Finally, This Should be Good News for Europe…

Guest post by Kris Sayce from Money Morning Australia 

There’s good news for Europe.

It’s just what the people there need.

We just hope they get to enjoy it.

But they probably won’t.

Because while it may be good for the people of Europe, it’s bad for Europe’s powerful elite…

Bloomberg reports on this ‘good news’:

‘Euro-area factories cut prices in September by the most in more than a year and German manufacturing shrank, underlining the mounting challenge facing Mario Draghi.
    ‘The European Central Bank president is on a mission to avert deflation as the euro region’s economic landscape deteriorates. Purchasing Managers’ Indexes from Markit Economics showed manufacturing activity also contracted in France, Austria and Greece, with a gauge for the 18-nation region pointing to almost stagnant output.’

We’ll translate that for you in case you don’t get it. Europe’s factories are cutting prices. They hope to encourage businesses and consumers to buy their products.

It’s price deflation. For those who live in Europe, where the jobless rate is in double-digit percentage figures, price deflation is good news.

The Biggest Crisis to Hit the Stock Market Since the Last One

Guest post by Kris Sayce from Money Morning Australia 

What did we tell you a few weeks ago?  It’s impossible for the stock market to move up or down until the Wall Street whiz kids and mainstream media create a new catchphrase.

‘Debt ceiling’, ‘fiscal cliff’, ‘credit crunch’, and ‘Grexit’.  You’ve heard them all.  Each time one of those terms rears its head, the market falls. Then soon enough someone finds a ‘solution’ and stocks roar again.

Well, it looks as though we’ve got a new excuse for stocks to fall. And this one is the scariest of all.

It’s ‘The Sequester‘.

What does it mean and should you worry about it?  For an explanation of The Sequester, here’s the Washington Post:

The sequester is a group of cuts to federal spending set to take effect March 1, barring further congressional action.
    The sequester was originally passed as part of the Budget Control Act of 2011 (BCA), better known as the debt ceiling compromise.
    It was intended to serve as incentive for the Joint Select Committee on Deficit Reduction to come to a deal to cut $1.5 trillion over 10 years. If the committee had done so, and Congress had passed it by Dec. 23, 2011, then the sequester would have been averted.

In short, the US Congress and Obama Administration need to agree to cut a bunch of government spending, raise taxes, or both. If they don’t then it means a total of USD$85.4 billion in mandatory cuts spread across defence, discretionary spending and Medicare.

So, they’ve got just about a week to figure things out. Will they? Or will you see history repeat itself? Here, let us explain…

Stocks Fall Again, Will They Rise Again?

Last Thursday the Australian share market dropped 118.6 points…or 2.3%.  Investors are worried. They’re worried the US Federal Reserve may turn off the money tap. If that happens the stock market will have to fend for itself.

Add that to The Sequester and you’ve got a recipe for a stock sell-off.

As we said at the start, the market and mainstream investors are so insecure that they can’t buy or sell anything without an excuse. They need a big macro-economic disaster…and they need to give it a name.

They’ve done that before. So many times we’re bored of it. Here’s a chart of the US S&P 500 going back to 2007. We’ve overlaid data from Google Trends. The marks on the chart indicate the point at which each phrase reaches the peak in news headlines:

Click here to enlarge
Source: Google Finance, Google Trends

You remember the ‘Credit Crunch’. Headlines containing that phrase peaked in October 2008. The fear of a Greek exit (‘Grexit’) from the European Union peaked in May 2012.

And the Fiscal Cliff hit a crescendo in December…just before US stocks bagged a 9% gain in four weeks!

Each of these phrases has something in common – a short shelf life. The media reaches a frenzy,stocks sell-off and then…that’s right, politicians reach a bogus deal and the crisis is over…until the next crisis arrives.

That’s where we are with ‘The Sequester’…

That’s where we are with ‘The Sequester’. Use of the term has gone sky-high since the start of the year. Check it out for yourself on Google Trends (and sign up for Google+ while you’re there so you can follow our commentary throughout the day).

But we’re prepared to bet that you’ll see another eleventh-hour squib of a deal and they’ll avert the crisis…until the next time anyway. And you can guess what will happen then: stocks will take off, as we dare say part of the deal will involve more spending and/or more money printing.  And if we’re wrong? That’s why we hold dividend-paying stocks for income, cash for safety and gold for insurance. This volatility and fake crisis solving is why we’ve gone on so much about spreading your money around into various asset classes.  If you’ve followed this advice, then yesterday you should have just sat back and enjoyed the view.

Just because politicians and everyone else is irrational, doesn’t mean you have to be.

Cheers,
Kris
Kris Sayce is an Investment Director for Port Phillip Publishing and an editor for Money Morning Australia.

KRIS SAYCE: Bad News from the “Asian Century”

Guest post by Kris Sayce from Money Morning Australia 

Part 1: Bad News from the “Asian Century”

Writing in Melbourne’s Age newspaper, Climate change adviser Ross Garnaut

has lambasted Australian executives for destroying shareholder funds in the blind belief China’s demand for Australia’s big three mining exports would continue to climb.’ 

Perhaps Mr Garnaut should ask why company executives are blowing up shareholder funds.

Maybe it’s because for 30 years, Australian governments have spouted off about the Asian economic boom.

And now the Aussie government has just released the Asian Century white paper. The gist of the white paper is that Asia will undergo an economic boom for another 100 years.

But before you trust everything the government says, just remember that they can’t even correctly forecast their budgets six months in advance. So we find it hard to take a 100-year forecast with anything more than a pinch of salt.

Our advice? Ignore the long-range forecast and look at history instead. That’s because history tends to offer useful lessons for the future…including a lesson Australia could learn from previous Asian booms and busts…

Take this report from the New York Times in 1996:

‘Are East Asia’s fiercely competitive tiger economies starting to lose their fangs?

‘Things probably have not gotten quite that bad. But if the teeth are still intact, they have lost some of their sharpness of late. Export growth for many countries in the region – including the original “Four Tigers” of Singapore, Taiwan, Hong Kong and South Korea, as well as a half-dozen other countries that are following the same fast-growth path – has slowed sharply this year. And China’s exports have actually declined.

‘The deceleration in part reflects a healthy cooling off of economies that were running the risk of overheating. But it also raises questions about the staying power of East Asia’s export-driven economic boom. In particular, it translates into a deterioration of the region’s trade balance.’

One year later, the Asian Economic Crisis was in full flow. The Asian Tiger economies collapsed and their currencies were devalued. To rub the salt in, the International Monetary Fund (IMF) handed out bailout money.

In simple terms, the cause of the Asian Economic Crisis was over-investment, over-borrowing, and over-enthusiasm…

Asian Tiger Slaughtered

It was a classic bubble. An investment or economy begins growing on its own fundamentals. This attracts attention. So more people invest. Things get even better…imagine if growth continued at this rate.

Then the snake-oil salesmen arrive. In this case they called it the ‘Asian Tiger’. Businesses expanded and new businesses appeared. But because they hadn’t saved enough, they had to borrow money.

The banks cautiously loaned money at first. But when they started seeing the returns, they imagined what they could have made if they had loaned twice or three-times as much.

You get the picture. In the end, like every investment bubble in the history of mankind, the world runs out of fools who are prepared to buy into the bubble.

