From Dan Denning in St Kilda:

--There are more signs that Australia is slowly being de-industrialised in exactly the same way America has been for the last 20 years. Whether it's a good thing or not is a separate question. But there can't be much doubt that it's happening.

--Case in point: Toyota. Yesterday the company warned of a "permanent decline" as a car manufacturer in Australia. The company disestablished 350 of its Australian workers, or about 10% of its total workforce. It cited lower export volumes to the Middle East as the reason.

--It's hard to believe Toyota can't profitably make cars in Australia. After all, Toyota makes cars profitably in America and Japan. The Germans make cars profitably in Germany. In all three places, wages are high compared to emerging markets. Labour costs are one issue. But it's hard to imagine they're decisive. So what's left?

--Well, in Australia, the mining boom has attracted a lot of skilled labour. This might make it hard for companies like Toyota to recruit, train, and retain the work force needed to make cars. There's a lot more money in the mines than there is on the assembly lines.

--The obvious culprit is the Australian dollar. The news media tends to treat the dollar like a sports team. Hooray for parity! A strong currency, though, is not like a sports team. Having pride in the exchange rate without understanding what it means to the economy is...well...stupid.

--Toyota's Australian operation makes money selling cars to the Middle East. The trouble is export volumes are down. It's probably not because the folks in Dubai are buying fewer cars. It's because they're buying cars not made in Australia.

--This leads your editor to wonder which Australian politician will be the first to call on the Reserve Bank of Australia to intervene and weaken the dollar. As far as we know, no one's done it yet. And after all, high interest rates set by the RBA contribute to the ability of the banks to borrow money on international markets. Australia has become quite the popular destination for foreign capital.

--But foreign capital flows to Australia - whether through yen, dollar, or euro carry trades - don't help Aussie manufacturers one bit. Capital inflows go into shares and currency and other short-term, high-yield investments. Capital intensive industries like mining and manufacturing have to go to the banks directly, or raise funds from shareholders.

--The strange result is that the strong dollar makes some export industries chronically uncompetitive. Not only does this make them bad investments, it damages their ability to remain a going concern. So the government has to transfer money it's collected from resource companies and give it as a handout to car companies. Sorry Peter, but Paul needs this money more than you do.

--If the government and the RBA instead joined the global currency war currently raging, the RBA would sell Aussie dollars and lower interest rates. Or, the government, like Brazil, would impose a tax on foreign capital entering the country. This would make vacations in Hawaii and New York more expensive for Australians. But it would also weaken the currency.

--In the global currency regime we live in, weakness equals strength. George Orwell would be laughing. In a world awash with productive capacity, only the lowest cost producers can survive making things. Established industries in the US, Europe, and Australia are finding it very hard to compete.

--Mind you, there are other ways to make a buck. High value-added manufacturers like Mercedes don't have trouble distinguishing themselves in a global marketplace. But at the lower end of the value-added chain, it's getting terminally hard to make ends meet. And what's worse, once an economy loses the capacity and knowledge to make capital goods, it becomes dependent on others.

--We're riffing on this today because we can't shake the feeling that 2012 is a transition year in markets. Everyone has been trundling along following the European debt saga. But the big back story is that the Western world is in the midst of a decade of deleveraging, accompanied by lower consumer demand and structural changes in the job market.

--Australia is caught smack dab in the middle of that deleveraging process. But the open question is whether the BRIC economies, led by China, are ready to usher in a new world order with a new brand of capitalism. More on this tomorrow...

Regards,

Dan Denning
for The Daily Reckoning Australia

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Tales from the Southern Hemisphere
By Bill Bonner

The Southern Hemisphere is not a bad place to be in the wintertime. That is, when it is wintertime in the Northern Hemisphere. By the time the chilly winds from Baltimore reach the southern tip of Africa they have been warmed by the South Atlantic. Flowers bloom. The sun shines. Gentle breezes glide over the fields and parking lots.

As near as we can tell, South Africa is booming. Driving along the freeways, you'd scarcely know you weren't in Southern California...or Texas. Except that it seems newer and more modern in Johannesburg than it does in LA. Most of the roads...shops...and offices you see in Jo'burg were put up only in the last couple of years. Those in LA date back decades.

But there are a lot of poor people in Africa, more than in California. And some of them are not very good neighbours. At intersections that are particularly favoured by hijackers, for example, signs warn motorists to watch out. Razor wire, stretched generously and lazily on the top of walls, reminds the visitor that this is no paradise.

Melbourne, Australia, is equally sun-washed this time of year. But it seems cleaner, safer, and more urban. People ride bicycles up and down the Yarra River. Couples stroll hand in hand in front of the old train station or through the narrow alleys, now filled with tables and outdoor dining.

Jo'burg is much cheaper than Melbourne. We paid $44 for a buffet breakfast at the Crowne Plaza hotel. Then again, Melbourne has become one of the world's most expensive and desirable cities. Each year, it and Vancouver vie for the top position in The Economist's list of the world's most liveable cities.

To summarise Australia's economic situation: the Aussies sell dirt to the Chinese. Since the Chinese have such a strong appetite for antipodal dirt, the Aussies are making money. Prices are rising. Investors are confident. The boom goes on.

