“Economists were therefore left scratching their heads when it was revealed only 36,000 jobs were added but that the unemployment rate had plunged to 9.0%.  Snow or not, it just didn’t add up.  Was the result good or bad?  The answer seemed to be bad, which actually means good because it means QE2 is well and truly here to stay.  Thus Wall Street closed higher.” – Greg Peel, FNArena

There’s something rather perverse going on in the markets right now.

Good news is good for the market.  And bad news is good for the market.

In fact it seems like bad news is better for the market than good news.  Because it means the US Federal Reserve will pump more fresh cash into the economy.

The Fed is tossing a double-headed coin and the market is calling heads.  It can’t lose.

The real problem is markets have become hooked on stimulus.

Which isn’t really a surprise. Markets and investors become hooked on things all the time.

The dot-com boom is a classic example.  Out of the hundreds of dot-coms that came to the market in the late 1990s only a few remain.

But at the time punters were hooked.  They saw one stock climb a gazillion per cent and so they wanted to find the next one.  When the same thing happened, the search started for the next… and on and on it went until the punters woke up and realised they were buying nothing.

They were buying pets.com and other rubbish.  Companies that had minimal revenues and no prospect of ever returning a profit.

But when you’re hooked you can’t see that.  All you can see are huge returns.  And you don’t want to miss out.

The mortgage securitisation boom got the punters hooked again.  It may have started out as a good idea to earn an income from mortgage payments, but it morphed into something completely different.

Rather than investors buying into the kind of mortgages they wanted, the demand for mortgage securities became so huge that the banks and investment banks couldn’t keep pace.

Because there weren’t enough physical mortgages on the market the banks had to create derivatives to mirror the performance of real mortgages.

And when yields became so low – due to demand and low central bank interest rates – the investment bankers started bundling in higher-risk ‘subprime’ mortgages.  But they still marketed them to investors as triple-A credit!

Even after inventing subprime mortgages out of thin air, the banks still couldn’t keep up with demand for mortgage securities.  So they had to convince those who didn’t have a mortgage to take one out – “Hey, house prices always go up, you can sell for a profit in a couple of years anyway.”

To give you an idea of the size of the demand, here’s what the recently released report from the Financial Crisis Inquiry Commission (FCIC) had to say about it:

“From 2000 to 2007, Moody’s rated nearly 45,000 mortgage-related securities as triple-A.  This compares with six private-sector companies in the United States that carried this coveted rating in early 2010.  In 2006 alone, Moody’s put its triple-A stamp of approval on 30 mortgage-related securities every working day.  The results were disastrous: 83% of the mortgage securities rated triple-A that year ultimately were downgraded.”

That’s what happens when you create a false market to meet demand.  It’s similar to the mad Australian house prices.  A house should be a low-risk stable investment.

But when you get banks offering 95% or 100% loans, and then telling people house prices always go up, the risk profile of housing changes.  It moves from low risk and stable, to high risk and volatile.

And it’s not just me saying it.

Look at the historical return on house prices over the past thirty years.  It’s comparable to the stock market.  That tells you both have a similar risk profile.

That’s not the way it should be.  Shares are high risk.  And so is housing.  But housing should be low risk.  The availability of cheap credit from banks has helped create this mispricing of risk in Australian housing in just the same way the mispricing of risk caused the collapse of the global economy.

Anyway, back to the FCIC report.  Not that we’ve got much time for its opinion.  After all, the report states:

“As our report shows, key policy makers – the Treasury Department, the Federal Reserve Board, and the Federal Reserve Bank of New York – who were best positioned to watch over our markets were ill prepared for the events of 2007 and 2008.  Other agencies were also behind the curve.  They were hampered because they did not have a clear grasp of the financial system they were charged with overseeing, particularly as it had evolved in the years leading up to the crisis.”

But now these same people who were “ill prepared” and who “did not have a clear grasp of the financial system” are the ones you’re supposed to trust to put things right again.

In fact on the same page of the report, just after calling them “ill prepared” and not having a “clear grasp of the financial system”, the FCIC pours praise on them:

“In making these observations, we deeply respect and appreciate the efforts made by Secretary Paulson, Chairman Bernanke, and Timothy Geithner, formerly president of the Federal Reserve Bank of New York and now treasury secretary, and so many others who labored to stabilize our financial system and our economy in the most chaotic and challenging of circumstances.”

You what?  The FCIC highlights how inept the three government-sponsored departments were in identifying the problems… And then praises the three men who were in charge of those departments as the crisis took hold!

It’s thanks to Paulson, Bernanke and Geithner that the markets have continued their addiction.  It’s just that the market has switched drugs.

They were hooked on credit from the 1980s through to the 2000s.  When that blew up, a new addiction was needed.  Step in Paulson, Bernanke, Geithner and their buddies.

Now the goal isn’t for the economy to improve by itself.  The goal is to maintain the current situation… so the Fed prints more fresh cash.

As I wrote in Money Weekend:

“The US Fed prints a lot of money. This devalues the US dollar. The devaluation of the US dollar increases in US dollar terms the foreign-earned income by US companies. This is reported as higher revenues and higher profits by US companies.

“But here’s the problem. Those US dollars are actually worth less than before. While the immediate impact shows an increase in revenues and earnings, when those same US companies need to reinvest in their business – buy more supplies, machinery, etc – they’ll find costs have risen.”

And why wouldn’t executives and bankers want the Fed to print more money?  It boosts share and asset prices, and it makes the exec’s look good.  All this extra money flowing into the tills and they don’t have to work for it.

It’s no wonder the unemployment rate is still so high in the US.  Corporate America wouldn’t want to go spoiling things by hiring more staff.

Because if the unemployment rate falls, there goes the excuse for the Fed to print new money.  And if the Fed stops printing, share prices will stop rising, people will stop spending, and the recovery sham will be revealed to all.

And so, as central banks tend to do, the Fed has signalled to the market what it considers to be its number one target – unemployment.  As long as unemployment remains high, the Fed will keep interest rates low and print more money.

Knowing that, why would any debt-laden business hire more staff?  If you know the Fed will raise rates as soon as unemployment falls, the last thing you’ll want to do is start hiring again.

As Mr. Bernanke outlined in a speech last week to the National Press Club in Washington, DC:

“In sum, although economic growth will probably increase this year, we expect the unemployment rate to remain stubbornly above, and inflation to remain persistently below, the levels that Federal Reserve policymakers have judged to be consistent over the longer term with our mandate from the Congress to foster maximum employment and price stability.  Under such conditions, the Federal Reserve would typically ease monetary policy by reducing the target for its short-term policy interest rate, the federal funds rate.  However, the target range for the funds rate has been near zero since December 2008, and the Federal Reserve has indicated that economic conditions are likely to warrant an exceptionally low target rate for an extended period.  As a result, for the past two years we have been using alternative tools to provide additional monetary accommodation.”

He continued:

“…The fact that financial markets responded in very similar ways to each of these policy actions lends credence to the view that these actions had the expected effects on markets and are thereby providing significant support to job creation and the economy.”

Only they haven’t.  Sure, stock markets have risen, but unemployment is still high. Which is why…

“My colleagues and I have said that we will review the asset purchase program regularly in light of incoming information and will adjust it as needed to promote maximum employment and stable prices.”

In other words, the stock market is going up so the money printing must be working.  Yet firms still aren’t hiring so that means more money printing is required.

That’s the trouble with addictions, they’re hard to break.  Companies are addicted to cheap credit from the banks and stimulus from the government.  As long as unemployment remains high the credit and stimulus drugs will keep flowing.

We could be wrong.  But don’t expect the US employment problem to be fixed any time soon.  That means more stimulus and higher asset and commodity prices.

