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The coming crisis

This page is focused on documented on useful information that might help us gain some insight into what I think is THE  COMING ECONOMIC CRISIS. In Australia, that crisis will be centred on historic levels of household and more broadly private debt (to GDP) and historic levels of real house prices - and unlike 2008/2009, in the coming crisis Australai seem likely to be one of the biggest casualties. More broadly in the Anglosphere (including USA, Australia and UK), it is household & private debt which will be a central focus but more broadly total debt/GDP is problematic.

Historic extreme private debt means it is only a matter of time before Australian economic crisis.

April 02, 2018

With private debt, it is as simple as this:

  • If you have too much debt, it does not take much for your family to have a crisis. eg because of rising interest rates causing debt servicing to become unaffordable - or if you lose your job/income, andhence lose your ability to service the debt.

  • If a company, has too much debt, it does not take much of an issue to cause a crisis (and potential fairlure) for the company.

  • And if collectively, we all have too much debt such that when there is a recession (rising unemployment) or rising interest rates, many families have a crisis - then the economy goes into crisis.

It is as simple as that. This is why it is not a matter of IF Australia has a major crisis, but WHEN ... and recession or rising interest rates seem the most likely assassin over the next few years.

If you wish to understand the profound risks of private debt in the developed world (and in the Anglosphere in particular), I would recommend reading this excellent paper from the Institute of New Economic Thinking.

There is a very important message here for Australia:

  • Australia has far too much private debt - very similar to USA and much of Europe before the Global Financial Crisis.

  • We have far too much debt in our very highly geared banks (Chris Joye has pointed to this over recent years), and the Australian economy depends for financial stability, too heavily on those banks (particular the big 4 banks).

  • And Australian private households hold far too much debt ( ) and 90% of this is mortgage debt. Australia has a 100 year+ historic record in terms of mortgage debt to GDP, more private debt/GDP than Ireland had before their massive house price crash in 2009. Already something like 20% of mortgagee households are in mortgage stress - even though cash rates are at historic lows for Australia - and globally, interest rates are now rising again.

  • This historic record private debt in Australia severely put Australia's future financial stability at risk. If either:

    • If interest rates rise sufficiently (making many mortgages unsustainable) - even just back to "normal levels" by historic averages OR

    • if we have a recession (where unemployment rises, resulting already financially stressed households being unable to keep up repayments on mortgages),

    • the the financial fragility of the Australian economy will become very apparent and Australia will have a financial crisis. This seems almost a certainty with only the timing in questions because:

      • if is only a matter of time before Australian interest rates (and Australian bond rates are ultimately outside Australia's control ....  and if western economies have significant more inflation [again outside Australia's control] Australian cash rates must rise) return to more normal levels like historic averages AND

      • it is only a matter of time before Australia has its recessions, which are ultimately an unpreventable normal part of the economic cycle.

      • THEREFORE: If does seem to be just a matter of time, before Australia has a severe economic crisis, because of economic fragility in the Australian economy - that we have allowed to occur, by allowing growth in the level of debt in the Australian economy - to current levels.

Chinese economic policy will determine the fate of the world economy.

February 09, 2018

A very wise and well-informed assessment of the global economy from Andrew Hunt:

  • As for the outlook, Hunt says central banks are not going to retreat from a set of policies that propelled and sustained higher asset prices, unless they are left with no choice. And in his mind, China, and in particular the will of policymakers to tighten conditions, holds the key to whether other central banks will switch to protecting the wealth of the masses by fighting inflation, or act to maintain asset prices.

  • Too much debt 

  • What worries him most is this: all the financial risk has accumulated with households, who have been enticed to take on too much debt and will suffer the consequences if conditions change. "Attempting to suppress price volatility and take risk out of the financial system has actually put more risk into the household sector and if we do see rising in rates then household balance sheets will prove frail," he said.

  • "If you tell a British, Kiwi, an Australian that house prices only go up, they won't buy a $1 million house, they'll buy a $2 million house. How do you afford a $2 million house? You load up on debt." No more so is that true than in Australia, where incomes aren't rising even as the terms of trade have improved. "For Australia I don't think the next 12 months are going to be easy – households have no income growth, at a time when some of the cheap credit may no longer be available."

