Dan Denning

Sound the alarm bells! A collision with reality is dead ahead!

The elephant in the room blasted out a mighty honk this weekend in a report by Access Economics, as reported in today’s Australian. “Batten the hatches,” Access says. “This is not just a recession. This is the sharpest deceleration Australia’s economy has ever seen.” Access adds that the federal budget is “buggered.”

“Leading economic forecaster Access Economics warns in its quarterly Business Outlook, released today, that the nation’s economic boom will ‘unwind scarily fast’, halving corporate profits, costing more than 300,000 people their jobs and blowing out the current account deficit to more than $100 billion.”

Dire stuff indeed. But the question from last week remains, is this massive dose of negative news already priced into Australian stocks? Or is it a further hammer blow that will drive them to new lows?

So far, the market seems to be taking the prospect of a prolonged earnings recession fairly well. Or maybe it’s just in denial. The Access report correctly points out that the fall in commodity prices will dry up government royalties and corporate taxes. This will lead to higher budget deficits, more unemployment, and a contraction in the mining industry after four years of break-neck expansion.

Australia’s government is now in the same pickle that Gordon Brown and Barrack Obama find themselves in: how do you distribute enough borrowed loot to keep your economy from shrinking without igniting inflation and a weakening of your currency? And if you accept that the government really can step in and spend money while households and businesses are not, where does it spend it? Roads? Bridges? Booze? Pokies?

Those are mostly political questions. Economically, it’s hard to see how corporate earnings will recover this year. Demand is falling. Miners are winding up projects. All this being the case, don’t look for earnings to lead to a big bear-market rally.

In fact, as we mentioned last week, we think it’s likely that you’ll see a large exodus of institutional money out of common stocks and into corporate bonds. Corporate bond yields are now much higher than what you’ll find in U.S. government bonds. And it is the habitual thing to do, changing asset classes rather than liquidating altogether.

The big sleeper so far this year is oil. Oil prices have fallen 25% since rallying to just over $50 last week. The leverage is out of the oil market. And with a global recession, the IEA now predicts oil demand will fall for the second year in a row. It’s the first time that’s happened since 1983.

But the real story is how the falling oil price is hammering oil producers. Multinational oil companies are cutting back exploration programs. They’re not looking for oil. And you can’t produce what you can’t find.

As for the national oil companies in Mexico, Venezuela, and Russia, well they too are being hit hard by the falling oil price. During the big run up to $150, national oil companies were cash cows. But it now appears that little of the oil bounty was reinvested in new production or even maintenance of existing production.

So what do we have now? We have a situation here. A situation where the falling oil price is leading a big reduction in oil production. This will match, for a while reduced demand for oil. But we also think it’s baiting the trap for a huge blowback in oil prices. And the spark for that could be geopolitical. More on that next week.

It didn’t seem possible, but things are getting worse for Americas largest commercial banks, Citibank and the Bank of Amerika. “The U.S. government, recognizing that the banking crisis is far larger than originally thought, is laying the groundwork for a second phase of its rescue attempt, with plans to purge bad assets that are paralyzing the financial system,” reports the Wall Street Journal.

Aha! Remember that phrase from last week, “incorporating the public debt?” This was the alchemical process by which a huge slab of outstanding debt was transferred to a new entity and converted into, ahem, “capital” in 17th century Britain. It now looks like you’ll see a new large national financial institution in America this year. It may even resemble a giant vacuum, or a garbage dump.

No matter what it looks like, it will be the receptacle for the metastasizing debt that is killing the financial sector. The Journal says that the discussions for the new “Bad Bank” between the Fed, the Treasury, and the FDIC, “show how the rapid deterioration of bank assets is outpacing the government’s rescue efforts. Banks are now struggling not only with the real-estate investments that sparked the crisis, but also with the car loans, credit-card debt and other consumer debt that have taken a hit with the faltering economy.”

