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Henry Thornton - Contributors: A discussion of economic, social and political issues Blogs
Stoop to conquer, Mr Stevens
Date: Thursday, February 11, 2010
Author: Henry Thornton

The Reserve Bank has just completed its 50th Anniversary Symposium.


Only four papers, but all of fine quality, indeed Olympian, with the gateway to Olympus here.


So far I have only fully read the exposition by RBA governor Glenn Stevens and colleagues on what we have learned about monetary policy in 50 years of trying.


Monetary policy had to contend with the Great Inflation of the 1960s, the Stagflation of the 1970s, breaking the stick of inflation for some in the 1980s, for others, including Australia, in the 1990s and the Great Moderation that followed, perhaps better described as the Great Complacency.


The latter description is not of course used by Stevens et al, although it was the title of a paper by Professor Ross Garnaut at the 2005 Melbourne Institue outlook conference.


The gods of Olympus, according to reports, were a pretty playful lot, who rarely if ever peered through the haze from Mount Olympus to learn from events in the mortal world.


Glenn Stevens et al provide some discussion of the challenges for the next decade or two.


One such subject is the role of fiscal and monetary policy, which some have taken to be a coded attack on the Rudd government's stimulus package.


Perhaps it is, but that is explicitly not the case according to Glenn Stevens and why would it be?


If anything, as befits a resident of Olympus, it is a coded warning to all the fiscal toilers, the Rudd government being small in the overall picture and by no means the most profligate - though as pink batts turn into electrified foil insulation one has to wonder.  But I digress


The other forward looking issue concerns 'Financial imbalances and monetary policy'.


A more humanised heading might have been 'Of asset booms and busts, and what to do about them.'


Stevens et al start with a caution - 'monetary policy can't resolve every problem', etc, etc.


'But the real question is simply whether monetary policy can plausibly escape any responsibility for a significant rise in financial system risk associated with large increases in asset prices and credit, and reduced lending standards'.


Stevens et al present an elegant discussion of the arguments against and the arguments for taking these matters into consideration in framing monetary policy.


They present sensible arguments, including the point that intervening late may make things worse.


The residents of Olympus conclude that 'it is unlikely to be credible for central banks not to move, in the next decade, at least somewhat in the "responsive" direction'.


This is a safe position to hold, but it is by no means the end of the story.


Here I attempt to outline a theoretic argument that should get the Olympians to think harder about the issue of asset inflation.


Milton Friedman established for a simpler world that 'inflation is always and everywhere a monetary phenomenon' - I ask forgiveness if the quote is inaccurate, but it gets the sense of his position.


The problem is to define inflation.


Friedman focussed on goods and services inflation.


For the past two decades, the rapid development of China and India has held down global goods and services inflation.


For much of the time, the US Fed created 'easy money' with low nominal rates of interest on short-term cash, sometimes even negative in 'real' (inflation adjusted) terms.  (Note again the need to define 'inflation' broadly. The moment you include asset inflation you will see the point.)


With goods and services inflation subdued by the rebalancing of global economic activity, excess money had to bubble up somewhere, and it showed up as asset inflation - sharp increases in the prices of shares, houses, commodities, art and other assets. Returns greatly exceeded the cost of borrowing in real (inflation adjusted) terms. (Don Sanders, I hope you are reading this.)


The US Fed was against acting against asset booms and other central banks followed suit.


When the asset bubble bursts, the dynamics change, and goods and service inflation is likely to emerge, but following that logic is for another day.


In the long boom of the nineties and the noughties smart people recognised that they could borrow cheaply to buy assets, not so smart bankers accommodated them and the credit boom was born. 


It was as if economists, commercial bankers and even central bankers were blind to the new world economic order and its consequences for markets and monetary policy.  


The problems hinted at by Stevens et al are far larger than he implies.


They cannot be understood in a traditional one good, one asset model.


There are various mere mortals striving to understand the new multi-good, multi-asset world order.


'Stoop to conquer' Mr Stevens, 'stoop to conquer'.


Published today on The Australian's website.


Previous papers on the theme of asset bubbles are listed here.


Inflation, asset bubbles and financial reform, November 2009


Monetary policy and asset inflation, October 2009.


Should the Reserve Bank drop inflation targeting?, April 2008.


Unwinding asset and credit bubbles, March 2008.


Asset inflation conundrum, June 2007.




Saturday Sanity Break, 28 Febuary 2015
Date: Saturday, February 28, 2015
Author: Henry Thornton

'Thousands more mining jobs to be cut as export earnings plunge' is one important headline this week.


The other recent bit of economic news is that non-mining investment is hardly rising and has no chance of replaving plunging mining investment, while infrastructure seems to be lost in the chaos of political confusion and budget blow-outs.


If you want to feel even worse, take a gander at Laura Tingle's Friday account of all the good intentions gone south.


'Remember the days when we all rambled on about the whacky Senate? Well that now seems like a millennium ago.


'Instead, we are now all absorbed by a whacky government that – if you have but a moment to pause and think about almost anything it has done in the past couple of weeks – seems capable of wreaking much more serious havoc on the rest of us than a bunch of accidentally elected senators dazzled by experiencing occasional brushes with power.


'It's not so much that the government – and the Prime Minister – seem to have lost their respective schtick, it's that their behaviour leaves us wondering what their schtick was in the first place'. Read on and sob, readers who believe a strong economy is vital for just about everything a government might wish to do.



The bi-annual Australian airshow proved to be a hotbed of political gossip. The conclusion was that Tony Abbott will be challenged and defeated next Thursday and that there will be big changes to portfolios made by Malcolm Turnbull, including Scott Morrison as the new Treasurer and more than a hint that David Johnson will be back at Defence.


