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The value of a credible threat

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I was talking last week about how you’ve got to have a ‘credible threat’ in negotiations, otherwise you’re dead in the water.

If you’re in negotiation with someone, and you can’t create any realistic down-side, then you’re not really in negotiation. You’re in a position of asking… pretty please with a cherry on top.

You’re not in a position of power.

And so sometimes this means you’ve got to be a little tough – or at least play a bit tough.

But a threat alone isn’t enough. It has to be credible.

For example: “If you don’t come around and fix this bodgy plumbing job you did in my new bathroom, I’m going to open a portal from hell and set the hordes of darkness upon you.”

Threat: yes. Credible: No.

And so a lot of people balk at making threats because they don’t feel they can deliver one that is credible.

If you’re a total softy nice-guy, always bending over barrels to help people out, it’s difficult to turn around and deliver a threat that’s credible.

But there is always something available to you.

It reminds me of a story I love about a guy who was set upon by a bunch of thugs. It was late, there was no one around. There was 5 of them, just one of him. It was a hairy situation.

And this guy wasn’t Bruce Lee or Jean Claude Van Damn. A threat to open a can of whoop-ass was never going to be credible.

But he came up with a credible threat.

He picked out the guy who seemed to be the ring-leader – the top dog. Then he looked him square in the eye.

“There’s a lot of you and I’m not much of a fighter. I’m probably going to get hurt. I might even die. I’m ok with that. But I promise you this. If we fight, I swear I will tear your ear right off your head.”

Suddenly he had a threat that was credible. If you were in a brawl, and you didn’t care whether you lived or died, and you set yourself single-mindedly to nothing but tearing someone’s ear off, there’s a decent chance you would.

And suddenly, this gang had a downside. They would still win the fight. They always would. But now there was a reasonable chance that their top dog was going to lose an ear.

There aren’t many things in life worth sacrificing an ear for. Dutch post-impressionist painting maybe, but not much else.

And so the negotiation was flipped on its head. It was no longer this guy pleading for his life, relying on the humanity of the gang. Pretty please with a cherry on top.

Rather it was a threat to get beaten up vs. a threat to lose an ear.

The gang walked away.

But do you see what I mean? There is always a credible threat you can make.

Credibility in turn relies on your strength and weaknesses. It needs to be consistent with who you are as a person, and what you are and are not willing to do.

And you need to be willing to follow through. This guy really would have gone after that ear. The gang felt that.

But yeah, if you feel you’re lacking power in a negotiation, come back and look for your credible threat.

And go hard.

The giant awakens

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It was a strong GDP print last week… and the truth is even stronger.

I just wanted to pull out two things from last week’s GDP release.

First up, every quarter it rolls around, we’re reminded of our record-breaking run without a technical recession (two negative quarters in a row).

We’re now up to 26.5 years!

It’s pretty impressive.

Of course, to a lot of people, it means we’re doomed. The business cycle moves in… well… cycles. So what goes up must come down.

We’ve had it too good for too long. We’re due.

But this was a point Glenn Stevens made before he retired: just because we haven’t hit that arbitrary recession mark, it doesn’t mean that the business cycle is dead.

And if you look at the chart, we still get all the ups and downs of a regular economy. We just don’t stay negative for long.

And in part, that’s been about population growth, particularly through immigration. If you look at the per capita numbers, then we’ve had several recessions in the past twenty years.

So this whole “we’re due” argument… I’m not buying it.

The other thing that jumped out at me from the GDP release is the building pressure on wages.

One of the mysteries of recent years has been the wageless boom in profits – normally corporate profits and wages move hand in hand. Look at the chart below. The correlation is pretty tight.

But at the end of 2016, we saw company earnings pick up, while wages remained flat.

But now wages pressure is building. It looks like wages are catching up quickly, and they’re currently rising sharply.

Looks like we’re heading towards 5-6% per annum.

It could even be more since wages have been repressed for so long.

This could be just what Australia needs.

If you look at the last quarter of growth, it was driven by a surprising surge in exports, together with strong public spending.

Household consumption was unimpressive.

That’s been the theme for a while now.

The Australian economy needs to pass the baton over from the resources sector to the household sector. So far, households haven’t been willing to take it on.

But with more cash in their pocket, they just might be convinced.

The other thing, of course, is that higher wages will eventually feed through into higher rents.

Rental growth hasn’t been keeping pace with prices, and yields have been compressing.

Growing rents will reverse that compression, and once yields get back to normal – say around 4% nationally, then growing rents will feed through into growing prices.

And so as the household sector starts spending again, they will become the engine of house price growth.

And that’s not a moment too soon either. Largely, recent price growth has been driven by credit. But thanks to APRA and the Royal Commission, the credit channels seems to be running out of puff.

There’s a baton change needed there too.

So this is a story of a giant awakening. The Australian household sector is huge, and it’s too important to go on sitting on the sidelines.