  • Globally, Hunt has some firm views about the surprise fall in the US dollar in 2017 and the melt-up in stock markets that accelerated in the latter part of the year. Hunt is of the controversial view that a large wrinkle in the US financial system arose because President Donald Trump inherited a $US500 billion ($644 billion) stockpile of cash at the US Treasury. Typically the government spends what it raises in the bond market, funding the deficit with debt issuance. But this time there was no offsetting bonds to mop up the money that found its way from the commercial banks to the deposit accounts of the large investment banks that, at one stage, amassed close to $US800 billion in excess deposits. As that idle cash weighed on their shareholder returns, Hunt says these banks, or even one bank, deployed one third of the capital in the form of leverage to institutional clients, while two thirds went offshore providing banks in Europe, Australia and Japan with plentiful funding. The resulting outflows weakened the dollar while the leverage they provided put a rocket under stock prices around the world. "We reckon dollar-for-dollar this was three times more effective in stimulating markets than quantitative easing because it was directly into an investment bank that had to use that money to provide leverage into the financial system." The impact was powerful and counter-intuitive but Hunt believes in 2018 this would wane and even reverse as the Treasury's stock of cash has run down.

  • Central banks, he says, have no desire to retreat from their role of supporting asset prices and will tread carefully as a result. "Central banks realise that having created this fragility they better not let asset prices go down. There would have to be a very good reason for a regime change." But what could force their hand? Hunt says the answer lies in China, which he says will determine the state of the financial system.

  • As China relaxed capital controls, savers got a taste for foreign assets, and even those controls that were reimposed in late 2016, households would no longer accept that their savings should be trapped in bank deposits. So they stopped saving and started spending, both in China and abroad. This he said triggered a turning point in the global economy's fortunes that surprised most economists, himself included. "The only thing big enough [to lift economic activity] was Chinese capital controls and collapse in the savings rate." But that is starting to create inflation within the Chinese economy, and potentially the rest of the world. "Asian inflation is everyone's inflation. Look around your own house – where are the goods made?"

  • BB: China's critical choice that will determine everyone's fate.

  • Hunt says (Chinese) policymakers may act to tighten conditions in China by raising interest rates, thus quelling a rise in inflation. That could derail global economic growth, but would be a good outcome. If stocks come off, it would be an opportunity to buy the dip as central banks come to the rescue.

  • If Chinese authorities choose to maintain looser conditions, that could put central banks in the West in a bind. An inflating China could push US inflation measures to 3 per cent and result in global nominal GDP growth in the 7-8 per cent range. The last time that happened, bond rates were around 6 per cent. "That will completely change the world and at that point central banks could feel that they need to protect the spending power of poor people in society – their primary target will be to contain inflation – not focus on asset prices. That's the regime change to sell the dip." A sharp rise in inflation would have a profound influence on asset prices. "If China is going to inflate the world then an awful lot of bond markets currently at zero yields look really expensive and the equity markets that priced off them."

BB Comment: I note that in Jeremy Grantham's January newsletter (P10), Jeremy also believes that the the US Fed at least, is not going to stand in the way of a 3rd US share market bubble forming (2000, 2008/9, and the one ahead). And if the US has another major fall as it did after the last 2 bubbles, the current most-natural reaction is likely to do what they did after the dot com crash and the Global Financial Crisis ... major monetary stimulus including slashing interest rates + quantitative easing. So Andrew Hunt and Jeremy Grantham are on the same page in this. The key section out of Grantham's newsletter is this.