Today's press, especially the Oz, seems to have decided it has given the PM enough stick for the time being.  Its editorial begins as follows:


'THE bed wetters, serial miscreants and executive panic merchants of the Liberal party need to reflect on recent history and hold their nerve amid the current political tumult. Public disappointment in Tony Abbott’s performance is manifest yet the government’s standing in the polls is by no means disastrous this far out from an election. What’s more, the Coalition has a reasonable chance of re-election because of Labor’s indolence and four areas of strategic advantage where the government can create a sharp contrast with the ALP: firm opposition to a carbon tax; proven strength on border protection; clear determination in combating jihadist terrorism; and demonstrable — if clumsy — commitment to repair the budget. Bill Shorten wants a price on carbon, plays to “compassionate” critics on border protection, has exonerated erstwhile Taliban loyalist David Hicks as “foolish” and refuses to admit the budget needs urgent repair'.


The gossip-mongers at the Airshow should have a bex and a good night's sleep. Today the B52 flies in from some Pacific Island, does a half-hour turn and flies home again, which will provide plenty of excitement for Australia's retired warriors. Meanwhile, Australia plays New Zealand in what is a danger game.  A loss to our cousins from over the ditch, now that would be a serious crisis.


New Treasury Secretary, John Fraser, has given tongue at a meeting organised by CEDA. Mr Fraser's conclusion makes perfect sense, as regular readers will recognise.


'If we set ourselves on a path of sensible fiscal repair and lay out credible plans for structural reform that address our long-term growth challenges, then the consumer, business and investor sentiment that is critical to lifting economic activity in the near-term will materialise'.


Read on here.  


Cricket'n'footy'n'stuff


Cricket minnows Afghanistan have beaten Scotland in a hair raising performance, and are said to be after Australia's scalp next.  Australia, meanwhile, are underprepared for their joust with New Zealand. I cringed when I read hairy-chested comments in the press from Australians saying we'd out-bowl them and out-bat them. An American president once said 'Walk softly and carry a large stick'. Right on the money in my view.


The footy makes a sputtering start soon but the real deal starts on Thursday April 2 when Caaaaarlton! meets Richmond at the 'G'.  Henry will be there with a fervant hope that Mighty Mick has finally got it right.  If 2015 is another fizzer, bring back Brett Rattan will be my cry, and Mick can go to Essendon to manage its resurrection.


More from the Essendon bunker here.


Image of the week



Courtesy The Oz


Economics Q&A
Date: Thursday, February 26, 2015
Author: Henry Thornton

Janet Yellen is ever so slowly preparing the way for a (gasp!) rate increase in the USA. 'If economic conditions continue to improve ... the committee will at some point begin considerimng an increase in the target range for the federal funds rate ...'. The care with which Dr Yellen is dancing around this matter is a wonder to behold.  Is the US economy so delicately poised that extreme care needs be taken to minimise the chances of great damage being wrought by, say, a 25 basis point increase in the 'target range'?  As I understand it, the current target range is 0 to 0.25.  As a modest contribution, Henry asks whether the range be raised to 0.25 to 0.50 but the new rate be put at the bottom of that range.


And in distant Australia, Treasurer Joe Hockey has warned us to hang on tight when the Intergenerational Report hits our desks for fear of falling off our chairs. We'll all be rooned, comrades, unless we decide to work harder and smarter and for longer.  Imagine the dilemmas in Japan and Italy, where more people are dying than being born.  No wonder asylum seekers are flooding to Italy in leaky boats, and someone should show them Japan as an idyllic destination with rapidly emptying villages set among beautiful scenery.


Closer to home, warm congratulations are due to Scott Morrisan and Patrick McClure for a brave reform agenda for welfare policies, annual cost $150 billion and rapidly growing. As Mr Morrison said, these reforms will not proceed unless Australians agree.  Simpler, fairer and more efficient, and the thrust is getting welfare recipients back to work, and who can sensibly disagree?  And the recent ABC report about rorting by the (private sector) employment agencies chilled the blood, and suggests there is a lot of fixing to be done.


Courtesy SMH


And in late breaking news, new Treasury head John Fraser has admitted to being a fan of Ronald Reagan's tax cuts, while not being a fan of the International Monetary Fund's (IMF's) 'claims in the past year that tough budget cuts had done more damage than good'. This has signalled that his advice to the Treasurer is likely to be less 'pro-Keynesian' than immediate predecessors Martin Parkinsin and Ken Henry. Perhaps Mr Fraser has more faith in the inherent strength of the Australian economy than his predecessors. He also asserted, reports Jacob Greber in the fin, 'I do not resile from the point that I don't think spending our way out of lower economic activity is the way to go'. Perhaps sensing that his listeners might be failing to understand this gnomic point, he later said "Spending your way out of these things just doesn't work".


David Uren asked Mr Fraser about the falling currency in a recent interview for the Oz. A lower exchange rate gave Australia some breathing space, the Treasury head explained, but not enough to rekindle growth. “We can’t pin our hope on a lower exchange rate to do all the magic. The lower exchange rate was a massive plus for us in the 1980s only because we used it to reinforce good fiscal policies and tackle structural problems.” (Advised by the RBA, not the Treasury, incidentally.)


Mr Fraser also confessed to thinking there are better things to spend money on than paying interest on the debt, and that his dislike of debt would leave the country "liable to the vicissitudes of the market" and that when interest rates go up, Australia would be "exposed".  We like your work, Mr Fraser, but where do you stand on the desirable pace of deficit and debt reduction?  If budgets have little predictable short-term effects, why not get the budget fixed in a hurry to minimise later "exposure" in the form of high debt in a world of rising interest rates?  And what about the likely effect of economic reform to boost growth, should rapid budget fixing slow growth?  Or are you skeptical about any attempt to improve the economy? My views are here.


Naturally Henry does not expect the Secretary of Treasury to respond to Henry's assertions, or to answer his questions, but surely the Senate committee could do more to draw him out? Committee chair, Senator Slamming Sam Dastyari, inspired by the Secretary's presentation, spoke of President Reagan's 'Voodoo economics'.  Well Senator, look at its effect on the US economy, and ask some real questions next time you meet John Fraser.


