RBA pause continues; GDP rises strongly in June quarter
Date: Wednesday, September 07, 2011
Author: Henry Thornton
As widely expected, the RBA left interest rates unchanged yesterday.
Extreme global uncertainty is making prediction difficult.
The key point was right upfront: 'Conditions in global financial markets have been very unsettled over recent weeks, as participants have confronted uncertainty about both the resolution of sovereign debt problems and the prospects for economic growth in Europe and the United States. As a result, the outlook for the global economy is less clear than it was earlier in the year'.
Inflation is expected to decline by year end, and monetary policy is excersising a degree of restraint - with credit growth low and house prices falleing - not in Canberra it must be noted, although Glenn Stevens was not so undiplomatic to point this out.
And in conclusion: 'At today's meeting, the Board judged that it was prudent to maintain the current stance of monetary policy. In future meetings, the Board will continue to assess carefully the evolving outlook for growth and inflation'.
As someone said, they don't know either. The governor's press release is linked here.
Students of the monetary framework, putting recent decisions of the RBA board into context, will enjoy a nicely crafted speech by governor Stevens, linked here.
More later today when June Quarter GDP data are released and Henry has seen Darwin's major art works. Our car is on the Ghan for Adelaide and we follow it by air shortly.
June Quarter GDP Figures released
Well, the figures for June Quarter GDP have been released here and show the Australian economy rebounding strongly from the flood-induced shrinkage during the March Quarter with Australian GDP growing at 1.2% on a seasonally adjusted basis during the June Quarter - an annual figure close to 5%.
The strong rebound suggests the RBA has been right to hold interest rates during the past few months and not cut despite the calls from many sectors of the economy. Interest rates are at historically low levels, and with an economy growing at nearly 5% per annum, it would be an unprecdented move to cut interest rates into the 'teeth' of this type of growth.
As further information becomes available about the state of the sovereign debt crisis in Europe, the RBA will clearly be able to take action accordingly in coming months.
It`s official - central bankers can be (gasp!) wrong
Date: Tuesday, October 22, 2013
Author: Henry Thornton
Confessing to such matters is especially likely when they are selling a new book, as is the case with the grizzled veteran of the interest rate wars, Alan Greenspan.
'In his new book, The Map and the Territory, to be released today', writes Alexandra Wolfe, 'Greenspan, 87, goes on a hunt for what has gone wrong in US politics and in the economy. He doesn't blame the Obama administration for today's partisan divide. The culprit?
"It's the benefits," he says, pointing to the disagreements between Republicans and Democrats over how to deal with the growth of entitlements.
'In the book, he also ponders why the Fed failed to predict the financial crisis, where he himself went wrong and how that discovery has completely changed his worldview'.
Mr Greenspan discovered the adverse effects of 'entitlements' when playing with GDP statistics, the way other 87-year-old play with lego (correction, their DIY pension plans). Rising entitlements and reduced savings are correlated. Joe Hockey, take a bow.
There's more. "I've always considered myself more of a mathematician than a psychologist," says Greenspan. But after the Fed's [massive, econometric] model failed to predict the financial crisis, he realised that there was more to forecasting than numbers. "It all fell apart, in the sense that not a single major forecaster of note or institution caught it," he says. "The Federal Reserve has got the most elaborate econometric model, which incorporates all the newfangled models of how the world works - and it missed it completely." ...
Mr Greenspan 'concluded that fear has at least three times the effect of euphoria in producing market gyrations'.
"I wouldn't have dared write anything like that before," he says.
Ms Wolfe continues: 'Greenspan set out to find his blind spot step by step. First he drew the conclusion that the non-financial sector of the economy had been healthy. The problem lay in finance, because of its vulnerability to spells of euphoria and irrational fear. Studying the results of herd behaviour provided him with some surprises. "I was actually flabbergasted," he says. "It upended my view of how the world works."
Curious, perhaps, that Mr Greenspan had not heard, or did not value, the frequently rehashed views of regular stock price watchers who say the markets show persistent phases in which greed and then fear predominate among 'the herd'. All of which reminds us of 'Animal Spirits'.
The other big mistake of Alan Greenspan is not mentioned by Ms Wolfe. This is Greenspan's belief that it is not possible to recognise or to act against an asset bubble while it is happening, but mopping up (with massive monetary policy stimulus) after the crash.
To be fair ('Why?', I hear you cry), his belated recognition of the forces of euphoria and fear perhaps amount to a half-confession.
Sadly, there is no tradition of Australia's former central bankers writing biographies, and thus gaining the benefit of cleansing their souls before shuffling off to meet whatever awaits them in the great hereafter. I suspect Ian Macfarlane were he sufficiently honest would confess to moving too little, too late to tighten monetary policy, and being saved by the global financial crisis. Also he could boast about banning serious model building at the RBA, meaning there doing away with the best articulation yet devised of how the economy works. The RBII model certainly worked well in predicting the rise of Australia's international debt in the 1980s and the powerful drop in the value of the Australian dollar. By the time the boom of the late eighties was underway, the model had been mothballed so we will never know if, used with appropriate expertise, it would have predicted 'the recession we had to have'.
It is far too soon to write the confessions of Glenn Stevens. But delivering really boring speeches might well be among the issues to be considered, at least if Tiresias of Canberra was involved in the process. Read on here, folks. I gotta zip.
Animal spirits - creating economic booms and busts
Date: Monday, October 21, 2013
Author: Henry Thornton
John Maynard Keynes believed 'the economy was not just governed by rational actors, who "as by an invisible hand" will engage in any transaction that is to their mutual economic benefit, as the classicists believed. Keynes appreciated that most economic activity results from rational economic motivations - but also that much economic activity is governed by animal spirits. People have non-economic motives. And they are not always rational in pursuit of their economic interests. In Keynes' view these animal spirits are the main cause for why the economy fluctuates as it does. They are also the main cause of involuntary unemployment'.
