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Henry Thornton - Contributors: A discussion of economic, social and political issues Blogs
Central banks to the rescue, but urgent problems remain
Date: Friday, September 16, 2011
Author: Henry Thornton

Leading central banks have agreed to pump US dollars into Eurozone markets, helping to produce a fourth day of gains to global equity markets.

(The banks involved are The European Central Bank, the US Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank, clearly a serious mob.)

A first sign of US goods and services inflation was ignored amid the general euphoria, as was an increase of initial claims for unemployment benefits and more evidence of weak manufacturing activity.

Debate continues to rage about the future of the Eurozone, with Anatole Kaletsky presenting a varient of Professor Alan Meltzer's notion discussed here yesterday. Kaletsky suggests that Germany (rather than a group of strong Eurozone countries as in Meltzer's plan) leave the Euro, allowing a defacto devaluation of other Euro currencies but without the risk of bank failure that would be inevitable if Greece leaves, followed by other weak nations. (Kaletsky's views are in today's Australian newspaper, but again without a link, like Meltzer's yesterday)

Ambrose Evans-Pritchard reports from the World Economic Forum meeting in Dalian

"This is the most urgent crisis facing the world today," said Zhu Min, the IMF's deputy managing director and China's voice at the institution.

"There is no room for politicians to muddle through: they have to take decisive action today. Banks must be recapitalised and made solvent."

In distant Australia, Henry has purchased some out-of-the-money puts in case the whole Euromess trashes equity markets. Meanwhile, politicians continue to trade abuse and to argue about items on the traditional pinhead.

However, the Australian Bureau of Statistics (ABS) has galloped (well, plodded actually) to the gummint's rescue by redefining the contents of the 'basket' of goods and services in the consumer price index to suggest inflation is less of a threat.

Treasurer Wayne Swan has removed from the 'independent' Reserve Bank the right to set the governor's salary.  Apparently he learned of Glenn Stevens' million dollar plus salary only 18 months after the event, via the RBA's annual report.

If this is true, it almost defies reason because of the risk to a climate of low wage inflation that it posed. If Treasurer, most of us would expect it to be at least mentioned by the gov'nor in one of his regular chats. After-all the Treasurer is the representative of the parliament to whom Mr Stevens is ultimately responsible, despite the 'independence' notionally granted to the RBA by means of an exchange of letters.  The Reserve Bank Act, which defines the relationship of the RBA and the people of Australia, makes it clear just who prevails in any conflict.

Former governor Bernie Fraser was on ABC radio defending (weakly Henry thought) the governor's salary, but Henry's sources say Bernie himself turned down similar largesse in his time, as reported here. (See the May 23 2011 entry of the author's Blog at GreatCrisesofCapitalism.com.)

If 'independent' salary setting can be removed at the stroke of a pen, so too can 'independent' decision making, and it would be one sure-fire way to get the Aussie dollar to depreciate.

Take care, Glenn Stevens. Mention of how much you give to charity each year (assuming it is quite a lot) might be wise about now.

Saturday Sanity Break, 7 June 2014
Date: Saturday, June 07, 2014
Author: Henry Thornton

Greetings, gentle readers, from Dubai airport, en route to St Petersburg. The airport at Dubai is growing before one's eyes and is full of Airbus 380s. As we sit in the lounge we hear announcements of flights to just about every destination one could imagine, New York, London, Sydney, Toronto, Seattle, Entebbe, Venice, Muscat, Houston, Colombo, Dusseldorf, Kabul, Algeirs, ...

Australia is (almost) at the end of the road, although we were on a flight that started in New Zealand. This is the mini-state that already has a freer trade deal with China and no budgetary problems despite being derided with sheep jokes.  When we checked in at Melbourne we found the Qantas first class lounge was closing for the night, although we were on a joint Qantas-Emirates flight.  The Emirates first class lounge in Melbourne is far more modest that the Qantas equivalent, but we were welcomed and Henry was, gasp, upgraded, due presumably to his long and dedicated work as a Qantas travellor.

In Dubai the equivalent lounge reaches Qantas standards but is built on an industrial scale. More evidence that Qantas international is doomed, and one reads in the Weekend Australian that we are still debating the easier visa regulations for brikkies and chefs, fruit picking is almost all done by kids from overseas and unions are fighting hard for 200 % loadings for work on Sunday.

One is everyday reminded there is a lot of ruin in a nation, and that successive governments just do not get what is needed for Australia to reach its potential.  We shall travel on to Mother Russia, and look forward to young Henry's take on the issues of the week. We already know that Russia has even more onerous regulations than Oz, given the amount of paperwork that is required to get a visa so we can inject somw vital dollars (little dollars, but still hardish currency) into the Russian economy.


Caaaarlton! went down to Geelong by 5 points overnight, but Henry has still not found a balanced discussion of the game. Did they fight the game out or throw it away by f**kwit brain snaps as they did last week?

Clearly it was a great game. But seems it was umpire brainsnaps, as suggested here.

Delicious to learn that ASADA's star witness has been pinched by the plod for allegedly dealing in drugs, and that Mr Dank is on their list also. The supplements saga gets more farcical every week, and it is surely time for ASADA to apologise to those whose reputations have been trashed and get its act  together .

We wish the lads well who are about to take on the might of world futball.  Just one win and two draws/small losses would be likely to see us all watching the games in the wee hours. Great pity about renewed allegatons about briberygate.

Image of the week

Courtesy The Australian


Australian monetary policy and where does it come from?
Date: Thursday, June 05, 2014
Author: Henry Thornton

A response from reader Paul Schefe to Henry's blog on Tuesday June 3, 2014.

Thanks Henry for comments on the interaction between Monetary Policy, goods and services inflation and asset booms. I like your work.

In my view these are all related.

Since about 2000 when interest rates started to decline, house prices started to rise, (we then witnessed a large number of TV shows promoting DIY renos and the corresponding jump in house prices).

At this time there was a wholesale push on behalf of banks etc. to make use of this new found wealth. A massive number of overseas holidays, new cars, shares and more property were all financed by rising levels of home equity.