The point here is that Yellen, too, sees no signs of dangerous stock prices and in general continues with the program of moral hazard. Yes, rates will rise, just as they rose from 2003 to 2006, but it is considered, quite rightly, to be cyclically normal in a tightening economy and so does not constitute a breach of contract. (The recent rate rises, just like the 400-basis-point rise from 2003 to 2006, did not at all get in the way of rising stock prices any more consequently than the two recent rises of this cycle have.) So why would the Fed stop its general asymmetric support before we reach a third bubble? Nothing is certain in life, but I would bet that a Yellen-like successor of the lower-rates-are-helpful variety will get the job done (Mr. Powell should fit the bill) and deliver a third in their series of Great Bubbles. A major shift in style of the Fed, on the other hand, based on an accumulation of new appointees who would turn away from the accommodating style of the last 30 years, would reduce the chances of a well-behaved classic bubble forming in the next year or two. But if we have a strong head of steam up by next February, it might well happen anyway. We’ll deal with that when we get there.
The bottom-line question is probably this: Will this administration, when faced with either a market break or unexpected economic weakness, not push the completely independent Fed committee for lenient, lower-rate policies? Surely it will. 

The financial instability caused by central banks

February 08, 2018

Richard Koo, Chief Economist at Nomura Research Institute, AFR 9/2/2018:

  • "If you're close to full employment, and prices are relatively low I think that's the best possible world already. If you then try to push this inflation to 2 per cent for whatever reason, I think you're going to end up creating all sorts of problems and many companies, the manufacturers in particular, when they see inflation picking up, they actually move factories even more outside," referring to off-shoring production. "This whole inflation target is really for the golden world, not for the world we have now."

  • In slashing rates and printing money, central bankers have introduced new instabilities to the financial system that were unleashed on Friday when a hint of wage inflation in the US caused a massive sell-off in bonds and a plunge on Wall Street. "There's a big disconnect between what the market has been saying or thinking and what's actually been happening. The market prices we see on assets and so forth, I'm afraid are not really on very solid ground," he said in Sydney on Thursday.

  • "All of these countries are basically facing the same problem," he said referring to the quantitative easing economies of Japan, the US, Europe and the UK. "No one's borrowing money. The money supply is not responding to all these massive actions by the central bank."

  • "But once every several decades, balance sheets are impaired because they all got themselves involved in a bubble." That creates a financial system without lenders or borrowers. "We can fix the banking side relatively quickly once you know what you're doing." However, that doesn't solve the problem of inactive borrowers creating "a balance sheet recession". "On top of that, we have this situation where the return on capital is higher abroad than at home. That makes this lack of borrower problem a lot more difficult." In this situation, monetary policy is highly ineffective. But fiscal policy can still be impactful even when the private sector as a group is "saving money".

    • BB Comment: This higher return on capital in places like Asia vs Australia is a major drag on the Australian economy.

  • "People are still thinking that we can go back to the golden world, because the golden world was such a great world. And that's how macroeconomics were kind of defined, all the textbooks were written during that period, some people are still insisting on 2 per cent inflation targets." That period, in Mr Koo's eyes, will be difficult to return to because the world "has changed so much"

    • BB comment: This is a reference to how the emerging world has changed everything.

  • People are still able to maintain a comfortable standard of living even though wages are not rising because of the proliferation of cheap imports. (BB comment: This may be true for some years, but the emerging world will just accelerated ahead of us.) "I don't think they" – meaning central banks – "should target anything all that strongly". "The usual borrowers are not borrowing to invest at home anymore, they may be borrowing but investing somewhere else."

  • In the golden era, which started in Japan 60 years ago, there was a rapid increase in investment and consumption at the same time. As Mr Koo sees it, developed economies have shifted to the "pursued phase" characterised by weak growth, import-led globalisation, widening income inequality, shrinking investment opportunities, and fussy consumers.

    • BB Comment: This is the impact caused by the developing world on the developed world, and there really is not a lot the developed world can do about it. This is just part of the process of price convergence that happens in every major emergence event  , except that since emergence event is the biggest ever, the impact that will be imposed on the developed world will be huge and will unfold over the decades ahead.

  • One solution he suggests is that the smartest thinkers should not be recruited by central banks and instead form an "independent commission" dedicated to finding infrastructure projects that can earn a rate of return on the government bond yield. Eventually the private sector will be ready to take the lead again. .....  "It sounds like there would be quite a few infrastructure projects here (in Australia) that would earn the 3 per cent rate of return and if that's the case, I would very much like to see those things happening.

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