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Henry Thornton - Contributors: A discussion of economic, social and political issues Blogs
Inflation shock - for some
Date: Thursday, April 28, 2011
Author: Henry Thornton

Schlock horror ... inflation surprises on the upside.

Henry said in early March: 'Australia’s goods and services inflation is rising, though when it will break through the RBA’s ‘target zone’ is a matter from legitimate debate. Sooner than you think, Mr. Stevens, is my view, but I do not expect you to take that view seriously. But goods and services inflation is well above that modest level in Australia’s rapidly growing major trading partners, including China.  And asset inflation is a far larger problem just about everywhere, as this column with other dissidents has been saying'.

Goods and service (CPI) inflation has arrived 'sooner than you thought' Glenn Stevens, but I assume you will comfort yourself with the fact that the price of bananas is the most inflated price - contributing to what the hopeful people on you staff and in the press are calling a 'price spike'.

On the subject of imported inflation, the great American inflationist, Ben Bernanke, this afternoon in Washington, said he had no timetable to tighten America's super-easy monetary policy.

Back in what you no doubt think of as the dark ages of Australian policy making, gov'nrt Glenn, Treasury argued that it was the 'temporary' price hikes of potatos and onions that was blamed when global inflation was taking Australia's economy in its frenzied grip, but I am prepared to bet you did not buy the groceries for your family then , nor so you buy the bananas now.

But people on normal wage and salary packages do buy groceries and it is the actual cost of living, not some confected 'underlying' cost of living, that matters to them.  Even Blind Freddie can see it is the prices of petrol, utilities (electricity, water and gas) , school fees and (legal) drugs.

Wage and salary earners went for it in the early 1970s, and it is hard to see their grandchildren holding back now.  Only the flexible exchange rate is offsetting easy fiscal policy and monetary policy in the neutral zone - when it should be tight.

That is why my early April column warned of the pressures of wage inflation.

The terrible temptation of anyone in your high position, Mr Stevens, is that you begin to believe your own rhetoric. 'Brilliant gov'ner' say the younger men you have surrounded yourself with at one of you dry sallies, or (the anointed heir) 'absolutely spiffing Glenn'.

My April column warned in conclusion that 'The government is spruiking a tough budget, which will allow for a flood levy and big new carbon tax.

'The Reserve will be tempted to leave interest rates unchanged until the budget is delivered and assessed.

'That would be a mistake, but an understandable one.

'If the Gillard government cannot persuade the major unions to go easy on wage claims, it will quickly be seen as an important mistake'.

There can be losers as well as winners now.  Either a gunuinely tough budget and further rate hikes prevents a wage blowout or it does not.

If wages blow, your reputation will be trashed and the fate of the Gillard government will be sealed.

Ho, ho, on with the show!

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!

Saturday Sanity Break, 5 July 2014
Date: Saturday, July 05, 2014
Author: Henry Thornton

What a week it has been for monetary policy.

First the Bank of England said it needed a new way to handle house price inflation, backing Henry's eighteen month campaign on the proper roles of monetary policy and what is now called 'macroprudential policy'.

Then the new head of the US Fed, Janet Yellan said something similar, although wider.

Both approaches are consistent with the view we have been running for 18 months now, with a special focus on the overvalued Aussie dollar.

Read all about it here and, please remember, you heard all this here for the first time, not in Australia's insular press.

Australia's unemployment problem

June Australian Unemployment was up 0.9 % to 10.6 %, reports Roy Morgan Research, and Under-employment up 1.4 % to a record 9.5 %. Now 2.51 million Australians are unemployed or under-employed. This is a terrible waste of resources. Readers may care to consider here how Australia became on of the world's richest nation - it was certainly NOT by wasting resources.

Gary Morgan said:

“In June Australian unemployment increased to 1.326 million Australians (10.6%, up 0.9%) and under-employment increased to1.188 million (9.5%, up 1.4%). Analysing longer-term trends shows Australian unemployment has now risen in June for the fourth successive year and has increased in June in five out of the last six years in June since the Global Financial Crisis. Now a total of 2.51 million (20.1%) Australians are unemployed or under-employed. This is only the fourth month more than 2.5 million Australians have been unemployed or under-employed – the first since February 2014.

