Debt Overhang Prevents Recovery

The massive overhang of debt is weighing on economies and creating a bear market in government-backed money. A breakout in gold is the result...

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Central Banks Buying Gold to Prepare for Falling Dollar

The world's central banks are on track to buy more gold than any year since 1971...

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Gold’s Fear-Based Trade

Imagine if you ran your finances like Washington runs the US...

JULY DIDN'T produce much in the way of excitement for stock-market investors, writes Dan Denning in his Daily Reckoning Australia.

But we have found out a few interesting things...

One, so long as sovereign debt woes in Europe persist, then US Treasury bond yields can go lower. Investors seeking a haven from Europe don't seem to have any problem buying US debt at near record-low yields. This is bizarre.

Of course, at a superficial level, if you were concerned that the European bank stress tests were a sham and that interest rates in Europe could go much higher unexpectedly, you might view US Treasury notes and bonds as "safe". This is only possible in a world of utter relativity.

After all, the US government ran a deficit of 9.9% of GDP in 2009. The Congressional Budget Office in Washington reckons next year's deficit will be $1.47 trillion. That forces the US government to borrow 41 cents of every Dollar it spends. Imagine if you ran your finances this way.

But it's a strange old world we live in. Europe's problems have been America's blessing. Demand for US Treasury bonds and notes is the highest on record, according to the Wall Street Journal. On July 23rd, the yield on two-year notes – a kind of near cash fight-to-safety proxy for big money – feel to 0.5516%. Ten-year notes briefly yielded less than 3% earlier this month, and for the entire month of July, the US Treasury managed to flog off $173 billion in bonds to investors.

This is an important development. As long as global savers – for whatever reason – are frantically bidding for US debt at auctions, US borrowing costs should stay relatively low. It should also allow the Federal government to run its absurdly large and reckless deficits. And most importantly, if investors are buying US debt it means the Fed doesn't have to, at least not yet.

This last point is the most important, we reckon, because it averts the dreaded hyperinflationary scenario in which Fed money printing leads to an inflationary shock. So far, investors (who may have gone wobbly on stocks) have decided there is safety in numbers in the US bonds market. We'll see how that works out for them.

All this has taken some starch out of the Gold Price. You will have known about this if you read the latest salvo in Michael Pascoe's increasingly strange vendetta against gold in today's Age. He points out that spot Gold Prices are at three-month lows in New York and down 8% from the June highs.

It's pretty obvious by now that Pascoe either doesn't understand gold's role as money or simply believes gold is an anachronism in which "money" can be created by central banks. Frankly it's a pretty unserious and mildly embarrassing argument to make given the last few years of economic events. But each to his own.

The bigger issue is what will happen with the Gold Price from here. Yesterday we spent an hour on the phone chatting about this and other things with Greg Canavan, the editor of Sound Money. Sound Investments. Greg pointed out that the Gold Price doesn't normally perform so well during the North American summer.

Our view? We'd be pleased to buy more gold on dips, even if for the year gold doesn't make a new high. Gold is insurance against financial disaster. And if you think there aren't any more financial disasters lurking, you're not thinking hard enough.

Yes, this is a fear-based trade. We are worried that bad fiscal and monetary policies worldwide can wipe out savings, depress share markets, and destroy purchasing power. Totally wacky of course. But there you go.

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Gold in a Bubble? Really?

Stocks say recession, bonds say depression. And what about Gold...?

INVESTORS have changed their minds, writes Dan Denning in his Daily Reckoning Australia.

Instead of pricing a second half recovery in the global economy, they're now pricing in a recession in the stock market and a Depression in the bond market. What gives?

As PIMCO bond guru Bill Gross points out in his latest missive, stocks are reflecting what he calls the "New Normal". It's a long period of lower than average economic growth, household and business and even public sector deleveraging, re-regulation (less leveraging in the financial sector), and de-globalization.

It's actually the last point that interests us most – that the end of artificially cheap capital and cheap energy is straining all the connections (trade, finance, and logistic) formed during the last thirty years. Contractions can be painful when you're giving birth to a new world order, or so we've heard.

Gross makes several other worthy points. One is that debt is no longer productive in boosting living standards. When it was, households were happy to borrow and so were businesses. But each addition Dollar of new debt taken on in the economy is producing less and less real growth. Indeed, each additional Dollar taken on is going, at least part of it, to service previously borrowed money. Unhealthy.

Gross also makes a great point about what "bringing forward" consumption does in the long run...

"Consumption when brought forward must be financed, and that financing is a two-way bargain between borrower and creditor. When debt levels become too high, lenders balk and even lenders of last resort – the sovereigns, the central banks, the supranational agencies – approach limits beyond which private enterprise's productivity itself is threatened."

We appear to have reached those limits. Or that is the proposition investors are weighing up.

But what about that gold bubble? We had hoped to take Rory Robertson and Michael Pascoe to task for being so wrong about gold. But since we're busily preparing to debate Macquarie Bank's Rory Robertson in Sydney...and tell him why he's so wrong about house prices instead...our colleague Greg Canavan stepped into the crease last night and hit Pascoe for six.

"First, let's kick off with an update on gold," Greg wrote to readers of his Sound Money.Sound Investments report. "Michael Pascoe wrote an article on Monday in The Age and SMH quoting Macquarie's Rory Robertson saying that gold is in a bubble. As contrarians this sort of stuff is music to our ears.

