I have just read Cormac McCarthy's No Country for Old Men. If you have not read this modern classic, do so asap. America's problems are deeply engrained, with the drug lords conducting what can only be described as war on any one who gets in their way.

As a character says: 'It starts when you begin to overlook bad manners. ... It reaches into ever strata. ... You finally get into the sort of mercantile ethics that leaves people settin around in the desert dead in their vehicles and by then its just too late.' 

'Gillard faces MP backlash over surplus' screams the Fin's headline.

Paul Kelly provides the answer in The Weekend Oz. 'If the surplus is not delivered it will prove Labor's misjudgments and it will mean its substitute "return to surplus" plan B will provoke inevitable scepticism.

'Ultimately, it goes to character. Whether it is Rudd or Gillard as PM, Labor has an incurable addiction to over-promising. It makes, for reasons of short-term politics without proper assessment, pledges of long-run consequence. This is a bad way to run a country. Yet Labor has done this from day one to the present day. It cannot help itself'.

Kelly also comments on the 'Currency Wars' issue.  My view is that the analysis of the stubborn height of the Australian dollar is correct - capital inflow from investors (including other central banks) seeking positive rather than zero returns and also fearing inflation created by the massive monetary expansion in the core 'developed' economies.

But reducing Australian interest rates to zero is not the answer, not even if this monetary easing was accompanied by draconian fiscal tightening - though such policy would help lower the dollar at some point. Nor will Reserve Bank intervention help.

The thing to try is some sort of tax on capital inflow.  We do not allow free entry of people into this country, so why allow refuge capital free entry, with its attendant costs to our economy.

Since economic policy is in the news, here Henry's talk notes for a recent event may stimulate your thoughts on this matter.

Christmas reading.

If you, or a loved one, is interested in the world's geopolitical future, do acquire and read Ian Morris, Why the West Rules - for now. Henry's review is here.

Image of the week

 Courtesy International Wire Services

The group meets for dinner several times a year in Basel, Switzerland, Hilsenrath says, at the headquarters of the Bank for International Settlements:

Over Sunday dinners in Basel, which often stretch to three hours, they now talk of pressing, real-world problems with authority. The meals are part of two-day meetings held six times a year at the BIS. Dinner guests include leaders of the Fed, ECB, Bank of England and Bank of Japan, as well as central bankers from India, China, Mexico, Brazil and a few other countries.

This is the opening salvo of an expose's expose, by Jon Hilsenrath.

The full article is available here if you are a subscriber to the Wall Street Journal or on p 22 of today's Australian.

The bit that intrigued Henry concerns the innovative nature of so-called 'quantitative easing'.

'There are two conflicting viewsof the central bankers. One is that central banks have not done enough to attack economic malaise. The other is that easy-money policies lack sufficient power to help economies and risk triggering runaway inflation'. (Toward the end of what is a fine exposition, even an 'expose'.)

Regular readers will note that Henry is firmly in the latter camp. Monetary polciy cannot solve real problems and risks producing massive global inflation.

More here. 

And do not miss the final Raff report for 2012.

Alan Kohler has been to New York and has learned America's 'dirty little secret'.

His thinking is published today on the back page of The Australian's business section, and is indeed a little gem.

The US Fed's massive quantitative easing will create massive inflation in due course.

Here is the dilemma for Australia, quoting Alan Kohler.

'Because it is trying to reduce the world’s reserve currency, the Fed is effectively giving other countries two choices: either allow your currencies to appreciate against the US dollar and thus make your economies less competitive and crunch your export industries, or print money with us and risk (or perhaps guarantee) inflation.

'It is a Hobson’s Choice, and like most other countries’ central banks, the Reserve Bank of Australia doesn’t quite know what to do'. ...

'For Australia the problem is compounded by the very large flow of safe haven capital inflow now arriving, which is largely blind to interest rates. Money is pouring into Australian dollars, including from other central banks, seeking the security of our AAA rating. That’s making the exchange rate immune from domestic monetary policy'.

