Reasons to Be Cheerful
Foreign holdings of US Treasury securities fell by a record amount in December...
SO GREECE hasn't been abandoned by the rest of Europe...not yet, writes Dan Denning in his Daily Reckoning Down Under from Melbourne, Australia.
Europe could probably leave Greece behind and preserve the integrity (such as it is) of the Euro as a sound currency. But 50 years of harping on about social justice and economic harmony and humane capitalism is going to make it hard for policymakers to leave Greece to its own devices.
This means the debt crisis is consolidating itself into ever fewer and larger entities...the European Union...the US government...and the UK government to name a few. In order to save Greece, historians may write, it was necessary to destroy the Euro.
But investors don't have time machines. And in the modern era of central banking, new lines of credit and public assumption of large liabilities – plus more credit creation – has always been the way out of a pinch. This makes the inevitable disaster that much worse.
Here in Australia, meantime, it looks like the financial crisis is receding. We have our doubts here in St.Kilda, but according to Gail Kelly and the good people at Westpac, bad debts were down even more than expected in the first quarter. That's the good news. The bad news is that, "the average cost of funding is going up."
The strategic weakness of the Australian banking sector – and perhaps the whole economy – is that it's a capital importer. That's why even when Aussie banks didn't have boatloads of US subprime debt, they still faced higher capital costs when the global cost of capital went up.
So what? Well, if Greece goes down or sovereign debt default spreads go up, it's going to make importing money into Australia more expensive. And that will probably slow credit growth in the economy. Aussie banks will get jealous of their capital and stingier with their lending. Maybe even house prices – contrary to the laws of Australian financial gravity – will fall.
If you think that's gloomy, then you won't want to read what Albert Edwards from Société Générale has to say about the status quo. Writing earlier this week, Edwards says:
"My own view on this is that obviously we should never have got into this wholly avoidable mess in the first place. But having got here, there really is no way out that does not trigger a major market-moving upheaval.
"Ultimately economic prosperity over the past decade has been a sham: a totally unsustainable Ponzi scheme built on a mountain of private sector debt. GDP has simply been brought forward from the future and now it's payback time. The trouble is that, as the private sector debt unwinds, there is no political appetite to allow GDP to decline to its 'correct' level as this would involve a depression. So burgeoning public sector deficits and Quantitative Easing are required to maintain the fig-leaf of continued prosperity."
This is what we meant above about the inevitability of the disaster that approaches.
Because when the government "brings forward" demand for housing and consumer goods via the FHOG or stimulus, it's stealing growth from the future in order to maintain current living standards. And in our view, that just perpetuates the misallocation of resources that took place in the credit boom and keeps the money in the weak hands (the financial sector) that took so many bad risks in the first place.
A real free market punishes financial failure with bankruptcy or insolvency. By not allowing a recession to take its natural course, monetary and fiscal policy prevent the conditions for the next growth phase. What's worse, they're doubling down on the debt-backed model of prosperity and piling up more liabilities on the public sector balance sheet.
That's the stage we're at now. And perhaps the more important news yesterday was that demand for US bonds by foreign investors fell by its largest amount ever.
Call this a strong Dollar?
Foreign holdings of US Treasury securities fell by $53 billion December. China reduced its holdings by $34.2 billion. The end game is beginning in the Chimerica relationship of vendor financing...where China buys US bonds to help keep US interest rates low so Americans can buy what China makes.
What China doesn't buy, the Fed will have to monetize – unless the Congress and the President suddenly cut American spending. Japan is now a larger holder of long-term US securities than China, but the long-term trade, we guess, is to get the heck out of US assets.
Whether "risk assets" like commodity currencies or commodities are the ultimate refuge is yet to be seen. But oil, Gold Bullion, and resource stocks are certainly getting a big lift today on greenback weakness.