"Apparently Robertson thinks that most people are buying gold simply because it is going up. While no doubt some traders are playing the momentum game, the vast majority buy gold because it is a time-honoured protector of wealth.

"Only those ignorant of financial history disparage gold with bravado. Take this piece of ignorance for example: 'The interesting thing about gold – beyond it being a much-loved 'pretty rock' that several generations ago was at the centre of the global financial system – is that it has no 'running yield', so there is no anchor, no firm benchmark for valuation...The price will be whatever investors are prepared to pay. How long is a piece of string?'

"To many people this is a very persuasive argument against gold and we have heard it trotted out for years. But it is so wrong it's not funny. Especially coming from a financial professional.

"No anchor, no benchmark for valuation? Gold is the benchmark. Its value doesn't change. What changes is the value of the various fiat currencies gold is measured against. It is the error and habit of the media that gold is quoted in terms of US Dollars. US Dollars should be quoted in terms of gold. That is, one US Dollar can now buy you 1/1245th of an ounce of gold, compared to 1/35th of an ounce back in the early 1970's when the US was last on some sort of gold standard.

"And like the paper notes in your wallet (cash) gold has no running yield. So what? Gold is money and money in its purest form has no yield. Yield is the reward or enticement for you to part with your cash and give it to a bank. At this point it ceases to become yours. It is a liability of the bank.

"Gold is no one else's liability. It has no counterparty risk. It therefore generates no yield. It's simple when you think about it. Why is that so hard for seemingly intelligent people to understand?"

Good question!

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So Low Rates Mean Housing Boom?

An ugly outlook for Australia's housing market...

TAX-EATING, power-mongering, pseudo-intellectual moralistic bullies are like terminator roaches, says Dan Denning in The Daily Reckoning Australia.

They never go away and they just seem to keep multiplying.

We had hoped to return from our quick trip to Seattle to find that the resource super profits tax and been beaten into the submission and defeat which it so richly deserve. But alas, through sheer stubbornness, ineptitude, or calculated determination, the government is persisting with a policy that's already destroyed shareholder wealth, made Australia a less stable and desirable place for foreign capital, and clouded the future of both existing and profitable resource projects as well as future ones that may never get off the ground now.

We haven't caught up on all the fake negotiations in the last week. And we're just guessing...but our guess is that the government will just try and wait out the public. The public will lose interest. Or, if the government repeats often enough that this is an issue of tax fairness - instead of the wanton act of vandalism on the nation's wealth producing assets that it is - the big lie will eventually stick as oft repeated big lies eventually do.

Anyway, we'll get back to that story with more precision in due course. Today, we again note that an intrusive outside (much like our self) is calling for an Aussie house price crash. It's Jeremy Grantham again, of global investment manager GMO. Granted, Mr. Grantham may not be aware that there is a secret force field that girds this land which makes its housing market immune to the same forces that have caused bubbles and busts in other countries.

But you have to give him credit for calling it as he sees it. And he says Aussie house prices would fall 42% were they to return to trend. You cannot possibly miss it," he told The Australian.

"The price of housing typically trades about 3.5 times of family income and in bubble it goes to 6 or...7.5 (times)...Australia is having one now. You are at near 7.5 times family income...which suggests you are twice the size that you should be."

Not everyone got the memo. But seriously, we can see that being daily assaulted by the forces of house price spruiking in Australia, it is easy to give up the good fight (stop using your common sense) and just go along with the group think. You begin to question your own sanity when everyone around you behaves insanely.

Grantham says Aussie house prices are a "time bomb." The trouble with credit bombs is that they cannot be defused. They eventually blow in the form of falling asset prices (deflation). This is happening all over the world right now. You could say that continued excessive credit creation funnelled into an asset class is one way of defusing the bomb. But that's really just credit carpet bombing.

In any event, the Reserve Bank of Australia, which is an Australian institution run by Australians, begs to differ with Mr. Grantham. In a speech earlier this week, RBA Governor Ric Battelino said that Australian households have taken advantage of a "structural" decline in interest rates to load up on debt. True, this higher household debt level exposes Aussie households to "shocks," like higher interest rates. But Battelino says there ain't no bubble.

Specifically, he rubbishes the price-to-income ratio Grantham quotes. The deputy Governor says, "The ratio of house prices to income that are published for Australia tend to focus mainly on prices in the cities, and they are quite elevated. But, if you look across the whole country, the ratio of house prices to income is not that different from most other countries."

But with nearly 65% of the population living in Australia's capital cities, according to ABS data, the fact that prices outside the cities are "not that different from other countries" is a hugely unuseful fact. The lending bubble has been concentrated in the capital cities, where most people live, and where price-to-income levels are most unsustainable.

Of course you might argue that the dense urbanisation of Australia's population is exactly what supports higher structural house prices. People have to live somewhere. And if they are going to live in a capital city, it's going to cost them. That's fair enough, as long as they can afford it without going into ruinous debt.

The last and obvious point will make is that it's pretty stupid to assume interest rates will remain structurally low from now on. Low interest rates are always trotted out as a justification for house prices. But if the world is in a credit depression, Aussie interest rates are not going to stay low. You will have had millions of people buy homes at the top of the price cycle and the bottom of the rate cycle.

How do you think that's going to end? When thing are unsustainable, the end comes eventually. Flying from Seattle to Los Angeles on Monday, we saw what looked like fault lines all along the California coast. These are the places where huge forces collide and eventually one gives way sending waves of damage in all directions. Naturally, it made us think of the Aussie housing market, even if there are many in Australia who say it can't happen here. Just wait.

