WHY NEW ZEALAND CAN’T CATCH AUSTRALIA

I once worked for a brief period in Tanzania, East Africa.
At the time, the country was the fourth poorest in the world, despite having a wealth of base and precious metals and masses of fertile land.
I quickly learned that one of the country’s biggest issues was a poor transport system. Most of the country’s roads are unpaved and seem to consist of a series of potholes joined together by dirt. As a result, it is virtually impossible to move crops from the hinterland to the population centres on the coast or to ports to be exported.
On the other hand, wealthy economies like the USA and Europe have excellent transport networks. Where did that wealth come from and why do so many other countries not achieve it?
Political, economic, and military intelligence company Stratfor has looked into the geographical benefits of the world’s largest countries and believes the USA will always have the strongest economy.
The most important aspect of the USA is not simply its sheer size, but the size of its usable land, which is much larger than any other country.
Also, the USA has a fortuitous combination of an extensive river network in the mid-west, not least of which is the Mississippi River, and three of the world’s largest and best natural harbours. The result is a free transport system that allows crops to be moved quickly to much of the country or overseas.
Thirdly, with less wealthy and powerful neighbours in the form of Canada and Mexico, the USA has not required a large standing army to protect its borders, leaving more funds available for stimulating capitalistic endeavours.
Significantly, major nations such as Russian and China also lack America’s natural advantages. Russia, although large, suffers climatic conditions much more hostile to habitation and agriculture and it has no river network to allow for easy transport of products.
Russia also has no meaningful external borders and has Europe on one side and China on the other. Because Russia lacks a decent internal transport network that can rapidly move armies from place to place, geography forces Russia to maintain massive stand- ing armies on all of its borders to protect against external threats.
China also faces significant hurdles. China’s core is the farmland of the Yellow River basin in the north of the country, a river that is not readily navigable and is remark- ably flood prone. Simply avoiding periodic starvation requires a high level of state planning.
China’s geography also encourages separate development by various parts of the country so its rulers are constantly using carrots and sticks (in the form of cheap loans and a large army) to hold the place together.
Europe has a number of rivers that are easily navigable, providing a wealth of trade and development opportunities. But none interlinks with the others, retarding political unification.
Stratfor doesn’t mention Australia or NZ but there are a number of lessons we can learn from its report. One is that Australia (wide, with lots of resources) is likely to be continually more successful than skinny little NZ. All our attempts to catch up with the lucky country’s per capita income are doomed.
For this reason among others, investors should look to put a sizable portion of their money into Australia, then have a hard think about doing the same in the USA.

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HOW MUCH IS A TRILLION?

Imagine you have borrowed a million dollars – interest free – and you pay it back at the rate of $1 per second. It would take you 12 days to pay it back. That is not too scary. Now imagine you have borrowed a billion dollars. At $1 a second, it would take you 31 years to repay the money.

While beyond the means of most people except Bill Gates and most governments, it still sounds conceivable. Now let’s take a trillion dollars on the same terms. Repayment would take a staggering 31,688 years! With that number in mind now consider that the USA has a national debt of US$14.4 trillion.

Most investment markets have performed extremely well in the past year but much of this growth has been stimulated by the extraordinary injections of liquidity by central banks. It is still not clear that the real economy can take over when this liquidity is reduced.

Also, it is not clear when or how the borrowing associated with creation of this liquidity and the legacy of running deficits to pay for social welfare programmes will ever be repaid, with interest.

While the USA is a world leader in debt accumulation, Japan is not much better off with national debts of just under US$11 trillion. The UK, with debts of ‘just’ US$1.9 trillion is still going to have a hard job paying those debts off. New Zealand has a relatively modest debt of $46 billion, although this will still take some effort to pay off (1,426 years based on the assumptions above) Of course, it is easier to pay back a large debt when you have a large income. Therefore, the percentage of debt to annual income is an important measure.

Unfortunately, the major economies don’t look very good on this measure either. If a couple wishes to borrow money from the bank to buy a house, they are told payments on the loan should not be more than a third of their income.

Governments have the ability to increase their income at will through taxation and so it can be argued they can borrow a higher percentage.

However, the US government’s debts equal 53% of GDP, the UK’s is 69% and Japan’s is an intimidating 192%, none of which inspire confidence. New Zealand’s is a much more reasonable 27%.

Using GDP is a flawed idea because no government receives all that money as income. If we take as a benchmark that government activities represent around a third of economic activity, then US government has 150% debt to income, Japan has nearly six times and the UK more than double. Again, it is hard to see how these debts can even be serviced, let alone repaid.

The one saving grace is inflation. At 3% a year, much of this debt will be worthless in a few decades. On the other hand, the debt comes with interest that is designed to match and exceed inflation. Given this, the only way governments can reduce the value of their debt is if inflation rises faster than the rates it pays on its debts.

Given that interest rates are starting to climb in many countries, the nasty scenario of an inflationary spiral cannot be ruled out.

David is chief investment officer of Investment Research Group Ltd. www.irg.co.nz A disclosure statement is available free of charge on request.

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HOW MOVIES HELP INVESTORS

Good investors don’t concentrate just on numbers but look for ideas and trends that might help them understand the economy and markets better.

So, as odd as it may sound, a study of trends at the movie theatre can be useful to an investor.

A recent article, adapted from a paper written many years by technical analyst Robert Precter of Elliott Wave International, does just that.

The updated excerpt notes that this year’s Academy Awards gave us movies about war (The Hurt Locker), football (The Blind Side), country music (Crazy Heart) and going native (Avatar), but a horror movie was not nominated.

