple. The financial sector led the way.
You see, bank and mortgage broking stocks were thrilled the Coalition government was still in charge.
As one analyst said, the finance sector rallied because we’d get more of the same ‘less restrictive’ banking policies.
In other words, there was a fear that a change in government would mean greater oversight of the Aussie banking sector.
But with the Liberal Party staying in power, it would mean more of the same loose lending, making the royal banking commission a thing of the past.
And, well, wouldn’t you know it…
The RBA doesn’t matter this week
Word on the street is that there’ll be a rate cut in June.
It’s rumoured the Reserve Bank of Australia (RBA) has been holding off until after the election, as a rate cut is an admission that the economy isn’t doing so well.
This wouldn’t have worked in favour of the Liberals’ political campaign, as the party kept promoting Australia’s supposedly strong economy.
The problem with the above analysis, though, is that the RBA is meant to be apolitical.
And I’m not entirely convinced that the RBA would hold off on a rate cut just because of an election. If the RBA does cut rates in June, then we can question its impartiality.
For now, I suspect a rate cut will come in July, when the RBA has second-quarter gross domestic product (GDP) data on hand.
More to the point, the RBA may not need to do anything in June, as one of Australia’s regulators is doing something on its behalf…
‘You are remembered for the rules you break’
Enter the Australian Prudential Regulation Authority.
You’ve heard of it, I’m sure.
APRA sets the rules for the Aussie banks to follow.
Although sometimes, the rules are more like guidelines.
For example, in 2014, APRA set a ‘rule’ that banks couldn’t allocate more than 30% in loans to interest-only lending.
By 2017, however, all four big banks had close to 40% of their mortgage books exposed to interest-only loans.
APRA knew all of this, too.
For three years, APRA ignored the banks ignoring the rules.
It was only in mid-2017 — with the whiff of a royal banking commission in the air — that APRA decided to ‘enforce’ the rule.
By ignoring its own rules, APRA allowed interest-only loans to hit nearly $400 billion.
And today, APRA has decided to once again change the rules.
This morning — with a Liberal government safe at hand — the banking regulator has said it will scrap the 7.25% benchmark rate banks must apply to home loan applications (to ensure borrowers can pay their loans if the rate was to get that high).
However, once again, this ‘scrapping’ doesn’t really mean much.
You see, APRA introduced this minimum test back in 2014, but it was largly ignored by banks. And again, APRA ignored the banks ignoring them.
Instead, banks added their own loan buffer of 2-3% over the cost of funds. It was only when property prices began to fall in mid-2017 — and banks realised their exposure to falling property prices — that the banks knuckled down and applied the 7.25% benchmark rate.
Then this morning, APRA announced the ‘benchmark’ is past its use-by date.
How can this be so, when it was hardly used?
The point is, APRA’s tendency to change the rules is meaningless when the rules were barely followed in the first place.
But this sudden change of heart gives you a very strong indication of what matters most to the government right now.
And that is, nothing can change.
And I mean nothing.
Everything must stay exactly the same, and the government will do everything it can to keep it that way.
And by ‘same’, I mean Aussie property prices can’t fall further. If they tumble much further, the debt loads would rip open the banks and destroy the consumption part of the economy.
Right now, the most important thing to our government — and the associated regulatory bodies — is ensuring that banks can lend to keep everything as it is.
Everything must be done to support the Aussie house price bubble.
That means regulatory bodies will change the rules to ensure banks feel they can lend.
Our own government is wading in, offering to put down a house deposit for first homebuyers. But how long until this scheme is extended to all potential buyers?
The point is, from here on in, powerful people and organisations are going to do everything they can to make sure nothing changes.
That may mean changing the rules. That may mean breaking them.
To borrow a phrase from General Douglas MacArthur, ‘You are remembered for the rules you break.’
Some dangerous precedents are about to be set.
Until next time,
Editor, The Daily Reckoning Australia
I’ve managed to escape Australia’s compulsory voting scheme by moving to London, only to receive monthly letters telling me to pay a TV licensing fee, despite not having a TV.
If I don’t pay, I risk ‘a visit from the Maidstone Enforcement Officers’. And a fine that makes missing an Aussie vote look boring. Luckily, there is a black-and-white TV option, which is significantly cheaper.
Here in Europe, less than half of people will bother to vote for their three EU presidents in the election next week.
Actually, nobody will. Because none of the EU’s presidents are up for election. Ever. And barely anyone could name them anyway, even if we could vote for any of them.
But that’s another story. My point is, perhaps Australia’s political system isn’t so bad after all. Comparatively speaking, anyway.
Try to keep that in mind today, if you don’t follow my advice below, and take the electoral system seriously.