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Germany’s Naked Politics

Germany's ban on naked short-selling of risky debt is purely political...

A FEW WEEKS AGO here at The Daily Reckoning Australia, we speculated that Germany might be an earlier victim of the sovereign debt crisis because its various banks and financial institutions own a lot of Spanish and Portuguese debt, writes Dan Denning in St.Kilda, Melbourne.

Credit default swaps were blowing out faster on German debt than other sovereign nations in which deficits and debt were bigger. But this was really a question of where risk resides in the credit system at the moment. And the market is pointing somewhere in the middle of Europe.

So if you were a speculator, or merely wishing to hedge your position in German financial stocks, you'd buy credit default swap insurance. It seems like a sensible thing to do, although apparently you can't do it anymore.

"The Euro slid to its least since April 2006," reports Bloomberg, "after Germany prohibited naked short-selling and speculating on European government bonds with credit-default swaps and the Bank of Italy allowed lenders to exclude losses on government debt."

Hmmn. Is this like not being able to buy health insurance if you have a pre-existing condition?

Investors unable to hedge their risk may have to sell. Or, short-sellers will have to cover, which means you could get a brief rally in European shares, the Euro, and Euro bonds. But it's hardly the sort of thing to boost confidence. Another Bloomberg article elaborates:

"Germany will temporarily ban naked short selling and naked credit-default swaps of Euro-area government bonds at midnight after politicians blamed the practice for exacerbating the European debt crisis."

The key words here are "naked" and "politicians". Naked short selling, unlike the covered kind, is selling a security you don't own instead of borrowing it first and then selling it. There's a healthy debate about whether you can or should be able to sell something you don't own or that isn't owned by anyone. Why speculators are doing it is obvious. Whether they should be able to do it is less obvious.

But that it's a good investment idea...well that is another matter entirely. And politicians who are blaming Euro bond weakness on short sellers are looking for a villain that is not them. It's a confusion of cause and effect, like blaming the buzzards for the death of the corpse. It does buy them time though, in the blame game.

Banning short selling does not improve the quality of sovereign debt or sovereign finances in Europe. And by the way, we've been copping it from European subscribers lately who feel aggrieved. They point out that there are other even more serious debt problems in the UK and the USA. And in terms of flawed currencies, what about the greenback and the pound?

Correct you are, aggrieved Europeans! The Dollar's day of reckoning will come too. But in the mean time, US bonds and the greenback are enjoying the "flight-to-something-else" bid. We wouldn't call it a flight to safety, mind you. But it does explain the chart below, which shows the Gold Price in both US and Australian Dollars.

Note the price rising in both currencies. And note that the Aussie Gold Price appears to move up as global investors flee risk (emerging markets and leveraged commodity plays). The greenback Gold Price is climbing too, but less fast.

Meanwhile, will the centralized slap-down on markets in Europe work? The authorities are trying to protect vulnerable institutions by preventing short sellers and speculators from attacking them. And the Bank of Italy's decision to exclude losses on government debt from capital adequacy considerations is nothing less than inspired. It could start a trend.

It's not a loss if you don't count it!

More seriously, why institute the ban on naked short selling now? And why take the extra step of preventing anyone in the market from going short government bonds? To be charitable, you could assume that the asset price falls (especially in government bonds) are the work of evil speculators (the global wolf pack) who are unfairly damaging and destroying confidence in otherwise credit-worthy securities and sound government fiscal policies (cough).

But more likely, if asset values on bank balance sheets are falling (principally government bonds) then it could again trigger the whole deleveraging vicious cycle we saw in 2008 where institutions are forced to sell some assets to cover losses on other assets or loans. You get a whole lot of selling and much lower prices, which is of course exactly what needs to happen.

Some in Europe are saying another EU aid package is "inevitably going to come" and that the Euro's decline is "unstoppabl.." Those are the words of former Bank of England policy maker David G. Blanchflower on Bloomberg Television.

"What we really have to think about," he said, "are rescuing the banks, dealing with this credit crisis, giving confidence back to the Euro area, which they've not done...And let's think about how we can organize the next rescue package, which inevitably is going to come."

Meanwhile, back on the resource ranch, the more we think about the Resource Rent Tax, the more obvious it is that it's a back-door nationalization of the mining industry through the tax code. Without asking permission from the miners or the Australian people - and based on the idea that the government owns Australia's resources even if private capital develops them – the government has made itself a partner in the profits and losses of Australia's miners.

You can understand, why, when times are good, you'd want to participate in profits - especially if you didn't have to take any of the risk (as is the case with imposing the tax on existing projects whose risks and costs were born by private investors). It reminds us of what John Dillinger said when he was asked why he robbed banks.

"Because that's where the money is."

But has anyone bothered to ask if the Australian people should or want to be responsible for 40% of the losses born by miners? Is that good public policy? What are the long-term consequences? Can anyone know?

That Australians would indirectly be on the hook for losses born by the mining industry is the case, as far as we understand the new proposal. Or, put another way, it's a subsidy to marginal projects and inefficient producers. In a market system, private capital takes risks and bears the losses and gains from those risks. Investors consent to put their own capital at risk in explorers and that is that.

But now the government is essentially agreeing to put your tax money at risk in the mining business. It raises the possibility that the resource tax going to increase the inefficiency of capital spending in the resource sector at the same it may decrease total investment by the private sector.