“In recent months unemployment had fallen – although this was driven in part by a declining workforce as people who had been searching for employment ‘gave up’ – while this month saw an increase in both employment (up 142,000 to 11,182,000) and unemployment (up 140,000 to 1,326,000). Looking within the employment figures reveals that the rise in employment was driven by a strong increase in part-time employment – up 177,000 to 3,713,000 while full-time employment fell to 7,469,000 (down 35,000). Increases in part-time employment are strongly co-related with increases in under-employment.

“Clearly Australian unemployment and under-employment is far too high at present and if the Abbott Government wants to stand any chance of winning the 2016 Federal Election it must enact significant reforms to Australia’s industrial relations laws to ‘free up’ the Australian labour market and increase the productivity of the broader Australian labour force".

And do check out Paul Kelly's superb contribution, which we cover under the heading 'Political gridlock; economic

Terminal 5, Heathrow

A senior mining man wrote as follows: 'Henry Thornton's comment last Saturday on the Terminal 5 experience at Heathrow reminded me of this Terminal's opening in March 2008. For months, the PR apparatus had been working at fewer pitch, photographers and journalists had been brought from all over the world to promote this "most advanced in the world" facility.

'On opening day staff arrived late because of inadequate parking space, the sophisticated computer-operated baggage system failed disastrously, escalators and travelling walkways broke down, only one of 18 lifts was working, electronic messsage boards failed. There were two hour queues, 34 flights were cancelled, 7 flights left without pasengers' luggage.

'It appears that six years later nothing has changed'.

Another friend wrote from London about our difficulties. 'Apparently on Saturday there was a shambles in Terminal 5 with luggage, so I'm pleased yours kept up with you. Some planes went out with 30 or 40 pieces only.


It is surprising, surely, that Aussie footy gets very little coverage on Italian TV, or in the international press.  But it is also sad that the AFL website is pretty ordinary, with 'live scores' posted only slowly with useless headlines that tell little about key points of the game.

Futball is also not much covered here, as Italy is out of the WORLD CUP. But, Costa Rica apart, it comes down to Europe (ex England) and South America. Any result but a win by Brazil will be a surprise, but Germany's highly disciplined outfit will give it a shake unless, like Phar Lap in America, they are nobbled.

At last, something to cheer about in international tennis.

Nineteen year old Aussie Nick Kyrgios topples no 1 Rafael Nadal at Wimbledon.

Gor Blimey, comrades, can this be true?

Henry today managed to complete the hardest walk - two hours up and down on the Chinque Terra in Southern Italy - without suffering a heart attack or stroke.  Even his knees are not hurting much, but tomorrow may be a different matter.

Took 4 trains and 4 hours to get back to our flat in Prato, where Mrs T is teaching for two weeks, but we arrived by 10.45 pm just in time for Henry to complete this brief report.

Image of the week  shows the steady fall in commodity prices received by Australia's exporters. Sad that the Aussie dollar holds up, but there is an answer, gentle readers.  Please ask your local member what is so wrong about a tax on capital inflow? Or ask Glenn Stevens if he appears in your local pub.

Image of the week

Financial stability-monetary policy breakthrough
Date: Friday, July 04, 2014
Author: PD Jonson

Regular readers will be aware of my attempts to persuade the RBA to sort out policies to control asset inflation, so far as this is possible, distinct from monetary policy, which involves keeping the overall economy on an even keel with low goods and services inflation. This week, Janet Yellen, US Fed Chairwomen, joined the crusade, which is all over save the shouting.

Glenda Korporaal yesterday reviewed the RBA's latest comment on monetary policy. She says 'yesterday’s glass-half-empty statement from Martin Place reveals a sense of frustration at the RBA with the stubbornly high dollar.

'A month ago, the bank was hopeful that some easing in the exchange rate could “assist in achieving balanced growth in the economy”, but now it’s not so sure.

