Looks like a robust recovery to me.
Increasing bank capital is in the interest of shareholders
Westpac CEO Gail Kelly warns that all Australians will have to carry the cost of making the financial system safer:
“Of course you can ever increase capital and become ever more safe, but that does come at a cost. The increasing of capital ends up having ultimately having a diminishing return in terms of safety, but the costs are real, capital is not free. Those costs will flow through to impact the economy more broadly, noticing and noting that banks are strong intermediaries within the Australian economy.”
What Gail fails to consider is that Australians already carry the cost of an unsafe banking system, with the broad economy contracting when banks suffer solvency or liquidity problems. And the taxpayer effectively stands as guarantor in the event of a failure.
I agree that capital comes at a cost — higher than the direct cost of deposit funding which capital would partially replace. But when one factors in the cost of the vast infrastructure required to attract and service those deposits, the margin narrows. Increasing the level of capital will also make banks safer and reduce the risk premium, further lowering the average cost of capital. And not only for equity: improved risk ratings will lower the cost of deposit-funding as well.
Banks with higher capital ratios also benefit from higher asset and loan growth according to studies conducted by the Bank for International Settlements.
Making the banking system safer is not only in the interests of the taxpayer, but also bank shareholders.
Read more at This Breathtaking Overstep From Gail Kelly Shows It’s Time To Call Australia’s Bankers To Account | Greg McKenna
Should Beijing raise subway fares? | Michael Pettis
Michael Pettis’ argues that not only are SOEs “destroying value in the aggregate on a huge scale” but misallocated investment is endemic in China.
I have to confess that the reason I started saying in 2006-07 that China was eventually going to replace 1980s Japan as the global archetype of investment misallocation was not because I had a lot of data proving my case. Overinvestment is almost impossible to prove until after the fact, especially when you consider the circularity of the data – the growth assumptions feed into the valuation of the investment, which then feeds back into the growth assumptions.
My reasons were much more “systemic”. I did not believe it was possible for any country not to experience significant wasted investment after so many years – more than a decade in this case – of the highest investment growth rate in the world funded by massive credit expansion at such incredibly low lending rates roughly one-third the nominal GDP growth rate, and 1-3 percentage points below the GDP deflator. Add more spicy ingredients to the stew – first, the very limited experience of Chinese bankers and regulators, and most of that in a one-way market, second, widespread moral hazard, third, weak corporate governance, fourth, very fuzzy data, and finally, no enforced system of accountability – and I found it impossible to doubt that investment was being dangerously misallocated.
He also dispels the counter-argument that “Western” models don’t apply to China and that “a very poor, low-capital-stock country far from the technological frontier like China” is able to absorb higher levels of investment.
In 2008 (Red Star) I compared China to a red star in astronomy:
Students of astronomy will tell you that a red star, far from indicating heat, is cooling appreciably. While its diameter may expand, its core is contracting and its temperature falling. Eventually it will either explode or shrink to become a dwarf star….
My warning of an imminent collapse may have been premature, but no economy can survive such high levels of investment misallocation without major upheaval. China risks following the boom-bust growth path of Japan and the Asian tigers in the 1980s and 1990s.
Read more at Should Beijing raise subway fares? | Michael Pettis' CHINA FINANCIAL MARKETS.
Surprising lack of inflation as unemployment falls | Bank of England
Sir Jon Cunliffe, Deputy Governor for Financial Stability at the Bank of England:
“The big surprise, therefore, for the [Monetary Policy Committee] … has been the extent to which employment has been able to grow without generating more inflationary pressure through higher pay increases. Understanding why that has happened and how long it will persist is, in my view, now key to deciding policy.”
One possible explanation may be a longer-than-usual lag between falls in unemployment and pay pressure emerging, which could mean that inflationary pressure is building in the pipeline that will be more difficult to curtail if the Bank does not act now. However, another is that a combination of factors has caused labour supply – the amount of hours of labour available to the economy – to be much stronger than in previous recoveries, for example due to the increase in women’s state pension age and changes to the incapacity benefits regime. And the fall in unemployment has included a high number of long-term unemployed, who probably act as less of a drag on pay.
Yet despite the biggest squeeze on real incomes for nearly a century, there appears to be little evidence that workers are demanding a catch-up in pay, Jon observes, possibly due to a shift in the psychology of UK workers resulting from the sharpness of the recession and the years of austerity that have followed it.
Read more at Bank of England | Publications | News Releases | News Release – Monetary policy one year on – speech by Sir Jon Cunliffe.
