Your Daily Scan of the New Global Economy


Intel Australia

  • Canberra's long road (or tramline) to light rail

    It might seem like talk of light rail in the nation’s capital has been going on forever — but in a matter of hours the ACT’s largest ever infrastructure project will go live. It’s the result of several years of false starts, changed routes, and squabbling over how to pay for it.

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  • China dobs on Australia to World Trade Organisation

    Let’s play a little game.

    Imagine you are getting a new lock fitted to your front door.

    You have two choices.

    The traditional deadlock.

    Nothing fancy. The sort of lock that’s been around in various forms for decades. Sturdy, reliable and basic.

    Or the latest technology front-door lock.

    One with a finger-scanning pad. Something that sends a ‘lock breech’ alert to your smartphone.

    Possibly the safest lock you could put on your front door.

    In fact, this lock is a market leader. Nobody in the world today has better technology.

    But that whiz-bang lock comes with a catch.

    The latest and greatest high-tech gadget is made by a company that’s repeatedly proven it can’t be trusted.

    Sure, they say it’s different this time. They’ve learned from the error of their ways. No more ex-criminals installing the locks.

    Can you put the past behind you?

    Or would you choose the other lock?

    The sturdy, basic, slightly outdated deadlock. The one produced by a company you trust.

    Whose lock do you pick to keep you safe while you sleep at night?

    Australia chose the sturdy deadlock

    Now, I want you to imagine Australia is the front door.

    And think of the coming-soon 5G network as the lock.

    China currently has the greatest 5G network in the world.

    Quite frankly, no other provider even comes close to what Huawei is offering, from a 5G technology point of view.

    Even though we know this, Chinese-backed firms Huawei and ZTE Corporation have both been booted out from bidding — and then building — our new 5G infrastructure.

    Instead, Telstra has partnered with Swedish-owned Ericsson to build our 5G network.

    Basically, we’ve picked the trusty, reliable deadlock over the fancy, high-tech one.

    The battle to keep Huawei and other Chinese telcos out of the 5G market is growing.

    Australia was one of the first countries to ban Huawei’s involvement in the NBN back in 2012. Then we banned them from building our 5G network in 2018.

    Japan and New Zealand quickly followed our lead. So have Taiwan and the US.

    In fact, the US is now pressuring other countries to follow suit and ditch any Chinese telco involvement in communications infrastructure. 

    According to The Australian last month, a US ambassador wrote to Germany’s economic minister, warning that if Germany allowed Huawei or any other Chinese vendors to participate in 5G projects, it would lose ‘cooperation’ privileges when it comes to intelligence among its allies.

    However, Germany has come out swinging, saying it has no intention of ending its arrangements.

    Same goes with the UK.

    The UK has been using Huawei’s technology for the past 15 years. However, it is now increasing the pressure on the tech giant to prove there’s no tech loopholes.

    The Chinese telcos are hitting back, complaining Australia isn’t playing fair…

    You can’t do that

    Turns out, the world’s leader in 5G technology isn’t going to take the ban lying down.

    At a World Trade Organisation (WTO) meeting in Geneva last week, Chinese officials brought up Australia’s 5G ban.

    Huawei’s Deputy Chairman Ken Hu has asked global governments to set up independent standards to decide who can and can’t be trusted.

    Backing this up was a complaint from Chinese officials that refers to Australia’s 5G ban as ‘discriminatory market access prohibition on 5G equipment[1], adding that it’s ‘obviously discriminative’ and breaks the world trade rules.[2]

    Furthermore, one Chinese representative said: ‘Country-specific and discriminatory restriction measures can not address the concerns on cybersecurity, nor make anyone safe, but only disrupt the global industrial chain, and make the country itself isolated from the application of better technology.’

    Does this mean China’s very public whinge will see the WTO overturn Australia’s ban on Huawei bidding for our business?

    Probably not, says former Australian trade negotiator Dmitry Grozoubinski.

    According to him, the WTO rules are loose enough that anything deemed a national security threat automatically means it’s unlikely to be challenged by the WTO. Grozoubinski told ABC news: 

    ‘[The WTO] has a very broad national security exception that basically says that none of the rules in the agreement apply if the receiving country interprets them to be contrary to their national security intrests.[3]

    Essentially, Grozoubinski says this broad definition isn’t used often, but the WTO specifically allows this type of ‘anti trade’ sentiment to pass. 