Mortgage interest rates are by far cheaper than personal loans or credit cards.

There are even bank products out there that encourage people to cost every purchase on the credit card and at the end of the month clear the card with house finance.

As time has moved on house prices have continued to increase mostly due to lower interest rates (ratios of income to house price increased from abt 3 times to 5 times, partially offset by interest rates decreasing from about 12% to about 6%), whereas banks required equity levels have stayed almost constant. (About 10%) give or take. Therefore most people that have a $40k deposit will purchase a $400,000 house before they purchase a $200,000 house as they aspire to a better house.

As the standard house-owner is now carrying much larger amounts of personal and mortgage debt. A say 10% correction in house prices downwards will wipe the equity of a large number of people. I believe that this will wipe the spending power in more luxury goods of a great many people. (say a 10% correction on a $400k house results in $40k of spendable equity disappearing).

I believe that it’s the ability of consumers to access house equity finance that has led to this correlation between monetary policy and goods and services inflation.

Secondly I believe that the share price boom is a domestic version of the “Carry Trade” Borrow from the house or the super fund at relatively cheap finance to invest in higher returning assets.

In conclusion I believe that this positive correlation between house equity, purchase of goods and services and share price booms works best when interest rates are low and house prices are increasing.

However I believe that when house prices decline (dependent on a number of factors, employment, interest rates etc.) the whole shebang might be in trouble.

Anyway these are my own thoughts on this matter.


Paul Schefe


Thanks for your note Paul,

you make some very salient points in regards to the greater access to finance for the prime purpose of purchasing a house - and the fact lower interest rates encourage greater speculation into property, and in turn larger and larger mortgages - and higher and higher house prices. Which allows greater financing on the spending of goods to fill up these houses.

A consumer boom. There is little doubt Australia has been living in an unprecdented boom in household consumption and consumer spending for the better part of 15 years now. It is almost as if Australia has been following the playbook we've observed from across the Pacific in the United States about how to inflate a property bubble and create this spending power....

There is no doubt that the United States went down the path of ultra low interest rates more than a decade ago - in response to the bursting of the so-called 'Dotcom Bubble Boom' of the late 1990s. US interest rates dipped below 3% for the first time in many decades in October 2001, and below 2% for the first time only two months later in December 2001.

Except for a brief period in 2006-07, when former Federal Reserve Chairman Alan Greenspan (who retired from the post in January 2006) and his successor Ben Shalom Bernanke raised interest rates in an effort to deflate the US housing bubble, US interest rates have spent most of the last 12 years below 4%, and indeed a majority of that period below 2%.

Analysing the recent history of US interest rates on a monthly basis shows that since first dipping below 2% in December 2001 US interest rates have averaged only 1.6%. Of the 150 months since then there have been 106 months with US interest rates below 2% (106/150 = 70.7%) and only 44 months with US interest rates at 2% or above (44/150 = 29.3%).

It should be abundantly clear that the low interest rates that have existed in the US for a dozen years have done little to create a 'sustainable' US housing bubble - which indeed heavily deflated half-a-decade ago and remains well below its 2006-07 highs.

It appears Australian policymakers have learnt little from the lesson provided by the US and the Australian experiment with low interest rates which began just over a year ago (Australian interest rates dipped below 3% for the first time since the independence of the Reserve Bank in May 2013), may well have many more years to run to try and keep the Australian housing market properly 'inflated'.

Is it sustainable? One would have to expect at some point it will prove unsustainable, but the other lesson from across the Pacific, and indeed from our neighbour to the North, Japan, is that policies that appear unsustainable can persist for a significant amount of time due to the great deal of inherent 'buy-in' to the system by an assortment of varied and vested interests - most significantly - the humble Aussie mortgagee and the politicians he elects to protect his nest egg.


Monetary policy reform #3
Date: Tuesday, June 03, 2014
Author: PD Jonson

The RBA board meets today and is widely expected to deliver a firm 'no change' outcome.  With goods and services inflation under control,  house prices taking a breather, economic forecasts having been revised down and the fierce debate over a modestly tough but badly explained budget, this is an acceptable outcome. This writer remains concerned, however, that there is a deep problem in how central banks respond to asset inflation and this is doubly concerning in a small open economy whose share price inflation comes 'made in America'.

Loads of research have proved that goods and services inflation is influenced, even determined, by the setting of monetary policy.  With fixed exchange rates it is US monetary policy that matters most, and a floating dollar gives more weight to domestic monetary policy.  There is a problem in defining monetary policy - is it cash rates, growth of money supply (with different definitions of money to play with) or 'Chairman's discretion', which can more respectfully be defined as 'the narrative'.

'The narrative' is the outcome of a diligent management group (the board of the RBA in Australia's case). This group, we know, considers the whole set of actual economic data, forecasts of key variables, especially goods and services inflation, growth of credit, behaviour of asset prices, the labor market, GDP, etc, etc. Such a group will take account of relationships established by economic research, such as that between growth of money and goods and services inflation, seeking to make allowance for known changes in these relationships. The clearest of these changes in this writer's direct experience was when the relationship between growth of M3 and goods and services inflation broke down and Australia had to abandon the 'conditional projections' for M3 growth. (This came as no great blow to the RBA governors at the time, as they were deeply suspicous about the supposed relationship - remember Goodhart's law.)

At the time, RBA's replacement of this relationship was called 'the checklist' which it is fair to say was not well received at the time by academics and journos. Naturally I regret that I did not propose 'the narrative', including with primary emphasis on actual and expected goods and services inflation. (A senior journo said recently that my views had not changed and finally I was in the right camp again.) However, confession of past inadequacies, while good for the soul perhaps, is no substitute for hard analysis.

My recent research investigates what Milton Friedman and Anna J. Schwartz might have discovered if they had included share price inflation in their masterful A Monetary History of the United States, published in 1962.  My analysis, with two colleagues, is available here. It shows that share price inflation usually moves in line with monetary growth, consistent with behaviour of goods and services inflation. But there are a number of key anomolies involving the war years but also times when monetary policy (as measured by money growth) was firm and under control, as was goods and services inflation, when massive share booms occurred. In US monetary history, these episodes were the 1920s, the 1950s, extending into the 1960s, and the 1990s. Japan in the 1980s is another similar 'aberrant' episode.