If both those things happen, the Rudd tax would distinguish itself in the annals of government policy as being doubly bad. That's quite an achievement. But really, do we want the same people who gave us the pink bats and BER programs to now get stuck into the mining industry?

Economically, this puts the government on the hook for bad investments in the mining sector in the future, and in perpetuity. When you're a partner, it's for better or for worse. For richer AND for poorer. If you really thought about it, you might have second thoughts about whether making all Australians compulsory partners in the mining business was such a good idea. But that would only occur to you if you were thinking. It's not just a question of coercion. It's a question of economic prudence.

Right now, the government is hardly thinking about future bad investments. It's thinking about billions in new tax money it can redistribute to achieve whatever ambition of the day it has for the Australian economy. But at what could be the top of this leg of the commodity cycle, those billions may never materialize.

And then?

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Gold, China & the Aussie Resource Tax

From Europe to China and Australia, gold is challenging the government intervention...

IS THE EXPANSION of the US Federal Reserve's balance sheet due to its new "swaps" agreements with Europe a trip-wire for inflation? asks Dan Denning in his Daily Reckoning Australia.

Bloomberg reports that:

"The Federal Reserve's balance sheet rose to $2.34 trillion, the first increase in a month, as the central bank reopened liquidity swaps with foreign central banks. Assets increased by $9.93 billion, or 0.4%, in the week ended yesterday, the central bank said in a statement. The balance sheet reached a record level of $2.343 trillion April 14."

The increase in liquidity swaps was $9.21 billion in the last week. That's presumably the money headed "over there" to Europe to reinforce the ECB's efforts to prevent a wider "contagion" in European credit markets. And the bigger the Fed's balance sheet gets the more support you'll probably see in the Gold Price.

Speaking of gold, J.P.Morgan analyst Michael Jansen told clients in a note that:

"The Gold Price is being driven by...the rising concern of the 'exit strategy' for central banks given that the ECB is the latest agency to join the (quantitative easing) bandwagon...Indeed, the perceived breach of the ECB's independence...adds to the view that in the long-term monetary and fiscal authorities will be forced to choose between anaemic economic conditions or monetary-driven inflation."

"Monetary-driven inflation" is, along with good old-fashioned fear, behind last week's move in gold and precious metals. It is easier for governments to lean on central banks to print money than it is to make politically unpopular (and socially destabilizing spending cuts). Bond markets will try to hold European governments honest by punishing those that don't commit to genuine spending cuts and deficit reduction.

But this not just an accounting debate or a fiscal policy debate. Europe's post-war social contract is being forcibly rewritten by economic circumstances. Markets enjoyed a massive "short squeeze" rally with the announcement of the bailout. But how markets behave now is anyone's guess.

Our guess is that austerity measures in Greece, Spain, Portugal, and probably Italy will prove so unpopular that governments who agree to them may find it hard to hold onto power. And then? Debt default remains a real possibility, and one not currently priced into equities, if you ask us.

But don't take our word for it. Last week the Australian Mint said it sold more gold coins in the first two weeks of April than in the entire first quarter of the year. Nearly all the buying was coming from Europe. The mint told Reuters that it sold 243,500 ounces of Gold Coins and bars in the first two weeks of April compared to 205,000 in the first quarter.

Meanwhile, what about China? We concede that all of our information comes second hand, and not from any correspondents on the ground (although some of our colleagues are headed that way next week). In the meantime, there are signs that property prices are already falling in Beijing and some analysts are joining in the prediction of a major credit bubble that's due for a popping.

Beijing commercial property prices may have fallen by nearly 31% in the last month, if we're reading this article correctly. "The average transaction price of commercial residential properties in Beijing for the week ended May 9 fell 1,790 Yuan per square meter or 9.6% week-on-week to 16,898 Yuan per square meter," reports The Beijing News. It cites statistics released by Beijing Real Estate Information Network.

"Compared with the week ended April 11, the average transaction price of commercial residential properties in Beijing plunged 31.43% or 7,744 Yuan per square meter."

That's just one source and one market. But if it's correct, that is...well...that is what it is, isn't it?

But according to Hong Kong-based hedge fund analyst David Roche, it gets a lot worse. "We've got the beginnings of a credit-bubble collapse in China," Roche told Marketwatch.com. Roche goes on to assert that the Chinese banking sector will face huge loan losses on bad loans made to local governments. And what does that mean for you?

Roche links a credit contraction in China with infrastructure spending, which he reckons accounted for 90% of China's economic growth last year. So while housing is a clear bubble, Roche says the contraction of bank lending will remove infrastructure investment as one of the key pillars of Chinese growth. He says that's negative for industrial commodities like iron ore and copper.

And as if the news wasn't bad enough for Aussie mining companies, what with prime minister Rudd's 40% resources grab...

Of course no one knows for sure what will happen next. The fact that so many people are talking about a China bubble is itself a disturbing sign. Normally you don't get that during a bubble, although claiming there is not a bubble in China because people are talking about it a fairly superficial way of dismissing the argument.

But inquiring minds often disagree on the same set of objective facts. That's what makes a market. Our colleague Dr. Alex Cowie has the full-time resource beat here in St. Kilda. Alex is recommending precious metals producers as part of his general strategy, with a particular focus on the inflationary policies of central banks.