The looming deflationary `crisis`
Date: Tuesday, February 24, 2015
Author: PD Jonson

In 1971 President Nixon cut the final link between the dollar and gold. Inflation quickly became a global problem, fuelled by America's attempt simultaneously to win the war on communism in Vietnam and the war on poverty at home. Inflation spread from America to the rest of the developed world, greatly reinforced by successive leaps in the prices of oil. Unemployment rose sharply with inflation, and the ugly word 'stagflation' was coined.


For much of the period since the 1970s central banks as well as businesses and households have feared inflation more than unemployment, which more or less looked after itself with the usual 'cyclical' fluctuations. Most central banks have adopted targets for goods and services inflation, while perhaps taking their eyes of other targets, especially asset inflation.


With the advent of the Global Financial Crisis (GFC) in 2007, attention shifted to the real economy as rates of unemployment rocketed. Monetary policy became super-easy, interest rates near zero, reinforced by so-called 'Quanititative Easing' (QE).


The USA and the UK were the earliest to adopt super-easy monetary policy, reinforced by widespread bailouts of financial institutions in trouble. Now these countries are showing signs of recovery in their 'real' economies, the clearest indicator of which is falling unemployment. Despite super-easy monetary policy, goods and services inflation is languishing to the point that 'deflation' is the new concern.  The prices of oil, coal, natural gas, iron ore and other metals are plummeting (very bad for resource exporters like Australia and Canada) and even consumer inflation is falling, in some cases almost to zero.



But asset prices have been rocketing, and we all know that this cannot go on for ever.  Every boom in asset values is followed by a bust.  If the next bust is big enough, the nascent recovery of developed economies is likely to be snuffed out.


The latest Economist has both a leader and a detailed article on the  perils of deflation in goods and services prices. Both make gripping if scary reading, with a focus on ways in which economic policy needs reconsideration when goods and services inflation is near to zero or even negative.


'FOR central banks in the rich world, two is a magic number. If prices rise at 2% a year, most shoppers can more or less ignore their slow ascent. And a touch of inflation is hugely helpful: it gives bosses a way to nudge unproductive workers—a pay freeze actually means a 2% cut—and an incentive to invest their earnings. Most importantly it keeps economies away from deflation and the depressing choices—hoarding cash, delaying purchases—that falling prices can bring. Yet despite the professed adherence to the 2% mantra, a period of falling prices is on the cards'.


I would like to propose an analytic framework that helps to explain the facts of recent experience and which is grounded in serious empirical research. There are three core concepts that are needed to explain recent oddities of macroeconomic experience - monetary disequilibrium, increased leverage and risk-taking by financial institutions, and the state of confidence, 'Animal Spirits' in the colorful phrase used by some of the world's best economists.


'Monetary disequilibrium' is a more sophisticated version of simple monetarism, where the stance of monetary policy is defined by monetary growth.  It also encompasses the ideas of John Taylor who represents monetary policy with a rule that relates cash interest rates to the state of the economy, in the simplest cases the rate of unflation and the rate of unemployment. Consumers and businesses, it is assumed, use 'Money' as a buffer stock, and adjust decisions in part on whether they have excess or deficient money in their buffer stocks.


For the period until the onset of the 1970s, research has shown that 'monetary disequilibrium' largely influenced the state of demand. Clearly, severe recession/depression produced low 'Animal Spirits' at times during this long period, and during the nineteenth century major gold discoveries in the 1850s and 1890s boosted money supply, and presumably also raised the spirits of households, businessmen and government officials. Both goods and services inflation and asset inflation mostly followed the ups and downs of monetary policy, even when simply represented by money growth.


In the 1970s and 1980s, with the final link to gold severed, 'monetary disequilibrium' also came to influence inflationary expectations, as therefore goods and services inflation. The more or less simultaneous impact of monetary growth on goods and services inflation and asset inflation remained the rule, although there were 'aberrant episodes' identified here that demand a more complete explanation.


The nexus between monetary growth (and therefore 'monetary disequilibrium') was broken in the 1920s USA.  Then monetary growth and goods and services inflation were moderate, but asset price inflation was allowed to boom  by credit advanced by the New York banks to speculators.  This was also a time of strongly positive Animal Spirits, at lerast in the USA. In the UK, in contrast, the mid-1920s return to the gold standard at prewar parity created pessimism rather than optimism..


Another time of very strong Animal Spirits was 1950s USA when, once again monetary growth (and therefore 'monetary disequilibrium') was controlled but asset price inflation was very strong. A similar period was 1990s USA, when strong Animal Spirits and strong growth and innovation was further boosted by strong credit growth as banks increased leverage in the wake of President Clinton's financial deregulation.


The 15 years of the 2000s and 2010s so far seem to me to contain several strands.  There was strong credit growth and strong Animal Spirits until the onset of the GFC. Then near zero interest rates and 'Quantitative easing' helped avoid a catastrophic decline of economic activity and cushioned Animal Spirits.


Throughout this period the influence of the 'Greenspan put' and the 'Bernanke put' meant asset demand recovered quickly after each asset crash, and rose strongly in the period as a whole, and this will surely have influenced Animal Spirits of investors.  Depressed demand for goods and services closed or slowed the normal recovery channels from recessions. The long period of depressed goods and services demand, combined with continued strong supply of goods and services, is the reason for the global goods and services price deflation.


I have still to put all of this reasoning into a coherent estimable model, but that is the next step. My intuition is that 'deflation' will be seem as a normal  response to a deep recession where the normal response to monetary disequilibrium is diverted to the asset markets instead of into depressed goods and services markets.


Readers seeking references for the assertions in this blog should contact Henry here.


