The Red zone; is Henry a Keynesian?
Date: Monday, September 26, 2011
Author: Henry Thornton
The world economy is 'in the red zone', 'navigating in dangerous waters' and a variety of other colourful and depressing descriptions. As the opening sentence of my book Great Crises of Capitalism asserts, the world may still experience a depression as a result of the global crisis that exploded in 2007-08. Indeed, the odds of this have risen appreciably since the book was completed in late 2010.
The descriptions of current risks are signs of deep frustration among world leaders. If they are honest they will recognize that they, or their predecessors, are responsible for the current mess. The sad fact is that it is far easier to wreck an economy than it is to fix it.
Here is a bold hypothesis. An economy, even one as complicated and many-layered as the global economy, has its own tides and timetables. Governments can steal (or borrow) from the future by spending more, but the future demands its payment which comes in the form of debt that needs to be serviced. Indeed, if markets come to think debt is too large, the debt needs to be repaid or else borrowers need to default. Governments can provide temporary stimulus, but this will be very unlikely to much change the overall level of activity, taking one decade with another.
A similar theorem applies to monetary policy. Stimulus now will increase economic activity now but the cost comes in the form of inflation and the tightening of future monetary policy, both responses that slow future activity.
When nations or banks become insolvent, a bailout now may alleviate the adverse effect on economic activity but, by adding to debt of the government (or a financial institution that acquires the failed institution), future activity will be slowed. And bailouts create 'moral hazard', encouraging a repeat of the foolish behaviour that created the insolvency.
The case for ‘activist’ economic policy is the same as the case for fixing potholes in the road, removing a cause of accident that might end the journey, or at least cause sizeable damage to vehicles hitting the pothole.
The trouble is, economic potholes are frequently filled with wasteful spending that weakens incentives to work, to save and to innovate. Spending or tax relief that does not add to productivity, as is frequently the case when there is unexpected economic trouble, is like filling potholes in the road with loose sand and gravel, likely to do more harm than good, if only by reinforcing the modern delusion that ‘the government will provide’.
The people I call 'bastard Keynesians' have been in charge. Such people rush around looking for potholes to fill and (worse) to fund great projects they described as 'nation building' with no benefit cost or other rational test of value. Keynes himself was concerned with the once in a century case of deep and intractable depression, when no compassionate leader can sit pat without offering policies with some chance of success. But, even in the case of deep depression, if households and businesses reject the attempts to alleviate the situation, 'Keynesian' policies will fail. This point was clearly recognised by my teachers at Melbourne University almost 50 years ago.
My bold ‘intertemporal policy impotence’ hypothesis has probably already been devised by some bright, mathematically inclined young economist at the University of Chicago, and if so I would welcome being sent a relevant reference. But, if it is supported after careful thought, it disposes once and for all of the Keynesian approach to economic stabilisation.
Now we have leaders rushing about looking for ways to bail out Greece and other weak Eurozone countries without draconian fiscal restraint and indeed to soften the obvious approach of imposing tight fiscal policy now. The trick is to tighten future fiscal policy without imposing very tight fiscal policy now (= austerity). One way to do this is to reform fiscal policy by removing tax breaks for the rich or, in the case of Greece, remove blatant and widespread tax avoidance and evasion. The rich and the Greeks naturally resent this attack on their accustomed rorts and throw metaphorical or real rocks at their leaders.
I have no doubt that solving the problems of Europe must start with an orderly writedown of Greek debts, and those of other overly indebted nations. (This was the approach in the case of excess debt during the Latin American debt crisis of the late 1980s. Note that people who brought heavily discounted debt made a lot of money, showing the inherent ability of capitalism to solve problems that seen intractable.) Debt write-downs must be accompanied by sufficient fiscal austerity, and a different set of tax and welfare arrangements. The overall object of such policies must be to encourage a return to thrift, responsibility and innovation to get each nation's debt onto a sustainable path. In severe cases, weak nations should devalue their currencies, but only after the overall debt load has been dealt with or there would be a row of falling dominos that the Eurozone would be unable to prevent.
Mr Robert B Zoellick of the World Bank pointed out that, while the original shock in the current crisis was anticipated by few people, there is no such excuse now. He said over the weekend that the problems of the USA, Europe and Japan could spread to the developing nations. Commodity prices (including even gold) have plunged and developing nations are ‘facing fresh headwinds’. This means Australia is not immune and, like other nations, our fiscal position is far less attractive than it was when the original crisis hit.
We must hope that the world’s leaders finally get their act together and find a way through the road of many potholes we are all travelling. Unless and until they do, investment should be conservative, at the very least accumulating cash rather than immediately plunging into the equity market. Henry expects there will be better bargains by the time the current crisis of confidence is finally resolved.
Someone at one of the meetings I attended last week asked me what I would do. The obvious answer is that, like the skeptical Irishman, I would not be starting from where we are now, as the final chapters of Great Crises of Capitalism makes clear. The world needs stable, well understood policies rather than the massive knee-jerk policies applied during the past 3 years. While some fresh pothole-filling may well be justified - especially cleaning up the debt burdens of Greece and the other weak nations of the Eurozone, and the banks who have lent to these nations - the authorities need to rethink their approach.
Confidence of households and leaders will only gradually be improved, but credible plans to implement stable, well understood policies with major reliance on anti-inflationary global monetary policy and greater use of automatic stabilisers would provide a good start.
Henry's pal, James Guest, commented this morning: 'Greece has a very small economy and a small population that the rich EU countries could easily subsidise, like their own aged and unemployed. Why then, apart from German voters’ distaste for indulging Greek budget extravagance and fraud, is the Greek insolvency allowed to drag on, threatening confidence all over the world?