However the key debate the rest of this year is how to value the miners. And you have two massive elements of uncertainty now. One is the Rudd Resource Tax. The other is China's growth. The only upside to all of this is that a great deal of uncertainty can distort valuations, which occasionally gives you a chance to buy something really cheap at a time when everyone else is petrified.

"You know," a friend said to us the other night over a drink, "sometimes you come off like a know-it-all smart arse. It's one thing for you to tell the Chinese they're doing it all wrong and predict a crash. But you're bagging out our Prime Minister and you're not even in an Australian. To be honest it's kind of aggravating and offensive."

"Good," we replied.

"How can you say that? Aren't you worried you're going to upset your readers? They won't become customers if they're angry with you."

"That's true. But you probably mis-understand what our business is. I don't want a customer who's easily offended by ideas. It's my job to provoke thought. And you do that by presenting ideas, challenging conventional wisdom, and just thinking harder about things."

Warming up to our task, and perhaps inspired by a sip of Maker's Mark, we continued, "When I see someone say something idiotic – or, if you prefer – something I think is totally wrong, I feel compelled to point it out. You have to challenge that stuff when you see it, or else people start to believe it. And once they start to believe it without really thinking about it, the game is up. You become a servile, passive, brain-dead whip dogged to be kicked around and cuffed about the ears by the Welfare State. You'll be lucky to get a bone."

The discussion came up because of this quote by the Prime Minister earlier in the week on the radio. He said:

"The core element of conservative economic management, in which I believe, is expanding the role of government in the economy when the private sector is in retreat.

"Had we not done that we would have had a quarter of a million more Australians out of work, many small business [sic] collapsing...

"Now that the economy globally is on a pathway to recovery it's time for the role of government to retreat. That's what conservative economic management is all about. That's what I believe in."

You have to give the Prime Minister credit. He says what he believes. But what he believes is all wrong. And we wish he'd stop using the phrase "the business of government". It's an insult to businesspeople. Government is not a business. It does not take risks with its own capital to create value and jobs. The Prime Minister is not an entrepreneur.

He is, however, by his own admission, a manager. And in that respect, his hubris and his error are revealed. It is not "conservative economic management" for the government to massively intervene in the private sector. It is Socialism.

You might agree with it or believe in the moral rightness of that intervention, mind you. But let's at least call things by their right names. It's one of the surrealities of the modern world that things are often given names that are in direct opposition to what they actually are. Examples include the Democratic People's Republic of Korea, which is neither Democratic nor a Republic, and Britain's Liberal Democratic Party, which is neither Liberal nor Democratic either. We would add to the list Kevin Rudd as a "conservative economic manager" of the economy.

In any case, the Prime Minister's error (shared by many members of the opposition who fail to rebuke him), is that he does not understand the inherent impossibility of managing a complex system like the economy. The second order error is probably just a disagreement about the government's role in the economy. But you can't have the second error without the first. And the first one is a fundamental question about the limits of human knowledge.

No human being, economist, and philosopher made this point more clearly than Friedrich Hayek. One of Hayek's great achievements – picked up today we think by Nassim Taleb – is forming a clearer picture about the quality of knowledge and what we can say that we really know. What does that mean?

Hayek simply pointed out that in a complex system like an economy, no single person can have enough information or even know what information is required to correctly allocate and direct the use of society's resources. To believe otherwise is to have an exalted sense of your own abilities as a micro-manager.

Hayek's critique of central planning – what he called the fatal conceit of socialism – was, and remains, the most sensible criticism of centralized economic authority. It can't work because human action is too complex and unpredictable and ultimately unknowable in a strict cognitive sense. You cannot plan and organize for what you do not know and cannot understand.

Market prices, on the other hand, are the sum total of human action. Those prices contain information and help maintain the relationship between supply and demand. That is the essential triumph of a free market: it allows people to be free and choose their own path and, at the same time, manages the most efficient allocation of resources.

It does this based on what people want as expressed through their own choices, not what government tells them they should or should not want. It produces this kind of peaceful and prosperous order – most of the time – without being organized by a smart man in an expensive suit serving on the public payroll.

But the basic idea simple. Individuals and firms know better how to plan their own future than the government. If you believe otherwise, you believe the government has the right and the obligation to make plans on behalf of people who are not fit to govern themselves. Proper names for that include: Nanny State, coercion, tyranny and more!

The Prime Minister here in Australia is a planner and a world improver. That is the "business" he is in. And perhaps his motives are building a better world. But the way to do that is to sweep your own doorstep and tend your own garden, we'd submit. His belief about the proper role of government in the management in the economy is based on an overweening pride in the knowledge and skill of government ministers and career bureaucrats.

How else can you explain a piece of tax law like the Resource Rent Tax, which effectively makes the government a silent partner in the profit and the losses of the resource industry without the consent of shareholders? Only a man who believed government had the right and the ability to insinuate itself into private business relationships would so proudly propose a scheme like that.

That's not to say that the government doesn't have a role in civilized society. It most certainly does. Its role is to guarantee and enforce clear rules that establish and protect the ownership of private property and enforce contract, as well as punish people who take what is not theirs. The Law – transparent, providing equal justice, and impartially administered – is as important an institution to civilized society as the free market, which itself is could be described as a mechanism for communicating prices.

By those standards – which are, of course debatable – this government has done the exact opposite of conservative economic management. It has changed the rules in mid-stream, proposed to enforce them retroactively, and demanded equity in private enterprise without paying for it like the rest of us.

