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Henry Thornton - Contributors: A discussion of economic, social and political issues Blogs
Growth exceeding predictions = inflation
Date: Thursday, April 15, 2010
Author: Henry Thornton

State treasurers have reportedly warned that Kevin Rudd's health reform plan will provide a precedent for the federal government to raid their GST revenue for future policy reforms in areas of state responsibility.


There is of course the question of credibility, one that the State Premiers would mostly prefer not to ask, for the obvious reason. This is a question increasingly being asked by sensible commentators.


The best compilation of the Rudd government's waste and mismanagement Henry has seen is by Andrew Bolt in yesterday's Herald Sun.


Waste and mismanagement is inflationary, as it boosts demand more than supply. This applies especially to Australia’s spending on ceiling batts and school refurbishment.  Glenn Stevens has declined to criticise the Rudd government's fiscal stimulus, and is unlikely to do so as he can claim to be apolitical.


It seems that the Reserve Bank's run of interest rate rises has done little to dent consumer confidence, which is not far short of the peak level reached before the global financial crisis.


The survey of consumer sentiment by the Melbourne Institute and Westpac found only a 1 per cent dip in confidence in the past month, despite last week's increase in the official cash rate to 4.25 per cent, which the banks immediately added on to mortgage rates.


"This is a surprisingly strong result," Westpac chief economist Bill Evans said, noting that from 2003 to 2007, increases in official interest rates were followed by much larger falls in consumer confidence of between 5 and 15 per cent


Why people, even competent economists, keep being surprised by stronger than expected growth is a mystery that flies in theface of the facts.


Over 20 years ago, my evaluation of Australia's monetary policy performance included the following conclusion.


'The most persistent tendency has been to underestimate the strength of demand in the Australian economy. The process of structural reform on which the government is now embarked is likely to intensify this tendency. The problem of how to cope with it needs more attention from the Bank, the Government and outside commentators.


'My conjecture is that the Australian economy is likely to show a continued tendency to grow too strongly for comfort. Fiscal policy is now in good shape and there are reasonable prospects of continued wage restraint. Reform of the tax system, improvements to work practices and the orderly reduction of protectionism is likely to give a further impetus to growth. Of course commodity prices will again turn down, there could be outbreaks of old-fashioned industrial strife, and so on. If adverse developments were sufficiently important to risk serious recession in the Australian economy then monetary policy might need to be eased. But in the circumstances most likely to be facing Australia the main question for monetary policy is likely to be the appropriate degree of firmness'.


The Asian 'Tiger' economies have an even greater tendency to achieve stronger than expected growth.


Singapore is the latest example.


The Wall Street Journal reports an almost unbelievable turnround.


'Singapore's trade-dominated economy grew 32 % in the first quarter on a seasonally adjusted annual basis, boosted by a 139 % jump in manufacturing, much of it electronic goods destined for the U.S. and China. While GDP data from this city-state's relatively small economy are volatile, both figures were the fastest rates of growth since the data series began in 1975'.


"This is not only a Singapore story," said Endre Pedersen, Executive Director of Fixed Income at MFC Global Investment Management. "It's an affirmation of Asia's strength compared with the rest of the world."


Inflation is the inevitable consequence of growth exceeding predictions.  This is because the necessary tightening of monetary policy is too little, too late.


Inflation is the biggest risk to recovery in the global economy.


Don't take my word for it, read the markets, especially the market for gold.


Posted today on The Australian's website.




Asset/credit bubbles - advice to the RBA
Date: Thursday, August 07, 2014
Author: PD Jonson

There is justified credit and 'bubble credit'. The former is fine, indeed it is how the capitalist world makes progress, but bubble credit is not so fine and can, and often does, lead to asset bubbles that inevitably lead to asset busts.  As in the world learned at great cost in the 1930s, a sufficiently bad asset bust can influence the world and may lead to global depression.


That is the message of Professor Jaume Ventura, a visitor to Melbourne University. Last night Professor Jaume delivered the twelth Corden lecture, introduced by Professor Max Corden, who is still working and is a rolled gold superstar of economics.  He described Jaume as his best student and a brilliant academic. I agree, and would add that Jaume is a genuine macro-economist who admits this part of the profession has learned it knows less than it thought it knew about how economies work and about appropriate policies to control 'bubble credit'. As Mark Twain is alleged to have said: 'It's not the things you don't know that get you into trouble, but the things you think you know that ain't so'.


Jaume Ventura started with a graph depicting the global ratio of credit to GDP since 1970. This ratio fell below trend in the 1970s, rose sharply in the late 1980s, fell again and then set new records in the late 1990s. If 1970 is 100, after the fall associated with the Global Financial Crisis, the ratio is now 160. That is, since 1970, credit has on average grown faster than GDP. Worse, the growth has been variable, and associated with increasing ups and down.  Asset prices have followed a similar pattern.


We were shown similar graphs for a number of countries.  The booms and busts of credit were not unifom, but all showed a strong upward trend and decided volatility.  'Worst' were Spain, Italy, Island and Greece. These countries were the worst hit during the GFC, unsurprising given the size of their preceeding credit binges.


Then we saw data on gross and net credit flows by country.  The stunning fact is that all OECD countries both import and export credit. It is import and export of credit that dries up when something goes wrong for a country. 'In crises everyone goes home' said Professor Ventura. 'During crises, countries go back to the closed economy model'. Already we learned a reason not to rely too heavily on overseas credit and I recalled James Tobin's call for 'sand in the gears of global finance', or indeed the logic of taxing capital inflow to protect local industry.