It’s a good news story.

Bad News: Your money in the bank- gonski in 60 seconds.

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Another day, another banking attack on democracy.

Valentines Day will go down as a dark day in Australian history.

It was the day that the banks overturned one of the few protections that depositors had.

Ask anyone how safe their money in the bank is. I'd say 80% wouldn't have a clue. The banks are big. The money must be safe.

Another 20% are probably aware that Australia has a federally-funded deposit guarantee scheme.

So if a banks goes broke, and you had money in the bank, then the government will give you your money back, up to $250,000.

It's called the Financial Claims Scheme, or FCS.

(Not to be confused with the government's current public relations program, ‘ffs'.)

So all good, right? Your money's safe.

Well, turns out, it's not so safe. It turns out the FCS is underfunded, and not actually much of a guarantee at all.

In 2011, the international Financial Stability Board based in Basel, Switzerland, found that Australia's FCS contained about $20 billion for each bank in Australia.

Sounds like a lot right. Well, actually, no so much. Each of the four majors, who account for over 80% of all deposits, they each have something north of $400 billion in deposits.

So if one of the big four went under, the chances that there'd be enough in the kitty to cover it are pretty small.

Especially when you remember how concentrated the Australian banking sector is. It's hard to see a situation where a major goes under without taking some of the regional banks with them.

So not a lot to inspire confidence there.

But that's ok, the government could just go into debt or print money to make sure it hit its FCS obligations, right?

Well, maybe, maybe not.

And this is what happened on Valentines day.

The government sprung a sneaky move on the Senate, ramming legislation through while just 7 senators (of 76!) were in the room to vote on it.

(I guess the others were taking their chief of staffs out for a candle-lit dinner).

It was the APRA crisis resolution bill.

What's in the bill?

Well, a bunch of stuff, but the most alarming was the removal of the guarantee bit from the deposits guarantee scheme.

At this point I have to introduce you to Dr Wilson Sy. He was formerly the Head of Research at APRA, so knows what he's talking about.

As he says, “the evidence collected here strongly suggests that the Bill is designed to confiscate bank deposits to ‘bail in' insolvent banks to save the financial system.”

How?

“Or”.

There was key change to the APRA mandate. APRA is normally responsible for “protecting depositors AND ensuring the stability of the financial system.”

However, in the latest bill, APRA is allowed to make its decision in secret, if it is in “the interest of protecting depositors OR ensuring the stability of the financial system.”

See what they did there?

Now typically, protecting depositors is part and parcel of ensuring the stability of the financial system.

But in the middle of a crisis? When banks are going to the wall and the government is running out of money?

When it's facing the prospect of having to print billions and trash Australia's financial reputation?

It's not hard to imagine a scenario where protecting depositors is not the best way to ensure the stability of the financial system.

And since that decision will be made behind closed doors, it's also not hard to imagine a situation where government lackeys just decide to fleece donors and bail-out their banking mates, given the choice.

As Dr Sy points out, the new bill gives APRA and the government “discretion.”

But it's just not a guarantee if the body behind it has discretion.

It's like your insurer saying to you, yeah, your house and contents are totally insured… you know, unless something else comes up. Let's just see how it flows on the day.

And in the middle of a crisis, with a disaster to blame and their banking mates to protect, you can bet that the politicians will use their “discretion.”

And so that's what happened. On Valentine's Day, in the cold, heart of Canberra, the government quietly rushed through legislation designed to screw depositors over.

Thanks, mongrels.

I know the banking sector gives us things to be angry about on a daily basis, but if you're looking for a good outlet for that anger, the Citizen's Electoral Council is running a strong campaign on it. Check it out.

And time to rethink our definition of ‘defensive' assets.

Why the apartment crash is on hold

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Banks are running a closed shop

I've been warning my readers about the high-rise apartment sector for what… like 3 or 4 years now?

They're still standing… Is it time to admit that I'm wrong?

While I generally agree with the line that being wrong about the timing is the same as being wrong, I'm standing by what I said. In fact, if you followed my advice and steered clear of the high-rise sector in recent years, I expect a thank you card for Christmas.

And if things play out how they look like playing out, I expect you'll want to throw in a top-shelf bottle of whiskey to accompany that card.

So if things are as shaky as I've been saying, why haven't we seen more cracks starting to appear in the high-rise foundations? And apart from blacklisting a few suburbs here and there, why aren't banks back-pedaling harder on their exposure to the sector?

These are good questions. One of the old salty dogs of the Australian economic commentariat, Robert Gottliebsen had a crack at answering them the other day. I think the answers were interesting:

“Nowhere in Australia are there more danger signals than in inner city apartments. Most of the property commentaries look at average dwelling prices in particular cities, not at specific markets.

