More Promises...

Another promise from Wen about buying more European debt.

I suspect that China's own debt problems will severely limit any debt purchases in Europe.

Sorry Angela, I think you might be on your own with this one. Roll out the printing presses...

Where is the money going to come from?

With the tug of war between returning to surplus to keep the ratings agencies happy and stimulating the economy in what we believe is a coming downturn, the question for future tax revenues starts to come into question. Ken Henry's mining tax should have been introduced many years ago, however the power of the mining companies was enough to bring down a prime minister over this issue.

Where will the tax revenues come from when China is not building empty buildings?

Will they tax super over 60 at some stage over the next decade or so? I am not so sure this is out of the question.

With an aging population requiring higher medical expenses and a lower working population percentage in the future, Abbott's fantasy idea that we can have a Howard style era is just that, fantasy. 

Aviation Safety

For some bizarre reason, the finance world likes to make all in bets. They use leverage to back themselves into corners and reduce their possible outcomes.

Aviation has developed over the years to avoid this kind of practice. In every commercial aircraft, multiple systems are in place to compensate for the unknowns. There is redundancy.

Warren Buffett talks about risk in a similar way to Aviation safety risk. He always looks to have a minimum amount of cash on hand to handle any unknowns.

As an international pilot, I spend numerous hours per year in a simulator working through different scenarios that could affect an aircraft. Luckily most of these scenarios will never happen in my career, however this does not mean we are not trained to be ready for them if they happen.

Whilst the system of the world of finance may be slightly more complex than the systems in an airplane, the strategies to prepare for the unknowns should be similar. Sadly, they are not.

Whilst our Reserve Bank and political leaders might attempt to con us that we do not have a housing bubble and China is not going to have a hard landing, they should not be complacent in their modeling of the effects of an extended slowdown in China and subsequent housing slowdown may create. This is their job. Not to sit in their big leather chairs and ignore the risks, but to think of all the risks and attempt to build in redundancy into the systems.

They may be doing this in the background without our knowledge, however housing busts and the surprise they caused to politicians and economists in the USA and around the globe have proven that this is unlikely.

The work of economists and finance professionals in todays world is not much better than the effectiveness of 18th century doctors and the technique of bloodletting to cure disease. 

When will it pop?

Breathe in as much air as you can. Then when you think your lungs are full, try breath in some more.

This is a similar problem China is facing at present. They have breathed in as much debt as they can, but popular thought is that they can continue breathing in as much debt as they like to keep the economy ticking along at high single digit rates, albeit with a soft slowdown to 7.5% this year.

Whilst they may be able to stimulate in the short term, it would likely cause greater imbalances over the medium to longer term as the majority of any stimulus would continue to be channeled to inefficient government directed fixed asset investment.

There is a great article here from Zarathustra about the loan issues China faces over the next few years...

Ignoring Fundamentals

I usually dont worry too much about short term moves in the markets as they can be quite irrational but current trends are puzzling me.

Iron ore has fallen significantly lately but yet the big miners BHP and RIO are going up? (See http://www.macrobusiness.com.au/2012/08/ore-swaps-bust-the-ton/)

Who is crazy enough to buy these companies when the fundamentals are heading in the opposite direction to where you would want them to go?

Are they betting on a bigger than 4 Trillion Yuan stimulus in China? I am not confident that the Chinese will introduce a stimulus equal to or larger than the previous 2009 injection. Without a large stimulus, I would suspect that there is a continual decline in commodities over the next few years heading toward longer term averages.

I suspect that China will stimulate, but at a level that they believe will stop the rot rather than ignite another boom. They have shown they are keen to keep the pressure on property prices in the larger cities and I expect this to continue in an attempt to stop a reflation of the bubble.

The fragility of the Chinese banking system, the potential for numerous de-listings of Chinese companies in the US and a capital outflow are just some of the risks to the Chinese economy in the near to medium term. I would suggest that it may be difficult for the Chinese to get past this coming speed hump without meaningful slowdown. You need to contend with these issues when buying the mining stocks at present.

Caveat emptor!

Belief in China's command economy to solve all problems when it is the command economy that caused the problem is a dangerous paradigm.  

Strange Strange World...

Strange Strange World...

We live in a world where bond yields are negative, Australian Banks are worth more than some of the largest American banks and Australian mining companies are trading at 3 to 6 times their book values at a point closer to the top of the cycle than the bottom.

Unfortunately all of the above scenarios may not work out too well for those that are placing their faith in the concept that the world will permanently be in this current situation.

My first ever blog post...

I am not sure if this is going to be a regular thing our just a way to get through to existing and future clients in the most efficient manner, but here it is...

In Search of Yield

The dangerous game of hunting for yield could lead to less than desirous results for investors who don't understand the economics of the businesses they invest in.

The banks are not "safe as houses" and those grabbing for yield could be in for a rough ride.

With one of the highest mortgage debt to GDP ratios in the world, Australia does not have a significant upside in our ability to borrow more for housing. This combined with a huge reliance on overseas funding puts our banks in a less than stable position over the next 5 to 10 years. If unemployment follows a pattern similar to any of the previous cycles in history, then it is unlikely to remain steady at low 5% range for ever. At some stage, rising unemployment with enormous mortgage debt becomes a problem. It may not be this year or next year, but a cyclical turning point is likely at some stage and those holding bank shares may not get their "utility like" returns (http://www.macrobusiness.com.au/2012/08/bank-gloomsters-are-from-mars/).

Anecdotally, I am speaking to clients, friends and family who have mortgages that take my breath away at 5,6 and even 7 times their incomes. Whilst they have previously had a bit of a buffer in the equity in the house, the house price falls of the last few years is slowly eating away at their margin of safety.

"Be fearful when others are greedy and greedy when others are fearful." (Buffett)  When the market capitilisation of Commonwealth Bank is more than the market capitilisation of Bank of America or Citigroup, I know which company I would be more fearful of owning.

Aussie Dollar

The mining stocks and Australian dollar are confusing me at present. I am not sure if I am missing something, but the recent "real data" coming from China is pointing to a significant slowdown. With electricity figures running at a negative year on year growth for the first time in a while, I would suspect that China is in the early to middle stages of a hard landing. There is likely more of a slowdown coming.

Having traveled to China dozens of times in the last 15 years, I am very suspect of the reported news that eventually hits our papers. You need to scratch under the surface to really understand what is going on in their economy. Half of the Chinese figures are so ridiculous that it makes them laughable.

In the short term, things can be irrational and the latest movements of the Australian Dollar and mining stocks are missing the point that no economy in history has had a smooth transition from an investment based economy to a consumption based economy and I doubt that China has rewritten the laws of economics.