The euphoria that sucked everyone in disappears. Replacing it is fright as everyone rushes for the exit.

They sell the investment at a loss. Businesses can’t sell enough goods to repay the loans. That means loans go unpaid. The currency falls as investors abandon it for safe haven currencies…and finally, the whole economy collapses in a heap.

That’s the (abridged) story of the Asian Financial Crisis. And it’s the story of every other asset or economic bubble…and it’s the story of the Chinese economic bubble.

‘Oh, but Kris, China is different, it doesn’t have a bunch of external debt. It owns other nations’ debts, so it will be fine.’

We often hear that excuse.

But, it’s worth paying attention to an article in Forbes earlier this year:

‘Here’s some terrific news about China’s economy: at the end of last year, the debt-to-GDP ratio of the Chinese government, the key measure of its fiscal sustainability, stood at 16.3%. That’s an improvement from the already impressive 17% at year-end 2010.

‘Based in large part on Beijing’s low debt load, the Economist’s “wiggle-room index,” which ranks economies on their ability to afford stimulative measures, assigns a great rating to China. Of 27 emerging nations, only petroleum-blessed Saudi Arabia and Indonesia look stronger…

‘All this sounds wonderful, but none of it correlates with the facts. The 16.3% calculation excludes Beijing’s “hidden liabilities.” Once you add them in, China’s debt-to-GDP ratio increases to somewhere between 90% and 160%. And if you believe Beijing has been overstating its GDP recently – it has, at least starting from the last quarter of last year – China’s ratio approximates Greece’s 164%.’

Greece is Nothing Compared to China

Wow! The European Union is on the verge of collapse, and asset markets have crashed due to Greece’s debt problems. Given the relative size of the Greek economy to the Chinese economy…

Click to enlarge

…can you imagine what will happen to asset prices when the Chinese economy implodes? It almost doesn’t bear thinking about. Only you have to think about it because the Australian economy is handcuffed to the Chinese economy.

Now, we’re not saying that China won’t be an economic force…to a large degree it already is. But what we are saying is something we’ve said for the past couple of years.

That is, regardless of a country’s strength, economic growth doesn’t go up non-stop forever. Booming economies will always have periods of bust.

If an economy sees excessive credit growth and an economic boom, as sure as night follows day, that economy will see credit contraction and an economic bust.

Bottom line: 100 years is a long time, and anything can happen. But don’t fall for the spin that Australia’s future wealth is safe.

The Chinese economy is following the same path as every other economic boom…and it will soon follow the same path as every other economic bust.

History will show that the Asian Financial Crisis was nothing compared to the coming fallout from the Chinese Financial Crisis.

Part II: Is the “Asian Century” Already Kaput?

It’s getting tasty in China.

Yesterday, the Financial Times noted:

‘Chinese listed companies have reported a sharp rise in unpaid bills during the third quarter, in one of the clearest signs yet of the toll that China’s economic slowdown is taking on corporate balance sheets.’

We wonder how that will fit in with the government’s plans for the so-called ‘Asian Century.’ Not very well we’ll wager…

Last weekend, Australian Prime Minister Julia Gillard released the long-awaited Australia in the Asian Century white paper.

The paper notes:

‘The Asian century is an Australian opportunity. As the global centre of gravity shifts to our region, the tyranny of distance is being replaced by the prospects of proximity. Australia is located in the right place at the right time – in the Asian region in the Asian century.

‘For several decades, Australian businesses, exporters and the community have grown their footprint across the region. Today, for Australia, the minerals and energy boom is the most visible, but not the only, aspect of Asia’s rise. As the century unfolds, the growth in our region will impact on almost all of our economy and society.’

It sounds impressive, right?

The argument is that Asia will become the global economic powerhouse. Therefore, because Australia is on Asia’s doorstep the Australian economy will benefit.

As impressive as it sounds, it’s also completely misguided, and we’re sorry to say, woefully wrong.

But we look at it like this: it’s like a fat man thinking he’ll lose weight if he stands next to a skinny man!

But we’re not the only one to criticise the white paper. Michael Pascoe wrote in Melbourne’s Age that ‘the PM has offered a statement of the obvious.’

While Clinton Dines, formerly of BHP China, told the Age, ‘With a slowdown and budget deficit looming, one suspects that Ken Henry’s efforts are doomed to go the way of his tax reforms.’

We’re happy when the mainstream criticizes government policy. Only this time, the mainstream is wrong too…

The “Asian Century” is Already History

The reality is when we look back at today from the future, the Asian century (in the way the government envisions it) will prove to be nothing more than an Asian decade…or two decades at the most.

If the government, businesses and investors have pinned their hopes on the Chinese Dragon and Asian Tiger, they’ll be sorely disappointed.

By attaching their hopes to Asia, they’re in danger of missing out on the real story of the next 100 years. It’s what we call the ‘Wired Century.’  (This is a theme we wrote about in the latest issue of Australian Small-Cap Investigator.)

The fact is, in some ways the era of backing one geographic location over another are over. So are the days of benefiting from being close to a booming nation.

Let’s be honest, Australia’s closeness to China hasn’t been as important to the Australian economy as most think. What’s more important is that Australia has the natural resources that China needs – copper, iron ore, and coal.

But Brazil has a bunch of this stuff too. So does Canada, Chile and Africa. And the last time we checked, Brazil is three times as far from China as Western Australia is from China…and that’s as the crow flies. In nautical miles the distance is even greater.

And if we’re not mistaken, the US has relied on Middle Eastern oil for years. You could hardly call them neighbours.

Distance doesn’t matter compared to having a resource in demand. The fact that Australia has a bunch of resources and is close to China is just a bonus.

In short, anyone hoping that Australia will cash in on the supposed ‘Asian Century’ is kidding themselves.

Australia Needs to Exploit the Wired Century

Yes, there are benefits of being close, but there’s something much more import. And that’s technological innovation and global trade.

This is the real benefit for Australia.

So if you’re after a clue about the future, we suggest you take in the two following excerpts. First this from the Age:

‘The rise of the internet has killed the newspaper business model, but demand for television remains enormous.

‘According to The Cross Platform Report by researcher Nielsen, United States viewers still spend around four hours a day watching TV, barely down from record highs.

‘Does this make the battered shares of Seven, Nine and Ten cheap buying for potentially-rich stocks? No.

‘Australian television broadcasters are at the very same tipping point newspapers reached a few years ago, just before their problems became near-terminal.’

And this from the London Times:

‘The world is “drowning in data” and computing companies are running out of space to store it, one of the technology sector’s best-known – and most controversial – figures has warned.

‘Mark Hurd, the president of Oracle, said that the amount of data being produced by the nine billion devices connected to the internet had grown eightfold over the past seven years, putting incredible strain on the companies that need to process and store it all.’

New technology, new business practices, and new consumer behaviour is having a big impact on the local and world economy. And that impact will only grow.

As we wrote in the latest issue of Australian Small-Cap Investigator, 16 years ago the Sayce household only had one device connected to the internet (a desktop computer).

Today, between  this writer, the missus and two kids, we have 12 internet-enabled devices. And as far as we’re concerned, the world is barely 5% of the way through the technological revolution.

The Most Important Skills You Can Learn

Bottom line: forget the Asian century. Forget the nonsense about forcing kids to learn Mandarin, Japanese, Hindi and Indonesian.

