The Aussie Bond

What's all the discussion about bonds?  We know and love the iconic logo of the maker of our favourite "comfy undies" but there is a very different significance attaching to government bonds in Australia and around the world at the moment.

A government bond is issued by a national government and is denominated in the country`s own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. The yield required by investors to loan funds to governments reflects inflation expectations and the likelihood that the debt will be repaid.

The Australian  bond yield looks like this today:

www.bloomberg.com.au 5/6/2012

This is called an inverted yield curve and is generally interpreted as a leading indicator of recessionary times. Orange line is yesterday, green is today.  This afternoon's rate cut by the RBA in the official cash rate of 25 bps is in line with the bond market's expectations with the expectation of more to come.


The 12 month chart for the Australian Government 10 year bond looks like this.



www.bloomberg.com.au 5/6/2012

Australia's Government Bond Yield for 10 Year Notes have declined since October 2011 which means it became less expensive for Australia to borrow money from investors. Historically, from 1969 until 2012, Australia Government Bond 10Y averaged 7.9%  reaching an all time high of 16.4% in May 1982 and a record low of 3.1% in May of 2012. 

The international picture for bonds can be seen here:


www.ritholtz.com 2/6/2012

This week US government bond prices reached all time lows. German and Swiss bonds currently can be bought with a negative interest rate.  Other than the obvious argument of "flight to safety", why would anyone want to buy sovereign debt with a negative return? John Mauldin writes here 

But even given the pessimism in Europe, why should Germany be able to sell €5 billion of two-year bonds at zero percent interest last week and see them trade this week at a slightly negative interest? Why would anyone buy a bond that is guaranteed to not even give you your money back? Is that a sign of severe potential deflation?
The answer is, not really. Buying German bonds, even at a slightly negative rate, is actually a cheap call option on the eurozone breaking up. A German bond that became a new Deutschemark-denominated bond would rise in value at least 40-50% almost overnight. If you are a pension fund, for instance, with a lot of sovereign debt from a variety of European peripheral countries and you think a break-up of the eurozone is possible, it is a way to hedge your investment portfolio.
Switzerland actually sold outright this week bonds that have a negative coupon. Again, not a sign of deflation but another call option, betting that the Swiss Central Bank will have to give up on its peg to the euro. That peg has got to be one of the biggest losing trades in central banking history, and the Swiss seem determined to lose even more money. If the euro goes to $1.15 or lower, that trade becomes an even more massive loser. At what point in the next year will the Swiss Central Bank decide it has endured all the pleasure it can stand in fighting the fall of the euro? If they abandoned the peg, the move in the Swissie (as traders call the Swiss franc) would be large and almost instantaneous. And the reward for investors outside of Switzerland buying Swiss bonds with a negative yield will be large. 

What about inflation?

We know PMI numbers are showing economic contraction.  We know we are living in deflationary times.  Australians are deleveraging fast - retail sales are down and we are paying back personal debt to the banks at very high rates.  Unemployment in the USA and Europe is at persistently high levels.  This leaves central governments around the world able to employ strategies such as Quantitative Easing without an immediate inflationary effect. Mauldin offers the theory that this is due to the slowdown in the velocity of money - for a fascinating explanation see here.  For those without the desire to read more deeply, it follows from his argument that low bond yields are here for a long time and will not change quickly.

He says the Fed "will be able to monetize more than you think without causing a repeat of the 1970s.  Eventually it will catch up to us, as there is no free lunch, but they are betting they will be able to reduce some of the actual inflation by cutting back on the money supply and raising rates.  But we are years off from that. So, yes, at some point inflation will be back".

The following chart shows the US Federal Reserve's holdings of US government bonds and the timing of such purchases, relative to each wave of quantiative easing:

Deutsche Bank

The significance of the above chart can be seen when reading, from Deutsche Bank:

In addition, central banks (Fed, ECB, BoE, BoJ) buying government bonds has lowered supply of risk-free bonds real money managers can buy (for example, the Fed currently holds 30% of all 5-10 year US Treasuries outstanding).