But first, some more important news.
The honeymoon is over. For me and the Australian property market…
After the wedding came the auction
Two days after my wedding, we took my new Japanese in-laws out for a quintessential Australian experience. A property auction on the Sunshine Coast.
But it was a bit melodramatic in the end. Nobody bid. And that was the second time around for the property. Last time, the vendor rejected the highest offer. Big mistake, as it turned out.
To be fair, the vendor’s terms didn’t allow for bids ‘subject to finance’. This undermined just about everyone’s capacity to buy, according to the auctioneer himself.
Not that finance is particularly forthcoming in Australia at the moment. The total value of investor mortgages fell 28.6% from January 2018.
Other disappointing property stats continue to fly in. They come in all shapes and sizes these days.
Dwelling approvals for March declined by 27.3% from the year before.
CoreLogic reports 76% of properties selling for less than listing price, at 6% below on average for the first quarter of 2019.
You know you’re in trouble when ‘the only positive figures in Australian property right now are prices in Hobart’, as Finder.com put it.
The Australian Financial Review says one in 25 mortgages is in negative equity. But only under an alternative statistical methodology to the one used by the banks. We know the banks are good with accurate figures though.
It’s also becoming harder to escape the bust. As property owners here in London are discovering the hard way too, it’s difficult to calculate what your property is worth when nobody wants to buy it.
Listings are appearing, disappearing and reappearing according to the watercooler chat here at the office. For the few who found a new home, moves are on hold because nobody showed any interest in their existing properties.
You can’t sell, you can’t buy. Nobody mentioned that to those who got on the property ladder…
Back in Australia, the outlook keeps getting worse too. Economists aren’t expecting an improvement in property prices for years now.
But don’t worry too much about the property bust. Your saviours are on the way. The politicians are waking up to the opportunity it presents. And riding in to save the day. Only if you vote for them today though.
Property gloom unfolds
To battle the property malaise, the Coalition wants to copy the US housing policy of the early 2000s. It wants to help a load of people who can’t afford property onto the property ladder using government funds.
What could possibly go wrong? And isn’t that precisely what the banks just got into trouble for?
The capacity of English-speaking politicians around the world to copy each other’s failed policies is worth a few Daily Reckoning editions in and of itself. Here in the UK, they copied the Aussie first homebuyer’s grant after it became known as the first home vendor’s grant.
Former Reserve Bank Governor Bernie Fraser isn’t worried about the Coalition’s scheme to support homebuyers. He’s backing it, despite the comparisons to America’s Fannie Mae and Freddie Mac. After all, ‘caution among banks would prevent borrowers taking on excessive debt’, says Bernie.
Clearly, someone hasn’t been reading the news…
But it looks like Labor will win the election anyway. What does it have planned for property?
Yellow Brick Road founder Mark Bouris is in trouble for providing the answer. Here’s part of what his pre-recorded robo-call told potential voters, potentially in violation of electoral advertising rules:
‘If Labor wins and they bring in negative gearing changes and the capital gains tax changes, house prices will fall, they’ll continue to fall at a very rapid rate, and what’s worse our kids are going to have to pay more rent because investors are going to have to put the rent up to recoup the losses they would normally get as a tax deduction.’
This makes we wonder why people invest in an asset that delivers them losses each month in the first place.
How to vote today, whether you like it or not
So, how should you vote today? Inspired by Bouris, I’d like to send out my own message. I’d like you to try something new at the ballot box.
Keeping in mind that not voting is illegal, you should do the following: Close your eyes and mark the paper at random.
In three years’ time, we’ll touch base and you can tell me if it made any difference compared to previous elections. Did your random vote impact your life differently?
Of course, few of you will take me up on the suggestion. Fair enough. My own attempt to buy a house here in London has me fretting about a Labour government too. Their reforms make Bill Shorten look boring.
Either way, just remember one thing. The government and its minions control both the supply of property and the demand. They make zoning laws and fiddle with interest rates.
When things go wrong, you’ll know who to blame, however you vote.
It’s been a while since I’ve graced these virtual pages. At least, it feels that way. So settle in and buckle up!
Markets are still coming to grips with the reality of the trade war after many months of complacency.
The first trade war since the 1930s has escalated and may continue for years to come.
Trump may not be done with tariffs. In the days and weeks ahead, we can expect further mentions of tariffs on all Chinese goods entering the US.
If Trump does go ahead with further tariffs, you can expect China to retaliate again, as it did in response to the latest US tariffs.
Initially, the stock market decided the trade war fears were overblown. Inside the Beltway, conventional wisdom said that Trump would reach a deal with China; that all of his tough talk was just a negotiating ploy.
