A global bubble looms large, but Labor wants to push us down the wrong path

October 4, 2015 -

We are now deep in bubble territory.

Australia's sense of its own prosperity floats in large part on a property bubble while the global economy floats on an unprecedented liquidity created by governments.

"Low rates, almost by definition, build bubbles – stock market bubbles, real estate bubbles, even bubbles in the art market," warns Carl Icahn, one of the world's most prominent financial magnates.

Last week, Icahn took the unusual step of releasing a 14-minute documentary video on YouTube entitled Danger Ahead, to warn of a coming financial storm: "I don't think it's if it will happen, it's when it will happen."

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He regrets his reticence in 2007, when he believed a financial storm was building and acted on his fears, but did not think he was public enough about his concerns.

"If more respected investors had warned about the market in '07, we might have avoided the crisis in '08. I've been worried for the past five, six months about the market, and the economy, and the dangerous spot we're in."

He is not making that mistake twice.

If Icahn is even half right, it is worth noting that the alternative government of Australia, led by Bill Shorten, intends to fight the next election on the issues of penalty rates, higher taxes, class warfare and subverting the Free Trade Agreement with China, all relying on union financing and manpower in campaign for marginal seats.

This is not an election strategy, it's a suicide note.

If Labor wins on this mandate, Australia loses. It is Rudd II. But if the electorate decides it does not want a union-dominated government to manage Australia through global financial stress, then Labor loses. It's a high-risk strategy.

The world economy is already a dangerous place for Australia. The crash in the global commodities markets is as precipitous as the general stock market crash of 2008.

Canada, another wealthy, resourced-based economy, is in recession. In three years the Canadian dollar has gone from parity with the US dollar to 75¢, the lowest in 11 years.

Australia's dollar has seen an even more precipitous decline. In April 2013, it was worth $1.05 US dollars. It has since declined to 69¢, a 34 per cent decline in 29 months.

This year, US$11 trillion ($15.75 trillion) has been wiped off the value of global stock markets, or more than 10 times the size of Australia's gross domestic product. At the centre of that decline has been the commodities crash.

Icahn thinks worse is to come. He blames corporate greed and a dysfunctional political culture in Washington.

He argues that the enormous liquidity, at near-zero interest rates, pumped out by the Federal Reserve and other central banks, is building pressure into the global system. "If low interest rates were a simple panacea, we would never have recessions."

"The irony of lower interest rates is that while you think it's going to help to create jobs and make workers more productive, it's not happening…

"The Federal Reserve balance sheet has mushroomed from less than US$1 trillion to over US$4.5 trillion. This is a huge, almost unbelievable move, and all that money, it crowds out the little guy, the middle-class investor. There's nowhere to go with their money but into the stock market or, even more concerning, high-yield bonds that are very risky ... It's financial engineering at its height."

Icahn offers a series of protective measures to release the pressure.

"One obvious problem the government should have fixed a long time ago is the carried interest tax loophole … Not having to pay full taxes on money that you are earning is an absurdity."

He also believes the world's largest economy, which the world needs as an economic locomotive, has locked up US$2.2 trillion in corporate cash sitting on the sidelines because US companies will not pay 35 per cent tax on income that has already been taxed abroad.

"No other country demands that from their companies. It's absurd. Because these companies are willing to pay a tax."

He then turns to what he ominously calls "the earnings mirage". He believes the share prices of hundreds of companies have been pumped up by financial engineering and accounting tricks, which he lists. "I know this stuff. I've taken over companies … These earnings are fallacious."

The scale of share buy-backs and corporate acquisitions have returned to the peaks they reached in 2007, just before the crash. "This year, mergers and acquisitions business has doubled in four or five years to US$2.3 trillion," says Icahn, describing most of it as short-term financial engineering. "It weakens the balance sheet."

Icahn is scathing about the amount of corporate debt being created to finance deals, another echo of the excesses which led to the 2008 crash.

"High yield really stands for junk bonds. People are buying these not really understanding what they are buying. If you look at the numbers, they are amazingly risky. There are US$2.2 trillion ($3.15 trillion) in junk bonds, up a trillion dollars in five years."

Icahn believes Donald Trump could crash through to presidential victory in 2016 and is so disenchanted with Washington he thinks Trump may represent the shake-up that Congress needs.

For Australia, the end of the China-led commodities boom does not spell an end to China-led export growth. Agriculture represents a huge opportunity, as do services and education, while China's need for commodities will never be modest.

Yet Labor has decided to oppose the China-Australia Free Trade Pact, risking serious blow-back from Beijing, largely because the corruption-riddled Construction, Forestry, Mining and Energy Union wants to protect its existing cartel arrangements.

Labor's compliance with CFMEU dictates is a recipe for economic decline. It could also prove a recipe for disaster for Labor in 2016.

Twitter: Paul_Sheehan_