A Good Looking Economy is Not Always a Good Economy

By: Gerard_Jackson

It is said that many look enviously upon the Australian economy's success in not only weathering the global financial crisis but to continue to prosper. Of course, there is no gainsaying the role that the resources sector played in providing the country with a vital economic buffer. But is everything as rosy as many seem to think, including some of our Treasury boffins?

The Reserve Bank of Australia reports that miners are preparing for the country's biggest investment boom. What is puzzling some commentators is the apparent absence of overheating and accelerating inflation. It was only yesterday -- so to speak -- that we were being told that income from the booming resource sector would soon begin to push up prices as it made its way through the economy, forcing the RBA to once again raise rates. So what happened? These people forgot that Australia has a floating currency.

One argument in favour of a float is that it helps to protect the economy from the monetary excesses of its trading partners. This means that no matter how much our trading partners expand their money stocks they cannot influence the supply of Australian dollars. If they want to buy Australian resources they must first acquire Australian dollars. Given this fact one can only wonder how these economic commentators were able to conclude that the mining sector's revenues would eventually raise the money incomes of the rest of the country. Dollar incomes could only continue to rise if the money supply was expanding. The following chart shows that from January 2009 to May 2010 the money supply was somewhat stable. But from May to January 2011 bank deposits rose by 22.8 per cent and M1 by 10 per cent, the latter averages 13.3 per cent per annum. This is a worrying trend.

It is argued that by allowing the Australian dollar to rise instead of inflating the money supply it is acting as "an inflationary relief valve that takes pressure off the Reserve Bank to lift interest rates". Now this is contradictory. If the money supply is not growing then the fall in the price of foreign currency cannot be described as anti-inflationary simply because it makes imports cheaper. What happened is that since the early 2000s the demand for our resources lifted the trade-weighted value of the dollar by about 70 per cent. (It rose by 13 per cent last year.) The result is that mining boom is inadvertently squeezing other industries.

In the 1920s Eli F. Heckscher explained that if the foreign demand for a country's goods rises then that country basically has two choices: let the exchange rate fall or keep it at its previous level by expanding the money supply. This is important because he was was refuting Gustav Cassel's theory that the quotient between the price levels of the two countries would always provide the equilibrium point for their exchange rates. Therefore a country's exchange rate was determined solely by its purchasing power parity.

But Heckscher's response showed that this was clearly not the case. Which means that a country can have an overvalued currency even on a floating exchange rate, a point I have argued in the past and one that Professor Davidson, a fellow at the Institute of Public Affairs, denied even though he later admitted that an exchange rate can deviate from its purchasing power parity. Moreover, a currency can remain overvalued or even rise further in the face of a domestic monetary expansion. As we have already seen, the Australian dollar rose by 13 per cent last year despite the fact that M1 grew significantly.

The reason for this apparent paradox, in the absence of political considerations, is that so long as the rest of the world is prepared to buy dollars at the current price and at the rate we are creating them the currency will remain overvalued. This situation could have devastating consequences for manufacturing. Now it could be argued that the value of the Australian dollar would be even higher if it were not for the current monetary growth. Be that as it may, the fact remains that an overvalued dollar sucks in imports at the expense of domestic production. (Think of it as a reverse tariff.) In these circumstances a monetary policy that raises nominal incomes will continue to suck in more imports. However, I am perfectly prepared to concede that in the absence of a monetary expansion the flow of imports could still be the same.*

Once one accepts that floating currencies can be overvalued then the argument that any reduction in manufacturing output brought about by cheaper imports is always a case of comparative advantage falls to the ground. This brings us to the the "hollowing out problem" which was bound to give rise to protectionist feelings, which is now the case. The Australian Workers Union has launched an anti-dumping campaign, claiming that firms need to be protected against the predatory pricing tactics of foreign firms.

Sinclair Davidson dismisses such concerns by asserting that firms just need to introduce "innovative business practices or products". His blasé attitude, which the Institute for Public Affairs shares, just will not do. Australia is supposed to be undergoing a boom. If this were really the case then manufacturing would also be booming. The following chart shows otherwise. A genuine boom should see the PMI, employment and production at around the 70 mark instead we have witnessed a sharp decline in these factors. Which way one looks at it manufacturing is sick. It ought to be clear by now, even to the Institute for Public Affairs, that the long the dollar remains overvalued, courtesy of the resources boom, the greater will be the decline in manufacturing.