Sure, those skills will be handy. But on the importance scale, they are far, far behind the most important skills any kid (or adult) could learn today. We’re talking about encouraging kids to learn more technological and web skills.

If Australia (or anywhere) has any chance of building a successful economy over the next hundred years it won’t be through foreign languages or as the mainstream economists seem to think, by building more houses, it will be by embracing and exploiting the Wired Century.

That’s the future for Australasia. But only if governments stops butting in and let schools and businesses get on with building those skills.

Cheers,
Kris

Kris Sayce is an Investment Director for Port Phillip Publishing and an editor for Money Morning Australia.

Why This Crisis Still Has a Long Way to Run

Guest post by Kris Sayce of Money Morning Australia 

When is a cut not a cut?

When it’s an increase.

Sorry to be cryptic, but we laugh when we see presidents, prime ministers and finance ministers talk about ‘austerity’ and ‘slashing budgets’.

Because just like central bank money printing, the markets get excited for about three minutes before they realise what even an idiot can see…

Cut spending isn’t what governments do. For governments, spending only ever goes one way. That’s up.

Last week the papers were going batty on the news that, ‘Spain unveils austerity budget as political turmoil mounts.’ So says the Australian newspaper.

According to the Wall Street Journal:

‘The Spanish government presented 13 billion euros ($16 billion) of spending cuts and tax increases for 2013 and said it will place new limits on early retirements as political turmoil heightens investor concerns over Prime Minister Mariano Rajoy’s ability to slash a towering budget deficit and stabilise one of Europe’s largest ailing economies.’

We wish Spain luck. Especially considering the following post to the UK Daily Telegraph‘s blog covering the Spanish budget overnight:

‘Spanish government sees unemployment bottoming out and has predicted an average rate of 24.3pc [per cent] for next year.’

The same blog also reveals:

‘Spanish deficit targets: 6.3pc in 2012, 4.5pc in 2013, 2.8pc in 2014, 1.9pc in 2015.

‘These cuts are aimed at chopping €40bn off Spain’s budget deficit next year.’

Right on cue, of course, Spaniards began rioting in the streets. Here’s a bit of free advice for Spanish Prime Minister, Mario Rajoy. When your government is announcing welfare cuts, it’s probably best not to be photographed chomping on a cigar in New York:

Source: Independent.ie

But before you start getting too excited about so-called spending cuts, and the positive impact it could have on the world economy, just remember this: when governments cut spending, it doesn’t mean they cut spending.

Not as Good as the Treasurer Claims

It was a bit like the smoke and mirrors from Aussie Treasurer, Wayne Swan. Last week he spun the argument that the Aussie federal budget was $661 million better off than predicted.

The mainstream press fell for it hook, line and sinker. What a great Treasurer they said. What a good boy.

What they didn’t focus on (just as the Treasurer hoped), was that last year the government spent $43.7 billion more than it raised in taxes.

To cover the shortfall the government had to issue more bonds…in other words go further into debt. And with commodity prices collapsing, the Aussie budget position is set to get worse.

It’s the same for Spain. Just because it reduces the annual budget deficit doesn’t mean the economy or debt position is any better. Last year Spain’s budget deficit was 8.5% of GDP, or about €97.8 billion. And its total debt will hit 85.3 percent of gross domestic product by the end of this year, and continue rising.

So even if Spain cuts spending by €40 billion, it’s still spending €57.8 billion more than it takes in with taxes. And by the end of next year its total debt will reach 90.5 percent of gross domestic product by end 2013—and continue rising.

And that’s assuming the Spanish economy doesn’t get worse, which it probably will given the proposed tax increases.

So, when is a cut not a cut?

When it’s an increase.

What we’re getting at is this: it’s nearly five years since the world economy started to fall apart.

The US Federal Reserve has virtually admitted that it’s out of ideas. The only solution it’s got is to print money…even though that’s never worked before.

The Eurozone thinks it can fix its spending problems by keeping on spending and creating a bigger debt problem instead.

And China thinks it can stop its economy from crashing by building more roads, buildings and railways…that no-one can afford to use.

And as for all those in the mainstream media who love the Chinese economy, and fall over themselves to praise it, just remember what we’ve said about China for the past four years – it’s a brutal economy and leadership that sees the Chinese people as a means to stay in power and line their own pockets.

How Chinese Infrastructure Projects Work

Take this news story from the New York Daily News that you won’t read in the compliant, China-loving Aussie press:

‘Stomach-churning photos have surfaced allegedly showing the moment a Chinese protester was crushed by a steamroller while trying to stop government officials from relocating his village to make way for a commercial development.

‘A local government official allegedly ordered the trucks forward, and the man was flattened beneath one six-wheeled hulking behemoth, the report said.’

How are you enjoying your iPhone now? And anything else that’s ‘Made in China’.

All this tells us that those in power are getting desperate. They’ll do anything to make sure the economy doesn’t collapse on their watch.

That means pretending to cut budgets while increasing debts, it means printing money as a last resort, and it means crushing people to death in order to erect a new building paid for with government stimulus money.

Kris Sayce is editor of Money Morning Australia. He began his financial career in the City of London as a broker specializing in small cap stocks listed on London’s Alternative Investment Market (AIM). At one of Australia’s leading wealth management firms, Kris was a fully accredited adviser in Shares, Options and Warrants, and Foreign Exchange. Kris was instrumental in helping to establish the Australian version of the Daily Reckoning e-newsletter in 2005. In late 2006, he joined the Melbourne team of the leading CFD provider in Australia.

This post first appeared at Money Morning Australia on 28 SEPTEMBER 2012

Why Government Intervention Hinders Progress and Innovation

Guest post by Kris Sayce from Money Morning Australia

‘The success of Asian economies such as Korea didn’t happen through the ideological miracle of economic bushfires, where the conditions need to be just right for their creation naturally.
‘They were deliberately built through considered and targeted government policy – picking winners and planning for long-term growth.
‘The Samsung story itself is incredible.
‘Driven by government-sponsored credit and policy vision, Samsung now accounts for more than ten per cent of the country’s GDP.’
            - Paul Howes, National Secretary, Australian Workers Union

In one breath, Mr. Howes denies the existence of entrepreneurialism and creative destruction.

In Mr. Howes’ (and other central planners’) world, it’s government that creates jobs.

They believe that a nation needs a group of wise overlords to guide and direct the economy.

In their view, nothing happens without government intervention.

As they see it, governments come up with the bright ideas and it’s then up to the market to fulfil those ideas. If the market doesn’t do it, it’s not because the idea is rubbish, it’s because the market has failed.

But while Samsung may be a wonderful example of a government picking winners, let’s not forget the other side of the coin — the hundreds or thousands of South Korean businesses that failed, the money lost and the lives ruined because the government backed Samsung while not giving the same favours to others.

Or let’s look at an example of another global brand that received government support — Nokia.

Until recently, Nokia was the world’s leading mobile phone company. And it was Finland’s biggest company.

Government Intervention and the Lesson of Nokia

But having favoured status didn’t protect the company from error. It made two crucial business mistakes that would cause it to miss out on the two biggest trends in the mobile phone industry during the past 10 years.