This arresting paragraph is from the preface to the first edition of Animal Spirits, written in early 2009 by George Akerlof and Robert Schiller. I purchased the second paperback edition, whose preface was written in late 2009 when tentative green shoots of recovery were beginning to be noticed. I regret not reading this book before writing Great Crises of Capitalism as it would have helped me strengthen some of its conclusions, but I will confess with appropriate humility I have found nothing to contradict my analysis.
I have acquired and read Animal Spirits now as with others I am about to test some hypotheses about the systematic causes of the asset booms and busts that are such a large part of the financial crises of capitalism. Akerlof and Shiller also acknowledge the strong positive animal spirits that produced the share boom in the 1920s USA, and the subsequent share bust, which they attribute to a dramatic shift of mood. They apply the same logic to Japan's asset boom in the 1980s and subsequent asset bust and again in the USA in the 1990s and beyond. These are three of the four dramatic 'aberrant episodes' identified in this author's article (with Elizabeth Prior Jonson and Ka Mun Ho) 'Monetary Policy and Asset inflation', still being reviewed in the USA.
The episodes are aberrant because boom and bust seem not to be related in any obvious or consistent way to changes in the stance of monetary policy. Akerlof and Shiller, if they noticed this statement, might reply that it strengthens (certainly does not refute) their hypothesis that it is changes in animal spirits that changes the trend of asset prices. Crucially, of course, their hypothesis needs testing, which ideally requires a measure of animal spirits, or an hypothesis about what causes animal spirits to vary.
The best attempt I have seen is Geoffrey Blainey's The Great Seesaw, A New View of the Western World 1750 - 2000, first published in 1988, curiously not referenced by Akerlof and Shiller. Blainey writes toward the end of his stimulating book: 'The factors which are capable of promoting oscillations in mood are more powerful and varied than ever before. The seesaw itself is more sensitive to slight pressures. These extreme swings of the seesaw come not only from war and peace, economic depressions and prosperity, the finding or depleting of new natural resources, inventions and pollution, but also from less tangible and more subjective factors operating in free societies'. (p 304). This passage goes on to list among more subjective factors the decline of Christianity, an 'increasing narrowing of human experience', 'the cobwebbed complexity of western civilisation', and what Blainey calls 'the cycle of expectations'.
Akerlof and Shiller, in the 'Preface to the Paperback Edition', writing in late 2009, say: 'Animal spirits are more than just confidence as measured by confidence indicators. We argue that declining animal spirits are the principal reason for the recent severe economic crisis'. (P vii). News media do not speculate about the roots of behaviour, but largely report changes in measurable economic facts such as share prices and retail sales. 'The reasons the leading indicators have improved remain mysterous'.
'There seems ... to be an unseen force propelling the economy, driving it to periodic booms and busts'. This view is not new. The Nobel laureates quote Baghot, in his 1873 book Lombard Street.
'Most people who begin to think of the subject are puzzled: Why should there be any great tides of industry, with large diffused profit by way of flow, and large diffused want of profit by way of ebb? The main answer is hardly given in our common books of political economy'. (Quoted by Akerlof and Shiller, Pp vii and viii).
The tentative recovery beginning in late 2009 'defies the analysis' of the many economists who build and use econometric models. Is also 'defies the analysis of those economists of the "real business cycle" persuasion, who are in the habit of thinking that all economic fluctuations are ultimately driven by exogenous changes in "technology" and "productivity", but cannot point to a descriptopn of the cause of such a change right now'. It also defies the work of people who seek to extract patterns from time series of data. (P viii). Clearly forming hypotheses to embed in minimal but largely complete econometric models - which is our plan - will be quite a challenge.
'The basic theme of this book', say Akerlof and Shiller, 'is that animal spirits are the force that drives all of this, and that to understand animal spirits we have to use methodologies outside of traditional economics, leading us to other social sciences'. (P ix).
They identify 'five psychological factors' ... that they think are of particular importance. They are confidence, fairness, corruption and bad faith, money illusion, and stories. 'Changes related to all these factors are the ultimate reason for the boom that preceded the world economic crisis, for the crisis and recessions in which we have been immersed, and for the apparent beginnings of recovery. These phenomena cannot be understood in terms of traditional economic theory alone'. (P ix)
Of course, the success of any such analysis will require it to be successfully applied to previous episodes of boom and bust and (of course) to be successful in predicting future episodes of a similar nature.
We say, again with appropriate humility, that our hypothesis about the 'aberrant episodes' previously mentioned is as follows: 'Clearly some plausible theory needs to be brought to bear if these episodes are to be incorporated into macroeconomic theory and policy modelling. We suggest that allowing for the state of confidence, Keynes’ ‘animal spirits’, would be a good way to start. Powerful confidence seems to have been an important part of the story of the USA in the 1920s, the 1950s and the 1990s, in each case associated with powerful innovation and strong growth. Powerful confidence might be expected to boost demands for both money and shares. Increased demand for money would presumably mean lower goods inflation for any given rate of money growth, and contained money growth would itself boost confidence. Powerful confidence would presumably make bankers more inclined to advance credit, and as Schularick and Taylor (2010) show so convincingly, strong credit growth is a vital part of the generation of asset booms'.
Establishing plausible ways to measure animal spirits, whether following Akerlof and Shiller, Blainey or Keynes himself (or all four such towering figures) is likely to be difficult and time consuming. Akerlof and Shiller's emphasis on 'stories' provides a possible form of linkage, and we plan to focus on this point.
To return to the Nobel laureates: 'We argue in Chapter 5 that human-interest stories that give vitality and emotional resonance to economic views drive animal spirits. Since economic expansions and contractions in the modern world tend often to be worldwide phenomena, these are not stories confined to any one country. The stories spread amidst a growing world culture, from country to country, since the same salience that works for a certain sort of story in one country in one country will generally work in another country as well'. (P ix)
The example used is a series called The Apprentice, which in the USA featured Donald Trump, and in its rapid global spread featured local tycoons. 'The tycoon is a tough man who shouts belligerently "You're fired" at the losers, but who, in his own harsh but distant ethical way, serves as a mentor to them all'. This series was shown in 2004, as the American asset booms began to really hot up, partly one assumes as a result of the Fed's sharp monetary expansion after the crash of the early 2000s. Sadly, this writer never saw the American Apprentice and is not aware of any Australian remake. Perhaps the lack of such a local product helped shield Australia from the worst of the global boom and bust, like the families in the American Appalachian mountians, lacking television and thus immune (according to the 'stories' hypothesis) from the general American madness. (Just joking, dear American friends.)
