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Henry Thornton - Contributors: A discussion of economic, social and political issues Blogs
Europe stuffed, US stagnating; Asia growing
Date: Thursday, November 03, 2011
Author: Henry Thornton

One of Henry's most read blogs was posted on 1 November 2007.  Its heading told the story 'US recession inevitable; China unstoppable'.

The visiting guru, like Voldemort whose name cannot be spoken, has returned to Australia for his annual visit, slightly peeved that his visit coincided with the horse race that stops a nation, as this reduces his opportunity to practice his guruship.

Henry caught up with said guru thanks to the good offices of Shane NcNeice.  His headline on this occasion might be 'Europe absolutely stuffed; US to struggle for a decade or more; Asia to grow strongly'.

(Alert readers will see that Henry has no future as a writer of headlines.)

'Greece will default' was the opening salvo.'Its public service is overstuffed; it joined the EU with dodgy numbers simply to get German rates of interest and borrowed far too much; the New Drachma's are already printed so Greece can cut wages by devaluing, which is far more palatable than cutting wages by 50 %'.

'There is no way they can avoid default; the Germans are simply not gonna pay; Greek debt will be written off 100 %; Greek banks will be bankrupt, and the State owned German banks and French banks, who also hold a lot of Greek debt, will be in trouble'.

'Greek debt default and interbank loans will freeze the Eurozone banking system which will need to be recapitalised'.

The guru acknowledged that US banks will not be immune as they are heavily involved in the Eurozone interbank market and have like Lehman Brothers issued a lot of credit default swaps that will be triggered when Greece defaults.  Like Lehman Brothers, we know there are a lot of these instruments out there but the statistics are almost non-existant.

When questioned the guru agreed that, 'within a year', Portugal, Ireland, Spain and Italy would also default. While the guru implied that all this Eurozone mayhem would largely be contained within Europe, many in the audience, including Henry, wondered how this could be possible.

'Mrs Merkel has no interest in solving this problem', the guru added. 'She just kicks the can down the road.  The crisis is keeping the Euro low, and with low wage increases and subdued labor costs in Germany this is helping to make German industry incredibly competitive'.

'There are no jobs in Greece (or the other weak nations of Europe) for young people who are queuing up to emigrate'.

'The big central banks are printing money 24/7; banks are not lending but accumulating cash to cushion themselves when the defaults are triggered.  The latest statistics show US base money grew by 37 % in the year to September'. Henry observes that Milton Friedman must be spinning in his grave.

'The US budget deficit is 9 % of GDP, or $1.3 trillion. The Democrats want to raise taxes, and the Tea Party Republicans want to cut spending.  There is complete political gridlock. Bene Bernanke is printing money like crazy and using most of it to buy government securities - eg $855 billion of that $1.3 trillion deficit.

'Foreigners are reaching their limit for buying US Treasuries and China is selling down'.

Warming to his task, the guru noted (to Henry's delight) that there aret two sorts of inflation - goods and service inflation and asset inflation.

Goods and service inflation is dead in the USA, as it was for 40 years after 1929.  Young people who can't get jobs will be 'scarred for life' and except for food and energy there will be no goods and services inflation.

'But asset inflation is everwhere, even asset bubbles.  The Australian dollar is a bubble, US Treasuries, Gilts, JGBs, even London houses, which are being purchased by Arabs, Russians, Indians and Chinese, are bubbles'.

'Eventually there will be a Northern Europe Euro and brutal readjustment in the South. We're talking about social revolution'.

There will be stagnation or slow growth in most of Europe and the USA, 'at least a decade of austerity'.  Demographics will also hinder Europe, where indigenous Europeans are not replacing themselves, except in Sweden where there is two years paid maternity leave'.

'China is allowing wages to rise so that consumer spending can replace exports.  China knows what it is doing'.

'There will be no war in Europe.  The most likely war is between China and Russia over Siberia - a vast, resource rich area largely empty and unexploited'. (Henry kept his thoughts about a similar rich, lightly populated region to himself.)

'What about Australia?' a brave soul asked. 'Australians will feel very rich when the Australian dollar hits US$1.20, but there will be a lot of industrial unrest, like the UK in the 1970s'.

We thanked the guru in the traditional manner and Henry presented him with a copy of Great Crises of Capitalism. With appropriate modesty , it may be appropriate to say that some of this book's themes are similar to those of the guru, though stated in generally less colorful language.

The group then retreated to Vlados for a traditional (and consoling) dinner of lightly cooked meat, salad and red wine. The guru drank only coke.

Suck it up, sunshine, #2
Date: Thursday, November 14, 2013
Author: Henry Thornton

If the USA pursues an extremely expansionary monetary policy, which is completely justifiable from its perspective, the problem is this spills over to the rest of the world, which experiences an exchange-rate appreciation as capital flows to earn a higher yield.

This is the guts of Guy Debelle's 'Suck it up, Sunshine' speech last week in Washington, as reported today the the veteran economic commentator Max Walsh.

(For obvious reasons, Henry is deeply sympathetic to old blokes having a red hot go. And also for crusty old journos giving succor to the RBA, whose officers occasionally notice such manna from journalistic heaven.)

Mr Debelle continues: “Even if the global portfolio reallocation that comes about from this is small from the US perspective, it can be large from the point of view of a small, open economy that is the recipient of these flows.

“In the emerging market world, the concern is often that the capital inflows will become capital outflows. In Australia’s case, an exchange rate appreciation that is not in line with fundamentals, if persistent enough, can lead to Dutch Disease [a hollowing out of those economic activities that are, or can be, exposed to offshore competition].

“This is the fundamental problem, be it a Trilemma, or Dilemma, as Hélène Rey labels it.

“But you might say, isn’t a strong US economy good for the rest of the world? Or, in other words, suck it up, sunshine".

This report, with quotes from the actual speech - available the RBA site, it must be said after quite a delay - suggests Mr Debelle's career is still on track.  Indeed, in an age of increasing openness in all matters, it may already have been enhanced.

