Links Oct 22: Post haste

Australia Post to take on banks. The Age
Britain slashes. Washington Post
ForeclosureGate and systemic risk. Baseline Scenario
A first for China. GDP down, CPI up. Econompic
And here's why. John Garnaut
Global steel production falling. Steel Orbis
The road to tariffs. John Taylor
US needs help breaking yuan peg. FT Interesting question, this. If the US is going to start with tariffs, isn't Australia better off supporting a break in the yuan peg?

Reverse engineering ore prices

A couple of excellent pieces are available today on the looming iron ore glut. The first is by Malcolm Maiden of The Age on Australian miners and their plans to expand production. The second is by Australasian Investment Review via the IBT on broader statistics in the global seaborne trade. Both are worth your time.

At some point this blog will take on the data storm around iron ore supply and demand but that will have to wait. For today, it would like to address the enduring mystery that is benchmark iron ore pricing.

Reliable sources in the industry have confirmed for this blogger that the Q3 (July-Aug) quarterly (benchmark) contract for Rio iron ore is in the high $150s per tonne and BHP close to that.

We also know that the Q3 benchmark was a 23% rise over Q2 (April-June).

We also know that the Q4 benchmark has been agreed at 10% lower.

We also know that the majors use a trailing formula of the preceding quarter's spot prices to calculate the following quarter's pricing.

Having averaged the daily spot market price for Q2 (the things this blogger does!), it has determined that the mean price over the three months is a close enough fit with the actual price changes to approximate the major's formula.

But, when applied to the change in the Q4 benchmark this no longer held. If the daily average of spot prices over the three months in Q3 was the key factor then the price for the Q4 benchmark should have fallen 16%. It actually fell 10%.

Assuming the Bloomberg data used is correct, this suggests several intriguing possibilities: First, the ore price formula is not simply the average price over the preceding quarter. Second, whatever the formula is, prices are more sticky going down than they are going up. Third, customers are going to abandon this system the first chance they get.

No wood, all trees...

According to Banking Day:

In a speech to a Finsia financial services conference, [RBA boffin Luci] Ellis argued that far from being complacent about a bubble, the RBA was searching for danger signs.

But, she said, it was important to go beyond statistical averages to understand the housing market. As an example, she set out new detailed data on housing loans suggesting that loan-to-valuation ratios are rising because there are fewer low-ratio loans, not because there are more high-ratio ones (see graph).

Ellis argued that simple ratios based on average data had wrongly led some observers to conclude, in the mid-2000s, that the US was less likely to have a housing price bubble than many other countries. In fact, while the average US borrower was safe, one group of US borrowers was taking out loans they could not pay back.

Prudential supervisors needed to see “the concentrations of risk, not just what is happening on average,” she said.

In riposte, this blogger will simply note an old expression that goes something like 'can't see the wood for the trees'. Below find an average that speaks for itself. Presenting updated charts of the earlier Housing Velocity post:









And just to prove its all damn lies and statistics, this blogger found a chart at the ABS which shows all of the established dwelling sales in this series are grossly underestimated. The below is owner-occupier sales only so if we add investor sales then the total turnover numbers rocket above the APM aggregates. Despite the discrepancy, the ABS data only strengthens the overall point. From 1997 to 2007 established dwelling sales were up 74% versus population growth of 15%.

We've been trading houses like footy cards since the nineties.

Links Oct 21: Iron fist

Fall out from China's rate rise. John Garnaut
The big supply-side iron response. Malcolm Maiden
The coming ore glut. IBT
Short term Chinese ore demand. Steel Orbis
BHP: ore pricing to go monthly. Trading Markets
Coal boom ahead. Mining Weekly
China gettin' nasty on rare earths. NYT
American plutocracy. Robert Reich
Capital controls debated. FTbeyondbrics
Saskatchewan hands Feds excuse to reject BHP bid. FT, Matthew Stevens
Dollar crisis tail risk. Naked Capitalism

In the dark

According to Reuters, Luci Ellis of the RBA said today that:

Financial institutions will have to share more information on their activities with authorities to lessen the risk of another global financial crisis... it was important that regulators could detect the build-up of risk and leverage as it happened and where the risk was concentrated. "All of these concerns imply that financial institutions will be expected to report – and disclose – more information than in the past...Financial stability analysts don't just need accurate data: we need more data, new analytical tools and in some cases a broader approach to that analysis."