Not only do we need to consider the economics of an overvalued dollar we must also take into account the political and social consequences of ignoring the situation. Senator Christine Milne is a green fanatic and a protectionist who understands how the situation an be exploited for political gain. She argues that the resource sector had hollowed out manufacturing and driven jobs overseas. Because our free marketeers refuse to even consider that the problem is fundamentally a monetary one they find themselves devoid of an effective response. What we generally get are noises about being a service economy and that the growth in jobs proves we don't need a significant manufacturing sector.

Let's look at the job market. III The Australian III reported that 330,000 jobs were created in the past year and that the participation rate had risen to 66 per cent of working-age Australians, the highest since 1978. We know that the mass of these jobs were not created in manufacturing or mining: that leaves only "services", confirming the opinion of many commentators that services are what really counts. Jagdish Bhagwati, Professor of economics at Columbia University, is of this turn of mind. In an article published in the Australian Financial Review ( The Manufacturing Fallacy, 31 August 2010) he basically argued that services could compensate for the disappearance of a large manufacturing sector. I think John Stuart Mill would disagree. He presented the standard classical view when he wrote:

I apprehend, that if by demand for labor be meant the demand by which wages are raised, or the number of laborers in employment increased, demand for commodities does not constitute demand for labor. I conceive that a person who buys commodities and consumes them himself, does no good to the laboring classes; and that it is only by what he abstains from consuming, and expends in direct payments to laborers in exchange for labor, that he benefits the laboring classes, or adds anything to the amount of their employment. (John Stuart Mill, Principles of Political Economy, University of Toronto Press, 1965 p. 80)

In today's jargon we would say -- or should -- that what raises the standard of living is investment in those stages of production that raise the marginal value of labour's product as against spending on consumption. The Austrian school of economics takes it further by explaining that a country's capital structure consists of highly complex and integrated stages of production with each stage made up of capital goods embodying technology. In a growing economy the structure lengthens and the stages become more complex. It is this process that raises the standard of living.

Should the structure shorten then real wages must eventually fall. It follows that if a currency remains overvalued for a sufficiently length of time it can shorten the capital structure making the economy excessively oriented towards services and consumption. The situation will resemble one in which the process of capital consumption has taken hold (See F. A. Hayek, Money, Capital and Fluctuations: Early Essays, Routledge & Kegan Paul, 1984, pp. 145-46).

This is a vitally important issue and it is about time that it was honestly and openly debated.

*This means that if there was no monetary expansion the flow imports would remain unchanged even though monetary incomes remained the same because the further rise in the dollar would lower the price of imports to the point where the rise in real incomes would equal the rise in money incomes that a loose monetary policy would have created. In other words, under either condition real incomes remain the same leaving the level of imports unchanged.

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Japan's Nuclear Disaster Is Going To Lead To A Surge In Demand For Gas

by Gregory White

Japan's nuclear disaster indicates that the country, in the immediate term, will be turning to other sources of energy to fill the gap.

New demand for fossil fuels is going to lead to higher gas prices as Japan compensates for its loss in nuclear output, according to Didier Laurens of Societe Generale:

The Japanese nuclear crisis could lead to a prolonged closure of major nuclear plant reactors affected by the earthquake and the tsunami. In a report issued this morning, SG Commodities Research estimate a loss of 52TWh from nuclear output (out of 278TWh in 2010) in 2011 which will have to be compensated by thermal plants, mainly gas (47%) and coal (39%) power, increasing the gas demand by 5bcm in 2011e. Therefore, our colleagues have revised up their gas price forecast for Europe by c.10% from Q2 11 and beyond.

And while oil prices may go down in the short term, after April the market should turn more bullish, according to SocGen analysts.

Putting in perspective Japan's reliance on nuclear, here's a chart showing what's at stake.

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What Japan's earthquake means for agricultural commodities

by Agrimoney.com

Japan's disaster may have a significant impact on grain prices. But not in a way that is not immediately apparent.

Sure, it is likely that the disaster will, for a while, continue to add to the negative pressure already weighing on agricultural commodities.