Mr Walsh suggests the speech conveys a sense of frustration that seems to be building at the bunker at the top of Martin Place: 'It wasn’t just the content, which was ripe with significant implications. It was also the tone of frustration that caught the attention.

'In this, he [Mr Debelle] reflected the current mood of monetary and economic leaders around the globe. Despite extraordinary measures of stimulus, the general economic disposition around the globe remains dispirited'.

Australia's economy and policy settings have been well-served by our floating exchange rate and focus on containing goods and services inflation.

But when a currency like the Aussie dollar overshoots on the upside, and remains stubbornly high, it creates what is known as the 'Dutch disease' in Holland and as the 'Gregory thesis' in Australia, or at least at the ANU.

'According to the OECD, using a gauge of purchasing-power parity, the Australian dollar is 27 per cent overvalued against the greenback.

'According to Debelle [reports Mr Walsh], this has posed an interesting conundrum in Australia in recent years.

“We have,” he told his Washington audience of central bankers, “been experiencing a ‘boom with gloom’. We have had the difficult balancing act of trying to tell foreigners that the country is not as good as they think it is, so stop sending us so much capital, while, at the same time, trying to convince the locals that the economy is not as bad as they think it is. Now, that’s a real dilemma.”

Mr Walsh concludes by adding further gloom to the story: 'But, so far, there has been no alternative strategy presented that addresses the flaws in the present system, which load us up with a vastly overvalued currency for what could be a considerable and damaging time'.

Henry wishes to point out to Messrs Walsh and Debelle that a respectable alternative has been proposed, and is discussed in Henry's various articles on monetary policy for 2013, which can be accessed here.

The first article for 2013 sets out the framework, including Milton Friedman's 'monetary policy cannot serve two masters' conclusion that has effectively been lost in the babble of lesser monetary economists since 1963.

As a parent, one is occasionally frustrated when one's children travel on paths that their more cautious parents know are likely to lead to trouble, or at least (one hopes) useful learning experiences.

Henry occasionally feels frustration when his intellectual offspring now running the RBA fail to see an obvious point, and ignore the wisdom of the relevant elder - Friedman, if not Thornton.

Today's advice? 'Suck it up, Glenn, and address your frustration (and the pain of other Australians) with a bold policy initiative'.

Further reading

The text of Guy Debell's remarks is available here.

Max Walsh's article is linked here.


The economy and the outlook
Date: Wednesday, November 13, 2013
Author: Henry Thornton

Hints that the US Fed might begin to end its monetary policy 'taper' buoyed the US dollar and therefore reduced the Australian dollar.  One assumes the RBA team quietly celebrated, although our monetary warriors will be well aware that the dollar has a long way to fall before the basis of 'balanced growth' is restored.

Maurice Newman, Tony Abbott's business advisor in chief, has delivered a zinger of a speech. Mr Newman, according to the AFR's Chanticleer, delivered the speech that the Prime minister might have delivered if he was allowed to tell us all what he really thought. 'Newman obviously believes it is his duty to shout from the rooftops how bad things are in Australia following six years of Labor Party rule'.

 Courtesy AFR

Meanwhile, in October, firms reassessed their confidence on the outlook as business conditions again disappointed. Capacity utilisation fell sharply – especially in manufacturing, construction, mining and retail – despite low interest rates and improved housing and equity markets. Other forward indicators deteriorated, reducing earlier gains and implying a continuing soft outlook for domestic demand. Price inflation outpaced by costs growth suggesting margins asre still tightening. This is the summary from Henry's banker. More from the mighty economics team at NAB here. 

China remains on track to achieve its growth target for the year with domestic demand holding up in October, while exports picked up from the disappointing outcome in September. Industrial production was slightly better than expectations for the month, while retail sales and investment were slightly below. Regulatory distortions to trade data are making it difficult to gauge the health of export manufacturers, but solid industrial activity and a pick up in demand from major advanced economies is a positive indication. Demand from these economies is expected to gradually improve.

The acceleration in activity since mid-year is expected to lose some steam going into next year as efforts to rebalance and restructure the economy gain more traction – we should get more guidance on how these reforms will unfold following the 3rd Plenary Session of the 18th CPC Central Committee, which is currently underway. We have maintained our forecast for 2013 at 7.6%, with growth decelerating to 7¼% next year. Despite higher headline inflation, temporary price pressures suggest little incentive for the central bank to materially change its stance on monetary policy. We expect the central bank to continue ensuring adequate liquidity for domestic banks while maintaining tighter overall monetary conditions to discourage speculative investment and rapid credit growth. Bouts of tight liquidity could prompt a cut to reserve requirements, but the central bank has been reluctant to do this so far, and indications that foreign capital is returning will likely add to their reluctance. Therefore, reserve requirements and benchmark interest rates are expected to remain stable.

More here.  

In October, indicators of global economic activity were mixed, casting some doubt over signs of recovery in the advanced economies that emerged in previous months. The upturn is still under way, but the pace of industrial growth and business sentiment in some big advanced economies has stopped improving. Activity in emerging economies has also varied.

Volatility has remained a feature of financial and commodity markets given political uncertainties and hesitation over the timing of US Fed tapering.

Oil prices were lower on balance in the month from the dissipation of geopolitical risks in the Middle East and data on rapid crude stocks accumulation in the US. However, WTI was disproportionately weighed down by the political uncertainty in the US while Brent was supported somewhat by renewed unrest in Libya. As such, the differential between Brent and TWI is wider than at anytime since March this year.
Steel input markets have been held up by improved activity in China, but we are entering a seasonally soft period for construction which should keep prices relatively range bound for the rest of the year. Thermal coal prices have now lifted slightly from their recent floors.

Base metals prices rose modestly in October, helped by stronger than expected growth in China in the September quarter as well as reduced fears of a potential US economic meltdown.
With the market currently anticipating no change to the Fed’s asset buying program until early 2014, investors seem reasonably comfortable holding gold in their investment portfolios, providing some support to prices in the second half of October. Nonetheless, the average price was around 2½% lower in October.