Kohler's answer is for Australia to undertake massive infrastructure building, which is part of a sensible response, and what a pity it is that this was not a major part of the response to the GFC, instead of the whole raft of wasteful and jerry-built schemes and handouts we actually got.

But a lot of infrastructure spending would create inflation, embracing the outcome that Kohler is seeking to avoid.

Henry has reached the conclusion that some form of market-based capital control is needed to restrain the massive capital inflows that are driving the dollar higher despite cuts to interest rates. Following the Swiss and Brazilian examples.

More on this in due course.

There have been three deveoplments, two of which are totally contradictory and show how in the modern corporation the right hand (senior management) it totally disconnected from the left hand (the worker bees who strive to do the right thing in very difficult circumstances).

1. On 5 November I received an email from xxx-Energy's customer service department. It said: 'I can confirm that your account is currently being investigated.  We have referred the account to our billing department to investigate the account and provide a detail (sic) explanation in relation to the account. Once this is completed we will organise a call back to inform you of the outcome.

'We appreciate your patience in relation to this matter'.

So far, there has been no call, and one assumes that the billing department is simply unable to disentangle its impenetrable, possibly scamming, billing system.

2. On 7 December I received a letter from Geoffrey Mendleson, Lawyers, dated 4 December.

Amongst what is no doubt intended to be a deeply threatening letter someone unidentified said the following.

'We act for Probe Collections and their above named client.

'We have been instructed to effect immediate recovery of your outstanding debt owed to xxx-Energy in the amount of $1,310.91 together with our costs in the sum of $143.00.

'The total of these amounts is $1453.91. If payment of the outstanding debt is not received within 7 days of the date of this letter, further recovery action will be undertaken against you without further notice'.

3. As I have been keeping the Energy and Water Ombudsman informed of this matter, I called this morning to discuss. I was told there had been over 60,000 complaints about electricity and water billing this year. The Ombudsman would immediately inform the relevant senior officer of xxx-Energy and require him or her to call me to set up a process to resolve this matter.  I have of course, also asked a senior lawyer, a family friend, for advice on this matter, and Mrs Thornton has called the ACCC who told advised her on steps she could take in this matter.

I find this matter deeply distasteful, as from the get-go I have simply sought an explanation of how the repidly escalating numbers on successive bills were achieved.

I am certain that there are other elderly people out there - some even more elderly than Henry, out facing this sort of bullying and that someone has to take a stand.

The US added 146,000 jobs in November, the Labour Department reported, up from a downwardly revised 138,000 in October. The November reading topped economists' median forecast of 80,000. The unemployment rate dropped to 7.7 %t from 7.9 %, compared with economists' predictions for it to remain unchanged.

'Europe and the USa are about to deliver Australia a colossal economic dividend' says Adam Creighton in the Oz's Inquirer section - but no link I could find.

The US and Europe overspent on the national credit cards for 30 years. While those major economies put their houses in order - likely to take a decade or more - the big saving nations of Asia are unlikely to want to park their savings with countries that have already overborrowed.

Ergo, Australia will benefit as a place in which to invest. Warwick McKibbin says of China's acquisition of of Cubbie Station: 'We ain't seen nothing yet', or words to that effect.

We should expect a high exchange rate and low interest rates, and should get used to it, like Canada, whose non-mining industries also had to adjust to a new reality.  Which, for the nation as a whole, was an enriching experience.

This is the view most economists accept but one wonders if we could engineer a lower dollar by imposing a tax on capital inflows, following Switzerland. This is a debate we have to have, so stay tuned, gentle readers, we intend to forment such debate.

The BIS Annual Report may opine on this matter next year, as the IMF has already done, but is worth a read in any case. 

The International Monetary Fund (IMF) has recently changed its long-held view against the view that capital flows should always be completely unhindered.

The Wall Street Journal recently said: 'WASHINGTON—The International Monetary Fund cautiously endorsed measures to limit surges of capital across borders, easing off decades of gospel about the free flow of money around the world'.