This is a bit rich isn't it? The RBA wants more information even though it and APRA won't give the market any. As discussed in the Invisopower! post, we are all in the dark about what precisely are the individual banks' wholesale debt positions and their respective maturity profiles, as well as who used the guarantee.

This blog understands that since the 1997 Wallis Inquiry, Australian financial system architecture has been divided in two. On one half, we have deposit-taking institutions whose capital ratios are controlled and policed by APRA. On the other half, we have market mediated credit, that is disciplined by the efficiencies of an informed market and governed by ASIC.

If we look at the letter of the regulatory law, regulators might be within their rights to withhold information on banks.

However, during the GFC, both halves of the architecture collapsed. The efficient market hypothesis turned out to be a chimera and when stressed, market mediated credit froze and originators disappeared. RMBS have only been issued since by dint of AOFM giveaways.

Similarly, when under stress, bank liabilities overwhelmed both the RBA and APRA safeguards. They needed a Budget guarantee.

There are, therefore, acute public interest questions to be answered about both halves of the regulatory structure around credit mediation. A gigantic moral hazard working at the heart of the both is hardly a solution.

Back to the article, Ms Ellis concludes:

"...When I am at international meetings, I sometimes hear my counterparts complain that they cannot get all the data they need from the supervisor." Ms Ellis said. "I'm glad to say that in Australia we don't have that problem."

Could have fooled this blogger.

Irrational policy

For the past few years, we've heard a great deal about the irrationality of punters in the "market". And rightly so. We humans are a bunch of hysterical children driven crazy by bouts of greed and fear. Not to mention other feelings.

But we never hear about the same irrationality effecting policy-makers.

Somehow our regulators are seen to be above emotional pressures. They are the parents guiding the market, immune to the maelstrom of feelings that guides everyday economic decision-making.

Yet even a quick glance at recent history makes that assumption laughable. Take the following as several examples:

Did Hank Paulson act rationally in evoking the US TARP bailout of US banks? Even as it was created it morphed from a plan to buy toxic mortgages to one designed to recapitalise banks.

Or, how about the captains of global economic management at the IMF or the G20 who swung from recommending balls-to-the-wall stimulus to all-in austerity in the blink of an eye.

Or, how about the Mastro himself, Alan Greenspan, who was so irrationally committed to a one-eyed libertarian view that he overlooked the most heinous debauching of banking practice in history.

Or, how about the delusion of Australian regulators who felt the banks could accumulate vast quantities of offshore debts without any adverse consequences for the economy or themselves? Not to mention yesterday's revelations (rumours) about the consequent shadow dance taking place between the RBA and the banks.

Perhaps it is the staid appearance of regulatory authorities that so fools us (though it must be said there was nothing rational about Alan Greenspan's choice of glasses). Or, it is the great, grey buildings they occupy that offers the perception of an immovable solidity.

Personally, being a media hack, this blogger puts it down to the trappings of power. That cloak of rationality, legitimacy and above all objective reality, that power provides.

We irrational little sheep don't want to challenge that. To do so would be to expose ourselves to our own vulnerability, alone and unprotected against a very large and cold universe (and this blogger is happily married).

Nonetheless, there are days, this being one of them, when the fog put forth by the talisman of power is rent and we catch a glimpse of the unsteady hand at the wheel of our fortunes.

As today's links make clear, a battle royal is underway about how best to handle America's slow recovery, China's speedy one and the fallout for everyone else.

So far as this blogger can tell, there is no clarity or consensus of thought on these issues.

It is at such times that we must rely on another form of irrationality to guide us: institutional memory. Regulators will do what they've always done, until the roof caves in, and probably still then.

It's always possible that the G20 will negotiate a settlement between the two great powers in Seoul. But unlikely. And in that event QEII will proceed with all of its consequences.

In Australia, it's always possible that the RBA and banks will negotiate a settlement of mutual satisfaction. But unlikely. Wouldn't it more rational to allow a new Wallis Enquiry to throw the light of reason onto how the bank's offshore debts have rewritten our financial structures?

