30 Years to 2010

Trends that just couldn't persist somehow didn't...

JUST AS THE NEXT 10 YEARS get started, let's briefly review the last thirty, says Dan Denning in the Daily Reckoning Down Under.

Over the last three decades, Americans bought stuff they couldn't afford and the Chinese sold it to them at prices that weren't sustainable. That was the gentlemen's agreement between the world's fading and rising economic superpowers for the last, oh, 30 years or so. But now that the cosy relationship has broken down, what will happen in 2010?

We start the year by thinking about adjustments and indexes. Aussie stocks were down 32% in 2008. The first three months of 2009 were even worse. On Wall Street, the Dow found itself down 25% for the year by March 9th, nearly 54% off from its all-time high.

But then the great bogus recovery began.

Thanks to fiscal and monetary stimulus, Western policy makers did the Bear's work for him. They suckered people back into stocks by creating a bull market. It beat cash. In fact, it beat just about everything. Aussie stocks finished up 31% in 2009 but were up 55% from the March lows. The Dow, not including re-invested dividends, finished up 18.8% for the year and the S&P 500 up 23.5%.

You look at an annual reckoning like that and you'd say the stock markets of the Western world are just fine. They'd be telling you that the financial sector cleaned up its act from 2007 and 2008. They'd be telling you the underlying economies of the US, UK, Europe, and Japan were primed for growth, even if the shares were a bit pricey. And they'd be telling you not to worry about the sustainability of public debt levels.

Trouble is, we're not convinced at all that the monetary and fiscal measures taken by Ben Bernanke et al in the last two years have really improved things. It's the trendy thing to say the Feds figured it out and saved the day. But bell bottoms were trendy too, at one time, and think how ridiculous they look now.

In fact, fashion trends change. But sound money must obey certain principles. And there aren't too many governments running sound money policies in the world. That explains Gold Bullion's strength last year and its prospects this year.

The other trouble aspect of the Western world's economic situation is that households and businesses seem to have adjusted to a new world of less debt but governments have not. That, faced with declining net worth and falling asset values (homes and stocks) households did the prudent thing and reduced spending. You might even say they resigned themselves to a long period of rebuilding the household balance sheet and lowering expectations about stock market returns.

This adjustment-psychologically and financially-is exactly what the world economy needed. But it hasn't been fully made because the crooks in Washington, London, and Canberra are fighting it. They apparently did not get the memo that you don't build a great nation by going into more debt.

But if Australia is going to be blindsided by events in 2010, it will probably come from China. China is the other partner in the great rebalancing of global growth. And it is cooperating with maximum resistance. For example, China's currency ought to be stronger. But Chinese authorities have left it pegged to the US Dollar for the last two years in order to sustain China's export machine, which sustains jobs and employment.

In fact, data last week showed that China's purchasing manager index – a gauge of manufacturing activity – expanded for the tenth month in a row. Chinese officials are counting on 8% to 9% GDP growth this year. These are all bullish signs for Australia's resource industry, which feeds the Chinese industrial production machine.

But it looks to use like China's currency policy has fuelled its speculative bubbles in real estate and shares. For political reasons, Chinese leaders pour money into fixed asset investment. This sustains demand for Aussie resources like coking coal and iron ore. But what happens when China's bubble pops too?

That's the event we're watching for this year. Australia managed to dodge the worst effects of the GFC because Aussie banks didn't own a lot of subprime CDOs. The credit crunch raised the cost of capital. But it didn't wipe out Aussie banks.

Australia can't avoid an involuntary collapse in Chinese resource demand. There is no faking GDP growth with cash splashes when your major trading partner has an asset bubble pop. That is Australia's big risk this year, and the biggest risk investors must reckon with. We'll be on the case.

Not that this situation is necessarily knew. Our friend Ron Manners – a real hero of the libertarian movement in Australia – recently published his memoirs. And if you're at all interested in how libertarians have fared in Australia over the last 40 years, you have to read Ron's book.

Ron points out that the policy mistakes of the 1970s cost Australian jobs and led to unsound monetary policy. The economy recovered with a burst of deregulation and entrepreneurial spirit. But now we are back to the 1970s with bad policy and real economic damage. So where to from here?

Well, literally speaking, to lunch! But for the rest of this year, we guess investors should look at the big structural changes that are forced on a country that goes into debt. What happens to China is the biggest factor in Aussie share prices. But what's bad for shares might, just might, be good for housing.

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