In three of the four aberrant episodes, the massive booms were followed by sickening crashes leading to depression or deep recession and slow recovery. The world is still recovering from the crash of 2000, despite the US Fed dropping interest rates to near zero, followed by a resumption of share inflation, another share crash, fresh near zero interest rates and slow recovery with US share prices again hovering at record highs.  I fear this drama has not yet reached its finale.

Galbraith in his analysis of the Great Depression of the 1930s, hinted that with a separate policy, reducing allowable margin of bank lending for speculative purposes, the US Fed could have restrained the share boom of the 1920s without harning the general state of the economy.  Such action, perhaps, might have limited the devastation after a (smaller) share crash in 1929.

Merely tightening monetary policy might have done the job, at the cost of creating a temporary check to growth, and seeing the Fed blamed for an (earlier, smaller) share crash, since 'Monetary policy cannot serve two masters'. Because the big, out-of-control share booms coincide with normal money growth and low goods and services inflation, tightening monetary policy to head of a share price boom would seem a very blunt instrument indeed. This logic is the basic cause of the 'Greenspan/ Bernanke put' - ie let the boom run and clean-up later (with very low interest rates).

I am happy to debate this matter with anyone, and have offered the following challenge, so far not accepted.

'Economic management needs flexible, ultimately automatic, variable bank asset ratios to lean into asset booms and to limit asset bubbles. Such an approach would leave variable cash rates to control overall economic conditions, with an ultimate focus on controlling goods and services inflation. Monetary policy would serve one master and bank prudential policy (as we might call variable bank lending ratios) would prevent runaway asset inflation.

'Tell me how I am wrong, central bankers, or stand condemned when you next bungle an asset boom and bust'.

More here.

For a small open economy, the exchange rate regime plays a large role in the narrative.  For Australia to avoid catching share price fever from Wall Street, or perhaps in a decade or so, the Bund, I have concluded we need a variable tax on capital inflow.

I am aware of the standard way to handle dissidents in central banking circles - maintain a lofty silence, later make adverse comments about the dissident, and still later say 'we knew this all along'.

In the age of the internet, dissidents can go directly to the public  - 'the great uwashed' in central banker speak - or to the politicians.

Read this and ponder, Joe Hockey, and friends from the G20.

Professor David Laidler comments: 'I don't have much to say that adds to your persuasive arguments. I agree that low and stable inflation is a good target for monetary policy, and that bitter experience shows that is it not sufficient to deliver asset market stability in a reliable way. I also agree that the best way to deal with this is to turn to regulatory tools to deal with the latter, but just what they should be, and who should be in charge - the central bank or some other agency - surely has to depend on local institutions and experience, which I think you'd also agree to'.

Saturday Sanity Break, 1 June 2014
Date: Sunday, June 01, 2014
Author: Henry Thornton

'Australian wages are too high and will have to come down'. Henry heard this heretical statement on, wait for it, ABC radio yesterday morning. 'I don't know if this will happen in one year, ten years or 50 years', Continued the voice, 'but it will have to happen'. After a bit more in this vein, the breathless young interviewer signed off and thanked Nobel Laureate economist, Sir James Mirrlees, for his views. Gor Blimey, comrades, this is pretty grim.

Shortly after, Henry was asked to discuss the state of a home renovation project with the relevant builder.  Un-prompted, our conversation drifted to the state of the nation, as this particular builder is a bright bloke with a deep interest in that subject. 'Wages are going to have to fall', John said. 'In the end it is Chinese wages that will decide what we can pay ourselves'.  I mentioned that a Noble Laureate agreed with this view. 'Most Australians know this, but they are hoping it does not happen too quickly or too savagely. The budget has made a start, but there is an awful long way to go'.

I was gob-smacked, comrades.  I knew that John was a bright bloke running a superb small business, but to find he agreed with James Mirrlees, and for that matter Henry (one of whose statements on this matter is available here) was literally mind-blowing. If is it is true that most Australians understand the problem, and are resigned to the remedy, what a pity there is no way to have a sensible national discussion and agree on the least disruptive answer.  The point made by Charles Dickens is relevant here, generalised as follows.

'National competitiveness strong, economic bliss.
National competitiveness weak, economic hell'.

Being experts in fighting for lost causes, the Australian Labor party will do its best to ensure we achieve the latter outcome.  The current government will get progressively braver, but will be distracted, naturally enough, by the need to get re-elected. As a start, Henry suggests that the pollsters find a way to begin asking relevant questions.

Global monetary policy

Last week, Henry strayed onto turf that is the responsibility of major central banks, with the RBA perhaps allowed a brief statement.

The relevant blogs are here and here.

The conclusion of part 2 is as follows: 'Friedman, curiously to this writer, says that the Fed could have nipped the 1920s share boom in the bud with a strategic rate hike, but this approach ignores his own 'two masters' advice.

Galbraith implies that in the 1920s, raising margins for share trading could have prevented the bubble and therefore made the share price crash less damaging. The same issue arose during the 1990s share boom, with The Economist saying the Fed should have raised interest rates sooner to prevent the share price bubble.

Raising margins for lending against shares, a seperate action to raising interest rates, could have prevented the bubble in the 1920s. An equivalent action in the 1990s, containing bank lending, could have reduced the  extreme share price action in the 1990s, and the subsequent drop to near zero in Fed fund rates.

Let me be absolutely clear.  Economic management needs flexible, ultimately automatic, variable bank asset ratios to lean into asset booms and to limit asset bubbles. Such an approach would leave variable cash rates to control overall economic conditions, with an ultimate focus on controlling goods and services inflation. Monetary policy would serve one master and bank prudential policy (as we might call variable bank lending ratios) would prevent runaway asset inflation.

Tell me how I am wrong, central bankers, or stand condemned when you next bungle an asset boom and bust.