'The missing key to this puzzle may lie in the person of the Greek Prime Minister. The third generation liberal or social democrat Papandreou PM, George Papandreou has such a strong American background, where his father was a professor of economics and his mother born American, that he can fairly be exempted from the suspicion that he wishes to continue Greece’s hopeless populist and fraudulent record in public finance. But how difficult it is for his government to force through the changes which remove entrenched privileges. And it is made more difficult because it appears to be the result of pressure from foreigners.
'The point is that Greece needs the changes which increase the retiring age, reduce public sector employment and lower the wages it pays, whether it defaults on its debts now, later or never. It won’t happen if Greece defaults now and it won’t happen if EU and IMF bail outs come without tension. So Papandreou needs the drama of the EU’s Greek problem ever teetering on the edge however much harm it does to confidence in the global economy'.
The Raff Report – March 2015.
Date: Wednesday, March 11, 2015
Author: Nick Raffan
Clip clop, clip clop, clip clop: it must be the King approaching in all his finery. The crowds are cheering as he passes by. But he is absolutely starkers. This fable reminds the Raff of the current status of financial markets. Last night some of the crowd saw the King as he really is and the Dow fell around 333 points, a fall of 1.85%. European stock markets also took a battering. The price of gold fell to a 3-month low of US$1,155.60/oz and silver tumbled to US$15.67. The Aussie dollar fell a cent against the USD to 0.7634. Why was this so?
it seems, all of sudden the punters perceived that the US Federal Reserve was set to hike interest rates soon. Readers might recall that when interest rates rise, the discount rate used for future cash flows rises, and the discounted value of future cash flow falls. This results in contraction of price earnings multiples and share price falls. Of course, it won’t only be the price of equities that will be affected, so too will be bonds. At its most simplistic, when interest rates back-up, the price of bonds fall and vice versa. For many years now the bond markets have been a one-way bet. When US interest rates start to rise it’s all over red rover for bonds.
What has been the real deal about equities in the US? What the Raff is about to say is not new but needs repeating because of its importance. Many US public companies have been borrowing at near zero interest rates to buy back their own shares. So what does this do? Let’s suppose that a company’s profits are the same every year. By buying back shares, each year the number of shares on issue fall and the earnings per share rises. At a constant price earnings multiple, the company’s share price increases every year. This steady rise in the share prices of companies with a strong influence on the leading US Equity Indexes ensures the good times keep rolling. Many share price performances have absolutely nothing to do with management running a business better or growing the business or doing anything else that might generate real value for shareholders. It is dear readers smoke and mirrors.
The prospect of a near term hike in US interest rates deserves pondering. Readers might recall that the spike in US orders a few months ago was because of an abnormal increase in new orders for aircraft which distorts the 12-month moving average, as shown in the following chart. By the Raff’s reckoning the previous business cycle started in December 2002 and ended in April 2008 for total 7 years and 4 months. This current cycle started in February 2009 and thus has gone on for 6 years and 2 months.
Orders seem to have peaked and without the unusual spike in aircraft orders the 12 month moving average would show rolling over heralding the plateau of this business cycle.
It seems odd that the Federal Reserve would increase interest rates at the top of the business cycle but nothing surprises the Raff any more. Maybe the powers that be want to teach financial markets a lesson and will try to regain control once more to dominate us all.
At the time of writing ASX Materials Index is down 3.1%. BHP is down 5.5% versus RIO only down 1.4%. BHP has been creamed because of its exposure to oil where the price is hammered by a global glut and strong USD. The battle between USD and precious metal continues with the former still winning. If anyone thinks that low commodity prices are a sign of a healthy global economy then they must be in the crowd cheering on the King as he passes by in all his finery.
From where the Raff sits the world is in deep trouble. The Raff is pondering when will come calls for tariff protection. There is no such thing as a flat playing field. The free trade agreements are one-sided. Manufacturing is near to dead as a Dodo in this country. Opportunities for the young are like hen’s teeth. Boy have we stuffed it. The Raff does not see any political party with a plan to remedy the situation. Throwing money at the problem will not help; just ask the Japanese.
Dan Greenhaus comments
Yesterday's release of the durable goods report for February missed expectations. The report joins a long list of recent economic data points that have fallen short of expectations. February existing home sales and industrial production and March Empire Manufacturing index and consumer sentiment readings are but a few of the recent reports meeting this description. While the Bloomberg consensus still looks for Q1 GDP to come in around 2.2%, we think GDP is tracking closer to 1.0% than 2.0% and expect the consensus to play catch-up in the next few weeks.
This communication does not provide complete information regarding its subject matter, and no investor should take any investment action based on the information contained herein. For additional and more complete information, including Important Disclosures and Analyst's Certification and the full post, please click here.
Click Here for the Full Blog Post: 'First Quarter GDP Tracking Close to 1.0%, May End Up Even Less'.
Stumbling reluctantly to the truth
Date: Tuesday, March 10, 2015
Author: Henry Thornton
'China dependency to hit Australia hard' says Crispin Odey, a wealthy hedge fund guy whose fund is no doubt set for the coming recession. Other similar hedge fund men are also mentioned as agreeing in the article that starts on the front page of the AFR.
Leafing thru this august news source, one is not surprised to read 'China slashes our imports'. The featured article on the same page says 'US jobs surge points to Fed rate hike'. US 'Quantitative easing', along with near zero cash rates, plus America's strong resilience, has stimulated America's recovery. Like destroying the villages to free the inhabitants, this has created the competitive currency devaluations that are giving our RBA (and all Australians) such a hard time. The same article reports 295,000 new jobs in the USA which, coming on top of several months of strong jobs growth, has reduced the rate of unemployment to a 'mere' 5.5%. Just as our unemployment is 6.4 % (or more) and 20 % for young people.