“The exchange rate remains high by historical standards, particularly given the declines in key commodity prices” (which is what it said last month) “and hence is offering less assistance than it might in achieving balanced growth in the economy”. (Read: now we are really getting impatient that the dollar isn’t coming down). More here.

I must admit my own frustration. In my case it arises from having proposed a solution eighteen months ago to be met with  lofty silence from the RBA.

Here is a link

Since then I have done a lot of work on asset inflation and monetary policy, mostly reflected in the regular articles on monetary policy in 2013 and 2014 posted here.

The rule that 'monetary policy cannot serve two masters' (a much ignored dictum of Milton Friedman) is slowly being taken up in the search for policies to curb housing booms. The traditional approach - and I confess to supporting this until my Pauline insight reported in January 2013 - was to use monetary policy (ie, interest rate policy) to moderate asset inflation.  That is, to raise interest rates more than would be required to control the economy in efforts to contain goods and services inflation when assets such as housing are looking dangerously uppity, and prior to that to talk about the dangers of excessive house price increases and threaten to raise interest rates. Or cut rates by more than required for overall stability in an asset crash.  This is sometimes called 'leaning into the wind'.

Now good thinkers, including the new governor of the Bank of England, Ben Bernanke himself and (I believe) senior people in the RBA, are considering or (in the UK case implementing) what is called a 'macroprudential' policy to directly curb house price inflation by controlling bank lending for housing.

And, earlier this week, the Fed's new chief, Janet Yellen, changed the goalposts for US policy, supporting the UK, hints from Ben Bernanke and the RBA.

The FT reports: 'Federal Reserve Chair Janet Yellen speaks at the International Monetary Fund in Washington, Wednesday, July 2, 2014. Yellen said she doesn't see a need for the Fed to start raising interest rates to address the risk that extremely low rates could destabilize the financial system.
'Janet Yellen has mounted a forceful defence of the US Federal Reserve’s decision to keep monetary policy loose in the face of soaring asset prices, arguing there was no need to increase interest rates to tackle financial instability because the central bank has other tools at its disposal.

'In a clear signal of how the Fed intends to prevent a repeat of the 2008 crisis, its chairwoman suggested the central bank is more interested in having a resilient financial system that can cope when asset bubbles burst than it is in popping them through rate rises'

But here is the clincher.“I do not presently see a need for monetary policy to deviate from a primary focus on attaining price stability and maximum employment, in order to address financial stability concerns,” said Ms Yellen.

“That said, I do see pockets of increased risk-taking across the financial system, and an acceleration or broadening of these concerns could necessitate a more robust macroprudential approach.”

'A macroprudential approach would involve using non-monetary policy tools designed to manage the safety of the financial system as a whole'.  Full report here.

With appropriate modesty, I feel I have been fishing in the right stream. Now, dear RBA, let's discuss the overvalued exchange rate. While the overvalued Australian dollar is not a 'bubble', it is creating general economic instability by distorting asset allocation across the economy.

'Macroprudential policy' will create a lot of debate in coming years, but I feel that policies like those discussed above, distinct from 'monetary policy' are going to be essential. 'Monetary policy cannot serve two masters', in this case control the overall economy sensibly and also 'influence' house prices, share prices or the exchange rate (or other asset prices), in an appropriate way except for short periods when the needs of asset inflation are in accord with the overall need for economic stability with low inflation.

The FT has already added to the debate with its editorial headed 'Caution on rates is wise but Fed could do more on bubbles', a proposition I agree with.

My simple point is this. If respectable central bankers see the necessity of curbing house prices, or excessive financial system risk, with 'macroprudential policy', why not do something about a stubbornly excessive exchange rate? Something other than cutting interest rates, which has been the unstated (in my view) approach in recent times in Australia.


Janet Yellen's speech is linked below, as well as a more recent speech by Vice Chairman, Stanley Fisher.

Janet Yellen, Chair, US Fed, 2 July 2014, including 'Watch live'option.


Stanley Fischer, Vice Chairman, US Fed, 10 July 2014


The conclusion of Janet Yellen's speech is quoted here.