But be warned, this is one risky bet.  The asset price good times won’t last forever.  When the market addiction is finally broken the outcome for markets will be much worse than that of 2007 and 2008.

Simply because this time they’ve got much further to fall.

As always, the biggest problem is knowing exactly when that’ll happen.  When I figure it out I’ll let you know…

Regards,

Kris Sayce
for Money Morning Australia

Recently, the US Federal Reserve downgraded its forecast for 2011 and 2012.

Initially many – economists and other people that consider themselves ‘in the know’ – suspected growth would be anywhere between 3.5 – 4.2% for 2011. However, it turns out the Fed now believes growth will be between 3% – 3.6% for 2011.

This is a massive downgrade.

You and I know the Fed would prefer the consumer to get out there and start waiving that credit card around again. But, finally admitting that it may not be able to control the consumer, the Fed turned its focus to the all-important unemployment numbers instead.

So basically, rather than focus on the dreary spending numbers – because they just weren’t getting any better – the Fed has turned its attention to the unemployment numbers.

Which aren’t so rosy either…

It’s expected that unemployment will remain at about 9% for next year.

First, is this forecast downgrade an admission in defeat from the Fed?

Never! Do you really think central bankers would hold their hands up and say, ‘Wow, we really got that wrong. Maybe we can’t control it after all.’?

But the lower growth expectations could potentially pave the way for more stimuli after the USD$600 billion printing spree, sorry, bond buying program ends.

Yet, all snide comments aside, the future downgrade for U.S. unemployment is a serious issue for the Fed.

You see, each week the Department of Labour in the U.S. releases data showing the number of ‘new’ jobless claims for that week only. Every week, the financial markets use this to gauge the labour market.

It’s pretty simple. The lower the new claims, the better the labour market is supposed to look. However the weekly figures are extremely volatile. The more accurate measure of new jobless claims is the four-week average, which doesn’t have the same volatility as the weekly numbers.

But this is where the cracks are starting to show. It doesn’t matter how much money the Fed floods the system with. No matter how hard they lobby the government to ‘create’ more jobs, the long term forecast for unemployment is going to remain where it is.

Why?

Mostly, as Bernanke conceded recently, the type of unemployment affecting the States is structural.

To most people, unemployed is just unemployed, but you know how economists love to come up with titles and sections to pigeon hole the people who make up an economy!

The problem with structural unemployment is that it lasts longer than most of types of unemployment. And it’s this that has the Fed worried.

Explained simply, structural unemployment is a mismatch of skilled people and jobs available in the labour market.

Think of it like this. Too many builders and no houses to build. Too many doctors but not enough hospitals. Or, too many banking CEO’s and not enough banks around to screw up!

The other problem with structural unemployment means that it’s hard to separate the data from what’s known as frictional unemployment. Frictional unemployment is best thought of as voluntary. As in, one job seeker leaving a position on the hopes of attracting another position with better perks, like a parking space or higher pay for example.

So with the economic technicalities out of the way, what can the Fed do about this structural unemployment?

Simply put, there’s pretty much nothing it can do.

While not solely reliant on the private sector, it does play a big role in getting these skilled people returned to the work force. The Fed can’t make ‘skilled’ jobs appear. Nor can the government. When it tries, it usually stuffs it up anyway.

The sort of jobs that attract skilled people are only really created in a free market situation and by private enterprise. Even government skilled jobs can only be created if there is the ability for the government to pay for them – and that means taxing successful private enterprise.

As much as Bernanke has tried, it can be almost impossible to force skilled job creation into the labour market.

A long term danger of structural unemployment is – if you don’t use it, you lose it. That is, the longer a skilled person is out of work in their field, the more chance they have of losing their skills, or their skills becoming less valuable to future employers.

When skills are lost or not developed it starts the creation of a vicious circle of ongoing unemployment that tends to last longer than unskilled or ‘in-between’ job status.

For this very reason, high unemployment numbers are likely to persist in the U.S. for years to come.

It might be time for Ben and his mates to throw their hands up in the air and admit defeat when it comes to America’s unemployment numbers.

Shae Smith

Assistant Editor
Money Morning Australia

Most important story of the week…

Kris ended the week with a startling revelation. That two of Australia’s own banks – accepted a hand out from the Federal Reserve Bank over two years ago during the Great Financial Crisis. ‘What?’ You cry. That’s right, two of Australia’s ‘safe’ banks accepted a combined USD$5 billion in hand outs…Click here for more…

Monday: Maybe it’s just a coincidence that the NAB’s computers should encounter a glitch at the time the Irish banks are being bailed out by European taxpayers… Click here for more…

Tuesday: In Tuesday’s Australian Financial Review stated a 6,000 point target for the S&P/ASX200 was possible… Today the index is at 4600. Right now 6,000 points by July 2011 looks overly optimistic. The index would need to rise by 30% from today in order to get there. Click here for more…

Wednesday: There simply isn’t enough capital in the world to bail out the financial system again. Not even the wholesale pilfering and expropriation of private pension funds, as has already started in Hungary, Argentina, France, Ireland… and yes, don’t forget about Australia. Click here for more…

Thursday: In the excitement of supposedly positive economic news from overseas and you get the kind of rapid-fire rally you’re seeing now. The problem with this kind of market move is that it can drag reluctant buyers into the market. Click here for more…

Friday: The Federal Reserve has announced that it will pump another $600bn into the US economy by the end of June next year to try to boost the fragile recovery. That’s $75bn a month – much more than most analysts expected. In this free ‘QE2 Tutorial’, Kris Sayce lays out a battle-plan for Australian investors to profit as some of this keyboard-produced cash floods the ASX in 2011. Click here for more…

The Chinese consumer price index (CPI) came in yesterday and the result was pretty much as expected: the cost of living in China is increasing.

The CPI increased 4.4% overall, and what would set off alarm bells in most countries was the 10.1% rise in food prices.

Now, I’m not quite sure if palm oil is one of the basket of goods that is measured in the CPI, but despite the rise in food prices, many Chinese are still unwilling to part with Palm Oil in their everyday meals.

As the quality of life for many Chinese has begun to improve, so has the quality of their meals. And the Palm Oil market has been unable to meet demand for the past three years, which has seen the price soar.

In fact, in just two weeks the price of crude palm oil has gained over 26%.

And coincidence or not, not long after the announcement of the Chinese CPI figures, the price of palm oil was higher by half a percent, and ended the trading day at MYR3441 (AUD$1,110), up a total of 1.41% for Thursday.

Either way, the recent spike in the price isn’t new. For the past two years the price of Crude Palm Oil has been rising steadily, more than doubling in this time frame.

Right now, the price is expected to remain high and to continue to rise, and there are a couple of factors affecting this.

While India is also a significant consumer of palm oil, just like with some Australian commodities, China does import the lion’s share. More than 60% of Malaysia’s palm oil exports go to China alone!

So where does all this palm oil come from?

Most of the world’s supply of palm oil is provided by Malaysia but they only just grab the title. In 2008 Malaysia produced 17.7 million tonnes, and Indonesia was a close second with 16.9 million. Combined, these two countries provide over 80% of the world’s supply.

Because of the nature of the plant, it thrives in tropical conditions, which has seen some success with plantations in Colombia and West African countries, like Benin and Ghana.

But the problem is, while countries like Benin and Ghana are produce palm oil, they don’t produce enough to meet their on domestic needs, which mean they often have to import lower quantities from Malaysia and Indonesia, putting further pressure on supply.

Like many other vegetable oils, palm oil is perfect for biofuels. As a result, over 35% of Colombia’s crop is exported for use solely in alternative fuels.

Normally, these issue aren’t a problem, as supply and demand have always been evenly met.

But lately, like many other agricultural commodities, the weather has been working against supply.