Professor Ventura was careful to point out that lots of good things happen when credit grows quickly. Booms are good for countries. Indeed, he has drawn a distinction of 'collateralised credit' (backed by real assets) and 'bubble credit' (resulting from chaims of credit ultimately backed only by hype and overoptimism).  It is bubble capital that we should try to contain.  But there is no consensus among macroeconomists about this matter, and Professor Ventura is trying to clarify this vital matter.


In short, Professor Ventura has discovered by sheer logic and some mathematical analysis that there is an optimal mix of the two sorts of credit. So the problem for central banks is to find that optimal mix for a given nation and devise policy or policies to drive their economy toward that optimal mix, 'leaning into the wind' of asset credit.  This is because there is no way for the economy unaided to find this happy outcome.


As the lender of last resort, a central bank should be able to do this.  The basic idea is if a boom is based on 'real things', let it rip. If it is based on irrational exuberance, lean into it.  My own view is that as asset prices, or credit (as a ratio to GDP), get too far from their long run trends, action to 'lean into' the growth are needed, but this should be in the form of macroprudential policies, not (except perhaps in extreme cases) using interest rates.  This is because normal development - take GDP itself - suggests that fundamental forces of productivity and population are always close to a reasonable steady trend, so as asset values or credit depart greatly from trend, this is surely a sign of an asset/credit bubble.


Professor Ventura said there are three ways to contain asset/credit bubbles.
1. Improve law enforcement and contract design,
2. Improve corporate governance, and
3.  Macroprudential policy.


Macroprudential policy includes reserve requirements of lending institutions and capital controls.  These should be 'owned' by the central banks and be seperate from monetary policy.  Given the key role of overseas credit - both inward and outward - there is a potential role for taxes on capital inflow, or if the economy is on the nose with international investors, subsidies.


As we walked out of the lecture, I said to one old friend 'I rest my case'. He observed that Professor Ventura had brilliantly made my case.


Further reading, from Jaume Ventura


Economic Growth with Bubbles (with A. Martin)
American Economic Review, 102 (6), 2012, 3033-3058


 Bubbles and Capital Flows
Journal of Economic Theory, 147 (2), 2012, 738-758


 Understanding Bubbly Episodes (with V. Carvalho and A. Martin)
American Economic Review: Papers & Proceedings, 102 (3), 2012, 95-100 


 Theoretical Notes on Bubbles and the Current Crisis (with A. Martin)
Read a non-technical summary on VOXEU
IMF Economic Review
, 59 (1), 2011, 6-40



By PD Jonson


Monetary policy and asset inflation, July 2014


Asset inflation and monetary policy (with Elizabeth Prior Jonson and Ka Mun Ho), June 2013


Great Crises of Capitalism, January 2011


Saturday Sanity Break, 2 August 2014
Date: Saturday, August 02, 2014
Author: Henry Thornton

Innovation is (probably briefly) in the news, thanks to new BCA Chair, and former CSIRO Chair, Catherine Livingstone. Her comments came about the same time that Henry heard the news that 800 scientists from CSIRO's Brisbane offices have been or are to be, made redundant.  This was (allegedly) the entire coal division, meaning a dispersal of the group responsible for research into this vital exportable resource.


Ms Livingstone and the BCA suggested that research and other support should go to 'proven winners'. Rod Sims of the ACCC immediately leapt into the debate with critical comments about 'picking winners', missing the point almost entirely. The Hon Minister Andrew Robb said the government had been spruiking the BCA view for years.


The relevant policies of The Industry Group for 'Growing the Trade Exposed Industries' are as follows.


In a study called The Mystery of Economic Growth, Israeli economist Elhanan Helpman reviewed all the available research on the sources of above average economic growth, especially growth of productivity. He found that the only single clear reason for higher productivity growth was corporate and Government spending on Research and Development (R&D) as a share of GDP. Singapore and Israel feature near the top of any list of nations that have commercialised inventions.


Australia’s total spending on R&D is not especially high on lists of international spenders and as the budgetary situation allows needs to be increased. The long established Cooperative Research Centre (CRC)  Association conducted a review by Allen Consulting Group in 2014. This review reported that, relative to the funds committed to the CRC program by the Australian Government, the CRC program has generated a net economic benefit to the community, which has exceeded its costs by a factor of 3 to 1.


We must stress, however, that it is not just R&D that matters. ‘Innovation’ requires successful commercialisation of R&D. By contrast to our average performance with R&D in the international league tables, Australia often ranks lowest in tables comparing successful implementation of the results of R&D. (See John Bell, ‘Innovation policy linked to productivity boost’, ATSE Focus, April 2014.)


Australian Venture Capital Association Ltd (AVCAL) has pointed out that the flaw in Australia's current policy prioritisation is that it does not invest enough in bringing its innovation to market.


AVCAL quoted a recent PricewaterhouseCoopers study that flagged venture capital as being one of the potential ‘game changers’ in contributing to Australia's innovation system: a position that has been echoed in many forums in recent years. It also highlighted the fact that the US spends over four times (per capita) what Australia spends through venture capital investment.


The 300 page Strategic Review of Health and Medical Research report referred to what it called the“valley of death” being the hiatus between discovery and successful commercialisation.


The evidence suggests that there are two key factors involved, firstly the availability of risk capital for commercialisation, and secondly the transfer of development to staff sufficiently trained and with the business skills required.


Another generic issue concerns the early sale of successful new Australian ventures to large foreign companies. The causes of this perhaps includes cultural obstacles and also lack of explicit tax benefits for investors, to compensate for the higher risk attaching to early stage innovation and development.


There is a further uncertainty with foreign owned companies as to the question of retaining the benefits of Government supported innovations and commercialisation within the Australian economy.


It may be necessary to focus assistance to smaller Australian companies. Larger global companies in the main have their own resources. For example, the German company Bosch, has 38,000 staff worldwide working in innovation and development and on average registers 14 patents each day.