In closing, the policy approach to promoting financial stability has changed dramatically in the wake of the global financial crisis. We have made considerable progress in implementing a macroprudential approach in the United States, and these changes have also had a significant effect on our monetary policy discussions. An important contributor to the progress made in the United States has been the lessons we learned from the experience gained by central banks and regulatory authorities all around the world. The IMF plays an important role in this evolving process as a forum for representatives from the world's economies and as an institution charged with promoting financial and economic stability globally. I expect to both contribute to and learn from ongoing discussions on these issues'.

Political gridlock, economic decline.
Date: Thursday, July 03, 2014
Author: PD Jonson

'THE trajectory of Australia’s relative decline now seems set with the nation in denial of its economic challenges and suffering a malaise in its political decision-making — signalling that a country that cannot recognise its problems is far from finding their solution.

'Australia’s political system is in malfunction. The evidence has been plentiful for some years and continues to mount. The origins of the crisis are deep-seated. This is the reason it is unlikely to be easily reversed. The nation’s economic advantages are extensive but unless buttressed by effective public policy they will erode relentlessly'.

This is the opening to Paul Kelly's latest commentary about Australia's grid-locked politics and near-certain relative economic decline.  Every voter should read this article and contact their local member to give him or her a wake-up call.  It is available here or in the printed edition of the Australian yesterday.

One example, close to Henry's heart, concerns monetary policy.  Since the RBA is formally independent of  Australia's grid-locked politics, the problem comes from deficient understanding, or reluctance to innovate to solve a problem that has been obvious now for over a year-and-a half.

Glenda Korporaal yersterday reviewed the RBA's latest comment on monetary policy. She says 'yesterday’s glass-half-empty statement from Martin Place reveals a sense of frustration at the RBA with the stubbornly high dollar.

'A month ago, the bank was hopeful that some easing in the exchange rate could “assist in achieving balanced growth in the economy”, but now it’s not so sure.

“The exchange rate remains high by historical standards, particularly given the declines in key commodity prices” (which is what it said last month) “and hence is offering less assistance than it might in achieving balanced growth in the economy”. (Read: now we are really getting impatient that the dollar isn’t coming down).

More here.

Henry must admit his own frustration. In his case it arises from having proposed a solution eighteen months ago to be met with a lofty silence from the RBA.

Here is a link

Since then I have done a lot of work on asset inflation and monetary policy, mostly reflected in the regular articles on monetary policy in 2013 and 2014 posted here.

The rule that 'monetary policy cannot serve two masters' (a much ignored dictum of Milton Friedman) is slowly being taken up in the search for policies to curb housing booms. The traditional approach - and I confess to supporting this until my Pauline insight reported in January 2013 - was to use monetary policy (ie, interest rate policy) to moderate asset inflation.  That is, to raise interest rates more than would be required to control the economy in efforts to contain goods and services inflation when assets such as housing are looking dangerously uppity, and prior to that to talk about the dangers of excessive house price increases and threaten to raise interest rates.

Now good thinkers, including the new governor of the Bank of England, Ben Bernanke himself and (I believe) senior people in the RBA, are considering or (in the UK case implementing) what is called a 'macroprudential' policy to directly curb house price inflation by controlling bank lending for housing.

This I am sure will create a lot of debate in coming years, but I feel that policies like that are going to be essential. 'Monetary policy cannot serve two masters', in this case control the overall economy sensibly and also 'influence' house prices in an appropriate way.

My simple point is this. If respectable central bankers see the necessity of curbing house prices, why not do something about a stubbornly excessive exchange rate? Something other than cutting interest rates, which has been the unstated (in my view) approach in recent times in Australia.

For more views on the BIS approach to asset bubbles, and related matters, discussed on Tuesday, see James Saft of Reuters.

BIS warns of bubbles
Date: Tuesday, July 01, 2014
Author: Henry Thornton

Happy new year, gentle readers.

'An organization representing the world’s main central banks warned on Sunday that dangerous new asset bubbles were forming even before the global economy has finished recovering from the last round of financial excess', reports Jack Ewing of the New York Times.

'Investors, desperate to earn returns when official interest rates are at or near record lows, have been driving up the prices of stocks and other assets with little regard for risk, the Bank for International Settlements [BIS] in Basel, Switzerland, said in its annual report published on Sunday.