La Nina, the sister to the El Nino phenomena, has been causing havoc with unusually high levels of rain which disrupted the planting season in Indonesia, Malaysia and South America last year. Not only that, but the prolonged period of rain has lead to damaged crops. Which means that there are substandard crops that are unsaleable, but what is available and of good quality will often end up with a higher price tag.

And despite the price increases for the oil, demand hasn’t dropped. In fact, demand has increased so much for palm oil, for food use and biofuel needs that a shortfall of 1.5 million tonnes is predicted for next year.

This shortfall will help support the already high price of palm oil.

You can expect that the long term costs of producing palm oil are likely to remain high. Many companies are that grows and harvest the oil are coming under pressure from environmental groups and animal lobbyists to reduce deforestation and to save the Sumatran Tiger and elephants in Indonesia, and the Orangutans in Borneo, which boarders Malaysia.

Not only do they face the lobbying pressure, but companies that sell and produce palm oil goods are finding that the high prices for palm oil are hurting their profits. Which, makes unhappy shareholders.

Wilmar International [SGX: MM9] recently reported a 23% gain in sales, but the cost of sales jumped a massive 31.5%, and most of this has been due to the higher costs of palm oils.

However, while it might be hurting some corporations bottom line, what are the options to you if you wanted to gain exposure to palm oil?

Aside from individual companies in the palm oil industry, the Bursa Malaysia, the country’s exchange, offers futures contracts for crude palm oil. However these are mostly traded by the companies that produce palm oil.

And, because of the growing popularity and interest in palm oil, the FTSE Bursa Malaysia Palm Oil Plantation Index (BMD: FBMPM] has been designed for investors that wish to track the industry without following individual companies.

Not surprisingly, this index has outperformed Malaysia’s major index for the past three years.

For the next year at least, thanks to bad weather and ever increasing demand, you can expect the price of palm oil to remain quite high.

Now let’s have a look what happened on the market’s yesterday…

The S&P/ASX 200 closed at 4,728.60, higher by 28 points. The unemployment rate jumped up from 5.1% to 5.4% – economists had tipped it to decrease to 5%

The Dow Jones Industrial Average was down by 73 points to 11,283.10.

Shares in Cisco Systems Inc [NASDAQ: CSCO] plummeted 16% last night, after Wednesday’s after market close sales forecast was significantly down. Cisco has long been seen as a ‘bellwether’ of the gauge of the markets and any sales downgrade from Cisco could suggest a weaker economy in the long term.

Overnight, the FTSE closed lower by only 1 point, ending the day at 5,815.23. Ireland’s ability to repay its debt is being questioned and was the main drag on the index.

And finally the Nikkei added 30 points, closing at 9,861.46.

The price of spot gold in Australian dollars is trading at $1,411.85 while in US Dollars it is trading $1,409.03. The price of silver in Aussie dollars is 27.72 and in US Dollars it is $27.668.

Copper prices hit a record high overnight of USD$8,966 a tonne of USD$4.08 per pound. China’s consumption of the metal remains steady however there is potentially a ‘supply shock’ coming from Chile.

Miners from the Dona Ines de Collahusai mine have been on strike since last week, demanding that their wages keep up with the copper price. The mine produces about 10% of Chile’s annual production.

Copper is currently USD$3.95 a pound (AUD$0) Nickel is USD$10.78/lb (AUD$) and Tin is USD$12.26/lb (AUD$0).

The Aussie dollar dropped below parity last night. Concerns over the Euro debt saw investors head towards the ‘safety’ of the U.S. dollar.

The Aussie dollar versus the US dollar was USD$0.9978, and against the Japanese Yen JPY 82.26.

Crude Oil closed at USD$87.75

For the biggest movers on the market yesterday click here…

That’s all I have you this Friday, have a great weekend.

Shae.
[Please note: neither the authors nor any of the employees of Port Phillip Publishing own shares in any of the stocks discussed in Money Morning unless specifically stated. The articles do not give trading or personal investment advice, but are intended to provide a useful, independent news and analysis service to supplement your own investing and trading. Consult your financial advisor before making any investment decisions.]

52-Week Highs and Lows

Number of companies reaching a 52 week high previous day: 85
Number of companies reaching a 52 week low previous day: 24

Yesterday I mentioned that the Australian Securities Exchange (ASX) is considering offering an index based on residential house prices.

The index – from what we can gather – will allow investors to bet, gamble or punt on the direction of the residential housing market.

In a moment I’ll begin to explain why this could be either a completely meaningless index, or why it could be really quite useful… depending on how it’s structured.

But first, I want to invite you inside the mind of a Keynesian economist. Don’t worry, I know it’s scary, but I’m here with you.

In all seriousness, we do wonder what planet Keynesian economists come from. Planet Keynes perhaps?

Last week we wrote to you about the bizarre mentality of the mainstream economists. How they fear the unemployment rate going too low because of the impact on inflation.

Apparently the mainstream economists consider full employment to be based on an arbitrary number. Somewhere around 5%. Once it reaches that point then that’s enough. No more employment please.

Even if there are people still unemployed who would like work.

Naturally enough when yesterday’s unemployment numbers were released by the Australian Bureau of Statistics (ABS) Comsec’s Craig James was eager to see a silver lining in the increased unemployment rate:

“Secretly the Reserve Bank wouldn’t be disappointed that the jobless rate has troughed for the time being.”

Wouldn’t want more people getting a job would we? Of course that’s easy to say when you’re a mainstream economist at a big comfy bank. Much better to keep that 5.3% of unemployed on welfare payments and have the taxpayer fund them rather than having someone in work and being able to fend for themselves.

But Mr. James also says, “It’s important not to over-react to one month’s set of figures”… but then that’s exactly what he does.

He goes on:

“Effectively the Reserve Bank lifted rates too far, too fast, robbing the economy of momentum at a time when the US and Europe continued to meander along…

Yet it was only two weeks ago on August 3rd that Mr. James wrote:

“Reserve Bank policymakers could indulge in some well deserved boasting. The Australian economy avoided recession, growth is ‘near normal’, emergency rate settings have been removed and inflation is back in the target band…

“While CommSec believes that it is more likely that rates will rise rather than fall in the future, the next move could very be in 2011 if the mixed domestic and global readings persist… We are pencilling in a 25 basis point rate hike late in 2010…”

And of course he finished off with, “property is still fundamentally attractive…”

It’s important to get at least one spruik of the property market in!

Now, the reason I’ve shown you these comments is not to play a game of Harry Hindsight, but rather to show you how 99% of mainstream economists – and Craig James is as mainstream as they come – have no clue about how an economy works.

That’s why they are unable to provide a consistent and logical message. It’s why their opinion flim-flams and flip-flops from one week to the next.

One week they’re praising the RBA for the great work it’s doing in manipulating interest rates, the next week they’re accusing the RBA of getting it wrong because the unemployment rate has moved higher.

You’d think they would have figured out by now that it isn’t possible to micro-manage an economy.

You can’t pull levers and push buttons in order to accurately predict and influence the actions of 22 million people. But still they carry on with their futile little game.

But anyway, we’ve strayed well off course here. Back to the housing index that the ASX is apparently looking at.

First off we’ll say that the ASX has a terrible record in the area of new product development. If it’s dealing in shares then it’s fine. It may not be perfect, but it seems to do a relatively decent job.

When it comes to the exchange traded options market, well, we’d give it no more than a C grade. It does its job, but once you get outside the top twenty or so stocks, the liquidity on the options market is pretty slim. But that’s not entirely the ASXs fault, hence why it still gets a C grade.

As for Index futures (SPI) on the S&P/ASX 200 it seems to do a decent enough job there as well. There’s plenty of liquidity and we dare say most futures traders are probably happy with what they get.