To be fair, that is "business" of a kind. Monkey business perhaps. Or "business" in the same way organising payments through the threat of violence is a "business." Or less threateningly, it's just meddlesome troublesome "business" that gets in the way of real people doing real business. As the economist and thinker Henry George wrote:

"It is not the business of government to make men virtuous or religious, or to preserve the fool from the consequences of his own folly. Government should be repressive no further than is necessary to secure liberty by protecting the equal rights of each from aggression on the part of others, and the moment governmental prohibitions extend beyond this line they are in danger of defeating the very ends they are intended to serve."

The world is complicated enough. Europe's sovereign debt crisis will eventually migrate its way to America and the super cycle in fiat money will end in either a debt deflation or massive inflation or both. Real wealth will be destroyed. Meanwhile, China faces a property and credit bubble of its own.

These are big enough worries for Australia without having to worry that its own government is unwittingly sabotaging the country's success. Sound economic management would have been to leave well enough alone. But that is not what the government has done. And it's going to reap the whirlwind, both in the markets and, perhaps, at the polls.

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With It So Far…?

Money printing is the near-certain "solution" to the Greek, Euro and wider sovereign-debt crisis...

WELL, IT'S ALL HAPPENING very fast now, notes Dan Denning in Melbourne for The Daily Reckoning Australia.

But let's pause for a moment to reconsider what may have happened last week with Wall Street's "trading glitch". Is it possible that traders saw the cops beating protestors in the Streets and surmised this:

"No matter what deal European leaders come up with to bailout Greece, that deal isn't going to fly on the streets of Athens. The Greek people will not feel obligated to keep the promises made by their politicians to the IMF. Greece is going to default on its debt..."

If Greece goes, then a lot of interesting things start to happen. But that is not the "narrative" being put out by the mainstream today. The official line today is that the $500 billion loan and lending package agreed to by European government is enough to roll over Greek debt, avoid a crisis, defend the Euro, and put an end to the widening credit default swaps in the derivatives market.

The trouble for Europe is that Greek debt is the tip of the spear. The Greek's must roll over $15.8 billion in debt this year and $31.3 billion next year. But it's hard to imagine Greece devoting a larger share of tax income to debt service while the economy shrinks. It won't be politically tolerable.

So what about the $251 billion in Italian sovereign debt that matures this year? And the $76.5 billion Spanish debt? And the $17.9 billion in Portuguese debt? The €500 billion aid package is not enough to disguise the fact that Europe's debts are larger than Europe can repay without resorting to debt default or the alternative: massive money printing.

The bond market has figured this out. In Europe and North America, the cost of buying insurance against a bond default in corporate and sovereign debt. According to Bloomberg:

"The Markit iTraxx Europe Index, linked to the bonds of 125 companies, soared 45 basis points to 133 basis points as of May 7, according to Markit Group Ltd. The Markit CDX North America Investment Grade Index, tied to 125 companies in the US and Canada, jumped 26.6 basis points to 118.7."

But did the action in the credit default swaps market migrate to Australia? Well, according to Bloomberg this morning, the news of the big deal in Europe took some starch out of the widening CDS spreads here in Australia.

"The cost of protecting Australian corporate bonds from non-payment fell the most in more than nine months, according to traders of credit-default swaps. The Markit iTraxx Australia index fell 15 basis points to 114.5 basis points as of 8:19 a.m. in Sydney, the biggest drop since July 21, according to prices from Nomura Holdings Inc. and CMA DataVision in New York."

That would suggest some major easing of the tensions in credit markets. But we'd take that with a major grain of salt. One quotation and one chart from the weekend tell Australian investors nearly everything thing they need to know about the effect a European sovereign debt meltdown would have on Aussie stocks and financial institutions.

The quotations come from Eric Johnston at The Age. On Saturday he reported that:

"Banks face a surge in wholesale financing costs as fears of contagion spread through global credit markets, with still-fresh memories of the funding squeeze during the global financial crisis not far behind. Some of the nation's major banks were yesterday believed to be looking at measures to top up holdings of liquid assets as concerns about risk increased on European credit markets. While Australian and Canadian banks continue to have ready access to credit markets, longer-term debt was becoming harder to obtain, bank treasury sources said."

Once again the link between solvency and liquidity rears its ugly head. Europe's troubles migrate to Australian balance sheets. And you can see the final proof of the pudding in the chart below from CMA Market data. It shows that when anxiety peaked last Friday night, it was Aussie banks that showed the largest credit deterioration in terms of the increase on their CDS. In other words, the cost of insuring yourself against default in the bonds of these Aussie firms went way up late last week...

That doesn't mean any of these firms are going to default. But it does mean bond market investors realize that a global capital crisis that begins in Europe has a massive affect on Australian banks. The effect is not so much on Aussie loan losses of European assets, although there is some exposure there. The effect is a liquidity crisis which forces banks to raise cash by selling assets.

The assumption domestically is that the banks won't have any trouble finding money to borrow abroad. But it might be a lot more expensive. And that might lead to higher bank interest rates here and less borrowing. Oh and by the way, the CDS rates for the miners were up too, last week, thanks to Kevin Rudd's 40% tax on natural resource companies, plus concerns about a China slow down.

In the meantime, if you're wondering what the end result of all the machinations in Europe are, it's probably more money printing, which explains Gold's recent move. And because the biggest debt problem of all is in America, you can expect more printing too.

Watch it live here...Or go and Buy Gold here...