In Australia, jobs growth, and jobs ads, remain depressed and the issue is whether further rate cuts can have any effect, apart of course from fanning the fires of asset inflation. Some economists have suggested that rate cuts will further fire the housing boom and therefore stimulate the slow growth of our former 'miracle economy'. The sane members of the tribus economicus point out that it is lack of supply that is the main reason for the housing boom, not lack of demand. Why is supply constrained? Ask you local council, dear reader, regulation piled on regulation.
This is a paradigm of reasons for our overall sluggishness. Another AFR article asserts the tax reform is the priority, which gets one (feeble) cheer from Henry. Tax reform is strongly needed to pay for the many programs that we cannot afford now that the mining boom has ebbed. Of course it would be good if the loonies in the Senate would come to their senses and find ways to cut spending. With China struggling, global demand is not going to actually encourage aggregate supply in Australia. Strong overall supply, especially strong exports and strong domestic sourcing of product, replacing imports, is what is needed.
The Oz asserts today that 'we can ride out recession'. Since the RBA is not expecting recession, this is no great comfort. But the mere existence of the relevant research report suggests someone in authority is beginning to fear 'recession' is likely, or at least possible. It is slightly more than 18 month since Henry said: 'Put crudely, Australia has pissed the proceeds of the mining boom up against a wall of gullible voter expectation. In the process, mining companies allowed their cost bases to expand to unsustainable levels. Cost bases expanded in sympathy in the non-mining parts of the economy in a climate of easier than desirable monetary policy and encouraged by those vainglorious spending programs of the Rudd and Gillard Governments.
'Restoring Australia's economy to robust health will require massive effort by all Australians. The budget must be restored to a point where it has a sustainable balance, that is a balance over the course of the conceivable ups and downs of the global and local economies. Ideally there will also be a return to sustainable budget surpluses, but that is for a future government to consider when the basic repair work has been undertaken. Tax reform is needed to improve incentives and enable elimination of the many nuisance taxes that cost so much to administer. Regulations generally must be slashed, and labour market regulations revamped, to give owners of small business encouragement to create sustainable jobs'. Full article here.
RBA legend, Austin 'Aussie' Holmes used point out that someone was 'stumbling reluctantly to the truth' when he had come very late to one of his (Austin's) radical prophecies or proposals. Henry is delighted to bestow the inaugural Aussie Holmes award to the editors and staff of the AFR and the Oz.
Saturday Sanity Break, 7 March 2015
Date: Saturday, March 07, 2015
Author: Henry Thornton
The political story of the past few weeks is the 'near death experience' of Prime minister Tony Abbott. Mr Abbott seems to have learned a few things from this experience, as others have done before him, and now looks far more comfortable in his own skin. Gary Scarrabelotti reflects on the whole episode and offers a few suggestions designed to strengthen the PM's future, increasingly successful, performance.
Scarrabelotti also offers a qualified prediction. 'If he makes it through next Budget, however, without major errors – if there are any, expect that second “spill” motion to re-emerge around 15 June – then Tony Abbott will lead the Coalition into the next elections and will win them with a reduced but comfortable margin.
'By the way, I do not expect there to be any major Budget errors. Abbott may be devilish hard to shake from his chosen course, but his recent “near death experience” has shaken him, indeed, and he has learned much about where he went wrong.
'There will come the day when Prime Minister Abbott will feel deeply grateful for the fearful drubbing he got from his many friends and well-wishers in the News Limited stable. They’ve proved friends indeed'.
Paul Kelly comments on the challenge facing newly resurrected Tony 'Whatever it takes' Abbott.
'The Prime Minister’s recovery from his “near-death experience” may win serious traction'.
But 'Abbott’s strategy is based on an unresolved contradiction that he makes no effort to disguise. He told parliament the IGR shows “that our country’s best days are ahead of us”, yet declared in the same breath this was “provided government can live within its means”.'
The economic issue of the week, and the decade, concerns the issues raised by the Intergenerational Report (IRG). While Henry did not fall off his chair, he was interested in the dire predictions embedded in its 50 year predictions, actually extrapolations of what is likely to happen with: (a) Labor's policies; (b) the current government's (or equivalent) policies as articulated in the Abbott government's first budget; and (c) the obviously preferred option with faster budget repair that ends the growth of national debt in short order and actually pays some of it back.
Henry was disappointed that there was no useful material on just how the preferred scenario (c) could be made to arrive. We are concerned in particular with the absence of policies to get more young people into satisfying jobs and boosting productivity.
Wonderful review by Peter Craven on the soon-to-arrive third season of House of Cards.
'... everything about this show — from the magnificence of its acting to the overheard quality of its dialogue — is stunning.
'Right down to the disquieting suggestion that this monster of a man may actually be a pretty good president'.
In response to questions, Henry's editor and founder, PD Jonson, says he plans to take an active interest in Henry Thornton.com for as long as he is able.
The National Library of Australia in the early 2000s selected Henry Thornton for preservation. It is scheduled to be re-archived regularly. here is the link. http://pandora.nla.gov.au/tep/33415
We are delighted to learn that, in addition,'the National Library of Australia is 'committed to continuing the archiving of the Henry Thornton website for as long as it is continued to be updated. If the site is no longer being updated for whatever reason we would most likely cease new archives of the site. We would however be committed to maintaining access to already archived material in perpetuity. The Library would undertake necessary digital preservation actions to ensure that future Australians could continue to access material archived through Pandora. The archive copies would remain as static copies of the original website as they were at the time of archiving'.