Saturday Sanity Break, 21 February 2015
Date: Saturday, February 21, 2015
Author: Henry Thornton

The event of the year for Henry is the advent of a new book by Geoffrey Blainey. Its arrival is celebrated in the weekend's Australian Magazine where Geoffrey explains ways in which he sees parts of Australian history with fresh eyes. This article covers largely the history of the first Australians and a theme is that 'Aborigines experienced what is surely the most significant event in our history. Nothing since 1788 can compare in magnitude to the great rising of the seas which – in full sight of scores of generations of coastal Aborigines – flooded coastal plains and valleys. It severed Australia from New Guinea in the north and Tasmania in the south'.



Professor Blainey adds that: 'In comparison, the rise in sea levels and the global warming currently predicted for the next 100 years seem like a sideshow. It is a triumph of the human spirit that Aborigines as a people survived an event which must slowly have drowned all or part of the homeland of perhaps one in every three tribes or “nations”.'


The concluding paragraphs comment on the so-called 'history wars' and follow with a nice remembered account: 'Controversy, not war, will continue for a long time to come. It is in the nature of history and of most intellectual activities, and the more so in a nation where the main strands of history – Aboriginal and European – are utterly different.


'In 1948 I was in the public gallery of the old parliament house in Canberra. There I looked down with a sense of wonder at the oldest member, the silver-haired Billy Hughes, who had been a member of the first federal parliament in 1901. I did not then know that in parliament he had often sat near William Groom, a senior Queensland politician who, as a 13-year-old back in the 1840s, had been transported as a convict to Australia.


'It shows the brevity of [conventional, post 1788] “Australian history’” that through good fortune I was able to see a living politician whose parliamentary colleague belonged to the convict era – the time when the first settlement at Sydney began. In contrast, the indigenous history of this country is unimaginably long'.


Read on here.


Professor Geoffrey Blainey’s The Story of Australia’s People: Volume I (Viking, $49.99) will be available in the best bookshops on Wednesday.


Political economy


Australia's latest blood sport, Abbott bashing, continues unabated, with even the senior journos throwing some punches, including stories that I find literally incredible, such as the allegation that Chief-of-staff Peta Credlin sometimes chaired the Expenditure Review Committee. 


But there is so much acrid smoke that one must assume that there are plenty of smoldering ashes. Even friends of Tony Abbott say they fear he will not survive for long.


In matters economic, Henry must say, with a heavy heart, that the budget is buggered, and that only drastic action will stave off recession.  Conventional budget reform would involve cutting expenditure or raising taxes, or some mix of the two. Such action is necessary to fix the budget and stop the rise of debt. This will almost certainly slow or delay recovery of the economy unless ...


... Budget reform is accompanied by bold action to encourage growth.


Nick Greiner in today's AFR says there is a need for a "grand compromise" to end the budget stand-off or risk the country grinding slowly toward a "train wreck".


Hear, hear to that, but simply cutting spending and raising taxes - the traditional Treasury way - will be deflationary unless positive energy is injected via serious economic reform.


Here is Henry's agenda for reform.


Kulture


Fiona Prior falls under the spell of Graeme Murphy's Swan Lake


Footy'n'cricket'n'stuff.


Wild storms have wreaked havoc in the deep north, and we sincerely hope people are safe and that the insurance companies do not play too hard in assessing the claims that are sure to be many. Rebuliding will add to economic activity and may provide a boost that helps the economy.  It is not a boost that John Maynard Keynes would salute, even though in a satirical moment he proposed digging holes and filling them in again.


At the time of writing, Australia's game with Bangladesh is likely to be truncated or called off.  With the minimun 20 overs each, anything could happen, and the Bangladashies (sic?) are sure to have noted how Brandan McCallum or David Warner make runs. Meanwhile, England seem disinterested, being flogged by New Zealand who are emerging as a real chance to win the tournement.


The footy season is somewhat delayed by the cricket but Essendon continues to hog the limelight. They have been granted permission to patch together a team, sadly not including men from the Ascot Vale firsts, and should get flogged until their regular players are allowed back.


What sad news it was that code-hopper Karmicheal Hunt has been charged with drug using and drug peddling. At least it was not in Indonesia, so he will not face a firing squad, but his new Rugby career seems likely to be over.


Recession or Reform
Date: Thursday, February 19, 2015
Author: Henry Thornton

Gor blimey, comrades, Messrs Abbott and Hockey are singing from the same hymn sheet and the subject is hell and damnation.


Tony Abbott pointed out, entirely reasonably I hasten to add, that Australia's massive budget deficits and rising debt was stealing from our children, and their children.


Today Joe Hockey has weighed in with some powerful rhetoric of his own, as reported by Adam Creighton.


* 'Speaking to business owners of the Sydney Business Chamber, Joe Hockey said the forthcoming Intergenerational Report – a five-yearly document looking at long term fiscal pressures, due for release soon – would make Australians “fall off their chairs”.


* 'But he said the Intergenerational Report would “stimulate a conversation” about whether the rules around superannuation were sustainable for the long term.


* 'Mr Hockey said the IGR would not be like past reports but “a very genuine attempt by the Treasury, in an unprecedented way, to launch a conversation about Australia’s future”.'


RBA Chief Glenn Stevens recently told the pollies that the debt and deficit situation could get far worse 'in a heartbeat'.


And the ratings agency S&P today put the cherry on the top by warning that Australia's AAA credit rating could be put at risk, meaning we'd have to pay more in interest on that debt.


This is Banana Republic Redux. The original Banana Republic was postponed by tough fiscal and wage policies by the Hawke-Keating government, then the recession it (and all of us 'punters') had to have, further postponed by the Howard-Costello government's reforms and seemingly banished by the mother of resource booms.


But motherly booms always end in busts, and the current bust has revealed the dodgy underpinnings of Australia's so-called 'miracle economy'.


Comrades, we know what is needed.  Without imagination and courage, austerity measures which all Australians except the real battlers embrace willingly will be needed. But the measures of austerity must be fair, and be seen to be fair.