With It So Far…?

Money printing is the near-certain "solution" to the Greek, Euro and wider sovereign-debt crisis...

WELL, IT'S ALL HAPPENING very fast now, notes Dan Denning in Melbourne for The Daily Reckoning Australia.

But let's pause for a moment to reconsider what may have happened last week with Wall Street's "trading glitch". Is it possible that traders saw the cops beating protestors in the Streets and surmised this:

"No matter what deal European leaders come up with to bailout Greece, that deal isn't going to fly on the streets of Athens. The Greek people will not feel obligated to keep the promises made by their politicians to the IMF. Greece is going to default on its debt..."

If Greece goes, then a lot of interesting things start to happen. But that is not the "narrative" being put out by the mainstream today. The official line today is that the $500 billion loan and lending package agreed to by European government is enough to roll over Greek debt, avoid a crisis, defend the Euro, and put an end to the widening credit default swaps in the derivatives market.

The trouble for Europe is that Greek debt is the tip of the spear. The Greek's must roll over $15.8 billion in debt this year and $31.3 billion next year. But it's hard to imagine Greece devoting a larger share of tax income to debt service while the economy shrinks. It won't be politically tolerable.

So what about the $251 billion in Italian sovereign debt that matures this year? And the $76.5 billion Spanish debt? And the $17.9 billion in Portuguese debt? The €500 billion aid package is not enough to disguise the fact that Europe's debts are larger than Europe can repay without resorting to debt default or the alternative: massive money printing.

The bond market has figured this out. In Europe and North America, the cost of buying insurance against a bond default in corporate and sovereign debt. According to Bloomberg:

"The Markit iTraxx Europe Index, linked to the bonds of 125 companies, soared 45 basis points to 133 basis points as of May 7, according to Markit Group Ltd. The Markit CDX North America Investment Grade Index, tied to 125 companies in the US and Canada, jumped 26.6 basis points to 118.7."

But did the action in the credit default swaps market migrate to Australia? Well, according to Bloomberg this morning, the news of the big deal in Europe took some starch out of the widening CDS spreads here in Australia.

"The cost of protecting Australian corporate bonds from non-payment fell the most in more than nine months, according to traders of credit-default swaps. The Markit iTraxx Australia index fell 15 basis points to 114.5 basis points as of 8:19 a.m. in Sydney, the biggest drop since July 21, according to prices from Nomura Holdings Inc. and CMA DataVision in New York."

That would suggest some major easing of the tensions in credit markets. But we'd take that with a major grain of salt. One quotation and one chart from the weekend tell Australian investors nearly everything thing they need to know about the effect a European sovereign debt meltdown would have on Aussie stocks and financial institutions.

The quotations come from Eric Johnston at The Age. On Saturday he reported that:

"Banks face a surge in wholesale financing costs as fears of contagion spread through global credit markets, with still-fresh memories of the funding squeeze during the global financial crisis not far behind. Some of the nation's major banks were yesterday believed to be looking at measures to top up holdings of liquid assets as concerns about risk increased on European credit markets. While Australian and Canadian banks continue to have ready access to credit markets, longer-term debt was becoming harder to obtain, bank treasury sources said."

Once again the link between solvency and liquidity rears its ugly head. Europe's troubles migrate to Australian balance sheets. And you can see the final proof of the pudding in the chart below from CMA Market data. It shows that when anxiety peaked last Friday night, it was Aussie banks that showed the largest credit deterioration in terms of the increase on their CDS. In other words, the cost of insuring yourself against default in the bonds of these Aussie firms went way up late last week...

That doesn't mean any of these firms are going to default. But it does mean bond market investors realize that a global capital crisis that begins in Europe has a massive affect on Australian banks. The effect is not so much on Aussie loan losses of European assets, although there is some exposure there. The effect is a liquidity crisis which forces banks to raise cash by selling assets.

The assumption domestically is that the banks won't have any trouble finding money to borrow abroad. But it might be a lot more expensive. And that might lead to higher bank interest rates here and less borrowing. Oh and by the way, the CDS rates for the miners were up too, last week, thanks to Kevin Rudd's 40% tax on natural resource companies, plus concerns about a China slow down.

In the meantime, if you're wondering what the end result of all the machinations in Europe are, it's probably more money printing, which explains Gold's recent move. And because the biggest debt problem of all is in America, you can expect more printing too.

Watch it live here...Or go and Buy Gold here...

Greece, China & the Fed’s Printing Press

What Athens can't do, the US central bank is only too willing to try once again...

WHETHER GREECE'S debt crisis ought to have any real affect on the share prices of Aussie banks and resource companies is debatable, says Dan Denning in his Daily Reckoning Australia.

What's not debatable is that stock markets all over the planet are selling off on the down-grading of sovereign debt in Greek and Portugal. The S&P was down 2.3% in the US, London down 2.6%, Germany's Dax down 2.7%, and in Lisbon the market sold off by 5.4%.

All of that was a bit predictable, given how far markets have come since last March without, we'd argue, much improvement in the debt picture that caused the whole global financial crisis in the first place. What is persistently strange about these sell offs in European and emerging markets is how it causes a rally in the US Dollar and US Treasury bonds, given how lousy America's fiscal position is.

But the bond market has ruled with the big thumbs down on Greek debt. In the last two weeks, the yield on 2-year Greek debt has more than doubled from 6.1% to 15.35%. This means the market is not confident Greece can meet its obligations and roll over new debt by May 19th. And the market is essentially rejecting the bailout/back stop offer engineered by the EU and the IMF.