    However, a Chinese complaint to the WTO isn’t so much about getting Australian business back, but about saving face.

    Chances are the formal complaints, and the suggestion to discuss cybersecurity threats, is more about adding credibility to Huawei’s current European contracts.

    But the noise at the WTO isn’t about giving China the chance to be part of our 5G network.

    Oh no. That ship has sailed.

    Now that China has been booted out of our key infrastructure, it’s all about payback.

    And they’ve already fired a warning shot.

    Billions of dollars lost

    Australia is firmly wedged between our biggest customer and our most powerful ally.

    And that hasn’t gone unnoticed in the Middle Kingdom.

    On the 5G ban, Chinese newspaper Global Times said last Friday that Australia is ‘under US command’.

    Come Monday, a person from China’s Ministry of Foreign Affairs said that any country ‘adopting discriminatory practices’ towards global companies would ‘only hurt its own international co-operation’.[4]

    China hasn’t gone as far as dumping us as a preferred supplier yet. But it is sending a very powerful message: Boot Chinese corporations out of Australian business, and Australia may find itself without Chinese business.

    What does that mean?

    Not only are our iron ore, coal and agricultural exports to China vulnerable, but others sectors to the Aussie economy are at risk.

    There’s the $3.8 billion Chinese-related tourism sector…

    …the $2.9 billion in wool we ship to China…

    …and the $16 billion in education we’ve sold to the Chinese.

    Or what about the $2.9 billion in gold the Chinese buy from us each year?

    The point is, our economy is not only reliant on rocks shipped to China. We have created entire sectors around what the Chinese are willing to buy from us.

    Current bilateral trade between the two of us stands at $183 billion each year.

    More to the point, we don’t provide anything unique to China. Many other countries have similar exports.

    Basically, China can go shopping elsewhere, but Aussies aren’t about to find a new customer with the same purchasing power.  

    Threatening global trade relations in this way could have a severe impact on Australians.

    Given Australia’s reluctance to allow China’s 5G tech into our projects, it won’t be long until we feel the wrath of Chinese retaliation. 

    Should Australia protect its national security first? Most definitely.

    But that protection comes at a cost. Knowing the days of sending cheap things to China are limited is one thing… Preparing for it is another.

    Any reduction in two-way trade between us and China could have serious implications for the Aussie economy.

    Until next time,

    Shae Russell Signature

    Shae Russell,
    Editor, The Daily Reckoning Australia

    The post China dobs on Australia to World Trade Organisation appeared first on Daily Reckoning Australia.

    Posted: by Daily Reckoning Australia

  • Diamonds aren’t forever

    Don’t expect much stock market news this week.

    The four days before Good Friday are much like the last few trading days before Christmas.

    The headlines are generally full of fillers.

    Same old property stories mixed up with some naughty footballers’ deeds and royal baby watching.

    It’ll be the same with the markets too.

    There won’t be much direction for the Australian stock market from the US or Europe this week.

    Future traders aren’t willing to put the big bets on this week. Instead, they tend to opt for smaller deals to keep the flow going.

    That means that without some sort of market shock, most movement in the Aussie market will come based on what’s happening in the Asian markets.

    And that’s exactly what I want you to look at today…

    It ain’t about gold

    Today I want to talk to you about ‘repatriation’.

    Now, normally when you read that word in an economics newsletter, I’ll bet you think of central banks bringing home their gold, right?

     After all, that’s been a common theme for the past couple of years.

    Both Turkey and Hungary have repatriated their gold. Germany too.

    Venezuela tried to, but the Bank of England said no.

    When it comes to China, however, repatriation takes on a different meaning.

    China isn’t trying to bring home its gold.

    For many countries around the world, repatriation is about bringing home the yellow metal. China, on the hand, is desperately trying to keep its money in the country.

    ‘Repatriation’ is about to take on a whole new meaning.

    Keeping the cash in the country

    The Middle Kingdom’s desire to keep its money in the country isn’t a new concept. It’s something Jim and I discussed almost two years ago now in Strategic Intelligence Australia.