Bottom line: More demand for risk-free assets and less supply of risk-free assets combined with significant long-term risks to global growth imply that interest rates are likely to stay low for many more years.

and via FT Alphaville on 4 June 2012:

...from JP Morgan’s Flows and Liquidity team on Friday, we have five reasons, other than quantitative easing, why rates will stay down for the foreseeable future:

- Regulations such as Solvency II, pension fund regulations, Basel III

- It is not only regulations inducing financial institutions to buy bonds, demographics may also be playing a part

- Due to ultra low policy rates, retail investors replaced money market funds with bonds as savings vehicle

- G4 central bank QE

- An acceleration of the global savings glut since the Lehman crisis.

- The end of the equity culture

What does a long term low priced bond environment mean? 

Bottom line, for self funded retirees in Australia, it means that we are likely looking at a low yield investment environment over potentially quite a long time.  This is not great news.

Jeremy Warner wrote in the London Telegraph in June 2011 (not much has changed in Europe in 12 months!):

The traditional relationship, which has ruled with only a small number of aberrations since the late 1950s, is that bonds yield more than equities. This juxtaposition is underpinned by the idea that equities are able to grow their earnings at least in line with GDP, and therefore over time will offer a better rate of return than fixed income investment.
The man most credited with creating this relationship was George Ross Goobey, who back in the 50s headed the Imperial Tobacco pension fund. By advocating equity investment as an appropriate policy for pension funds, he brought about a revolution in investment thinking.
Pension funds developed a previously non-existent appetite for risk and switched wholesale from fixed income into shares. The "cult of equity" was born. Shares began to yield less than bonds to reflect their supposedly superior growth and inflation hedging characteristics.
But what happens when growth slows, society ages and risk appetite diminishes? Well as it happens, bonds have been outperforming equities for many years now, but it was only with the onset of the financial crisis that the cult of equity's fifty-year reign started to crumble.
Post the Lehman crisis, we saw an extreme reversal in the yield gap, followed, after the policy response and signs of a spluttering economic recovery, by an uneasy truce, when the two yields essentially tracked each other. But since June this year, the relationship has gone unambiguously back into the post Lehman danger zone.
It's still too early to say this is the new normal. We are once more in one of those periods of extreme risk aversion, with multiple uncertainties crowding in on investors. It's not surprising that there should be a dash for safe haven assets.
In a downturn, corporate profits will fall, dividends will get cut and insolvencies will rise. Bonds, by contrast, become the default security of choice. Money that would normally be spent on consumption or invested in productive assets gets hoarded instead, generally in cash or the nearest equivalent, government bonds.
As risk aversion grows, a vicious circle establishes itself of falling demand, employment, and economic activity. The more risk averse that companies and households become, the more they save. In Japan, they've had this phenomenon for twenty years now and still there is no end in sight to the deflationary funk.
The mood is infectious; having let rip with deficit spending in the immediate aftermath of the Lehman's collapse, governments too are losing their appetite for further risk and are reining in as fast as they reasonably can.
It's hard to be bullish about prospects for equities right now. Investors won't return until uncertainties over the US and eurozone economies are lifted, and that's going to require a level of political leadership which right now seems entirely absent on both sides of the Atlantic.
Extreme volatility and sideways trading look set to remain the order of the day for some while. That's not to say equities are not worth buying. Some businesses prosper, even in a depression. But we seem to be going back to the old, pre-war days, when equity was priced for risk.
Equity is becoming scarcer, and therefore more costly, just at a time when large swathes of the banking and corporate landscape, not to mention the economy as a whole, need most.

Interesting times continue.

Superannuation - in the Budget

The Australian Commonwealth Budget was handed down this week and in amongst the detail there are two matters relevant for our clients.