The country is, after all, one of the world's biggest (and perhaps the biggest) food importers, relying on bought-in products for 60% by calories of what its citizens eat, according to the US Department of Agriculture.

So any sign of a fall-off in its demand following the devastating earthquake and tsunami would be felt in easing up tight crop supply pipelines.

And external markets may not offer much support, given that investors were already in the mood for dumping riskier assets, such as shares and metals as well as crops.

Yen factor

For now, the potentially stimulating impact on Japanese food imports of the disaster are unlikey to get a look in.

The idea that Japan the need to import more food – albeit maybe of, say, finished products such as pork rather than feed corn - if much the country's own agricultural capabilities have been put out of action.

And of it having the stronger currency to make buy-ins more affordable. Ironically, one of the expected impacts of the disaster is to strengthen the yen, as insurers repatriate funds to pay claims, and the country sells foreign currency reserves, largely in US Treasury bonds, to raise cash.

After the Kobe earthquake in 2005, the yen appreciated by some 20% against the dollar within three months.

Food vs fuel 

But a longer-term impact may become harder to ignore – in reviving the case for agricultural commodities as a source of energy as well as food.

Soaring food prices appeared, early in the year, to have the biofuels lobby on the ropes, with energy crops seen as taking farmland from its "true" purpose of feeding the world.

However, the nuclear reactor problems caused by Japan's earthquake have redrawn question marks over one key form of conventional energy creation at a time when the shortcomings of another, oil, were already being examined following the unrest in the Middle East and North Africa.

Fuel security is back on the agenda. And while other conventionals such as coal and natural gas will do their bit to fill the gap, as will alternative sources such as wind and tidal power, farmers will likely be asked to carry a bigger burden -  even at a price in world food security.

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THE BLOWOFF PHASE OF A BUBBLE TENDS TO BE STEEP….

by Cullen Roche

There are, in my opinion, few things that threaten the sustainability of economic growth more than market disequilibrium. As I’ve discussed in recent months it is not mere coincidence that the Fed’s increasing involvement in the economy has coincided with the increase in market bubbles in recent decades.  The Fed has helped exacerbate the financialization of the US economy and this has helped directly contribute to our current predicament.  The result has been an appearance of stability inside an increasingly unstable system that is characterized by high valuations, more frequent recessions, deeper recessions and a growing discrepancy in the quality of life across the country.

This evolution has been fairly simple in my opinion.   The highly flawed economic theory of the 60′s & 70′s led policymakers to believe that markets were self regulating systems that could be largely controlled so long as the money supply was managed adequately.  These flawed theories resulted in mass de-regulation, placed a specific emphasis on monetary policy and gave the Fed an increasingly important role in markets.  Because the Fed can only intervene in markets via the banking system it was only natural that the Fed’s increased role in markets resulted in an increasingly important role by the banks themselves.  This resulted in what is now an obvious financialization of the US economy.  The effect of this financialization has become apparent in recent years as the banking system nearly brought the entire system to its knees in 2008.  But this financialization is far from over.  Since no reforms were implemented following the recent crisis (and the Fed and banks grew MORE powerful) it’s not incorrect to assume that this cycle of booms, busts and bubbles is not over. And we’re already seeing signs that the problems are only growing again.

As I’ve discussed in recent months the latest victim of the Fed’s intervention appears to be the commodity markets.  And I’m not the only one who has noticed this disequilibrium.  In his latest missive John Hussman discusses the recent rise of the bubbly commodity market:

“On that note, it’s clear to me that we’re seeing classic bubbles in a variety of commodities. It is very unlikely that this is due to global demand growth. Even with an exhaustible resource, it is a well-known economic result (Hotelling’s rule) that the optimal extraction rule is one where the price rises at a rate not much different from the interest rate. What we’ve seen lately is commodity hoarding, predictably resulting from negative real interest rates provoked by the Fed’s policy of quantitative easing.”

“Fortunately for the world’s poor, the speculative dynamic that has created a massive surge in commodity prices appears very close to running its course, as we see very similar “microdynamics” in agricultural commodities as we saw with oil in 2008. That’s not to say that we have a good idea of precisely how high prices will move over the short term. The blowoff phase of a bubble tends to be steep, but so short-lived that it affords little opportunity to exit. As prices advance in an uncorrected parabola, the one-sided nature of the speculation typically gives way to a frantic effort of speculators to exit simultaneously. Crashes are always a reflection of illiquidity in two-sided trading – the inability of sellers to find eager buyers at nearby prices.”