Australia’s number one Bernard Tomic went past the Czech Republic’s number two player Jiri Vesely 6-4 6-3 7-6 (7-5). Thanasi Kokkinak (age 18) was picked ahead of Henry's hero LLeyton Hewitt and turned on an 'absolute cracker', fighting his way back from two sets down to beat the home team’s top rated player Lukas Rosol 4-6 2-6 7-5 7-5 6-3. More here.
The team at HenryThornton.com greatly enjoyed Australia's big win over the spirited lads from Afghanistan. But with its murderous travel schedule, inconsistent form of Captain Clarke (who has hardly played) and number 3 batter/partnership breaking bowler/star fielder 'Watto' Watson (who was dropped), the former World Cup favourites face a big task to win from here.
Kevin Sheedy has returned home, to his beloved Essendon. Should Essendon players be given time off by ASADA and/or the AFL, James Hird, say the smarties, will be finished as coach. Essendon let the Bomber go, but having a golden oldie like living legend 'Sheeds' as the club's strategy chief with a younger man running the show on game day looks like a plausible solution.
Image of the week - by acclamation
Intergenerational Report 2015
Date: Friday, March 06, 2015
Author: Henry Thornton
Gor blimey Comrades, in 50 years we'll be dead (certainly Henry and most dear readers) but Australians lucky enough still to be living will be older, possibly poorer and deeper in debt, unless we and our kids pull our fingers out and get on with it. The press is full of reporting and analysis, so I shall limit my comments to points I have not seen elsewhere.
I feel especially sorry for the kids. Even in Melbourne's leafy eastern suburbs many kids do not yet have regular jobs despite having at least one excellent degree, and being polite, drug-free, nicely presented and with excellent work habits. Most of the Mums and Dads can work for longer and will never require a pension or other welfare assistance, unless governments and central banks really stuff things up. The people living in Melbourne's leafy Eastern suburbs are generally well off, but only the spirits in heaven central know what it is like in remote western suburbs of our cities or in distant rural outposts. The TV news, however, suggests that 'grim' is an understatement.
Australian industry is deeply uncompetitive, the budget is out of control, there is no plan to boost competitiveness by introducing radical economic reform, and if there were the loonies in the Senate would block it. As a one-time member of the ALP, Henry is ashamed at that once great party's mulish attitude to whatever reforms that are suggested - even some it espoused before the last election - and its apparent Olympian attitude to Australia's economic challenges. Correction, FIFA's attitude to cleaning up corruption in the world game. (More here on FIFA's and Sepp Blatter's opportunity for redemption. Mr Shorten, please note.)
Even the ABS cannot totally stuff up numbers of Australian's, including numbers in different age groups. The scariest numbers in the IGR concern numbers of workers likely to be available to support pensioners by 2055. The ageing of the population, and likely rates of births, deaths and net immigration, will mean that by 2055 there will very likely be only 2.7 workers for every retiree compared to 4.5 today and 7.3 in the mid 1970s. It should be noted that equivalent numbers in most 'advanced' nations are even worse.
One of the Treasurer's lines is that 'the best is yet to come', but please note the caveat - only if more Australians work harder and more productively for longer. Henry is irristably reminded of a senior British insurance company CEO who returned from a visit to the regulator in London to report 'the best is yet to come' and that his company had beaten the main opposition once again since his company's fine for mis-selling policies was greater than their's. Our major bank CEO's perhaps feel the same about the extent of mis-selling by the financial planners they bid for so keenly when they were chasing the superannuation honey-pot.
I am aware that these comments will support the view that Henry is one of the more enthusiastic practitioners of what is sometimes called 'the dismal science'. Please note that Henry believes there are policies that would greatly improve Australia's efficiency and competitiveness.
Another line in Joe Hockey's IGR is 'the world is a competitive place'. I am confident that Australia's currently unemployed children accept the need to work harder and smarter to create a solid future for themselves and their future children. The message of the IGR is that Australia as a whole needs to do this, meaning on average every Australian faces the same challenges. Here is Henry's advice for Joe Hockey and his colleagues currently in government. As a current member of the Liberal Party, Henry sincerely hopes he is not as ashamed in five years of his colleagues in government in 2015 as he was with his Labor mates in 1975.
Date: Wednesday, March 04, 2015
Author: Henry Thornton
'At today’s meeting the Board judged that, having eased monetary policy at the previous meeting, it was appropriate to hold interest rates steady for the time being.
'Further easing of policy may be appropriate over the period ahead, in order to foster sustainable growth in demand and inflation consistent with the target.
'The Board will further assess the case for such action at forthcoming meetings'.Read on here.
The RBA acknowleged that growth is 'continuing at a below-trend pace, with domestic demand growth overall quite weak'. There will be spare capacity and with wages subdued goods and services inflation should 'remain consistent with the target over the next one to two years, even with a lower exchange rate'.
The problem, of course, is that asset inflation, especially house price inflation in Sydney and Melbourne, is glowing in the dark, and global shares are also setting new records. The correction of local share prices when the RBA announced its 'no cut' decision yesterday shows that monetary policy effects asset prices. The fact that the currency jumped before the announcement is, or should be, of great concern to the RBA as it was very likely due to a leak, even worse than suggestions last month of selective briefings.
If it is only Sydney and Melbourne house prices that are of concern, APRA could impose some sort of limit on bank lending for housing in those two cities, a Macro Prudential policy response. But it is surely now recognised that monetary policy cannot serve two or three masters. This means it cannot be used simultaneously control the overall economy to keep goods and services inflation in the target zone AND help reduce the exchange rate AND control asset inflation.