    In fact, in our ‘Sell Australia’ report, Jim explains exactly how China has taken steps to stop capital from leaving the country.

    Well, the next step to stop investment capital leaving the country is to stop consumers from leaving the country.


    By convincing the wealthy to spend their money within the Chinese economy.

    And the only way to do that is with a tax cut.

    At the start of the year, Chinese authorities lowered the VAT — a consumption tax similar to our GST — from 16% to 13%.

    Part of the tax reduction had to do with reducing the demand for ‘daigous’. That is, the international shoppers who send goods over to China.

    By clamping down on these grey imports, authorities could prevent locals buying from overseas.

    In addition, the lowering of the VAT was aimed at increasing local consumption.

    Basically, the Chinese ‘repatriation’ is about spending inside the country, rather then people flying overseas for luxury shopping sprees.

    Because propping up the Chinese economy is crucial right now.

    We’ve seen the well-worn headlines about Chinese gross domestic product falling.

    The Chinese government has let billions of yuan run wild through its economy to encourage growth. But there comes a point when only so many planes, trains and buildings can be built.

    Authorities want the economy to transition from emerging market to developed. But the only way to do that is to move from being a manufacturing nation to a consumer nation.

    That means there’s no point spending money on infrastructure anymore. The government needs to convince people to spend their money locally.

    In other words, the tax cut is the new stimulus for the health of the Chinese economy.

    However, this ‘repatriation’ may already be failing.

    Two French companies explain Chinese economy

    Here is a staggering figure for you.

    Last year, 33% of all luxury consumer goods were bought by Chinese people.

    That’s a heck of a lot of handbags, watches and high-end cosmetics. In fact, some 170 billion yuan (AU$35 billion) was spent on the stuff.

    Furthermore, it’s estimated that luxury British retailer Burberry owes 37% to Chinese consumption.

    And we can see just how profitable high-ends goods are in companies such as Kering [MC:KER] and LVMH [MC:LVMH]. Kering is the owner of brands like Gucci, Balenciaga and Yves Saint Laurent. LVMH is behind Louis Vuitton, Dior and Fendi.

    Since 2015, the share prices of both luxury fashion houses have tripled as the Chinese luxury goods market grew 20% every year.

    And investors can thank a millennial for that.

    According the South China Morning Post, this demographic are keen to spend their parents’ money on Western status symbols.

    While growth in luxury goods has been impressive, it’s tipped to halve this year. At best, consumption of luxury goods may ‘only’ increase 10% this year.

    Look, don’t get me wrong. That’s still a huge number of overpriced handbags and watches being sold.

    But analysing what’s happening in luxury goods in China gives us insight into how the wealthy are spending their money in the country.

    We know that the Chinese government is trying to increase local consumption. Yet early signs are in that the wealthy Chinese are feeling the pinch.

    The slowing Chinese economy is affecting just how much people will spend on frivolous things.

    Given that both Kering and LVMH’s share prices are at all-time highs, any fall in earnings from both companies will see the share prices hit hard.

    So this week and next, while the news is quiet, watch both companies.

    Because the numbers of Gucci watches and Fendi bags being sold will tell you just how well the Chinese economy is going.

    Until next time,

    Shae Russell Signature

    Shae Russell,
    Editor, The Daily Reckoning Australia

    The post Diamonds aren’t forever appeared first on Daily Reckoning Australia.

    Posted: by Daily Reckoning Australia

  • Ditching greenbacks for gold.

    Central banks bought 651.5 tonnes of gold in 2018.

    That’s the highest level since 1967.

    In a world run by fiat currencies and where gold is demonised, that’s an awful lot of countries moving into hard money.

    Russia led the way.

    The Russians were behind almost a third of the total gold purchased last year, topping up their reserves with some 274.3 tonnes.

    The goal? To move away from the US dollar and into gold.

    The Russians aren’t the only ones doing this, either.

    China is believed to be increasing its gold reserves, although it doesn’t report this.

    An increasing number of central banks are bumping up their gold stores. Not as a way to profit from a gold bull market…but as a way of moving out of the US dollar.

    In fact, the US dollar as part of global reserves has dropped 10% in nearly two decades.