But anything outside of that, the ASX is hopeless.

Take a look at the trading volume for anything outside the major bond and index futures. There’s nothing traded. You can see for yourself here.

Then there’s the ASX listed contracts for difference (CFD) market that was marketed in a blaze of glory about three years ago but which has never risen above the level of also-ran.

The ASX thought it could get in on the CFD craze and make a killing, winning back some of the trading revenue it had lost to the over the counter (OTC) CFD providers. But they haven’t and it’s been a flop.

At some point the ASX will give up and ASX CFDs will likely go the same way as the International trading service the ASX quietly closed down about four years ago.

You probably don’t even remember it, it was so unmemorable. We think – from memory – it was called Trade Link, or something like that. The idea was that you could buy shares in international companies such as Microsoft and IBM through an Australian broker.

An added benefit was that the trades would be settled in Australian dollars and would appear on your CHESS holding statement so that you wouldn’t have to fuss around with foreign exchange, separate accounts, and all sorts of other nonsense.

To be fair, it was a nice idea, but as is usually the case when a monopoly organisation tries to innovate, the service went nowhere. Brokers weren’t interested, nor were their clients and so the ASX closed it down.

Now they’re looking at operating a housing index.

Our first bet is that it’ll never happen. We could be wrong of course, but that’s just our take on it.

Our second bet is that even if it does get off the ground it’ll be a complete waste of time. The ASX makes it’s money from the stock market. From people trading shares.

Anything outside of that, forget it.

Think about it, most of the trading volume on the ASX goes into trading the top fifty stocks on the market. Why? There are many reasons, but mostly because they’re the most well known and biggest companies. It’s only natural that most investors would tuck into those stocks.

But it’s also the impact of the funds’ management industry too and their desire not to underperform their peers. Therefore they will all tend to hold similar portfolios.

In that case, what are the odds of big and small investors having any interest in a property index?

That’s where it comes down to how the index is measured. Done right and there could be a lot of interest. Only ‘could’ mind you.

Share indices for instance are based on the value of shares that comprise the index – no points for getting that right. It’s pretty simple and reasonably transparent. You know that the biggest companies in the index will have the biggest impact on the performance of the index.

In other words, not only can investors see the price action of the index but they can see the price action of the stocks that comprise the index.

Of course there’s already one property index on the ASX. It’s the SPDR S&P/ASX 200 Listed Property Fund [ASX: SLF]. Subscribers to Australian Small-Cap Investigator will recall we tipped that index as a buy recommendation early last year, right near the depths of the market downturn:

We tipped it at $6.41 in March 2009 and then sold at $8.00 in November 2009 for a 24.8% return.

As it happens it was nowhere near as big a return as we had banked on. Unless there’s the prospect of a triple-digit percentage gain we don’t even consider tipping a stock.

However, we saw it as the ultimate contrarian play. Buying into the property market right at the point where property bulls and bears – including your editor – were most bearish (until now) on the housing market.

Of course, that particular index is an index of commercial property trusts, so it can’t be directly compared to the housing market.

But take another look at the chart above. This time the volume bars. Each bar represents the volume traded during one week. And this is where the problem lies for any potential housing index.

Even the most voluminous week – during March this year – there was still only two million shares traded. That works out as around $3.2 million worth of shares each day during that week.

Yet in recent weeks the volume has struggled to get even to $800,000 per day. Compare that to the blue-chips where already this morning ANZ Bank [ASX: ANZ] has traded more than $17 million worth, and it’s not even 11am!

So this particular index has low volume and quite frankly low interest among investors. But importantly, and in its favour, this index has component stocks. In other words you can check out which property trusts comprise the index.

You can choose to either invest in those components or in the index depending on whether you want to spread your risk or not. And just like a share index you can see the impact that the price movement of the underlying stocks has on the level of the index.

What I’m saying is that any housing index operated by the ASX must have the same level of transparency. Anything less than that and investors just won’t be interested.

If the index is just based on a theoretical price level of housing or a mathematical calculation of house prices, our guess is that it would become nothing more than an interesting novelty.

The question you’d need to ask is whether investors would trust punting big money on something that was a computer model driven rather than something based on the actual price and income stream from real houses? Some would, but we’ll guess the majority wouldn’t.

And that’s why we doubt the index will even get off the ground.

But there are two other points we do want to cover off. The main one being how a housing index could work. If done properly. It would involve residential rental properties as the underlying asset.

As far as we can see it shouldn’t be that difficult, and thinking about it, we’re rather surprised it hasn’t already been tried.

The other point we’ll cover is that the high price of housing could actually be a bar that prevents making an investable housing index a success.

But more on that on Monday…

Cheers.
Kris Sayce
For Money Morning Australia

Maybe the catering team make really good sandwiches.

Perhaps we’re being a little arrogant, but really, what are the chances the Fed are going to surprise the markets and increase rates?

I’d say slim to none.

In fact, I have an Oz lotto ticket for tonight’s draw, and I reckon there’s a higher chance of me winning a slice of the $40 million at stake than there is the Fed increasing rates even one tiny basis point.

You see, every time the Fed has got together recently monetary policy hasn’t changed.
And there hasn’t even been an indication for investors when things may change because the Fed keeps using the term ‘extended period’.

So much so, that when the minutes are released, some people spend hours going over them, looking for any hint of a future direction the Fed might take.

But the problem is, there’s no real direction for the US economy in the minutes. The Fed is desperately trying to steer the economy towards a recovery but it’s not working.

All of the widely used tools for determining if a rate rise is required are pretty ordinary. Unemployment in the US is hovering around 10%, even after the so called job creation package. Consumers are so selective about what they spend their money on now that they can’t be relied on to “save” the economy. And supposedly, even with all of this loose money floating around, inflation is low and not a threat.

As I mentioned last Friday, it’s widely accepted that the cash rate will remain near zero until at least next year.

However with interest rates near zero for an ‘extended period’ what can the Fed actually do to boost the recovery?

And it’s starting to become pretty clear, that no matter how much the central bankers fiddle around with the economy, they just can’t fix it.

Even all of that money printing hasn’t fixed the economy.

So what can they do now? Well at the moment they’re not doing a great deal.

Look, it’s no secret that the current policies coming out of the Fed are being criticised.

In fact all of the things they’ve done to fix the economy are more likely to cause long term damage.

Initially this policy implemented by the Fed was an attempt to keep the markets going rather than giving into panic. And the next part of the plan was to get the economy going again.

While that might have seemed like a great idea at time – to some, over the past two years the economy has revealed it doesn’t want to get going again.

As a regular reader, you’ll be well aware that we’ve argued at length that there’s no place for central bankers in a true free market.

And because in the last few months very little has been done by Dr Bernanke to ‘direct’ the market, you could have almost thought the Fed is scared of upsetting the economy by moving rates.

But here’s the thing. It may be scared of upsetting the economy, but it’s still got a plan to interfere with things should the dreaded ‘double dip’ recession come around.

The poor performance in May clearly showed that the recovery is far from ideal. David Wyss, a chief economist at Standard & Poor’s recently pointed out that it’s ‘… a fragile recovery. There is still a lot of stuff that could go wrong.’

Now, the fact the US is in a delicate state isn’t new information to anyone. But this is where the Fed has ‘plans’.

A former member of the Fed, Vincent Reinhart has suggested in that in the event of double dip recession occurring, the Fed would need to show a firm commitment to keeping rates near zero. For longer.

Reinhart said that that the next move could be for the Fed to reopen its purchases of housing related securities. However he actually doesn’t think this move would help.

But after that, there aren’t a lot of idea’s floating around.

Clearly, the lack of idea’s in how to kick start the economy at the Fed is demonstrating that there isn’t anything they can do. No amount of tweaking, buying, swapping, lowering or printing will get the US data moving in the direction that Bernanke and his crew want.