More on commodity markets here. 

Overall, our forecasts for commodity prices have been left largely unchanged. Our near-term forecasts for some metals were raised slightly, while we have also widened our forecast for the WTI-Brent spread. We continue to expect only a modest recovery in demand over the forecast horizon, but the recovery is expected to be bumpy, ensuring ongoing volatility in commodity markets

Global growth expected to rise from 2.9% in 2013 to 3.5% next year. The national accounts and business surveys show a quickening pace of growth in the big advanced economies with the UK and Japan the standout performers. The emerging economies present a mixed picture with solid outcomes in  China, a disappointing record and outlook for activity in India and only moderate growth across Latin America and East Asia.

Australian GDP growth to soften to 2.3% in 2013, rising to 2.4% in 2014 and 2.9% in 2015. Unemployment to nudge 6% by end 2013 and reach 6½% by end 2014. Given the soft outlook, core CPI expected to edge down to 2.3% by end 2013 and 2.4% by end 2014. Rising asset price trends and higher confidence likely to see RBA wait to see how labour market trends play out before cutting again in May (previous cut expected in February).

More detail on NAB's forecasts here.

Readers interested in another, mere elegant but similar view, may caere to read the RBA's latest economic rundown.

Deflation and asset inflation
Date: Monday, November 11, 2013
Author: Henry Thornton

'WHAT is a central banker’s main job?' asks the Economist. 'Ask the man on the street and the chances are he will say something like “keeping a lid on inflation”. In popular perception, and in their own minds, central bankers are the technicians who squeezed high inflation out of the rich world’s economies in the 1980s; whose credibility is based on keeping it down; and who must therefore always be on guard lest prices start to soar. Yet this view is dangerously outdated. The biggest problem facing the rich world’s central banks today is that inflation is too low'. (Read on here.)

 Courtesy The Economist

The Economist this week writes about the 'perils of deflation' and warns that both the USA and Europe seem to be slipping into deflation, the problem that afflicted Japan for two decades after its asset bubbles burst from late 1989.

'As Japan’s experience shows, deflation is both deeply damaging and hard to escape in weak economies with high debts. Since loans are fixed in nominal terms, falling wages and prices increase the burden of paying them. And once people expect prices to keep falling, they put off buying things, weakening the economy further. ...

Ultra-low inflation or outright deflation 'makes both government and household debts harder to pay off. And low inflation makes it tougher for uncompetitive countries within a single currency to adjust their relative wages. With Germany’s inflation rate at 1.3%, Italian or Spanish firms need outright wage cuts to compete with German factories.

'What’s more, too little inflation will undermine central bankers’ ability to combat another recession. Normally, during a period of growth bankers would raise rates. But policy rates are close to zero, and central bankers are reliant on “unconventional” measures to loosen monetary conditions, particularly “quantitative easing” (printing money to buy bonds) and “forward guidance” (promising to keep rates low for longer in a bid to prop up people’s expectations of future inflation). Should the economy slip back into recession, the central bankers will find themselves unusually impotent'.

All these are good points. They make a case that super-easy monetary policy is legitimate. Super-easy monetary is creating asset inflation, which is no great surprise. But there is a point not made by the Economist.  As Henry's research shows, super-easy monetary policy usually creates asset inflation. If goods inflation is subdued, as it was by goods price controls in the US economy in the second part of WWII, easy money will produce asset inflation far greater than it otherwise would.

Indeed, even with monetary policy apparently under control, (eg as judged by growth of the money supply), times when goods or goods and services inflation is subdued tend to be times of massive asset inflation.  Examples from Henry's research - available here - are the USA in the 1920s, the 1950s and the 1990s.

Current super-easy monetary policy and low goods and services inflation bordering on deflation may be uncharted waters, and central banks need to be especially careful.

Luckily, Australia's RBA has not descended into the region of super-easy monetary policy, but faces (with low goods and services inflation) rising house prices and a stubbornly high exchange rate.

Beware the asset inflation, gentle readers.

Saturday Sanity Break, 9 November 2013
Date: Saturday, November 09, 2013
Author: Henry Thornton

RBA downgrades forecasts; leading journos question future of the motor vehicle industry; banks announce record profits; Sydney house price boom; $A remains greatly overvalued; ATO pursues a genuine baddie; Indonesia grumbles about alleged spying; and parliament resumes. It's all happening folks, in the former 'miracle, glass half-full, 'suck it up sunshine' economy'.

Sadly it seems as if the global crisis has arrived downunder, like the radioactive cloud in 'On the beach'.

Treasurer Joe Hockey has announced that incomes may actually (gasp!) fall if Australian productivity does not surge.  Of course, Mr Hockey has yet to announce the new policies that will miraculously raise productivity growth tby the large amount needed, but these will surely come in due course.

Here is the line of argument offered by Henry when a small group of non-economists were discussing the future of Qantas recently.

'Australia's living standards, and general cost levels are, say, 30 % higher than those of competitor nations.

'Therefore, unless Australians are prepared to pay 30 % more for the privelege of flying Qantas, the airline is doomed'.

In response to the cries of outrage from representatives of other industries under threat, Henry continued.

'Pick your industry; in agriculture and mining we are still competitive, essentially because productivity is sufficiently high that the cost differential can be overcome.

'Industries that cannot match this performance will all wither and die'.

So what other industries have a chance? the non-economists cried.

'Our best chances are in medical research and treatment, tourism, education and sport, although the last of these is fading before our eyes as the cricket team gets belted, the Rugby team can't buy a win and the indigenous all stars get flogged by the Irish in the hybrid game that is definately not played in heaven.  Seeding and reforming these industries should be the aim of a sensible government, while letting all the others die as the natural forces of globalisation do their thing.