Links Oct 20: Policy chaos

US QEII fail. Joseph Stiglitz
US QEII fail. II. Stephen Roach
BOE QEIII fail. Bloomberg
RBA fail. Stephen Bartholomeusz
China raises interest rates. Bloomberg
A good idea. Michael Pettis
QEII bad for China says Yu Yongding. Bloomberg
The political economy of QEII. The Economist
China still buying Treasuries (hint for Gotti). Economipic
ForeclosureGate gets serious. Zero Hedge I, II
Risk off: I, II, III
Great news: RSPT deal in trouble. SMH
Wine catches Dutch Disease. The Oz
Universities already have it. (h/t The Lorax) ABC
Ore ramp done? Reuters
China ore demand to slow in 2011. Reuters
But not for copper. Mining Weekly

The gold bubble

Ten years ago, when the NASDAQ bubble came a-cropper, this blogger was a day trader. And yes, like many others it took a bath.

It was an invaluable lesson. It offered an inside glimpse of bubble psychology. How a market can dislocate and seize the collective imagination. And how, afterwards, the whole thing appears so outlandish, populated with fallen heros like Chris Tyler of star tech rocket Solution6, which was bought by Telstra in a play to merge it with Sausage Software at the peak of the madness.

Within a few short months, Tyler was on the streets carrying the moniker "Two bags". As the market fell, a previous conviction for pot smuggling in the US had been exposed. He had been caught with two garbage bags of weed.

Such is the lunacy that takes hold in a market mania.

We should juxtapose this, today, with a piece in the FT by Mark Williams, who apparently "teaches finance at Boston University School of Management". In it, he labels the gold bull market a gigantic bubble because:

Historically, two-thirds of gold demand comes from the jewellery industry and from countries like India and China. The remaining demand is generated by investors, manufacturing and the dental industry. But over the last four years, gold has staged a spectacular price rise and won many new investors. Everyone from hedge funds to individuals has jumped in, seeing gold as a way to improve portfolio diversification. Today portfolios often allocate 5 per cent or more to gold. A decade ago such an allocation in sound investment circles would have been heresy.

Market dynamics have changed too, with investors playing a larger part in what is driving prices higher. Now private investors hold over 30,000 tons of gold, more than the entire holdings of all the central banks on the planet. In short, gold fever has arrived on both Wall Street and Main Street. But all fevers eventually break.

The 2010 gold bubble is fuelled by a combination of five main factors: historically cheap cost of borrowing, a prolonged bull market, early profiteers, marketing hype and the risk being ignored. Investors claim that the current market high of $1,380 an ounce is not overpriced, but a reflection of global economic uncertainty, high unemployment and a decline in currency values. Gold is acting, as it should, as a hedge.

Investors also point to the 1980 bubble, when gold peaked at $850 an ounce and plummeted by 60 per cent in one year, as an aberration. Inflation was then over 13 per cent and short-term interest rates were above 16 per cent. Today none of this exists. Gold enthusiasts note the 1980 pre-bust price in today’s dollars and say gold must climb to $2,100 before hitting such dangerous levels. But such logic is flawed in that it assumes that 1980 is a good benchmark for the future. Ignored is the 20-year period from 1980 to 2000 when money invested in gold was dead money.

Today price is increasingly being determined by investors’ insatiable appetite for gold. But what happens when the shine wears off?

After this blogger's misadventures with tech stocks, it spent a lot of time researching what had gone wrong. It concluded that the NASDAQ bubble was nothing more than the latest expression of a deeper problem; that Keynesian US monetary and fiscal policy was being destabilised by a doomsday cycle of increased debt. That meant asset bubbles were now everyday events. It recommended to everyone it knew to buy gold. Generally, it was laughed at.

Since then, the doomsday cycle has only gotten worse, to the point now where it is threatening to engulf the entire world in a trade war. The underpinnings are as clear as day with the US stuck in debt-deflation and having to reverse course on its policies of de-industrialisation (just as we will have to).

The moral of this story is that these are fundamental drivers for the gold price. So far as this blogger can see, gold is the only asset that has such long-term, strategic fundamentals. Look at the alternatives: Housing is laughable, equities and bonds are in a Fed bubble; emerging markets are caught in a trade war, industrial metals are fine but hostage to Chinese GDP growth. Gold is all there is. This is why countries, like the ROK, are revisiting gold as a reserve asset. Back to the article:

Despite their human origins, most bubbles are not easily spotted until it is too late. The dotcom bubble took four years to burst; the real estate bubble six. The last speculative gold bubble, in 1980, took four years to implode, while this latest reincarnation is seven years in the making. This bubble will likely be pricked only when economic outlooks improve and unemployment figures in countries like the US drop below 8 per cent. This might come in 2011, but it could take much longer.

