Collapse of US Economy Will Have Indirect Impact on Australia

Your editor has abandoned plans for a property theme in Money Morning this week.

The response on the online blogs and to the Money Morning mailbag has been too much for our walnut-sized brain to cope with.

You can view the articles online at www.moneymorning.com.au and www.dailyreckoning.com.au and of course you should feel free to post your own comments.

However, despite today’s respite from property, we will be back challenging the housing shortage fibbery either tomorrow or Friday. It all depends whether something else pops up to grab our attention.

Take today’s headline from the Associated Press:

“Most red ink ever: $9 trillion over next decade”

Fortunately it’s not anything directly to do with Australia. Instead it’s those fiscally redundant Americans.

As AP goes on to report:

“In a chilling forecast, the White House is predicting a 10-year federal deficit of $9 trillion — more than the sum of all previous deficits since America’s founding. And it says by the next decade’s end the national debt will equal three-quarters of the entire U.S. economy.”

Notice I’ve said ‘directly.’ Indirectly, the collapse of the US economy, its currency and its entire financial system will have an indirect impact on Australia.

The problem is figuring out whether the collapse will have a positive, negative or neutral impact on us.

But one thing’s for sure, it’s proof that you can’t spend your way out of trouble.

It continues to amaze your editor the number of news reports and commentary we read claiming government needs to keep spending to keep the economy on track. That somehow spending more money and going deeper into debt is good for you.

The problem is, these so-called economists and commentators appear to have a very warped view of how a government fits into an economy.

They seem to think that government is disconnected from an economy. That God-like it can simply fiddle with the economy and remove itself, and no-one will notice.

And of course, that any interference can only benefit the economy.

Clearly this is all nonsense. Unfortunately, governments are not able to fine-tune an economy to make it run smoother. It cannot interfere to quickly remedy a problem.

There is only one – that’s right, just one – mechanism that can effectively correct distortions. That is a free market.

Allowing a government to spend as much as they can to get the economy out of trouble just gets us into more trouble.

Take the crazy ‘Cash for Clunkers’ initiative in the US. The UK has had a similar policy too.

We can only hope the Australian government doesn’t follow this example following the drop in vehicle sales last month.

Anyway, the gist of it is car owners can trade in their old fuel-inefficient banger and get a cash payment from the government to put towards buying a new fuel-efficient car. The weird logic is that this will help the environment by reducing fuel emissions while also giving a ‘vital’ boost to the car industry.

Naturally, the real outcome is that not only will the policy achieve neither of those aims but it will also harm other areas of the economy too. Let me explain…

Let’s take a look at the environmental issue first. Claims have been made that getting all these old bangers off the roads will reduce carbon dioxide emissions by several million tonnes per annum.

Now, we have no way of telling whether that’s true or not. Of course, neither do the people making the claim. But odds are it won’t have anywhere near as positive an outcome as they claim.

Our guess – and it’s only a guess – is that armed with a brand new car, people are more likely to drive it more than they did their old clunker. A more fuel efficient car means you can drive it further on the same amount of fuel.

A newer car is perhaps less embarrassing to drive than a bomb.

A newer car is nice and new. Generally people like showing off their new things. What better way to show it off than to drive it everywhere. Why not take that 200 mile drive to the country that you never would have considered in the old bomb.

But, as I say, we’re only guessing. Maybe we’re wrong.

What about the ‘boost’ to the car industry? Undoubtedly it will provide some benefit to car dealers and car manufacturers. After all, if they are able to sell cars now that they otherwise may not have sold then that is more money to the car dealers bottom line.

However, once the scheme finishes it will soon be apparent that it has provided no benefit at all. As with any distortion to the market, the ‘Cash for Clunkers’ programme has merely shifted the scenery. It’s the same scenery, it just looks different.

You see, it doesn’t address the underlying problems with the car industry. The car dealers and car manufacturers may get extra dollars in their pocket now, but next month they’ll get less dollars.

And the month after they’ll get the same less dollars. Because not only will marginal purchasers have bought now, but those that would have purchased next month or the month after will have brought forward their purchase.

And those that didn’t purchase? Well, perhaps they’ll just hold off buying. Maybe they’ll think the government will introduce another ‘Cash for Clunkers’ scheme once car sales plummet again.

But the real damage is done to what isn’t seen.

In other words, the manipulation of the demand for cars has a negative impact on every other sector of the economy.

We heard Jim Cramer on CNBC try to rebuff this argument by saying something like: “As if someone is going to choose between buying a pair of sneakers or buying a new car.”

Well, Jim, in effect that’s exactly what happens. Maybe Cramer thinks it is laughable but it isn’t.

The simple fact is, very few of the car buyers would have paid cash for the car. They would have taken out a loan.

Taking out a loan means making repayments. Those repayments could be $100, $300 or $600 per month.

That money has to come from somewhere else in the household budget. If the buyer has had to take out a loan to buy the car then we can assume they don’t have a million dollar bank balance.

In order for the buyer to afford the monthly repayments on the car loan they have to source the money from one of two areas. Either they cut back on spending elsewhere, or they draw down their savings.

Again, we can assume most buyers will have to re-allocate their savings from elsewhere. What does that mean? It means they may have to spend $100 less on shopping – that’s $100 less to the supermarket owner.

Maybe they’ll spend $100 less on going to restaurants. That’s $100 less to the restaurateur.

Or perhaps they’ll spend $100 clothing. That’s $100 less to the clothes store.

And all in the aid of propping up an inefficient industry with taxpayer funded bribes.

It’s called the misallocation of resources, and it only succeeds in distorting the economy further and making things worse.

Australia has had its own distortions – the property market included – and despite the constant refrain of “it’s different here,” the outcome will be that things are no different at all.

Other Stuff on the Markets

The S&P/ASX200 slipped 0.46% yesterday, while overnight on Wall Street the Dow Jones Industrial Average added 30 points. In Europe the FTSE100 gained 0.42% and the CAC40 added 0.78%.

The price of gold in Australian dollars is trading at $1,132.50, while in US Dollars it is trading at $945.30.

The Aussie dollar remained steady versus the US dollar and Japanese Yen, trading at USD$0.8349, and JPY78.58.

Crude oil closed overnight at USD$71.75.

For the biggest movers on the market yesterday click here…