Business regulation and taxation arrangements can be unhelpful for commercialisation of ventures. For example, entrepreneurial people granted shares in cash strapped start-up companies immediately pay the full amount of income tax based on the theoretical value of the shares - value that may never be realised.


No comment on innovation is complete without recognition of staff in the workplace being able to recognise the opportunity for innovation with improvements to processes and products. Smith referred to the value of workers contributing to innovation. He said: “A great part of the machines made use of in those manufacturers in which labour is most subdivided, were originally the inventions of common workmen, who, being each of them employed in some simple operation, naturally turned their thoughts to finding out easier and readier methods of performing it.”


Today his comments would apply to a wider range of employees.


Such innovations can support the management philosophy of continual improvement known in Japan as Kaizen management. Toyota benefits from a sophisticated system whereby employee ideas are given consideration and where adopted the employee gets a benefit reflecting the value of the innovation.


Recommendations:


1. It is recommended policies 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.


2. To attract capital to this high risk area, tax concessions would be appropriate. For example, for  approved projects foundation shares could be capital gains tax free and further calls up to set limits tax deductible. This could reduce the requirement for payments by Government to support innovation and commercialisation.


3. Remove the tax penalty applying to shares issued in start up companies commercialising innovations.


4. It is recommended a task force be constituted to review best practice arrangements in countries which lead the table of performance with innovation and commercialisation. The outcome be a basis to review and implement policies which would be relevant for Australia.


The internal process, if available, of successful companies in this field such as Bosch, would also be relevant.


5. The Government consider claw-back of grants and/or tax concessions within, say, five years as a way to discourage too early sale to overseas interests.


6. Ensuring tax certainty and consistent long term policy settings for innovation and commercial development.


Read the full report, including policies in related areas, here.


Geopolitical tragedies


The events in Gaza make one weep. We have a natural sympathy with the Israeli side, but the terrible price they are exacting from the inhabitents of Gaza seems dispropionate. That said, no country cam allow regular rocket attacks on its territory.


The failed attempts to rescue the bodies remaining on the crash zone of the downed Malaysian airplane get more farcial by the day. Horrible for everyone involved, except perhaps for whoever gave the order to destroy the plane and its almost 300 passengers and crew.  President Putin has a lot to apologize for, and one hopes that severe trade and financial sanctions will eventually bring him to heel.


The various other global atrocities in Syria, Iraq, Africa, the list goes on, show the need for an effective global policing group.  That seems at least as far away as good sense in Australian economic and welfare policies.


Footy'n'swimming'n'athletics'n'stuff


Caaaarlton! cheered Henry with its brave attempt to beat Freo on its home turf, but left him almost weeping with frustration at yet another loss by a tiny margin.


Coach Merciless Mick Malthouse said he did not know why this was the case, but it seems clear the team has just forgotten how to win. Partly, perhaps, due to morale sapping coaching.


Like 'Innovation' it is a difficult subject, but Henry is certain in footy it requires occasional shafts of kindness to the players, not constant criticism, which is what Mick the Merciless seems to dish out. Henry learnt this lesson by changing his coaching style for an under-age footy team a decade ago, and is available for psychological councelling at Caaaarlton! if needed.


Meanwhile, in Scotland, the Aussie women and men are acquitting themselves with honour.  The swimmers seem to have rediscovered their mojo, the marathoners have exceeded expectations, ditto the shooters, and Sally Pearson looked terrifyingly focussed when she won a heat or semi-final by a second or two. From the other side of the world, this seems like a happy team, and the sacking of the apparantly merciless head(?) coach will have lifted team morale further. Go Sally!


Image of the week


C


Inflationary expectations and monetary policy
Date: Tuesday, July 29, 2014
Author: PD Jonson

Inflationary expectations have also risen, as reported by Roy Morgan Research. Here is the graph.



We are not yet embrioled in an inflationary fiasco but there is a dilemma, that last week we tried to set out in slightly satiric terms. (See Blog two down.)


I have for some time also been worrying like a dog with a bone how to define the stance of monetary policy, and I have now solved this, to my satisfaction at least.


I have also made progress in showing with Economics 101 supply and demand graphs - albeit drawn in the air - how monetary policy might transmit itself to goods inflation but also to asset inflation.


Here is the link, and I am keen to receive feedback.


Is there any competent macro-economists out there?  If there is, am I on the right train? Was this all said in an unpublished note 50 years ago? It is trivially obvious, or wrong, or both at the same time?


Saturday Sanity Break, 26 July 2014
Date: Saturday, July 26, 2014
Author: Henry Thornton

'Need more policy reform' say both RBA Chief, Glenn Stevens, and Treasury Head, Martin Parkinson. 'The budget should have been tougher' says someone who is allegedly quoting Smokin' Joe Hockey. 'Hear, Hear' squark the pet shop galahs (just joking, galahs) but it is a refreshing development that these three important Australians now feel they can edge toward saying what they really think, and what the galahs think. (See Parkinson and Stevens.)


Tony Abbott's chief economic advisor, Maurice Newman, no galah, more like a robust emu on the run, says 'We're heading fast for a one-way trip on the escalator of decline'. This echoes Paul Kelly's message of some weeks ago, and that of senior galahs like Ross Garnaut and Henry Thornton himself.


Henry is mighty pleased to see 'Asset inflation' recognised as: (a) heavily influenced by super-easy monetary policy; (b) presenting a distinct risk to financial stability (and therefore to economic stability - think 1930s); and (c) requiring so-called 'macroprudential policy', rather than monetary policy alone, to deal with.


There is a further feature of asset inflation, which is to exacerbate inequalities of wealth and incomes. Like financial instability, stretching the gap between rich and poor is a sure road to ruin, as the world's elite thinkers (eg Keynes and Marx) have frequently asserted. (Here is a recent example. 'Asset inflation makes richer; unemployment makes us poorer'.)