First, it missed the trend towards ‘flip’ mobile phones. It stayed with the ‘brick’ style that had won it millions of customers over the years. But at the time consumers wanted compact and sleek phones. The kind you could neatly hide away in a pocket or handbag.

But as you know, technology changes quickly. The trend for compact and sleek phones didn’t last long. Perhaps if Nokia caught the next trend wave it would be fine.

But no, it missed that too. That was where consumers wanted theopposite of sleek and compact. Mobile phones (smart phones) became fashion accessories.

Consumers wanted big screens. The bigger the better. No longer were mobile phones stashed in pockets or handbags, now they were laid out on the table or desk where everyone could marvel at the size of your screen and the smallness of your pixels.

Nokia missed out. But Apple and Samsung didn’t.

The result is that Nokia’s share price has fallen from USD$40 in 2008 to just USD$2.82 today.

Success and failure come and go quickly in business, especially in technology. So the idea that any business should account for 10% of a nation’s GDP (gross domestic product) isn’t a point of pride, it’s a point of concern.

Take an example close to home. BHP Billiton [ASX: BHP] and Rio Tinto [ASX: RIO] made combined revenues of $127 billion last year.

That’s about 10% of Australia’s GDP. Again, that may sound great, but not so much when those revenues are at the mercy of a slowing Chinese economy.

So South Korea, like Australia, isn’t a poster-child for positive government intervention. Rather they are poster-children for what happens when a government intervenes and manipulates to create a lop-sided and fragile economy.

Of course, the idea that government intervention creates prosperity is nonsense.

Government Intervention Hinders, Not Helps

Government’s don’t create opportunities…or plan for long-term growth. Governments hamper opportunities. And they only ever plan for short-term growth (even though they pretend they’re planning for the future).

That governments take the credit for progress, wealth and high standards of living is a falsity that must be corrected. Progress and wealth comes from freedom and opportunity, not from central planning and State intervention.

Tomorrow, we’ll explain how it hasn’t been the increase of government intervention powers that has created so much wealth and progress. Instead, it was the end of centuries of human oppression and the reduction in government involvement.

Kris Sayce
Editor, Money Morning Australia

How This Bear Market Could Last Another 18 Years… Just Like Japan’s

Guest post by Kris Sayce from Money Morning Australia, who looks at the country that most famously began following the “stimulus” prescription more than twenty years ago.

Last week, Bloomberg News reported:

‘Japan’s Topix Index (TPX) entered a bear market, with stocks plunging to a level not seen since 1983 as Europe’s debt crisis spurs a global flight from risk assets, driving up the yen and threatening exports…
    ‘In 1983, the Topix was in the sixth year of a 12-year advance that ended when an asset bubble burst, ushering in an era of deflation and economic stagnation. The gauge has lost 76 percent since peaking on Dec. 18, 1989.’

It has been a rough time for Japanese stock investors.

An entire generation of Japanese have lived through a bear market. Japanese investors who were 18 when they bought their first shares in 1989 are now 41 years old.

And so, as the Aussie market nears the end of its fifth year as a bear market, the question on every investor’s lips should be: Will Aussie stocks fall for another 18 years?

We’ll give you our take on it now…

Until recently, most people thought asset prices always went up.

This was mostly the view among stock and housing investors.

Why?

Because it was what they had seen during their lifetime. Even when house and stock prices fell, it wasn’t long before they recovered and went higher again.

Take the 1987 and 2001 stock market crashes. Or the early 1990s housing bust. Soon prices stopped falling, levelled off, and then soared higher.

What the Japanese Bear Market Tells Us

But as the Japanese experience shows, stock and housing prices don’t always go up, and they don’t always recover after a crash.

Look at that quote from Bloomberg again. The Topix Index ‘has lost 76 percent since peaking on Dec. 18, 1989.′

And the important thing is, if Japanese stock market history tells you anything, over time the impact of the crash gets worse, not better. As this chart of another Japanese index, the Nikkei 225 shows:

Source: Wikipedia

Following the 1989 peak, the index halved over the next four years. Then it steadied into a range, before continuing to fall.

The Japanese stock market is an important lesson for any investor about the impact of credit-fuelled bubbles. We won’t go into the history of the Japanese bubble, except to remind you of how the 3.41 km2 of land containing Tokyo’s Imperial Palace was valued at ‘more than all the real estate in California’ during the 1980s boom (Edward Jay Epstein, 2009).

What it tells you is that rather than stock and housing prices always going up (in the long run), they behave more like a bouncing ball.

In Japan during the 1980s, the credit-fuelled boom threw the ball high into the air. It began to fall in 1989. The ball hit the floor in the early 1990s…bounced until the mid-1990s…fell and hit the floor again by the mid-2000s…and so on.

You get the point.

But why should this happen? And what can it tell us about the future direction of the Aussie market?

Following Japan’s Bear Market Lead

The Japan experts will tell us Japan is unique. The usual spiel is that Japan owns all its own debt and so it’s different to the debt picture in the US, Europe and elsewhere.

Maybe that’s true. And maybe it isn’t. Or maybe Japan’s economy is just a few years ahead of the game. Consider these two charts from the latest Banque de France Financial Stability Review:

Click here to enlarge
Source: Banque de France

Right now, Japanese residents and the Bank of Japan hold 94% of all Japanese government debt.

Compare that to 52% of US government debt held by the Fed and private residents. In fact, US Fed and government (including government agencies) hold USD$6.328 trillion…about 40% of all US debt.

And according to a 28^th March report by the Wall Street Journal, ‘The Federal Reserve is propping up the entire US economy by buying 61 percent of the government debt issued by the Treasury Department…’

The report concludes that this is ‘a trend that cannot last’.

But what if it can last?

What if the US Fed keeps buying US debt?

Who’s to say that in 10 or 15 years, US residents and the Fed won’t own 94% of all US debt?

It doesn’t seem likely now, but then, four years ago it didn’t seem likely that the US government would own 40% of its own debt today.

With so much money flowing into government coffers, investors need to face the facts: the era of financial asset growth is over.

No government will ever choose to cut spending. Remember that all the talk of austerity is false. Government spending in the US, UK and Australia will go up over the next few years…even though the politicians claim they’re making savage cuts.

(All they’re doing is cutting the spending growth rate, not the nominal rate. In other words, if the previous forecast was to grow government spending by 5% next year, but it only grows 4.5% they call it a spending cut…even though spending has risen.)

We’re afraid things are the same for Australia.

The Boom is Over, Get Used to a Long Bear Market

Australia has benefited from a decade of the China resources boom. But that boom is over. US and European private spending is falling. And as Europe and the US are China’s two biggest export markets, any problems in those economies will impact China…and therefore Australia.

That’s despite what the mainstream media told you when they claimed Europe is ‘so far away’. That growth was in Asia…where we are. That’s only true if Americans and Europeans kept spending.

The problem facing Australia over the next few years is the problem that the US and Europe face now. How to pay for an expensive welfare system when tax revenues fall?

The answer will be to look to Japan, Europe and the US… print more money and have the central bank buy the government’s debt.

Anyone who thinks Australia or New Zealand is different due to the lower levels of government debt is kidding themselves. It only takes a few years of budget deficits and suddenly the government and taxpayer are running just to stand still.

So, far from being an exception, Japan is more like the blue-print for governments and central bankers everywhere. Get ready for this bear market to last another 18 years…at least.