The learned gentleman is right about one thing. Gold will sell off, probably dramatically at some point. It is a very volatile market. But the bull market won't end until US monetary and fiscal policy are cured with discipline somewhere far into the future. Either that, or the $US is replaced by a global reserve currency backed by discipline. A point implicitly acknowledged by Williams:

Unlike previous asset bubbles gold is a tiny fraction of total global investment capital. When the bubble pops, it will represent less than 2 per cent of the world’s total. Those most hurt will be the investors who are the last ones out. These tend to be the smaller investors – just as in the real estate bubble, those who can least afford to lose. However, in the aftermath of the credit crunch we have entered into an era in which global systemic risk is high and unpredictable. Even small events, seemingly unrelated, can trigger larger financial events.

If there is a silver lining to this bubble, when it does go bust, and gold prices plummet, it will be a sign that the global economy has snapped back from economic chaos to prosperity. This will signal job growth, stable currencies, a stop to US Federal Reserve quantitative easing. Then there will be little reason to own gold. In the end, speculators will relearn an age-old lesson: gold in times of financial stability is hazardous to investor health. Like tulips, it is pretty to the eye but does not provide lasting sustenance.

In short, when the great struggle of our time ends, so will the gold bull market. This blog is not holding its breath.

This is not investment advice and this blogger does not hold any investments outside his home and cash.

Links Oct 19: Gold rush

ROK joins gold rush. FT
Gold over the long run. Econompic
Gold's bull market. PragCap
When the gold bubble bursts. FT
Fed wants equities bubble. David Rosenberg
And from 2009, when Greenspan confessed the same. FT
But can only get it through emerging markets. Doug Noland
Who's buying the US Treasury's in the UK? (take a guess) Zero Hedge
ROK rocked by currency war. Joongangdaily
UK QEIII. Bloomberg
yuan will not rise. Reuters
G20 coming. Reuters
Australia gets QEII boobie prize. Peter Hartcher
"Show me the note". ForeclosureGate crux. Zero Hedge
Frozen by fear of ForeclosureGate. Baseline Scenario
Steel squeeze. Global Times
Vale at full throttle. Steel Orbis
More parity porn. Peter Martin

Enemy mine (updated)

Any regular reader of this blog will know two things for certain. The first is that it is intensely concerned about the effects of Dutch Disease. The second is that it finds Ross Gittins's smug baby-boomer prattle intensely annoying. So, when you put those two things together, spleen hits the screen.

From Gittins today:

Our high dollar - which could easily go higher - is imposing considerable pain on our farmers, manufacturers, tourist operators and education providers. The pain will intensify over time, but guess what? The econocrats think it's a good thing.

The pollies don't mind either, because the punters think parity with the US dollar is Christmas come early.

Remember, too, that about three-quarters of Australian industry is non-tradeable - it neither exports nor competes against imports. So it is not directly affected, except to the extent that it uses (the now cheaper) imported components and capital equipment.

A higher exchange rate is anti-inflationary and thus does a similar job to a rise in interest rates. It lowers the price of imported goods and services, which reduces consumer prices directly (though, these days, the process is quite attenuated, with foreign suppliers and importers tending to absorb rather than pass on the short-term ups and downs in the exchange rate).

As well, a higher dollar helps to ease inflation pressure by redirecting some domestic demand into imports (for instance, it makes locals more inclined to holiday abroad than at home) and by dampening production of exports (such as accommodation for foreign tourists or education for foreign students).

So, to some extent, a higher exchange rate is a substitute for further rises in the official interest rate. But I wouldn't take this to mean a further rise in rates this year is now unlikely. At best it could mean a rise in early December rather than Melbourne Cup Day.

This blog doesn't dispute any of this. The dollar should rise during such a boom and it does do all the things outlined. However, the question Gittins fails to ask is how much should it rise? As addressed in the post Houses and Holes, the vast majority of the dollar's rise is nothing more than speculation. The Bank of International Settlements estimates just 17% of currency flows are based around actual commercial and government transactions.

In the case of the Aussie, that would mean that of the $190 billion daily turnover, only $32 billion is based on transactions of real value. Does this sound like a revaluation based upon fundamental value or some outsized bet in a monster casino?