The last nomination was for Sweeney Todd, The Demon Barber of Fleet Street in 2008, for art direction (which it won), costume design and best actor.

Disregaring whether horror films win Academy Awards, movie trends are a useful reflection of how the general populace is feeling.

Elliott Wave’s research shows that horror films are popular during bear markets, whjile upbeat, sweet-natured movies show up during bull markets. The lack of popular horror movies in the past year or more corresponds nicely with the strong upturn in equity markets over that time.

Prechter’s paper, quoted extensively below, noted that while musicals, adventures, and comedies weave into the markets’ patterns, one particularly clear example of correlation with the stock market is provided by horror movies.

Horror movies arrived upon the American scene in 1930-1933, the years US stock market collapsed.

Five classic horror films were all produced in less than three years. Frankenstein and Dracula premiered in 1931, in the middle of the great bear market. Dr. Jekyll and Mr. Hyde played in 1932, the bear market bottom year and the only year that a horror film actor was ever granted an Oscar. The Mummy and King Kong hit the screen in 1933, during a second market downturn.

These are the classic horror films of all time, along with the new breed in the 1970s, and they all sold big.

For 13 years, lasting only slightly past the stock market bottom of 1942, films continued to feature Frankenstein monsters, vampires, werewolves and undead mummies.
Shortly after the bull market in stocks resumed in 1942, films abandoned dark, foreboding horror in the most sure-fire way: by laughing at it. When Abbott and Costello met Frankenstein, horror had no power. That decade treated moviegoers to patriotic war films and love themes.

The 1950s gave us sci-fi adventures in a celebration of man’s abilities; all the while, the bull market in stocks raged on.

The early 1960s introduced exciting James Bond adventures and happy musicals. The milder horror styles of the bull market years and the limited extent of their popularity stand in stark contrast to those of the bear market years.

Then a change hit. Just about the time the stock market was peaking, film makers became introspective, doubting and cynical. How far the change in cinematic mood had carried didn’t become fully clear until 1969-1970, when Night of the Living Dead and The Texas Chainsaw Massacre debuted. Just look at the chart of the Dow and you’ll see the crash in mood that inspired those movies. The trend was set for the 1970s, as a wave of slice-and-dice horror movies hit the screen.

For now, people seem to be anticipating moderately good times ahead – but be prepared to move into cash when the next horror movie is a hit!

David McEwen is Chief Investment Officer of Investment Research Group. He can be reached by email at david@irg.co.nz or by mail care of this newspaper. A disclosure statement is available free of charge on request by calling 0800 474669 or visiting the website www.irg.co.nz

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Perils of the crystal ball

Making predictions is a difficult game, but that doesn’t stop people trying. Many try to cover themselves by making vague predictions that they hope will at least be partially correct.

That’s why I am impressed at the detail presented by US markets commentator Jim Willie. Unlike most soothsayers, Willie, who has a PhD in statistics, tries to assess the
probability of an event occurring.

Here are just some of the predictions, ranked at zero percent for a very low probability of the the event happening and 100 percent representing a near certainty.

Warning: There are no positive predictions. The Saudi Arabian royal family loses government control to Islamic fundamentalists and is replaced. Scores of old royals escape with hundreds of billions of dollars in assets. Disruptions and instability spread across the entire Persian Gulf.

A clampdown of fundamentalist groups in other Gulf nations increases social disorder and terrorism (chance: 20 percent).

China experiences chaos. Falling export trade, faltering bank reserves, empty commercial buildings, rising unemployment, idle factories, stalled construction projects, and restive population contribute to a national crisis. Armed with a US$2.5 trillion of reserves, China begins to convert assets into rescues, aid, and welfare (chance: 20 percent).

The United States suffers a second round of bank and corporate failures, debt defaults, institutional liquidations and market disruptions. The major cause is the spread of the property decline, home foreclosures and defaults. Deep recession follows (chance: 40 percent).

Japan suffers a severe economic crisis. A recession takes hold, spreading to its financial markets. Its export trade grinds to a near halt, and major banks announce insolvency (chance: 40 percent).

Russia enters a severe dispute with Eastern European nations, in particular Ukraine, and cuts off the flow of natural gas. Disputes centre on return to Russian dominance of satellite countries with ties to the West. (chance: 50 percent).

The United Kingdom becomes the first major industrialised nation to lose its high credit rating. UK bond yields then rise substantially. The British Pound falls. Shock waves reverberate. (chance: 50 percent).

Mexico fails as a state as drug-fuelled gang warfare escalates and the country’s income from oil runs out. Hyper-inflation then hits Mexico, resulting in social chaos. (chance: 70 percent).

The London Metals Exchange closes as gold orders are unable to be fulfilled. Companies shut down, lawsuits result and prosecutions begin. Midlevel officials are arrested, with some turning state’s evidence amid accusations of fraud and market manipulation. The gold price enters a state of extreme confusion, with vast discrepancies between paper gold price and physical gold price. (chance: 70 percent).

Greece defaults on its debt as Germany declines to help. A chain reaction begins with Portugal, Italy, and Spain also defaulting. All but the strongest European currencies withdraw from the Euro bloc (chance: 80 percent).

Food prices soar. The divergence between official crop forecasts will clash with the reality of crop failures and profound shortages by mid-2010. Foreign nations
sell US dollar-based assets in order to finance food, causing a raft of political tensions (chance: 80 percent).

The good news is that many of these crises won’t occur. But what if just one does? Are you prepared to bet that all of the above are mere fantasies? My advice, as always, is to expect the best but cover yourself by preparing for the worst.

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