Geopolitical matters.


It is cheering to see gradual (though sadly overdue) progress in recovering bodies for respectful identification and return to family members. We salute Tony Abbott for his strong global leadership in this sad matter, and Julie Bishop for success in achieving a unanimous decision by the Security Council.


Mr Putin will probably still annex Eastern Ukraine  and terrorists will still run amuck in hellholes without the law, and surely it is time for a fast response policing unit overseen by whichever country is chairing the Security Council?


'Mind you own business, Henry' is no doubt the view of those currently in office, but surely this latest atrocity will make those currently in office think outside the existing boxes.


Here is what the experts say - Paul Kelly and Greg Sheridan.


Kelly: 'THE nation is seeing a new Tony Abbott — the Prime Minister as crisis manager. It is a time when more people than usual focus on their leader and the leader, in turn, operates as principal mourner, chief diplomat and security guardian'.


Sheridan: 'AS every day the news from eastern Ukraine grows worse, Australia has found itself in the middle of one of the greatest geostrategic crises of our day.


'Irony has come here to attend tragedy. For decades, our strategic debate has been transfixed by the rise of China. But it is Russia, the old enemy from the Cold War, which has drawn us intimately into first-order global power plays'.


Footy'n'cricket'n'Commonwealth Games'n'stuff


Today is the second part of another 'split round', an innovation Henry does not like as he requires a weekly diet of footy during the winter chills. And what a winter it is proving to be. The wags say this is due to the presence of Al Gore, because everywhere he goes the weather turns cold.  And there are reports of cooling in the world's deep oceans. But I digress.


The Indians have again beaten the pestiferous Poms in the fine old game of five day cricket.  Soon it will be summer and we can have our own crack at the curry munchers.


At least we can enjoy news of gold medals and world records, mostly due to the efforts of Aussie shielas in Glasgow. ...


Image of the week



Courtesy The Australian


Inflation - of all varieties - rising
Date: Thursday, July 24, 2014
Author: Henry Thornton

'Inflation', the common or garden variety, means 'goods and services inflation'.  This sort of inflation in Australia has reached 3 %, top of the range agreed between the government and RBA. One can imagine Joe Hockey, newly fired up by the release of his authorised biography, asking 'What's going on Glenn?'


The RBA will be asking itself  'Have we overdone the easing of monetary policy?'  when its bright economists reflect on why interest rates were cut so far. Some brave soul might even say 'Because were were trying to get the bl**dy exchange rate to fall'.


House price inflation seems to be on an unward track. As The Oz reported recently: 'The house price boom shows no sign of cooling despite the onset of winter.


'PRICE growth in almost all capital cities in the three months to June has helped the median Australian house price soar almost 11 per cent in just 12 months'. Ouch! House inflation 11 %?


The RBA should be asking itself  'Is this in part a consequences of interest rates too low, as we sought to help stimulate the economy and reduce the bl**dy exchange rate'.


A supplementary question should be: 'Is it time to implement the latest ideas about the need to implement "Macroprudential policy" to contain house prices?'


Then there is share price inflation, continually setting new records despite the great geopolitical risk with the various dangerous global hot spots. 'Nothing we can do about that, governor', the head of Economic Analysis Department might say, 'Share prices are set on Wall Street'.  'But surely the share boom is looking dangerous, a risk to global financial stability, as I hinted in my latest speech', Glenn Stevens might reply.*


'And the bl**dy exchange rate is still too high, decimating the export-oriented trade industries, which Joe Hockey said we should be encouraging'.


There we have it, gentle readers. Mixed up confusion.


* I should note that this speech is one of Governor Glenn's finest. Despite my concerns that the RBA has not yet come to terms with the problems of sensibly influencing the overall economy (and garden variety inflation) and asset inflation, most of the necessary pieces are clearly in the governor's mind, especially when he recognises the role of 'Animal spirits'.


Growing Australia`s Trade Exposed Industries
Date: Tuesday, July 22, 2014
Author: Henry Thornton and friends

The Australian Government has made very clear its resolve to advance fiscal and structural reforms to strengthen the Australian economy. They include the policy areas of infrastructure, taxation and financial regulation. Improvements to labour flexibility and reducing energy and regulatory costs are also seen as critically important.


Four Australians designated as 'The Industry Group' offer recommendations arising out of the current economic environment, including areas that are not so evident, but require urgent attention to ensure the trade exposed industries of the Australian economy can have a sound future.


Governments, Regulators, Industry and Unions have often failed to recognise, understand, or give consideration to the less obvious and often longer term consequences of their decisions and actions, and their impact on Australia’s competitive position.


This is particularly significant when such decisions, as outlined in this paper, lead to long-term operating and capital cost penalties and market constraints, some of which may be difficult to reverse. It is the collective impact of these factors which has been so detrimental for the Australian trade exposed industries. It is clear what Ludwig Erhard had to say about the threat to competitive free markets is as relevant today as it was in his time.


Ludwig Erhard, the Former Vice Chancellor of Germany, writing about “Prosperity through Competition” said “Efforts will only be successful so long as competition is not hindered or eliminated through artificial or legal manipulations.”


Inevitably, it becomes necessary to replace or radically upgrade or expand ageing production facilities to improve productivity and restore a world competitive position. Increasingly however, the logical economicsbased response by business in current circumstances will be a decision not to undertake such major capital expenditure. An adequate return would be unlikely because there appears no realistic prospect that international competitiveness can be restored.


Recent examples of these consequences are the progressive closure of our oil refineries around the coast, rather than their replacement with one or two world-scale facilities, and the closure of alumina refining, aluminium smelting and aluminium rolling capacity. These plants which a decade or so back were at thelow end of the world cost curve could survive periods of global production exceeding demand.