'Here is the thing' as a young man might put it.  Without imagination, there are two roads to redemption.  Cut spending and hold it down until the budget disaster and lack of competitiveness is fixed.  Or raise taxes.  Or some mix of the two.


If handled badly, and perhaps even if fiscal reform is handled well, we shall experience the recession we did not need to have.  It is 18 months since this warning was offered, and perhaps too late to avoid recession. 


The best chance of avoiding recession involves a burst of economic reform to create growth that would help the budget and create jobs. When ratios to GDP are out of whack, a government can cut the denominator or raise the numerator.


Here are eight big ideas to raise the numerator, with the full analysis available here.


* Immediate action needs to be taken to reverse cabotage rules introduced since 2009, and phase out as rapidly as possible the entire cabotage system and its unique work practices regime. This would allow costal shipments of products and raw materials to be transported at internationally competitive rates.


* High efficiency super-critical coal fired power generation must become again the major base for a return to Australia’s power and energy cost advantage, even if we eventually decide Australia is ready for nuclear alternatives.


* Company tax reform needs to provide for the write-off of new manufacturing equipment to match overseas competitors.


* Government should urgently remove regulatory impediments to management and labour flexibility, to allow work practices and conditions of employment to be tailored to the specific needs of each individual business.


* Policies need to be put in place to raise the overall spend (Government and corporate) on R&D as a percentage of GDP, to global best practice levels. The program would need to ensure that relevant business and administrative skills and experience are available to use any Government support effectively. The government's new 'Growth Centres are relevant here, as is the long-standing CRC Program.


*  A task force needs to be constituted to review best practice arrangements in countries which lead the table of performance with innovation and commercialisation. The outcome would be a basis to review and implement policies which would be relevant for Australia, which currently is the lowest county in the OECD rankings in this vital area.


* A persistently overvalued exchange rate is a form of asset pricing imbalance that involves instability of industry structure and which requires fresh thinking by the Reserve Bank of Australia.


* Priority be given to mergers which favour the formation of a strong group which can compete in international markets rather than having weak fragmented entities. The ACCC brief needs appropriate revision.


It is very late if recession is to be avoided.  But better late than never, as Grandma Thornton used say.  Radical economic reform requires both courage and imagination.


We shall soon find out if our leaders have what it takes.


The coming global property bubble
Date: Wednesday, February 18, 2015
Author: Henry Thornton

'KEEP interest rates low for long enough and the property market will eventually boom' asserts Buttonwood of the Economist. 'That has been a good rule of thumb for investors throughout history. It is even proving true in Europe, despite the continent’s sluggish economy'.


There you have it, dear readers, a similar view to Henry's, as presented last week.  Henry's graphic hints of a focus on housing, reflecting the traditional Aussie bias.  But the basic logic is similar to Buttonwood's far more sophisticated offering.


The venerable mag summarises, and offers an entirely rational explanation. 'Europe’s rebound outpaced the 9% rise in global property transactions, although not a 15% rise in American deals. Office buildings and hotels were the most active sectors worldwide.


'It is hardly surprising that investors are enthusiastic for bricks and mortar. In both the cash and government-bond markets, yields are zero or even negative. By comparison, yields of 5% on American property or even 4% on office blocks in central London look attractive'.


Yields on property are falling, but long-term returns from property look very respectable. 'In the ten years to end-September, American commercial property delivered a total annualised return of 7.9%, according to IPD, a property-information group; returns in both Canada and New Zealand were in the double digits over the same period (see chart). That compares with the 8.1% annual return (including dividends) achieved by American equities over the same period and with the 6.8% annual return achieved on long-term Treasury bonds'.


Is the market due for another downturn? 'Not necessarily. Property is vulnerable to three things: a rise in interest rates, a downturn in the economy that hits demand, and a burst of speculative building that leads to oversupply.


* 'On the first point, central banks are still cutting rates in much of the world. There is the possibility of rate rises in America and Britain over the next year, but with inflation very low, central banks are likely to be cautious.


* Second, 'The world economy is not exactly racing, but forecasts (for what they are worth) predict GDP growth of more than 1% in the euro area and Japan and more than 3% in America. In any case, prime properties, which investors are most enthusiastic about, managed to weather the 2008-09 recession and so should be resilient to another downturn.


* 'In terms of supply, it is easy to be misled by the view from The Economist's offices of the flocks of cranes perched over London. This is the exception. Globally there is yet to be the kind of development spree that usually marks the peak of the property cycle. Deals involving development land fell by 29% globally last year, including a 3% decline in Europe'. Trevor Swan, one of Australia's few globally significent economists, once advised the young Henry that the may cranes of Sydney had stopped moving. 'That's all you need to observe to see the recession has started' the old boy (as he then was) announced.


The cranes of London are still moving, and elseware they are like the famous parrot - not dead but resting. 'So it is possible that commercial property’s streak could last a good deal longer. Lots of investors need income and the obvious alternative to property—corporate bonds—has had a very good run. Investors have even been willing to accept a negative yield on bonds issued by Nestlé, a Swiss foods group, in effect paying for the privilege of lending it money.


'Until the 1970s property was the asset of choice for long-term investors such as university endowments and pension funds. It has been replaced in recent decades by government bonds, which are much more liquid. If yields on bonds stay at Japan-like levels for a while, however, the allure of property will only increase. And if inflation returns, property will be a better hedge than conventional government bonds'.


And in conclusion: 'Eventually, such logic will inflate a bubble, of course. Residential property in London (fuelled by a combination of low rates and international capital) has already reached that point. But the surge of interest in second-tier and more speculative commercial-property projects that marks the top of the cycle is only just beginning, at least in Europe. The skyscrapers will tell you when to worry'.