There’s no telling when a bubble ends and it’s impossible to quantify its impact.  Oliver Wyman Group thinks this commodity bubble could be far from its climax, but they are clear about its impact:

“Western central banks pumping cheap money into the financial system was seen by many as having the dual purposes of kick-starting Western economies and pressing China to appreciate its currency. Strict capital controls initially enabled the Chinese authorities to resist pressure on their currency. Yet the dramatic rises in commodities prices resulting from loose Western monetary policies eventually caused rampant inflation in China. China was forced to raise interest rates and appreciate its currency to bring inflation under control. The Western central banks had been granted their wish of an appreciating Chinese currency but with the unwanted side effect of a slowing Chinese economy and the reduction in global demand that came with it.Once the Chinese economy began to slow, investors quickly realized that the demand for commodities was unsustainable. Combined with the massive oversupply that had built up during the boom, this led to a collapse of commodities prices. Having borrowed to finance expensive development projects, the commodities-rich countries in Latin America and Africa and some of the world’s leading mining companies were suddenly the focus of a new debt crisis. In the same way that the sub-prime crisis led to a plethora of half-completed real estate development projects in the US, Ireland and Spain, the commodities crisis of 2013 left many expensive commodity exploration projects unfinished.

Western banks and insurers did not escape the consequences of the commodities crisis. Some, such as the Spanish banks, had built up direct exposure by financing Latin American development projects. Others, such as US insurers, had amassed indirect exposures through investments in infrastructure funds and bank debt. Inflation pressure in the US and UK during the commodities boom had forced the Bank of England and Fed to push through a series of interest rate hikes that forced many Western debtors that had been holding on since the subprime crisis, to finally to default on their debts. With growth in both developed and emerging markets suppressed, the world once again fell into recession.”

I am not so certain that the end of this bubble is far off.   As I said above, booms and busts appear to be becoming more frequent. In “The Bernanke Put and the Fed’s Trilemma” I discussed how the current environment is not dissimilar to a very obese man who suffers a series of heart attacks, but because he never resolves his inherent problems, his health problems only continue to deteriorate:

“What I fear most about the current cycle is that we have not allowed the markets to sufficiently clear.  If that is the case you can think of the global economy like an obese man who fights to lose weight in an effort to fend off what is an almost certain heart attack.  After a multi decade binge he suffers a massive heart attack (think LTCM circa 1998).  The doctors save him by intervening, but they don’t actually help the man fix his inherent problems (dying internal organs and lack of discipline).  In the case of the economy this is global imbalances, structural flaws in the banking system and a lack of regulation.  The man vows to lose 50% of his total body weight, but after losing 20% of his total body weight he decides the process is too grueling and is taking too long.  A fast food restaurant opens up next door (hello government bailouts!).  He once again feels the need to stimulate his lust for food.  So, he binges again (think Greenspan 2001).  A new boom occurs before he ever becomes fully healthy.  Over the ensuing 7 years his body weight doubles.  He’s now 60% heavier than he was in 1998!  Of course, this is unsustainable.  His body begins to breakdown.  Before you know it he is suffering a total system failure (think Lehman brothers).  But again, thanks to modern medicine (or incessant Fed intervention) the man is once again saved.  Over the following year he loses 25% of his body weight.  It’s an arduous process and certainly not enjoyable, but it must be done.  The good news is he’s 25% lighter.  The bad news is he’s 20% heavier than he was in 1998 when he had his first setback.  Nothing has changed inherently.  He has the same failing internal organs and the same failing disciplines.   But his next binge begins from a weaker starting point and a more dangerous level. You can imagine how this story ends.”

We are indeed the obese man who simply refuses to accept that he has a very real problem that requires dramatic lifestyle changes.  It’s clear that policymakers have no interest in accepting the facts.  But as investors we can calculate the risks and attempt to sidestep the Fed’s landmines.  Forewarned is forearmed.  As Mr. Hussman says, “The blowoff phase of a bubble tends to be steep, but so short-lived that it affords little opportunity to exit.”   With the exception of gold (which will serve as a fear hedge), commodity prices look increasingly unstable….