However, Reinhart has pointed that it’s not the financial markets that are broken and need repairing. The problem is no one wants to spend any money.

The average person in the US has decided when times are tough, like now, it’s not a good idea to spend money and they’re saving some cash. When all the Fed wants them to do is step and spend some newly printed greenbacks.

You know, the funny thing is, the American consumer has got it right, whereas the Fed and the mainstream economists have got it wrong.

So it’s a little surprising that the Fed decide to lock themselves in a room for two days to discuss rates and the general state of the economy. Let’s be honest, with things unlikely to change, it could be done over email without them bothering to get out of bed.

Regards.
Shae

We think we’ve just found the new motto for Money Morning. We’re pretty sure we’ve come across that quote before, but for some reason when we heard it yesterday it’s the first time it’s stuck in our head.

But we also love this quote from our favourite information source, Wikipedia on the 15th president of the United States, James Buchanan:

“Buchanan’s efforts to maintain peace between the North and the South alienated both sides, and as the Southern states declared their secession in the prologue to the American Civil War…”

That’s the background, but it’s the following sentence we like most:

“Buchanan’s opinion was that secession was illegal, but that going to war to stop it was also illegal; hence, he remained inactive.”

That’s the kind of politician we could get to like… It’s just a shame about his pro-slavery stance among other things that kind of ruins it.

But the idea of remaining inactive brings us in a roundabout way to emails we receive some weeks ago from several Money Morning readers. They were emails alerting us to the US Commodity Futures Trading Commission (CFTC) hearings into “Futures and Options Trading in the Metals Markets.”

The main concern expressed by the readers was the apparent manipulation of the gold and silver markets by traders at two major banks.

As you can imagine, that certainly pricked our ears.

The only problem was finding the time to carefully look through all the info rather than just flying off the handle without thinking… You’re not laughing are you?

Anyway, as I was saying, we were trying to find the time to go through as much of the information as possible. So, yesterday evening we settled down to start watching the five hours, thirty-four minutes and thirteen seconds of hearings held on 25th March.

And it was from the hearing that we gained the first quote we highlighted above: “It takes great courage in a time of crisis to do nothing.”

As we say, we like it. In fact, we liked the whole presentation made by Dr. Henry G. Jarecki of Gresham Investment Management. I’ll tell you why in a moment.

The main reason readers brought this hearing to our attention was because of the alleged market manipulation. Accusations have been made by a London based trader called Andrew Maguire who claims that two banks in particular – JPMorgan and HSBC have such large positions in the market they are able to manipulate the price of gold and silver to suit themselves.

What I quickly discovered is that if I tried to get even my large head – but small brain – around the full issue, we’d still be here in 2050. So, rather than give you the full lowdown I thought it best to give you a summary of our thoughts and then let you look at all the evidence for yourself.

So, for starters, you can check out the full video of the CFTC hearing by clicking here. And then click on ‘View Archived Webcast.’ Remember it’s over five hours, so it’s probably best to watch it during work hours so you’re not wasting any of your own valuable leisure time!

I’ll be honest, as I write I’m only three hours, fifty-one minutes and forty-nine seconds into it, so I can’t comment on the entire hearing. As an aside, Commissioner Bart Chilton has the best hairstyle this side of the Mississippi.

Once you’ve watched that webcast – or before if you like – I suggest you click here to listen to an interview of Andrew Maguire on King World News. It’s apparently, the first interview given by Maguire.

In a nutshell, Maguire says that manipulation in the bullion market was so predictable that he contacted regulators – including Commissioner Chilton – and told them exactly how the manipulation works.

But Maguire went one step further. Several days prior to a predicted ‘takedown’ of the silver price that would follow the non-farm payroll numbers, Maguire sent an email to the regulators explaining exactly how it would all pan out. Not only that, but Maguire exposed the manipulation live as it was happening, pinpointing to the second as the big bank traders manipulated the market.

To be honest, we’ve no reason to disbelieve anything Maguire says. But check out the evidence for yourself. Do you know what, we think this story is much bigger than even the gold and silver bugs are making out.

You can tell by the fact this story has been almost ignored that the mainstream considers it to be another conspiracy theory nutjob story.

But what this story really tells you is that the manipulation of the gold and silver markets is just chickenfeed compared to the manipulation that goes on elsewhere in the markets.

But let’s stick with the bullion market for a while. One of the most extraordinary bits of information from the hearing was the following chart:

Apologies for the poor quality, you can view it in the original document by clicking here. The points of interest are the pink bars which indicate short silver futures positions held by US banks. You’ll notice there is a huge spike in the short positions (pink bars) in August 2008.

The total position soars from about 5,000 contracts in July 2009 to around 35,000 contracts in August 2009.

The significance of the date? Well, it just so happens that was the month JPMorgan finalised the takeover of failed investment bank Bear Stearns. The failure of two Bear Stearns hedge funds in late 2007 is kind of seen as the first signs of the ensuing market collapse.

We won’t pretend to know the ins and outs of this. But quite clearly it suggests that Bear Stearns either directly or indirectly held a massive short position in silver, a position that presumably only became apparent to the CFTC once the exposure appeared on the JPMorgan balance sheet.

But what this also points to is the massive positions held by other non-banks that the CFTC doesn’t get to monitor. And furthermore, if the banks and non-banks are doing this to the tiny bullion market, can you imagine what they’re doing in other markets?

Don’t forget the $13 trillion of off-balance exposure held by Australia’s banks. Multiply that ten, twenty or a hundred times to consider what the global exposure held by overseas banks is, and you can see what a massive risk there is to the economy.

But again, back to the bullion market. Make no mistake, the JPMorgan position is a huge exposure. As another witness at the hearings, trader Mark Epstein points out:

“The largest single position is held by a bank on the short side, and the size of that position is about 30,000 contracts (or 150 million ounces), which is about 120 million ounces larger than the current accountability limit!”

As we understand it, accountability limits are supposed to be limits put in place by the exchange to discourage excessive holdings by one individual or institution. But they’re ’soft’ limits which can be exceeded if approved by the exchange.

Epstein goes further and backs up Maguire’s claims about market manipulation of the gold bullion price using this real life example:

“I can tell you all kinds of statistics about the markets and the prices, but let’s take a quick look at 10:15 am on Feb 4, 2010. Somebody seems to have been in a rush to sell gold, and in less than a quarter-of-a-second, they sold about 2,000 futures contracts driving the price down instantly a hundred ticks. This represents 200,000 ounces of gold, or about $215 million dollars worth of gold at that time. That was a very big trade, and it took place in the blink-of-an eye. There aren’t many players in the gold market capable of playing that big, and I’m not sure what motivated them to decide to overwhelm the price of gold instantly (rather than selling more slowly), but this kind of thing happens in the metals markets. Not even India’s move to buy $6.7 billion worth of gold from the IMF on Nov 3, 2009 created this big of a disruption to the gold futures markets.”

Got that? A trader selling USD$215 million of gold inflicts a bigger disruption on the markets than the IMFs sell of USD$6.7 billion worth of gold.

But as I say, don’t think this is isolated to the bullion markets. This is the sort of chicanery that happens every day in other financial markets. Whether it’s equities, bonds, derivatives or anything else, you’ve got the big boys in there causing big movements in the market, most of it right under the nose of the regulators and the central bank.

Look, in some way we don’t blame the regulators. They’ve got an impossible job. They certainly can’t prevent mishaps, all they can do is clear up the mess afterwards.

In fact, we’ll argue – unsurprisingly – that it’s the presence of central banks along with government that is the ultimate cause of the market manipulation due to their creation of money and low interest rates.