Concessional Contributions
The government has deferred until 2014 its proposed raise from $25,000 to $50,000 in the concessional contributions cap for individuals over 50 with less than $500,000 in super.  This is a 50% reduction on the cap available this tax year.


It has been noted by industry commentators that this saving to the budget will come from the pockets of older taxpayers with relatively small superannuation account balances, the ones needing to boost their savings to ensure a comfortable retirement.

The lower $25,000 annual cap is likely to result in more taxpayers incurring penalty tax bills for exceeding the annual contribution cap. Even with the larger caps applying currently there are employees who are receiving penalty tax bills as a consequence of exceeding the annual contribution cap.  

Thomson Reuters comment:

The deferral of the start date for this measure will have significant implications for salary sacrificing arrangements and deductions for personal contributions and transition to retirement pension strategies.  Taxpayers will need to review their strategies before 1 July 2012 when the concessional contributions cap for those aged 50 and over will drop from $50,000 to $25,000 for 2012-13 and 2013-14.

A taxpayer aged 50 or over on the top marginal tax rate who is currently making full use of the $50,000 concessional contributions cap will effectively pay an extra $7,875 in tax if she or he has to restrict concessional contributions to $25,000 from 1 July 2012, and take the remaining $25,000 in cash salary.

Contributions tax rate rise
From Thomson Reuters' Budget Summary:

From 1 July 2012, individuals with income greater than $300,000 will have the tax concession on their concessional contributions reduced from 30% to 15% (excluding the Medicare levy).  This means that the tax rate on concessional contributions will effectively double from 15% to 30% for very high income earners from 1 July 2012.

It is noted:

Precisely how (and from whom) the Government will collect this additional 15% tax on concessional contributions for very high income earners will be determined following consultation with the superannuation industry. No doubt the Government may consider reintroducing a superannuation surcharge tax regime to collect this additional contributions tax directly from the superannuation fund holding the contribution on behalf of the very high earner.

We hope not as the cost to administer would significantly nullify the benefits of additional tax received.  The Government will be collecting a maximum of $3,750 from a taxpayer who contributes $25,000 into super where their taxable income plus super contributions exceeds $325,000 in the year.  This is an overall tax increase of 1.15%.  It is estimated it will affect approximately 180,000 taxpayers.

An easier way to collect this tax would have been to increase the personal tax rates for the high income earners and this option would not erode the desirability for retirees and those nearing retirement from boosting their super contributions.

The above changes to superannuation make negative gearing for high income earners outside super more attractive.  Treasury would be aware of this and the next "tax grab" from this group may be a limit on the amount of interest deductions.

For more information on the Budget read

Global PMI

Have a look at the the following mapped chart showing April 2012 PMI numbers.
PMI stands for performance of manufacturing index and readings below 50 (coloured pale pink, pink or red on the above map) denote a contraction in the activity with the distance from 50 indicative of the strength of the decrease.

Eric Platt/Business Insider

The second map is based on manufacturing reports from March, highlighting the rapidly changing conditions in both the U.S. (which saw continued strength), and Europe (which fell further into decline). It also shows improving conditions in Russia and worsening conditions in Australia and Brazil (commodity based economies with currency pressures).

Read more: here

For the Australian numbers and more information read here.  An interesting point to note from the PwC/AI Group report is that April 2012 was the 119th consecutive month of increasing input prices across manufacturing industries in Australia.

www.businessinsider.com 3/5/2012

On any analysis Australia's April PMI of 43.9 (a monthly drop of 5.6) shows a sharp decrease in manufacturing activity and must have formed a part in the RBA's decision last week to drop the cash rate by 50 basis points.

Other indicators are showing similar weaknesses.  Australian Services and Construction sectors are both showing significant declines according to the PwC/AI Group report.  You'll find commentary on this here too.

Following from our previous post about the international context of Australian investment decisions, these maps show quite clearly the strong improvement in the USA's manufacturing activity and the ongoing difficulties in Europe.