    However, this is just the beginning.

    More challenges to the US dollar are coming, says Jim below. According to him, the popularity of the US dollar is declining at a faster rate than expected.

    Read on for his full analysis.

    Until next time,

    Shae Russell Signature

    Shae Russell,
    Editor, The Daily Reckoning Australia

    US Dollar Dominance Under Multiple, Converging Threats

    Jim Rickards, Strategist

    Jim Rickards

    For years, currency analysts have looked for signs of an international monetary ‘reset’ that would diminish the US dollar’s role as the leading reserve currency and replace it with a substitute agreed upon at some Bretton Woods-style monetary conference.

    That push has been accelerated by Washington’s use of the US dollar as a weapon of financial warfare, including the application of sanctions.

    The US uses the US dollar strategically to reward friends and punish enemies.

    The use of the US dollar as a weapon is not limited to trade wars and currency wars, although the US dollar is used tactically in those disputes.

    The US dollar is much more powerful than that.

    The US dollar can be used for regime change by creating hyperinflation, bank runs and domestic dissent in countries targeted by the US.

    The US can depose the governments of its adversaries, or at least blunt their policies without firing a shot.

    But for every action, there is an equal and opposite reaction…

    Russia leads the way

    As the US wields the US dollar weapon more frequently, the rest of the world works harder to shun the dollar completely.

    I’ve been warning for years about efforts of nations like Russia and China to escape what they call ‘dollar hegemony’ and create a new financial system that does not depend on the dollar and helps them get out from under dollar-based economic sanctions.

    These efforts are only increasing.

    Russia has sold off almost all of its US dollar-denominated US Treasury securities and has reduced its dollar asset position to almost zero.

    It has been amassing massive quantities of gold and has increased the gold portion of its official reserves to over 20%.

    Russia has almost 2,000 tonnes of gold, having more than tripled its gold reserves in the past 10 years.

    It has actually acquired enough gold to surpass China on the list of major holders of gold as official reserves.

    This combination of fewer US Treasuries and more gold puts Russia on a path to full insulation from US financial sanctions.

    Russia can settle its balance of payments obligations with gold shipments or gold sales and avoid US asset freezes by not holding assets the US can reach.

    And Russia is providing other nations a model to achieve similar distance from US efforts to use the dollar to enforce its foreign policy priorities.

    Escaping the US dollar

    Certainly, any talk of a monetary reset must involve China.

    Despite its present weakness, China is still the second-largest economy in the world and the fastest-growing major emerging market.

    Like Russia, China is amassing gold, and likely has far more gold than it officially lists.

    It has also been helping to suppress gold prices so that it can buy gold cheaply without driving up the price.

    Europe has also shown signs that it wants to escape US dollar hegemony.

    For example, German Foreign Minister Heiko Maas has called for a new EU-based payments system independent of the US and SWIFT (Society for Worldwide Interbank Financial Telecommunication) that would not involve US dollar payments.

    SWIFT is the nerve centre of the global financial network.

    All major banks transfer all major currencies using the SWIFT message system. Cutting a nation off from SWIFT is like taking away its oxygen.

    In the longer run, these are just more developments pushing the world at large away from US dollars and towards alternatives of all kinds, including new payment systems and cryptocurrencies.

    The signs of a reset are everywhere, but at least for now the US dollar is still king of the hill.

    SDRs to replace the US dollar?

    The US dollar represents about 60% of global reserve assets, 80% of global payments and almost 100% of global oil sales.

    With such a dominant position, the US dollar will not be easy to replace.

    Still, the trends are not good for the US dollar.

    The international reserve position may be 60%, but as recently as 2000 it was over 70% and just a few years ago it was still at 63%.

    That trend is not your friend.

    Another challenger to the US dollar is the IMF’s special drawing rights or SDRs.

    The SDR is a form of world money printed by the IMF.

    It was created in 1969 as the realisation of an earlier idea for world money called the ‘bancor’, proposed by John Maynard Keynes at the Bretton Woods conference in 1944.

    The bancor was never adopted, but the SDR has been going strong for 50 years.

    The IMF could function more like a central bank through more frequent issuance of SDRs and by encouraging the use of ‘private SDRs’ by banks and borrowers.