'Recovery from the financial crisis that began in 2007 could take several more years, Jaime Caruana, the general manager of the B.I.S., said at the organization’s annual meeting in Basel on Sunday. The recovery could be especially slow in Europe, he said, because debt levels remain high.

“During the boom, resources were misallocated on a huge scale,” Mr. Caruana said, according to a text of his speech, “and it will take time to move them to new and more productive uses.”

The BIS has been ahead of the general curve in advising on how to moderate asset booms so thay don't turn into bubbles. 'Bubbles' do not slowly deflate, but rather pop.

The USA has experienced three major stock market booms in the twentieth century - in the 1920s, in the 1950s and in the 1990s. The first such boom turned into a bubble and burst, helping to produce the Great Depression. The booms in the 1990s burst and marked the end of the so-called 'Great Moderation. The US Fed's rapid easing of monetary policy helped stave off serious recession but re-ignited the stock boom and this led directly to the Global Financial Crisis (GFC). (Why the asset boom of the 1950s, extending into the 1960s did not turn into a bubble is worthy of careful analysis.)

As The BIS said in the quote above, the world economy is still struggling with the aftermath of the 2007 market crash.

This writer said in late 2010, in the opening paragraph of Great Crises of Capitalism: 'The Global Financial Crisis of 2007-08 might still produce a great depression. Massive monetary and fiscal stimulus has been thrown at the problem. Major financial institutions, with one exceptions, have been bailed out by taxpayers. The problems created by excessive debt and over-easy monetary policy have been 'solved' by more of the same'.

Now the BIS is warning of renewed bubble problems and it is time for investors to be especially cautious.

The summary of the BIS report is as follows: 'A new policy compass is needed to help the global economy step out of the shadow of the Great Financial Crisis. This will involve adjustments to the current policy mix and to policy frameworks with the aim of restoring sustainable and balanced economic growth.

'The global economy has shown encouraging signs over the past year but it has not shaken off its post-crisis malaise (Chapter III). Despite an aggressive and broad-based search for yield, with volatility and credit spreads sinking towards historical lows (Chapter II), and unusually accommodative monetary conditions (Chapter V), investment remains weak. Debt, both private and public, continues to rise while productivity growth has extended further its long-term downward trend (Chapters III and IV). There is even talk of secular stagnation. Some banks have rebuilt capital and adjusted their business models, while others have more work to do (Chapter VI).

'To return to sustainable and balanced growth, policies need to go beyond their traditional focus on the business cycle and take a longer-term perspective - one in which the financial cycle takes centre stage (Chapter I). They need to address head-on the structural deficiencies and resource misallocations masked by strong financial booms and revealed only in the subsequent busts. The only source of lasting prosperity is a stronger supply side. It is essential to move away from debt as the main engine of growth'.

Access to the full report is available here. It is worthy of careful reading and even more careful thought.

For later discussion of the BIS approach to asset bubbles, and related matters, see James Saft of Reuters.

Saturday Sanity Break, 28 June 2014
Date: Saturday, June 28, 2014
Author: Henry Thornton

Here we are, in the British Airways lounge in Heathrow after an hour long queue to dispose of the baggage. Twice in the past week, a fellow queuer (sic?) told us, there were major problems at Terminal 5, which is dedicated to BA. The problems involved luggage, and just as we joined a summer Saturday queue the system for sending luggage to be sorted and loaded stopped.

'Why don't they tag it and pile it up somewhere?' Henry asked a tall, courteous fellow traveller. Said traveller went to inquire from a BA staffer, only to return to report 'They heard you'. Tags were being added to bags and the owners were being sent to a muster point to dispose of them.  Presumably in many cases that would be the last time anyone saw them, but that is the case even when the mechanised system is operating. Our line inched forward.

Just as it was our turn to tag and dispose, the mechanical system cranked into action. We wished the bags a fond farewell and headed to the security check. As when we came into the country from mother Russia, the security and customs staff were far more numerous, with far better systems, than their Russian counterparts. Soon we were having porridge and kippers for breakfast in the BA lounge.