The remainder of the late 2009 preface goes on to argue for an activist approach to economic management, as opposed to those this writer calls the Tea Party economists, (with reference to the Mad Hatters' tea party, incidentally, not the law-breaking tipping of tea into Boston harbour in 1773). I liked particularly the following passage, which relates to the absence of effective financial system regulation in the USA during the boom of the 2000s: 'The public, and the regulators who were supposed to act on their behalf, had failed to understand a fact of life that is totally obvious to everyone who has played a serious team sport: there have to be rules and there has to be a referee who enforces them - and a good and contientious referee at that. Otherwise there will be random cheating that destroys the sense of the game, and dangerous and aggressive play, so that many people will get hurt and the game will cease to reward good play'. (p xiii).
Amen to all that.
Saturday Sanity Break, 19 October 2013
Date: Saturday, October 19, 2013
Author: Henry Thornton
Exhibiting superb just in time management, US legislators caved in to President Obama's wishes that the mighty USA not default.
The partial shutdown of the USA government cost the economy a few points of GDP in the forth quarter, and cost unpaid government employees a rather larger share of their income.
It is important ro recognise that global monetary Armegeddon has been postponed, not eliminated, and we shall in all liklihood come back to more useless grandstanding by Tea Party zealots early in 2014.
Treasurer Joe Hockey boasted that he had a plan 'in his back pocket' in case of Armegeddon, but Gov'nor Glenn Stevens on ABC radio as Henry drove home from the airport last night said while his team 'had a few notions' about what might be done if the real crisis had erupted, the truth was the world would be in uncharted territory, with no clear guidance from anywhere.
This is the headline summary of RBA chief Glenn Stevens' speech to a worthy group in Sydney yesterday.
The report itself continues as follows: 'The dollar rose to a four-month high of US96.46¢ on Friday after markets bet the US government shutdown would delay the Federal Reserve’s plans to withdraw the cheap financing that has driven global investors into higher-yielding currencies like Australia’s.
'Mr Stevens, who has repeatedly lowered interest rates in part to try to drive the dollar down, acknowledged the Reserve Bank’s ability to stem the currency’s latest rise was limited.
“I personally think a lower currency than this will be helpful in rebalancing the growth sources of the economy. Whether it’s in my gifts to make that happen is another question,” Mr Stevens said at a lunch for the Australian British Chamber of Commerce.
“Fundamentally, I don’t think you could really credibly say that the level of cost and productivity in Australia, on those metrics, would point you to present or higher levels being really sustainable.”
Read on here. Or, if you prefer your tonic without the gin provided by feisty newspaper reporters, the real thing is available here.
As it happens, Henry was also speaking to a group in Sydney yesterday.
The notes for his part in a debate on the wisdom of capital markets, conducted by the Paul Wooley Centre for the study of Capital Market Disfunctionality, are available here.
On the subject of the RBA's 'powerlessness', key points were as follows: 'The floating exchange rate has meant that resources are allocated more efficiently than they were when the currency was fixed.
'However, resource allocation is far from optimal when a floating dollar becomes stubbornly high, as it has in the past few years. (The RBA governor's statement today that he is 'powerless' in this matter is surely a joke, or an admission that he is overdue for retirement. A tax on capital inflow would fix this problem, but the bureaucrats lack the courage to implement such a tax, fearful that it will cause capital inflow to dry up.)
Also, in conclusion: 'I would be happy to discuss how the world might move to a wiser system of capital allocation if time permits, but for the present debate it is sufficient to demonstrate that current policies and our present policy framework, fail to allocate capital wisely. But let me pass on an iron law to the RBA people present here today. Milton Friedman said 'Monetary policy cannot serve two masters'. Manipulating interest rates cannot both contain inflation and overall economic stability (two tightly linked objectives) and also contain a housing bubble or restrain an overly buoyant currency'.
I might mention that the dominant member of the opposing team, Professor Tom Valentine, admitted that the current system for allocating capital was far from ideal. But he won the debate, and the biggest laugh of the day, by asking if the audience would prefer 'The Obeid method: management by corrupt politicians', or 'The bureaucratic method: management by incompetent bureaucrats'.
It was notheworthy that Valentine agreed that Henry was right about Friedman, and Friedman was right about the limits of monetary policy. 'If you want to control a housing bubble', he thundered, 'you need a seperate way to do it'. From what Luci Ellis, head of the RBA's financial stability department said in her paper (linked here), I doubt she would agree. But since her boss has not yet opined on this matter, she wisely faffed about.
Sources of Australia's prosperity.
Gov'nor Glenn did, however, opine on the bigger question of Australia's long-term prosperity. He discussed the value of overseas investment, of cash and human capital, and the mineral wealth that was not obvious at the first glance of Dutch and other mariners.
'But it wasn't just money, land and minerals. There are other countries with resources and land that do not enjoy the same incomes. And there are nations with very little in the way of resources or land that are wealthy. It was other things about the British heritage that were of higher value. ...
'It turns out that the English language is just about everyone's second language, which means even with our broad accent, we can communicate with educated people virtually everywhere and engage in commerce in most places. The common law and parliamentary democracy provide a foundation for the sorts of property rights and governance processes that are widely and rightly regarded as fundamental to building a prosperous modern economy. That property rights could become so well established in a society in which the ‘immigrants’ of 1788 had no such rights is, perhaps, an ironical outcome. And we are still coming to terms with the property rights of those descended from the inhabitants who were here before 1788.
'But the point is that this heritage, so important for enterprise, is something we have in common with the UK. One has to observe as well that Britain traded with and invested in her former colonies, however imperfectly, rather than simply extracting the rents. The fact that so many prominent English-speaking former colonies are counted among the rich of the advanced world today is perhaps not entirely a coincidence'.