The proposed new tax on overseas buyers of new houses, with forced sales of second hand properties purchased illegally by overseas buyers, is another (dare I say) crude and narrowly-based Macroprudential policy. It is a partial and therefore ineffective version of Henry's plan for a tax on all forms of capital inflow. This was apparently 'too hard' for important geniuses/madmen in authority to have considered, or even noticed. The latest Hissink file may provide perspective.
Words fail me. Perhaps this image may do more than words to capture attention.
Saturday Sanity Break, 28 Febuary 2015
Date: Saturday, February 28, 2015
Author: Henry Thornton
The other recent bit of economic news is that non-mining investment is hardly rising and has no chance of replaving plunging mining investment, while infrastructure seems to be lost in the chaos of political confusion and budget blow-outs.
If you want to feel even worse, take a gander at Laura Tingle's Friday account of all the good intentions gone south.
'Remember the days when we all rambled on about the whacky Senate? Well that now seems like a millennium ago.
'Instead, we are now all absorbed by a whacky government that – if you have but a moment to pause and think about almost anything it has done in the past couple of weeks – seems capable of wreaking much more serious havoc on the rest of us than a bunch of accidentally elected senators dazzled by experiencing occasional brushes with power.
'It's not so much that the government – and the Prime Minister – seem to have lost their respective schtick, it's that their behaviour leaves us wondering what their schtick was in the first place'. Read on and sob, readers who believe a strong economy is vital for just about everything a government might wish to do.
The bi-annual Australian airshow proved to be a hotbed of political gossip. The conclusion was that Tony Abbott will be challenged and defeated next Thursday and that there will be big changes to portfolios made by Malcolm Turnbull, including Scott Morrison as the new Treasurer and more than a hint that David Johnson will be back at Defence.
Today's press, especially the Oz, seems to have decided it has given the PM enough stick for the time being. Its editorial begins as follows:
'THE bed wetters, serial miscreants and executive panic merchants of the Liberal party need to reflect on recent history and hold their nerve amid the current political tumult. Public disappointment in Tony Abbott’s performance is manifest yet the government’s standing in the polls is by no means disastrous this far out from an election. What’s more, the Coalition has a reasonable chance of re-election because of Labor’s indolence and four areas of strategic advantage where the government can create a sharp contrast with the ALP: firm opposition to a carbon tax; proven strength on border protection; clear determination in combating jihadist terrorism; and demonstrable — if clumsy — commitment to repair the budget. Bill Shorten wants a price on carbon, plays to “compassionate” critics on border protection, has exonerated erstwhile Taliban loyalist David Hicks as “foolish” and refuses to admit the budget needs urgent repair'.
The gossip-mongers at the Airshow should have a bex and a good night's sleep. Today the B52 flies in from some Pacific Island, does a half-hour turn and flies home again, which will provide plenty of excitement for Australia's retired warriors. Meanwhile, Australia plays New Zealand in what is a danger game. A loss to our cousins from over the ditch, now that would be a serious crisis.
New Treasury Secretary, John Fraser, has given tongue at a meeting organised by CEDA. Mr Fraser's conclusion makes perfect sense, as regular readers will recognise.
'If we set ourselves on a path of sensible fiscal repair and lay out credible plans for structural reform that address our long-term growth challenges, then the consumer, business and investor sentiment that is critical to lifting economic activity in the near-term will materialise'.
Cricket minnows Afghanistan have beaten Scotland in a hair raising performance, and are said to be after Australia's scalp next. Australia, meanwhile, are underprepared for their joust with New Zealand. I cringed when I read hairy-chested comments in the press from Australians saying we'd out-bowl them and out-bat them. An American president once said 'Walk softly and carry a large stick'. Right on the money in my view.
The footy makes a sputtering start soon but the real deal starts on Thursday April 2 when Caaaaarlton! meets Richmond at the 'G'. Henry will be there with a fervant hope that Mighty Mick has finally got it right. If 2015 is another fizzer, bring back Brett Rattan will be my cry, and Mick can go to Essendon to manage its resurrection.
Big economic questions
Date: Thursday, February 26, 2015
Author: Henry Thornton
Janet Yellen is ever so slowly preparing the way for a (gasp!) rate increase in the USA. 'If economic conditions continue to improve ... the committee will at some point begin considerimng an increase in the target range for the federal funds rate ...'. The care with which Dr Yellen is dancing around this matter is a wonder to behold. Is the US economy so delicately poised that extreme care needs be taken to minimise the chances of great damage being wrought by, say, a 25 basis point increase in the 'target range'? As I understand it, the current target range is 0 to 0.25. As a modest contribution, Henry asks whether the range be raised to 0.25 to 0.50 but the new rate be put at the bottom of that range.
And in distant Australia, Treasurer Joe Hockey has warned us to hang on tight when the Intergenerational Report hits our desks for fear of falling off our chairs. We'll all be rooned, comrades, unless we decide to work harder and smarter and for longer. Imagine the dilemmas in Japan and Italy, where more people are dying than being born. No wonder asylum seekers are flooding to Italy in leaky boats, and someone should show them Japan as an idyllic destination with rapidly emptying villages set among beautiful scenery.
Closer to home, warm congratulations are due to Scott Morrisan and Patrick McClure for a brave reform agenda for welfare policies, annual cost $150 billion and rapidly growing. As Mr Morrison said, these reforms will not proceed unless Australians agree. Simpler, fairer and more efficient, and the thrust is getting welfare recipients back to work, and who can sensibly disagree? And the recent ABC report about rorting by the (private sector) employment agencies chilled the blood, and suggests there is a lot of fixing to be done.