Read on here.

Internet availability

Apologies, gentle readers, for late arrival of this missive, but Telstra failed (for the third time this week) to provide access to the world wide web earkier today.

Usually it is rain that disrupts access in our home in leafy Kew, but this week it seems to be the heat.

We were told the Internet was creasted to maintain communications during a nuclear war, but normal rain and heat?

Another problem caused by Tony Abbott, one must assume.

Politics

Conspiracy theorists have been promoting the idea of an early election so that the gummint will not have to fess up to another broken promise - the one that (withour qualification) said 'We shall deliver a budget surplus'. Henry never fell forludicrous this due to his belief that a softening economy would cause that promise to be impossible to keep, or at least so damaging to the economy not even Wayne Swan would decide he'd rather have his Prime minister take another integrity blow.

Christopher Pearson, however has come up with a more plausible theory - if Julia thinks she is about to be rolled, she will go to the G-G and ask for an election, which will surely be granted.

Given the verious reports that the PM nearly lost her job over the UN vote on Palestine, and a general view that Labor is very likely to lose the next election, quite possibly in a wipeout, a cleanskin like Bill Shorten could be seen as safe pair of hands who would limit the damage.

Here is the link. 

Image of the week

Courtesy The Oz

The Australian today has a new angle on the drive for a surplus (aka 'tightening fiscal policy') - 'blunting' the effect of the RBA rate cuts. Read on here.

'Leading economists say further deterioration in budgets is likely as commodity prices fall, and that governments should be considering debt-financed infrastructure spending to support growth'.

Henry would be a lot happier with this advice if so much of taxpayer's money had not been wasted on the fiscal frolic that supposedly saved Australia from the GFC.

Fact is, of course, it is now clear that the crisis of 2007-08 is far from over, and spending on much needed infrastructure about now would make perfect sense, assuming we could afford it.

Imagine if the money spent on dangerous pink batts (both putting in and taking out), cosmetic school refurbishment and the unnecessary National Broadbent Network, plus handouts to all and sundry, was now available to spend on much needed infrastructure?  Boosting productivity in all liklihood.

Unemployment has supposedly fallen back to 5.2 %, but regular readers will be aware that the Roy Morgan poll, which uses more accurate definitions, says a more realistic number is 10 %.

With job vacancies down by 30 % from the peak, and people dropping out of the workplace like flies at the end of summer, anyone in the 'real world' - and I do not mean the nominal world divided by the price level - knows things are not so good out here.

The RBA completed its backdown with pike this week, providing the second of two 25 basis points proposed by Henry way back in October. (There is the great tradition of moving too little, too late, to maintain.)

The final proof for the RBA of a rapidly weakening economy was this week's drastic downward adjustment to investment intentions.  Rising mining investment has been boosting growth, but the mining investment cycle is now expected to peak in mid-2013 at a lower level than earlier expected. And investment in the non-mining sectors is virtually disasterous.

In global news, the US President and 'House Republicans' are wrestling on the edge of the fiscal cliff. Earlier hopes for a rational resolution of the wrestle - give up fighting and reach a compromise -  have faded but are not completely dead. Certainly one to watch in the weeks ahead.

The Eurozone is still hanging together, but unemployment has exceeded 20 % in Greece and Spain and is still rising in other Eurozone nations and for the Eurozone as a whole. Can this go on, gentle readers?  Why not say the skeptics - after all, the so-called Great Depression went on for a decade and was only ended by outbreak of war, and the bursting of Japan's asset bubble in 1989 ushered in two decades of stagnation.  The clue to a sharp rebound after a negative shock is to let the necessary corrective action happen in all its arbitrary but effective ways, as the USA did in the nineteenth century.

But modern nations think that officials can do better than simply letting adjustment rip, and people have learned that 'the gummint will provide'. Ergo, adjustment is blocked, and suffering gets drawn out.  In Europe, and perhaps in the USA, there will be a lost generation of youths denied work at the most formative time in their lives, a permanant underclass.

