Gold News

Banking Fungus, Inflation Virus

Contagion risk is everywhere rightnow...

THERE'S A fungus among us. But is itthe banks? Or is it a caterpillar fungus that boosts sex drive and issoaring in price as China imports Ben Bernanke’s inflation virus? asks Dan Denning in his Daily Reckoning Australia.

You didn’t have to know there wasmore trouble coming from Ireland. Just have a pint at any of the pubshere in St. Kilda and you’ll hear a veritable symphony of Irishaccents. Most of the girls are behind the bar serving drinks. Most ofthe boys are at the bar drinking drinks. All of them seem to behaving a pretty good time, even if they are a long way from home.

Meanwhile, back in Ireland, a Europeandrama is playing out. It’s putting pressure on the Euro and justlike back in may, that word “contagion” is being thrown aroundagain. The U.S. dollar is moving ahead while commodities cool off.

But what about the Irish? Thegovernment has a deficit equal to 32% of GDP which it’s rapidlytrying to bring down through spending cuts. And if interest rates onsovereign Irish debt weren’t rising (they are) the governmentdoesn’t appear to be in any kind of immediate funding crisis.

Down the track though, investors arelooking at the Irish banks and realising the Irish banks are stillstuffed with heaps of toxic assets. Irish banks have been borrowingfrom the European Central Bank in order to refinance theirobligations to other lenders. But ultimately, Ireland’s governmentis on the hook for bailing out the banks (again). And if Ireland’sgovernment doesn’t have the money to do it (it doesn’t) then thetask falls to the ECB.

Of course it’s possible the Irishgovernment finally stops the madness and says to its banks, getstuffed. Based on the number of punch ups we’ve seen at pubs in thelast year, we know the Irish aren’t afraid of a fight or a littlerebellion now and then. But the rest of Europe—especially Greece,Spain and Portugal—are keen for Ireland to agree to an ECB plan andhalt an investor run on the euro and on European sovereign debt.

Does any of this really matter toAustralia? Well, aside from expecting even more Irish to invade St.Kilda if the Irish banks fold, the weaker euro is leading to arelatively stronger dollar. That’s causing carry traders whoborrowed in cheap USD to take profits on their “risk” trades inhigher yielding assets like the Aussie dollar, which you can now buyfor ninety six US cents.

Ireland “matters” in the largersense that it’s also a test of popular tolerance for socialisingthe losses of the banks. No one knows what the consequence ofallowing major Irish (or any other) banks to fail. But we are told,mostly by the bankers, that it would be such a disaster for theeconomy that the government simply must assume those bad debts andthe central bank must print more money to recapitalise the banks.

The problem is really the same now asit was two years ago—way too much bad debt that cannot be cancelledout by issuing more debt. The “solution” offered by theauthorities doesn’t really seem like a solution. It just seems likea get out of jail free card for the bankers and endless more debt asfar as the eye can see.

There’s no doubt there’d be somereal havoc in financial markets and the economy with a real reckoningin the banking sector. But the situation we have right now is prettylousy too. Could allowing the banks to fail be much worse? At somepoint the debt is going to have to be liquidated or restructured.

Closer to home here in Australia is thenews that China is trying to choke down inflation by reducing loansto property developers. Bloomberg reports that China’s four biggestbanks--Industrial & Commercial Bank of China Ltd., ChinaConstruction Bank Corp, Bank of China Ltd. and Agricultural Bank ofChina Ltd.—have all met their lending targets this year and won’tbe making any more loans. China’s M2 measure of money supply rose19.3% over the last year, according to figures released last month.

That kind of lending boom leadsto 15-story hotels allegedly being built in six days. Italso leads to politically destabilising inflation in the goods peoplebuy every day. For instance prices in Shenzhen are now growing muchfaster than prices in Hong Kong, which is a reversal of thetraditional relationship. “Shoppers report that certain food andgrocery items can be to 40% cheaper in Hong Kong,” reports ColleenRyan in yesterday’s Australian Financial Review.

“It is not just fresh fruit andvegetables. Even items like Dove soap, which is manufactured in Anhuiprovince in China, is 25% cheaper in Hong Kong...The increase hasbeen more than 300% for a small group of herbs. Caterpillar fungus,said to slow down the ageing process and boost sex drive, has beenone of the top performers.”

The other obvious inflation China is inthe share market. It’s turned down in the last two days, droppingover 4% Tuesday, with metals producers and property developers hitthe hardest. Note also that the Aussie market (the All Ords in thegold line) has pretty much tracked the Shanghai Stock Exchange. TheAussie Dollar looks pretty elevated compared to both.

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Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

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