Back to the article:

I'm trying to get from the immediate cyclical issue to the longer-term structural one. Sooner or later, coal and iron ore prices will fall back from their present dizzy heights, though they're likely to stay well above their long-term average.

The second element of this boom - the thing that distinguishes it from previous commodity booms, giving it a medium-term, structural element - is the unprecedented boom in mining investment that's about to get started, coming on top of a level of business investment spending during the downturn that was already remarkably high.

Even if some of these projects are abandoned and some are delayed, we're still talking about a huge expansion in our mining sector that constitutes a historic change in Australia's industry structure, affecting the oil and mining industry, the mining services industry and - for a decade or more - the engineering construction industry.

This will require a huge application of resources: labour and financial and physical capital. But because it comes at a time when we're already at full employment then, to the extent we're not adding to our supply of skilled labour via immigration, this will require a reallocation of resources within Australia.

Labour and capital will need to move from non-mining industries to the mining sector and from the non-mining states to the mining states.

The textbook, closed-economy way for this to happen is for the mining sector to bid up wages and other ''factor'' prices until it gets what it needs and can still afford. But in an open economy, the textbook promises the process of reallocation will be assisted by a high exchange rate, which will cause the non-mining tradeables sector to contract, thus releasing labour and other resources to shift to the mining sector.

Now do you see the other reason the econocrats want a high dollar? It is a key part of the market mechanism by which the industrial restructuring of our economy will be brought about without it exploding.

All very neat and tidy but let's have a look at the data shall we. The first graph (above) is the top 9 employing sectors plus mining. It is clear that mining is a paltry employer, on a par with arts.

Moreover, if we look at the same figures by the percentage growth across sectors it gets worse:



Mining hasn't budged since 1984. The two other sectors that look mining-related and have Gittins excited are Professional Services and Construction. Let's break them down. First, the Professional Services category (which includes engineers):



Solid growth, sure, but it also looks like we're radically restructuring the economy toward bookkeeping. How about construction?



There is some evidence here of mining-related growth, with construction one of the highest employment growth sectors. But the breakdown is interesting and looks as much governed by general building and the rise of the sub-contractor. Cutting back a bit of stimulus could do wonders here.

Finally, it seems to this blogger that it is ridiculous to restructure your economy toward these sectors because, for heavens sake, they only make things once. Once you've built stuff, or the income prompting you to build dries up, it's game over.

The three sectors that do keep on giving (in output terms) look sick. Manufacturing is in terminal decline. Tourism is rolling over and education is flat.

The point of this is not to argue that mining-related investment is not high. It is. What this blog is illustrating is that with one afternoon's research you can get a reasonably granular sense (you can go deeper) of where demand for labour is growing. A bit of sensible government skills generation and tinkering with spending solves most of the issues without shutting down every export sector we have outside mining.

But of course, that approach doesn't come with ideological purity.

Update
Late yesterday the SMH quoted the Treasurer saying he:

..dismissed calls to artificially lower the Australian dollar, [because] such moves would be ‘‘dangerous’’ for the economy ... In a ministerial statement on Monday, Mr Swan said he understood that a high dollar would have an impact on trade-exposed industries such as tourism, manufacturing, agriculture and education.

But he said the opposition’s suggestions to lower the value of the dollar would lead to higher inflation and higher interest rates, ‘‘and with a collapse of confidence in the management of the Australian economy’’.

‘‘This would hurt our manufacturing, agricultural and tourism industries, as well as homeowners right around country,’’ he told parliament, saying such suggestions were ‘‘dangerous’’.

‘‘Because it risks fracturing the long-held bi-partisan consensus on the floating exchange rate,’’ he said. ‘‘The floating of the dollar was one of the big changes which made our 20-year record expansion possible.’’

He said it helped Australia manage both ‘‘positive and negative shocks’’.

‘‘Any action to artificially lower the value of our currency would also encourage retaliation from our trading partners, not something that’s in the interests of our export industries,’’ he said.

Sigh. It's not, of course, artificially inflated by global markets whose only remaining strategy is front-running the Fed. Back to the article:

He also dismissed the opposition suggestion that the government’s fiscal policy was feeding the rise in the dollar.

‘‘If this logic were true, with larger fiscal deficits in the US, we would see the US dollar appreciating against the Australian dollar, not depreciating,’’ he said. ‘‘The fact is Australia has one of the strongest fiscal positions in the developed world.’’