I thought Gov'nor Glenn's exposition owed a lot to Ian McLean's recent book, The Historical and Global Roots of Australian Prosperity, reviewed here, but it was curiously not in the list of references. Accidental omission or parallel discovery, but who cares, comrades. The conclusions are what matter, right?
Not much footy stuff this week, so we must pass on to Rugby, where Australia searches for redemption tonight. The Kiwi's fearsome captain is out with an injury, so the game may be worth watching, provided one's expectations are low.
Cricket is creeping into the news. Davey Warner belted a quick century on a small ground, seen as a step to his redemption. The one day side got belted in India, and are at one-one, with presumably more very hot curry to come.
The 'futball' (soccer) team beat even less competent Canadians and the local futball community celebrated. The powers are said to be trying to decide between three Aussies for their new coach, but things are looking very grim for the world cup. Bring back Davey Warner is Henry's advice ['Dad, you just don't get it' says one of the junior Thorntons.].
The image of Australian sport has beem greatly shaken by allegations of widespread drug use in AFL and Rugby League, says retiring global anti-drug crusader John Fahey. Best let the courts decide that matter, Mr Fahey. No convictions yet mate.
Image of the week.
Courtesy The Oz
Markets fail to allocate resources wisely – the affirmative case
Date: Friday, October 18, 2013
Author: Henry Thornton
Notes for Henry's contribution to a debate on 'Capital markets, as presently structured, fail to allocate capital wisely', conducted by the Paul Wooley Centre for the study of Capital Market Disfunctionality.
1. Two economists are walking down George Street. Let us call them Fama and Schiller. Shiller says to Fama: ‘There is a $100 dollar bill. Let’s pick it up’. Fama replies: ‘It that was a $100 bill it would already be picked up’.
2. This well-worn anecdote neatly sums up the debate between economists who believe every situation reflects some voluntary ‘optimal’ situation and those economists who recognise situations of disequilibrium, or non-optimal situations. Some such situations can persist for long periods of time. This is in my view a normal state of affairs.
3. Recognition of Shiller's point can lead people in two different directions: - One direction leads into policy analysis – attempts to find ways to improve allocation of resources to restore the rate of unemployment to a more nearly normal, or ‘proper’ state. Often, such efforts merely make things worse, or have toxic side effects such as imposing great burdens of debt on future taxpayers. - The second direction leads some individuals to attempt to take advantage to the situation, as when George Soros famously took advantage of a highly over-valued UK pound in 1992.
4. I have travelled down both paths in my career as an economist. The first direction is easily the harder, as it requires a large number of planets to line up, as for example when the Australian government agreed to float the dollar. This herculean policy reform occurred when the Campbell committee of experts (which included our opponent today, Tom Valentine), the business community generally, the government, as advised by the Reserve Bank (but not Treasury) all agreed to free the Australian dollar to allow for a more efficient way to manage the Australian dollar and the Australian economy.
5. The floating exchange rate has meant that resources are allocated more efficiently than they were when the currency was fixed. However, resource allocation is far from optimal when a floating dollar becomes stubbornly high, as it has in the past few years. (The RBA governor's statement today that he is 'powerless' in this matter is surely a joke, or an admission that he is overdue for retirement. A tax on capital inflow would fix this problem, but the bureaucrats lack the courage to implement such a tax, fearful that it will cause capital inflow to dry up.)
6. As a young mann at the RBA I was more than once told to 'say it again with examples'. That is my approach today.
7. I will provide three cases of improper, or inefficient, certainly unwise allocation of resources.
8. The first is unemployment, the inefficient allocation of human capital. Many people bewail the waste of resources with high unemployment that so worried Keynes. In various Southern European nations overall unemployment is in the range of 20 to 30 %, and for young people it is well over 50 %. Even in the mighty USA, overall unemployment is still officially measured at around 7 %, and this is despite near zero cash rates and so-called ‘quantitative easing’ that amounts to massive monetary policy stimulus. Europe has equally easy monetary policy, but tighter fiscal policy, as the Eurozone’s leading economy, Germany, sees austerity as the main answer to the Eurozone’s economic woes. This will end badly, perhaps very badly.
9. Labor markets are everywhere among the most constrained, and for whatever mix of ignorance, institutional rigidities and outdated regulations generally, involves massive misallocation of resources.
10. There is a clear barrier to full employment globally – the prohibition on free international movement of people seeking a better life. Most if not all economists agree that freedom of people to move internationally would increase the efficiency of the global economy. But few recommend such a radical policy, especially those running small enclaves of western-nation prosperity in the ocean of third-world poverty.
11. A softer version of labor market freedom is the modern trend to outsourcing of jobs to third-world work-forces. This is usually strongly opposed by those who lose their jobs in developed nations but there are few examples of unions willing to allow their member’s wages to be cut to keep the jobs at home.
12. A second example is misallocation of scarce investment resources, this time involving the more conventional matter of where to allocate scarce financial resources. In most western nations there are considerable tax advantages for investment in the family home. Here in Australia, for example, there is no taxation of capital gains on the family home, and at various times there have been cash grants for first-time home buyers. Australia perhaps leads the world in production of McMansions, enormous and elaborate houses on the fringes of the major cities with swimming pools, spas, home theatres, good heating and cooling and room for several upmarket cars in which the family members battle heavy traffic on inadequate roads or scarce public transport.
13. Yet Australia, and other developed nations that invest a lot in houses still has a housing shortage, defined by the number of people who have no place rented or owned by them to provide adequate housing. Economists might say that the homeless people lack adequate human capital, and this may well be true, but it is certainly another example of inefficient allocation of capital.
14. Whilst back on the subject of human capital, one should observe the overspending on acquisition of degrees to the point that people with more than one degree live at home for lack of a job or the inability to find a job that allows them to acquire a dwelling place of their own. A ruthless economist might remark with surprise the sub-optimal number of unexplained deaths amount parents who so stubbornly refuse to die of natural causes.