Last night Henry was at a dinner to celebrate the 50th anniversary of the Melbourne Institute. Created by Ronald Henderson, revived by Dick Blandy, expanded and greatly improved by Peter Dawkins, all helped by constructive Advisory Boards, the Institue is flourishing in its dynamic middle years.  Guest speaker, Bruce Chapman made a wonderful speech full of gentle humour (well, most of it was gentle) and revealed the stunning fact that happiness is related to alcohol with a clear 'U-shaped curve'.

On average, people who are happiest are in two catagories in relation to the demon drink - those who drink no alcohol at all, or those who drink 14 glasses a day.

The most unhappy people are those who consume 6 drinks each day. 'So if you are drinking 6 drinks a day and are unhappy, you have a choice - give up or increase the amount you consume'.

A noted visiting economist's glass was empty when Henry's OJ was consumed. 'Can I get you a drink?' Henry inquired. 'I'll have another scotch, no ice, no water' said the distinguished visitor. 'Make it a double'.

A happy man, clearly a 14-a-day man, so fill up my glass bartender. (How does Glenn Stevens manage to keep his glass permanantly half-full? Frequent top-ups is my guess.)

People who said that, the Treasurer said, were not qualified to comment on the economy. (That's what I thought I heard - will someone send the transcript, sounds too silly to be correct.)  In any case, Nicholson (see cartoon below) said it all really.

Well Wayne, many people more qualified than either of us say the economy is in deep trouble, and the real smarties are beginning to suggest it is your government's fault.

* Panic-induced spending hikes during the GFC are being replaced by panic-induced spending cuts now you have grasped that tax receipts are drying up as the economy slides.

* Your IR policy is making it harder to hire and fire, raising labor costs.

* Red tape and green tape are driving footloose industries, like modern mining, offshore.

* You have spread a mentality that 'the gummint will provide', completely useless now the government is trying to achieve a (tiny) surplus to demonstrate it really is a good economic manager.

* Household surveys show people are lacking confidence, with a high degree of concern for job stability, despite your constant bleating about the strength of the labor market - check out the Roy Morgan survey, and do some deep pondering. 

* Business surveys are also deeply pessimistic, citing rising costs, red tape, green tape and the burden of taxation.

Stephen Bartholomeusz provides a nice discussion of changes in the RBA's post decision comment on its own decision.

The most pregnant comment is perhaps the following: 'Last month’s RBA statement was tinged with careful optimism about the global outlook, a slight concern about inflation and an expectation that the 1.5 per cent reduction in official interest rates in the current cycle would put a floor under the housing market and flow through to stronger growth in consumer confidence and spending. Today the RBA governor, Glenn Stevens, made some modest but significant departures from that script after the bank’s December board meeting'.

Henry's reading is that this is another mini-step in the RBA 'stumbling reluctantly to the truth', to quote a legendry RBA official - not, not Henry, but a free Goldmembership comes to the first woman or man to get the right name.

(Contact Henry here.) 

But the messages the morning after are surely mixed

* The Oz emphasises the cash rate is at post-GFC lows.

* RBA fails to curb dollar, says the SMH.

* Several newspapers say 'its the economy stupid' for young people.

* 'More. more' says at least one of the many AFR writers.

* But the hard men of the Oz say this rate cut may be the last.

Courtesy The Oz

Ambrose Evans-Pritchard recently addressed this emerging conventional wisdom. He notes that Studies by the World Bank covering two centuries of data sketch a pattern of 10-year supercycles, followed by a slide for the next 20 years or so as excess investment leads to a flood of supply. 'The long bear market can be cruel for those hanging onto to resource stocks, convinced that the rebound must be nigh'.

He adds that this view has been accepted by Mark Ryder, Australian investment chief for UBS. 'Ryder says we are reaching just such an inflexion point as China’s manic construction phase gives way to more sedate growth, and Europe, America, and Japan take their fiscal medicine. "The commodity super cycle’s end is at hand. The scene is set for a momentum shift," he said'.