Geopolitical musings

Tiresias provides a splendid expose of the geoploitical consequences of the mad situation in the Ukraine.

On the potential costs to Australia: 'Make no mistake about it – the Zhongnanhai will very quickly move to strengthen relations with their one-time friends and one-time rivals in the Kremlin. The hardliners in China, especially the officer corps of the Peoples’ Liberation Army, will be strengthened immensely, as will the Chinese secret services. Those elements inside the Chinese leadership that might have been sympathetic to seeking an accommodation with the US will now be greatly weakened. The potential cost of defence spending in Australia in the ensuing decades may well be colossal'.

Read on here.


The Swans, with their multimillionaire forward line, blew away a young Geelong team on Thursday night.  This afternoon, Caaaarlton! struggled all day against bottom side Brisbane and then squandered a 16 point lead with a few minutes to go. Result - there goes the season. Sigh! Lots of time to attend to the garden, gentle readers. Offsiders waw speculating darkly about changes yet to come at Princes Park.  Bring back Rats seems to be the cry.

The Futball team are in Brazil and were filmed attending a beach. Sun, surf and s*x, there could be no better preparation for an upset goal, even a scoreless draw or (gasp!) a win in the Group of Death. Trouble is, the Italian, probably a previous Australian immigrant with a chip on his shoulder, who ended our run at the last World Cup is probably still plying his trade.

Our two national hockey teams have hit form at the right time and are aiming for two world titles in Holland, or is it the Netherlands? Go girls and go boys.

Image of the week (And then there was this, demanding extra staff ... Did no one tell Mr Palmer the Age of Entitlement is over ... OVER.)

Monetary policy reform #2
Date: Thursday, May 29, 2014
Author: Henry Thornton

The longest and strongest boom in American share prices ended in two stages. Stage one was the peak in Tech stocks.  In April 2000 the Nasdaq collapsed, losing one quarter of its value in a few days. Investors, previously ‘exuberant’, became cautious.  The broader indices fell in sympathy, but by August, both the Dow and S&P were inching their way back toward their earlier peaks.  Investors expected rates to stay on hold when The Fed met on 22 August.

Evidence for a slowdown was still not strong. First quarter growth was 5 %, and, while preliminary estimates of second quarter growth were similar, but mainly into inventories,  it was widely believed that risks were still tilted toward inflation.

Complicating matters, healthy pay rises had not yet translated into increases in unit labor costs, and inflation seemed to have slowed.

The Economist asserted that the economic arguments were 'finely balanced'. The venerable mag added:

* Politics says do not hike rates during a (presidential ) election; however
* Psychology suggests a 25 point rate hike – investors think it is going to be ‘no increase’ and absent a rate hike shares may surge, reigniting the powerful boom.
Bob Shiller's book appeared, and presented some worrying arguments.  The bottom line, the take-away message, was that every previous technological revolution had created a speculative bubble, and there is no reason it should be different now.

Shiller tracked the Price-earnings (Pe) ratio through 120 years, a period covering huge technological change.
*  Nineteenth century was a period of great invention, with prosperity helped along by massive gold discoveries, and these factors drove the Pe ratio to peak in 1900.
* The 1920s were another time of rapid devlopment in which the Pe hit its peak in 1929, then tumbled by 80 % in next three years.
* Ominously, share prices in 2000 were higher in relation to profits than in 1929.

A comment on the the Fed’s performance
* If inflation (traditional indicator) is correct, Fed has done a superb job.  Low inflation has combined with strong growth.
* The Fed has argued that faster growth is due to strong productivity increases and has allowed economy to run faster.  This has allowed share prices to rise further, into bubble territory.
*Some say either higher productivity or higher share prices justifies rate hike, and so the Fed should have done more.

(From almost 10 % in 1989, the effective Fed Funds rate had fallen to a low of around 3 % in 1993, risen to a peak of 6.5 % in mid 1995. Subsequently, there was a fall to 4.8 % in early 1999 followed by a gradual rise toward 6.5 % in late 2000.)

In a powerful article in December 2000, The Economist pointed out that '… four years on, to the very day, and with stockmarkets considerably higher than in 1996, Mr Greenspan injected some irrational exuberance of his own. With a reassuring speech that was taken to imply that the next move in interest rates would be downwards, and that the Fed was ready to ease if the economy slowed too sharply. Mr Greenspan lifted shares by almost $600 billion in a single day. The Nasdaq rose by 10 %, its biggest-ever daily gain.

Markets were now discounting a half-point cut in interest rates in the first half of 2001. But that would only happen if consumer spending falls.  If instead it rises, rates may need to rise.

History showed, The Economist asserted, that central banks very rarely steer economies to a soft landing.  ‘The borrowing binge that has taken place in America on the assumption of ever-rising profits and share prices may seem especially unwise as growth slows. And pessimism can be as contagious as exuberance’.

In another end-year reflection, The Economist asserted that cutting rates in 1987 and after the 1998 LTCM affair may have created an enduring problem.

‘The risk is that the Fed has created a classic moral hazard problem: it has encouraged investors to take more risks in the belief that interest rates will always be cut if share prices slump or the economy slows. That may engineer a soft landing now, but it also runs the risk of an even harder landing in the future when the markets and the debt overhang have climbed even more’.

‘The fate of the whole world hangs on America.  The American economy may get its soft landing. But only a fool would take this for granted: the risk of a much bumpier downturn is real’.

Alan Greenspan quickly cut Fed Funds rate to one percent.  The Greenspan put was now firmly in place.  The Economist's hard landing was avoided, for the moment. Yet within a decade, Greenspan's successor had cut Fed funds virtually to zero, banks had to be bailed out and 'quantitative easing' invented.

In this writer's view, there is a fundamental flaw that is inherent in almost every central bank's view of how to control an economy.  Milton Friedman said that 'Monetary policy cannot serve two masters'. The 'Greenspan put', with Ben Bernanke's endorsement, agrees with this judgment in the booms but abandons that view when the share bubble bursts.

Friedman, curiously to this writer, says that the Fed could have nipped the 1920s share boom in the bud with a strategic rate hike, but this approach ignores his own 'two masters' advice.

