Cheerful thoughts on inflation, retirement, banks, and the destruction of private wealth...
THE SHORT VERSION of this little essay has a rather depressing point, sighs Dan Denning in The Daily Reckoning Australia.
Unless reversed by a personal wealth strategy that works, pensioners and retirees are getting poorer and poorer with each passing day. Probably less free as well. But definitely poorer.
It's not just that stocks are falling, although they did that yesterday in both Sydney and New York. It's that in the rush to the fill void of bankers who've currently gone on strike, more and more tax and pension money is being put at risk in markets. At this rate, if you're serious about your retirement plans, you'd better have a close look at what your government is doing to your money and your pension/retirement assets.
But let's go back to the beginning, with bankers going Galt. Going Galt, of course, refers to the strike of the wealth producers in Ayn Rand's book Atlas Shrugged. High taxation, wealth confiscation, and wealth redistribution drive a whole class of hero industrialists to take a runner on capitalism and retreat to a secret fictional valley in Colorado called Galt's Gulch, where they catch and grill trout and wait for the world to burn down.
The comparison breaks down now that we think about it. A small portion of today's bankers are not wealth producers. They are wealth stealers (or destroyers). But let's run with the idea that they are going on strike.
What do we mean by a bankers' strike? Take a look at what this idea means for Aussie mining companies, for instance. By bankers going on strike, we mean that local Aussie banks are not doing much to help local Aussie miners raise money to stay in business. While the government has set up the new "Bank of Kevin Rudd" to fund what the prime minister calls "viable" commercial property developments (which indirectly supports bank loan portfolios), it apparently thinks the best thing to do for the miners is let them go broke – as they typically would at this stage of the resource cycle – or sell them to China.
The Aussie government is clearly of two minds on this last option (or of no mind at all, perhaps). But why aren't the banks lending locally to support the miners, and what are they doing instead?
Well, they're probably terrified that commodity prices won't recover any time soon, rendering the collateral posted by mining companies worth a lot less. Or, worried about future losses in commercial property, the banks are saving up for a rainy day.
In fact, one place they are saving is at the Reserve Bank of Australia. That's where banks can park money in RBA's exchange settlement accounts. Late last year, the banks were parking billions of dollars there overnight. For three days in October, the total figure crested over $10 billion and on December 19th, it spiked to over $16 billion.
Using our crude Excel skills, we've built a chart of your showing the overnight balances in Exchange Settlement Accounts (ESAs) since the credit crisis broke in June of 2007, when two hedge funds owned by Bear Stearns went bust.
[NB: That should be "millions", not "billions"...]
The RBA pays an overnight interest rate on ESA balances that's 25 basis points below whatever the current cash rate is. It does this to encourage banks to lend money into the marketplace and not hoard it at the RBA.
Or in the Bank's own words, "The rate on ES balances is set 25 basis points below the cash rate target to encourage ES account holders to lend surplus funds into the market rather than leave them with the RBA."
But here we are over eighteen months into the great global deleveraging and Aussie mining firms can't seem to borrow money from Aussie banks. "Mining companies will be forced to consolidate and seek further support from Chinese and other Asian state-owned interests as local and foreign banks baulk at committing to A$36 billion in loans due from the sector in the next two years," report Jo Clarke and Katja Buhrer in today's Financial Review.
"The collapse in commodity prices has threatened the viability of new projects and slashed mining profits, pushing more producers down the path taken by Rio Tinto and Fortescue Metals Group, which have sought large capital injections from Chinese state-owned enterprises." And Lachlan Edwards, head of corporate financing at Goldman Sachs, adds that:
"The majority of mining companies in Australia are going to be dependent on fighting for limited bank availability."
If you grant that a large portion of the debt that comes down is Rio Tinto's US$18.9 billion to pay for the Alcan acquisition, you still have a lot of companies left on the outside looking in. They really have only four options:
- Tap private bond markets as BHP has in the last two weeks (although smaller firms won't be able to do this);
- Do a rights issue to raise money from existing shareholders (hello Rio);
- Sell assets at whatever price the market offers; or...
- Find a capital partner in China.
"But wait!" says Australian Small Cap Investigator guru Kris Sayce. "What about the A$50 billion Future Fund? Does it have a role to play in capitalising Australia's credit-starved small cap miners?
"We're not sure what's going to happen to the Future Fund, but its chairman David Murray has put himself about recently," Kris writes in today's Money Morning (his daily e-letter on Aussie share markets).
"We wonder if this is the first step in the transformation of the Future Fund.
