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Keen to be beaten

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When I started railing against interest rate rises late last year, the guy I pulled out to wave at authorities was University of Western Sydney economist Associate Professor Steve Keen. He was right about debt levels inevitably spooking stock markets, but now he has to end up being wrong.

It is now a battle of the world versus Keen, where the might of world central banks, international governments and the collective global private sector have to get it right to make this hopefully eccentric professor wrong.

To be less dramatic, which probably is not appropriate considering the potential threat to our hip pockets and our material future, you have to hope Keen’s theory is beaten by reality.

Back in April 2007, when we were getting wind of a sub-prime problem in the USA, he warned about our Debt to GDP levels.

“The level of Australian household debt  — the sum of mortgage debt and personal debt — is every bit as extreme as the USA’s,” he told me. “And contrary to popular opinion, our debt binge dwarfs America’s.”

Australia’s household debt to GDP ratio had been growing more than three times as rapidly as the USA’s since 1990. The ratio had grown at an average of just over 2 per cent per annum in the USA. It has grown at over 6.8 per cent per annum here.

Being a glutton for punishment, I had Keen on my Money Makers program on Sky Business a few weeks ago — before the shock 1 per cent rate cut from the Reserve Bank of Australia.

He predicted a cash rate of 2 per cent in 2009 and zero per cent by 2010. If that comes about we would be in the worst economic slump since the Great Depression.

So when US President George Bush calls for a series of global summits to rescue confidence and stimulate stock market buying, you have to believe that this is a rare moment when George W is on the money.

Underestimating the potential seriousness of the economic fallout has been a worldwide shortcoming. The former Federal Reserve Vice Chairman Alan Blinder — an unfortunate name in the current circumstances — recently observed: “It looks to me like the economy has fallen off a cliff.”

And there’s a growing queue of economies around the world ready to take the plunge because their banks screwed up their risk management and have been starved of funding for months.

But the main game for investors praying for some shares to head up is Wall Street and its shares are now controlled by credit markets.

The best news recently was that credit markets were thawing, albeit slowly. Also JP Morgan lending to European banks was a very positive sign.

This came when the Dow Jones index had its best week since 2003, rising 4.7 per cent. In fact, the share prices of Morgan Stanley, UAL and Ambac all rose by more than 100 per cent in the week before last.

In the same week, 59 per cent of US companies beat analysts’ expectations and only 27 per cent missed.

Meanwhile Warren Buffett turned scribe in the New York Times advising Yanks to buy American industry. But the guy I took some heart from was Paul McCulley, the managing director of PIMCO, which is one of the world’s best bond market players.

He believes a lot of good things have been done to turnaround this credit market mess.

“We have some serious artillery in play,” he said last week. And that was a vote of confidence in the rescue packages and the efforts to kickstart the commercial paper market.

At a time of market failure, the government solution is the only way, and as the money markets crisis has now become a macroeconomic threat to business profits, businesses themselves and jobs, everything has to be thrown at the problem to shore up confidence.

The chief investment officer of PIMCO, Bill Gross, summed up the current problem in his October newsletter.

“We are to the point of fearing fear itself — America in all its resplendent free market capitalistic glory is on the auction block with few bidders,” he laments. “As recognition of a systemic period of capitalistic instability becomes apparent, the focus has legitimately shifted to a systemic solution.”

The big interventionist play is crucial now and we will have to deal with the impacts of this later. It will mean higher taxes, relatively higher interest rates on average, less profits and we will have to get used to a stock market that does not do four years in a row of 20 per cent plus returns.

The massive rise of debt to Gross Domestic Product caused this, so lower interest rates both reduce our debt repayment obligations and stimulate demand and production. The negative headlines have to be beaten to prevent a serious recession in Australia.

Keen hopes he is wrong, and so do I, but complacency could be our greatest enemy.

Published on: Tuesday, October 28, 2008

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