    At the current rate of progress, it may take decades for the SDR to pose a serious challenge to the US dollar.

    But that process could be rapidly accelerated in a financial crisis where the world needed liquidity and the central banks were unable to provide it because they still have not normalised their balance sheets from the last crisis.

    In that case, the replacement of the US dollar could happen almost overnight.

    Individuals will not be allowed to own SDRs, but you can still protect your wealth by buying gold.

    That’s what Russia and China are doing.

    Both countries have more than tripled their gold reserves since 2009.

    But attacks on the US dollar are not limited to gold or SDRs themselves.

    The most imminent threat to the US dollar actually comes from a combination of gold and digital currency.

    Cryptos and gold take on greenbacks

    The fact that Russia and China have been acquiring gold is old news.

    Still, there are practical problems with using gold as a form of currency, including storage and transportation costs.

    But Russia is solving these transactional hurdles by combining its gold position with distributed ledger, or blockchain, technology.

    Russia and China could develop a new cryptocurrency that would be transferred on a proprietary encrypted ledger with message traffic moving through an internet-type system not connected to the existing internet.

    Other countries could be allowed into this new system with permission from Russia or China.

    The new cryptocurrency would be a so-called ‘stable coin’, where the value was fixed with reference either to a weight of gold or another standard unit such as the SDR.

    Goods and services would be priced in this new unit of account.

    Periodically, surpluses and deficits would be settled up in physical gold.

    Such net settlements would require far less gold than gross settlements (where every transaction had to be paid for in real-time).

    This type of system (also called a ‘permissioned blockchain’) is not pie-in-the-sky, but is already under development and will be deployed soon.

    But you can count on the US government being the last to know.

    The development of a gold-backed digital currency is just one more sign that US dollar dominance in global finance may end sooner than most expect.

    And we may be getting dangerously close to that point right now.

    All the best,

    Jim Rickards Signature

    Jim Rickards,
    Strategist, The Daily Reckoning Australia

    The post Ditching greenbacks for gold. appeared first on Daily Reckoning Australia.

    Posted: by Daily Reckoning Australia

  • Money Is Gold, and Nothing Else

    Late last night, I received a text message from a relative in another state.

    Through their own late-night web travels, they accidently ended up on one of my YouTube videos.

    The messages flooded in…

    I found you on the internet!

    Ah, so that’s what you do.

    Wow. How the heck do I go about buying gold?

    What I found amusing about these messages is that they came only 24 hours after another friend of mine wanted to know how to buy gold.

    Is it coincidental that both of these people were suddenly looking into gold, or had they simply read the writing on the wall?

    It catches me by surprise when people don’t know how to go about buying gold.

    When you’ve been doing this as long as I have, you forget that many people still don’t know much about buying gold — or even why you should own it in the first place.

    So, why own gold?

    There are many reasons.

    Wealth protection is one. Creating your own ‘sound money’ principles is another. Plus, it’s a way to keep some of your wealth out of a financial system run by politicians and powerful people.

    Or, as Jim explains today, there is another reason why people should look to own gold.

    Read on for more.

    Until next time,

    Shae Russell Signature

    Shae Russell,
    Editor, The Daily Reckoning Australia

    PS: Before I dash off today, my recent ‘Sell Australia’ report shows you why owning physical gold is a crucial part of protecting yourself from Australia’s turbulent economic times ahead. This report is something that Jim and I spent months putting together. Go here now to get your hands on it.

    ‘Money Is Gold, and
    Nothing Else’

    Jim Rickards, Strategist

    Jim Rickards

    Following the Panic of 1907, John Pierpont Morgan was called to testify before Congress in 1912 on the subject of Wall Street manipulations and what was then called the ‘money trust’ or banking monopoly of J. P. Morgan & Co.

    In the course of his testimony, Morgan made one of the most profound and lasting remarks in the history of finance.

    In response to questions from the congressional committee staff attorney, Samuel Untermyer, the following dialogue ensued as recorded in the Congressional Record:

    Untermyer: I want to ask you a few questions bearing on the subject that you have touched upon this morning, as to the control of money. The control of credit involves a control of money, does it not?