Clearly this is just rhetoric. But one has to ask, if there is no imbalance emerging from the high currency then why did the Treasurer trash his QLD mate's Prime Ministership by attempting to implement a resource rent tax that redistributed mining revenue to other parts of the economy?

Links Oct 18: Give me Dutch Disease

Gittins all in for Dutch Disease. Ross Gittins, Alan Kohler
Parity porn from the Treasurer. SMH
I will post on these three later today.
ForclosureGate smashes everyone. Megan Mcardle
Week ahead for the DOW. Calculated Risk
Solving Ireland's pain. Businessweek, FT Alphaville
Sun King shadows Obama. FT
Dot-com over again. Robin Bromby
Ban these now. FT
OPEC and the weak dollar. AFP
Shark chewing through the babes. The Age

BHP to get shafted?

And now for something completely different. As you know, BHP is bidding for Canada's dominant potash producer, PotashCorp. On Saturday, the only other mooted bidder, Sinochem backed out. So the way is open for the Big Australian.

Or is it?

This blogger had a spare moment to peruse the Investment Canada Act and its National Security hurdles.

Not much is available beyond the conditions under which a National Security Review can take place. They are available here.

For the most part the Australian media has been nervously endorsing the likelihood of BHP winning regulatory approval. But, to be honest, this blogger will not be surprised if the Canadians squash the bid.

The rationale for doing so is quite straight forward. Food supply is a strategic issue for China. Potash is therefore a strategic commodity. And in the past, BHP has proved itself very capable of favouring profits over national security interests. Let me explain.

Take a look at the Conference Board of Canada's review of the bid. In it they describe the Potash market thus:

The global potash market has many of the characteristics of a traditional oligopoly market.For example, there are few players in the industry, with the Canadian, Russian, and Belarusproducers accounting for the vast majority of global trade. There are also high barriers toentry, with few large deposits of potash globally and high costs and long development timesto develop new mines. Finally, most of the large producer companies in the industry areprice setters, rather than price takers. Although potash producers do negotiate their sellingprices with their customers, they have considerable bargaining power given the limitednumber of players operating in the industry.

A distinctive feature of an oligopoly market is the interdependence of a few large firms,each of which has the ability to influence broad market conditions. Therefore competing firms must take into account the actions of the other market participants. In some situations, this can lead to various forms of collusion, such as passively allowing a market leader to set prices, which the smaller producers then adopt; or more active measures, such as seeking to increase prices by limiting production. At the other extreme, oligopolistic markets can be extremely competitive, with firms seeking to maximize market sharethrough aggressive price discounting. This situation is more common in markets with undifferentiated products and high levels of fixed costs, both of which characterize the global potash industry.

I'm not sure what school of business behaviour these analysts went to but the first rule of oligopoly business is NEVER drop your prices.

And that is not what BHP did in the iron ore market, even though it ramped production. Rather, BHP understands that strategic commodity markets do not work on the regular laws of supply and demand.

In regular markets if prices rise then demand falls, as well as vice versa. But in strategic commodity markets, where governments depend upon security of supply for legitimacy, the opposite happens. When prices rise, demand rises further because governments get spooked about security of supply. Stockpiling and strategic investment in production ensue.

It is for this reason that BHP broke the annual contract system that had served to balance the needs of buyers and sellers for fifty years in the iron ore market. Prices have been riding high ever since.

The Canadian potash producers sell through a similar annual contract system to the one BHP has just trashed in iron ore, using a single desk arrangement called Canpotex. BHP has already announced its intention to abandon Canpotex.

Just as it did in its iron manouvres, BHP is selling this idea as market friendly because it appears to be breaking up a cartel. But in reality, BHP is trading security of supply for higher prices. Of course, the customers - especially China - are royally pissed by the whole business.

This, you might say, is all fair enough. The Australian government didn't give a hoot and has been enjoying higher tax revenues ever since.

But the Australian government was happy to outsource its foreign policy to BHP. If you're a Canadian security analyst, and you're considering what's in the national interest, the notion of a foreign-domiciled firm poking an already dirty stick into your China relationship can't feel too comfortable at all. It is quite the rogue element you're introducing, and with vast other potential trade with China (already Canada's third highest export destination) and the need to diversify away from a huge US export dependency, sustained good relations are key.

The famously Presbyterian Canadians have already muted their human rights concerns and, who knows, they may seek to trade a favour.