Investing in a QE World

www.bbc.co.uk

We've written a lot about global macro issues lately.  The debt issues of Europe and the USA are enormous and ongoing.  They remain unresolved.  The statistics are staggering: the combined central banks of the world have "printed" so much money since the GFC that their balance sheets now constitute a third of global equity values: see

Bianco Research: www.arborresearch.com, 27 January 2012

We maintain Australian investors need a global context for their investment decisions.

What is QE?
Quantitative Easing ("QE") is an expanding of balance sheets via increasing bank reserves.  The purpose of QE, as explained by this Bank of England video,  is to increase bank reserves through purchases of fixed income securities in order to lower interest rates.  This makes fixed income securities relatively unattractive/overvalued and pushes investors out the risk curve.  This should increase buying for riskier assets such as stocks, pushing them higher in price.  Theoretically these higher prices should lead to a wealth effect and increased economic activity. see

Everybody (else) is doing it
The  major economies of the world are exercising monetary policy in order to stimulate economic activity as the first chart shows.

By contrast, the Australian economy is undergoing an unprecedented mining boom at the same time as other sectors of the economy are contracting.  We call this our "two-speed" or "patchwork" economy.  Some argue it's a manifestation of "dutch disease".  The Gillard Government's trade policy is premised on the following:

Non-mining businesses seeking to retain their employees and contractors will need to bid for them against extremely profitable mining-related businesses. And since the mining boom is not confined to Australia, overseas bidders have also entered the market for Australian expertise. Similarly, the prices of materials and equipment used in mining-related activities are being bid higher.
An independent, inflation-targeting Reserve Bank, confronted with these price pressures, would be obliged to consider raising interest rates to prevent inflation from rising above its 2-3 per cent band of tolerance. The blunt instrument of interest rates hurts non-mining businesses and regions of Australia, accentuating the patchwork economy.
A further natural economic consequence of the mining boom is a rising exchange rate, the Australian dollar having surpassed parity with the greenback in November 2010 for the first time since well before the currency was floated in 1983. A high Australian dollar has the desirable consequence of putting downward pressure on prices by lowering the cost in Australia of imported goods and services — taking some pressure off the Reserve Bank to lift interest rates. But a high Australian dollar is also damaging our import-competing and export industries, weakening their ability to compete for productive resources against mining-related industries. While this, too, has an anti-inflationary effect, it is more deeply embedding the patchwork economy.

What to do?
Where does all this money printing  leave the Australian investor?  Holding your deposits in cash eats away at their value longer term if inflation kicks in.  How does the SMSF Trustee determine the best course for achieving the returns required to fund retirement?

You could take the risk of riding the upward trajectory of the risk markets such as stocks.  The risk is described well here

Until a worldwide exit strategy can be articulated and understood, risk markets will rise and fall based on the perceptions and realities of central bank balance sheets.  As long as this is perceived to be a good thing, like perpetually rising home prices were perceived to be a good thing, risk markets will rise.
When/If these central banks go too far, as was eventually the case with home prices, expanding balance sheets will no longer be looked upon in a positive light.  Instead they will be viewed in the same light as CDOs backed by sub-prime mortgages were when home prices were falling.  The heads of these central banks will no longer be put on a pedestal but looked upon as eight Alan Greenspans that caused a financial crisis.
The tipping point between balance sheet expansion being bullish for risk assets versus bearish is impossible to know.

A new option for Australian investors
One new option is to consider a high interest cash exchange traded fund such as Beta Shares new offering, the Australian High Interest Cash ETF.

Characteristics of this product include:

• diversification of investment portfolio - the product as part of a cash or term deposit allocation aims to earn a higher rate of interest than the 30-day bank bill swap rate after fees and expenses
• suitability for cash flow for SMSF pension holders - monthly income payments may be made
• the ETF is backed by deposit with an Australian bank trading under new ASX AQUA rules
• investors buy and sell units in the ETF through a broker (and pay brokerage)
• as interest is earned each day on the deposit, the value of the ETF will rise, providing investors with liquidity, coming with the ability to sell at any time without penalty (in contrast to term deposits).