Broadly one and two bedroom apartments units sold on a “used” basis are down about 20 per cent in the three main markets – Sydney, Melbourne and Brisbane. Melbourne has a very serious problem in this market because a large number of the apartments have explosive high fire-risk cladding that must be replaced, which will either send builders and other industry players to the wall or will be paid for by owners who are risking their own or their tenants' personal safety each day. As this becomes understood the value of these apartments will fall by a lot more than 20 per cent.

Ok, hang on a sec. “Explosive” high fire-risk cladding? I've written about the cladding issue before, but I'm not aware of anyone saying that the cladding had the potential to “explode”. Maybe it was senior moment… Anyway:

Right now there are series of developers and apartment owners that in years gone by would have seen the bank heavies move in and take control.

But the banks are just sitting there watching the crisis unfold. Why? Here are five possible reasons and I give my rating out of 10 for each of the reasons.

Firstly the banks have changed their spots and are going to be soft in the future. Possible accuracy rated out of 10 – nil.

Secondly, the banks are scared about the impact on the total market if they pull the plugs. Rating – nine.

Thirdly, in Melbourne, taking control of fire risk apartments either by appointing receivers to builder/developers or taking control of individual apartments is extremely dangerous for banks. Stay low: Rating – nine

Fourth, the banks are worried about the royal commission and don't want bad headlines at this time. Rating – eight.

Finally, when interest rates are low banks are less likely to be vicious because the cost of allowing money to be frozen while the borrower tries to solve the problems is low. Rating, seven. But this will change if interest rates rise.

At some point the banks will have to confess their problems in this area and my guess is that the combination of higher global interest rates and the royal commission will force those confessions.

Maybe. I suspect to the only way to get the truth out of the banks is to pry it from their cold, dead hands.

However, on the idea that the banks are colluding to prop up a sector and to prevent the entire industry taking a bath… well, we've seen it before and it certainly wouldn't surprise me if that was the case.

I think the banks probably did get a little blind-sided by the king tide in foreign capital – a tide that came in quickly, and is quickly on the way out.

They don't want to be left holding the baby on that one, but they're stuck with it.

A managed unwind is actually probably the best we could hope for.

I think the next 12 months are going to be make-or-break. Developers and early buyers will be looking to off-load stock on a new generation of buyers.

But the only generation of buyers that's going to fall for that – or be dazzled by free i-pads, and interest free furniture packages – is a generation that is probably not going to be particularly savvy.

(They're not going to be readers of my blog, that's for sure.)

That also means that they're probably not going to be in a super-strong financial position. They're more likely to struggle with mortgage payments if the economy stumbles.

That is, the market is trying to hand-ball the baby on to a new bunch of suckers, and those suckers are the most likely to go down, fall hard, and go down en masse.

That wouldn't be fabulous for the economy.

So spread the word. Is grandma thinking of tipping her nest-egg into an off-the-plan apartment in inner-city Brisbane?

Get her to think twice.

The sleeper-cell in Aussie property

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This could be a total game-changer

I’m still not sure that people are awake to what a big deal this could be for Australian property. It’s lying like a sleeper-cell, but if it gets activated, oh boy, look out.

I’m talking about cladding.

The cladding that goes on the outside of apartment towers, and was responsible for the London Grenfell disaster earlier in the year.

Apparently, it’s a problem here too.

The thing is though, no one really knows how much of a problem.

And that’s because the dodgy, flammable cladding is indistinguishable from the code-compliant stuff.

So even builders who thought they were doing the right thing, maybe have been wrapping their buildings up in dodgy imports and turning them into a powder keg.

Apparently, there’s no way to know unless you actually try and set fire to them. Maybe we have to make that a clause in any new building development? Cladding has actually had to have had a blowtorch applied to it at some point.

Every silver lining has a cloud in the modern economy. And so while open borders and expanded trade routes have brought all manner of cheap goods into our homes, it also means that we don’t really know where things are coming from, and our compliance structures hinge of the integrity of authorising bodies in Chinese provincial back-waters.

Modern life.

And the scale of the problem is potentially huge. In Sydney, Melbourne, Perth and Brisbane we’ve been building apartments like it’s going out of style.

Most apartments have now been built post-GFC. And that means post the era where cheap imports started washing up on our shores.

So we’re talking huge.

The Victorian government’s task force hasn’t reported back yet, but they reckon there are more than 5,000 buildings in Victoria that are non-compliant, according to the ABC.

So no one seems to be arguing the toss that we’ve got a problem.

The only question is what we do about it?

And on that front, surely complete remediation is the only option right? Surely you can’t have dangerous, flammable cladding stuck to the sides of buildings that people actually live in.

So obviously the dangerous stuff will have to be replaced.

But let’s run through another scenario.

Let’s say the problem isn’t as dangerous as we fear. Of those 5,000 buildings in Victoria, only 20% are actually Grenfell-level dangerous.

The rest are just non-compliant in a slightly dangerous way.