It wasn’t. Agree or disagree with Trump, he means what he says about tariffs and trade.
Trump has never wavered in his belief that China and other countries are taking advantage of the US’s low tariffs to export to the US, hurt US industry, and steal US jobs and intellectual property.
The only reason he didn’t act sooner was because he wanted China to help him reel in North Korea’s nuclear program. But those efforts largely failed, and Trump took off the gloves.
This month, the conventional wisdom proved wrong — again — and the stock market has now been forced to shift its view. Just look at the market reaction since Trump began tweeting that a deal was unlikely earlier this month.
Monday’s losses were particularly heavy after China announced retaliatory tariffs shortly before the market opened (do you think the timing was a coincidence?).
Yesterday, the market recovered some of Monday’s heavy losses. But I don’t place much stock in yesterday’s market rally. There are fundamental differences in the US and Chinese positions that cannot easily be negotiated away.
There’s a big difference between confronting China today versus confronting, say, Japan in the 1980s. Remember when everything was made in Japan and the Japanese were buying up American icons like the Empire State Building and Rockefeller Center?
But today, China has much more leverage than Japan ever had. China is also in a much more adversarial posture towards the US than Japan was. The US basically defends Japan and maintains several military bases on Japanese territory. Despite some local frictions, Japan welcomes the US presence as a counter to Chinese ambitions in the region.
These realities mean that China will not acquiesce but will retaliate for any actions taken by the US. It has already proven that. Next time, the Chinese may choose to retaliate not only with further tariffs of their own, but with other forms of financial warfare. China could also become more aggressive in confronting the US in and around the South China Sea.
With regional tensions already high, the risks of an incident between US and Chinese forces could increase even further.
One of my major theses is that in times of too much debt and too little growth, countries resort first to currency wars and then to trade wars, and then finally to shooting wars to steal growth from trading partners and geopolitical rivals.
The problem with currency wars is that all advantage is temporary and is quickly erased by retaliation. Not only is the world not better off, but it is worse off because of the costs and uncertainty resulting from the currency manipulations. Eventually, the world wakes up to this reality and moves to the trade war stage. Then to the shooting war stage.
This new trade war will get ugly fast and the world economy, which is already slowing, will be collateral damage. Given the trillions in US dollar-denominated debt in emerging markets, a full-scale foreign sovereign debt crisis could be in the making if emerging market countries cannot earn dollars from exports to pay their debts.
Markets still are not fully prepared for this, but you can be. Now is a good time to increase your cash allocation to reduce volatility, and increase your exposure to gold.
Let’s pray the shooting wars are not hot on the heels of this coming trade war.
In the meantime, let’s continue on with today’s Reckoning…
Why tariffs are ‘as American as apple pie’
(and the flaws in free trade ideology)
Listening to hysterical commentary from the mainstream media about President Trump’s tariffs, one would think his policies were in violation of the US Constitution. Nothing could be further from the truth.
America grew rich and powerful from 1787-1962 — a period of 175 years — using tariffs, subsidies and other barriers to trade in order to nurture domestic industry and protect high-paying manufacturing jobs.
In fact, tariffs are as American as apple pie.
Trump is using the same basic playbook that predominated in US policy from George Washington onward. Washington’s Secretary of the Treasury, Alexander Hamilton, drafted a report to Congress called the ‘Report on Manufactures’, presented in 1791. Hamilton proposed that in order to have a strong country, America needed a strong manufacturing base with jobs that taught skills and offered income security.
To achieve this, Hamilton proposed subsidies to US businesses so they could compete successfully against more established UK and European businesses.
These subsidies might include grants of government land or rights of way, purchase orders from the government itself or outright payments. This was a mercantilist system that encouraged a trade surplus and the accumulation of gold reserves.
Hamilton’s plan was later proposed on a broader scale by Kentucky Senator Henry Clay. This new plan began with the Tariff of 1816. Clay’s plan was called the American System. Abraham Lincoln adopted the American System as his platform in the election of 1860, and it became a bedrock principle of the new Republican Party.
The 19th and early 20th centuries were a heyday of the American System. This period was characterised by enormous economic growth and population expansion by the US. The American System was also accompanied mostly by low inflation or even deflation (which increases the purchasing power of everyday citizens), despite occasional financial panics and some inflation during the Civil War.
Trump is simply returning to that tradition.
Against this mercantilist system was a theory of free trade based on comparative advantage, as advocated by British economist David Ricardo in the early 19th century. Ricardo’s theory said that trading nations are endowed with attributes that gave them a relative advantage in producing certain goods versus others.