And in late breaking news, new Treasury head John Fraser has admitted to being a fan of Ronald Reagan's tax cuts, while not being a fan of the International Monetary Fund's (IMF's) 'claims in the past year that tough budget cuts had done more damage than good'. This has signalled that his advice to the Treasurer is likely to be less 'pro-Keynesian' than immediate predecessors Martin Parkinsin and Ken Henry. Perhaps Mr Fraser has more faith in the inherent strength of the Australian economy than his predecessors. He also asserted, reports Jacob Greber in the fin, 'I do not resile from the point that I don't think spending our way out of lower economic activity is the way to go'. Perhaps sensing that his listeners might be failing to understand this gnomic point, he later said "Spending your way out of these things just doesn't work".
David Uren asked Mr Fraser about the falling currency in a recent interview for the Oz. A lower exchange rate gave Australia some breathing space, the Treasury head explained, but not enough to rekindle growth. “We can’t pin our hope on a lower exchange rate to do all the magic. The lower exchange rate was a massive plus for us in the 1980s only because we used it to reinforce good fiscal policies and tackle structural problems.” (Advised by the RBA, not the Treasury, incidentally.)
Mr Fraser also confessed to thinking there are better things to spend money on than paying interest on the debt, and that his dislike of debt would leave the country "liable to the vicissitudes of the market" and that when interest rates go up, Australia would be "exposed". We like your work, Mr Fraser, but where do you stand on the desirable pace of deficit and debt reduction? If budgets have little predictable short-term effects, why not get the budget fixed in a hurry to minimise later "exposure" in the form of high debt in a world of rising interest rates? And what about the likely effect of economic reform to boost growth, should rapid budget fixing slow growth? Or are you skeptical about any attempt to improve the economy? My views are here.
Naturally Henry does not expect the Secretary of Treasury to respond to Henry's assertions, or to answer his questions, but surely the Senate committee could do more to draw him out? Committee chair, Senator Slamming Sam Dastyari, inspired by the Secretary's presentation, spoke of President Reagan's 'Voodoo economics'. Well Senator, look at its effect on the US economy, and ask some real questions next time you meet John Fraser.
Comment by Des Moore influential former senior Treasury official and regular commentator on important policy issues for Australia.
Despite its length, because the address by new Treasury Secretary, John Fraser, is potentially so important I am including below the full text of it. It is important in terms of both substance and tone, the latter because critics of economic rationalism and small government will find it harder to find substantive responses. Indeed, the image of the address is also helped by Fraser’s indication of support for government assistance to the “worst off”, his criticism of excess spending financed from the commodities boom and starting under Howard, and his emphasis on the need for a well-functioning tax system that is “fair”.
If as reported Abbott is searching for a “policy reset”, he has the basics in Fraser’s speech.
Except for The Australian (which appears sympathetic), so far the media has been largely in a straight reporting mode (see attached). As at 1.00 pm the ABC’s digital “Just In” has not even mentioned the address. No doubt the doubters will be searching for items they can use to try to undermine but the one that appeared so far –that Fraser is a Reaganite – won’t get very far.
It will be of interest to see whether comments are sought from leading politicians, including both Abbott and Shorten, and academics.
The looming deflationary `crisis`
Date: Tuesday, February 24, 2015
Author: PD Jonson
In 1971 President Nixon cut the final link between the dollar and gold. Inflation quickly became a global problem, fuelled by America's attempt simultaneously to win the war on communism in Vietnam and the war on poverty at home. Inflation spread from America to the rest of the developed world, greatly reinforced by successive leaps in the prices of oil. Unemployment rose sharply with inflation, and the ugly word 'stagflation' was coined.
For much of the period since the 1970s central banks as well as businesses and households have feared inflation more than unemployment, which more or less looked after itself with the usual 'cyclical' fluctuations. Most central banks have adopted targets for goods and services inflation, while perhaps taking their eyes of other targets, especially asset inflation.
With the advent of the Global Financial Crisis (GFC) in 2007, attention shifted to the real economy as rates of unemployment rocketed. Monetary policy became super-easy, interest rates near zero, reinforced by so-called 'Quanititative Easing' (QE).
The USA and the UK were the earliest to adopt super-easy monetary policy, reinforced by widespread bailouts of financial institutions in trouble. Now these countries are showing signs of recovery in their 'real' economies, the clearest indicator of which is falling unemployment. Despite super-easy monetary policy, goods and services inflation is languishing to the point that 'deflation' is the new concern. The prices of oil, coal, natural gas, iron ore and other metals are plummeting (very bad for resource exporters like Australia and Canada) and even consumer inflation is falling, in some cases almost to zero.
But asset prices have been rocketing, and we all know that this cannot go on for ever. Every boom in asset values is followed by a bust. If the next bust is big enough, the nascent recovery of developed economies is likely to be snuffed out.
The latest Economist has both a leader and a detailed article on the perils of deflation in goods and services prices. Both make gripping if scary reading, with a focus on ways in which economic policy needs reconsideration when goods and services inflation is near to zero or even negative.
'FOR central banks in the rich world, two is a magic number. If prices rise at 2% a year, most shoppers can more or less ignore their slow ascent. And a touch of inflation is hugely helpful: it gives bosses a way to nudge unproductive workers—a pay freeze actually means a 2% cut—and an incentive to invest their earnings. Most importantly it keeps economies away from deflation and the depressing choices—hoarding cash, delaying purchases—that falling prices can bring. Yet despite the professed adherence to the 2% mantra, a period of falling prices is on the cards'.