With these plant closures there is also a decline in demand for a range of supporting services.


Other current examples of this substantial hollowing out of Australian manufacturing industry are the reductions in cement and steel manufacture and closure of a number of food processing operations.


Also, some companies have chosen to relocate overseas or have preferred to build new plants overseas.


Industrial development in Australia in the Post World War II years focused on the supply of domestic demand behind tariff protection. Later, countries in the region led by Japan and then South Korea focused on the economic benefits of larger plants to supply not only domestic demand but exports. They were assisted by tariffs and other forms of protection for their local markets, some of which remain in place.


Unfortunately Australia has missed out on a second stage of industrial development, with world-class plants with improved productivity, as a result of the continuing impact of past policies. The failure to gain the benefit of plants with improved productivity is of particular concern. In the report by the Productivity Commission, the Chairman Peter Harris said, “Our (productivity) performance has been significantly worse than that of most other developed economies for more than a decade.”


Decisions against major renewal investment in more productive equipment are made ever more likely when the cost impediments are compounded by low rates of tax-deductible depreciation and the absenceof accelerated write-off to match overseas competitors. This has led to minimum capital expenditure and a focus on immediately tax-deductible maintenance to preserve the status quo as long as possible beforethe inevitable final plant closure.


Free markets have been accepted by policy makers as central for economic growth. Nevertheles ssovereign states, despite statements supporting free markets, are intervening with measures which hinder competition in favour of their national interests and these activities have significance for Australian industryand agriculture.


The trade exposed industries are now operating in a global economy. Markets no longer have a national or regional emphasis but have a global perspective. Specialisation provides gains in productivity but it is the size of markets which enables these gains to create national wealth with opportunities to generate jobs, economies of scale, resources for research and innovation and an increase to the national tax base.


For Australia however, there have been a number of impediments for industry, which have seriouslyconstrained market opportunities and competitiveness.


The full paper is available here. 


Saturday Sanity Break, 19 July 2014
Date: Saturday, July 19, 2014
Author: Henry Thornton

The horrific loss of lives in the air over Eastern Ukraine shows the desperate need for a way to impose the rule of law globally.  Most of my Tea-Party friends (who are against even most forms of national government (until they are mugged or worse) will oppose this idea but can the great majorities in civilised nations continue to suffer attacks of increasing horror by terrorists? While we are at it, one thing Australia can do on our own is to refuse citizenship or even the right to live here to people who explicitly refuse to accept the rule of (Australian) law.


'Multiculturism' is a wonderful concept, but society with a minority of distinctly alien members will eventually fracture, with enormous negative consequences for the great mostly silent majority. Let's start by blocking the return of 'Australian Jihadists' from places where they have been plying their evil trade with an Australian passport in their back pockets. The fact that they are Australian citizens just shows how lax has become our willingness to bestow citizenship. Scott Morrison, let's see how we can tighten up the whole process.


Political economy


What a week it has been for politics and economic policy. Now as well as stopping the boats, the Abbott government has ditched the carbon tax and Bill Shorten has promised to fight on, a promise that is likely to hang round Labor's neck like a long dead sheep. The mining tax is wobbling on its shaky base and seems destined to fall also, if only the swinging Senators can take a fair share of responsibility for Australia's fiscal mess. No chance of Labor helping; in their rush to behave like a third class opposition, Labor members are opposing even reforms they first thought of.


The government's dead wombat is the budget.  It is vital but far from 'tough' but has been badly sold, including the wrong rhetoric that there is a 'budget emergency' and perception that that Aussie battlers are being asked to shoulder too big a share of fixing. There is a serious crisis coming down the budget pike, as we among many others have been warning ever since the Rudd'Gillard'Rudd'Swann government went on its spending frolic. A small budget surplus, and an absense of government debt allowed the Rudd'Gillard'Rudd'Swann government to spend like drunken sailors. Now people say that there is no need to fix the budget since, as a ratio to GDP, Australia's national debt is far smaller than those of major overseas countries.


Budget deficits and high levels of debt are limiting governments everywhere.  Australia's Rudd'Gillard'Rudd'Swann government was able to reverse Australia's happy situation, left by Messrs Howard and Costello, and in doing so applied substantial fiscal stimulus to limit the downturn following the GFC. This was unnecessary, but is an outcome that cannot be repeated given current and prospective fiscal situation of enormous deficits and sharply rising government debt.  Treasurer Joe Hockey says he can do things that do not involve parliamentary approval. Mr Hockey, however, failed to provide examples and, short of a constitutional s**tfight of majestic proportions, this is a fantasy.  Given the size of predicted deficits, fixing the fiscal mess without parliamentary agreeing is just not possible.  Australians are not mugs, Joe, and overstating your case does you no good at all.  Getting the narrative fixed should be your first priority, and I sadly believe you lack the advisors to do this vital task.


What would you do Henry? I hear some readers cry. As previiously stated at greater length, I'd:


(1) begin a long and thorough review of every spending program with the stated aim of cutting overall spending by 20 %; 


(2) review the income tax act to greatly simplify it by removing all the 'special' provisions that allow systematic tax avoidance, including negative gearing; (If this is too big a task go to previous reviews and pick every suggestion for simplification that appears more than once.);


(3) broaden the GST to cover all areas of spending and raise the rate by whatever is required to balance the books within three years.