Cheers,
Kris.
Posted by permission of Money Morning Australia, where this post first appeared.

The US Dollar – The “Strongest of the Weak”

Guest Post by KRIS SAYCE

The idea of risk is a very personal thing.

What we see as risky, you may not.

And what you see as risky, we may see as completely safe.

One trick to successful investing isn’t to just figure out what you see as risky, but to also figure out whether other investors see it as risky too.

If you can pull off that trick it can help you stay one step ahead of the crowd. More below…

The following headline from Bloomberg News caught your editor’s eye this morning, ‘Dollar Scarce As Top-Quality Assets Shrink 42%’.

‘Dollar Scarce’?

It doesn’t seem possible.

After all, you’ve no doubt seen this chart from the Federal Reserve Bank of St. Louis:

Source: Federal Reserve Bank of St Louis

It shows the explosion of US dollars on issue since 2008.

How can US dollars be scarce when the monetary base has increased from USD$800 billion in 2008 to USD$2.7 trillion today?

The answer is risk.

The Bloomberg News story explains more:

‘International investors and financial institutions that are required to own only the highest quality assets to meet investment guidelines or new regulations are finding fewer options beyond dollar-denominated assets. The US is one of only five major economies with credit-default swaps on their debt trading at less than 100 basis points, meaning they are viewed as almost risk free. A year ago, eight Group-of-10 nations fit that category…’

For the past four years, most of the talk has focused on the US. And most of that talk has centred on the US budget deficit, government debt and the devaluation of the greenback due to money-printing.

To some degree the US dollar has taken a back seat as markets and commentators focus on the euro…and its inevitable demise.

Just as it looks like the euro crisis is over, another spanner gets jammed in the works. The latest problem is with Spanish bank, Bankia S.A.

The Weakest of the Weak

This week, the European Central Bank (ECB) rejected the Spanish government’s proposal to prop up Bankia. We’re not surprised. It was nothing more than an indirect way of Spain tapping the ECB for a bailout.

The Spanish government had proposed issuing a bunch of debt to Bankia, which it could then use as collateral with the ECB. The ECB saw through this snide plan and so it looks like the Spanish government will have to bailout Bankia directly…undoubtedly causing the Spanish government to go further into debt, with Spanish bond yields going higher.

As the chart below shows, Spanish government bond yields are now near the highs of last November:

Source: Bloomberg

So, why are Spanish bond yields going up? Because big investors see Spain as too risky. Only last week savers withdrew 10% of deposits at Bankia on fears it would collapse.

As Slipstream Trader Murray Dawes told us this morning, ‘Why would you believe what the other banks say? You’d sell now and ask questions later.’

But with European nations holding a single currency, grouping together basket-cases like Spain with non-basket-cases like Germany, it’s not just a case of selling Spain and buying Germany.

However, many investors are doing that, which is why German 10-year bond yields are at a record low of 1.36% (During the market crash of 2008, the 10-year bond yield barely dipped below 3%).

But when push comes to shove, investors are going where they’ve gone during every previous crisis – the US dollar and US bonds.

The Strongest of the Weak

At the end of March, foreign holdings of US government bonds totalled USD$5.1 trillion. That’s a 14% increase from the same time last year. 10-year U.S. government bonds are trading at 1.7% – a higher yield than German bonds.

As risky as the US dollar seems, investors are still willing to buy it.

So, what’s the takeaway from this?

Simply this: as expected you’re seeing investors migrate from the weakest of the weak and towards the strongest of the weak.

You could say it was the next logical step towards the end of paper currencies. If you’re worried about your Spanish savings, you sell them and buy German savings. You hold those until you’re worried about the safety of your German savings.

After that, it’s into the lap of the world’s reserve currency, the US dollar.

How can you tell when that’s started to happen? We can’t say for sure. But a likely sign is in the following chart:

Source: Bloomberg

The orange line is the US government bond yield. The green line is the German bond yield. German bond yields have fallen as investors seek the safety of German assets over other European assets, to the extent that yields are lower in Germany than in the US.

The signal that investors are genuinely fearful over the future of the euro (rather than just Greece leaving the euro) will be when the green line starts ticking up and perhaps even rises above US bonds.

That should tell you that one more paper currency is about to fail as money flows into the strongest of the weak – the US dollar.

This is a key chart to watch over the coming months.

Cheers,
Kris.
Reposted by permission from  Money Morning Australia

What Isaac Newton Knew About House Prices …That the IMF Should

Guest post by KRIS SAYCE, from MONEY MORNING AUSTRALIA

‘Actioni contrariam semper et æqualem esse reactionem: sive corporum duorum actiones in se mutuo semper esse æquales et in partes contrarias dirigi.’
          – Law Three, Principia Mathematica Philosophiae Naturalis, Sir Isaac Newton

Or to non-Latin speakers (including your editor)…

‘To every action there is always opposed an equal reaction: or the actions of two bodies upon each other are always equal, and in the parts directed to contrary.’

Apparently, this is a new idea to the guys and gals at the International Monetary Fund (IMF). But thanks to ‘three decades’ of research, the boffins at the IMF have finally found out what Sir Isaac Newton knew 325 years ago.

That is, every action creates an opposite and equal reaction.

It’s Newton’s Third Law.

OK. Newton’s third law doesn’t directly relate to house prices. And strictly speaking, he’s not saying that what goes up must come down.

Even so, you can easily apply the words from the Third Law to asset price action. And we strongly suggest you pay close attention to them.

Because the latest IMF report (World Economic Growth 2012: Growth Resuming, Dangers Remain) reveals the central bankers’ plan to ignore the laws of maths and physics. Instead, they’ve got their own ideas on how things should work.

Only this time, they assure you, things will be different…

We were stunned when we read this statement buried on page 89 of the latest IMF report:

‘Based on an analysis of advanced economies over the past three decades, we find that housing busts and recessions preceded by larger run-ups in household debt tend to be more severe and protracted.’

Really?

They’ve only just figured that out?

It’s taken them ‘three decades’?

Oy vey.

But that statement was nothing. We read on…

‘Based on case studies, we find that government policies can help prevent prolonged contractions in economic activity by addressing the problem of excessive household debt. In particular, bold household debt restructuring programs such as those implemented in the United States in the 1930s and in Iceland today can significantly reduce debt repayment burdens and the number of household defaults and foreclosures. Such policies can therefore help avert self-reinforcing cycles of household defaults, further house price declines, and additional contractions in output.’

Bottom line: it’s not the job of the State and the central banks to prevent asset bubbles. It’s the job of the State and central banks to inflate asset bubbles and then make sure they don’t burst.

How?

By implementing ‘bold household debt restructuring programs…’

You understand that’s shorthand. It means using private savings and taxpayer dollars to bail out those who get over their head in debt.

Of course, as we see it, the State and central banks cause the asset bubbles in the first place. So it’s no wonder there isn’t a peep from the IMF about government and central bank intervention causing price bubbles.

No, in their view the market causes all the problems and so the government must intervene.

Bubbles are good…busts are bad. That’s why they’re so keen to keep the ‘good’ stuff and get rid of the ‘bad’ stuff. Trouble is they ignore the fact that too much of the ‘good’ stuff causes the ‘bad’ stuff.