'Personally, I'd add defence to the list of industries that deserve help.  The government is the monopoly buyer (now that the bikie gangs are being suppressed) and encouraging a robust skilled manufacturing industrial base will be facilitated if defence kit is purchased from Australian firms and maintained here'.

The discussion sputtered out, but it is the debate cabinet should be having, and perhaps has been having.

Blainey awarded University of Melbourne top honour

Melbourne University announced this week that: 'Distinguished Australian historian Professor Geoffrey Blainey will be awarded the University’s inaugural Tucker Medal, in recognition of his substantial contributions to the University, the Faculty of Arts and to public life'.

Those who know the story of the University's earlier treatment of Professor Blainey will cheer quietly.

AFR Scoop

Rowan Dean today explains the case of the missing young women 'found wandering dazed and confused through the ABC's Lateline studios last week'.

'Believed to be called Tanya, the blonde female known to the public as ‘the lost girl’ has been desperately trying to find her way onto the front page of every newspaper and weekend magazine for the past few weeks.

'Media agencies have been trying to establish the woman’s identity since she was found in an overtly distressed state screaming abuse at the TV screen on a Saturday night exactly two months ago.

'Originally thought to be an undergraduate student because of her unblemished skin and adolescent mindset, authorities now believe Tanya is in fact much older and may indeed be the deputy leader of an obscure Australian political party known as Labor'.

Read on here.

Reflecting on this matter, and the clearly excellent state of australia's cartooning industry, Henry wishes to add 'Satire' to the list of industries to be encouraged by Australian governments.  Of course, no actively different behaviour is needed - so long as Australian politicians continue to act as they have been, our satirists will need no further help.


The pestiferous Poms are complaining at the weakness of the bowlers in the Australia A team, plus the inclement weather in Hobart, as hindering their preparation. Surely next time they visit we can arrange a game on Bruny Island, with a rough grass'n'tussock pitch and Lillee'n'Thompson opening the bowling.

Meanwhile, competition for places in the Australian cricket team has hotted up, prompting all right thinking Aussie economists to smile at the virtues of competition.

The much maligned Rugby team gets its chance to be flogged again, this time by the pasta eaters of Italy. The Rugby League team is doing well so far in the world cup, and wisely being modest in its expectations. Footy, as opposed to the round ball game called 'Futball', is only in the early stage of season 2014.  Fresh light has been thrown on the sacking of the St Kilda coach this week.  Coach Watters is apparently vertically challenged, and player unhappiness with his methods resulted in the hiring of two even more vertically challenged entertainers. Setting fire to one of the entertainers was apparently a politically incorrect action designed to symbolised what the players thought ought happen to their then not-much-loved-coach.

Image of the week (Courtesy AFR)

Suck it up, sunshine
Date: Friday, November 08, 2013
Author: Henry Thornton

This insensitive advice was allegedly (according to the AFR, attributed to Bloomberg) offered to anyone who was listening at an IMF conference overnight. It is attributed to newly promoted (presumably) 'Deputy governor' of the RBA, Guy Debelle. To further advance the young man's career, the AFR's engaging photo shows Mr Debelle's film star visage, slightly wild hair and non-white shirt.

Time to get the image smoothers'n'spinners in, Mr Debelle, and to learn the power of the clever crack.

(Policeman judged to be young used to be the sign that the perceiver was getting old.  Perceiving 'Deputy governors' of central banks as young blokes presumably carries a similar message about the ravages of the old bloke with the sythe and the loudly ticking watch.)

With many others, two of Henry's about-to-be graduated offspring cannot find a paying job for the year ahead.  The good news is that one has won an unpaid 'internship' and the other is pursuing (further) higher ed.

Henry's offspring will be fine, but there are many Australians with far less opportunity including victims of an exchange rate that has been far too high for far too long.  Farmers, junior miners, people employed in tourism, manufacturing and small businesses of all types are presumably today sucking it up and reflecting that the glass half-full that was officialease for the state of the economy earlier this year is suffering fast evaporation.

Was Mr Debelle misquoted?  Henry's visit to the ever-reliable RBA website shows no speeches by the 'newly promoted' (presumably) 'Deputy governor' since August 16, when Mr Debelle was described as  Assistant Governor (Financial Markets).  One hopes sincerely that Mr Debelle survives this verbal slip, if slip it was.  In Henry's day as a start a verbal flogging would have been administered by men who knew how to hand out a good tongue-lashing, and possibly the deadly word 'unsound' would have been inscribed on the perpetrator's file.

As to the reality of the Australian economy, now it seems the RBA has reached the end of what can be achieved with subtle moves of cash rates and is resorting to open mouth policy. 'Suck it up', 'in case you failed to notice the glass is half-full' and 'the dollar is higher than it should be, wait a bit and all will be well'.

Gor blimey, Gov'nor Glenn, what if the USA keeps super-easy monetary policy through 2014, the green shoots of confidence in Australia curl up and turn drought-stricken again and this time next year there is even less water in the glass to be sucked up?

There is another way, Glenn and Guy, and you can read about it here.

A reader sent the following snippet: 'Thought this was the funniest thing I read today, from an esteemed central banker, Mr. Mario Draghi.

'Mr. Draghi rejected comparisons to Japan. "The fundamentals in the [euro zone] are probably the best in the world," he said, citing reduced budget deficits, low inflation and high current-account surpluses.

'Can he possibly be serious!'

'Suck it up, Greeks, Italians, Spaniards', other lesser people without the law'.

The report by Macrobusiness is here, followed by a number of comments.

Unemployment surges; jobs dry up.
Date: Thursday, November 07, 2013
Author: Roy Morgan Research

In October 2013 an estimated 1.33 million Australians (10.7% of the workforce) were unemployed. This is up 36,000 (0.3%) from last month. The Australian workforce* was 12,465,000 (virtually unchanged – down 2,000) comprising 7,417,000 full-time workers (up 4,000), 3,715,000 part-time workers (down 42,000) and 1,333,000 looking for work (up 36,000) according to the Roy Morgan monthly employment estimates. These figures do not include people who have dropped out of the workforce and given up looking.