Traders at the big firms are forced to take huge positions and huge risks because they can’t make money for themselves or their firms without it. Especially not when most Western central banks are holding interest rates below 1%.

We pointed that out yesterday with our paper money example. Those that get hold of the money first have the advantage, but they need to use the advantage to their benefit before others get in there first.

But, the most we’ve taken out of this hearing so far is, wouldn’t it be great if one of these toothless regulators held the same kind of hearing into the fiat money system? Calling the central bank and the government to account for their manipulation of money.

Because the type of manipulation taking place in bullion markets and doubtless every other market is no different to the manipulation the central banks inflict on the value of your money.

I mean, what’s the difference between a big trader artificially pushing down the price of silver and a central bank artificially pushing down the price of money – interest rates?

To our way of thinking there’s absolutely no difference. So while the exposure of the fraud taking place in the bullion market is interesting, a far more interesting and important story would be if the likes of central bankers such as Greenspan, Bernanke, King and Stevens were put in the dock and called to account for their manipulation of the market.

They should be carted off to The Hague and charged with crimes against humanity such is the effect of their market manipulation.

So, how do you solve market manipulation? Simple, you leave it to the free market. Without doubt, the free market is the best server of justice there is. Take this tale by Dr. Jarecki about the infamous attempted ‘cornering’ of the silver market by the Hunt Brothers in the late 1970s:

“Jim Stone was the Chairman of the Commission in those days and, as the silver price moved up and up, any number of brokers granted the Hunts more and more credit on their physical holdings. Fear gradually emerged that a bursting of the silver bubble and a subsequent failure by the Hunts might take down large brokerage houses and lead to a domino panic similar to what was recently seen [in 2008].”

Ah, history repeats. Almost. Dr. Jarecki continues:

“Jim Stone was leaned on by the most powerful figures in that era’s Administration, by the Treasury Department and even by the Federal Reserve Bank. They wanted him to intervene in the market, to “settle” the contracts to stop trading, or to set a ceiling price.”

Gee whizz, doesn’t that all sound familiar? And look who it is putting the pressure on to ‘do something’ – the government, bureaucrats and the central bank. And what do they want to do? They want to save the big end of town. Back to Dr. Jarecki:

“Chairman Stone said that the markets had the ability to right and to regulate themselves and that the best thing to do was nothing at all. Perhaps he had heard of the ancient Greek who said… ‘It takes great courage in a time of crisis to do nothing.’”

Hallelujah, leave it to the markets. So, according to Dr. Jarecki Chairman Stone did nothing. The outcome? Dr. Jarecki concludes:

“As the price of silver over very few months rose from $7 to $17 and then to $30, 40, and 50, the American public took its rings off, sold its silverware, and some even took their silver teeth out of their mouths. People lined up, two hundred deep, to sell silver. The smart people laughed at them. The market price of silver was $50 and the yokels were selling it for $30 to the scrap dealers who were selling it to the bullion dealers for $40 who were hedging it in the futures markets at $50. But when these billions of dollars worth of new silver got refined and came on the market and the Hunts, in an effort to keep the supply-induced price drop from causing margin calls that would bankrupt them, had to buy it up, the corner failed. It was not by an act of the Federal Government, but because the market itself corrected the imbalance between supply and demand and thus ultimately bankrupted the Hunts. It is here worth mentioning, of course, that it was the little guy who made

the big profit and that it was he, through the market, that foiled the Hunts’ attempt.”

We love the last couple of sentences: “It was not by an act of the Federal Government, but because the market itself corrected the imbalance between supply and demand and thus ultimately bankrupted the Hunts. It is here worth mentioning, of course, that it was the little guy who made the big profit and that it was he, through the market, that foiled the Hunts’ attempt.”

It pretty much sums things up. You’re seeing people selling their gold now of course. Also at a cheaper rate than the physical gold price. Could that portend a collapse in the gold price? We don’t think so, not with the price being kept artificially low by the bank traders, but anyway…

Dr. Jarecki’s statement sums up exactly in whose interest the bailouts of the last two years have been made.

The recent bailouts weren’t made to protect the economy or to avoid depression or to stop unemployment. The bailouts were made to stop big firms and the politicians mates from going down the swanny.

The only beneficiaries of a bailout for the brokers caught up in the Hunt Brothers scheme would have been the brokers that gave them credit. Just as today the only beneficiaries of the economic stimulus packages are the banks and their favourite customers – the building industry.

As an example we noticed this excellent article in The Age yesterday that provides further proof – if evidence from the former Soviet Union wasn’t enough – that central planning doesn’t work. That all it does is breed corruption.

It’s inarguable that the bullion market is being manipulated. The proof is there. It’s happened before and it’s happening again.

But more importantly, it’s also inarguable that the biggest manipulation of all time is occurring elsewhere. It’s occurring in the interest rate market where central banks and governments are artificially keeping the price of money down in order to benefit themselves and their buddies.

However, like all attempts at manipulation this one will also fail. And like happened with the Hunt Brothers, our bet is the winners will be the ‘little guy.’

Wouldn’t it be beautifully ironic if the manipulation by the banks to keep the gold and silver price low only resulted in giving the ‘little guy’ more time to buy gold and silver while it’s still cheap?

The message to take away from this is that free markets and freedom are your best friend. Governments, bureaucrats and those that tell you to ’shut up and pay your taxes’ are the ones to be feared. The evidence speaks for itself.

Cheers,
Kris.

But, we’ll stick to our guns and leave any p——y or h—–g comments until next week.

Anyway, our comments on pay equalisation seem to have set off something of a discussion both on the Money Morning website and in emails we’ve received to the Money Morning mailbag.

It’s an interesting topic so I thought it worth our while having another look at it based on some of the comments we’ve received.

A few interesting comments include this from ‘Zengirl’ that was left on the Money Morning website:

“It’s overwhelmingly disappointing that the attitudes of men toward equality are no different in the 21st century than they were in the last few. Using the concept of ‘competitive advantage’ to justify inequality is outrageous and simply cannot be supported in any way. Indeed, if your argument had any weight, then indigenous people (who are paid far less than any of us) would be the most competitive in the labour market!”

And also this from RB:

“IF women have a ‘competitive advantage in the workforce’ by being paid less, why do we not see women as heads of most of the board rooms, businesses and corporations throughout the country?”

Plus this one from CB:

“You have to be employed at a decent wage, so that your employment actually bestows you a decent spending power for it to be much good to yourself, your dependents, and even the overall health of the economy.”

And this comment from Nick:

“None of my staff’s pay is rated on anything else but job description and ability. Only a fool would jeopardise his company or business just to save a couple of dollars. Good people are the foundations of any business. I have found that people who are loyal to their employer are also loyal to their families, and visa versa. And if an employer is incapable of recognising that, they will suffer in the long run.”

Finally there was this gem:

“Charming re the low pay for women… women do 90% of the work on the planet and own 2% of the assets Big Daddy… disgusting especially when 99% of men are less intelligent than I am. get knotted Kris”

The first point to make, before we go any further, is that there will always be a degree of generalisation with this issue. The numbers from the pressure groups who favour pay equalisation trumpet the ‘fact’ that women are paid on average 17% less than men.

Is equal pay fair?

The call by them and others is that pay should be equal regardless of whether you’re male or female.

‘Equality’ is interesting because it suggests that all people should be paid at an equal rate. Therefore it suggests if Person A produces 200 widgets a day they should be paid the same as Person B who produces 201 widgets per day.

Is that fair? Probably. It’s close enough not to worry about anyway. But what if one is producing 300 and the other only 150? Is it fair they are paid the same? Now, this example isn’t specific to gender pay rates, but what it does is provide a case for employees to be paid different wages.