Weekend Reading: Currency war, but not here

Currency crisis is now. Alphaville
And how. Michael Hudson
Roubini agrees. Nouriel Roubini
Now it's bovine shrinkage. FT
Don't worry, keep eating, little sheep. Barf. Ross Gittins
2008 redux complete. Banks smashed. All else up. Bloomberg
Bill Gross telegraphing MBS bailout. Zero Hedge
But baby steps on QE2. FT, Calculated Risk
Physical-backed metal ETFs. Be afraid of this. ETFdb
Quarterly ore contract down 10%. People's Daily
Sinochem abandons Potash bid. Bloomberg
BHP to bid for Rio in 2013. Good luck. Bloomberg
As in any duopoly, one lazy effort deserves another. Irvine then Hewitt
Delusional from Mordor. Delusional Economics

Fitch as a fiddle

This week's Fitch report on stress-testing the banks in the event of a housing crash has produced a muted response but one divided equally between consternation and joy.

On the one hand, the idea that Australia can escape a 40% house price crash with a simple $15 billion loss, divided between banks and mortgage insurers, hardly seems to pass the laugh test.

On the other hand, the banks and their supporters are no doubt chuffed as hell at the good management this suggests.

This blogger has spent the last couple of days digging and can now throw some light on the issue.

The Fitch stress test is a simple credit risk assessment for the big banks' mortgage portfolios. That is, Fitch asked what would the losses be for the banks in the event of three housing bust scenarios, one mild, one medium and one severe.

The test is a straight three year model without econometrics.

It makes no reference to any macroeconomic scenario.

Nor does it take account of losses in other areas of the banks' greater portfolio of consumer and business loans.

Nor does it take account of the liability side of the banks' balance sheets and the liquidity risk buried in their wholesale borrowings.

In short, the test is the functional equivalent of judging the safety of an aircraft by jumping up and down on its wings. If they hold, we're cleared for takeoff. The coughing engine, missing tail and dead pilot get ignored.

Still, Fitch has been good enough to provide the report slides, so judge for yourself.

Fitch Presentation

Blame it on the chicks

Jessica Irvine of the SMH takes on the bubble today and, well...lets down her sisters. According to Irvine:

The basic argument of bubble theorists is that prices must return to their historic average as compared to incomes. On most measures, house price growth has far outstripped growth in incomes.

The crudest way to measure this is to compare the median house price to the average annual wage. So, for instance, the full-time, adult ordinary wage is now $65,300, according to the Bureau of Statistics, while the median Australian home prices is $413,000, according to RP Data-Rismark. Combining the two, house prices are now nearly seven times average income.

This compares to just under four times in mid-1994 (when the average wage was $32,400 and the median house price $125,000). Such analysis delivers something close to Grantham's claim that Australian house prices cost about 7.5 times average income.

But this crude calculation overstates the deterioration in affordability by ignoring several important developments.

First is the rise of dual income households. That's right ladies, the fairer sex is partly to blame for rising house prices. The incomes women have earned from going to work has boosted the ability of households to pay for bigger and more expensive housing. It is also the case that households derive income from sources other than wages, such as government transfers, interest on deposits and share dividends.

That is why the Reserve Bank prefers to use household disposable income (i.e. after-tax) when considering movements in affordability. This measure paints a better picture of affordability - with the median house price just over four times the average household income of $95,100 a year.

Irvine goes on to cite the old arguments of freely available credit and supply constraints before concluding on the fence with the new 'over-valued but not a bubble' meme.

This blogger is very disappointed at the lack of sharp interrogative effort.

For instance, Irvine simply accepts that the dual income thesis is fair dincum. There is no effort to examine its rigour. I took this blogger five minutes of research at the ABS website to discover that female workforce participation has increased 5.5% since 1995, the majority of which has been in part time positions.

Moreover, over the same period, if you study the chart really hard, you can see women's percentage of total national income has moved ever so slightly upwards.

Are these rather paltry gains enough to explain house appreciation of roughly 200% over the period? And the swelling of multiples to income she quotes? Not to mention the RBA using household income as its denominator for measuring bubbleness?

Even if we accept Irvine's line, she might have stopped to ask whether rising female incomes - such as they are - are causal in house price rises. She offers no evidence for this conclusion, only points to a (weak) correlation.

It could just as easily be argued that families are chasing bubble prices higher because they have no other choice if they want to own a home.