Among those who were employed 1,077,000 Australians (8.6% of the workforce*) were under-employed, i.e. working part-time and looking for more work. This is 88,000 more than a month ago (up 0.7%).
In October in total an estimated 2.410 million Australians (19.3% of the workforce) were unemployed or under-employed. This is up 1%, or 124,000 from September, and much higher than 12 months ago in October 2012 (up 272,000, 1.5% from 2.138 million).

Of those looking for work an estimated 726,000 Australians (up 119,000) were looking for full-time work, while 607,000 (down 83,000) were looking for part-time work.

The latest Roy Morgan unemployment estimate of 10.7% is a substantial 5% more than quoted by the ABS for October 2013 (5.7%) – the Abbott Government needs to immediately establish a working committee to demand the ABS release the true and complete unemployment figures each month.

Gary Morgan says:

'Australian unemployment has risen to 1.33 million Australians (10.7%, up 0.3%) only a month after Tony Abbott was elected as Australia’s new Prime Minister in September - this is the highest since March 2013 when 1.37 million Australians were unemployed. An additional 1.08 million Australians (8.6%, up 0.7%) are under-employed meaning a total of 2.41 million Australians (19.3%, up 1.0%) are either unemployed or under-employed – the highest since February 2013 (2.47 million).

'Australia’s high level of unemployment and under-employment following the Federal Election means the new Coalition Government must undertake urgent reforms to restore the confidence of Australian businesses in the Australian economy to ensure the ‘drivers’ of employment are pointing in the right direction'.

David Uren, the morning after, using the (less accurate) ABS numbers.

'IT IS harder for the unemployed to get a job now than at any time since the 2000 slowdown, and the deteriorating labour market is set to dominate economic policy for both the Reserve Bank and the new government for many months to come.

'The cyclical softening in the economy as the resources investment boom comes to an end is compounded by the ageing of the population, which now has baby-boomers retiring in large numbers.

'For a long time, the monthly labour force reports have been surprising for their resilience in the face of dismal business surveys showing companies cutting back their hiring and falling numbers of job advertisements.

'The outgoing Labor government was still able to go to the election claiming there was "almost full employment". Treasury analysis has shown that when unemployment drops below 5 per cent, labour shortages start pushing wage costs and inflation higher.

'However, the labour market has been slowly weakening since April last year. Until about February this year, the jobless rate was creeping higher by about 0.1 percentage points every three months. Since then, the pace has picked up to 0.1 percentage points every two months.

'Hiring has stopped, at least in net terms. There has been no increase in the total number of people with jobs since February'.

Read on here.

RBA grapples with `dilemmas', ordinary Australians suffer
Date: Monday, November 04, 2013
Author: Henry Thornton

The RBA governor has said he cannot deal with the excessively strong exchange rate, but that eventually falling commodity prices will do the job for him.

With his fellow senior officers, Mr Stevens has has dismissed thoughts of a bubble in housing, but at the top end of some markets, especially Sydney's rich belt, bubble-like signs are evident to rich people, or ordinary people who read newspapers.

Journalists are at last (at last!) discussing the dilemmas that are worrying our friends in the bunker at the top of Martin Place.

With appropriate modesty we point out that our regular column has used the words 'dilemma' or similar quite often in the past year, and also that we have articulated an appropriate way for Glenn Stevens to approach these dilemmas.  Here is the evidence.

Our tagline is that 'monetary policy cannot serve two masters', appropriated with attribution from the master monetary economist of the twentieth century, Milton Friedman.

His point is that monetary policy must focus on restraining goods and services inflation and guarding the economy from the ravages of financial instability.

Other objectives need actions other than the subtle movement of interest rates which takes most of the time of central bankers. (What they do after their morning tea is mysterious to most people, which is why central bankers do not often invite critics, or even old friends who occasionally offer advice, into the bunker.)

Here is Australia's current position.

The economy is sluggish, though the latest job ads (a highly reliable indicator that has been falling for some time now) may finally be stabilising. Jobs are hard to get and an oversupply of university graduates, and of older, highly experienced workers, is making jobs even harder to get for ordinary Australians.

Inflation is low but may be rising.  If there is a big and sudden fall in the value of the Australian dollar, inflation will quickly exceed the RBA's target zone. If our central bankers think things are difficult now, imagine double digit inflation with double digit unemployment to follow.

Interest rates may already have gone a bit lower than is wise, partly in the hope of reducing the Australian dollar, which seemed to be working for a time but the RBA has now thrown in the towel.

The trouble is, we have been told, the pesky American central bankers keep deciding not to begin to restore a sensible monetary policy, and the resulting global boom in asset prices is holding the Australian dollar up and may drive it higher again.

The RBA needs help.  Australian monetary policy alone cannot solve the problems posed by global asset inflation.

As our better economists have said, one approach to an overvalued exchange rate is to introduce new economic policy reforms to help companies to cope with a high dollar that is greatly hindering efforts to export and to compete with imports.

Here is the rub. No practical and feasable program of economic reform could do more than raise Australia's productivity by a few percent each year.  The Abbott government has at least stopped the productivity reducing policies of the late, unlamented Labor govenment but will hasten methodically with its reform program.  Labor is committed to doing its best to prevent  the axing of the carbon tax and would certainly scream with rage if the Abbott government tried to improve the working of the labor market or attacked fiscal spending sufficiently to create the real hardship in Canberra.

It is a sad fact that it is only an actual economic crisis, or plausible fear of a real crisis, that gets big reforms done quickly.  Crises also focus business leaders and ordinary workers on the main game of improving productivity, but this is almost always accompanied by a powerful and damaging increase in unemployment.

This is why I believe we need to fix the currency problem by imposing a modest across-the-board tax on capital inflow. The skeptics point out that Australia is a capital importing nation and cowardly skeptics imagine that global investors would cross Australia off their investment lists if we imposed such a tax.  'Rubbish' is the correct answer to such arguments.