In setting up the whole process, explain carefully why this is necessary and ways in which it will make Australia a stronger, more self-reliant nation, able to spend more on defence and programs that will increase sustainable growth, such as Research and Development and programs to foster innovation - putting Australia's generally excellent R&D to work producing new businesses far more thoroughly than happens at present. And while you are at it, talk to Bob Hawke about his plan to make Australia even richer and more self-sufficient by developing a uranium enrichment program, including a program of storing nuclear waste returned by our clients in carefully selected geologically stable areas of outback desert. And crank up the process of removing unnecessary regulation, including deeply damaging regulation of labor markets,


'All totally impossible' I hear you cry. The alternative, gentle readers, is to become a third rate outpost of British-American culture, diluted by far too many alien influences that will attack the British-American heritage from within. What follows is an example of exactly the sort of radical action that is needed.


Dump NBN model


'Let telco competition rip' says Michael Porter, the real one, not the American Michael Porter.
  
'The government is about to receive an abundance of advice on the national broadband network about its formation, cost-benefit analysis and competitive policy options.


'Malcolm Turnbull, under the guidance of experts including Bill Scales, Michael Vertigan and Ian Harper, is seeking a way to ensure Australia gets competition as well as broadband innovation. How can we, in the spirit of the Australian Competition and Consumer Commission, escape the loss of wholesale competition caused by the Rudd-Conroy government monopoly? And cut the $100 billion cost associated with the flagging NBN?'
  
Michael G Porter is research professor of public policy at Deakin University and his trenchent views on matters of industry reform are always worth taking seriously. The answer to both of his questions is 'Why not, indeed'.


The full article is available here


Footy'n'stuff


Caaarlton! finally played four quarters of footy and beat a top 4 contender in North Melbourne. One game does not make a season, and there is a lot of rebuilding to be done.  And how did St Kilda thrash Freo, until now expected to give the premiership a big shake?


We await the rest of the season with resigned detachment about the questions to be asked and answered. Will Judd play on?; Will Waite be traded?; Will Malthouse be paid out and Ratts be asked to return, etc, etc.


Image of the week



Courtesy The Australian


Saturday Sanity Break,12 July 2014
Date: Saturday, July 12, 2014
Author: Henry Thornton

Janet Yellen's bold view about the seperate roles of monetary policy and prudential policy have changed the art of central banking by at least 90 degrees.  While she is at it she has done away with the 'Greenspan put' and the 'Bernanke put',  the idea that central banks should let asset booms run and clean up afterwards by dropping interest rates, to 1 % in Mr Greenspan's case and to near zero plus 'quantitative easing' in Mr Bernanke's case.(To Mr Bernanke's credit, he began to talk about a regulatory response to asset inflation in his valedictory book, reviewed here.)


Bene will hope his bold actions will eventually be acclaimed as staving off another Great Depression. It is far too soon to make judgments like that, and we are far from being out of the woods of the GFC. The recurrant bouts of asset inflation that seem to Henry to be more than capable of derailing the slow and hesitant global recovery - hardly noticable in Europe - that everyone is hoping for.


Anatole Kaletsky yesterday in the International New York Times made the bear case. '... it is when investors get uniformly bullish that the pessimistic case deserves more attention. Many distinguished economists believe that the current improvement in global conditions is just a blip and that the world faces years, if not decades, of "secular stagnation".


Henry's favourite fund manager is still running with the bulls, but this becomes increasingly risky the longer the boom goes on.  He points out several reasons to hang in there: Liquidity remains abundant and it has to go somewhere; High asset correlations are a function of risk being priced off the US long bond; Valuations are a poor timing signal; Bonds are in a bubble but stock prices are not (i.e. if you used the 10yr US bond in your DCF calcs, stocks are relatively cheap); Bull markets do not die of old age. They end when either a recession is around the corner or interest rates rise (often an inverted yield curve) or both.


He does agree there is always the risk of a shock to the system. I plan to have a thoughtful weekend.


And you might take in the report of an interview with RBA Chief Glenn Stevens, with its implied (very sensible) advice to the pollies - 'get you act together comrades'.


Henry's sojorn in the wilds of Europe is coming to an end. Monday Henry and Mrs Thornton join a flight from Milan airport to Dubai, then change planes to Melbourne. We have had great fun, but it is time to return to normal life, and we look forward to picking up the usual threads of life in Oz and catching up with friends and business colleagues.


Footy'n'futeball'n'stuff


Caaaarlton! won its fifth match of the season last weekend, beating fellow cellar-dweller St Kilda is a sparkling performance. But both teams have a long way to go, and Supercoach Mick Malthouse has now decisively underperformed Coach Brett Rattan.  Come back Ratts, all is forgiven, is the call of some supporters.


Brazil have crashed out of the World Cup, beaten 7 - 1 by Germany.  Sadly for the Brazillian fans, Argentina beat Holland in a penalty shootout, so it is North vrs South, as widely expected, just the 'wrong' South.'Go Germany' is the response from the stricken fans.


Interestingly, Brazilian fans interviewed by the global press said Brazil could not afford the cost of hosting the World Cup. 'We need schools, hospitals and help for those at the bottom', one such fan opined. Now that their team is out of the competition in such a pathetic way, this may possibly become a dominant theme.


Image of the week


 


Asset boom; when comes the bust?
Date: Thursday, July 10, 2014
Author: Henry Thornton

'Welcome to the Everything Boom — and, quite possibly, the Everything Bubble. Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals. The inverse of that is relatively low returns for investors'.


Neil Irwin reports for The International New York Times.


Mr Irwin says that the phenomenon is rooted in two interrelated forces. The first is 'Worldwide, more money is piling into savings than businesses believe they can use to make productive investments'. To me, that is part of a wider phenomenon.  The development of 'emerging economies' - principally Chana, but also India and other sources of cheap goods and services. Also there is the lingering Great Recession. In developed nations, workers fear for their jobs and do not press for wage hikes. Retailers, capitalists generally, fear to lose markets they have held onto, and restrain increases in goods and services inflation, maintaining profit margins thanks to workers trying to hang onto their jobs.