Galbraith implies that in the 1920s, raising margins for share trading could have prevented the bubble and therefore made the share price crash less damaging. The same issue arose during the 1990s share boom, with The Economist saying the Fed should have raised interest rates sooner to prevent the share price bubble.

Raising margins for lending against shares, a seperate action to raising interest rates, could have prevented the bubble in the 1920s. An equivalent action in the 1990s, containing bank lending, could have reduced the  extreme share price action in the 1990s, and the subsequent drop to near zero in Fed fund rates.

Let me be absolutely clear.  Economic management needs flexible, ultimately automatic, variable bank asset ratios to lean into asset booms and to limit asset bubbles. Such an approach would leave variable cash rates to control overall economic conditions, with an ultimate focus on controlling goods and services inflation. Monetary policy would serve one master and bank prudential policy (as we might call variable bank lending ratios) would prevent runaway asset inflation.

Tell me how I am wrong, central bankers, or stand condemned when you next bungle an asset boom and bust.

Monetary policy reform #1
Date: Tuesday, May 27, 2014
Author: Henry Thornton

After a severe global recession, the year 1993 provided new start and fresh hope. The economic outlook was for slow recovery for those OECD economies that were first into the recession (America, Britain, Canada), while some of the others continue to slow down (Germany, France, Italy).

Bond markets are usually a better guide than economists’ forecasts. Bond markets gave no support to the ideas of doomsters that the 1990s would be a rerun of the 1930s. ...  If any of that was more than just talk, money would be rushing out of real assets (land, machinery, offices) and into government paper; bond yields would have collapsed. Despite three years of disinflation, yields in the world’s seventh largest economies had barely fallen.

The mood of most companies and many individuals in the 1980s was to borrow, spend and hope. It turned rather suddenly to repay, save, fear.

Average inflation in OECD countries had fallen to 2.5%, lowest in 30 years. The Economist said: 'The battle against inflation has been won: the industrial world has entered a golden age of stable prices'.

US GDP growth was just short of 6 % in the fourth qtr 1993, so the ball was in Chairman Greenspan's court.  He had to act before inflation started to increase, so the US Fed was expected soon to begin raising cash interest rates.  The first rate hike for five years came in early February of 1994. Instead of falling, bond yields rose, in Western Europe and Japan, sharply.

America kept growing fast, rapidly running out of spare capacity, unemployment was at levels that had sparked inflation in the past and another bond market rout followed a bigger than expected rise of employment in March.  Kaufman - Dr Doom - said bond yields could easy reach 9-10 % from current 7.25 %.  But inflation was not yet rising.

President Clinton's budget was described as 'verging on the miraculous'. There were no cuts to Education, Social Security and Medicare, but tax cuts were promised while  the deficit was to be reduced.
One expert said the budget 'raises the white flag at the red ink of government spending'. The budget was ‘profoundly cynical’, the president leaving budget cuts to Republicans.

There were fears Mexico will not be able to pay its debts and that  Mexico’s crisis would further swell America’s $150 billion CAD.

In Europe, the strength of the D-mark was producing 'renewed chaos' in Europe’s currency markets.

Gordon Brown, the UK's shadow Chancellor, promised tough targets on spending, borrowing and inflation. Good economics, a newspaper said, but would it prove good politics?

The US dollar’s 'dizzy descent' further  unnerved the world’s currency markets. Chairman Greenspan (finally) said it was 'unwelcome and troublesome'. But Americans seemed untroubled.  Market players predicted that interest rates would need to rise.

On April fools day of 1995, The Economist pontificated:  ‘It is no coincidence that the countries that have seen the biggest falls in their exchange rate in the past year, and the sharpest rise in bond yields, have been those that are the most heavily indebted’.

‘Beyond a certain level', continued the venerable mag, 'indebtedness can cause a vicious circle: rising debt boosts interest payments, which leads to higher borrowing, and so on’.  This was a theme to worry many nations, but it did not seem to worry the mighty USA.

One of many discussions of US budgetary policy concluded in a manner Mr Abbott might recognise: 'Draft budgets of some courage have been put forward by the Republicans in Congress.

'Butchering corporate pork will not balance the budget, for the big cash is in middle class entitlements …’

‘A program of fundamental reform requires congressional courage, presidential vision and – not to be forgotten – considerable public sacrifice’.

Still America did not seem to care about the budget games. The Standard and Poors share index rose by 34 % in 1995 and experts concluded 1996 would be more subdued. After moderate falls in January, steep increases resumed, faster than in 1995. 'So far, the pundits ‘have been gloriously wrong’.

At the end of 1996, Greenspan 'fretted' about 'irrational exuberance' but thereafter went quiet on the issue of share price inflation.  Ordinary inflation remained benign despite continued, suprising to many, strong real growth and low unemployment.  As Galbraith said of the final stages of the share boom of the 1920s, when the Fed's feeble attempt at restoring sanity was defeated: 'For now, free at last from all threat of government reaction or retribution, the market sailed off into the wild blue yonder.' 

President Clinton was reelected – the budget still a big issue. Amazingly little discussion of highly favourable economic conditions in a time that became called the 'great moderation'.  In early 1997, The Economist pointed out that there was great diversity in setting monetary policy.

The Bank of England uses an inflation target.The Bundesbank keeps its eyes on various measures of money. Others prefer growth of nominal GDP.

A  paper from the Fed of New York ‘suggests that heavy reliance on money-supply measures is a bad idea’. 

'Experience from Canada to New Zealand suggested inflation targets are best'.

The Asian crisis in 1998 raised in some minds the issue of 'moral hazard' - if debtor nations are bailed out, won't they be tempted again to get into the same trouble?

America’s continuing stock market boom created great wealth, and also discussion of the 'virtuous circle' - strong low-inflationary growth boosts share prices, which boosts investment and hence productivity.  This, in turn, helps to sustain growth …

But there could be too much of a good thing - an 'overheated' stock market could cause overheated economy and push up inflation.