Once you agree that one method of determining different rates of pay is valid then you have to accept that there may be other ways of determining different rates of pay – not just based on the amount of widgets produced.

Then there are other comments that suggest there already is pay equality. That bosses would be mad if they paid female employees less than male employees.

We’ve no doubt that’s true. If there is no need or incentive for an employer to pay one group of employees differently from any other then the employer will pay the same or similar rate to all.

It will be a decision the employer has made based on experience and the market.

Furthermore, there’s the argument that female employees don’t “accept” lower pay, that rather it’s forced upon them.

We’d argue that everyone who takes a job “accepts” the level of pay. If they did not “accept” it they would not take the job. People only work if it’s in their interests to do so. They may not like the pay, but if it’s more beneficial for them to work than not to work, then they will work.

Finally, a quick note on the excellent comment from Zengirl, “if your argument had any weight, then indigenous people (who are paid far less than any of us) would be the most competitive in the labour market!”

‘Do-gooders’ cause more harm than good

Isn’t this an argument against arbitrary wage policies? If it’s true than indigenous Australians are discriminated against, then doesn’t it make their position much harder if they are unable to compete in the labour market?

If a minimum wage is set at $10 an hour a discriminating, racist or unenlightened employer may choose to employ a white person as that is their preference. But if there is no minimum wage, perhaps a discriminating, racist or unenlightened employer would be prepared to pay only $8 an hour to an indigenous Australian.

Perhaps the discriminating, racist or unenlightened employer would soon figure out that the indigenous Australian is just as – perhaps more so – capable than the white Australian and therefore increase the wage to $10 an hour.

However, at a mandated $10 per hour the indigenous Australian doesn’t have a chance, because the discriminating, racist or unenlightened employer has a prejudiced view that the indigenous Australian is less productive and is therefore only worth $8 per hour.

We’ve used the terms discriminating, racist or unenlightened employer, but we’re just using an extreme example. The fact is there’s obviously a barrier to employing indigenous Australians because even non-discriminating, non-racist, enlightened employers may be reluctant to do so.

Because if there wasn’t a barrier then indigenous unemployment rates would be the same as for all other groups. Our bet is that government interference is at the core of it – in fact, we’ll guarantee it.

There are plenty of other arguments and opinions as well. Feel free to leave your feedback when this article is posted to the Money Morning website later today.

But for now we’ll make this comment. Wage rates are determined by the market. In some cases it’s a free market, and in other cases it’s a manipulated market – eg. Award rates, trade union interference, government interference, etc…

No bumper pay day

But in all cases wages are determined based on what an employer can afford to pay. Artificially raising a wage rate doesn’t provide an across the board bumper pay day to everyone.

Instead it will provide a bumper pay day to some but create a pay cut or loss of pay to others.

Let’s take a look at a timely story that appeared in the Herald Sun: “Julia Gillard supports pay equity bid.”

According to the story:

“The Australian Services Union will launch a test case with Fair Work Australia today regarding the lower pay of community sector workers. They are the people who work in women’s refuges, family support centres, drug and alcohol rehabilitation and migrant resources. The union will argue that lower wages in the feminised community sector should be brought into line with pay rates in a similar, male-dominated industry.”

The article doesn’t specify which “similar, male-dominated industry” they want to align the wage rate with, so we’ll just have to make a whole bunch of generalisations. As I’ve mentioned it’s one of the things you have to do with this subject, so we’ll do that right now…

Our guess is that women’s refuges, family support centres, drug and alcohol rehabilitation and migrant resources jobs are either funded by government, quasi-government or charity-based organisations.

We’ll also make another sweeping statement to say that most of these services are either provided for free to the end user, or they may ask for a ‘donation’ from the end user to use the services. We’re prepared to be corrected if we’re wrong.

So, the question we have is how will the new higher wage rates be paid for?

According to the Herald Sun, “Australian Council of Trade Unions (ACTU) president Sharan Burrow admitted the push for a $100 a week pay rise for 200,000 community sector workers was not small.”

For the record, our Canon LS-100TS calculator tells us that’s an extra $20 million that these women’s refuges, family support centres, drug and alcohol rehabilitation and migrant resources organisations will need to come up with.

If we’re right and these organisations mainly rely on charitable donations and taxpayer funds then it means an extra $20 million will need to be raised just in order for them to provide the same level of service as they currently do.

Failure to do so will mean these groups will either need to reduce the number of staff or reduce the services they provide.

Naturally the argument will be, “Aha! If these are government funded then it’s easy, the government can just increase taxes to pay for it, it’s the socially right thing to do.”

Well, you know our opinion on taxation so we won’t delve into that again today. But let’s say the government does increase taxes to pay for it – after all, it’s just $1 per person per year, that’s not too much for anyone to cope with is it?

[Ed note: Our trusty calculator deceived us. Of course the full calculation is $100 x 200,000 = $20 million, times 52 weeks, equals $1.04 billion. That’s a cost of about $50 per Australian per year].

The problem is this. It’s our old favourite scenario of considering what is not seen.

What do I mean by that? If these government funded organisations do receive the extra money to pay for increased wages and they have done so due to higher government taxation, then it means less dollars in the pockets of individuals.

And perhaps it means that with fewer dollars in the pockets of individuals, there is less money for those individuals to donate to charities. With government subsidisation of one set of welfare organisations it potentially means other welfare organisations – those that rely on volunteers – could see a drop in donations.

Especially if taxpayers start to consider that a portion of their taxes is going to charities. Evidence in the early years of the National Lottery in the UK was that people donated less to charity as they were aware that a portion of the cost of their lottery ticket went to charities – that may have changed.

In other words, women’s refuges, family support centres, drug and alcohol rehabilitation and migrant resources gain, whereas donation-only or volunteer-only organisations potentially lose due to lower donations.

But that’s not the only potential problem. There’s the issue of the type of person drawn to these jobs.

Unskilled workers lose again

Let’s say for arguments sake that current employees in these organisations earn $30,000 per year (just to repeat, we’re just using this as an example). And let’s also say that this particular wage attracts a certain type of person, a person that has the desire to earn $30,000 per year and is skilled or qualified to do so.

So, what happens when the wage is increased by $100 per week to $35,200 per year? And let’s assume that the government stumps up all the extra cash so there are absolutely zero job losses.

Any guesses about what is likely to happen?

Well, one obvious impact is that the job will now attract all people who would like to earn up to $35,200 per year. We can take it one step further by saying – again using a generalisation – that those who expect to earn or who can command a wage of $35,200 may have more skills than those who were doing the same job but who were prepared to accept $30,000.

The consequence is that if the new legal minimum wage in this sector is $35,200 rather than $30,000 for what is in effect the same job, employers will be more inclined to employ someone with a higher skill set so that they are getting more ‘value for money.’

In other words, why would an employer pay someone $35,200 when they are only worth $30,000? They wouldn’t, not if they can attract someone with more skills who is potentially more productive for the same wage of $35,200.

Therefore, even though there may be a zero net impact on jobs, the effect is that the lower skilled workers are being priced out of the market by those with more skills. Simply because a mandate from the government decrees that $30,000 is too low a wage.

The employee that is only worth $30,000 to the employer is now unable to get a job in that industry and instead will have to seek work elsewhere. And that’s even though the potential employee may be perfectly qualified to do the job.

Of course, it implies the cost for the pay rise is fully underwritten by the government. In reality it won’t be. So not only will those with lower skills be pushed out of this type of employment, but there will also be fewer job opportunities for those with the skills as organisations will be forced to reduce staff levels.

Remember, pay equalisation doesn’t mean equality of pay for all. It means equality of pay for some at the expense of others.

Cheers.
Kris.