We note:

• the Government Guarantee on bank deposits for Australians is now limited to $250,000 per deposit with one bank/ADI (authorised deposit taking institution).  Participation in a cash ETF does not equate to a deposit for the purposes of the government guarantee.
• A Cash ETF provides the possibility for a spread of risk from one institution to many, exposing the investor to multi-party credit risk akin to the former Macquarie Bank Cash Management Trust product.  (Note: the current Macquarie CMA attracts single party credit risk). 
• the BetaShares Cash ETF currently only offers single bank risk (Westpac) though the PDS describes the possibility of deposits with other major Australian Banks: see here Accordingly, we recommend this is a product to watch, and once they and others offer diversification of credit risk we would recommend our clients to consider these products.

There are similar new products coming onto the market in Australia such as offerings from  iShares and Russell Investments.  You can read more about these products in The Age/SMH or call us to have a chat about your needs and risk appetite.  

Please note this is not financial advice and you should not rely on opinion/s expressed in this blog post.

Barry Ritholtz: US Banks and Housing, Greek Default & Euro Sovereign Debt

www.labouratorio.it 28/07/2011

If you are trying to make sense of macroeconomic issues in the USA and Europe, and wonder about the degree of interconnectedness of the global banking system, you must see this. Watch the Bloomberg TV video:here


Barry Ritholtz, chief executive officer at Fusion IQ and author of "Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy," talks about the health of the U.S. banking system, the housing market, and Europe's sovereign debt crisis. Ritholtz, speaks with Tom Keene on Bloomberg Television's "Surveillance Midday" on Monday 5 March 2012 (Source: Bloomberg)


As Ritholtz notes in the Bloomberg interview, the issues surrounding CDS's  (in relation to Greek debt) have been experienced in the USA (in relation to mortgage securitization) with devastating consequences only recently.  


In 2008, Steve Hsu, Professor of Physics at the University of Oregon created a chart, designed to show the interrelationship of CDS's in the US mortgage market, see here.  It attempts to explain in simple terms the incredible complexity of the market in which AIG operated, which created the systemic risk to the US banking and financial system which ultimately required such massive public bailout.  Hsu writes:

Imagine removing -- due to insolvency, lack of counterparty confidence, lack of shareholder confidence, etc. -- one of the nodes in the middle of the graph with lots of connections. What does that do to the detailed cancellations that reduce the notional value of $45 trillion to something more manageable? Suddenly, perfectly healthy nodes in the system have uncanceled liabilities or unhedged positions to deal with, and the net value of contracts skyrockets. This is why some entities are too connected to fail, as opposed to too BIG to fail. Systemic risk is all about complexity.

The lack of transparency and complexity of CDS arrangements is a significant uncertainty in the current Euro debt crisis.  But in addition to these factors we note the perception is increasing that CDS will not achieve the purpose for which is was designed.  Why?


Ritholtz speaks plainly.  In relation to the CDS issue (which we addressed on 9 November 2011 here)  he writes on The Big Picture: What are the repercussions if CDS hedging fails?  a fascinating piece on 3 March 2012.  He lists the participants on the committee which determines whether a default has occurred for the purposes of paying out under a CDS.  

Who is on the ISDA committee?

• Bank of America Merrill Lynch
• Barclays
• Credit Suisse
• Deutsche Bank AG
• Goldman Sachs
• JPMorgan Chase Bank, N.A.
• Morgan Stanley
• UBS
• BNP Paribas
• Societe Generale
• Citadel Investment Group LLC
• D.E. Shaw Group
• BlueMountain Capital
• Elliott Management Corporation
• PIMCO

A day earlier (2/3/12), Ritholtz posted this piece explaining this history behind the deregulation of derivatives such as CDS in the USA.  We've not read this elsewhere to date.  It's worth restating (bold & italics added):

