Did We Really Survive?

Or Did We Simply Get It Put Off?

Today is a triple barrel sort of entry about things to do with the GFC that have been bugging me. Well, Pleiades sent me a link that started me on a trail of reading that’s depressed me, so I’m going to start somewhere a bit else.

Here’s an opinion piece in the SMH about the RBA’s decision not to raise interest rates yesterday. Basically he argues that the RBA is caught between a rock and a hard place. The rock, is the inflationary forces of the mining boom to come, with capital investments going through the roof in the second half of this year. The Hard Place is the process of trying to deleverage the massive property bubble we’ve got ourselves into, and if it should mismanage the deleveraging process, you can count on there being a massive deflationary force.

As the ratings agencies have made abundantly clear, Australia can no longer prudently expand its offshore debt.

That means the banking system cannot grow except through internal funding, which also means the mortgage system will struggle to expand. This much is on the record.
There’s reason to go further. The RBA is engaged in a grand project of attempting to keep household debt from growing in the hope that through deleveraging (lowered credit growth rates) Australia can grow into its enormous debt and housing bubble.

This has a long way to run. Based on GDP to March and March credit aggregates, Australia’s debt to GDP is at 153 per cent, albeit down from 170 per cent in 07/08.
(See here for related posts on the ratings agency catching on, and how mortgage debt is on the slide.)
The RBA is also attempting to prevent household debt from growing for the other oft-stated reason, to make room for dramatically expanded resources investment.

In short, the RBA is managing two historic economic transformations simultaneously.

And there is your problem right there. Now, here’s the thing. All of the former pressure towards inflation is predicated on Chinese growth, and even that massive expansion of capital investment that’s coming through in the second half of the year is predicated on China growing as it has between 1998 and 2008. The catch is that it may not continue to happen, as China is in a bubble and it may be forced to readjust.

TCR: Talk a little about the renminbi. The Chinese government has been making noises about possibly allowing it to rise against the dollar, but from a practical standpoint, can they actually afford to let that happen?

VK: They could let it rise on a very gradual basis, but they absolutely cannot allow it to rise very rapidly because that would quickly diminish the value of the foreign reserves. But there is a conundrum. When the Chinese economy bursts, there is a very good chance the renminbi will actually depreciate, because you are going to have a flight of capital leaving China. So right now you may argue that China’s currency is too cheap, but during the crisis it’s probably going to get cheaper.

TCR: What’s your general sense about how much longer they can keep the game going before they collapse? And is collapse the right word?

VK: I really don’t know. In the case of Japan, their government basically ran out of chips. I think the Chinese government still has enough chips to keep the bubble going awhile longer. These bubbles usually last longer than the reputation of the person who predicts their demise.

TCR: Do you think it will occur within a decade?

VK: I think so, yes. GMO became famous for predicting the Japanese bubble collapse, but they started predicting it in 1986, so they were “wrong” for a while because it actually burst in 1989-1990. The point being, these bubbles typically last longer than you would expect, but it’s going to burst.

TCR: Let’s talk for a minute about some of the potential implications of a bursting Chinese bubble. There are some fairly obvious ones, like Chinese real estate, but there are a lot of somewhat less obvious consequences, for example the hit this would cause to the Australian economy because its export sector depends heavily on China.

VK: China has been responsible for a very large portion, if not all, of incremental demand for commodities in recent years. If you’re talking about copper, about oil, or pretty much all the industrial commodities, China was responsible for a very large portion of the demand. When the economy slows down and the bubble bursts, then the demand for those commodities will decline dramatically.

It’s going to impact economies that benefitted tremendously from China’s ascent, so Australia will be impacted, Russia will be impacted because oil prices will decline and Russia is basically a commodity-driven nation. Brazil will be impacted. Any economy you can think of that benefitted from China’s ascent will get hurt from its descent as well.

That’s probably all very abstract if you haven’t been following what’s been going on but the Chinese have built entire cities for people to live in but nobody’s moved into them because they can’t afford to. There are huge shopping malls that got built that have less than 2% occupancy. Basically all that building and constructing and manufacturing went into these white elephant projects by the truckloads. At some point it’s going to have be re-priced or written off and it’s not going to be a happy event.

That’s a big warning sign flashing right there. If you thought Australian properties are over-priced, they have nothing on the insane prices in Shanghai and Beijing; and because our economy’s recent success is implicitly tied into the so-called growth engine that is China, you can’t see a bubble-burst in China not affecting Australia in a significant way. So when will this happen? We don’t know.

Which brings me back to Pleiades’ first link about the GFC.

“There is definitely going to be another financial crisis around the corner,” says hedge fund legend Mark Mobius, “because we haven’t solved any of the things that caused the previous crisis.”

We’re raising our alert status for the next financial crisis. We already raised it last week after spreads on U.S. credit default swaps started blowing out.  We raised it again after seeing the remarks of Mr. Mobius, chief of the $50 billion emerging markets desk at Templeton Asset Management.

Speaking in Tokyo, he pointed to derivatives, the financial hairball of futures, options, and swaps in which nearly all the world’s major banks are tangled up.

Estimates on the amount of derivatives out there worldwide vary. An oft-heard estimate is $600 trillion. That squares with Mobius’ guess of 10 times the world’s annual GDP. “Are the derivatives regulated?” asks Mobius. “No. Are you still getting growth in derivatives? Yes.”

In other words, something along the lines of securitized mortgages is lurking out there, ready to trigger another crisis as in 2007-08.

So it could be any number of things including a re-run of the credit crisis, all of it revolving around the US$600 trillion in derivatives doing the rounds in the Globe, which happens to be about 10 times the size of the whole planet’s GDP. If that stuff seriously gets unstuck – and it seems inevitable that it will, seeing that nothing got fixed – then we’re going back to the point at which shares collapsed, housing bubbles burst, everybody’s savings got eaten up and all the other economic horrors that are now visiting upon Portugal, Ireland, Greece, and Spain.

If you add up the pieces, we’re not going to be lucky the second time through. If anything, the only reason we got through was because China over-spent its stimulus spending and ended up propping up Australia’s property bubble. You can see why the RBA might have changed its tune in light of this impending-doom scenario. Hold on to your hats.


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