by John Mauldin and Jonathan Tepper
This book was referred to me by a friend who had been tipped off by a financial adviser that we both respect.
The key essence of this book and the key conclusions are;
- most Western Governments are already at historically high and dangerous levels of indebtedness by any metric.
- they are continuing to run significant deficits.
- the start of pension entitlements for baby boomers is only going to make this much worse.
- there are no solutions – only a range of very difficult choices that are likely be highly unpopular and difficult politically.
This was illustrated in the last few months by large protests in Spain and Greece in response to the country’s poor economy, high unemployment and the government’s draconian austerity measures that affect mostly the middle class.
The book explains the magnitude of the Spanish housing problem – which is staggering.
I quote from the book;
“Spain has 603,512 homes that are finished but unsold as of December 2008, according to the Spanish housing industry. To that number, you would have to add 626,691 homes that were under construction as of that date. Although, 250,000 were sold [but subject to cancellation], and the others were ready to hit the market.
So conservatively Spain has more than one million unsold homes. Unfortunately, many of the homes are on the Coast, and without a return of over-leverage British Tourists, they likely to remain unsold. Spain’s homes are in all the wrong places.”
Now you might say why does Spain or Spanish problems impact on me, I live in Australia?
Well apart from the impact on global confidence of these sort of problems [witness recent volatility on the share market] the problem is that through internationalisation of our money system – problems in one country, ultimately leading to default impacts on banks in other countries and the wholesale money market.
Now interestingly Australia’s banks get about 40% of the money that they loan from the global wholesale markets. The authors devote a small chapter to Australia.
Now whilst Australia’s government debt is at quite low levels internationally this could change. The reason that levels of government debt in many other countries is so high [e.g. Ireland] is that those governments were forced to (chose to) bail out their banks to prevent even greater collapse.
Now how could this possibly happen in Australia when our banks are so solid?
Problem #1 is that by any measure Australia’s housing market is very overcooked.
The Economist global house price index suggest that Australian house prices are about 60% above a long term global comparative indicator.
This is basically a sort of price/earnings ratio analysis. On that measure it’s quite feasible that Australia’s house prices could fall 30%.
Now a lot of people have been suggesting that this will be deflate slowly – rather like a balloon slowly deflating rather than popping. Maybe, maybe not.
One of the key ideas that flows through the book is that when things reach unsustainable levels you can be sure that at some point there will be a day of reckoning. That day of reckoning may be much sooner than expected or much later than expected – but it will come. What will be the one grain of sand that causes the whole pile to tumble ?
They also introduce the idea of the “fingers of instability”. Because of the inter-connectedness we don’t actually know how everything links up. What would be the impact of a Greek debt default. A balance sheet problem for one or more French Banks ? What would be the ramification of that ? Not all of the links are transparent.
Okay so let’s assume that Australia’s residential house prices came under very severe pressure. That would lead to a potentially significant increase in the Australian banks bad debt provisioning requirements and without further capital injected would have a downward impact on their credit rating.
What if this happened at around the same time that there was widespread panic in the global wholesale funding markets?
So that the price of money went up and it became much less easily available. It’s quite feasible that a perfect storm of this type could require the Australian Government to make a bail out of Australia’s banks thereby dramatically increasing Australia’s Federal Government debt levels.
What if before, during or after there was a significant change in China’s circumstances or Japan’s circumstances that lead to a significant decline in commodity prices?
I have more than a sneaking suspicion that China is dramatically under-stating it’s debt levels. What would be the impact if this was true? Certainly it would increase the risk of a Chinese slowdown / crash.
From where I see it at least all of this is feasible and I would say at least some part of it likely. It is quite feasible that global conditions could deteriorate significantly and rapidly and that Australia could get the full brunt of the GFC that it has so far avoided. The authors predict that globally this could impact in different countries in different ways – we could see deflation, inflation or hyperinflation.
Quite feasibly different countries will have different outcomes.
Either way it is highly likely that economic growth in the foreseeable future will be limited – financial markets will be more volatile, and there will be lots of pain. People get a bit frisky when pension entitlements that they have looked forward to (or currently receive) are substantially changed. This is exactly the sort of thing that gets people on the streets. Some of the decisions that politicians will need to make are not the sort of thing that fits into short term political cycles. It is all very well to be patted on the back in 10 years time for taking the hard decisions now but that doesn’t necessarily lead to re-election.
A powerful, competent book and I strongly recommend that you read it.
Some of my friends have been calling me the Merchant of Doom but I’ve thought for at least 12 months that problems were coming and I suppose I see myself as a realist rather than a pessimist.
I would rather understand what I think is likely to happen and at least consider in advance the potential business and personal financial scenarios.
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