15. Then we come to the more conventional investment markets. Here the near-zero cash rates and ‘quantitative easing’ of recent years have played havoc with capital allocation. I have recently re-examined the data of Friedman & Schwartz to ask how the admission of asset inflation (specifically share price inflation) has altered the analysis. In most of the episodes analysed by Friedman and Schwartz, share price inflation moves in similar directions to monetary policy, as defined by the rate of growth of money. - Money growth fast, both sorts of inflation rise - Money growth low or negative, both sorts of inflation low or negative.
16. However, there are several episodes in which money growth is ‘moderate’, as is goods inflation, and share price inflation goes through the roof. The 1920s, the 1950s and the 1990s in the USA, and Japan in the 1980s are the most startling examples. Since in three out of these 4 episodes the share boom was followed by a bust that clearly created widespread economic distress, these aberrant episodes deserve far greater scrutiny than they have so far received.
17. The near zero cash interest rates of Mr Greenspan and the virtually zero cash interest rates of Mr Bernanke (plus ‘QE’) is part of the fallout from the share crash at the end of the so-called ‘Great Moderation’ of the 1990s. Whenever there is a hint that the US Fed might begin to end its super-easy monetary policy financial markets take fright, which suggests to me that current levels of share prices and bond prices are not the result of wise allocation of capital, but rather opportunistic speculation.
18. This is fine for successful speculators but not the best we can do and should do for the majority of our citizens.
19. I would be happy to discuss how the world might move to a wiser system of capital allocation if time permits, but for the present debate it is sufficient to demonstrate that current policies and our present policy framework, fail to allocate capital wisely. But let me pass on an iron law to the RBA people present here today. Milton Friedman said 'Monetary policy cannot serve two masters'. Manipulating interest rates cannot both contain inflation and overall economic stability (two tightly linked objectives) and also contain a housing bubble or restrain an overly buoyant currency.
20. To go back to my opening story, it is not a $100 bill that we might choose whether or not to pick up, but a mighty IOU that we shall all be forced to deal with very soon.
Psycho-history predicts US chaos
Date: Thursday, October 17, 2013
Author: Henry Thornton
'On the surface it seems inexplicable. The government of the most powerful country on earth has shut down and is dangerously close to defaulting on its debt. Its people and economy are feeling the consequences, and a new global financial crisis might not be far behind. And all this because a minority faction of one house of Congress will not approve a budget unless a healthcare measure that has already been passed into law is suspended.
'But for Peter Turchin, a mathematical ecologist at the University of Connecticut in Storrs, the stand-off was predictable. He is one of a small group of people applying the mathematics of complex systems to political instability. They have been anticipating events just like this – and they say that if we don't find some way to respond to the warning signs and change course, things are bound to get a lot worse before they get better'.
This has echos of Kondratieff's long cycles, even Asimov's psycho-historian Hari Seldon,'the only man who can see the horrors the future has in store: a dark age of ignorance, barbarism and violence that will last for thirty thousand years'.
'Turchin has found what he believes to be historical cycles, two to three centuries long, of political instability and breakdown affecting states and empires from Rome to Russia....
'Workers or employees make up the bulk of any society, with a minority of employers constituting the top few per cent of earners. By mathematically modelling historical data, Turchin finds that as population grows, workers start to outnumber available jobs, driving down wages. The wealthy elite then end up with an even greater share of the economic pie, and inequality soars. This is borne out in the US, for example, where average wages have stagnated since the 1970s although gross domestic product has steadily climbed.
'This process also creates new avenues – such as increased access to higher education – that allow a few workers to join the elite, swelling their ranks. Eventually this results in what Turchin calls "elite overproduction" – there being more people in the elite than there are top jobs. "Then competition starts to get ugly," he says'.
In Turchin's theory, the current phase in the cycle should also be marked by political polarisation and rising government debt – both current crises in Washington. Real wages, the minimum wage, trade union suppression, the share of wealth owned by the richest one per cent, even filibusters and fights over judicial appointments – all have changed at the same time in ways reflecting reduced social consensus. Meanwhile, the elite class has grown sharply. Between the 1970s and 2010, college fees rose, yet the numbers of doctors and lawyers qualifying per head of population nearly trebled. Workers have steadily lost out. The "real shocker", says Turchin, is that the average height of Americans peaked in 1975. It has actually declined in black women since then – a fact that could be down to falling nutrition standards linked to lower incomes. None of the trends shows any sign of reversing.
This approach deserves scrutiny and the most rigerous testing. The only reliable test is to predict developments ahead of time rather than 'explaining' them after the event. Begin the scutiny here, and contact Peter Turchin if you can find him. But if his approach works, a Nobel prize must be in the pipeline.
US budget impasse ... Plans A, B & C
Date: Wednesday, October 16, 2013
Author: Henry Thornton
The quality press in Australia is saying that a deal will soon be made to fix the US budget impasse, even if this is just a bandaid fix over what is best seen as an oozing, toxic fiscal mess.
The media, like market participents, has largely been saying the mess must be fixed because not fixing it would be 'unthinkable'. 'Logic must eventually prevail' is the line of thinking.
But even if the bandaid is applied and we all go back to enjoying the zero interest rate/quantitative easing fuelled asset boom, how does the US fiscal mess get fixed in the longer term? This was the question fired at Henry by his visitor from Sydney yesterday.
There are only three ways to fix a fiscal mess of the size the USA has accumulated. The underlying cause is spending in excess of tax receipts, a policy that Ronald Reagan got away with for some time. Read Alan Moran's analysis of that historic policy, as told by Mr Reagan's budget director, David Stockman, courtesy Quadrant.
Stockman 'sees near-unresolvable economic problems, the cause of which he lays squarely at the door of successive governments with their extravagances, bad spending decisions, budget deficits, and artificially low interest-rate settings that have brought excessive investment in housing, savings disincentives and potential inflation. These are aggravated by what he sees as an undermining of the capitalist structure caused by owners’ agents, management, looting of company profits through financial engineering and by recent government bailouts of poorly managed firms.