The question was posed - perhaps the Fed should already have raised interest rates. But in a sentance that could have been recycled from Galbraith's The Great Crash, it was pointed out that if the Fed did this now, it would to be blamed. From about now, expert discussion spent less time and space on budgets and more time and space on the boom in share markets - was the boom in danger of becoming a 'bubble' and, since bubbles always end badly (think 1929), what could be done to head off bubbles?

A comment from 1928 was dug out and reproduced: 'There is no means of knowing beyond question how far this recent rise in stock prices represents excess speculation and how far a real adjustment of values to increased industrial efficiency … and … larger profits'. So far as we know, this was the sentiment that Chairman Greenspan adopted. Do nothing and cut interest rates after the crash to minimise the damage. This was later described as 'The Greenspan Put'.

The Economist added: 'The two big investment-led recoveries this century – America’s in the 1920s and Japan’s in the late 1980s – ended in deep recessions. The risk is that over-investment, encouraged by a booming sharemarket, could lead to overcapacity, declining profits and – eventually – to a nasty contraction’.  It knew what should be done - 'pop the bubble, now', a mantra repeated with some regularity and ignored with perfect regularity by Chairman Greenspan.

Mr Greenspan adopted the  view there was a new age of IT driven productivity increases to explain low inflation, strong investment and strong growth generally with booming share prices. Experts said there were similar periods in the late nineteenth century, in the 1920s and the 1990s was a welcome action replay.

For a while in 1999 and 2000, demand ran well beyond any sensible estimate of enhanced product growth fuelled by productivity increases, and the Fed raised interest rates.  Then there was a rabid debate about the possibility of recession.

Thomas Meyer, hawk from US Fed Open Market Committee, said with US unemployment only 4.1 % more rate hikes would be needed. The Bank for International Settlements (BIS) ‘issued a blistering warning of a global hard-landing – led by the United States’.  There were articles about the possibility of bank failures.

Continued here.

Saturday Sanity Break, 24 May 2014
Date: Saturday, May 24, 2014
Author: Henry Thornton

What about debt asks one of Australia's leading businessman, Don Argus of NAB, BHP Billiton and Brambles fame.Don Argus is also concerned at the creation of asset bubbles, especially the stock price bubbles emerging from the USA, as the US Fed pumps money into a severely recessed economy. The money pumped in has gone dispropionately to raising share prices, not lifting the boats of a recessed real economy.

Debt and bubbles are two great risks to australia's economic well-being.  In Henry's view, lack of competitiveness is an even larger problem, one that Don Argus recognises but does not seem to rate too highly as a risk to prosperity. 

Here is a link to this important article.

A feature of Mr Argus' analysis is his focus on total (gross) debt - debt of governments, households and companies. Here is the table, which will repay study.

Don Argus says current debt levels will stifle growth: '... government debt is relatively low by global standards but total debt is quite high, and it is more skewed towards households than in the past. We cannot ignore household debt in our national discourse since the bulk of the Australian stockmarket and economy is exposed to the consumer wallet.

'At best this debt burden portends a long period of low growth for Australia because as you rack up debt you are bringing forward consumption'.  Note Bob Hawke's bold attempt earlier this week to help Australia become seriously rich while helping the world to drown in its own pollution. Linked here.

A constant theme in political commentary since the budget concerns the government's poorly explained attempts to rein in a budget out of control, 'the narrative'.

Henry tried to get this point over - linked here - before the budget was locked in stone, but got a dusty reception from the economic advisor to Mr Hockey, while Mr Abbott's economic advisor was too busy to respond.  Pollies really do need to interact with people like Don Argus with grey hair and battle scars.  Was the Abbott-Hockey economic narrative even road-tested with John Howard, one is forced to ask?

We are where we are, and one hopes that the Australian people will give Tony Abbott a second term.  It is worth recalling that we gave even Gough Whitlam and Rudd'n'Gillard'Rudd a second chance, so there is precedent.

Post-budget polling has emphatically confirmed a second major shift in public opinion since the election, the first being a strikingly early dip in the new government’s fortunes in November, leaving the opposition with a narrow lead when the dust had settled.

The latest landslip looks even bigger than the first, says William Bowe, Crikey's polling analyst and The Poll Bludger blogger, and it sends the Coalition into territory that was all too familiar to Labor during its tumultuous second term in office.

See Image of the Week below, which shows opinion polls that look absolutely horrific for the Abbott government.


Fiona Prior finds Hidden Treasure from Kabul at the Art Gallery of New South Wales. Gold, garnet, torquoise ... and treasures from 2200 BCE to 200 CE! Enjoy her overview here.

Footy'n'futball'n'other stuff

The socceroos are to have a young captain for the futball World Cup, and a bias to youth in team selection. Good luck to them, and if the team can survive the group of death many Aussies will be burning the midnight oil.

Caaaarlton! faces Adelaide this weekend, and we shall no doubt tune in to the telecast with limited expectations. 

The competition seems to have settled down to the best - Hawthorn, Geelong, Port Adelaide and Freo - and the rest. The big improvers are the Goldcoast Suns, and the Giants are also looking good.  Like Sydney in its day, it is always possible by offering extra help to boost a new team, and that has unbalanced the competition.

Melbournians with allegiances to their old suburban teams are beginning to wonder what is going on. Soon there will be two divisions and a new aim, to avoid relegation.  Works for Futball in other places, so it is another way for the AFL to make money.

Image of the week

Australia can be (seriously) rich ...
Date: Thursday, May 22, 2014
Author: Henry Thornton

... says Australia's great reforming PM, Bob Hawke.

There was a special poignancy in the speech by RJ (Bob) Hawke at the Cooperative Research Centre (CRC) conference this week.  Here was the Prime Minister who introduced the CRC program on the advice of his Chief Scientist, Ralph Slatyer, just a week after the Abbott government slashed 12 % from the CRC program.  This was done despite the proven effectiveness of the CRC program, as demonstrated by several rigorous reviews, most recently by the Allen consulting Group in 2012. The summary of that study is: 'Between 1991 and 2017 CRCs produced technologies, products and processes that were estimated to have a direct value of almost $14.5 billion'. And also: 'Relative to the funds committed to the CRC program by the Australian Government, the CRC program has generated a net economic benefit to the community, which has exceeded its costs by a factor of 3.1'.