We may as well get on with full nationalisation of the financial system. Thus far, it’s been incremental. But the end game is increasingly obvious now. Governments will either begin guaranteeing all mortgage lending and corporate debt (as plans in the U.K. suggest) and/or assume responsibility for the toxic assets impairing financial balance sheets (in exchange for equity).

What this means for stocks, paper currencies and gold bears more discussion. More on that next week.

Dan Denning

January 22, 2009

Dan Denning

Dan Denning is the author of 2005's best-selling The Bull Hunter. A specialist in small-cap stocks, Dan draws on his network of global contacts from his base in Melbourne, Australia, and is a frequent contributor to The Daily Reckoning Australia.

  • BC

    Comments to this reader

    “I read your article with interest. As an African, I most certainly don’t have your experience and/or knowledge, but I do believe that your article is true to historical facts as we know it. Would you not agree that the election of Obama as your president is a momentous historical event worth celebrating?”

    I disagree and I am dismayed that folks would want to celebrate this man becoming President just because of his color. I will be one of the first to celebrate if/and when he accomplishes anything credible besides winning an election. An expert at winning elections does not a good leader, and President make.

    I was disappointed that Obama did not set aside his pride, and tone down the inauguration to save tax dollars. I would have gained tremendous respect if he had done so. I hope that as an American, Obama will stay true to his platform of change and begin dismantling those institutions of government that the politicos were never given permission to form in the first place.

    True public service in the form of reducing the size of government vs. our GDP would put our country and it’s citizens on the road to real change, and would be worth celebrating.

  • MzScarlett

    The very FIRST car built in the USA by Henry Ford was built to last 100 years; contained no “formaldehyde” one of the most toxic chemicals on the planet; it got 26 MPG & ran on GRAIN ALCOHOL which is quite simply NOW known as ETHENOL; according to Washington Journal on C span Laurence Burns top researcher for GMC I believe the car company was: it was Weds of last week; ETHANOL is the “newest” thing: ANYONE can grow it as long as it is a non food source: like prairie grass/weed. SO: go to visit the teapot dome scandal; Prohibition was NOT about “temperance” at all: it was cuz ANYONE could make & grow ethanol: & the mentality that THE PEOPLE MUST PAY which is cuz the SAME FOLKS running the huge plantations went to our political leaders & said hey hey hey let’s do it THIS way instead; THIS “oil” was SHOVED down people’s throats for the very simple reason of making some folks rich. The USA has always worked THIS way: claiming to be a “democracy” they are not & have not been for a very long time; they write laws that are on the books only for looks with no intention of enforcing them; just to “please” or fool the public. They have cleverly changed the laws & rules with each administration: HOWEVER: in TRUTH this actually TAKES PLACE PRIOR to any “election”; cuz it is a one party system cleverly using the “divide & conquor”; it is all theatricals & charades; knowing the “power of image” they USE the TV & newspapers which are not free press at all; & most NEWSPAPERS are owned by folks who are in on this like Murdoch.
    The “country” of which THEY speak is NOT the true COUNTRY which of course consists of the majority of the population, the land, air & water. THIS is the “country” which of course only makes sense; however, they speak with forked tongues as my fathers ancestors learned: & have NEVER kept 1 single promise made to anyone of the Indian tribes; nor to the military: they are trying hard to create a “new world order” & it’s money: by bribing thru tillions of $ the heads of OTHER countries including Australia’s to hey hey hey do it our way, we have gotten away with it for years; they KEEP all the $ “at the top”; they RULE not Govern; NOTHING is done for social need; & they “courts” CALL to determine how to “rule” as seen in US FED court of appeals Mahr vs Ashcroft; Judge Sonya Sotomeyer on C span; they are a clever dictatorship who while listening to the people or appearing to do so, have NEVER listened to nor done what the PEOPLE wanted; oh, it may be on the books but no environmental laws at all have been followed nor many more. USURY laws predate the Constitution & THIS “housing” crisis & mess was deliberately created for such a time as now; cleverly they have done this for years with premediatated cold blooded malice in their minds & hearts toward not only the people of the USA but now globally.
    THIS is the REALITY of what is going on from country to country. They are told: keep all the $; have millions of dollars; do whatever you want, whenever you want, however you want & never be punished or brought to court for it. It is all “theatricals & charades”; in seeing them in their committess voting etc; Our leaders have cleverly gotten so incredibly much money from off the people thru robbing them repeatedly & the only “freedom” in the USA is the freedom for any & all to do whatever they want as long as it is against the people; the “PUC, & gov agencies are quite simply “shells” to FOOL the people into THINKING that they are there for them.