Alleged Oil Shock Isn’t All That Shocking
Keith Johnson discusses the impact of crude oil at $80 per barrel:
….Cheaper oil prices means lower prices at the pump and for everything that is ever shipped, from food to flip-flops. The recent fall equates to a massive, unplanned stimulus package for the world’s shoppers. Citigroup, for instance, figures that cheaper prices amount to a $1.1 trillion global shot in the arm.
Read more at Note to World: Alleged Oil Shock Isn't All That Shocking.
Abbott’s federation reform push is sound | MacroBusiness
Abbott’s federation reform push is sound | | MacroBusiness http://t.co/S8pMt7U7vm
— Colin Twiggs (@Colin_Twiggs) October 27, 2014
RBA targets mortgage lending
Barclays: RBA considers macroprudential by end of 2014 and double risk-weight for investor home loans | MacroBusiness http://t.co/Go0jLA0Xgg
— Colin Twiggs (@Colin_Twiggs) October 22, 2014
Why Australian Consumers Are Happy With Their Finances But Aren’t Spending | Business Insider
From Greg McKenna:
There is a lot of focus on the wealth of Australians through property and super but many Australian households and Australian households in aggregate are still carrying a large amount of debt. A stock of debt which must be repaid with a flow of earnings no matter how wealthy they might be on paper.
So consumers are more confident about their finances and their financial future but they aren’t spending — yet.
Something that puzzles me is why household debt as a percentage of disposable income is constant. If consumers have accelerated their credit card and mortgage debt repayments, surely this figure should be falling.
Read more at Here's The Best Explanation Of Why Australian Consumers Are Happy With Their Finances But Aren't Spending | Business Insider.
Jean Tirole: How to regulate monopolies
Catherine De Fontenay and Sven Feldmann discuss Nobel prize-winner Jean Tirole’s work on how to regulate monopolies:
If the regulator imposes a rigid price cap, the firm has an incentive to operate efficiently and minimise costs; but since the regulator does not know the firm’s overall costs, the firm may either be very profitable or at the brink of bankruptcy depending on where the price cap was set. To avoid this problem regulators moved to regulating the rate-of-return the firm is allowed to earn based on what is deemed a “reasonable” rate of return on the firm’s investments.
But as a result the firm no longer has an incentive to operate efficiently—indeed, additional capital investments raise the cost-base on which the rate of return is calculated and thus increase the firm’s total profits. In the context of the Australian electricity grid this phenomenon is known as “gold-plating”. Thus each of these two forms of regulation addresses one problem while exacerbating the other….
This is a common problem in dealing with public utilities and even with departments within government. Absence of competition bedevils the process. Fixed price caps lead to poor quality service, while cost-plus pricing introduces an incentive to inflate expenses. The challenge is to balance the two incentives: negotiate low-margin, cost-plus pricing but with incentives for service quality and efficiency.
Read more at Nobel economics prize winner an economist and a gentleman.
Market lifts despite weak global economy
Minutes of the September FOMC meeting highlight growing unease with the strong US Dollar and a weak global economy. The market read this as “low interest rates” and commenced a buying spree. Last year the quarter-end sell-off ended on October 9th after a 4.2% fall. This year’s correction fell 4.7%, lasting 13 days (so far) compared to 15 days in 2013.
Roberto Dominguez at NY Daily News reports:
“The start of earnings season, with companies including Costco and Alcoa reporting quarterly profits that beat forecasts, also helped push the S&P 500 to its biggest rally in a year.”
While Cullen Roche writes that the US fiscal deficit is shrinking:
“…tax receipts have surged by 7.7% year over year and are up 48% over the last 5 years. And while some of this is due to tax increases the vast majority is due to a healing private sector.”
Bellwether transport stock Fedex continues its primary up-trend, signaling improved economic activity.
No doubt boosted by a falling outlook for crude oil.
With positive news about, we should be careful not to forget the Fed’s concern with a weak global economy. While this may drive oil prices even lower, the impact on international sales of major exporters will be closely watched.
S&P 500 recovery above 2000 would indicate the correction is over, while follow-through above 2020 would signal another advance. A 21-day Twiggs Money Flow trough above zero would signal a healthy up-trend. Reversal below 1925 is unlikely, but would test primary support at 1900/1910.
* Target calculation: 2000 + ( 2000 – 1900 ) = 2100
CBOE Volatility Index (VIX) retreated to 15%, indicating low volatility typical of a bull market.