But then what message does it send if we say, oh well, there’s a bunch of non-compliant buildings that we’ve uncovered, but we’ve decided to turn a blind eye in this case because it’s just going to cost too much money to bring them up to code…

Could they really do that?

What message does it send about the codes themselves?

“More like guidelines. Ideal if you can afford it, but if not, don’t worry.”

What’s the point in having codes at all?

And what does it say about enforcement?

“As long as you’re not using kerosene-soaked rags as drapes, you can pretty much get away with anything.”

Yeah, nah.

Neither of those options is viable in my mind. The whole integrity of the system is at stake here.

The government has to enforce the code and it has to order all faulty buildings to be remediated. I really don’t think it has a choice here.

I mean, imagine the PR disaster that would follow a human disaster if a building that was found to be non-compliant now, was not forced to refurbish, and then was involved in some sort of tragedy down the track.

And if we’re talking about refurbishment costs, who ends up footing the bill. The builder? The dodgy Chinese importer? The government? The property owners?

Right now, I feel for the 137 people who own units in Melbourne’s Lacrosse building, which caught fire in 2014 and was found to be using the same cladding as Grenfell. They’re now locked in a legal battle with the builder LU Simon.

They want to the builder to pick up the tab for the mandatory refurbishment costs. The builder is arguing that the panels they used were up to code at the time. It’s not their fault…

… or their responsibility.

Nothing but trouble once the lawyers get involved.

So this is all bad news, right?

Well, not exactly…

It’s bad news if you own one of these flammable shoe-boxes, that’s for sure.

But for the market overall, that’s a different story.

Basically, the only thing that’s kept a lid on prices in recent years, as the mining boom income works through the system, and we continue to support record numbers of immigration into our big cities, has been unit construction.

The phenomenal surge of apartment construction has helped us keep pace with population and income growth, and has helped keep a lid on prices.

(If you can call 50% in 5 years ‘a lid’).

And there has always been a qualitative difference between units and houses, but now we’re going to be looking at a markedly differentiated market.

There’ll be detached houses, with the little conveniences that come with having your own patch of turf.

And then there’ll be apartments, with a potentially hefty refurbishment bill hanging over their heads.

I mean, would you be buying into these things without being 1000% sure that the cladding was compliant?

(Hint: you shouldn’t.)

In my mind, there’s a massive TILT light going on, as demand tilts even further towards detached housing, and away from units.

And if this is as huge as it looks like it’s going to be, then we’re talking about huge price movements in the detached housing market.

Huge.

But we still don’t know for sure. The true extent of the problem is hidden from view.

The giant is still sleeping…

But look out if he wakes up.

Do you see this having a big impact on the market?

What is a house? (asking for a friend)

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Housing isn’t the concept that we thought it was… have you caught up?

What is a house?

If like most people you said something like, “a place where people live”, then you’d be right, but you’re missing a big part of the story.

Even if you put on your investor hat and said, “a place where people live, that you can also own and earn a rental income from,” again, you’d be technically right. Full marks from Investopedia for you.

But again, this is only part of the story.

Housing, as a concept, is changing.

And if you’re not watching this space, then you’re going to miss the biggest opportunities on offer over the next twenty years.

For a long while, you’re “a place where people live” definition would have served you well. Up until about the late 1980s, that was pretty much right.

But then ordinary Australians started cottoning on to the investment potential in property. They realised that housing was a place where people lived, but it was also something you could invest in.

The game changed, and a big part of the story behind the ongoing boom we’re living through is that more and more people are making property part of their portfolio.

But now the game is changing again.

Some of those changes are easy to identify.

Take the evolution of AirBnB for example. That has surged in recent years, and it’s a whole new way of thinking about housing.

Now a house is somewhere that people live, that can be invested in, and can give you access to the Tourism dollar if you fancy being a hotelier.

The latest stats show there are 115,000 listings on Air BnB right now.

And a study from the University of New South Wales shows that in Sydney, 60% of Sydney’s 20,000 listings are for entire homes.

That means there are 12,000 homes in Sydney, that used to just be a place where people lived, but are now a sort of quasi-hotel.

And if we extend Sydney’s experience around the country, that means we’re talking about something like 60,0000 to 70,000 homes, across the country, now dedicated solely to the short-term accommodation market.

This is a real shift.

I mean, we’re talking about almost a full year’s worth of housing supply, just never making it to market. That’s got to have an impact on prices.

Or take the way housing has become a ‘store of wealth’ for rich globalists.

Rich people (even aspiring rich people!) from China to the US, from the UK to Russia, are looking to Australian property, not because it earns an investment return, but because it gives them a way of storing their wealth…

(… and possibly hiding it from the authorities back home.)

There were almost a million empty homes on Census night. We don’t know how many are due to investors deciding that they’re better off leaving their investment empty, but we hear stories of entire apartment blocks in inner-city Melbourne and Sydney being used for just this purpose.