But the IMF commentary is more than just about house prices. It gives you a sneak peek inside the maniacal mind of central planners.

The Market is Sending Warning Signals

All around you, the market is screaming out. It’s sending warnings left, right and centre that something isn’t right. The message?

That the market needs a natural purge of all that’s bad…bad banks…bad economies…bad governments…bad central banks…

The whole darn lot needs a dose of economic Metamucil so world economies and the free market can start from scratch.

But that won’t happen anytime soon, because, as the IMF notes, it has a different take on things:

‘We also highlight the policy implications. In particular, we explain the circumstances under which government intervention can improve on a purely market-driven outcome.’

This morning Bloomberg News reports:

‘Spain said it would take over Bankia (BKIA) SA and may inject public funds into the banking group with the most Spanish real estate as the government prepares the fourth attempt to overhaul the financial system.’

According to the report, Spain will use 4.5 billion euros of taxpayer dollars to buy a 45% stake in Bankia.

And as the chart below shows, Spain’s biggest bank, Banco Santander, S.A. has fallen 64.2% since reaching a post-bust high in 2009:

Click here to enlarge
Source: Google Finance

Meanwhile, in the U.S., JP Morgan Chase & Co. [NYSE: JPM] announced a USD$2 billion loss due to… ‘synthetic credit securities…’

The banks will never learn as long as they know there’s a government and central bank to provide the ultimate backstop.

And finally, Bloomberg News reports the following comments from U.S. Federal Reserve chairman, Dr. Ben S. Bernanke:

‘If no action were to be taken by the fiscal authorities, the size of the fiscal cliff is [so large that there's] absolutely no chance that the Federal Reserve would have any ability whatsoever to offset that effect on the economy.’

In other words – you got it – the government must spend more so the economy keeps growing. And as a result, they delay the necessary bust yet again.

We’re not a fan of former U.K. PM, Margaret Thatcher, but she got one thing right: ‘You can’t buck the market.’

It’s just a shame to see so much taxpayer money wasted in order to refute her—or rather, to save the bacon of politicians, bankers and other vested interests.

Cheers,
Kris.

This post originally appeared at Money Morning Australia on 11 May 2012

Financial Repression: Why Every Bank Will Soon Be a Tax Collector for Every Government Everywhere

Guest post by Merryn Somerset Webb, Editor-in-Chief, MoneyWeek (UK)

Financial repression. A few years ago when a few people (Gillian Tett, Russell Napier, etc) started predicting that it would be the thing that made our crisis go away, not many were convinced. The phrase refers to the various methods that hideously indebted governments use to channel the money knocking around an economy to itself rather than anywhere else.

It can include anything from capping interest rates on government debt or deposit rates (as seen all over the world at the moment); forcing institutions to buy government debt; or, at its most obvious, putting in capital controls to prevent anyone taking their money out of the country.

All these things have the same effective result: by taking away other investment options they allow governments to issue sovereign debt with much lower interest rates than they would otherwise be able to. That brings down the cost of debt nicely. But if you then chuck in a little inflation you can make the real value of the debt come down too. Keep that up for a couple of decades and you can repress your way out of trouble.

Financial Repression

This, of course, is exactly how many countries dealt with their horrible post-war debts: let’s not forget that the UK was subject to capital controls until 1979. However, even a few years back, there was a general view that in our new deregulated world, it wouldn’t be possible for governments to use these time-tested methods to get themselves out of trouble. Turns out that it is entirely possible. As Edward Chancellor pointed out in the Financial Times, even in a time of apparently free capital movement, financial repression is entirely possible if everyone does it at the same time.

And doing it they are. “Negative real interest rates are to be found not only in the US but also in China, Europe, Canada and the UK,” where headline price inflation is running at 3.4%, “far above both short and long-term interest rates… Western governments have learnt the lessons of history”, so they are all maintaining interest rates at levels well below inflation. At the same time, inflation is pushing up nominal GDP, and will in time “reduce the real value of outstanding debts, both public and private”.

But the authorities aren’t leaving it there. Far from it; they are going for more explicit repression as well. At the same time, everyone is pushing for their banks to hold more debt for “macro prudential reasons.”

And even when regulation isn’t actually put in place, political pressure is. An article in the Wall Street Journal late last year noted that “senior bank executives” from Italy and Portugal said they were being cajoled into buying government debt. Last year, the idea started circulating in Ireland that pension funds should be forced to sell foreign assets and buy Irish government debt. It makes no sense, said one commentator, that pension funds should hold bunds yielding 2-3% when they could hold Irish debt on 6-10%.

Hmmm. This year, Irish prime minister Enda Kenny is about to make it “easier” for pension fund managers to shift from bunds to Irish debt – by transferring the risk of holding it from the pension fund to the pensioner. Hungary has gone the whole hog and annexed pension funds. In 2010, for example, in an effective nationalisation of their private pension fund system, Hungarians were told to hand their private pension fund assets to the state or lose their state pension.

And capital controls? The idea sounds extreme to modern consumers, but they are certainly back under discussion (see Gillian Tett on them), and you could even argue that, in some ways, they are already with us.

The Long Reach of Uncle Sam

Those who work in the investment business will know of a new US regulation known as ‘Fatca‘ (Foreign Account Tax Compliance Act). Fatca is an extraordinarily wide-ranging, arrogant and intrusive piece of legislation (enacted in 2010) that requires all “foreign financial institutions” – that’s non-US banks, fund managers, custodians and so on, to tell the US taxman about all US taxpayers they deal with both directly and indirectly by the middle of next year.

This is quite clearly an admin nightmare (what is an ‘indirect client’?) so you might think that most non-US institutions would simply ignore it. After all, what jurisdiction does the US have over them? You’d think wrong. No one can ignore it: if they do, the Internal Revenue Service (IRS) will charge them a 30% withholding tax on all dividends, interest and sales proceeds made in the US.

The tax will begin to be deducted at the beginning of 2014. There will be no refunds. Failure to comply will also be a criminal offence under US law. How is this repression? It makes it harder for US citizens to invest abroad – already institutions, wary of the fact that they aren’t or can’t be compliant, are turning down US business until they see how the whole thing shakes down (how can you find out all you need to about all your clients and ‘sort of clients’ without running into confidentiality problems, for starters?).

The whole thing very dramatically changes the investing and tax landscape for Americans with money abroad. Worse, the crazy US rules won’t be the end of it. No, read this piece by William Hutchings in Financial News, and you will see that Fatca is about to go global.

Watch Your Back

“In the last three years, the Federal Reserve, Bank of England, European Central Bank and Bank of Japan have taken on an extra $10 trillion of debt, according to risk management consultancy CheckRisk, taking their collective balance sheet to $15 trillion.

“They are looking at every possible way to help pay it off. Ramping up their powers of tax collection is one of the few things they can do to help themselves. It is not such a big jump from there to the introduction of a global Fatca, an international framework obliging foreign financial institutions everywhere to act as tax collector for every government.”

John Redwood pointed out in his blog this week that the UK state is currently spending around 48% of GDP a year. Yet the maximum ever tax take is 38%. The gap has to be made up by someone – just as it does in every other Western country.

Financial repression creates that someone – by making a population hold debt that loses them money in real terms be it via their pension funds or banks, by cutting the return they get on their deposits, by upping their taxes and by letting inflation chip away at their assets. That someone is you.