Sunday Sanity Break, 15 February 2015
Date: Sunday, February 15, 2015
Author: Henry Thornton

The new year is already looking like the old year.  Henry's corporate commitments are still limbering up and his major research project is on hold and so there has been time to listen to or even watch the antics in the hig house on capitol hill. We have been slowed up by a serious carpel tunnel problem that fortunately was fixed in time to avoid real problems.  While in recovery mode - NO TYPING - there has been almost enforced Skye News watching. Parliament seems more than ever like a public school where the boys have taken over and the headmistress is trying unsucessfully to rule the roost from her podium in the Assembly Hall. The rules remain absolutely no generosity of spirit, no sense of common purpose and no common courtesy is to be shown by either side.


As well as watching (and seething with frustration) I have at least found time to produce a few blogs. As is my wont these include comment on monetary policy ahead of the RBA board meeting and afterwards. My strong advice ahead of the meeting was that the economy needed the budget to be fixed as well as policies to make Australia more efficient and competitive. There was little justification for further cuts to monetary policy, unless the economy was in deeper trouble than senior members of the government, or for that matter the RBA, had indicated.  And there was a real chance of renewing, or strengthening, the housing boom, although the RBA may be relying on APRA to impose new-fangled 'macroprudential policy' to sort that problem.


The view that there was little case for further rate cuts was of course trumped by the RBA Chief with a rate cut.  Many will say that the RBA is looking good in the light of the large jump in the official (ABS) unemployment rate data released today. The RBA forecasts were shaded, not slashed, however, so it is reasonable to ask why the RBA has changed tack. (This is discussed in my latest blog, linked here.  This blog also touches on the touchy subject of pre-meeting 'briefing' by the RBA, which it has been asserted was especially obvious before this latest meeting of the board.


The weekend AFR reports that Glenn Stevens has said to a meeting of parlimentarians that the budget problem could get much worse 'in a heartbeat'.  If they were not terrified, they should be.


Gov'nor Glenn also said there is a limit to what monetary policy can do. This was because interest rates are already low, but a far bigger issue is that other policies, concerning regulation, fiscal policy and policies of state and local government have far more impact on the economy than a small cut (or cuts) in rates of interest.  I am sure that Glenn Stevens agrees with this, but no doubt thinks the RBA has to be seen to be doing its bit. But rate cuts will be positively unhelpful if they stimulate asset inflation.  Initial impacts suggest this is a real risk.


Art lovers may care to comment on my editor's latest post-modern painting, designed to illustrate that monetary ease in current circumstances goes more reliably into asset prices than economic stimulus.


All of Henry's friends bemoan the state of Australian politics and ask what can be done. In 'Political economy, Aussie style' I provide an answer. A reader asked if I was advocating policy made by technocrats rather than politicians. I remarked that the independant central bank with a clear mandate had served Australia well.


While giving Treasury independance plus a mandate to run a sensible fiscal policy is probably a bridge too far, what about requiring Treasury to provide us all with its policy advice, as the RBA does in its field.


This is worth debate and, when it bobs up in a newspaper, please recall you heard it first here.


All the best for the year ahead. Remember this is a time to tread carefully with seatbelt engaged.


Kulture


Fiona Prior is back, reviewing Cirque de Soleil. She says, for those of Henry’s [mostly elderly] readers 'whose idea of a circus is a ringmaster, elephants, and men with whips facing off giant cats – Cirque de Soleil is a completely different experience altogether (except, maybe, for a shared penchant for sparkly leotards)'.


You must not miss this, elderly readers.  It will help you to look cool to your grandchildren.


Henry judges that this summer's movies are the best for years. The latest stunner is Selma, the story of the freedon marches in Alabama several short decades ago.


Hard to accept that back then American Negroes, as African Americans were called, were blocked from voting, a century after the Civil War. Lovely work by all concerned, and here is a trailer. Watch the ad, Shen Yen, 5000 years of Chinese history in one gorgous sitting.


Footy'n'cricket'n'stuff


Australia beat England by 111 runs in the second match of the World Cup of Cricket.  This was despite batting failures by Warner, Watson and Smith and with Mitch


Marsh getting five for while Johnson and Starc dealt gently with the pestiferous poms (PPs)  Smith chimed in with the best catch I have seen, and Starc pulled of a close second miracle catch. George Bailey scored 55 and captained the team well. Sadly, Bailey may be required to stand down in favour of Michael Clark, which seems like a real pity.


As predicted here last weekend, it seems that Essendon will be 'topped up' with a team mainly from Ascot Vale and other suburban teams.  Hope a suburban coach is in charge of the team, not Sir James Hird - did you miss Tony's latest cap'ns choice? Imagine the furore if Essendon Vale beat an AFL heavyweight, like Collingwood.


With cricket on for 6 weeks, by which time the footy will be underway, there will not be much time for moping, or trying to help Tony save his job.  Some honest toil, that's what we both need, like choppimg trees or weeding vegetable patches.


Image of the week



Courtesy The Oz


Rate cut - Asset inflation or economic boost?
Date: Tuesday, February 10, 2015
Author: Henry Thornton

The RBA's latest excellent summary of the world and local economies, and the implications for monetary policy, was made available on Friday.  One could not assume that the timing was designed to distract us all from the political hi-jinks, but if it was it failed.  But now we are back to business as normal it is only fair to devote serious attention to the excellent work of the men and women of  the RBA's economic department.



Key questions remain. Resuming the policy easing may provide some boosts to non-mining activity and some assistance to a lower exchange rate.  But what if it fuels further housing inflation, as initial responses suggests is likely?  Will APRA's untested 'macroprudential policy' be able to prevent a housing boom turning into a bubble?


First we summarise the latest Monetary Statement. I shall use a staccato presentation of main facts.  In short:


* Growth slowed a bit in Asia - China, Japan, East Asia.


* Growth increased in USA.


* Price of oil fell further.


* Price of other commodities fell, but a bit slower rate.


* Net effect: 'Australia’s MTP growth is expected to continue at around its pace of recent years in 2015 as a number of effects offset each other'. [Sadly, 'MTP' is not something I have encountered before, which confession will strengthen the general view in Henry's household that the old boy is past it.]