“Consider a man and a woman each with a productivity of $10 per hour, and suppose, because of discrimination or whatever, that the man is paid $10 per hour and the woman is paid $8 per hour. It is as if the woman had a little sign on her forehead saying, ‘Hire me and earn an extra $2 an hour.’ This makes her a desirable employee even for a sexist boss. But when an equal-pay law stipulates that she must be paid the same as the man, the employer can indulge his discriminatory tendencies and not hire her at all, at no cost to himself.”

This example is applied to a comparison of male labour versus female labour. As was our article yesterday.

But in reality, it’s not even a Male v Female thing.

Because just take the same example and switch in ’skilled worker’ in place of ‘man’ and ‘unskilled worker’ in place of ‘woman’ – not that we’re saying all female employees are unskilled of course! – and the same principle applies.

Or interchange ‘experienced’ in place of ‘man’ and ‘inexperienced’ in place of ‘woman.’ Or any other example where wages are artificially manipulated by government decree.

You can use the same comparison to relate it to the minimum wage. In effect, pay equalisation is just another form of creating a minimum wage. It makes it illegal for an employer to employ someone for a lower wage than someone else.

And like the minimum wage, one consequence is that it creates unemployment.

Anyway, we just thought we’d drop that in. You can still leave comments on this article by going to the Money Morning website.

Back to today. We notice that even the mainstream commentary over at Business Spectator is starting to get a bit antsy with all this ‘economic recovery’ thing.

Two articles yesterday, one from Karen Maley and the other from Robert Gottliebsen clearly warn – as we have – that things aren’t as rosy as they seem.

Right now we’d say, hats off to these two mainstream commentators for saying it. However it’s too late, much too late for it to have any impact.

As the saying goes, the die is cast. The bubble has expanded. It’s like when you blow up a balloon. No-one likes having the thing pop right in their face, but there’s still the temptation to try and make it a little bigger, and that’s what’s happening with the Australian economy now.

The only problem is that in mainstream economics they either don’t believe that bubbles exist, or they believe they are caused by something else, or that even if bubbles do exist then they think they’re smart enough to manage them.

I mean, they’ll look at the last eighteen months and conclude they know the recipe for curing bubbles. So that even if another one is brewing, don’t worry about it, they’ve ‘fixed’ it before, they can do it again.

Look at all the economic data that’s been paraded before your eyes. As you know, we’ve been critical of the way the ANZ Job ad numbers have been reported.

Well, finally you could say the February job ads do look more impressive than some of the previous numbers. In February, ANZ Bank reports a total of 158,611 jobs advertised compared with just 109,177 in January.

You’d expect a pick-up in February, but still, it’s a 45% increase over the previous month. Although, compared to the same time last year, when the economy was on the verge of recession, job ads are still down by 3,723.

And remember, we’re using the original numbers, not the seasonally adjusted or trend numbers.

And then look at the other stats: “Australian economy continues to grow: ABS.”

According to the Australian Bureau of Statistics (ABS):

“Latest ABS figures show that GDP, in seasonally adjusted volume terms, grew 0.9% in the December quarter 2009, after growing 0.3% in the September quarter.”

The Australian economy continues to grow, grow, grow. That provides even more evidence to the mainstream that Australia has figured out how to perfectly direct and manipulate an economy to avoid collapse.

Although, the next paragraph from the ABS statement gave the real game away:

“Growth in the expenditure measure of GDP was driven by a 3.5% increase in private investment , a 10.2% increase in public investment and a 0.7% increase in household expenditure. Offsetting these increases was a fall in net exports. The fall in net exports was due to imports (up 7.7%) growing faster than exports (up 1.7%).”

Actually, we’ll rephrase that. We’re not sure it’s really given the game away as everyone knows public spending – or public ‘investment’ as the public sector drones prefer to call it – is going mental: money spent to ‘create’ jobs, then more money spent to ’save’ jobs, then another bunch of cash to compensate for jobs lost.

The madness never ends.

But that brings us back to the point we made above. While it’s good that some in the mainstream press are starting to whiff a bit of trouble, it’s all rather too late.

The time for warning about the nonsense idea that you can borrow to get yourself out of debt was a subject for twelve months or two years ago.

Yet at the time the mainstream press was too excited about making sure their elected representatives ‘did something.’ At the depths of the market meltdown, it wasn’t the time to ‘play politics’ or get bogged down in ‘economic theory.’ It was the time to ’save jobs’ and help those families who seemed to be constantly ’sat around the kitchen table.’

But the biggest problem right now is the sense of false security – or false sense of security, whichever you prefer.

We’ve noticed quite a bit of excitement about all the increased profits Australia’s robust and excellently run companies have made in 2009. Today’s Australian Financial Review (AFR) trumpets, “Earnings return, are shares next”, “Property turns the corner” and “How banks came out in front.”

According to the AFR, 80% of Australia’s companies reported profits in-line with expectations. It goes on, “Profits for industrial companies rose 3.8 per cent from a year earlier.”

But the AFR does point out, “Cost-cutting was an important driver of profits in the half. Some big companies reported falling revenue but were able to increase profits by reducing their spending on wages, property and technology.”

That’s something we noticed last week. This is what we wrote to Australian Wealth Gameplan subscribers last Friday:

“Last week we conducted a simple exercise. We looked at the company results for that week as reported in the Australian Financial Review (AFR). It printed the earnings results for 131 companies – large and small. As you’ll have read in the mainstream press, a lot of companies produced bumper profit results, such as Flight Centre [ASX: FLT]. What the mainstream press didn’t report was the less than exciting news on the revenue figures. Of the 131 companies detailed, just over half (66 of them) reported lower sales revenues than the previous corresponding half-year or full-year.”

It wasn’t just ’some big companies’ that reported falling revenue, it was half of those companies that reported during that one-week period.

What does that tell you? Well, as the AFR reports, many companies have slashed costs in order to beef up the bottom line. So the first question is whether they can keep doing that?

The other question is whether they can increase sales by as much as the market is now pricing in? Our guess is that will be much harder to achieve. And much of that is down to the sense of false security and the misplaced belief that the bright economists and central bankers have engineered Australia’s escape from the global meltdown.

The economy is growing, companies are hiring again, miners are mining stuff, credit is booming, and everything appears to be ticking along as though nothing has happened.

And as for that old subprime stuff, well surely that’s all fixed up, and no-one will make that mistake again. Trouble is, it’s often forgotten that subprime wasn’t the cause of the problem, it was the effect. The cause of the problem was excess credit and government interference.

Excessive credit simply manifested itself as subprime loans. Subprime borrowers were the means by which politicians could parade themselves as helping the poor, and by which bankers and young gun traders could earn themselves a bucket load of cash.

Therefore, solving the subprime problem will do no more than shift the excesses of credit elsewhere.

We’ve seen that before. Look at Enron. The trading guys at Enron weren’t specialists in electricity trading. They were young kid traders sat in front of six computer screens who just had to click ‘buy’ or ’sell’.

As soon as Enron collapsed they went off looking for other things to ‘buy’ and ’sell’. Many of them probably ended up trading credit default swaps and other such derivatives. Financial instruments that they were just as ignorant of as the electricity market.

Solving the global meltdown by blaming it all on subprime and removing that risk is like taking the keys from a youngster who’s been driving a sports car too fast, and instead handing him the keys to a 3000cc motorbike.

There will still be carnage it’s just that it will look different.

As much as the mainstream commentators may claim that lessons have been learned and that Australia didn’t have a subprime culture, it all misses the point. The old habits of excessive borrowing are still unchanged, and in fact are likely to get worse.

So the message is, if you’re looking for the next big economic meltdown to come from the US subprime housing market, odds are you’re looking in the wrong place. So where will it come from?

We’ll look at that another day. But our guess remains that you need to look north. Because China is brewing up quite nicely right now.

Cheers.
Kris.