Again, this has got to have an impact on the market.

And again, we need a new framework for thinking about housing. This isn’t just “a place to live” or a place to invest in.

This is something different.

So what is it?

This is important. The people who made money in the early days of the internet were the ones who saw what the paradigm shift was really about. It wasn’t just a way to connect a bunch of boffins at elite universities.

(It was an unprecedented vehicle for porn!)

Same story with the blockchain technologies. The ones to make money will be the ones who see the full promise of the technology on offer – a promise that may take years to realise.

So how should we think about housing?

Well, at the risk of drifting off into abstract space, I would say this:

Property is the gateway between the real and the unreal worlds.

I don’t mean that if you set up your Ouija board in the right way, property becomes a portal for communicating with the dead.

I mean that there are fundamentally two types of economic activity. There’s real world activity – making cars, growing fruit, building stuff. And there’s unreal economic activity – writing blogs, marketing, mining for bitcoins.

No one is any better than the other, but at some point, all economic activity needs to be made real. We work so that we can ultimately buy real things – food, housing, clothing etc. You can’t live on blogs.

And while you can have a real economy without any unreal elements, you can’t have an unreal economy without any real elements.

So the unreal rests upon the real.

Property – and land in particular – are unique then because all real activity must be grounded in the earth. The minerals that make up your IPhone have to come from somewhere. Your factory has to be located somewhere. Your zucchinis have to be grown somewhere.

And so property is the place where all the unreal economic activity – the vast billions and billions of dollars that rush about producing nothing anyone can touch or see – it is the place where all this activity grounds.

It’s the way that lightning needs to ground to exist. A lot like that.

The great colossus of human economy must at some point pass through the gates of property.

And the bigger the economy becomes, the bigger those gates have to be. The more value they hold.

And so as our economies continue to expand rapidly, and as the balance continues to shift from the real to unreal, as it has done for the past 50 years, the relative value of property increases.

And so we digitised hotels – that revolution grounds out in property values. We digitalised taxi’s. Now everyday parking spaces are factor of production.

China produces a thousand billionaires. They want to ground their wealth into something real before it is taken away from them.

So this is what I’m suggesting. Over the long, long run, I’m thinking about property this way – it is the gateway between the unreal and the real worlds.

No modern economy can do with out it.

And once you have that level of necessity, its potential long run value becomes limitless.

What’s your framework for thinking about property?

Whispers of the next boom

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Warning – the economy might actually be a whole lot stronger than we thought.

Okay, little bit of a news flash.

You know that “moderation” in house prices we’ve been waiting for? That little bit of a pause we were expecting to let reality catch up? That softening, that slow-down, that plateauing?

Might not be coming.

In fact, in as much as there was a slow down / pause / time-out in the naughty corner, it might already be behind us.

And the next boom might only be a few months away.

How do I know this?

Well, I don’t. Not for sure. Some economists will tell you they have a crystal ball, but sooner or later the market comes along and gives them a swift kick to the crystal balls and their reputations shatter.

But, you’re always operating with less than perfect information.

And the thing that really jumped out at me was this report from the economists at CBA.

They were taking a look at the labour market data, and I was shocked at how strong recent months had been.

In my mind I’m still assuming that the labour market is still softening, wages growth is weak, and there’s little fire coming from that sector of the economy.

But that’s not what the data says at all.

In fact, if you believe the last four months, the economy is gearing up for another bull run.

And I know a lot of my readers are a canny bunch, and don’t put too much stock in the “official” numbers. And they’re right to be sceptical. So when they say the unemployment rate is 6%, you have to take that with a large grain of salt.

That said, the trends are useful. If the unemployment rate is going down, from whatever number it is, then house prices are normally growing.

So even if I don’t believe (or care about) the exact levels, I am watching trends.

And as I said, right now, the trends are actually pretty promising.

The take home chart from the CBA report is this one. It compares employment growth with GDP:

You can see that they tend to move together – which makes sense: you need to employ people to make stuff.

But right now a gap has opened up. Employment growth is heading north. We’ll have to wait and see what GDP does.

So the gap will probably close pretty soon, based on past experience. But which way? Will employment correct, or will the economy bounce?

Again, hard to say for sure, but the employment data is looking pretty solid.

Because when you break it down, all the signs are good.

Like the split between part time and full-time employment growth. We’ve actually seen a switch-out, with full-time employment growth picking up, at the expense of part time employment growth.

That’s a good thing. Firms tend to employ people part time when things are tentatively picking up, and when the future seems more certain, start employing people on a full time basis.

And when you break it down by state, it’s also looking strong across the board.

Victoria continues to lead the way (“spectacular” was the word CBA used), but growth is also holding up in NSW, and there’s been a quick bounce back in Queensland.