Taxing capital inflow will help to discourage the buying of expensive houses by wealthy people from overseas and rich Australians who play asset booms bravely and well. But, in the next decade or so, house price inflation will only be controlled if there is sensible reform by state and local governments, reforms that allow more people to live in the inner city areas, with higher density housing, faster releases of land for suburban housing and junking of near-useless regulatory blockages by local governments.  Governments also need to find ways to encourage people to live and work in rural towns and cities.  Like economic reform in general, this process will be at best slow and will not be sufficient to solve the problem of house price inflation. The people who oversee Australia's financial system need to introduce some new policies under the heading of 'macroprudential policy'.

Required asset ratios for financial institutions are part of the solution, ratios that flex up when asset booms gather strength and flex down when the booms decline or when overheated bubbles burst.

When the RBA meets today in that large, quiet, board room that seems such a suitable place for quite contemplation or even religious observation (if only a pipe organ with a competent organist were installed), one sincerely hopes that the governor leads his board members in prayer for the wisdom to face their problems (which are the problems of ordinary Australians) honestly and with clarity of vision.

The RBA cannot do more to achieve general reform than to advise quietly and speak generally and not often on the subject.

But the RBA can advise government and should do so in the strongest terms about the urgent need to reform the state of Australia's asset markets by giving it the tools it needs to keep the economy on an even keel while methodical general reforms are planned and carried out.

Long weekend Sanity Break, 2 - 5 November 2013
Date: Saturday, November 02, 2013
Author: Henry Thornton

Where are Australia's manufacturing industries going? That is the question of the decade and there is no easy answer. Specialised hi-tech manufacturing, like just-in-time 3D printing of structures to replace bones in serious cancer surgery, is a world-leading example of manufacturing with promise. Manufacturing of cars or processing food when there is a flat global supply (cost) curve, and Australia has high domestic costs but lacks access to vast economies of scale, is a mug's game.

New age protectionism

Saturday was long and lazy but a mining man phoned as Henry was taking exercise to ask if he had read Judith Sloan's column.

I had to confess that I had not.  Said mining man told Henry that Sloan was onto something, something that applied to mining.

The source of this shaft of clear white light is here.  It is about the lack of competitiveness that is driving Australia's old-fashioned,  heavily unionised food processing businesses offshore. Mention is made of excessive wages, and Ms Sloan quotes the story of the lack of (inexpensive) scallop shuckers (in Tasmania, with its horrendous rate of unemployment) that has led Aussie scallops being shucked in Thailand, and then re-exported back to Australia.

In some excitement the mining man said 'It's just like mining. Think of a steeply rising cost curve.  If a mine is in the first quartile of efficiency, as many Australian mines are, then good profits can be made. But metal manufacturing, or manufacturing generally, has a flat cost curve, so even an efficient enterprise finds it hard to make good profits. Why do you thing BHP eventually sold its steel mills, and RIO never had any'. (Henry's correspondant is a retired RIO man, who hates to miss a chance to deliver a cruel barb to the old enemy.)

I had to agree that this analysis was as tight as an unopened scallop, and another brick in Henry's so far limited understanding of microeconomics has been cemented in place.

[Later: A very senior mining man emailed as follows: ' Your Saturday Henry Thornton blog is spot on.
'Mining projects in Australia today have to be either high grade or very large scale and export the first saleable product to be economically viable. As an example, at Olympic Dam WMC built a smelter and refinery to produce highly refined metals (copper, gold and silver), as well as uranium oxide. The (now shelved) BHPB plans for Olympic Dam expansion were based on exporting a mixed concentrate for refining in China. 
'Under the present conditions no further smelters or refineries can be built in Australia. Existing such plants may well have to close when they need substantial capital replenishment.

Mrs Thornton came out punching on the matter of subsidies for vehicle manufacturing whilst watching Insiders on Sunday morning.

'Who wants to use taxes to subsidise companies to make cars here? If the goverment wants to do that the least they can do is extract shares in return.'

Henry could not fail to agree, as he had previously argued, in discussing the bail-outs of failed American financial enterprises, that all government bail outs should only be made in return for equity that could presumably be sold later at a substantial profit.

Ruminating a bit further, Henry and Mrs T had the amazing insight that another condition of a bailout could be forced merger of failing vehicle manufacturers in Australia.  If Australian governments had been accumulating equity in exchange for bailouts, by now they would have enough equity to enforce mergers, thus improving scale of Australian vehicle manufacturing.

Of course, as Ms Sloan and the mining men understand only too well, the global cost curve for cars is very flat and Australian wages and conditions (not just sub-optimal scale) puts us at the top of the global cost curve. ]

Politics downunder

The political news is, to put it colorfully, as boring as bats**t'.  Labor has decided to fight the end of the carbon tax, and will live to regret this ignoring of the will of the people. (Correction, might live.)

Rather than running about like two-headed chooks, the Abbott government is proceeding slowly and purposefully.  The second week without boats of paperless would-be immigrants and the extradition from Indonesia of an Iraqi person-smuggler are both signs of an election promise being kept.

Australia has been accused of spying on the nations of Asia, upsetting the Indonesians but apparently not the Chinese, who if anyone there noticed might have said with grudging admiration: 'Didn't think the Aussie's had it in 'em'.

Monetary policy shenanigans

The RBA's confession of its powerlessness to control the excessively strong dollar has been much commented on.  Most fulsomely in the Weekend Fin, where John Kehoe says "As the economy muddles through at sub-par growth, the Reserve Bank of Australia may be forced to admit defeat – at least until Ben Bernanke starts the great stimulus unwind".  Mr Kehoe quotes everyone except Uncle Tom Cobly and, wait for it, Henry, with his bold plan to tame the dollar by taxing capital inflow.  First articulated in January this year with the aid of Friedman's aphorism 'Monetary policy cannot serve two masters'.

Compare and contrast, gentle readers.

Kehoe and friends, including Glenn 'I'm out of ideas' Stevens.