These attributes could consist of natural resources, climate, population, river systems, education, ports, financial capacity or any other factor of production. Nations should produce those goods as to which they have a natural advantage and trade with other nations for goods where the advantage was not so great.
Countries should specialise in what they do best, and let others also specialise in what they do best. Then countries could simply trade the goods they make for the goods made by others. All sides would be better off because prices would be lower as a result of specialisation in those goods where you have a natural advantage.
It’s a nice theory, often summed up in the idea that American football star Tom Brady should not mow his own lawn because it makes more sense to pay a landscaper while he practices football.
For example, if the UK had an advantage in textile production and Portugal had an advantage in wine production, then the UK and Portugal should trade wool for wine.
But if the theory of comparative advantage were true, Japan would still be exporting tuna fish instead of cars, computers, TVs, steel and much more.
The same can be said of the globalists’ view that capital should flow freely across borders. That might be advantageous in theory, but market manipulation by central banks and rogue actors like Goldman Sachs and big hedge funds make it a treacherous proposition.
The problem with this theory of comparative advantage is that the factors of production are not permanent and they are not immobile.
If labour moves from the countryside to the city in China, then suddenly China has a comparative advantage in cheap labour. If finance capital moves from New York banks to direct foreign investment in Chinese factories, then China has the comparative advantage in capital also.
Before long, China has the advantage in labour and capital, and is running huge trade surpluses with the US, putting Americans out of work and shutting down US factories in the process.
Worse yet, countries such as China can pull comparative advantage out of thin air with government subsidies, exactly as Hamilton proposed 227 years ago. The most famous example of this is Taiwan Semiconductor.
In the 1970s, Taiwan had no comparative advantage in semiconductor production. But with government subsidies to a national champion, today Taiwan Semiconductor is the largest supplier of semiconductors in the world.
When did the US abandon the system that worked so well for so long?
Beginning in 1962, the US turned its back on a successful legacy of protecting its jobs and industry, and embraced the free trade theory. This was done first through the General Agreement on Tariffs and Trade, or GATT, one of the original Bretton Woods institutions in addition to the World Bank and IMF.
Beginning in 1995, the World Trade Organization (WTO) displaced GATT and has been the main venue for US free trade policy ever since. China became a member of WTO on 11 December 2001, but has notoriously broken many WTO rules since joining.
The globalist approach might work if everyone were a free trader and no one resorted to tariffs, subsidies, non-tariff barriers to trade, and theft of intellectual property. Unfortunately, that’s not the world we live in.
We live in a world where the US is a free trade sucker and everyone else breaks the rules. In a world where a few parties are free traders but most are mercantilists, the mercantilists win every time. They are like parasites sucking the free traders dry.
If open trade and open capital flows are flawed ideas, why do elites support them?
The switch in US policy from quasi-mercantilism to free trade was driven partly by academics who embrace the simple version of free trade without understanding the flaws (exemplified by China and Taiwan).
Others understand the flaws in free trade well enough, but value the world at large over the US. Their agenda is to diminish the power of the United States, and the US dollar, in world affairs and to enhance the power of rising nations, especially China.
If several hundred million Chinese can be pulled from poverty by leaving the US market open while China subsidises its companies, imposes its own tariffs, steals intellectual property and limits US foreign direct investment, then that’s fine. If US workers lose their jobs in the process, that’s fine too.
The globalists consider that a form of progress towards their ‘one world’ utopia. They don’t care about the US; they only care about their ‘one world’ vision.
Globalists are often supported by major international firms in the pharmaceutical and other industries that profit from global supply chains even as Americans lose their jobs.
But Trump is a thorn in the globalists’ side. Trump focuses on restoring lost US jobs, even if the cost to China is high. That’s China’s problem, not America’s. Trump’s policy is ‘America First’ and he means it.
Now the battle is heating up again. Whoever wins the war of the globalists versus the nationalists could decide the world system for decades to come.
A little over a year ago, I wandered into the office far too early.
I sauntered up the stairs with an overpriced latte in hand.
Our tired-looking web guru was already in the office, setting up the Skype meeting for me.
And there I found him, chatting to Jim.
You see, Jim had agreed to have a meeting with me from his home in Vermont.
Trump had launched his trade war only months before. And I had many questions. What could people expect…and, more importantly, how did this directly affect Aussies? Not long after, Jim and I turned those questions and answers into a 20-page report exclusive for Strategic Intelligence Australia subscribers.
Here’s the thing. What Jim has written about today is similar to the chat he and I had over 12 months ago.
The mainstream has continued to try and push the trade war aside as old news.
But that’s simply not the case.
As Jim pointed out a year ago — and then again today — the trade war is still only just beginning.