And even in the smaller states, and even in WA, we’ve seen employment growth pick up strongly in the past four months.

This is especially good news for WA. I can hear the pollies across the Nullarbor breathing a huge sigh of relief. Employment growth has picked up, and the unemployment rate has dropped significantly.

Perhaps WA has turned the corner?

So it’s all looking pretty solid.

Surprisingly solid even.

But look, I don’t want to lay my crystal balls on the line here. These are early days, and you can’t be too certain about which way trends are going until they’ve had time to properly establish themselves.

But by then, everyone knows about them.

So the scenario I want to flag is that the economy has actually got more traction than we thought. That’s going to keep feeding through to employment growth, and that in turn will help drive property demand and property prices.

Property price growth moderated over the first half of this year (though Sydney and Melbourne are still pushing at double digits), but maybe that’s all we get. Maybe once the rubber hits the road and the economy really gets going, we’ll start pushing back towards 10, 12 percent growth.

And when you look at the population growth data, that’s not so far fetched.

Of course, it could all still get derailed by something. Trump could bomb someone or China could get the wobbles. But in the absence of any sort of shock, you’d have to think that the most likely scenario is continued growth from here.

Economies do move in cycles after all.

We might not be quite ready to lock it in, but we need to start thinking and planning for it.

So watch out! Good times ahead.

What’s the feeling in your crystal balls?

NO B.S. FRIDAY: Revolution delayed until further notice

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The dream of a golden crypto-currency future copped a serious blow this week.

Around 2004 I was presented with an opportunity.

It was a special ‘insider’ offering into a plucky American start up. They had a radical idea – to create a site where people could upload and share videos with each other, over the internet.

I turned it down.

I don’t really remember why. It all seemed a bit risky. The technology was new. They didn’t have a clear direction for how they were going to monetise the service. So I knocked it back.

Was it a mistake?

Hardly. The company went belly up after about 18 months. I would have lost everything.

This company wasn’t YouTube. It was one of about a hundred companies aspiring to be YouTube at the time.

YouTube just won the race. I don’t even think they were the first to get their product to market. But with three of PayPal’s exec’s at the helm, they were able to scale rapidly, until they became the dominant player in an ecosystem that was only ever going to support one player.

It’s one thing to have a million dollar idea. It’s another to have a million dollar business.

And so when I was presented with that investment opportunity back in 2004 or whatever it was, I had no way of knowing if they had a good business. They had a good idea, sure, but beyond that, I just didn’t have enough info to tell.

And I don’t like to take risks with my money. So I knocked it back.

It’s the same story with all the crypto-currency stuff.

Someone asked me my opinion about it the other day. Sure, I get the power of block-chain. I get the revolution it has the potential capacity to deliver. It could be a whole new ball game.

But what is it going to be? Which “coins” are going to dominate the market? We hear a lot about Bitcoin and Ethereum, but there are hundreds of crypto-currencies out there.

Like, did you know there’s a thing called ‘Potato Coin’? This one aims to become a unit of currency for poor African farmers (a noble aim).

Or what about ‘Wankcoin’? (Seriously, I’m not making this up.) This is designed to help porn-enthusiasts support their industry.

Someone has even launched ‘Ponzicoin’ – and people are actually buying it.

The whole alt-currency world is very weird. And as far as I can tell there isn’t a way to buy an exposure to block-chain currencies at a concept – you have to invest in individual coins.

It’s like in back in 2004 – if I could have invested in the concept of video-sharing over the internet, it would have been a no brainer. The need was obvious, and technology was certainly heading that way.

And you would have made a motza.

But you can’t invest in concepts. You can only invest in companies.

And that introduces a whole lot of complexity and uncertainty.

And they’re concepts I just don’t like to see attached to my investments. I’m a simple guy at heart.

Anyway, there was some other news this week that has made me rethink the whole crypto currency proposition.

What news?

Yep, one of the largest investment banks in the world, and depending on what conspiracy theory blog you subscribe to, is responsible for AIDS and faking the moon-landing. They’ve just brought out their own currency.

They’re calling it SETLcoin, and it aims to help parties settle share transactions. There’s a niche here. Currently it can take up to three days to settle a share trade. SETLcoin will make it instantaneous.

I was excited about crypto-currencies when I thought they were being built by 14-year old Japanese boys in their bedroom on retro-fitted Sega-64. But if we’re talking about one of the wealthies banks in the world?!?

That’s an entirely different story.

But I guess when you step back and look at it, it was always going to go this way wasn’t it? Money is power, and the powerful aren’t just about to let money get ‘democratised’ out of their control are they?

To be honest, I’m feeling a little deflated today.

I feel like it’s similar the revolution going on in the media. Traditional newspapers are dying. Their readership is too broad, their business models obsolete.

But rather than getting agenda and vested-interest free micro media – media created by the people for the people – we’re getting fake news. We’re just getting BS.