Credit Default Swaps (CDS) are Insurance Products, Not Tradeable Assets
Our story thus far:  The Commodity Futures Modernization Act of 2000, sponsored by Texas Senator Phil Gramm as a favor to his wife Wendy (who sat on the Board of Directors of Enron, which wanted to trade energy derivatives without oversight) was rushed through Congress in 2000. Unread by Congress or their staffers, it was signed into law by President Bill Clinton on the advice of his Treasury Secretary Lawrence Summers.
The CFMA radically deregulated derivatives. The law changed the Commodity Exchange Act of 1936 (CEA) to exempt derivatives transactions from regulations as either “futures” (under the CEA) or “securities” under federal securities laws. Further, the CFMA specifically exempted Credit Defaults Swaps and other derivative products from regulation by any State Insurance Board or Regulators.
This rule change exempting CDS from insurance oversight led to a very specific economic behavioral change: Companies that wrote insurance had to explicitly reserve for expected losses and eventual payout in a conservative manner. Companies that wrote Credit Defaults Swaps did not.
Hence, AIG was able to underwrite over THREE TRILLION DOLLARS worth of derivatives, reserving precisely zero dollars agianst potential claims. This was enormously lucrative, except for that whole crashing & burning into insolvency thingie.

The radical deregulation the CFMA generated led directly to the collapse of AIG, Bear Stearns and Lehman Brothers; indirectly to the collapse of Citigroup, Bank of America, and Fannie/Freddie. It was a significant factor in the near death experiences of Goldman, Morgan Stanley and others.
Despite the horrific impact this legislation had, it was never actually overturned, only modified. Obama made the personnel error of bringing back Larry Summers (he apparently had not wrought enough damage to the nation yet). Rather than admit the error of CFMA, and overturn it, Summers instead downplayed its role. Thus, the CFMA was merely modified somewhat. The same risk the CFMA presented to the economy still exists. Swaps now must be be cleared through exchanges or clearinghouses — but they are still exempt from Insurance regulations. Which is bizarre, because they are little more than thinly disguised insurance products, with the CFMA kicker that there is no reserve requirement. Counter-parties may or may not demand one, but the dollar amount is negotiable.

Which brings us to today.
The Greek government has been declared in default by S&P; most common sense definitions of default — failing to make payments on a timely basis, declaring your intention to default, involuntary change of loan terms by borrower, etc. — have already occurred.
That last point is especially important in light of the Greek Sovereign Debt default — which International Swaps and Derivatives Association, in a nonpublic meeting of derivatives bankers, declared to be a NONDEFAULT.

I’ll be damned if I can figure out why.

Any tradeable asset — stocks, bonds, futures, options, funds, etc. — settles on its own. There is a market price the asset closes at, a total volume of sales, and a final print for the day, month, quarter and year.  No interpretation required.
Yet with Greek CDS, we have a committee of bankers, lawyers, accountants and other interested (not unbiased) parties interpreting the details, weighing the circumstances, describing what happened.
Does that sound like a tradeable asset to you?  To me, it sounds more like an insurance policy dispute. Because in reality, these CDS are in fact, nothing more than an unreserved and unregulated insurance products.  That is the legacy of the CFMA, and one that apparently has not been overturned.

The banks, hedge funds, and securities firms who are the prime dealers of these products  greatly prefer to have their derivatives supervised by Federal regulators. Why? Because the standards they use — general safety and soundness — are empty-headed nonsense, easily evaded.
The State Insurance Boards and Regulators are far more exacting, far more specific — and require boatloads more money in reserve.
Hence, this is how the Greeks have managed to default, yet an insurance-like product will not (yet) payout. With insurers or their regulators involved, this would never have happened.