These reasons for goods and services inflation to be subdued come into collision with Mr Irwins second fact: 'At the same time, the world’s major central banks have been on a six-year campaign of holding down interest rates and creating more money from thin air to try to stimulate stronger growth in the wake of the financial crisis'.  This is absolutely correct.


Very easy money has often created both goods and services inflation and asset inflation.  With goods and services inflation subdued because of the China effect plus nervousness of workers and businesses alike in developed countries, asset inflation is far stronger that it would otherwise be.


“We’re in a world where there are very few unambiguously cheap assets,” said Russ Koesterich, chief investment strategist at BlackRock, one of the world’s biggest asset managers, who spends his days scouring the earth for potential opportunities for investors to get a better return relative to the risks they are taking on. “If you ask me to give you the one big bargain out there, I’m not sure there is one.”


Mr Irwin continues: 'But frustrating as the situation can be for investors hoping for better returns, the bigger question for the global economy is what happens next. How long will this low-return environment last? And what risks are being created that might be realized only if and when the Everything Boom ends?'


We wrote earlier this week about art price inflation, again reaching heights previously scaled in 1987 and again in the late 1990s.


Assets, like United States Treasury bonds, widely believed 'safe', have been offering investors paltry returns for years, ever since the global financial crisis. 'What has changed in the last two years', reports Mr Irwin, 'is that risky assets, like stocks, junk bonds, real estate and emerging market bonds, have also joined the party'.


Logically, the asset boom would be squeezed if goods and services inflation began to increase. Even if this remains a possibility sufficiently likely for central banks to begin to tighten monetary policy, asset prices will be squeezed.


Asset inflation, as Mr Irwin points out, has become highly correlaterd. Tighter monetary policy will produce correlated asset busts.  If asset prices are in bubble-land, as Mr Irwin and I believe, there will be big asset busts.


Take care, gentle readers.


A traipse through the latest art `madness`
Date: Tuesday, July 08, 2014
Author: Henry Thornton

Henry whilst in Europe has naturally taken in some art galleries. Indeed, as usual, this has resulted in a dose of Stendhal's disease - a feeling of nausea that attends the sight of yet another Masterpiece. The Royal Academy in London was a bit of a shocker, to which I will return.


I have been revising Great Crises of Capitalism for a new edition, and today I got to the chapter on the Dutch Tulipomania of 1636, with some remarks on the modern market for great art. Naturally as an economist with artistic tendencies, I take a great interest in the market for art and its relation to other great asset booms, such as share booms.


Winners from great stock market booms, if they are smart, take profits before the equity bubble bursts and diversify into assets such as property or fine art. In the final stages of the great share boom of 2003 – 2007, the London art market was also booming. Adrian Ash reported in a magazine called MoneyWeek in February 2007 that Sotheby's  midweek sale of contemporary art in London netted £45.7 million – some US$90 million. Indeed, it was 'the most successful contemporary sale ever staged in Europe,' for a total of $173 million; Christie's achieved $177 million with its own Impressionist and Modern auction; the next two days brought Sotheby's Contemporary sale, followed by Christie's auction of Post-War and Contemporary art which netted $138 million, including a new Francis Bacon record, nearly double the previous high of $30 million.


In summary: ‘Four days...one city...$578 million. That's more than the gross inflows for the entire UK mutual fund industry over the same period. But don't forget Sotheby's commission on top!’.


Is the market for fine art based on ‘fundamentals’, ‘speculation’ or ‘irrational exuberance’? Dare I say all three in varying proportions?


The dominance of the art auctions by people who are seriously rich means that ‘Caveat emptor applies ... even if the art is to your taste. Doig's White Canoe isn't all that bad, but you wouldn't know it from the Saatchi Gallery's description’ (quoted by Ash):‘[Doig] paints white like it’s got every colour in it; he paints dark like it’s got every colour on it. A mirrored image of a lake at night, White Canoe is a wishful infeasibility where the reflection is more detailed than the landscape itself. The boat is aberrantly glowing. The landscape has the all-consuming blackness of an oil slick, deafening and motionless; all other colours seem to slide across it in a rustic laser show. The blue stains of tranquil moonlight have the eerie effect of erasing; Peter Doig’s perfect night seems to be melting like celluloid stuck in the projector....’


Japanese billionaires set the pace in buying art during their great asset bubble of the 1980s. They were buying trophy properties all over the world, including Hollywood studios in California and the Exxon building in New York. Japanese buyers purchased a Renaissance chapel in France, complete with stained glass windows, intending to dismantle it stone by stone and ship it to Japan. This provoked the French to pass a law prohibiting the export of national treasures.


Japanese buyers were prominent at major art auctions in London, Paris and New York, where they bought famous works of art for phenomenal prices. Just as American tycoons would do ten years later, the Japanese began buying art as if they really liked it. A crime boss, Susumu Ishii, discovered common stocks in 1985 and influential friends helped him to make vast gains. He invested a small part of his fortune to buying works of art by Chagall, Renoir, Monet and others. The Yusuda Fire and Marine Insurance Company paid nearly $40 million for Van Gogh’s Sunflowers. Ryoei Saito spent $82.5 million on another of Van Gogh’s paintings, Portrait of Dr Gachet, and a further $78 million for Renoir’s Au Moulin de la Gallette.


Australia's billionaire beer baron and yachting superstar, Alan Bond, also made headlines in 1987 when he purchased Van Gogh’s Irises for a then world record $53.9 million.  Controversy was redoubled when it emerged that Sotheby’s had lent him half of the purchase price and held the painting under lock and key in a secret location. ‘What troubles critics of the transaction’ said Rita Reif of The New York Times, ‘is that the extraordinary price paid for Irises, less than one month after the Wall Street crash on Oct. 19, 1987, fuelled an atmosphere of euphoria in the art market. The price became the bench mark most often cited as proof that art was a commodity that had weathered the economic crisis’.