Apparently a bunch of those fake news sites in the last US election were just built by bored kids in Serbia, just looking to make a buck.

And crypto-currency, rather than democratising money, could just be about to concentrate it in hands even less accountable than our governments (low bar I know).

That’s not going to be an improvement.

And as strange as it is to say, I think I prefer a government controlled money to money controlled by Goldman-Sachs, or whatever global financial powerhouse it ends up being.

Suddenly, I’m pro-government?!?

Oh dear, oh dear.

Turns out that revolution I was waiting for… well, looks like it’s going to be a little further off than I thought.

It’s enough to drive a man to drink.

What does the crypto-currency future look like to you?

What game theory says banks will do next…

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Are the banks going to blow the whole thing up? Do they even have a choice?

I was talking about this Bank Levy business with a good friend of mine. He’s a smart man – has a PhD in mathematics and game theory. His take on the whole bank levy thing has really got me thinking… and a little bit scared.

On the face of it, I like the levy. The too-big-to-fail banks enjoy an implicit government guarantee. That means that if sh!t hits, the fan, the government (i.e taxpayers) has their back.

The markets recognise this situation, and so are willing to lend them money more cheaply. As a result, Aussie banks are some of the most profitable in the world:

Killing it.

Christopher Joye at the AFR reckons the government guarantee saves them about 0.18bps on their funding costs. So a levy that slaps them with 0.06% on their liabilities, only claws about a third of it back.

So it’s only fair. And it many ways it helps level the playing field with smaller banks who don’t have a government guarantee.

But as my friend pointed out, the problem is that this isn’t directly tied to their funding guarantee. It’s just a levy. Just a tax. Just because ScoMo said so.

And this makes it dangerous. The UK introduced a bank levy a few years back, and guess what happened? Since then they’ve jacked it up 9 times.

9 times! And why wouldn’t they? It raises a lot of revenue, and everyone hates the banks. It’s like free money. Whee.

And since our Bank Levy isn’t tied to anything either, what do you think the chances are that it will stay at just 0.06bps?

Would sod-all be a fair estimate? (That’s what my mate reckons it is.)

So think about this from the bank’s perspective for a sec. This is not just a one off cost that they somehow have to manage. Who knows where it’s going to end up?

Letting the government tax you now is like letting Dracula set up a catheter in your jugular and trusting him to only take as much as he needs.

(Just a couple of drops to tide me over to pay day…)

So there’s a lot more at stake here than the initial estimate of $1.5bn a year. It’s a liability that could quickly grow to $3bn or $6bn or $12bn!

So the stakes are high – much higher than I thought.

The question now is how are than banks going to play it?

So far, their response has been fairly predictable. And that’s because somehow the government did a good job of keeping it secret. The banks genuinely seemed to be caught off-guard.

And so their response has been pretty lame. It’s “tax by stealth”. It’s going to be passed on to consumers, or maybe shareholders. Jobs are at risk. It’s “playing fast and loose”. It’s poorly thought out and light on detail.

The banks seemed to be throwing up a bunch of muck and seeing what stuck. But all it did was just create noise, and by the time the banks had figured out their story, the front pages had moved on.

The PR battle has been fought and won.

And this is what makes me nervous. If the PR battle is won, what happens next? If you back a grizzly bear into a corner, what happens next?

As my mate says, the banks can’t afford to roll over on this one. If they cop it sweet, and spread the cost out across their consumers, shareholders and staff, all it says to the government is that cookie jar is open.

Next time you need the money, just dip in here first.

My mate says that the banks have to go hard and they have to go now. They don’t have a choice. Even if they lose this particular battle, they have to leave the government with enough scars to make any future government think twice about tapping the Bank Levy cookie jar.

If they don’t it will cost them another $6bn… at least!

So how would they do that?

Well, what does a banking sector on the offensive look like?

I don’t know what you reckon (I’m genuinely curious, let me know your thoughts), but I think whatever counter-offensive we see, it’s going to involve rate hikes.

A lot of rate hikes.

My friend reckons the dominant strategy for the banks is to hike rates so hard that they almost put the economy on the floor. … almost.

And I think they could do that. They could say, we’ve got the bank levy to deal with. We’ve also got APRA on our backs about shoring up our capital bases. Fine. You want us to be “unquestionably strong”? Here it is.

100 bps.

Bam.

(I’m in a pretty sweet position but even I would notice a full extra percent on my interest payments.)

And if they really wanted to stick the knife in, they could focus hikes on investors (since negative gearing would mean the government would actually get less revenue) while giving first home-buyers a discount to try and sway public sentiment.

They could also go hard on foreigners purchasing apartments to try and push the (already-shaky) apartment segment over.

100bps, overnight, would hurt. A lot. It could be enough to break sentiment in the property market and in the broader economy altogether.

It could be enough to bring on a recession, which would be enough to ensure the government was turfed from office.