We have just spent two days and three nights with a dear friend in London.  Mrs T went to look at galleries while Henry and friend worked on their research project, aimed to test rigorously if current US monetary policy risks creating systematic instability in the US and therefore the world economy. It is likely to come down to how the monetary system interacts with the 'real' sector and how asset inflation influences both. Expect another report in a few months, gentle reader, because the research involves building, estimating and examining the dynamic properties of a model for the US similar to the RBII model of the Australian economy but with asset inflation added. (Here is a link to the non-rigorous version of the research so far completed.)

By amazing coincidence, the debate on how to handle asset inflation is raging in the UK. Today's FT includes a nice article by John Authers titled 'Rate rises pose biggest test for BoE bubble theory'.

The BoE has announced a 'macroprudential' policy (as recommended by Henry and colleagues in the aforementioned paper) to deal with asset inflation, specifically house price inflation, in the UK. No-one thinks there is a general housing bubble in the UK, but there is (it can be argued) in London. So the BoE has to tread carefully. The specific policy involves a 15 % cap on the proportion of mortgages that can cover more than 4.5 times the borrower's income.

Furthermore, lenders must carry out a new test of affordability in which they work out if borrowers could still service the loan should interest rates rise by 300 basis points. The BoE says 'this is not a stringent cap'.

Many other central banks will be watching this approach to controlling asset inflation with great interest. (Until now there has been  a non-policy of 'benign neglect', wait for the crash and clean up afterwards with very low/near zero interest rates. But the BoE, and one seems to remember the RBNZ, have discovered the stunning fact that 'monetary - interest rate - policy cannot serve two masters' and have decided a new policy - or an old policy  - of controls on the banks - is needed.)
Of course, as currently specified, this policy does not cover lending to fund share inflation, nor the sort of progressive tightening (preferably based on well understood rules with automatic tightening that Henry advocates), as an asset bubble develops. And the BoE governor says interest rate hikes are still a 'last resort'  to deal with asset inflation. But it is a good start, and one can be confident that this will be a large area for debate in coming years.

London is booming and, except in the poorest parts of the Scottish Highlands and western Isles, so is most of the rest of the UK economy.

David Cameron is involved in the S**tfight with other Eurozone leaders, and Henry's money is on the UK leaving the EU in due course.

Links to Henry's ramblings in St Petersburg and Scotland are available below. Thanks to Fiona Prior, most of the individual reports now have images.

Scotland the Brave, and sometimes foolish.

Mother Russia guards her borders. But why, comrades, that is the question.


Henry has been too busy to follow the footy, but assumes the season is over for his beloved Caaarlton! Tomorrows game with Collingwood may be the best realistic chance to stay in touch with the finals. Henry also assumes the Swan's millionaire forward line is wreaking havoc, and that Hawthorn is fighting on, along with Freo, Adelaide's Power and Mr Ablett's Suns.

The local (ie global) press is focussing on the WORLD CUP, where a star player has been kicked out of the game, even training for the game, for 4 months for biting an opponent, apparently his third such transgression.

A person of amazing insight in one of the hundreds of newspapers available in London argued that biting is a deep human instinct inherited from our carnivore ancestors and FIFA should go easy on the poor superstar. But his sponsors are abandoning him and his club has him on the market for 180 million Euros, so after a nice rest, and one hopes some serious psychotherapy, he'll come out snarling for another club.

Makes the AFL's 'supplements' scandal look pretty tame.

Poor old England, losing a test series to Sri Lanka after their belting by Mitch Johnston and his mates in Oz. Much heart searching after the self-congratulation of their own win over Australia on doctored pitches in England, was it earlier this year?

Image of the week

Iona, courtesy Google images and Fiona Prior

Henry in Scotland - land of the brave
Date: Wednesday, June 25, 2014
Author: Henry Thornton

After escaping Mother Russia only after thorough administrative survaillance - why were they being so careful about letting bog-standard tourists leave? - Henry and Mrs T arrive safely in Scotland.  Though St Petersburg had been fun, it was a relief again to be in a free nation, correction, apart of a free nation, where about 45 % of its people would like to be freer, but poorer, with their own nation.