* The oil price falls are putting downward pressure on global prices of goods and services. The dread word 'deflation' is being discussed in hushed tones in central banking land, especially in the ECB.


* Central banks have eased - 'QE' in Europe, rate cuts elsewhere, financial markets have pushed back expectations of rate hikes in the USA. 'Sovereign bond
yields in the major markets have fallen significantly, particularly at longer maturities, although the size of the decline in yields is difficult to explain' [Ouch, if the RBA is puzzled, Henry is absolutely baffled.]


* Here is a zinger: 'The increasingly divergent paths of monetary policy among the major advanced economies have led to some sizeable movements in exchange rates'. The Swiss Franc moved dramatically after the Swiss abandoned policy of holding their currency down, and US dollar rising against most others, as next move in US rates is expected to be up.  The  so-called 'currency wars' are hotting up.


* And another: Australian financial conditions remain 'very accommodative'. The Aussie dollar has fallen relative to the US dollar, although not as far as commodity prices. We appear to still be a safe haven, though (ahem) the budget is in a right mess.


* 'Available data since the previous Statement suggest that the domestic economy continued to grow at a below-trend pace over the second half of 2014. Resource exports and dwelling investment have grown strongly. Consumption growth remains a bit below average. Growth of private non-mining business investment and public demand remain subdued, while mining investment has fallen further'.


* 'Housing price inflation has eased from the very rapid rates seen in late 2013, although it remains relatively high, particularly in Sydney and Melbourne'.


* Household consumption growth has picked up since early 2013, but is still below average, despite support from 'very low interest rates'.


* Various positive factors, increased wealth, etc, etc have been partially offset by 'weak growth in labour income, reflecting subdued conditions in the labour market'.


There we have it, dear readers. There is a lot of global uncertainty, with local political unceertainty to compound this,  but Henry must admit no strong case for the rate cut we received a week ago today.  This was well advertised in advance by a 'well connected' journo or two, and Henry reflects on how much things have changed since a few serior staff we authorised to take calls from the press when Bob Johnston took the reins. 


[As an aside, it is worth noting that properly trained economists believe that inside information makes a desirable contribution to creating a properly informed market. Why it is against the law is therefore one of those sweet mysteries of life, and presumably the current restrictive law will be changed as part of Josh Frydenberg's ongoing efforts to deregulate Australia's overregulated economy.]


But readers will be far more interested in why, with a weak rate cut case, and little warning, except via the trusties of the press, the deed was done.


There are three theories scudding about.


First, the economic outlook is worse than most people believe.  As I said in my pre-board briefing: 'Unless the RBA has joined the 'serious trouble' camp, its own stated position does not call for further rate cuts'.  But the degree of overt concern in the typically excellent RBA commentary summarised above does not support that theory.


Second, the fear might be, absent a rate cut (or two, or three), Australia will be a loser in the currency wars, the welcome fall in the Aussie dollar will stall and there will be no further improvement in competitiveness to pull the economy out of its current glide path. Again, while there are hints in this direction, it could be said that the near zero rate nations are in far worse shape that Australia, whose Treasurer keeps telling us the nation is in extremely good shape, and that the rate cuts will greatly improve the situation.


Third, in the absence of action to fix the budget, and improve efficiency and competitiveness, the RBA must do its bit to help. This might be seen as insurance in case an unhappy Treasurer begins to talk openly about removing Treasurer Costello's reform that made the RBA so much more effective, giving it a clear focus on 'goods and services inflation' and the power to act independantly in pursuit of that objective.


And it may be inflation - asset inflation rather than goods and services inflation - that is the main result of this rate cut and others anticipated by 'well connected' members of the press.


Perhaps we shall never know, except in the unlikely case Glenn Stevens uses his well-deserved retirement to write a blisteringly honest biography.  Perhaps the truth is there was a bit of all three argumeents at play, and also Barnaby's full moon.


But the good news is the rate cut comes at a good time to illustrate Henry's editor's latest post-modern painting.


Read the full RBA statement here.


The first painting in the style of this is available here.


Sunday Sanity Break, 8 February 2015
Date: Sunday, February 08, 2015
Author: Henry Thornton

'This dog will not run
'This boat will not float'
.
Ross Cameron, former Liberal backbencher, ahead of Party spill, now scheduled for 9 AM Monday.


'Tony has had absolute support from his senior colleagues. I will support him in any leadership spill'. Malcolm Turnbull, today.


As with the equivalent affirmation from Julie Bishop, 'this promise will not hold if a spill motion is passed'. The mob, to a man ... correction, person.


'Replace Joe Hockey as Treasurer by Malcolm Turnbull', Uncle Tom Cobley and many others in the past few days.  After all, it is the failed budget that is a main substantive weakness of Tony Abbott's performance in government.


'If Joe Hockey would agree to leave economic policy to Messrs Fraser and Stevens, at least until the current mess is sorted, I would vote for him to be given a second chance.  This is not a totally silly idea, dear readers. When a country gets so deep in the economic mire that it needs help from the International Monetary Fund, the tecnocrats get to call the shots.


'Far better to let our technocrats sort out the economy while there is still time to do so without advice from arrogant foreigners.  We've tried arrogant.  Let's have some genuine competence'. Henry Thornton, Friday 6 February.


So there you have it, dear readers. More political instability, following economic policy stasis amid assertion and counter assertion about which government is more responsible for the current mess. Greg Sheridan said among a blizzard of blame and analysis in the weekend press: ''... any government is now under constant attack from many of its own natural supporters, for not going far enough in the direction that alienates the majority of voters. There is a tremendous pincer movement of the extremes of your own base, louder than ever on social media, and the disgruntled in the centre and on the other side, louder than ever in their contradictory complaints'.