"If you recall, the Fund was set up to cover the underfunded public defined benefit pension fund. The main sources of the funding were from government profits (i.e. It taxed more than it spent) and the transfer of the last batch of Telstra shares...So why the sudden increase in David Murray's profile? He's been pouring forth on the global economy, on the Australian banking system, and now according to The Age newspaper, credit ratings agencies.
"Our guess is that with billions of dollars under management, and the clamor for more stimulus packages, the temptation for the government to dip into the Future Fund and spend it 'in the national interest' will be too much to resist."
Of course, China Inc. has much deeper pockets than the Future Fund. But if Aussie banks and foreign banks won't extend new lines of credit to miners like OZ Minerals, maybe the Future Fund will. Stay tuned.
Also be warned. Investing the assets of public pensioners in the stock market doesn't always work out. Remember, the stock market is not a retirement machine. It involves risk. Just ask the Pension Benefit Guaranty Corporation (PBGC).
The PBGC is the agency set up by the US government to cover the defined benefit pensions of employees of bankrupt companies. When companies aren't going bankrupt, it's not necessary for the PBGC to funded by Congress. The company can manage its own assets.
But lately, the PBGC has been pretty busy. And with Chairman Obama indicating that General Motors is headed for bankruptcy, the PBGC will have even more defined benefit pensions to pay out in the coming years. Too bad it dumped most of its assets into the stock market in the last few years.
The Boston Globe reports that, "Just months before the start of last year's stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks. Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such as stocks in emerging foreign markets, real estate, and private equity funds."
Be careful if you ever hear these words, "We're from the government. We're here to help you retire."
If the government can't manage pension funds, how do you think it's going to handle managing a company a complex, bankrupt industrial/financial enterprise like GM? Granted, GM's deposed CEO Rick Wagoner is a model of incompetence. But is Barack Obama going to much better? Have you taken a look at HIS business plan for America? You know...the one that ends up with over $10 trillion in debt over the next ten years?
At first Obama's rhetoric was disarmingly pleasant and almost vacuous. Change. Hope. A better tomorrow. Who is against those things? Who is for a worse tomorrow?
But behind the $10 trillion smile is a mind of malice toward free markets. We are entering the age of command capitalism where the government becomes the lender (not real capital when you're borrowing Chinese money, but let's not quibble) and manager of last resort. The audacity of the command economy is that the folks in the White House can run GM better than the folks in Detroit. Truth be told, neither has been doing very well, which doesn't bode well for the United States.
And if Australia is facing the consolidation of the mining sector as the number of cashed up capitalist and willing bankers dwindles, than Washington is witness to a consolidation of failed and failing institutions. Bear Stearns, GM, and who knows besides are gradually swallowed up by the biggest and most wobbly institution of all, the Federal Government of the United States and its paper thin Dollar.
"While devaluation does not rescue countries from weak global demand, it does provide help at the margin, as well as alleviating deflationary pressures," reports The Economist. It adds that repeated cycles of competitive currency devaluations worldwide could keep the US Dollar stronger for longer than most of us dollar bears expect.
"Under our main risk scenario, governments are happy to see their currencies devalue provided it does not have adverse consequences for solvency of borrowers. This results in repeated cycles of competitive devaluations. There are periodic calls for co-ordinated action to stabilize foreign-exchange markets, although agreements prove elusive. Under this scenario, the US Dollar proves stronger than US policy makers would like, as investors continue to view the US currency as a safe-haven of sorts."
There are lots of global players like the Chinese and Russians who clearly do not view the Dollar as a safe haven at the moment. But at the moment, they don't have much to choose from. So perhaps the Economist is right. Competitive devaluations will continue, making the dollar a winner by default.
This means that the whole project of ruining the dollar is going to require even more effort by Obama and his sidekick Tim Geithner. And as Edward Chancellor points out in today's Financial Times, until bank lending rises to match the expansion in the global monetary base, inflation will not pass into the real economy.
"Monetarists concede," Chancellor writes, "that central banks are printing money in vast amounts to stimulate their economies. This will not lead to inflation, they say. The newly minted cash is not being lent out but stored in bank vaults.
"The 'money multiplier', to use the technical term, has collapsed. It is no secret why this is happening. Households and businesses are over-stretched and fearful about the future. As a result, they are borrowing less and saving more. As long as such fears persist, according to monetarist logic, the Federal Reserve can carry on printing money with impunity."
But there must be a penalty for such a rash expansion of paper money. The Economist explored that too in its Dollar doomsday scenario. Because once "the process of deleveraging" has run its course, and those "safe haven" flows of capital into the US start to look elsewhere for a better return – free from massive monetary inflation – we all risk a collapse of the world's reserve currency.
It won't be much fun – and it won't look or smell much like a solution to the current debt-deflation we're living through today.