Controversy increased when Bond’s business empire collapsed, and again when Bond went to gaol. While he was in gaol Bond became a competent painter of pictures himself; a self-portrait is held by Australia’s National Portrait Gallery in Canberra. All that is needed to close the circle is for some future rich person to buy one of Bond’s paintings for an outrageous sum of money.


Ash concludes: ‘The Japanese were awash with money by 1989. Their cheap money pump – flooding the bond, commodity and derivative markets with carry-trade Yen – finally was washing across Old Masters and New Pretenders alike’. Yet the hubris, or perhaps just sensible asset diversification, that made Japanese billionaires acquire so many fine art works and expensive buildings soon faced nemesis in the form of the Japanese market crash that started at the very end of 1989.


Here is another fact that overturns conventional wisdom. Such wisdom has it that a portfolio of very different assets provides protection against a meltdown in any one asset class. Often this is ‘proved’ by studies purporting to show that the ‘correlations’ between prices of different asset classes are low or negative. This may be so for particular periods of time, perhaps carefully selected to make it so, but in the case of the major crises of capitalism such correlations usually become irrelevant as all asset classes boom together and crash together, or within short time periods from the date of the first asset class to crash.


Following the crash in the prices of equities which began in late 2007, the bubble in old and new art took its time to mature, but in November 2008, Miriam Kreinin Souccar observed in Crain’s New York Business: ‘The bubble has finally burst in the art market. The frenzy that made art students stars overnight, spawned scores of fairs around the world and turned young investment bankers into major collectors has come to an end’.


The market was down by a third, and canny buyers with deep pockets were quietly strengthening their collections. An optimistic art sales executive observed philosophically that what was happening seemed like ‘a return to normalcy after the hyper-reality of the past three or four years’. He added, no doubt after a reflective pause: ‘It will give the artists a chance to focus on their work instead of trying to sell out their studio during the first year of their M.F.A, program’.


The tendency for the art market to boom when share markets boom, or in some cases after that boom is over, provides an ominous perspective on current events. A recent article by Scott Reyburn in The New York Times reported: 'The momentum seems unstoppable. Last week in London, Sotheby's, Christie's and Phillips raised an aggregate 200 million Pounds Sterling, or about $340 million, from their evening sales of Post-Modern and contemporary art, a 26 percent increase on the equivalent series of sales last Summer'.


Our old friends from 1987, Francis Bacon and Peter Doig were well represented, Bacon with a triptych of Greg Dyer (£26.7 million) and Doig a nice pastel landscape, much less spooky than White Canoe, with a multi-coloured rock (£8.5 million) as viewed from the wing mirror of his speeding car. (How does he do this? one is forced to ask.) And there was a lovely image of Tracey Emin's untidy bed, a snip at £2.5 million.


'London's sales', we were told, 'came on the heels of an Art Basel fair in Switzerland last month, where an Andy Warhol self-portrait sold for about $30 million, and a block-buster series of contemporary evening and day auctions in May that totaled $1.6 billion'.


What does all this mean, gentle readers?


To those of us who are merely well-off, such prices may seem extraordinary, perhaps even irrational. But people, even rich people, are entitled to spend their money as they wish. The prices of works by the world’s celebrity artists is a very concrete thing, and their purchase by very rich people surely does no great harm to society. Indeed, many such works of art end up donated to great galleries where they become available for viewing by all people either freely or for a modest sum.


It is not unknown for people rich and poor to bet on horse races, or in casinos, or to buy lottery tickets. People with deep pockets have been known to invest in trying to make new drugs, or to drill for oil or even to make movies in the hope of extraordinary gains or in some cases the expectation of useful tax losses. Howard Hughes was obsessed with building and flying better aeroplanes, a highly speculative venture (that was the subject of a reasonable film.


Tulipomania was succeeded by the Mississippi Bubble, the South Sea Bubble, new territory bubbles, railway manias, land development delirium, Miningmania, Iris- Warhol- and Monet-mania, the ‘new economy’ (Internet) boom and the excitement of many other fads and fashions in capitalist development. It seems clear that some people at least are inveterate gamblers. It is fashionable to be critical of gambling, but is the gambling spirit an essential part of being human? Is a propensity to take bets one of the chief drivers of human progress?  Are the gamblers among us some of our most valuable citizens?


It can be asserted that Tulipomania was no ‘crisis of capitalism’. But it was at least a proto-crisis in a proto-capitalist economy. As such it contains features that we see repeated throughout history, especially and typically very substantial asset price inflation in a relatively short period of time. Unlike modern crises of a similar type, it did not spread internationally, nor was the asset price bust serious enough to produce massive economic dislocation. Tulipomania adversely impacted on ‘honor and trust’, and in this sense it was a clear precursor of the type of crisis that has subsequently become both more widespread and more serious.



As already mentioned, we took in the Royal Academy exhibition in London. About ten rooms, each arranged by a 'Fellow'. of the Academy, initials RA after his or her name. This consisted of paintings (and sculpture) chosen from the RAs and 'promising' artists, pals of RAs one assumes. Hundreds of items per room, a cacophony of paintings, a weird description for a weird concept.


I was shocked at how awful most of the paintings seemed to me, which I assume just shows how ignorant I am. I cannot recall any names, but there was a small (9' X 15' perhaps) painting by a lady RA that consisted of a white centre with apparently random splashes of blue paint around the edges, price £66,000!


Crikey, comrades, what a whiz.


My advice you young Australian artists is that they move to London, find an RA to cozy up to, and give the poms a dose of the Aussie outback. Sadly, as Bazza McKenzie said, the poms don't like to plan and simple!


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