Paul Kelly, also yesterday, weighed in as follows. 'Rarely has the prime ministership seemed such a poisoned chalice. What is needed now, above all, is strong government. Yet resolute government is being put into grave jeopardy probably regardless of whether Abbott or Turnbull prevails.


'Two competing mantras echo across the partyroom. From Abbott: don’t surrender to chaos, weakness and Labor’s disease. And from the motley bunch of Turnbull travellers: seize this chance to save the government and invest it with new hope'.


More here, including a video.




Footy'n'futball'n'cricket


This being a doldrum amongst the usual tempest of sporting news and views, the focus is on 'Leadership'. Leadership of Australia's world cup of cricket. Will Clarkie's hammy hold up? And if it does not, what about George Baily's form? And would Smithy lead the team if the hammy breaks again and George's form remains bad?


But there's more, dear readers. What about Watto's whatever? Is Johnno back to his scary best? Will Faulkner come up ok? If all the questions are answered in the affirmitive, Australia cannot lose.


In footy, the single biggest question is will Essendon be allowed to compete with all its players in 2015? Also: 'Will James Hird be leading them as coach? and 'Will Caaarlton! beat Essendon, even if the Dons are playing a hastily arranged team from Ascot Vale?


Great to see Timmy Cahill getting a fair suck of the sausage from the Shanghai dragons, and is also available to play for the Socceroos should the coach require him to do so. Go for it Ange.


Image of the week



Courtesy AFR


Political economy, Aussie style
Date: Friday, February 06, 2015
Author: Henry Thornton

What to say about politics, Aussie style, as it relates to economic policy? Four Prime ministers in four years would be clearly excessive, because how are holders of that high office meant to learn how to perform well in such a difficult job? Of course it can be remarked the Prime minister's job is not for someone on work experience, but that is too glib. Every Prime minister learns a lot in his or her first term, which I suspect is a main reason that most Australian governments have been given at least a second term. But no, this is no longer the case, if the examples of Rudd'n'Gillard'n'Rudd, or of the hapless Campbell Newman, are any guide.


A friend suggested this is the result of addiction to smart phones. This addiction means many people just have to have the latest version, so whenever a new model appears they just have to have it. A scarier possibility is that people will just refuse to cop some sacrifices so that they are not stealing from their children and their children's children. Or perhaps Tony Abbott's brilliant attacks on Labor's leaders in government have established new standards for opposition leaders and he is reaping what he sowed. Yet demolition derby is no way to run a counry, and I at least remain confident that a more generous and more patriotic approach by oppositions will eventually repair politics and allow a more rational discourse about economic policy.


Maybe the situation will only be tackled when there is a real economic crisis, so real and so immediate that we can all understand it?


The government has, almost by definition, failed to establish a coherent narrative. At the start there was supposedly a 'budget emergency', really a looming debt trap.  Why did the Treasurer not establish some sensible budget projections as a matter of priority - both 'best guess' and 'realistic worst case'? Such projections would include the 'realistic worst case' in which commodity prices continued to fall relentlessly and with US recovery global interest rates would begin to rise. The 'realistic worst case' projections could have included 'loss of confidence in Australia's economic policy leading to an abrupt fall in the Australian dollar'. And jobs growth too weak to prevent the rate of unemployment from rising relentlessly.  Even if such assumptions were sneered at by the Labor opposition at the time as scaremongering, about now the government's 'realistic worst case' scenario would have shown the government to have been prudent.  Assuming of course that it had responded with policies designed to tackle the realistic worse case if such a future arrived.


Yet the hard graft of constructing 'realistic worst case' scenarios and debating them with cabinet and then the 'punters' - aka the voters - was not done. Instead the first coalition budget included very mild assumptions about the economy and the deficit.  It was celebrated by scenes of Joe Hockey and Mathias Cormann smoking big cigars on a porch in the parliamentary building. Conveying the totally inappropriate message of 'job done, problem fixed'. 'Its the end of the age of entitlement' said Smokin' Joe, 'cop our reforms and all will be well'.


There was of course a further glaring inconsistency in the coalition's narrative. Budget emergency but a generous paid parental leave scheme, the 'captain's pick' in economic policy. Deregulating university fees was a good policy that failed to engage the punters. Ditto Medicare copayment hike, if that is the right description. (Henry can hardly understand the current system, and never knows when to claim from Medicare and when to claim from the private healh fund, and consequently often fails to claim from either.  And hopes to be considered for a gong in the new category of 'taxpayer of the year'.) With other budget savings, the overall budget was instantly declared 'unfair' and there was no serious attempt to refute this pub and BBQ allegation. There was a good reason for this - the budget wasn't fair, and Australians will not cop unfair.


It is also unclear if the Treasurer has the desirable technical understanding.  Earlier this week he received the cut to cash rates as 'good news'. I suppose if it is regarded as a sign that he now realises just how bad the economic mess is that would be fine.  But he was more accurate whilst in opposition when he asserted the rate cuts were a sign of an economy in trouble. As I said in my latest advice on the matter, linked here, "unless the RBA has joined the 'serious trouble' camp, its own stated position does not call for further rate cuts".


If sketchy reports are accurate RBA chief Glenn Stevens and new Treasury Secretary John Fraser have given cabinet a far more realistic account of the state of the world and Australian economies, presumably based on current best guesses but also I hope with at least a tinge of 'realistic worst case'.  But I doubt that the same team lead by Smokin' Joe has the credibility to oversee the response.  Tony Abbott has said he will leave gongs to relevant officials in future.  If Joe Hockey would agree to leave economic policy to Messrs Fraser and Stevens, at least until the current mess is sorted, I would vote for him to be given a second chance.  This is not a totally silly idea, dear readers. When a country gets so deep in the economic mire that it needs help from the International Monetary Fund, the tecnocrats get to call the shots.


Far better to let our technocrats sort out the economy while there is still time to do so without advice from arrogant foreigners.  We've tried arrogant.  Let's have some genuine competance.


Henry's collected writings on economic policy over the past decade are available here.


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