Thursday, November 20, 2008

Now for the really bad news

The Dow Jones last night fell another 5% to end up below 8,000 - its lowest level for 5 years.  Banking stocks were again savaged as were auto producers - a large slab of the US auto industry faces the prospects of collapse. In addition the US is experiencing deflation - the US CPI dropped 1% in October. The December Share Price Index Futures was down 4.6% in Australia so a future dramatic rout on Australian equity markets will occur today driven in part by an overnight commodity price retreat.   The All Ordinaries is at half its peak level of about one year ago.  Indeed the betting agency Intrade are selling bets on the possibility of the US going into Depression in 2009 with GNP falling by 10% or more (HT Gregory Mankiw) . The current implied depression probability is around 0.15.  It is not a negligible disaster probability.

The problem for Australian and the world is that people all want to save more because they see their residential and share market wealth decreasing.  This has created a 'paradox of thrift' - in seeking improvement in individual financial positions by saving more they bring about a sharp contraction in demand and therefore economic activity that makes society as a whole worse-off. Indeed they end up saving less. The RBA is not convinced that lower interest rates will succeed in expanding the economy - the real need is for a traditional Keynesian fiscal expansion.

The share market collapse is a leading indicator that Australia is in for very tough economic times ahead.  That is for sure.


whyisitso said...

As of 20 minutes after Thursday's opening the All Ords is 51% down from its peak of 1 November 2007.

The deepest bear market in Australia's history as measured by the All Ords was in 1974 when the market fell by 60%, so we still have another 20% fall to come to match that.

Back in 1974 I remember being told by a senior manager that the market always eventually bounces back and surpasses its previous peak. This did happen several years later.

The Dow fell 89% in the early thirties and didn't regain its previous peak until the 1960s. The Nikkei is less than a quarter of its previous peak of the late eighties, and I doubt it will ever regain it. I won't be selling, but the conventional wisdom that the market always regains its previous high may well turn out to be a myth this time.

Socialism is back with a vengeance, and even the Liberal Party has turned a deep shade of pink, rushing to disown the Howard years in an indecent fashion.

We are in for a very very tough several decades.

Uncle Milton said...

Grim times indeed.

You haven't quite got the paradox of thrift right Harry. The paradox is that by saving more, people drive the economy into recession, and with the lower incomes that that entails, they end up saving less.

It's a bit alarmist though to say that we are headed for a depression. There is a big difference between now and the 1930s. This time governments and their advisers know what to do about it and they are doing it with as much fiscal and monetary stimulus as they can. In the 1930s, governments did the opposite of what was needed, because they thought it necessary to maintain "sound finance". This time only the brain dead NSW government seems determined to repeat the mistakes of the past.

hc said...

Thanks Uncle Milton I have recast hopefully more accurately.

I don't believe a Depression is likely for the reasons you cite. Others don't agree however as the trades on Intrade confirm. Prominent economists such as Gregory Mankiw also don't rule it out - although they too regard this as unlikely.

I am particularly concerned about the second round effects of a severe recession in triggering a new round of bankruptcies.

observa said...

It'll be fine because we've decoupled from the US and we're all Asians now and besides Treasury and Reserve reckon we'll grow 2% next year, 1.5% at worst and they're the experts in these things and making sure it all happens and so yes there is a Father Xmas Virginia. He's the poor bugger paying off the funny money credit card in January.

observa said...

'It's a bit alarmist though to say that we are headed for a depression. There is a big difference between now and the 1930s. This time governments and their advisers know what to do about it'

The same Keynesian govts who rolled the printing press for so long and oversaw the greatest boom in asset prices in history and according to Austrian analysis have now created the world's greatest malinvestments to be unwound? We're about to see who's right and who's wrong although the Keynesians are looking a lot like headless chooks to me at present. Maintain the faith in that surge of theirs I guess.

Uncle Milton said...

It would be interesting, in a way, if there was a government somewhere that faithfully implemented Austrian economic policy. We could then see in modern setting what happens when you tighten policy during a recession to purge out the mal-investments; a kind of economic policy as enema.

But the Austrians have never made it into positions of power or influence anywhere, not even in Austria, so we'll never know.

observa said...

Austrians would argue that with zero or -1% monetary inflation they wouldn't need to purge these malinvestments, although there may be some mild animal spirits from time to time.