  • Tahoe Valley Lines

    “Railroads” & banking, sez he…

    Henry Ford made Model “T”, but made sure he owned a railroad: the Detroit, Toledo & Ironton, to assure he got his supplies on schedule. Another Whiskey writer mentions crucial times for America; Civil War and WWII, for example. 1863 marked the beginning of the US Trans Continental RR project; WWII included last big show for the rails, rail doing heavy lifting for unpecedented freight traffic, much on rehabbed, recently abandoned corridor, moved by steam power. Trucking has benefited from cheap petroleum, and must make rapid shift to other fuels to keep traffic share.

    While trucking strives to reorient fuel diet, USA must rehab remaining dormant rail branchlines to maintain mobility of critical freight & victuals. State National Guard organizations should recommission the Railroad Operating & Maintenance Battalions, assuring pool of rail savvy personnel for the civillian sector. Noticed by some, but not the responsibles with titles and big paychecks, miles of unused rail branchlines in and around the hurricane disasters in Louisiana & Mississippi. Certainly the rails could have helped with handling megatonnage of debris.

    An important military moniker: “Second Dimension Surface Transport Logistics Platform”, descriptor for railways. Quick read on strategic rail subject is in James A. Van Fleet’s little book, “Rail Transport and The Winning Of Wars” (Association of American Railroads, 202-639-2100).

    Investment advisors like Puplava, Whiskey Inc., and Catherine Austin Fitts have low-key references to railroads as a component in the Peaking Oil Solution Set, but stop short of outright support of an aggressive rebuild/rehab of the US rail matrix. This is an oversight, an omission with grave consequences. Railroads reaching local warehousing with foodstuff and perishables, goods & necessities of life, are more important than gold. Particularly when the Feds will eventually have to call in gold coins & Bullion in order to cover foreign exchange (read oil imports).

    Along with the State Guard office adjutants, investment advisors should obtain Railway Map Atlas volumes for their respective states. One source is (spv.co.uk), also museums, historical societies, and old (circa 1940-1960)Thomas Bros. maps are good for downtown rail footprint and track geometry servicing produce markets and goods warehousing.

    Bankers. Snap out of your reverie, pay attention to what’s up! We shall need your help to create a new generation of Equipment Trust Certificates, Railroad Construction Bonds, and local capital channels to rehab branch rail lines. A new US Savings Bond Series: “Energy Independence Bonds” are called for- this is an All-Hands-On -Deck situation. Fed Executive Orders to re-direct ferrous scrap to domestic mills producing railroad rail, track hardware is of importance now. Bank officials, contact General Motors, other automakers having idle plant and labor needing employment: transition to railway oriented production. GM is a recent Locomotive Builder, Diesels from La Grange, Illinois. GM is natrural partner to refocus America to the rail mode, just as they were instrumental in getting America onto rubber tires circa 1950.

    A helpful book on renewables applied to localized economies and transport, see “ELECTRIC WATER” by Christopher C. Swan (New Society Press, 2007) See Association For The Study Of Peak Oil & Gas, (peakoil.net) articles 374 & 1037 for other on the rail rehab.

  • http://forexfantastic.com/ geoff

    This is the sharpest deceleration Australia’s economy has ever seen..? hope so..

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