I would like to propose an analytic framework that helps to explain the facts of recent experience and which is grounded in serious empirical research. There are three core concepts that are needed to explain recent oddities of macroeconomic experience - monetary disequilibrium, increased leverage and risk-taking by financial institutions, and the state of confidence, 'Animal Spirits' in the colorful phrase used by some of the world's best economists.
'Monetary disequilibrium' is a more sophisticated version of simple monetarism, where the stance of monetary policy is defined by monetary growth. It also encompasses the ideas of John Taylor who represents monetary policy with a rule that relates cash interest rates to the state of the economy, in the simplest cases the rate of inflation and the rate of unemployment. Consumers and businesses, it is assumed, use 'Money' as a buffer stock, and adjust decisions in part on whether they have excess or deficient money in their buffer stocks.
For the period until the onset of the 1970s, research has shown that 'monetary disequilibrium' largely influenced the state of demand. Clearly, severe recession/depression produced low 'Animal Spirits' at times during this long period, and during the nineteenth century major gold discoveries in the 1850s and 1890s boosted money supply, and presumably also raised the spirits of households, businessmen and government officials. Both goods and services inflation and asset inflation mostly followed the ups and downs of monetary policy, even when simply represented by money growth.
In the 1970s and 1980s, with the final link to gold severed, 'monetary disequilibrium' also came to influence inflationary expectations, as therefore goods and services inflation. The more or less simultaneous impact of monetary growth on goods and services inflation and asset inflation remained the rule, although there were 'aberrant episodes' identified here that demand a more complete explanation.
The nexus between monetary growth (and therefore 'monetary disequilibrium') was broken in the 1920s USA. Then monetary growth and goods and services inflation were moderate, but asset price inflation was allowed to boom by credit advanced by the New York banks to speculators. This was also a time of strongly positive Animal Spirits, at least in the USA. In the UK, in contrast, the mid-1920s return to the gold standard at prewar parity created pessimism rather than optimism..
Another time of very strong Animal Spirits was 1950s USA when, once again monetary growth (and therefore 'monetary disequilibrium') was controlled but asset price inflation was very strong. A similar period was 1990s USA, when strong Animal Spirits and strong growth and innovation was further boosted by strong credit growth as banks increased leverage in the wake of President Clinton's financial deregulation.
The 15 years of the 2000s and 2010s so far seem to me to contain several strands. There was strong credit growth and strong Animal Spirits until the onset of the GFC. Then near zero interest rates and 'Quantitative easing' helped avoid a catastrophic decline of economic activity and cushioned Animal Spirits.
Throughout this period the influence of the 'Greenspan put' and the 'Bernanke put' meant asset demand recovered quickly after each asset crash, and rose strongly in the period as a whole, and this will surely have influenced Animal Spirits of investors. Depressed demand for goods and services closed or slowed the normal recovery channels from recessions. The long period of depressed goods and services demand, combined with continued strong supply of goods and services, is the reason for the global goods and services price deflation.
I have still to put all of this reasoning into a coherent estimable model, but that is the next step. My intuition is that 'deflation' will be seem as a normal response to a deep recession where the normal response to monetary disequilibrium is diverted to the asset markets instead of into depressed goods and services markets.
The RBA's Philip Lowe has grappled with some of the issues covered here. Here is a link to his speech. In my opinion, Mr Lowe is too heavily focussed on interest rates as the primary transmission mechanism for monetary policy. A direct monetary effect, in my view formulated as 'monetary disequilibrium', would help explain the conundrum he is exploring in this speech.
Saturday Sanity Break, 21 February 2015
Date: Saturday, February 21, 2015
Author: Henry Thornton
The event of the year for Henry is the advent of a new book by Geoffrey Blainey. Its arrival is celebrated in the weekend's Australian Magazine where Geoffrey explains ways in which he sees parts of Australian history with fresh eyes. This article covers largely the history of the first Australians and a theme is that 'Aborigines experienced what is surely the most significant event in our history. Nothing since 1788 can compare in magnitude to the great rising of the seas which – in full sight of scores of generations of coastal Aborigines – flooded coastal plains and valleys. It severed Australia from New Guinea in the north and Tasmania in the south'.
Professor Blainey adds that: 'In comparison, the rise in sea levels and the global warming currently predicted for the next 100 years seem like a sideshow. It is a triumph of the human spirit that Aborigines as a people survived an event which must slowly have drowned all or part of the homeland of perhaps one in every three tribes or “nations”.'
The concluding paragraphs comment on the so-called 'history wars' and follow with a nice remembered account: 'Controversy, not war, will continue for a long time to come. It is in the nature of history and of most intellectual activities, and the more so in a nation where the main strands of history – Aboriginal and European – are utterly different.
'In 1948 I was in the public gallery of the old parliament house in Canberra. There I looked down with a sense of wonder at the oldest member, the silver-haired Billy Hughes, who had been a member of the first federal parliament in 1901. I did not then know that in parliament he had often sat near William Groom, a senior Queensland politician who, as a 13-year-old back in the 1840s, had been transported as a convict to Australia.
'It shows the brevity of [conventional, post 1788] “Australian history’” that through good fortune I was able to see a living politician whose parliamentary colleague belonged to the convict era – the time when the first settlement at Sydney began. In contrast, the indigenous history of this country is unimaginably long'.
Professor Geoffrey Blainey’s The Story of Australia’s People: Volume I (Viking, $49.99) will be available in the best bookshops on Wednesday.
Australia's latest blood sport, Abbott bashing, continues unabated, with even the senior journos throwing some punches, including stories that I find literally incredible, such as the allegation that Chief-of-staff Peta Credlin sometimes chaired the Expenditure Review Committee.