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U.S. Economy on Steroids, Poverty Levels Equal to the 1930s

By: Bob_Chapman

Wall Street at least temporarily relieved of the burden of having to buy Treasuries & Agency bonds, is looking at the jump in oil prices as nothing more than an irritant to their plans for a higher market. Bill Dudley of the NY Fed, a most powerful member, continues to make a vigorous defense of Federal Reserve policies. He, and a few other Fed participants, and Chairman Bernanke believe liquidity is the key for solving problems. That is not only in the realm of debt purchases, but in the relief it brings to Wall Street and banking. It relieves them of the responsibility of having to make those purchases to assist the Fed.

Those funds can then be directed toward other investments, such as la liquidity-driven stock market rally. The correlation between the movements in the Fed balance sheet and market can be traced to 85% of market movement for the past 2-1/2 years. An interesting result of Fed manipulative policy is low level of short interest during this period. Most of the professional market players knew the market was headed higher, because they knew such overwhelming liquidity injections would have to take it higher. 

They also knew that the Fed had to keep the wealth affect going, because the market was the only generator of wealth left, as the bond market bubble would be broken eventually. The Fed has engineered a market recovery and Wall Street knew what they were up too. QE1 saved the financial community and QE2 saved the government debt structure at least temporarily. The wealth effect has been saved temporarily as well. The public has been left with a pile of crumbs as they struggle for survival. Unemployment has improved ever so slightly and now we have a new problem to increase the suffering and that is much higher oil prices.

The largess sponsored by the privately owned Federal Reserve has still not been enough to spur adequate growth and the effects of Fed monetary creation and deficit spending have not been enough to produce higher economic growth and now the economy has to deal with rampant inflation, the result of QE1 and QE2, plus stimulus, of what will turn out to be a subsidy of some $5 trillion, plus rocketing oil prices. It then is not surprising that we are seeing downward revisions of analysts in 3rd and 4th quarter growth estimates. We still are seeing declines in home prices and sales, as well as in orders and shipments. All this cannot help but negatively affect consumer spending. At the same time the states and municipalities are severely cutting back.

The inventory overhang, higher interest rates and lack of funds for down payments have again trapped the housing market. As we predicted long ago, before anyone else, that the downside in housing has at least two years to go, and perhaps four years, before a bottom is found. Then how long will it bump along the bottom? Perhaps eight years or 20 years, or more. Even new homes are facing lower appraisals.

There is lack of job creation and debt control. The Republicans want to cut $61 billion from the budget deficit, which is a pittance and an insult with a deficit of $1.6 trillion. They cannot be serious, but they are. This shows you how out of touch with reality most politicians are and that they only answer to those who are paying them off, not their constituents.

There has been no impetus on job creation at a time when real unemployment is 22.4%. It is like the American worker didn’t exist. The situation at the state and municipal levels isn’t helping at all either, as cutbacks and layoffs prevail. This while food and gas prices head toward the stratosphere. As we predicted earlier, 2011 is not going to be a good year for growth at 2% to 2-1/4% at best. The stock market is not expecting this, and when it becomes evident the market will fall.

It is interesting to note that personal income rose 1% month-on-month, but as tax relief is subtracted, you remember that pork package from December don’t you, and growth would have been 0.1%. Hardly a number to write home about. As a result January spending fell 0.1% and that should continue negative. Don’t forget all that credit card debt from November and December has to be paid off. As we predicted the fist quarter should show negative spending and consumption.

The personal question we are asked is when will the Fed find out it cannot continue to create money and credit? Whether most of you realize it or not present monetary policy has been in action for 11 years, so this is nothing new. That is how long inflation has been created over those years. It shows you that central banks have major leeway and a long time line to do their dastardly deeds. The problem for these bankers is that in the end they lose every time. Historically they have extracted themselves by buying everyone in sight. When the Lombard League collapsed in 1348 they were exiled and in 1789 in France their heads were removed.