Another guru, Dylan Grice from Societe Generale, describes the current commodity boom as "a credit bubble built on a commodity market built on an even bigger Chinese credit bubble". Henry is not totally certain just how this effects the argument, but it certainly makes one think thoughts of mega (multi-layered) boom leading to mega-bust.

Citigroup’s Edward Morse that has also rattled resource bulls. 'He claims that America’s shale gas revolution -- which has cut US natural gas prices by 70pc -- is a taste of what will happen across the gamut of commodities as vast investment comes on stream. The inference is that parking money in "long-only" resource index funds -- worth $250bn -- has become a mug’s game'.

These are not silly views.  After all, 'this time it's different' is a well-worn assertion by people who get bedazzled and bewitched by each new boom. Indeed, one important reason for writing my recent book Great Crises of Capitalism, now available on Amazon and at other progressive global bookshops, was to point out how often the 'this time is different' boosters have been wrong. And also to warn that policies adopted during the current crisis might generate continued, even greater, financial and economic instability.

Three giant iron ore mining companies, BHP Billiton, Rio Tinto, and Brazil’s Vale, have all cut back on expansion plans. 'All three are battening down the hatches as hopes fade that this year’s 23pc fall in iron ore prices will soon reverse'.

'Mr Morse says China’s growth will slow from 10.5pc to 5.5pc by 2020 - Credit Suisse thinks it could be as low as 4pc, and the US Conference Board 3.7pc - but the crucial twist is that appetite for resources will wane as the Politburo calls time on history’s greatest building boom and opts instead for a modern, sleek, consumer and service-driven economy'.

Henry observes that occasionally booms last far longer than average results for two centuries, and if that occurs now pessimists who attach their boats with a firm anchor will be swamped by the tide that raises all boats, which may appear more like a tsamnumi.

Evans-Pritchard quotes Australia's own much-loved central bank to the effect that that construction in China will not peak in absolute terms for another five years as 20 million rural migrants pour into the cities each year. The pace will not slow much until the urbanisation rate reaches 70 % in 2030. And the RBA says that China’s growth will become more "steel-intense" -- not less -- as building shifts to high-rise blocks and urban sophistication. "Steel used in residential construction will peak around 2024, at a level that is 30 per cent higher than in 2011," it said'.

China is predicted to add 125 million cars over the next five years, half the entire US fleet, which will have to be parked in multi-story blocks or below ground. There will be strong demand for fuel for all these cars.

Evans-Prtichard has, of course, been to China and has talked with leaders in deep inland places such as Chengdu, Chongqing, Xi’an, Changsha, and Kunming.  He says these and other similar leaders 'are attempting to replicate the East Coast booms with their own metropolitan extravaganzas over the next decade'.

'Nor is it clear that the Communist Party is yet ready to wean the country off state credit, top-down planning, and chronic over-investment, an addictive model for Maoist patronage.

'China’s Development Research Council knows that the catch-up model launched by Deng Xiaoping in 1978 is no longer fit for purpose as China moves up the technology ladder.

'Yet the Party’s 10-year power transition last month seems to have been a victory for hardliners. Key reformers were shut out of the seven-man Standing Committee. The North-Korea trained Zhang Dejiang has tightened his grip, a boon to the state-owned behemoths. It looks as if the Politburo may try to keep the infrastructure blitz going for another cycle, extending it to the 800m or so people of the hinterlands'.

This will create major problems for China, but 'could kindle a fresh burst of uber-growth, with demand cascading through the Asian tigers and the commodity complex'.

So we must not be surprised if China cranks up its growth again, America turns the corner and underlying commodity scarcity takes its toll? Has Malthus finally found his target? Only time will tell, but it is plausible that China's massive growth, increasingly being followed by others, may have changed the resource equation for the forseeable future.