    Morgan: A control of credit? No.

    Untermyer: But the basis of banking is credit, is it not?

    Morgan: Not always. That is an evidence of banking, but it is not the money itself. Money is gold, and nothing else.

    Morgan’s observation that ‘Money is gold, and nothing else’ was right in two respects.

    The first and most obvious is that gold is a form of money.

    The second and more subtle point, revealed in the phrase ‘and nothing else’, was that other instruments purporting to be money were really forms of credit unless they were redeemable into physical gold.

    Unlimited printing power

    So much of the gold market is ‘paper gold’.

    This paper gold market is so manipulated, we no longer have to speculate about it. It’s very well documented.

    A central bank, for example, can lease gold to one of the London Bullion Market Association banks, which include large players like Goldman Sachs, Citibank, JPMorgan Chase and HSBC.

    Gold leasing is often conducted through an unaccountable intermediary called the Bank for International Settlements (BIS).

    Historically, the BIS has been used as a major channel for manipulating the gold market and for conducting sales of gold between central banks and commercial banks.

    The BIS is the ideal venue for central banks to manipulate the global financial markets, including gold, with complete non-transparency.

    But it all rests on a tiny base of physical gold.

    I describe the market as an inverted period, with a little bit of gold at the bottom and a big inverted pyramid of paper gold resting on top. 

    There’s just not that much gold available.

    But in the paper gold market, there’s no limit on size, so anything goes.

    Leasing of paper gold by bullion banks allows them to sell the same gold as much as 10 times over to 10 different buyers.

    It’s like a game of musical chairs, only with more participants and fewer chairs.

    Yellow metal getting harder to find

    Someday, probably sooner than later, somebody is going to show up and say, ‘I want my gold, please’ and the custodian won’t be able to give it to them.

    What if a major institution wants its gold but can’t get it?

    That would be a shock wave. It would set off panic buying in gold, driving prices through the roof.

    Meanwhile, the physical fundamentals are stronger than ever for gold.

    It appears that peak gold production is already here.

    There are fewer gold fields of any significance to be discovered.

    There is no new technology that can extract gold from places where it cannot now be recovered.

    This does not mean gold production stops — just that output does not increase and will start to go down.

    Panic buying drives up the price

    Of course, gold exists in minute quantities in everything from seawater to distant asteroids, but the costs of recovery from those sources are astronomical and make no commercial sense.

    When it comes to gold, what you see is what you get.

    Yet global demand continues to rise from central banks and sovereign wealth funds in Russia, China, Iran, Turkey and other countries around the world (not including America, it seems).

    You don’t need a PhD to realise that if supply is declining and demand is increasing, then gold prices have nowhere to go but up.

    With limited output but massive ongoing demand, it’s only a matter of time before a link in the physical gold delivery chain snaps and a full-scale buying panic erupts.

    Then the price of gold will soar regardless of paper gold manipulations.

    All the best,

    Jim Rickards Signature

    Jim Rickards,
    Strategist, The Daily Reckoning Australia

    The post Money Is Gold, and Nothing Else appeared first on Daily Reckoning Australia.

    Posted: by Daily Reckoning Australia

  • The next financial crisis will be called…

    In 2008, it became known as the sub-prime crisis. Today, we call it the GFC. Because the problem spread so rapidly. But the trigger is still burned into every investor’s memory as ‘subprime mortgages’.

    To be honest, that’s a little misleading. It was widespread mortgage fraud that set up the crisis — on both prime and subprime lending. From there on in, everything relied on dodgy information.

    The securitisation process and the creation of CDOs. The derivatives and the risk weightings. The credit ratings and the GSEs like Fannie Mae. You can blame who you like for the GFC. But the key to the crisis was the mortgage fraud right at the beginning of the process.

    I mention that because Australia’s own mortgage lies are now mainstream news. I wonder what happens next…

    Back to today’s topic. I’m offering you a chance to get ahead of the game. To name the next financial crisis, before it even begins.

    I’ll even make it a multiple choice option for you. Unless you want to email us your own suggestion. Here’s what I came up with:

    1. The Basel Bubble
    2. The Zero Risk Ruination
    3. The Capital Crunch Crash
    4. The Bail-in Blow-up

     Before you make your choice, I better explain the different options.

