by Scott Pape - March 28th 2009
At a dinner party the other night, three reds in, I came to the shocking conclusion that many of my mates didn’t have a cracker of an idea about the biggest financial crisis since the Great Depression.
All they could muster was “bad loans”, “poor people bought houses they couldn’t afford” and “George W. Bush is an idiot”.
Nice try, but no cigar. Maybe it was the red, but I was determined to prove my point. While everyone is focused on the short-term problems, it’s the longer-term effects that could be setting us up for one hell of a sucker punch.
US banks are sick
Right now, the world’s focus is on the health of the US banks – and they’re pretty sick.
As we all know, they played the lending equivalent of musical chairs, and when the music stopped they ended up holding the beanbag.
No one really knows just how many trillions of dollars of dud loan losses sit on their balance sheets. The banks don’t want to tell us because, if they did, we’d work out that they’re basically broke.
So long as the banks are crippled with these loans, they won’t go out of their way to lend, which makes it harder for consumers and businesses to spend and lift the economy out of the slump it’s in. And it’s one hell of a slump – 600,000 people are losing their jobs each month.
Obama’s top priority
So the top priority of Obama and his boys is to rid the banks of these toxic assets so they can begin to lend again. This week we saw the latest plan from the politicians – it was different from the other plans before it, but had the same ending: the US taxpayer is on the hook for an unspecified amount.
Will it work?
No doubt. Eventually, they’ll rid the banks of these toxic assets, one way or another. That’s without doubt. It’s the cost of doing it that concerns me.
Uncharted territory
And it should concern you.
The British and US governments have lowered their interest rates to practically zero in order to goose their economies, but it hasn’t worked. The patient is still on life support.
This is uncharted territory. I spoke to an economist this week who said that in all his years of hanging around the
Keynesian Cross he’d never heard of the strategy these governments are employing.
They call it quantitative easing, which sounds very scientific until you understand that it really means “we’ve got no other option than to print more money”.
Governments around the world are at this very moment pumping trillions of dollars into their economies to ward off the global recession. Recently, the US said it would print $US1.2 trillion of money it doesn’t have.
The inflation factor
The more money you print, the less it’s worth. When you increase the amount of money in the financial system, prices rise but you’re no better off. Your year 8 economics teacher called this inflation.
She was right.
Had you been listening, she would have also explained that the only way to battle high inflation is to raise official interest rates. Runaway inflation is why in the early 1990s people were paying 18 per cent on their home loans.
A well-known multi-billionaire, who has made his dough doing the opposite of what everyone else does, is warning that over the next few years we will see an onslaught of inflation.
True to his word, practically no one is paying attention to this. In fact, people believe the exact opposite is occurring.
Nickleback Announcer Theory
It’s so prevalent that I’ve even created my very own economic indicator around it. I call it the Nickelback Announcer Theory.
Being a media tart, I find myself on more FM radio stations than The Veronicas – and talking about money, no less. Over the past three months I’ve increasingly had DJs tell me that interest rates will drop, and stay low, and therefore the best course of action is to keep your mortgage variable.
The punters appear to be listening. According to broker Mortgage Choice, a record 92 per cent of loans in February were variable.
The Nickelback Announcer Theory states that when a bloke whose job it is to back-announce Celine Dion and hand out icy-cold cans of Coke starts giving you his forecast on the economy, it’s a smart decision to do the exact opposite.
Devil’s advocate
Why? Allow me to play the devil’s advocate.
Let’s say that unemployment continues to rise, and our trade slows in line with the global economic recession. Our Reserve Bank listens to Take 40 and decides to cut rates to help the economy – but, just like in the US and Britain, it does little.
In response to the gloom and doom, our government gives more handouts and continues to spend up big. In a few years from now the Reserve Bank could be in the position of having to lift interest rates to contain inflation.
Doomsday scenario
This is a doomsday scenario for many.
First-home buyers are being hoodwinked by ridiculous government grants and the belief that rates will go low, and stay low, so they can buy homes that they can (just) afford right now. What happens if rates rise? What happens if that coincides with them losing their job?
Professor Steve Keen, from the University of Western Sydney, refers to them as the new sub-prime borrowers. I agree.
Middle Australia could also be inadvertently lining up for a knock to the chin. Six months ago things were tight – being among the most indebted households on the planet takes its toll.
Yet since September they’ve been able to loosen their belt buckles. The 4 per cent cut in rates has delivered savings of $600 a month. Happy days.
How many of these households have prudently continued paying a higher amount on their mortgage, and how many have squandered the windfall?
Nervous retirees who pulled their money out of the share market for the safety of cash have in many cases crystallised their losses, and may find that what little they have left is at risk of being eroded by the power of inflation.
I explained to my dinner party (many of whom had now lost their appetites) that I could be completely wrong. I hope I am. Yet with everyone focusing on the world’s short-term problems, investors (and debt holders) would be well advised to investigate the likely side-effects of the current economic policies, which are largely being produced on the run.
Tread your own path!
Photo: www.flickr.com/photos/imranchaudhry/696081589/
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