And in conclusion, support for Henry's views as articulated today in The Australian: 'And never, ever ignore the global money supply. The key gauge -- real six-month M1 -- touched bottom at 1.5 pc in May. It jumped to 3.7 pc in September and seems on the same track for October. The world’s kindling wood is crackling again. Can commodities really stay cold?'

Much later, Sarah-Jane Tasker, 4/2/13, reports the commodity 'supercycle' is back.

'LEADING commodity forecasters have predicted a new stage of the commodity "supercycle" this year, underwriting optimism in the sector after a bumpy 2012.

'In what would be welcome news in an election year for a federal government banking on a mining tax that has yet to deliver any revenue, the prediction is for higher commodity prices this year.

'Colin Fenton, JPMorgan's chief commodities strategist and head of commodities research, said he was "getting bullish" as it was clear that the mid-cycle slump was over.

"The data is coming in much stronger than we had anticipated for the first part of January," the New York-based strategist told The Australian during a visit to Sydney.

"We see business flows picking up around the planet and, very critically, the level of implied volatility is about as low as it can go".'  More here.

We are grateful to the newly appointed Deputy-Governor of the Reserve Bank, Philip Lowe, for addressing some of the implications of this highly innovative development in a recent speech (linked here). As Mr. Lowe put it in a speech in late October: ‘From one perspective, this setting of monetary policy is hardly surprising. The sluggish growth in many of the advanced economies means that little, or no, progress is being made in reducing high rates of unemployment. At the same time, core inflation is subdued. ...

‘But from another perspective, what we are seeing is highly unusual. Since mid 2008, four of the world's major central banks – the Federal Reserve, the ECB, the Bank of Japan and the Bank of England – have all expanded their balance sheets very significantly, and further increases have been announced in a couple of cases. In total, the assets of these four central banks have already increased by the equivalent of around $US5 trillion, or around 15 per cent of the combined GDP of the relevant economies. We have not seen this type of planned simultaneous very large expansion of central bank balance sheets before. So in that sense, it is very unusual, and its implications are not yet fully understood’.

Mr. Lowe discusses two implication of this ‘highly unusual’ development.   The first is that it increases the prices of assets that the central bank is buying, thus lowering the yields on those assets. Thus bond yields in the USA, the UK and Japan are all very low, and in the Eurozone nations whose bonds have been purchased by the ECB yields have retreated from the clearly unsustainable levels they had reached before the ECB began buying.

The second implication is that cashed up institutions, including banks, will at some stage seek out higher yielding assets, and their acquisition of those assets will drive up their price. Expansionary monetary policy creates inflation, but with markets for goods and service depressed, it will be asset inflation that is the main immediate effect. We have seen this response to expansionary US monetary policy already, following cash rates near zero under Alan Greenspan, and even lower under Ben Bernanke.

There are substantial risks in this situation, risks that are only hinted at by Mr. Lowe. Asset booms are always followed by asset busts, and if these are serious enough they can hinder economic progress. If the asset bust makes for a continuation of easy money, it will eventually spill over into markets for goods and services and create inflation.  Money is widely used as a buffer stock, and which market excess money finds its way into, and with what lags, is not something that has been nailed down, and is unlikely to be nailed down in the forseeable future.

Eventually, however, unless there is very deft and timely reversal of ‘quantitative easing’, which seems highly unlikely, the excess money now being produced will produce a large burst of goods and services inflation. This is not a conclusion drawn by Mr Lowe, but it is an issue we shall all be grappling with eventually. If it is commodity prices that are inflated most, Australia may even be a net beneficiary of what could produce a very dangerous risk to the stability of the global financial system.

Further reading.

'Money, prices and output', Kredit und Kapital, 1976. Reprinted in David Laidler (ed), Foundations of Monetary Economics, Edgar Elgar Publishing Limited, UK, 1999.  Here is a link.

Asset Prices and Monetary Policy, Proceeding of a Conference, Reserve Bank of Australia, 18–19 August 2003.

Download the full contents here.