'Stockman blames the present endemic US current economic crisis on politicians’ spending programs and loose monetary policy. The adverse effects of these have been growing like a cancer for almost eighty years, reaching a crescendo with the Global Financial Crisis (GFC) of 2008 and an aftermath that continues to plague the world economy'.
Plan A to fix the fiscal mess is to reverse America's 'extravagances, bad spending decisions, budget deficits, and artificially low interest-rate settings'. But the US legislators are finding it hard even to agree on a temporary rise in the limit on allowable borrowing by the US government, despite the possibility that the USA will have to default on its debt repayments, unleashing a global crisis that will make the failure of Lehman Bros look like a teddy bears' picnic.
Put a line through Plan A.
Plan B is to repudiate the debt. The mighty USA act like a failed entrepreneur and abandon its commitment to the rule of law? To be sure, the US corporate culture (and corporate law) allows failed business leaders to become bankrupt and start again, sometimes to fail again but occasionally to succeed beyond their wildest dreams. 'It works for American business failures, why not the US government' will be the cry of the Tea Party Republicans.
Global interest rates would leap, central banks would strive mightily to provide liquidity, but trust, that vital but often unstated pillar of global capitalism, would be smashed. Massive disruption of business, trade and capital flows would result.
For goodness sake, US Tea Partiers, put a line through Plan B.
This leaves Plan C - massive global inflation. As already noted, massive monetary stimulus would be applied under Plan B, but even if the bandaid is applied successfully, this is the likely scenario when Plan A - fix the underlying fiscal problem - fails.
Historically, some nations have succeeded with Plan A - Australia in the 1980s (but the crisis came anyway, in 1991), Germany more than once, but only after terrible hyperinflation that wiped out both government debt and the savings of the middle classes, the UK up to a point regularly, with help from the international agencies.
But history says debt default or inflation, or some horrible mix of the two, is the usual solution to a proper fiscal mess. Tea Partiers say, explicitly or implicitly, 'bring it on' as they say only a proper crisis will get Americans to live within their means.
Countries that have defaulted, eg Argentina, are often allowed to borrow again, too soon for the proper messages to be absorbed in Henry's view. 'So USA will again be able to raise new debt before long' say the Tea Partiers, but Henry questions this view. If USA and therefore the world is plunged into depression, borders will close, capital flows and most trade will dry up, and radical politicians of all stripes will battle for ascendcy.
At this Henry explained to his visitor that the implied China-USA economic compact was an economic version of the MAD ('Mutually Assured Destruction') balance of terror that governed US-Soviat relations during the cold war. China lends to the USA so that Americans can spend on Chinese imports. A US debt default would put a spoke in that wheel whose long-term effects would destroy world trade just a certainly as a nuclear strike would have flattened major cities if the cold War had hotted up.
By all means enjoy the equity boom that will go on if and when the bandaid is applied to the oozing, toxic fiscal mess in the USA. But consider what you will do to protect your family's wealth and welfare when Plan A fails and some mix of Plans B & C is applied to the US economy.
Postscript: We note the Australian dollar stubbornly continues to rise again. A rise in a worst case is more likely that a fall (unless Australia's economic policies fail, which is very unlikely under the current government). Please re-read Henry's 2013 articles on economic policy and ask whether a tax on capital inflow is needed to tame the Aussie dollar, interest rate cuts and the RBA's open mouth policies having failed to achieve this worthy objective.
Why saving makes us happy
Date: Tuesday, October 15, 2013
Author: Henry Thornton
A dear friend of the Thornton family is visiting us from Sydney. Said friend is (I would judge) of the political left, but on this occasion admitted to taking Henry's advice in matters economic.
'I've paid off all my debts', said friend confessed, 'and I am amazed how happy I feel'. 'Why is that?' Henry asked, it being more usual for him to be punished for offering good advice than to be thanked. 'I just feel uneasy about the future. My business (which involves selling antiques) could dry up overnight. But I am surprised just how good I feel now that I am debt free'.
Henry offered congratulations and also confessed to being free of any debt. 'Other friends make fun of me for having what they call a "lazy balance sheet", but we are not alone. Australian households are now saving around 10 per cent of their incomes, I suspect for similar reasons to you, a general feeling the financial crisis is not over and reducing debt will improve the resilience of their family finances'.
'Reducing debt is one thing, but what about saving?' asked said friend. Reducing or eliminating debt puts an individual, or a family, in a stronger position to cope with hard times. Saving, building a positive war chest, provides even greater resilience, as well as the opportunity to take advantage of hard times. Buying shares or houses during a big asset bust is one way to get financially comfortable, so long as it is a risk one can afford to take. The same logic applies to nations as to individuals or families'.
The discussion continued. Was Norway, with its massive sovereign wealth fund, being prudent or merely excessively paranoid? Why did the Howard government not save more of the bounty provided by the mining boom? Will the Abbott government do any better?
All good questions, with no easy answers. The bottom line for Henry is that being debt free makes a person, or a family, or a nation far freer than if him, or her, or it, is saddled by debt. A nation with no debt plus a large sovereign fund, plus a solid program of wise investments, eg in infrastructure, and adequate defence personnal and kit, should be well into the happy zone, and those of its people who are similarly well positioned should at least have less anxiety than their debt-ridden over-committed friends and relatives.
So endeth the lesson. Here is Henry's advice for the young, first published here almost fifteen years ago. Building a financially strong family or nation takes time, but in the end will create happiness, or at least remove an almost certain cause of unhappiness.
Saturday Sanity Break, 12 October 2013
Date: Saturday, October 12, 2013
Author: Henry Thornton
Clive Palmer's ascent, travel rort repayments, sagging jobs market, it's all happening folks.
Fortunately for Australia's political stability, clive's men and women are likely to vote mostly with the government, provided they are treated with appropriate civility.
Travel rorts are an endemic challenge for politicians and should somehow be done away with, eg by provision of standard amounts on a sliding scale from small for backbenchers, to moderate for opposition front benchers to large for the PM, Treasurer, Minister for Finance and Foreign minister, or perhaps for all holders of high office.
(Inspired by this, a similar approach could be taken for the general run of taxpayers - eg abolish all deductions in return for a lower rate of income tax.)