But there is so much acrid smoke that one must assume that there are plenty of smoldering ashes. Even friends of Tony Abbott say they fear he will not survive for long.
In matters economic, Henry must say, with a heavy heart, that the budget is buggered, and that only drastic action will stave off recession. Conventional budget reform would involve cutting expenditure or raising taxes, or some mix of the two. Such action is necessary to fix the budget and stop the rise of debt. This will almost certainly slow or delay recovery of the economy unless ...
... Budget reform is accompanied by bold action to encourage growth.
Nick Greiner in today's AFR says there is a need for a "grand compromise" to end the budget stand-off or risk the country grinding slowly toward a "train wreck".
Hear, hear to that, but simply cutting spending and raising taxes - the traditional Treasury way - will be deflationary unless positive energy is injected via serious economic reform.
Wild storms have wreaked havoc in the deep north, and we sincerely hope people are safe and that the insurance companies do not play too hard in assessing the claims that are sure to be many. Rebuliding will add to economic activity and may provide a boost that helps the economy. It is not a boost that John Maynard Keynes would salute, even though in a satirical moment he proposed digging holes and filling them in again.
At the time of writing, Australia's game with Bangladesh is likely to be truncated or called off. With the minimun 20 overs each, anything could happen, and the Bangladashies (sic?) are sure to have noted how Brandan McCallum or David Warner make runs. Meanwhile, England seem disinterested, being flogged by New Zealand who are emerging as a real chance to win the tournement.
The footy season is somewhat delayed by the cricket but Essendon continues to hog the limelight. They have been granted permission to patch together a team, sadly not including men from the Ascot Vale firsts, and should get flogged until their regular players are allowed back.
What sad news it was that code-hopper Karmicheal Hunt has been charged with drug using and drug peddling. At least it was not in Indonesia, so he will not face a firing squad, but his new Rugby career seems likely to be over.
Recession or Reform
Date: Thursday, February 19, 2015
Author: Henry Thornton
Gor blimey, comrades, Messrs Abbott and Hockey are singing from the same hymn sheet and the subject is hell and damnation.
Tony Abbott pointed out, entirely reasonably I hasten to add, that Australia's massive budget deficits and rising debt was stealing from our children, and their children.
Today Joe Hockey has weighed in with some powerful rhetoric of his own, as reported by Adam Creighton.
* 'Speaking to business owners of the Sydney Business Chamber, Joe Hockey said the forthcoming Intergenerational Report – a five-yearly document looking at long term fiscal pressures, due for release soon – would make Australians “fall off their chairs”.
* 'But he said the Intergenerational Report would “stimulate a conversation” about whether the rules around superannuation were sustainable for the long term.
* 'Mr Hockey said the IGR would not be like past reports but “a very genuine attempt by the Treasury, in an unprecedented way, to launch a conversation about Australia’s future”.'
RBA Chief Glenn Stevens recently told the pollies that the debt and deficit situation could get far worse 'in a heartbeat'.
And the ratings agency S&P today put the cherry on the top by warning that Australia's AAA credit rating could be put at risk, meaning we'd have to pay more in interest on that debt.
This is Banana Republic Redux. The original Banana Republic was postponed by tough fiscal and wage policies by the Hawke-Keating government, then the recession it (and all of us 'punters') had to have, further postponed by the Howard-Costello government's reforms and seemingly banished by the mother of resource booms.
But motherly booms always end in busts, and the current bust has revealed the dodgy underpinnings of Australia's so-called 'miracle economy'.
Comrades, we know what is needed. Without imagination and courage, austerity measures which all Australians except the real battlers embrace willingly will be needed. But the measures of austerity must be fair, and be seen to be fair.
'Here is the thing' as a young man might put it. Without imagination, there are two roads to redemption. Cut spending and hold it down until the budget disaster and lack of competitiveness is fixed. Or raise taxes. Or some mix of the two.
The best chance of avoiding recession involves a burst of economic reform to create growth that would help the budget and create jobs. When ratios to GDP are out of whack, a government can cut the denominator or raise the numerator.
* Immediate action needs to be taken to reverse cabotage rules introduced since 2009, and phase out as rapidly as possible the entire cabotage system and its unique work practices regime. This would allow costal shipments of products and raw materials to be transported at internationally competitive rates.
* High efficiency super-critical coal fired power generation must become again the major base for a return to Australia’s power and energy cost advantage, even if we eventually decide Australia is ready for nuclear alternatives.
* Company tax reform needs to provide for the write-off of new manufacturing equipment to match overseas competitors.
* Government should urgently remove regulatory impediments to management and labour flexibility, to allow work practices and conditions of employment to be tailored to the specific needs of each individual business.
* Policies need to be put in place to raise the overall spend (Government and corporate) on R&D as a percentage of GDP, to global best practice levels. The program would need to ensure that relevant business and administrative skills and experience are available to use any Government support effectively. The government's new 'Growth Centres are relevant here, as is the long-standing CRC Program.
* A task force needs to be constituted to review best practice arrangements in countries which lead the table of performance with innovation and commercialisation. The outcome would be a basis to review and implement policies which would be relevant for Australia, which currently is the lowest county in the OECD rankings in this vital area.
* A persistently overvalued exchange rate is a form of asset pricing imbalance that involves instability of industry structure and which requires fresh thinking by the Reserve Bank of Australia.
* Priority be given to mergers which favour the formation of a strong group which can compete in international markets rather than having weak fragmented entities. The ACCC brief needs appropriate revision.
It is very late if recession is to be avoided. But better late than never, as Grandma Thornton used say. Radical economic reform requires both courage and imagination.
We shall soon find out if our leaders have what it takes.