What is interesting is that in each case and there were many, the bankers knew exactly what the outcome would be, but they proceeded in spite of that. Today, the Fed is trying to stabilize inflation at about 2%. Official figures are 1.5% when in reality the figures are between 7% and 9%. There is supposed to be a sustainable recovery in jobs. That has not happened as yet with only an official reduction of 1% in the U6. Needless to say, we question those statistics in as much as government has great difficulty telling the truth. 65% to 70% of jobs are created by small and medium sized businesses and loans to these businesses have been reduced by almost 30%, hindering the ability for these companies to expand and create employment. The situation hasn’t changed. 

For the most part only AAA companies have easy access to credit and percentage-wise they have cut employment most. Consumer growth has been limited by bankruptcies and unavailability of credit. 17 million jobs were created out of 26 million as a result of securitization of credit, a market that no longer exists. As a result over the past two years the economy has lost 2 million jobs. Those losses are complicated by the losses attributable to free trade, globalization, offshoring and outsourcing. Due to this trade policy the economy cannot increase output to any great degree, nor can it produce jobs. The birth/death ratio doesn’t fool any inquiring mind. It is simply bogus and the millions of jobs created under its statisticians are lies and worthless. As long as we have such a trade policy we will have to have quantitative easing indefinitely.

QE2, which we predicted in May of 2010, began in June not later unbeknownst to most professionals. The full amount of funds to be used was $900 billion not $600 billion and it remains to be seen just how much money has again been created out of thin air. The purchase of CDS and MGS, known as toxic waste was supposed to have ended, but we know some was purchased from China. We wonder just how much was purchased and where it is being hidden? The QE2 and stimulus funds will have all been spent by June, which means the second half of the year will see an economic slide, which few are expecting. That could be in part why we are finally seeing a market correction. As far as we know the Fed is holding about $1.3 trillion in Treasuries followed closely by China, which has about $1.17 trillion. Americans hold $3.3 trillion and foreigners $4.45 trillion. The inflation created by monetization of US government debt is now showing in price inflation, particularly in food. That has been aided by a flight to quality to gold and silver, but also to all commodities. 

That flight will continue. The market may be telling us as well that quantitative easing is going to end. If that happens the world economy will collapse. Those who want an end to QE cannot understand what they are asking for. Deflation will immediately take over sucking the entire world economy down with it. The withdrawal of liquidity will be devastating, but for sometime price inflation already in the system would prevail, but would be on a downward slope. The Fed is the director and what happens depends on what they do. The inflation caused by QE 1 and 2 and stimulus 1 and 2 cannot be contained by the Fed. It is already in the system and it will have to play itself out unless the Fed begins QE3 this fall accompanied by stimulus from Congress. Sound economic growth hasn’t existed for 11 years and it is worse now than ever. The Fed cannot hold up the economy indefinitely no matter how much liquidity they inject into the system. It is all only a holding action. We probably will get QE3 and there may be more, but in the end it is all for naught. This system has to self-destruct.

What the Fed has given Wall Street and banking, which owns the Fed, is an economy on steroids, which is not a cure but a continuing palliative. Debt and unfunded liabilities spread worldwide will end up dishonored. The Fed’s idea is to inflate the problems away, but that can only work in general terms. How do you really inflate debt away without default? Perhaps the market is beginning to realize no matter how much money and credit is injected into the system that is not going to ultimately work. The elitists are at a dead end and they are well aware of it because they deliberately created this monstrosity. Everything is in place for economic, financial, social and political failure not only in the US, but in many other countries as well. The result will negatively impact the world for sometime to come. Materialism is coming to an end. You have been warned.

In the US living standards for some 16% of the population is already at poverty levels equal to the 1930s. Can you imagine where it would be without food stamps and extended unemployment, etc. this is caused by the wages of debt, accompanied by the disparity and inequality between the rich and the poor. That 16% is a total of some 45 million Americans. 

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Worries Over Nuclear Meltdown Shakes Markets

Worries over a nuclear meltdown in Japan sent the benchmark Nikkei 225 Average down as much as 5% Sunday night.  There were a number of reports of explosions at the country’s nuclear facilities and the radius of evacuations was expanded.  In the worst national disaster since World War II, more than1,500 are confirmed dead with reports that the eventual number of deaths will top 10,000.

Gold prices and government bonds gained amid the liquidation pressure while S&P 500 stock futures slid 6.00 to 1,294.80.