And the day before, read here on 1 March 2012:

“The International Swaps and Derivatives Association said on Thursday that based on current evidence the Greek bailout would not prompt payments on the credit default swaps. ”Here is a question for the crowd: Exactly how brain damaged, foolish and stupid must a trader be to ever buy one of these embarrassingly laughable instruments called derivatives? The claim that Greece has not defaulted — despite refusing to make good on their obligations in full or on time — is utterly laughable.  In order to get paid on a default, you need a committee to evaluate whether or not failing to make payments is a — WTF?!? — default?  Even more ridiculous, the committee is composed of biased, interested parties with positions in the aforementioned securities?ISDA: After this shitshow, why on earth would anyone EVER want to own an asset class that requires you to determine payout? Indeed, why should ANYONE ever buy a derivative again?

The question then becomes, what happens to CDS's held in relation to other sovereign debt after the current Greek debt situation is resolved one way or another?  Ritholtz' interview with Keene indicates there is significant doubt surrounding the future efficacy of the system as presently designed outside "blue chip" government bonds.


The coming few days will tell the story of whether the CAC (Collective Action Clauses) are triggered by virtue of the % uptake of the PSI (Private Sector Involvement) in the Greek bond deal, and accordingly, whether a default is determined by the ISDA.


A non-default declaration by the ISDA in circumstances where the CAC is triggered would beggar belief, and we remain sceptical of the system.

Australia's Debt Position - the whole picture

Household Debt

Daily in the mainstream media we are told "Australia's debt is very low by international standards".  In terms of government/sovereign debt, this is undoubtedly true and this is extremely important.

However, add in household debt and that of companies and financial institutions and a different picture emerges.  The following chart, from macromonitors.com using 2011 data tells a very interesting tale:

Leaving aside the corporate debt position, you can clearly see Australia's household debt position relative to the ten largest mature economies of the world is significantly larger.  Yes, our government debt levels are relatively low.  But put the picture together and then Alan Kohler's excellent piece in yesterday's Business Spectator starts to make real sense.

Kohler writes:

 The only thing that makes sense as a single cause of Australia’s misery is excessive debt.He makes the points:-

• Household debt has stayed at its historic highs of around 150% of disposable income for the past five years where other countries' households have deleveraged;
• Interest paid as a percentage of income has doubled in 20 years;
• the cost of land is among the highest in the world (in spite of Australia being so sparsely populated)
• restrictions on residential developments in cities combined with population growth have also contributed to extremely high prices for residential real estate
• reductions in mortgage rates don't counteract the psychological effect of the size of household debt.

So in the current political environment in Australia where "middle class welfare" such as the private health rebate is currently in issue, it makes sense to appreciate the pressure and stress created by these levels of personal indebtedness.

Kohler again:

And now there is widespread terror that house prices will eventually collapse and leave millions with no equity, as happened in the United States. As a result the savings rate has skyrocketed and consumers are on strike, putting money aside for Armageddon.

Debt is making everyone grumpy and hypersensitive. When ANZ put up its mortgage rate by just 6 basis points last week – 0.06 per cent for heaven’s sake! – there was national outrage and attacks in parliament

Our daily diet of gloomy news from Europe and the United States in relation to debt is ringing the warning bells in Australians' minds.  We know we are part of the global economy and there will be fallout for Australia from the current financial calamity unfolding in Greece and other nations of Europe such as Spain, Ireland, Italy and Portugal. We also see from afar the politicians' seeming inability to take bold political decisions and we watch distrustfully the involvement of the hedge funds and bondholders in the process of "voluntary haircuts".

So we need to listen when Kemal Dervis (former Turkish Economics Minister, Administrator of the UN Development Program and vice president of the World Bank, currently Vice President and Director of the Global Economy and Development Program at the Brookings Institution) writes on Project Syndicate:

Beyond the specific problems of the monetary union, there is also a global dimension to Europe’s challenges – the tension, emphasized by authors such as Dani Rodrik, and Jean Michel Severino and Olivier Ray, between national democratic politics and globalization. Trade, communication, and financial linkages have created a degree of interdependence among national economies, which, together with heightened vulnerability to financial-market swings, has restricted national policymakers’ freedom of action everywhere.