As with reports from Russia, the latest will be at the top, making travel into the past relatively easy.

Farewell bonnie Scotland, home of the brave, and the foolish.

Harris and Lewis, siamese twins of islands.

Over the Sea to Skye, where Bonnie Prince left dressed in Fiona McDonalds dress.

And. so to Iona, the place where Christianity was introduced to the Picts and the Scoti.

Scotland, Bonnie Scotland - Arrival, inducing mild euphoria at again feeling free.

Monetary policy reflections
Date: Tuesday, June 24, 2014
Author: Henry Thornton

The Bank of England has signalled that the next change of interest rates is likely to be up, while the ECB has just made cash rates slightly negative. The US Fed is 'tapering' its bond buying project, and today we learn from the FT that central banks generally are planning to cut their bond holdings to minimise capital losses when interest rages generally begin to rise. Forecasts for global economic growth have been reduced, and world trade has started the year very slowly, indeed may have fallen slightly. 

Does the phrase 'dog's breakfast' leap to mind?

Economists had been hoping for stronger, not weaker growth of wotld trade but, if the sluggish start to the year continues, 2014 might be the third year in a row that world trade has grown less than, or no more than, growth of global GDP.

So far at least, the global economy is looking a lot like Japan in the 1990s - sluggish growth, slow recovery and low inflation, tending some think to actual deflation, of goods and service prices.  This is a natural consequence of large debt levels, with these levels still growing.

At the same time, differently to Japan in the 1990s, global asset inflation has shown unusual strength, plausibly reflecting unusually easy global monetary policy - near zero cash rates and 'quantitative easing', ie bond buying. Prices of shares, and house prices in many countries, have boomed despite sluggish global economic activity.

When and if the US Fed, and other important central banks, begin to raise global interest rates, there will be repurcussions beyond rising bond rates.  One must assume share prices will fall, possibly by large amounts, from record levels. House prices will lose bouyancy, and may also fall substantially. If all this is happening while economic activity is still sluggish, questions will be asked about the job being done by major central banks, and governments are likely to clip the wings of the central bankers.

That will be a pity, but one can make an argument that it will reflect the unwillingness of central bankers to work out how to deal with asset inflation. Trouble is, will politicians, advised by national Treasuries and Departments of Finance, do any better?

More here from the (later) pages of the Financial Times.

Does the phrase 'dog's breakfast' leap to mind?

Crashing the party

`Sharing`, self employment and the grey economy
Date: Tuesday, June 17, 2014
Author: Henry Thornton

There is a new way of doing business in the UK.  This is called 'sharing' - people my rent out a room, or their house, or call a non-cabbie car hire network, or rent a dress if they are a gorgeous young thing with a big date and a low budget.

Phillip Inman of the Guardian wrote yesterday about this development, and Henry cannot wait for it to get to Australia.  It could be called monopoly busting, whether the monopoly is the taxi companies, who are unreliable, or the golden legion of real estate agents, or the department stores who extract massive profits from selling nice dresses to poor but attractive young women.

Naturally, there new economy forces are being fought by the pld economy monopolists in the UK, and no doubt the monopolists in Australia are watching and readying themselves for battle.

Elderly British survey fillers are against the new economy development already described, but younger Britains are more likely to embrace the idea. Phillip Inman explains the economics behind this movement: 'This rising tide of self-employment accounts for two out of five jobs created in the past year, pushing the number of people who work for themselves to one in seven of the workforce. While many will be self-employed out of necessity and earning, on average, about 40% less than their employed counterparts, a sizeable proportion consider themselves entrepreneurs and are excited about being their own boss.

'Analysis by the Royal Society of Arts shows that for every worker who loses out there are three who say they benefit. It is an entrepreneurialism that the RSA argued is indicative of an unstoppable shift.

'Respondents [to a major survey] cited factors such as being able to live where they want and work around caring for older relatives or children. The rising cost of childcare was a key consideration, as was the escalating cost of commuting.

'Largely unspoken was the lack of pay, wage rises and decent pensions on offer in mainstream jobs culture.