Take the US vis a vis China now, although it could apply to us too. How long will it take to correct the production/consumption structure that has been built up on all that funny money now? Well unless Chinese factories and workers are going to continue to make all those products for more financial derivatives. Can't see that happening now can you?

rabee said...

Here is a summary of the US CPI data

1) Food and beverage: all items increased in price

2) Housing costs excluding energy utilities: all items increased in price.

3) Apparels: all items increased in price.

4) Medical care. All items increased in price.

Basically oil and its derivatives decreased in price. That's about it.

Now let's all run around like headless chooks screaming depression and what not.

hc said...

&clothes, food, milk...yep, people are scared of deflation.

sir henry casingbroke said...

Yep, indeed, we are headed for some kind of depression, and Australia, once again, is going to cop it harder, like it did in the 30s.

That's because of the idiotic proposition of Ricardo's comparative advantage theory that was okay for the early 19th century but makes no sense in the age of the micro-chip.

Again Australia's total dependence on agricultural and mining exports mean that it will be the hardest-hit Western (I hate to use "advanced") economy. Already, the ASX is the worst performing of all. Does that not tell you something? All that talking up from the shills on the TV will actually do sweet FA.

And now we come to our ridiculously overvalued real estate on which rest super funds and people's savings. First-home buyers schemes, grants and the tax-dodges inherent in them and the like has only made things worse. As real estate prices now tumble people will owe more than their asset is worth. And mutual/super funds which invested in mortgages heavily will go belly up. This will also hit the banks already exposed to the funny money instruments. I think I'll have a lie down now.

rabee said...

Harry why don't you have a look at the actual data.

Much of the negative changes (aside from energy) are positive before seasonal adjustment.

Unadjusted data tells you what consumers actually pay.

What does it mean when seasonal adjustment changes the sign?

Once again, here's the data

observa said...

If you believe Austrian analysis and I do, ie it is largely monetary expansion that causes the investment cycle but real factors that constitute it, then you can look back with hindsight and see how it works.

Central bankers by and large were concentrating on goods and services inflation and printing money (low interest rates) whenever a mini-crisis appeared. Now normally flinging that dough around would hike inflation as it did so swiftly with a youth generation in the late 60s, early 70s. This time round that same demographic cohort was thinking about retirement and began to 'invest' it with that in mind.(Austrian analysis didn't necessarily pick this massive demographic impact but it always knew there was no such thing as a savings glut, just idle balances looking for a home and didn't the financial sector oblige swimmingly) So they start to bid up asset prices and as they do Asian savers, who don't have the same trust in their own backyard for lending, begin to pile on the growing ponzi scheme. When sub-prime breaks and the music stops with housing, where can fiat money find some anchor in real value? In commodities and commodity streams (Rio, BHP, Woodside,etc)of course and just RE they bid them up to levels that would smash the real economy, particularly oil. When that music stopped deleveraging of credit was inevitable since there is too much fiat money chasing too few investment opportunities now. (Can you believe Citibank sent me today, a cold call credit card offer of 2.9% for 18 months for balances transferred, when Citigroup are laying off staff?)

Basically because of the length and depth of malinvestments due to corresponding massive credit expansion, the market has now put us in administration. Deleveraging of credit and now deflation, which means if wages can't fall to accommodate that, there will be massive unemployment. If Austrian analysis is correct then Keynesians are pissing into a hurricane now with countercyclical policy, because of the historical depth of the problem. Their well intentioned muddlings may just make our leaders look foolish, create more uncertainty and prolong the agony, just like the 1930s.

What a sobering thought for those of Keynesian bent now? Doomed to repeat the same mistakes of the past, despite all their new found wisdom supposedly. Here's their problem in a nutshell now and note Obama's words-

If Austrian anlaysis is correct then all the tempting Keynesian remedies will just make things worse. That's because they can't print or borrow enough money to bail out a 1930s style depression. Just look at Paulson and Bernanke now and going down the same path here with bailing out ABC Learning and now some car industry greening will all look equally as stupid when they have to pull the plug on such measures as the costs rise toward ruinous. 'You did it for them so why not us!' they'll all scream. As for Treasury and the Reserve growth forecasts, the stock market is laughing at them all now and the more our leadership looks stupid and out of touch and out of control, the longer it will take for business investment confidence to return, not to mention picking favourites and then having to turn off the spigot.