Perhaps the most dramatic sign of this tension came when Greece’s then-prime minister, George Papandreou, announced a referendum on the policy package proposed to allow Greece to stay in the eurozone. While one can debate the merits of referenda for decision-making, the heart of the problem was the very notion of holding a national debate for several weeks, given that markets move in hours or minutes. It took less than 24 hours for Papandreou’s proposal to collapse under the pressure of financial markets (and European leaders’ fear of them).

Around the world, the stock of financial assets has become so large, relative to national income flows, that financial-market movements can overwhelm most countries. Even the largest economies are vulnerable, particularly if they are highly dependent on debt finance. If, for some reason, financial markets and/or China’s central bank were suddenly to reject US Treasury bonds, interest rates would soar, sending the American economy into recession.
But being a creditor does not provide strong protection, either. If Americans’ appetite for Chinese exports suddenly collapsed because of a financial panic in the United States, China itself would find itself in serious economic trouble.

These interlinked threats are real, and they require much stronger global economic-policy cooperation. Citizens, however, want to understand what is going on, debate policies, and give their consent to the types of cooperation proposed. Thus, a more supra-national form of politics is needed to re-embed markets in democratic processes, as happened during the course of the twentieth century with national politics and national markets.

The scale of this challenge becomes apparent when one sees how difficult it is to coordinate economic policies even in the European Union, which has moved much further than any other group of countries in the direction of supra-national cooperation. Nonetheless, unless globalization can be slowed down or partly reversed, which is unlikely and undesirable in the long run, the kind of “politics beyond borders” for which Europe is groping will become a global necessity.

Indeed, the European crisis may be providing a mere foretaste of what will likely be the central political debate of the first half of the twenty-first century: how to resolve the tension between global markets and national politics.

EU Creditwatch: S&P - so what?

S&P put Eurozone on credit watch

Stephen Bartholomeusz' summation of the overnight news from Europe is worth reading.  He makes the following points (emphasis is ours):-

1. The reasons cited by S&P for putting 15 of the 17 core eurozone members on negative credit watch, which means they could be downgraded within 90 days, are very familiar to the markets, which had acted pre-emptively as it became apparent that the eurozone authorities were struggling to respond to the escalating crisis.
2. The ratings agency referred to tightening credit conditions across the eurozone. Credit conditions have been tight for months, to the point where European debt markets are effectively shut and bank lending has shrivelled.
3. The continuing disagreements between policymakers about how to tackle the crisis and ensure fiscal convergence in the longer-term has been the central factor in the market’s increasing fear and loathing of all things euro, although at least the agreement between Germany and France overnight provides a pathway towards the longer-term objective, with a mechanism for binding members to fiscal discipline and sanctioning those who stray.
4. The eurozone, as S&P noted, is awash with debt at both the government and household level, a situation compounded by the near-inevitability of a region-wide recession. It is that combination, and the apparent freezing under pressure of eurozone policymakers unable to respond to the complexity of the crisis, that caused the markets to take fright months ago.

The effect of a S&P downgrade?

1. It could...impact intra-eurozone holdings of sovereign debt and the pricing of any new debt issued. There are institutions that can, or will, only hold AAA-rated paper.
2. It may also affect the ability of the European Financial Stability Facility – which the eurozone authorities are hoping to leverage to help bail out and support sovereign debt refinancings – to raise funds itself. It would certainly adversely impact the EFSF’s cost of funds.

In summary:

The pact between Germany and France does provide a blueprint for a different and more effective pan-European fiscal regime in future, but doesn’t address the near-term issues and the need to reassure markets that the authorities have a plan to stabilise Italy and Spain, to re-open credit markets, stabilise the eurozone banking system and maintain some level of economic growth to blunt the severity of the austerity policies being imposed on the more indebted nations.
In the absence of a compact that deals directly with the immediate issues, the crisis will only deepen, destabilising not just the eurozone but the global economy and financial system in the process