The sagging jobs market is a far more serious matter, and various pundits are stumbling reluctantly to the truth, as the late Aussie holmes would have put it.
From years ago there is Henry and Roy Morgan, last weekend John Black in the Oz and this weekend its the fin. This lagging source has on its front page 'Boomers finally hit retirement', and Alan Mitchell on p 22 says 'The labor market is weaker than it looks'. Mitchell includes a graph showing a reasonably steady fall in the ratio of employment to population aged 15 and over.
Various gurus have been touting economic reform, including (gasp!) reform of the labor market. Sadly this will not happen fast, and we shall need to rely on improved household and business confidence to give some upward stimulous to the market for jobs.
The great Non-race for the leadership of the once great Australian Labor Party is almost over. As someone said over lunch this week 'Statistically, neither candidate stands the slightest chance of becoming Prime minister'.
He documents Labor's refusal to grant legitimacy to John Howard's time in office, Tony 'unelectable' Abbott's time as opposition leader and professes to see the same useless failure to face reality now that Mr Abbott is actually the boss, and failing to bring on war with Indonesia..
Here is the killer conclusion: 'If you style yourself as the antithesis of a successful mainstream politician you must, by definition, push yourself to the margins'.
Buddy goes to Sydney (unfair!), Eddie Betts goes to Adelaide (sob!), Daisy Thomas comes to Caaarlton! (one hand clapping) and perhaps the JPod also (three cheers!). Imagine the Blues with a powerful 33 year old crashing the packs at Centre-Half-Forward, with Judd, Garlett and Yarran cleaning up the crumbs and kicking goals.
The Aussie cricket team lost its 20/20 game in India, and now will settle down to five one day games, in which one win would be cause for celebration. Then its the return visit by the pestiferest poms, and the prospect of yet another belting. Cannot out once great cricket team be paid by results - $10,000 for turning up, $40,000 for a win, $20,000 for a draw and zippo for losing? Also, for Henry's sake, bring back the Sheffield Shield.
George Thomas, part of the dynamic editorial team at Quadrant, has kindly allowed us to reproduce his review article from the 500th issue of the venerable mag, which will be celebrated in Sydney this week. Good stuff about the demise of amateurism and the wonderful career of Bert Sutcliffe.
Economy - Americans being sensible ... we hope
Date: Thursday, October 10, 2013
Author: Henry Thornton
Special correspondant, Treasurer Joe Hockey, reported via ABC radio from Washington that American legislators will almostly certainly behave sensibly over the matter of raising the US debt ceiling by a cool trillion dollars or so.
Apparently the game is to find the money to pay the interest on the debt, a cool 6 billion a year, which the Tea Partiers regard as 'not defaulting on the debt'. Sounds too good to be true, like President Reagan's 'voodoo economics', reviewed here by David Stockman and Alan Moran.
Mr Hockey contrasted the likely sensible behaviour of American legislators with that of Wayne Swan, who left the new government with a debt ceiling that will bite by about Christmas. Wall Street confirmed the Aussie Treasurer's positive view by pushing shares higher, while Uncle Joe told us that a 1000 point drop in US equities would signal things were actually not Aok.
The International Monetary Fund (IMF), best regarded as a lagging indicator, has lowered its forecasts for global, Chinese and Australian growth for, I seem to recall, about the sixth time.
The imminant appointment of Janet Yellan, to succeed Ben Bernanke, will entrench a monetary 'dove' in the US Fed, which presumably will allow current super-easy monetary policy to continue for longer. It is best remembered that government debt is most easily rendered harmless by a good burst of inflation. So far we have seen a lot of asset inflation, firstly shares, latterly houses, and other types of inflation cannot be too far behind. (Our first recognition of Ms Yellen was in 2006, and shows just how well the dreaded GFC was predicted by all and sundry - a powerful message, comrades.)
It seems that the switch in the Australian government from Rudd to Abbott and from Swan to Hockey has greatly boosted business confidence. Holden Australia is apparently unconfident about ever exporting a vehicle, even to New Zealand, so that should fix its claim for even more taxpayer assistance.
Ordinary Australians, however, are almost as worried as they were during the height of the GFC-induced frenzy about losing their jobs. As we have repeatedly said, Australia's labor market is in far worse shape than commonly believed, and later today we shall get another reading from the seriously deficient ABS numbers. 'Economists' apparently expect that the flawed 'rate of unemployment' will remain at 5.8 %, and if it rises this will be just another signal that things are worse than expected by unnamed 'economists'.
If the ABS rate of unemployment is stuck at 5.8 %, or even (gasp!) falls, readers are encouraged to applaud the ABS staff for their attempts to keep us all happy, at least until the pre-Christmas shopping season is successfully completed. Pity about that pesky 'Supply' difficulty, Australia's description of a debt ceiling inconvenience.
The global crisis: another view
Date: Wednesday, October 09, 2013
Author: Alan Moran
The following extract is from Alan Moran's review of David Stockman's The Great Deformation: the Corruption of Capitalism in America. We thank both Quadrant and the IPA (where Alan Moran is Director of the Deregulation Unit) for permission to publish this material.
As a chronicler of economic history and a policy advocate, David Stockman combines economics training with an inside operator’s knowledge gained at the highest levels of government and finance. Back in the 1980s he was plucked from relative obscurity as a junior Congressman to become President Reagan’s Budget Director. In The Triumph of Politics (1986) he lifted the lid on the Reagan revolution with its successes and its failures. The failures were associated with the “supply side” budgetary policy involving tax cuts without associated spending cuts. He vigorously opposed that at the time and considers it sowed the seeds for an acceptance of the excessive deficits now in place.
In The Great Deformation, Stockman extends and enlarges that historical analysis. He sees near-unresolvable economic problems, the cause of which he lays squarely at the door of successive governments with their extravagances, bad spending decisions, budget deficits, and artificially low interest-rate settings that have brought excessive investment in housing, savings disincentives and potential inflation. These are aggravated by what he sees as an undermining of the capitalist structure caused by owners’ agents, management, looting of company profits through financial engineering and by recent government bailouts of poorly managed firms. ...