(This latest of several studies of the CRC program is available here.)

In introducing Mr Hawke, CRC Association Chairman, Tony Staley described Mr Hawke as 'one of Australia's great Prime ministers'. He added that he knew his friend, John Howard, agreed with that evaluation. I can add here that, as a 'sherpa' at Mr Hawke's Economic Summit held shortly after the Hawke government was installed, I was greatly impressed with the political good sense of the summit, and (of course) even more impressed as the economic reforms began to flow, including the float of the Australian dollar. (This writer's account of that key reform is available here.)

At the CRCA conference, Mr Hawke delivered a dramatic speech, that so far has received only minor coverage by the mainstream press. (Here is a short example.)

The first part of the speech was about that formation and performance of the CRC program. Mr Hawke had appointed Australia's first Chief Scientist early in his time in government. Professor Ralph Slatyer was a former school friend of Mr Hawke, at the famous Perth Modern school.  He was 'quiet, studious and obviously brilliant' and went on to have a brilliant scientific career. Hawke and Slatyer shared 'wonderment' at the pace of change in the modern world, and Mr Hawke quoted the economist Kenneth Boulding who said something like (my notes might be defective): 'The world today is as different to the world in which I was born as that world is to the world of Julius Caesar'.

Clearly, if Australia is to have any chance of being on the pace we have to be smart enough to understand, and contribute to, the driver of the world's rapid change, which is global Reaearch & Development (R&D). And to maintain our place at the table of leading nations, even mid-level nations, we shall have to be a whole lot better at turning R&D into commercial outcomes.  That is the purpose of the CRC program, to provide taxpayer's cash to encourage scientists to work to solve real problems for end-users, be they companies or government agencies. This program is much admired by, and copied in, other countries, including China where this writer had some practical input to the relevant transfer of ideas.

The guts of Mr Hawke's speech was his announcement about the importance of nuclear power as a major way to solve the problem of global environmental pollution.  (He said 'climate change' but I believe 'pollution' is both more general and equally important to the asserted problem of global warming that is so passionately believed by climate change activists.)

In short, Mr Hawke wants Australia to enrich our plentiful stocks of uranium (40 % of known global stocks in some estimates), sell it others to provide fuel for the many nuclear reactors now being built (notably in China, where pollution is a major issue) and then take back the waste for safe storage.  Australia is the ideal place for such storage as it is geologically stable, and it was time for Australia to consider the idea with 'calm consideration of facts'.

During his time in government, Mr Hawke said, he had identified places in Western Australia and the Northern Territory that were ideal for safe long-term storage. Mr Hawke said that he had more recently spoken to relevant aboriginal groups, who were willing to consider the proposal provided only trhat they received their fair share of the fees involved.  He also said that he had spoken with the Northern Territory's Chief minister, who was keen on the idea.  Mr Hawke was also confident that Western Australia's premier would support the idea.

Enhancing uranium and storing waste would provide great wealth to Australia, and would solve the great fiscal constraints now causing such angst. More importantly, it would make Australia a 'responsible global citizen' and (I would add) make us easily able to provide for our defense.  Mr Hawke added that the facilities for enrichment and storage should be owned and run by government, a proposition which this writer totally endorses.

Concerns of some, Mr Hawke asserted, about China's future as a global power were wrong.  China has always been a peaceful power, and is deeply engaged in solving its own problems, including the massive problem of pollution. China is busy building modern nuclear power stations, and would regard Australia's involvement as proposed as a 'win-win'.

I think it is fair to say that the proposal was greeted by many present with shock, perhaps even shock and awe. Certainly the applause that accompanied the first part of Mr Hawke's speech dried up, and pins could be heard dropping in the vast lecture theatre. I was moved to say it might well be the most important of Mr Hawke's many contributions to Australia's welfare and place in the world. It deserves widespread discussion and deep consideration.

Mr Hawke's full address is available on the CRC Association website.

Disclosure: This writer is a former Chairman of the Federal government's CRC Committee, and a current Chair of CRC Care, a leader in remediation of polluted sites. 

Gor Blimey, comrades
Date: Tuesday, May 20, 2014
Author: Henry Thornton

'Who'd of guessed it?  Tony Abbott has taken the axe to every program he can find, even adding to the taxes paid by his rich Liberal mates. He's hit us battlers harder, of course, and the brothers at the local pub have all agreed to vote for Bill Shorten or Clive Palmer.  Gary Morgan says the Libs are buggered, and even the Oz says Abbott and his mates are in their own world of pain.  Dunno why, as all they're sufferin' is a wage freeze plus less free plane trips when they quit politics. Which looks like commin' sooner than they thought.  Even the useless bloody State Premiers are whinging, and most of them are Liberals'.

Henry's roving reporter filed this missive from a battleground of the class war, the front bar of Balmain's most traditional pub. The newspapers, even Rupert's Australian, have not been kind. They point out that structural budget reforms will help taxpayers in the long run, when some of us will be safely dead. The AFR yesterday gleefully (in Henry's view) reported the massive hit to the Coalition's standing in the polls and in Tony Abbott's standing relative to the Opposition Leader.

Laura Tingle says that Messrs Abbott and Hockey 'have no choice but to go back and rethink the entire political and economic strategy on which this budget is built'. Alan Mitchell points out that Mr. Shorten if in government would be forced to replace Mr. Abbott's unpopular measures by tough ones of his own.  But as Tony Abbott showed so brilliantly, an opposition does not actually have to present its own plan, just attack the plans of the government. One is irresistibly reminded that those who live by the sword are likely to die by the sword.

Henry spend yesterday in Adelaide with some up-market citizens, all baffled at the government's political strategy. 'Designed by someone whose never had a real job' was one comment. Another said they had no need to slice and dice the battlers - 'They could have fixed the budget by abolishing negative gearing, ending tax free super for the over sixties and killing Tony Abbott's fee kick for new mothers'. An economist in the group disputed this. 'The simplest solution is to broaden the GST and raise its rate to 15 %'. He pointed out that Tim Costello seemed to support that approach, and he added 'Tim is no Liberal thug'.