The soaring bond yields are just another way of saying that investors now expect a restructuring of Greek debt which includes a default. Bond investors are not going to be made whole. But something will have to be better than nothing.

The fact that Greek trouble has spread to Portugal and many of the other fiscally-challenged European states shows what really needs restructuring-expectations on the level of social welfare the nation state can be expected to deliver without bankrupting an economy. But this is a larger issue than politicians have the stomach (and the intellect) to deal with.

So a great whirlpool of uncertainty now begins to swirl over who is going to pay for what, or whether it can be paid for at all. That is not good for investors in the short-term. But there IS one way in which it's useful. It's preview.

That is, the Greek problem is also a Euro problem. And the Euro problem is a paper money backed by nothing problem coupled with high levels of debt. You can see that the only resolution to a sovereign debt crisis is default of inflation. Because it does not control its own interest rates or money printing (monetary policy) the Greek government is at the mercy of the European Central Bank. And being genetically descended from Germany's Bundesbank, the ECB is not willing to print Euros in order to save Greece.

The US Federal Reserve, of course, CAN print as much as it would like. And this is why we firmly believe the resolution of America's own sovereign debt problem will be inflation. That's the investment scenario we're preparing for...a world awash in increasingly worthless paper claims on the full faith and credit of the United States government. But in the interim, the Dollar is getting the 2008-like "flight to safety and liquidity" bid.

You may not believe this, but in the midst of the accelerating Greek crisis, it's not even the country that keeps us up at night. That distinction would have to go to China. Mind you we're not sharing the same bed with China. It's a big country. It wouldn't fit on our queen sized mattress.

But like it or not every Australian investors is in bed with China, or in a relationship if you prefer. And for the last ten years, that's been a very amicable relationship. And arguably, as big a story as the sovereign debt crisis is (because it impacts global capital flows, which highlights an Australian vulnerability to the rising cost of capital), what happens in China will have a longer-lasting effect on the Aussie share market and the Aussie economy.

Shanghai stocks fell 2.1%. According to BusinessWee, "Concerns about government efforts to cool a housing price boom have hurt makers of building materials and construction-related machinery, said Liu Feng Feng, a strategist for Central China Securities in Shanghai."

China has become a giant construction site where loose credit policies have unleashed a building boom that's fuelled demand for Aussie resources. When China's credit bubble pops, the real estate money machine will grind to a halt. And then?

It all depends on how much confidence you have in men to manipulate markets. It would be more than a little ironic if Beijing's central planners pop the bubble and unintentionally unleash a real estate collapse. But this is the trouble with thinking a small committee of decision makers can manage an economy of 1.3 billion people.

The problem, as Friedrich Hayek pointed out, is one of knowledge. There is just too much to know for so few people. How is any one group of people supposed to know what the idea price of money is, or where credit should be allocated and to whom? Those decisions are best left to individuals with local knowledge acting in their own best interests with transparent pricing information that actually reflects what people want and what they're willing to pay.

China can tax third homes on individuals and curb credit or it increase land supply to try to make home values appreciate more slowly. But its property market is fundamentally organised to maximise revenues for local government. It encourages speculation. And the bubble is already baked, full of Australian coking coal and iron ore and zinc and copper and coal.

It's the bursting of China's centrally planned bubble that looms largest for Aussie investors. So even if you get a relief rally after some transparently false resolution to the Greek crisis, you may want to consider a much bigger picture and a longer-term investment game plan. Stay tuned for that.

And here's a bonus thought for the day: what if the inevitable collapse of the social welfare state funding model leads people to change their primary loyalty from the State to something more local? For starters, it would mean, we reckon, that the centralising principle of the last 200 years of Western history (in commerce, politics, and living arrangements) may have reached its natural limits.

The centralizing principle would reach those limits for various reasons. One is the inherent fragility of complex systems and their increasing vulnerability to systemic collapse. Globalization and the division of labor on a global level creates tremendous complexity AND vulnerability.

Politically, the centralizing principle, as emotionally successful as it has been in winning market share/votes (let us live at one another's expense) is being exposed as economically fraudulent (as well as morally wrong to coerce other people to your way of thinking through taxation). It's a nice idea, but it may be unaffordable without literally mortgaging the future or destroying our standard of living in the pursuit of a social welfare utopia.

Just to refresh, Robb defines a primary loyalty as:

"A connection to a non-state group that is greater than loyalty to a state. These loyalties include those to clan, religion, tribe, neighbourhood gang, etc. These loyalties are reciprocated through the delivery of political goods (by the group that the state cannot or will not deliver)."

In a prosperous liberal democratic state where people see justice as fair and view the burden of civilization (taxes) as equitably shared, where corruption is not rife and opportunities exist for social and economic mobility, having your primary loyalty to an abstraction (the rule of law or the State) is no problem. It is the norm.

But when the State expands the promises it makes and then fails to deliver on more basic ones, people begin to question their primary loyalty. This doesn't mean they revolt. No one really wants to do that. You only do that when you have no recourse economically and no better prospects.

We reckon a retreat to a more local way of life is in the works. The rising cost of energy and capital will be one factor. And frankly, to use a Marxist term, people might feel less alienated from their labour and life if they felt more connected to their neighbours and their work. And that's more possible in a small, more sustainable resilient community than it is.

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