    Over the years, the world’s bank regulators have regularly met at Basel in Switzerland to rejig bank rules. Specifically, bank capital rules.

    It’s a bit like Australia’s bank regulator, APRA, discussing how much of a deposit home buyers need while visiting Launceston.

    When you buy a house, your deposit is your capital. It’s also the lender’s protection — a buffer. As long as house prices don’t fall beyond the amount of capital, the lender is safe. It can repossess the house and get back enough money to cover losses.

    If you go into negative equity on your home, there’s trouble.

    Banks themselves operate in much the same way as property buyers, when it comes to capital. They borrow money and lend it out, but maintain a capital buffer to absorb any losses.

    At Basel, the regulators decide how much equity banks need to maintain. To protect people from the bank’s failure. Well, to reduce the probability of the bank’s failure.

    The rules, known as Basel I, II, III and soon IV, are effectively global. But each jurisdiction implements them slightly differently.

    Basel III went active two weeks ago, by the way.

    The trouble with all this is that rules don’t work. The moment you create them, you just create a new set of incentives. People look for loopholes, ways to profit from the rules, or ways to misinterpret them.

    The other problem is that the rules are made by politically influenced people. They tend to favour governments and government priorities. Such as lending to subprime borrowers for political reasons…

    So it’ll come as no surprise that the Basel rules have created a bubble in demand for government bonds. Effectively, bank loans to governments.

    But they did so in a peculiar way.

    If you buy a government bond, your financial adviser should tell you something along the lines of ‘No investment is risk free’ and ‘Do not invest more than you can afford to lose’.

    We have to say that stuff. It’s the rules.

    But if a bank buys a government bond, it’s different. According to the Basel rules, that government bond is risk free. And so banks invest more than they can afford to lose.

    Now, sovereign debt is obviously not risk free. But before we get to how this will go disastrously wrong, what were the Basel attendees even thinking?!

    Their answer is that central banks can always print money and buy government bonds. So the chances of a default on government bonds are effectively zero.

    The trouble is, that’s not necessarily true in Europe. The ECB is restricted in its ability to rescue individual governments in the eurozone.

    And the Basel rules’ ‘zero risk’ justification doesn’t address the problem that default risk isn’t the only risk. You also face price risk on sovereign bonds. Their value can fall, just as your house price can fall, putting the bank into negative equity.

    That’s when you get a banking crisis. And it’s how the next banking crisis will begin.

    The Basel Bubble in sovereign bonds sets up the Zero Risk Ruination, creating a bank Capital Crunch Crisis. A banking crisis far more spectacular than subprime.

    But what’s the bail-in blow-up?

    That’s something new. Something I’ve only just untangled over the last few weeks of research.

    I’ve warned you about bank bail-ins before. The idea is to use depositors’ money to rescue a failed bank instead of taxpayers’ money.

    It’s the law in Australia, just FYI…

    But it’s not just depositors who can get shafted. Anyone who lends the bank money, or owns bank shares, can wake up in the morning to discover they have nothing. Or that their loan to the bank was converted into bank shares at worthless prices.

    One Italian committed suicide as a result of this. It’s very real. But it’s not what I want to focus on today.

    The purpose of a bail-in is to rescue a bank in a way that prevents contagion. Contagion is what usually makes a banking crisis so dangerous. Banks lend to each other a lot, so when one goes broke, the next one follows, then the next one…

    The traditional solution to this is a bailout. But politicians don’t want to pay for bailouts anymore. Some can’t afford it — their debt to GDP is at crisis levels. So they turn to depositors, lenders to the bank and investors instead.

    People who invest in and lend to a bad bank should weather the losses, after all. It’s called capitalism.

    The trouble is, the biggest lenders to banks are, you guessed it, other banks. So the bail-in solution doesn’t change the equation much. There will still be contagion as each bank is bailed in to rescue another.

    It’s a Bail-in Blow-up.

    Until next time,

    Nick Hubble Signature

    Nick Hubble,
    For The Daily Reckoning Australia

    The post The next financial crisis will be called… appeared first on Daily Reckoning Australia.

    Posted: by Daily Reckoning Australia

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