'The tax system also encourages workers to look beyond the workplace for extra income. A combination of income tax and national insurance places a 32% marginal tax rate on standard rate taxpayers. Capital gains tax by contrast charges the basic rate taxpayer a rate of 18%, and a higher-rate taxpayer 28%. As such, gains on wealth are more lightly taxed  than earned income'.

Henry notes that an effective tax rate on conventional paid employment of 32 % perfectly explains why people will accept 40 % lower incomes in the self-employed sector - most of the 'Self-employed income is from the black/gray economy and therefore effectively untaxed.

Henry knows of many young Australians with fine education, positive attitudes and no jobs in the standard economy or poorly paid jobs with little prospect of advancement. Crime is one solution for these kids, but being self-employed is the logical alternative.

In the UK, a peer of the realm, Lord Young, is reporting on this phenomonon and pressuring the government to relax rules that support the monolply positions of entrenched enterprises like the London cabbies. One hopes that Maurice Newman can find the courage to address these issues as they affect Australia's struggling manufacturing economy.

Read more from Phillip Inman here. 

Saturday Sanity Break, 14 June 2014
Date: Saturday, June 14, 2014
Author: Henry Thornton

"A government big enough to give you everything you want, is strong enough to take everything you have".

This quote from Thomas Jefferson might serve as daily support for Joe Hockey as he tries to make Australians give up the entitlement mentality. Henry is overseas, but did hear on BBC news (the only English language news channel available in our modest hotel) that New Zealand has raised interest rates.

What is New Zealand up to?  Is it possible that the difference from Australa is more realistic government and people – quickly fixed the budget (GST hike, low top rate of income tax) and then got on with making a living.

More here on the tax policy that seems to have done wonders for our cousin over the ditch. Source: Tom Hazledine and The Conversation.


A canny friend said overnight: 'The Australian housing situation is becoming serious. Before the budget it was carrying consumption with it although that is now cooling. No sign of life in tradables investment including new resources.

'Our share market boom is now just banks ... monopoly plus the Fed'.

He later reported that we are getting a new bout of currency appreciation after the Euro relaxations last week ... 'even as resources prices fall in a heap'.

This makes the case for Henry's tax on capital inflow, iniatially proposed here (and in The Australian) 18 months ago.


The alternative is further cuts in interest rates, which would repeat the mistakes of America and the Eurozone.

It is only lack of national confidence that prevents taxing capital inflow: enter, stage left, senior official (wringing hands) 'we are a capital importing nation and cannot choke off that source of national prosperity'.


Henry and Mrs T spend the best part of two days exploring the Hermitage Museum in St Petersburg this week and will provide a seperate report in due course. But getting in was a nightmare, despite booking on line and thereby supposedly 'avoiding queues', and finding ones way around was almost as bad.

Amazing collection, many Rembrants, a lot of Titians, one Georgioni (a rare example) and not an Australian impressionist to be seem. What do these Ruskies think thay are doing, ignoring Streeten, Roberts, Condor and the rest of our boys. Come to think of it, this creates an opportunity, especially if Australia does well enough in the World Cup to hit the news here.

Visit the Hermitage here, where a virtual tour is on offer.  www.hermitagemuseum.org

We took in a performance of Magic Flute at the new Marinsky Theatre last evening. Of course it was in Russian, and a shouted 'Nyet' and other gutteral noises does not fit naturally with Motzart's music, but small matters like that were ignored as the performance had style, humour and great singing.

Coming home as the sun was threatening to set at 11.30 pm was a strange experience, but the streets were busy and cars and busses were battling it out as if it was peak hour. Thursday was Russia's national day and both it and Friday are holidays, so there was a festive air about the place. We were helped to find the appropriate bus stop at 11.15 pm by two American gals, from Texas and Ohio respectively, working here and learning Russian as they go. Two Japanese girls got on the bus at the next stop, waved off by a young Japanese couple from the front door of their home. Its all happening in St Petersburg, folks.

Here is the Mariinsky's website.  www.mariinsky.ru

And here is Henry's collected trip reports. http://www.henrythornton.com/blog.asp?blog_id=2785

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