Stockman blames the present endemic US current economic crisis on politicians’ spending programs and loose monetary policy. The adverse effects of these have been growing like a cancer for almost eighty years, reaching a crescendo with the Global Financial Crisis (GFC) of 2008 and an aftermath that continues to plague the world economy
Prosperity in the 1990s was, for the most part, fuelled by money-printing and a cumulative $2 trillion trade deficit. But this created financial crises, each one more serious than the one before. With the dotcom bubble bursting in 2001, even more liquidity was added, with near-zero interest rates leading to the housing boom and a supercharged Wall Street from then to 2008. However, liquidity injected into the system must eventually be spent on goods and services, the supply of which is impaired by the money supply boost misallocating spending away from new productive investment.
Loose money reached its apogee, marked by near-zero interest rates which pretty well exhausted its further potential to fuel demand. In spite of this documented failure of pump priming, this Keynesian policy was turned to in 2008 by Friedman’s pupil, the Fed chairman Ben Bernanke, and the former Goldman Sachs “bond salesman”, Treasury Secretary Henry Paulson. The USA launched its $800 billion stimulus and $700 billion Troubled Asset Relief Program (TARP).
The inevitable frittering away of these funds on faddish and heavily lobbied expenditures was seen in the exotic energy-spending failures like Solyndra and Tesla. And the USA had its equivalent of our own pink batts and superfluous school hall expenditures. The TARP included among its loans a $200 million facility to a business that planned to make auto loans set up by two totally inexperienced housewives whose husbands were executives of the already bailed-out Morgan Stanley Bank.
Deficit spending as in the 1930s has failed and left enormous debts. And there is no end in sight:
The much ballyhooed budget of [Vice Presidential candidate Paul] Ryan for fiscal 2012 added $7 trillion to the national debt, for instance, before it would achieve a balanced budget twenty-five years later; that is, in 2037. Eisenhower would have thought such a fiscal plan the scribbling of a madman.
Massive deficits cumulating year on year were added to policies like the creation of a highly unstable housing market. Low interest rates and political pressures on banks to lend to high-risk borrowers compounded this. The government-controlled re-insurer, Fannie Mae, fuelled the frenzy by facilitating debt. Home loan assets grew from $1.7 trillion in 1994 to $6 trillion in 2008, by which time the prices were falling. The securitisation “innovation” of the 82 per cent of sub-prime loans is now recognised as badly mistaken and hiding rather than smoothing risk. Similarly, the merger and acquisition frenzy of the past thirty years has been shown to have destroyed rather than created value.
Such activities have undermined previous standards of prudence on the part of businesses. One outcome has been a hollowing-out of listed companies as Wall Street brokers combined with management to create value by buying stock on the basis of which executives were rewarded.
The largest twenty-five companies on the Fortune 500 list [had] net income aggregated to $242 billion during 2007, but only 15 per cent ($35 billion) of that hefty total was reinvested in their own businesses; that is, allocated to additional capital expenditures and other working capital after funding depreciation and amortization of existing assets. By contrast, these same twenty-five companies ... invested nearly $345 billion in financial engineering and shareholder distributions. This stupendous total represented 140 per cent of the aggregate net income of these leading companies.
Stockman’s focus on monetary policy and the harm from very low interest rates is well placed. However, it does lead him into some doubtful judgments. Among these is his dismissal of the shale oil and gas revolution that is now under way in the USA. He considers this has been artificially stimulated by low interest rates undervaluing the cost of capital. It is much more plausibly a function of genuine innovation in the location and tapping of hydrocarbon reserves previously uneconomic. As in the dotcom boom, there are doubtless over-exuberant investments in shale oil, but gains from the new technology are real.
Spending increases, the TARP and company bailouts were justified as a counter to prevent meltdown. But the decline in inventories that signalled the downturn (15 per cent) was little different from earlier downturns and only one quarter that of the Great Depression. Stockman considers therefore that panic was uncalled for. The Fed and Treasury’s deficits meant a massive increase in government bonds and the attempts by the authorities to restore growth by pushing liquidity onto the market meant money from these bond sales was not on-lent as there was no demand. Stockman says of those deficits, “Specifically, the excess consumption enabled by subnormal household savings resulted in year after year of recorded GDP growth that amounted to little more than theft from future generations.” There was no payoff in terms of growth, which remains at its lowest since the Great Depression. But government debt grew from 67 per cent of GDP in 2006 to 103 per cent in 2011. The liquidity was used to fuel the stock exchange, and with every move to end it the market panics. This process continues.
In 2008 the main beneficiaries of the government bail-outs and the TARP were the major banks, which had invested in the housing market, and such businesses as GM which had developed excessive costs based on poor labour market management. Among financial institutions only the majors, very highly leveraged on mortgage and other toxic debt, were in trouble. By contrast, regular banks with under-performing mortgages on their books would not collapse but would instead incur losses that would be taken over many years.
But the GFC and governments’ responses is now history. The present Armageddon is the result of the frantic efforts to stave off a financial crisis set up by government measures designed to rectify spates of excessive credit creation over the past sixty years. Stockman offers a route back to stability involving measures that include: • allowing interest rates to be set by the market and not determined by the Fed • allowing only deposit-taking banks not engaged in trading and derivatives to have access to Fed funding support • requiring balanced budgets, eliminating subsidies, abolishing the minimum wage, Obamacare and a clutch of government departments and agencies • instituting a 30 per cent wealth tax payable over a decade to eliminate government debt
Little of this is going to happen. Stockman gloomily says:
In November 2012 the people voted for the only real choice they were presented; that is, for paralysis and stalemate. Now it is only a matter of time before the state finally fails as a fiscal entity. It is ... so overloaded with mandates and missions that it cannot move forward and it cannot move back. Instead, it will become ever more paralyzed and dysfunctional. The cruel corollary is that free market capitalism cannot help, either. It has been abused, burdened, demoralized, and impaired by decades of central bank money printing and the speculative raids and rent-seeking deformations which it fosters.