Speaking of picking favourites, have a listen to the Ford CEO responding to Rudd's latest greening after announcing Ford will keep their engine plant open now (well he would say that now wouldn't he) How would this pearler rankle with every decent business manager struggling with recession now-

'Ford Australia chief executive Marin Burela made the announcement at the company's Geelong engine plant late this morning saying it would stay open past 2010.

He said Ford was focussing on ways to make the business viable.

"It is time that we consider our business in a slightly different way. Let's not look at the glass and say it is half empty, let's look and say it is half full. Our role is to look for a way to fill it," Mr Burela said.'

You and many others now Mr Burela.

observa said...

Actually for the link to Jonah Goldberg's article just google
'No' To Obama's Experimental Government

He starts off with-
'On Sunday night, President-elect Barack Obama told 60 Minutes that Franklin D. Roosevelt would be a model of sorts for him. “What you see in FDR that I hope my team can emulate is not always getting it right, but projecting a sense of confidence and a willingness to try things and experiment in order to get people working again.”'

and comes to the conclusion-
'In short, don’t just do something, President Obama, stand there.'

And if the Austrians are right then I reckon he's got a point and we're about to see who's right and who's wrong.

hc said...

Sir Henry, Comments criticising the principle of comparative advantage cannot be tolerated on this blog. This principle is foundational to all economics - it says you should specialise in doing those things you are relatively good at. It is unarguable.

Rabee, Seasonally adjusting means removing seasonal impacts - tomato prices rise in the middle of winter.

The seasonally adjusted CPI for all items declined 0.1% for October and by 2.2% over the previous year.

Observa, On cars and Kim Carr. The Australian Government has a proportionately bigger rescue package than the Yanks - $6.2 billion in all. The Ford factory $21 million expansion will be more than half funded by Kim Carr. And Sir Henry this is the lunacy you get when you abandon comparative advantage.

rabee said...


I'm asking what it means for seasonal adjustment to change the sign of the change.

For us the sign is important in this case.

I'm having problems understanding the idea that a
1) price of a good went up
2) seasonally adjusted it went down
3) we have deflation and all its ills.

observa said...

rabee, think of LPG which traditionally rises in our summer due to northern hemisphere winter demand. Now think of a stable price regime(yes I know it's hard) Suppose regularly our Qtr1 and Qtr2 price is 70c/L and Q3,4 are 75c/L as a result, then the seasonally adjusted prices will be 72.5c/L in all qtrs. Now suppose you notice Q3 price this year is to 73c/L ie an actual price rise as per usual but not by as much, the seasonally adjusted price has actually fallen(changed sign). Of course should our summer prices rise to match then our seasonal adjustment needs some adjusting. Basically it's now deeply flawed. That's the bane of CPI measurers just like changes in technology affecting utility or wiping out some good we're measuring ie cassette players to CDs to Ipods.

observa said...

Rabee, I stuffed up the qtrs but you get the drift. Also note that if say actual prices fall in our example in all 4 qtrs by the same percentage then actual and seasonally adjusted inflation measures are the same. Practically the seasonal adjusting allows us to read the tea leaves quicker than having to wait the 4 qtrs, bearing in mind caution over any structural changes that threaten seasonal adjustment.

Harry, as for the lunacy with stuffing Ford with greening money now, note they've said they now want to continue developing and manufacturing a green engine here for Europe. That's assuming they can survive their parent's woes and don't nick off with the loot(subsidised R&D) anyway. However let's assume their best case scenario and they manage to pull it off and they're busily making green engines for the EU. What do you reckon they'll be bleating to the Rudd Govt the moment ETS and those emission permits are on the table? In for a penny in for a pound now taxpayers and consumers, except it will be EU car buyers enjoying all that green pork.

sir henry casingbroke said...

Ah yes, to paraphrase Henry Kissinger, there's lunacy and then there's lunacy.

sir henry casingbroke said...

We are now, a nation of bellhops, good at carrying other people's bags. That's our comparative advantage, sucking up to tourists in a happy, sunny safe destination. But if people don't come to stay at our hotels (owned by international chains) we're rooted.