Henry and Milton Friedman.

If you wish to learn more, Henry's editor's latest research is available here.


Fiona Prior views Woody Allen’s Blue Jasmine and visits Sculpture by the Sea, 2013.

She concludes that Woody still has a few problems to sort through!

Image of the week

 Courtesy Google images

Managing money for the ages
Date: Friday, November 01, 2013
Author: Henry Thornton

Ever keen to help central bankers, as well as ordinary punters, Henry's research team presents their research on the tricky matter of Asset inflation and Monetary policy.  The summary is here, and contain links to other important contributions and to the full paper, including footnotes and references.

Readers familiar with the London underground will recall, perhaps fondly, the recorded message: 'Mind the gap'. We have long suspected that there is a gap in monetary history and analysis, a gap that is far more important than the gap between train and platform in the London underground. The gap in question concerns the role of asset prices in the analysis of the effects of monetary policy.

Milton Friedman famously said: 'Inflation is always and everywhere a monetary phenomenon' (Friedman, 1963, p. 17). Inflation in this context is goods inflation, or goods and services inflation. This was based primarily on the masterful historical analysis of Friedman and Schwartz (1963), but has been confirmed with statistical analysis of different levels of complexity and is now part of the canon of macroeconomics.

There has, however, been a long and we judge inconclusive debate about the interaction of asset prices and monetary policy. There has been resort to complex econometric techniques of different sorts and simulation analysis of simple models. But this work has not resolved the issue. We approach this question by repeating in summary form the analysis of Friedman and Schwartz including (as they did not) asset prices as represented by US share prices, specifically the S&P 500 index, with the advantage of five decades of additional data.

We must stress that this paper is fundamentally empirical, as we believe were Friedman and Schwartz.  Our aims are to determine: what are the facts; and what does the data suggest about how to include asset inflation in existing models.

US share prices are more volatile than the monetary, price and real income variables used by Friedman and Schwartz. But all the major episodes, and most of the sub-periods, analysed by Friedman and Schwartz, show trends in both share price inflation and goods and services inflation directionally consistent with changes in monetary policy as represented by growth of the money stock.

But there are also cases when share prices are suppressed, such as in the first world war and the second part of the second world war, when goods and services prices rise much faster than suggested by their normal relationships with money growth.  Conversely, when goods and services prices are suppressed, share prices rise especially rapidly, as they did in the second part of World Was II. The Roaring Twenties and the share booms of 1948 to 1960 and 1990 to 2000 are far more important examples in which money growth and wholesale inflation were both low but there were large booms in share prices. Another key example of such an apisode, is the Japanese land and share boom that ended in late 1989. These 'aberrant episodes' (as we call them) are of especial interest and when appropriately allowed for will improve both theory and empirical analysis of how economies work.  This is a vital matter as the 'aberrant episodes' have almost always ended badly,

Clearly some plausible theory needs to be brought to bear if these episodes are to be incorporated into macroeconomic theory and policy modelling. We suggest that allowing for the state of confidence, Keynes' 'animal spirits', would be a good way to start.  Powerful confidence seems to have been an important part of the story of the USA in the 1920s, the 1950s and the 1990s, in each case associated with powerful innovation and strong growth. Powerful confidence might be expected to boost demands for both money and shares. Increased demand for money would presumably mean lower goods inflation for any given rate of money growth, and contained money growth would itself boost confidence. Powerful confidence would presumably make bankers more inclined to advance credit, and as Schularick and Taylor (2010) show so convincingly, strong credit growth is a vital part of the generation of asset booms.

We are aware of no systematic measure of the confidence of investors that stretches back to post-Civil War America. When questioned about this matter, share brokers usually comment that the best measure of confidence is the behaviour of share prices, which is of course circular if used to explain strong share booms.

Blainey (1988) provides a systematic and persuasive analysis of the effects of the 'Great Seesaw' of swings in confidence in the history of the Western world from 1750. Kindelberger and Aliber (2005) say: 'Asset price bubbles - at least the large ones - are almost always associated with economic euphoria'. (p 115). Galbraith (1955) documents in telling detail the progress of euphoria during the boom of 1922 - 29, and especially in 1928 and 1929.

Daniel Yergin's wonderful 1991 book, The Prize, summarises in just a few pages the dramatic post-WWII development of America. 'The inexorable flow of [cheap] oil transformed everything in its path'. (p 532). Suburbanization gathered pace requiring widespread ownership of cars.  Great highways were built, drive in restaurants and movie theatres were built, cars added fins and other symbols of innovation and success. (Pp 530 - 536).

Ben Bernanke (2013), reviewed here, says 'low and stable inflation over a long period supports healthy growth and productivity and economic activity'. (p 40) Then in discussing the so-called Great Moderation, he remarks: 'With twenty years of relatively calm economic and financial conditions, people became more confident, willing to take on more debt'.

These contributions, and others like them, especially Akerlof & Shiller (2009), reviewed here, provide useful hints for modelling investor confidence, and Bernanke's general statement suggests a way to relate low and stable goods inflation with the genesis of asset inflation.

The aberrant experiences deserve emphasis because all three of the relevant episodes analysed in this paper ended badly, in the latter case with continued uncertainty more than five years after the start of the crisis itself. As previously noted, Japan's experience in the 1980s, with a massive asset bubble while monetary policy seemed to be restraining goods and services inflation, (also followed by a massive asset bust), fits this 'aberrant' scenario well, and was followed by two decades of poor economic performance.  The build-up to the Global Financial Crisis also involved great confidence, especially the almost manic confidence of the bankers of Wall Street and the City of London.

Apart from further efforts to quantify 'confidence', or 'Animal Spirits', there are several obvious extensions of this work - to include other assets, especially real estate - and to investigate more systematically alternative or subsidiary measures of the impact of monetary policy.

Application to smaller economies is not straight-forward because, even if they have flexible exchange rates, small country share prices are influenced directly by swings in Wall Street, as well as by in-country monetary policy, real growth, goods inflation and other domestic factors.