Australian property prices seem way out of line, at least compared to Baltimore. An office building that might sell for $1 or $2 million in the heart of Baltimore is on offer in the St. Kilda area of Melbourne for $7 million. Then again, St. Kilda is lively, hip, and attractive, with an exciting nightlife and a beach next door. Baltimore, on the other hand...oh, never mind.

And more thoughts...

We went around the world last week. We wish we could say we learned something. But modern travel has been standardised...and culture and technology have been "globalised"...so that the more you travel the more you feel you never left home.

"How was your trip around the world?" asked our assistant when we got back in the office in Baltimore.

"No problem. Nothing special," we replied.

How could a trip around the world not be 'special'? Well, the airports all look alike. The planes are all alike. The restaurants and hotels are all alike, usually international chains. So are the shops...and the products.

You can travel to the far side of the globe...and except for the fact that you can't quite remember where you are...or what time it is...you might as well have stayed put...

Returning to the US...

We got the big news when we picked up a copy of USA Today in the LA airport.

"Light at the end of the debt tunnel?" asked the headline.

We thought we knew the answer before we started reading.

But the report in USA Today tells the results of a study by McKinsey Global Institute. As a percentage of GDP, the US cut its "private and public debt" by 16 points, since 2008, it says. That puts it tied with South Korea in the debt-cutting derby.

We were only a paragraph into this report when we began to suspect that neither the reporter nor the McKinsey researchers had any idea what was going on.

Sixteen percentage points is not bad. But, as we recall, total debt in the US was around 325% of GDP. Take off 16 points...it's only a 5% reduction. Besides, US government debt alone INCREASED during this period. The feds are the largest debtors in the world. And they added 66% to their debt over the last three years. It was $9 trillion in '08. Now it's $15 trillion. An addition of $6 trillion.

The dots given in the USA Today report don't connect with the dots we know. It maintains that total debt in the US was 279% of GDP in the second quarter of last year. And it says financial debt fell by less than $2 trillion and household debt by half a trillion. Huh? That doesn't sound like $6 trillion.

We found a better report in The Financial Times. Gillian Tett explains that while the private sector is de-leveraging, the public sector is borrowing and spending more than ever. She goes on to take issue with McKinsey's "light at the end of the tunnel" conclusion.

Yes, the private sector is de-leveraging - just as you'd expect. Most of the debt that is being eliminated is mortgage debt and most of it is eliminated by default and foreclosure. At this rate, McKinsey reasons, US consumers "could reach sustainable debt levels in two years or more."

Hallelujah! We just have to wait until 2014 for a recovery.

But wait a minute. McKinsey's conclusion was based on the experiences of two Scandinavian countries, Finland and Sweden, in the 1990s. The two countries spent too much. Then, they had to cut back. The private sector went into a slump and the public sector took up the slack. When, after a few years, the private sector had reduced its debt sufficiently, it could resume its former growth...while the government gradually paid down its debts. All was well that ended well. The researchers on the project argue that "today the United States most closely follows this debt-reduction path."

We don't think so. We think the US is on a very different path. Finland and Sweden could pull off this 'rescue' because conditions were completely different.

First, they have smallish populations with much social and political cohesion.

Second, they were able to get back on the growth path because there was a boom going on almost everywhere else; they exported their way back to financial health.

Third, they didn't have that much debt in the first place. The Finns and Swedes could add debt without pushing themselves beyond the point of no return.

Not so the US...on all points. America has too much debt. It has no plausible path to recovery. And the feds are adding more debt than it can pay off.

You can do the math yourself, dear reader. With government debt-to-GDP at 100%...and rising...and the shift to short-term financing over the last few years...the feds are extremely vulnerable to an increase in interest rates. A chart in Sylla and Homer's "A History of Interest Rates" suggests that investors want a real rate of return from government bonds in the 3% to 5% range. That's what they've been getting, according to the chart, all the way back to 1850.

The current CPI-measured rate of inflation is about 2%. This suggests that nominal bond yields should be in the 5% to 7% range. But at 5% interest, the feds would have to pay out about $750 billion in annual interest charges, which is between a third and a quarter of all expected US tax revenues. It's the equivalent of the military budget, for example.

At 5% interest, bond investors would probably be wondering how the feds could stay in business. Most likely, yields would spiral out of control quickly...forcing the feds to print more money to cover deficits. In a matter of days, the whole jig would be up.

Which is what makes the other big news so puzzling.

"Negative yield fails to deter investor appetite for Tips," said one headline.

"30-year US loan rate hits nadir," said another.

What both headlines are telling us is that either we're wrong about how the world works...or the world isn't working quite as well as it should be. The second explanation suits us best. The public sector is leveraging up. It is going deeper and deeper into debt. As it adds to the quantity of its debt outstanding, the quality should go down. And the price too. But it's not. So, either the times are out of joint...or we are.

For now, the weaker US finances get, the more people seem to want to lend it money.

This has to end badly...

Regards,

Bill Bonner
for The Daily Reckoning Australia