And that, maybe, would make any future government think twice about tapping the cookie jar.

And ScoMo says he’ll be watching the banks closely, but it doesn’t matter. Even if the ACCC forced them to reverse course at some point down the track, you only need high rates for a short time to snap the neck of sentiment. A month would probably do it.

If my mate is right, it’s a dangerous situation because the banks’ strongest play seems to be to take the economy to the brink of collapse, if not over it altogether.

It’s killing me imagining what’s going on behind the scenes right now. It’s going to make a fantastic book one day.

If we make it through.

What do you think? Is my friend making a mountain of a mole-hill?

Chinification

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The Chinese economic model – built on debt and secrecy – has found a new outlet store: Australia.

You know, I kinda like China’s gumption. Through an era where the anglo way was the only way as far as economic development was concerned, China remained sceptical.

And while they were being lectured by the West about free-trade and capital flows, I think they saw it for the smoke screen that it was.

“It was low tariffs and free flows of capital that made you rich, was it? It wasn’t slavery, military conquest and the covert over-throw of democratically elected opponents then… No? Really?”

And so they have steadily developed their own way of doing things.

What that way exactly is, is a bit of a mystery. So much so that you wonder if even anyone in China really knows what’s going on.

And China has long since passed the point where most ‘free’ economies would have collapsed in on themselves.

Like Japan. Japan got too high on the debt-juice, and is still wrestling with the hangover twenty years later.

But it hasn’t quite played out that way in China. And partly that’s because the Chinese authorities still have some control over everything.

So say developers borrow too much to build a bunch of buildings nobody wants. In Australia that could bring the banking system to its knees. But not in China. You just order the local governments to buy up the buildings, and the banks to go easy on the debt repayment schedules.

Problem sorted.

And so the Chinese economy looks kind of bananas, but then it’s doing it own thing so who knows how it’s going to play out.

And if the truth be told, even the Australian economy, with a monetary system disconnected from anything real and sky-rocking household debt looks pretty bananas too.

But that’s the modern world. Everything is bananas. What’s a monkey to do?

But then things got a little weird over the weekend, with two data-publishers in China ‘going dark’.

Reuters was running the story:

At least two major Chinese private providers of home price data have stopped publishing the figures, at a time when economists are split whether the red-hot property market will remain a driver of the economy in 2017.

The China Index Academy, a unit of U.S.-listed Fang Holdings, has stopped distributing monthly housing price index data for 100 cities that it usually issued at the start of the month.

The academy told Reuters on Friday it had suspended distribution indefinitely, without giving a reason for the suspension.

“I don't know who exactly is making the order, and it's not mandatory,” said a source with knowledge of the matter, who declined to be identified as the topic is a sensitive one.

E-house China, another influential private real estate consultancy, has also indefinitely suspended its monthly housing price index for 288 cities.

“Judged by current conditions, we won't publish it in the future… Housing prices are an extremely sensitive matter right now,” a source with knowledge of the matter said on condition of anonymity.

The Chinese property bubble has been drawing ohhhs and ahhhs from the kiddies for ages, so now what? The Chinese government bans the data because it doesn’t like what the data is saying?

“I fixed it. I’m a fixer.”

So normally this would be a “not my circus, not my monkeys” type thing, but I think Australia could well be inside the fallout zone.

And the thing I keep thinking about is all these Chinese developers, who have developed their business model under the firm and protective hand of the Chinese state, coming and setting up shop here.

I mean, you look at the coming apartment glut, which is as obvious as the nose on my face, and you think, what are these developers thinking?

And maybe they’re not thinking. Maybe they just don’t even care about supply and demand projections.

Maybe they just happily build, safe in the knowledge that someone will buy it. If it isn’t the public, then the state will always step in.

Chinese developers have totally changed our urban landscape, and they’re still coming. From the AFR:

Chinese developers roared back into Melbourne in the final five months of 2016, snapping up three-quarters of development sites as they shrugged off concerns about apartment oversupply, tougher planning rules and higher property taxes.

Real estate agent CBRE said 75 per cent of the 45 Melbourne development sites they transacted between August and December were sold to mainland Chinese buyers.

“We’ve sold more properties to Chinese buyers in the past five months than in any other five-month period since 2009,” said CBRE national director Mark Wizel…

Bananas.

I don’t really worry about what impact its going to have on the Australian financial system. Aussie banks stopped lending to these things three quarters of a year ago.

But I do worry that Australian cities have become an outlet store for the Chinese development model. Chinese money is funding Chinese developers to build apartments to sell to Chinese buyers.

Who the hell signed up for that?

And how far can we trust a state that is willing to flip the switch on it’s own data providers? And how closely do we want to be tied to an economic model that’s only sustainable so long as everyone is kept in the dark?

These are big questions. Huge.

Why are we still not talking about it?

What do you think China’s up to?