Merryn Somerset Webb
Editor-in-Chief, MoneyWeek (UK)

Publisher’s Note: This article last appeared at Money Morning Australia.

“Lose a Shirt, But Gain a Wardrobe”

As Silvio Berlusconi leaves office, brought down in the end not by his own petard but by his government’s penchant for spending money they don’t have, guest writer Kris Sayce from Money Morning Australia gives some perspective to the “infinite stupidity” on display as European politicians and banksters embark on what is “ultimately a sure road to complete economic destruction”: the monetisation of exploding government debt.

* * * *

“U.S. stocks slumped, driving the Standard & Poor’s 500 Index to its biggest
decline since August, amid concern that European leaders may be
unable to keep the euro zone intact as Italian yields surged to a record…”
                                – Bloomberg News

Europe’s problems shouldn’t be a surprise.

The big news now is the Italian 10-year bonds. Yields last week reached the highest level since the creation of the euro currency in 1999. The cost for Italy to issue debt hit 7.25% [the level that prompted Greece, Ireland and Portugal to seek bailouts], before falling back overnight to 6.29%.  They won’t stay there.

The chart below shows the six-month progress of the Italian 10-year bond. The red square is where the yield stood after last week’s move:

Click here to enlarge
Source: Bloomberg

But don’t panic. European leaders are still trying to come up with a plan… oh, hang on, maybe you should panic.

Let’s show you why…

Italy to Follow Greece?

So you can see why Italy’s yield action could be just the beginning of its problems. Take a look at the chart below of Greek government 10-year bonds:

Click here to enlarge
Source: Bloomberg

Those bond yields hit 7% in April 2010.

A few weeks later, after bond yields had soared above 10%, the market cheered. The Independent newspaper reported:

“Global markets surged in relief yesterday at the €720bn (£616bn) Eurozone stabilisation package put together to allay fears of contagion from the Greek sovereign debt crisis…
“Greek 10-year bond yields fell by 499 basis points [4.99 percentage points] and two-year yields fell by a record 1,327 basis points [13.27 percentage points] as panic about the restructuring deal receded.”

The joy didn’t last long. Nineteen months later and the Greek 10-year bond yield hit 30%… and two-year bond yields are now 107%! So much for the “Eurozone stabilisation package”.

Which brings us back to yesterday’s post at Money Morning Australia:

“The markets love the latest non-event from Italy. But the excitement will soon wear off and the market will fall. Then we’ll get another non-event… which the market will love… until that wears off too.”

We’ll repeat: the market is so volatile you can’t just pin your flag to the bullish or bearish side of the market…

You’ve got to play both sides.

Let’s get something straight. Of course Italy will need a bailout…

The only thing that’s not certain is how they’ll do it…

Stabbing Investors in the Back – Again!

Will it be a Greek-style default? Or will it be U.S.-style money printing? It’s the difference between being honest (default) or deceitful (money printing)…

Put another way, will they stab investors in the chest or in the back?

Neither is pleasant. But at least you’ve got a better chance of defending yourself if you know what’s coming.

It’s also important to remember the real criminals in this – governments, central banks, bankers and progressives – will look for a scapegoat to shift the blame.

Rather than admit the European debt problem is due to failed economic, financial and political systems, they’ll pin the blame on so-called bond vigilantes.

This is a term for investors who look to profit from falling bond prices. They’ll claim nations are being punished by bond traders who unfairly push bond yields too high by selling or short selling bonds.

(When bond prices go up, bond yields go down and vice versa.)

In reality, bond traders are just taking a position in the market. And don’t forget, for every seller, there’s a buyer.

What’s more, short-sellers provide a useful service to the market. They warn other investors of potential problems. Using Greece as an example again, in early 2010 commentators and investors pinned Greece’s debt problem on bond vigilantes.

At the time, Greek finance minister, George Papaconstantinou told a press conference:

“A number of people have been betting in certain ways [on a Greek default and debt restructuring]. All I can say is they will lose their shirts. I want to categorically restate that any notion of restructuring is off the table for the Greek government.”

He was right. Some short-term traders probably did lose their shirts.Business Insider noted at the time, “Greece’s ten year bond yield has collapsed a remarkable 47% to 6.6% from 12.4% (as bonds surged) just before Europe’s new bailout fund was announced…”

But the traders who kept short-selling Greek debt gained a whole new wardrobe. As the chart before shows it didn’t take long for yields to climb. And short sellers could have pocketed a 354% plus gain as Greek bond prices collapsed.

More Trouble Ahead

Could the same happen to Italy?

It’s possible. The consensus is Italy’s debt is too big to be bailed out… and it’s probably too big for a Greek-style restructuring.

That tells us you’re more likely to see something underhanded (a stab in the back for investors). But, as always, we’re not saying Italian bond yields will keep climbing in a straight line from here.

As with Greece, we’re sure European leaders will give investors plenty of false hope. Just make sure you don’t fall for the spin.

Because, if you only buy stocks because you think they look cheap, you’re taking a much bigger risk than investors who supplement their buying by selling and short selling stocks.

The market rallied recently because investors foolishly thought European politicians and bureaucrats could solve the problem. As we’ve said all along, the very involvement of politicians and bureaucrats is a sure sign the problem won’t be solved…

In fact, it’s only likely to get worse.

Cheers.
Kris.

PS: Just for clarification, the interest rate or yield on a bond tends to go up as the price of the bond goes down. Which means as demand for a bond collapses, the interest rate paid by the bond issuer goes through the roof. And when the bond issuer is sitting in a sea of IOUs, that can get very unsustainable very, very quickly.

GUEST POST: The Naked Central Banker

Guest post by Murray Dawes from Money Morning Australia

Well it looks like Bernanke has finally given up.

Operation ‘Twist in the Wind’ couldn’t jump-start a Honda Civic.

Delivering lower long-term interest rates won’t inspire crippled banks to lend or indebted consumers to borrow. The unintended consequences of this new plan are the Fed will increase its risk at the long end of the yield curve while bond prices are at the highest in a generation.

So who’s going to bail out the Fed if bond prices crash?

Oh that’s right, they’ll just print their way out of trouble.

What will printing do? Ultimately it will feed into higher inflation which should make long-term interest rates go up, not down.

But it’s not just what the Fed has said it will do. You can read a huge amount into what the Fed didn’t do.

There are internal splits within the Fed on the issue of money printing.

The market was hoping for some more candy from the Fed but got none. That is big news. The Fed is basically saying it won’t bail out the market right here. That’s bad news for the share market.

The only reason shares have been holding up lately is because of the fear or hope that the Fed might print more money to keep markets afloat.

Without that crutch, the market is faced with an economy that has stalled and a European Union that is cracking wide open. Based on that, why would you buy the stock market?

For all of the talk about how cheap the market is, you have to remember that the cheapness is derived from bottom-up forecasts [Ed note: analysts who look at individual stocks are called bottom-up analysts, analysts who look at the broader economy and then select stocks are called top-down analysts]. And they are looking decidedly optimistic based on where most economic indicators are currently pointing.

And as those forecasts ratchet down the market won’t look so cheap.

On a technical note, we have rarely seen so many charts resting on the precipice as they are now.