The theory that the government is playing a long game with the aim of getting the states to demand a GST upgrade may or may not be true, but adds to the 'mean and tricky' image that all pollies in Australia are already tarred with.

Sadly is seems the 'budget emergency' narrative has failed. Australia has a very low ratio of official debt to GDP and slow adjustment would keep Australia's position low on the international debt league table. What has only emerged now is the massive ramp up of Labor's programs in years 5 and 6, now that the previous five has become four.  This is a complicated matter, and it would have been much better if the prebudget narrative had consistently stressed that 'the budget is much worse that we expected'. Even better if the pre-election attack had included the repeated suggestion that things would be a lot worse than Labor's numbers implied. How could you not have expected that, Mr hockey, when Swannie's predictions had been so excessively rosy?

Henry's view remains that Australia has a nasty budget problem to unravel, but the bigger problem is Australia's relatively high cost level, and there is almost nothing in this budget except austerity for battlers to help sort this problem. As advised on April 30, if the government had taken a 20 % cut in their own salaries until the budget and competitiveness emergency was over, and invited business leaders to do something similar (having privately persuaded a number of senior business leaders to match the offer), the whole package would look far fairer, and in addition would be better economics.

A splendid analysis of the 'narrative' issue is in The Oz for 22 May, by Niki Savva.

Saturday Sanity Break, 17 May 2014
Date: Saturday, May 17, 2014
Author: Henry Thornton

Like the galahs in the petshop, every economist has been saying 'Why not the GST, Messrs Abbott and Hockey?'  'We promised not to change the GST until after an election in which we said we would', say the boys from Riverview. Fair enough, but the people at large think you have already broken a whole lot of promises, and might well prefer one 'repair the budget' broken promise than a whole series of smaller promises that most people think are unfair, considering the lack of  'heavy lifting' by people on high (>180 K pa) incomes who lose a mere 2 % of income above $180 K.

As one wag put it:

if it ain't hurting
it ain't working

The elites (those who don't drop their haitches) tend to sneer at the Herald Sun, a newspaper that has the bravest stories and especially the best sporting coverage of them all.  This newspaper yesterday was the first to come out for the GST.  Its prominant story yesterday led off as follows: 'RAISING the GST to 12.5 per cent and applying it to fresh food, health and education would raise $25 billion a year.

'This would more than compensate state governments for federal budget cuts to hospitals and schools funding while also funding tax cuts for low and middle income families.

'According to Deloitte Access Economics modelling, lifting the GST rate from 10 per cent to 12.5 per cent would raise $13 billion a year.

'Broadening the GST to apply to fresh food would raise another $6.5 billion. Applying the tax on health and education would raise another $3 billion each'.

Read on here.

The ex-Treasury man who provided these numbers, Chris Richardson of Deloitte Access Economics, said state premiers would be wise to lead a national debate about lifting the GST to fund critical services. The conspiracy theorists have been saying all week Messrs Abbott and Hockey are extremely clever, instructed in the dark arts of politics at Riverview, and have planned such a horrible budget so that State Premiers, indeed all the galahs and most voters, will cry 'The GST, the GST, we want a broader GST at a higher rate'.  Little New Zealand bit that particular bullet some time ago and now has a growing economy with (gasp!) a budget surplus.

Don't have a double dissolution, Mr Abbott, but instead a referendum like that Queensland ad, with more options.

Which option do you prefer (only one box can be ticked)

1. The budget's mix of spending cuts, asset sales and the temporary debt levy.

2. An across the board 10 % rise in every rate of tax except the GST.

3. A widening of the GST so there are no exemptions with the rate increased to 12.5 %.

4. The budget's spending cuts plus however much of options 2 and 3 that are needed to produce a balanced budget in 2014-15.

5. No action to fix the budget, continued growth of debt and a chronically weak economy.

Clearly Treasury would need to check the numbers, and it might be desirable to include the medical research fund in every option to lock in the academic vote.

Sorry folks, just joking, but the GST option is the fairest and most likely to fix the budget while improving the economy in the process.

Time to be totally serious.

The old master, Paul kelly, puts all this into serious perspective in the Oz.

On the GST debate, Kelly says: 'Abbott and Hockey have ignited a long reform fuse. By cutting $80 billion to the states from Labor’s fiscal expansion in schools and hospitals funding they are provoking a new debate about the federation including a bigger GST.

'This is a calculated move. Their intention is to provoke the states.

'Their message is that Labor’s financial centralisation requiring Canberra to meet greater funding shares for schools and public hospitals is untenable. The groundswell for a GST debate is apparent with the welfare sector, unions and business conceding the conversation is inevitable.

'The trade-offs are obvious: if we don’t rely more on the GST, then benefits will be tightened further and personal income taxes will do more heavy lifting'.

Read on here.  Ask yourself, as Paul Kelly does: 'Is Abbott crazy brave?'  Or just a dedicated economic reformer.

Even some people prominent in the welfare sector accept the view that widening the GST would be the least harmful way to set the budget on a sustainable course., and perhaps in the end a majority in either the old or the new Senate will do so as well.

In conclusion, I must insist that in the great debate over the budget, fixing national competitiveness has been overlooked, or put aside for another day.  My thoughts are summarised in terms of the narrative I would have preferred for the budget debate, or indeed the overall reform task.


There is respite this weekend as Caaarlton! is having a rest. Most of the better sides will be struttin' their stuff, with threat of ASADA 'show cause' letters hanging over 40 heads at Essendon high on the list of rumoured shocks. Even Henry, for whom Essendon is a tribal enemy, would not welcome such an outcome.  Some teams just play harder for longer, presumably because of better recruiting, training and motivation, like some companies. If it becomes proven that some teams used some sort of jungle juice instead, or in addition, it will do great damage to Aussie rules, as happened with cycling and the Olympic 100 metres.

Image of the week

Courtesy The Oz

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