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Henry Thornton - Contributors: A discussion of economic, social and political issues Blogs
IMF throws in the towel
Date: Wednesday, September 21, 2011
Author: Henry Thornton

The IMF Chief Economist Olivier Blanchard has thrown in the towel and downgraded the lumbering international agency's economic forecasts.

Though Blanchard still expects 4 % growth for the world, hardly shabby, his forecasts for developed countries have been edged down from 'barely acceptable' to 'bloody miserable'. (These are technical economic terms that sound far more impressive in French, ze language of love.)

As warned yesterday, expect a backflip from Madam Legarde on the question of whether developed nations should tighten their belts or send out for more pizza.

Australia's Treasurer has been made 'Finance Minister of the year', an accolade that must peeve Ms Wong. Henry recalls once being told that 9 out of ten winners of Btitain's 'entrepreneur of the year' award ended up broke withing 2, or was it three, years.

Flushed by the award, will Treasurer Swan now blame the slippage into developed nation misery as an excuse to abandon the 'return to surplus by 2013' promise.  Like 'no carbon tax' and 'we will never send asylum seekers to countries who have not signed the UN protocol and dealing with refugees' this budgetary election commitment will prove to be just as firm.

In the gloaming

Amongst the fading light, the Rugby World Cup was meant to kindle light and hope, that is until Australia was choked into an all-but-impossible position by an inspired Ireland.

TP Maher reports here, and if he stays off the turps will continue to do so as the tournement unfolds.

[Ed: We must apologise and withdraw.  TP Mahar would never dring turpentine.  We acknowledge that he is a lifetime single malt quaffer.]

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

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

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

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

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

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

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

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

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

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

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

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

Read more from Phillip Inman here. 

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

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

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

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

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


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

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

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

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


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

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


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

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

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

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

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

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

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

Henry in Russia - never to be the same
Date: Friday, June 13, 2014
Author: Henry Thornton

St Petersburg is a place Mrs Thornton has long wished to visit. Naturally this led eventually to the idea of Henry and his sweet lady flying to the former Russian capital city, captured by Peter the Great from Sweden, a once serious player in Northern Europe's wars and in European politics generally.

As usual, Henry feels constrained to provide reports for his faithful readers, who no doubt are missing the usual trenchent commentary on matters economic and political. And travel broadens the mind, so it is to be hoped that Henry returns to Australia - that miracle economy - freshly reinvigorated andwith a mind broadened if not deepened.

Time will tell but, in the meantime, here is an index of Henry's reports from St Petersburg.  It will be updated each time a new report is posted, with the latest on top so no-one can feel she is being tricked into reading any report twice.

(If coming new to this e-journal, consider starting from the bottom and moving up.)

Military might and reflections on departing.

Is the Russian Empire experiencing a slow, ultimately false, sunset or is it toward the end of  a long decline that is destined to turn Russia into a poor, undeveloped nation whose great days are steadily fading further into history? That question is beyond my current pay grade, gentle readers but, as previously noted, there is a lot of room for improvement in matters economic.

We leave Morther Russia with great memories, but with this question seriously on our minds. Very likely, we shall not pass this way again

The Hermitage

The Hermitage will blow you mind, and even the digital tour may cause you to buy a ticket to St Petersburg

Gilded palaces, forests and public transport.

Henry masters (!) St Petersburg's public transport and visits more gilded palaces and their grounds.

White nights in St Petersburgh - Peterhof

Henry makes only his second visit to Russia. In 1973, he briefly visited Tashkent, on route to the socialist finishing school known as the London School of Economics. Sadly for the socialist cause, almost all the teachers at the LSE proclaimed the power of capitalism. Much to Henry's father's delight, Henry returned with a totally different outlook on life.

US jobs data boosts share prices - que?
Date: Monday, June 09, 2014
Author: Henry Thornton

Finally, after six long years, US jobs have surpassed the previous peak in January 2006. In previous post-war recessions, the previous peak has been exceeded in just a few years, often only one or two years.  The latest result came after four months of over 200 K new jobs created in a row, the best result for 14 years.The rate of unemployment held steady at 6.2 %.  The US share market hit a new record.

There is a catch, of course. During the Great Recession, as the post-GFC downturn has been labelled, a lot of American workers dropped out of the workforce, and the data suggests that many will not be back.  This is the outcome in many countries, and suggests that future economic capacity will be limited compared with pre-GFC estimates. This is an issue that has been discussed by Gavyn Davies of FT fame, in an article just posted,

Davies says that central bankers, especially in the USA and UK, strongly believe that the damage of the GFC can be repaired, in the sense that pre-GFC trendlines for GDP can eventually be recovered. After all, 'none of the growth fundamentals in the system – the state of technological knowledge, the available labour force, and the amount of fixed investment that is profitable to deploy – has been permanently destroyed by the Great Recession', although the loss of skilled and experienced workers might take a long time to replace.

'A more pessimistic view is that the Great Recession has resulted in a permanent (or at least very long lasting) loss of economic capacity, in which case it would be inflationary to attempt to re-attain previous trendlines. On this view, the global economy has now locked on to a different path, with its effective capacity being much lower than previous trends might imply. The latest estimates of capacity published by the IMF and OECD, who should be able to do this sort of work better than most, clearly imply this'.

A reason, apart from loss of skilled labor, is the debt overhang that helps to explain the very slow recovery of US jobs already noted. Japan is the example that people who worry about debt fuelled economic bubbles point to, perhaps an extreme example due to the size if its asset bust and the extreme aging of its declining population.

The Economist, like the FT another venerable newspaper, has a proud record of warning that the debt-driven  market bubble of the 1990s, which crashed and was revived twice by near zero interest rates, would eventually create serious economic mayhem. Henry is with the pessimists on this issue, and has asked his asset management to begin reducing his risk profile.

Despite the causes for caution - possible permanant loss of economic capacity, new share price records and the clear challenge of returning US monetary policy to a sensible neutral position - Wall Street's “fear gauge” has fallen to a seven-year low. This is a clear warning sign, suggesting a new take on the old adge about the time to sell being when the lift drivers are at their most enthusiastic.

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.

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