There is very little support beneath current levels. And Bernanke revealing himself as the king with no clothes should be enough of a catalyst to cause a stampede out of stocks.

In the latest YouTube free market update we said Bernanke needed to surprise the market to engineer a rally. He didn’t. He moved the deckchairs on the Titanic and shrugged his shoulders!

Look at this chart of the ASX 200:

ASX 200 daily chart

[Click here to enlarge]

You can see that over two years’ worth of buying is now out of the money.

I assure you most of these buyers have not hit the sell button yet. If we get another bad night tonight in the US then you could feel very confident that the S&P/ASX 200 will revisit the August low of 3765… and perhaps fall lower. [Update: there was a bad night. And the ASX went as low as 3880 and is now at 3906.]

The key level to watch in the US is 1155 on the S+P 500. This is the ‘Point of Control’ of the most recent distribution (we explain this in the latest free market update, click here to watch now).

If the market busts under there, then it’s odds on the S+P 500 will move down to 1100 points [Update: as of writing it is at 1129 and falling] . And if the market falls below that level, what then?

Below there it gets really scary.

Murray Dawes
Slipstream Trader

Related Articles at Money Morning Australia:

• The Other Side of Short Selling
• Manipulation on a Grand Scale
• The Madness of Mad Men
• Three Steps to Wealth: Leverage, Volatility and Risk
• The Wonderful Wizard of Washington

Watch What the Rich Do, Not What They Say

Guest post by Kris Sayce of Money Morning Australia

“Back in the 1980s and 1990s, tax rates for the rich were far higher, and
my percentage rate was in the middle of the pack. According to a theory
I sometimes hear, I should have thrown a fit and refused to invest
because of the elevated tax rates on capital gains and dividends.”
– Warren Buffett, op-ed, New York Times

Mr. Buffett says the U.S. Congress should raise taxes on the rich.

He says he’s so rich he should pay more tax.

Then why doesn’t he?

According to the U.S. Treasury, during the 2010 financial year $2.8 million was donated as “Gifts to reduce debt held by the public.”

That’s right. Americans who choose to can make voluntary contributions to the U.S. Treasury to cut the national debt.

Trouble is the U.S. has a national debt over USD$14 trillion.

That meant, in 2010 the U.S. Treasury’s interest expense was a whopping USD$413.9 billion.

Put another way, the $2.8 million donated reduced the national debt for…3.5 minutes… before interest costs wiped it out!

This financial year the donation wipe-out will take even less time. The interest expense is already at USD$412.5 billion… and will likely increase by another USD$50 billion over the next two months of the fiscal year.

It’s no wonder so little is raised through donations.

Buy an investment or pay more tax?

Certainly Mr. Buffett and his rich pals see little point. With all their wealth, they’d surely donate more than USD$2.8 million.

After all, Mr. Buffett could double the amount donated to the U.S. Treasury each year by handing over just 0.007% of his personal wealth.

Or, if he’d prefer, he could get his listed firm, Berkshire Hathaway [NYSE: BRK-A] to make the donation. It’s not as though his firm is short of a few bob. According to Bloomberg News, Berkshire Hathaway has “$47.9 billion of cash”.

Or, he could have donated to the Treasury rather than buying 1.5 million shares of U.S. listed firm, Dollar General [NYSE: DG]. A stake that would have cost his firm over USD$40 million – 14-times the sum donated each year to the U.S. Treasury.

What point are we making?

First, it gives you another example of how stuffed the U.S. economy is. And why you should be wary about getting suckered into this one-week suckers’ rally.

For all the talk overnight about markets rallying on the back of takeover activity, the U.S. economy is just as stuffed today as it was two weeks ago.

But second, it highlights how you should pay more attention to what big investors do rather than what they say.

If Buffett’s real concern was paying more money to the federal government then he’d just do it. Making a gift to the U.S. Treasury to pay down the debt is simple: write a cheque and send it off to Parkersburg, West Virginia. (Amusingly, the Treasury also accepts credit card donations!)

But helping out the federal government isn’t his real concern. Bloomberg News gives away what’s really on Mr. Buffett’s mind:

“Berkshire’s equity portfolio was valued at $67.6 billion as of June 30, with 40 percent in consumer products firms and 37 percent in financial firms such as banks and insurers. The rest of the portfolio was in a group Berkshire labels ‘commercial, industrial and other.’”

In other words, you’re looking at a portfolio of economically sensitive stocks. Stocks that rely on an economy not going into recession.

Why higher taxes won’t help

But here’s the biggest flaw in Mr. Buffett’s plan. In his op-ed for the New York Times (where else, it’s like expecting the Age to print an op-ed calling for tax and spending cuts) he makes the point that the income of “the highest 400 [wealthiest people] had soared to $90.9 billion.”

Of this – he calculates – USD$19.5 billion was paid in taxes.

But here’s the thing, Mr. Buffett doesn’t reveal how much more taxes these people should pay. Think about it, an increase in taxes to USD$30 billion would mean an extra $10.5 billion and cover just 2.3% of the interest cost of outstanding U.S. debt…

Or wipe just 0.00007% off the federal debt.

Perhaps he thinks his rich pals should be taxed at 100% of their income? But even so, it would cover just 20% of the interest expense or wipe a measly 0.0006% off the federal debt.

Now, we can’t speak for the rich, but we’re pretty sure a tax burden of 100% would cause them – in Mr. Buffett’s words – to throw a fit and refuse to invest.

If you’re taxed 100% of your salary this year, what are the odds on you bothering to earn anything next year?

The simple reason more people don’t donate money to governments is because they know it’s not an effective use of capital. Mr. Buffett and his rich pals know for a fact if they invest money rather than donate it to government, everyone’s a winner.

The rich guys hopefully get a return on their money… the people the rich guys bought the investment from make money… the people that work for the firm they bought get to keep their jobs and perhaps more people will be given jobs… and consumers who use the goods or services produced by the company continue to get the goods or services they want.

Contrast that to government services which are things people either don’t want, or want but don’t want to pay for.

The fact is – and Mr. Buffett of all people should know this – government is a handbrake on any economy. It’s not the throttle.

Creating innovation from destruction

Economies are built on innovation and individual entrepreneurial spirit. An economy isn’t built on a democratically elected dictator swiping wealth from individuals to use as bargaining chips to secure election or re-election.

If Mr. Buffett was concerned about the future of the American economy he should call for a wind-back of the state. And with it, lowering the tax burden on entrepreneurs and successful businesspeople. That’s a simple way to increase wealth for everyone.

Instead, like all people in powerful positions and influence the goal isn’t to spread the wealth – it’s to keep theirs and make sure others spread their wealth.

Because winding back the tax burden and cutting regulations is the last thing an existing businessman or woman wants. Companies that are brand leaders and market dominators (the kind of firm Mr. Buffett invests in) also happen to be the direct enemy of the entrepreneur.

Entrepreneurialism and creative destruction are the true drivers of economic progress. But they can only drive progress if given the chance. Wealthy people calling for higher taxation on other wealthy people won’t do a darn thing to help.

All that will happen is the Feds will keep spending while the wealthy find new ways of avoiding a higher tax bill… and that means a bigger burden on the middle classes, more debt, bigger government and less innovation.

But don’t expect anyone in a position of influence to figure this out anytime soon.

Cheers.

Kris Sayce
Money Morning Australia