Despite the difficulties of wars and depression, the regularity of the relationships exhibited in the full paper, linked here, should provide fresh impetus to modelling of interactions between share prices and other key economic variables.

The paper also discusses the implictions for monetary policy. Essentially the results justify policies other than manipulation of cash interest rates if asset booms and busts are to be modified.  This is a point that Australia's Reserve Bank seems to be ignoring with great focus. Unless this apparent blind spot is overcome, Australia's economic performance will suffer, perhaps in a big way.

Here is the key point: 'Tightening monetary policy, as in the USA in 1928 and 1929, on top of a general expectation that markets are over-valued, will bring any asset boom to an end. But, as Friedman and Schwartz say, there are 'great difficulties in seeking to make [monetary] policy serve two masters' ...  and 'the Board [in the 1920s] should not have made itself an "arbiter of security speculation or values" ' (p. 291).  In our view, policy-makers need to have a clear way to modify asset booms when the evidence suggests the strong risk of such a boom getting out of control. Ironically, the evidence suggests that firm monetary policy is likely to promote asset inflation, which is a powerful reason not to rely on monetary policy to control asset inflation. The literature generally has missed this point, which has resulted in many wasted and unproductive articles on the subject of this paper'.

We hasten to assert that the aim should not be to strangle a boom for its own sake, since much that is constructive occurs in the boom times. Rather the aim should be to control the asset boom so that it is not based on 'irrational exuberance', or excessive credit growth, especially not credit based on lending with narrow asset backing or highly risky credit standards.

Managing money in troubled times
Date: Wednesday, October 30, 2013
Author: Henry Thornton

Sometimes an unorthodox approach to a knotty problem is required.  Yesterday, Henry's favourite fund manager (FFM) made this point by telling his audience about the unorthodox approach used by Lord Nelson to the battle of Trafalgar.

The starting point, and much of the discussion, was about the dramatic growth of the USA's national debt and what that means for investment markets. As the chart shows, US government debt is currently forecast to rise, as a ratio to GDP, to the height reached following the onset of depression and war in the 1930s and 1940s. This debt ratio fell sharply as vast armies were returned to civilian life and what became one of history's great economic booms began to gather pace.  There is no expectation of such a natural debt reduction for the next decade and a half, though one should perhaps be aware that, in economics as in life, good things sometimes turn up unexpected.

While the USA has made progress in reducing its budget deficits and economic recovery seems to be underway, recovery will raise the rate of interest required to service the debt and put an expansionary spoke in the wheel of debt reduction. So far, every time the US Fed discusses reducing the so-called 'taper', ie reduction of super-easy monetary policy, bond yields rise and equity prices fall sharply.

There are only three ways to reduce a debt mountain of the size predicted for the USA: turn budget deficits into surplusses (Plan A); repudiate the debt (Plan B);and inflate the debt away (Plan C). Here is a discussion of the relevant issues.

As this earlier discussion put it: 'By all means enjoy the equity boom that will go on if and when the bandaid is applied to the oozing, toxic fiscal mess in the USA.  But consider what you will do to protect your family's wealth and welfare when Plan A fails and some mix of Plans B & C is applied to the US economy'.

Henry's FFM said that he hoped the whole show could go on without drama in asset markets, implying I thought a continuation of asset inflation setting new records for asset prices and with no dramatic fall to be avoided or not as the case may be. No one was rude enough to point out that 'this time it's going to be different' is simply wrong, and Henry's FFM does not believe that either, in my view.

There was much discussion of what, if anything, could be done to take advantage of the situation. Extra exposure to real estate was ruled out as most of the audience were already long real estate. Our FFM had some radical ideas of what might be done by the Abbott government to reduce negative gearing, thus reducing investor demand for houses and flats, and keeping prices down for first home owners. We reminded him of how Paul Keating's efforts in this direction required a backflip after only five weeks, which ended that discussion.

'What about the usual rule that old people, like us, should increase their holdings of bonds?' asked one of the oldish persons present. 'There are two possible futures for bond prices apart from continued steady yields that we might all hope for', replied our FFM, 'inflation or deflation. Either approach will be bad for bond yields - falling yields with deflation and rising yields with inflation. Either outcome will smash returns from bonds'.

Our FFM asked us if we were aware of current levels of long bond yields in Spain, Italy amd Australia. 'All are approximately 4 %' he pointed out. Perhaps, however, Spanish and Italian investors are expecting 2 % annual deflation, while Australians are expecting 2 % inflation - ergo, real yields are far higher in the banana republics of southern Europe.  Precisely what this might mean for asset allocation decisions was unclear to Henry, possibly because it was fast approaching the time for his afternoon nap.

Another question concerned the apparently relatively excellent returns from Australia shares relative to overseas shares over long runs of history. Henry was jolted awake to point out that Australia has historically suffered greater inflation than the USA, and our currency has fallen, meaning higher yields here suffer from what economists call 'money illusion'. 'Of course, the Aussie dollar is very high now, and that is a good reason to put money offshore', Henry opined.

As well as avoiding bond markets, our FFM suggested he will shortly be applying a policy of gradually reducing holdings of shares, starting with the most heavily overvalued. When he perceives that real trouble is in the offing, he will try to cut overall equity holdings quickly, although he conceded that many other fundies will also be poised with fingers hovering over the sell button. This approach is unorthodox as fund managers usually stick to the old saw that 'time in the market beats market timing', but this time the boldest among them are planning to avoid the inevitable crunch with the caveat 'to the extent possible'. The quote of the day was 'Being too prescient can appear to be too conservative'.

The meeting broke up quickly about then, all of us agreeing that Glenn Stevens was not going to accept advice to put a tax on capital inflow any time soon. And a cheeky comment on fees was allowed to go through to the keeper.

Who'd be a fund manager?  It would not be so bad if the job did not involve pesky clients, but at least Henry's FFM is prepared to meet and brief his customers.

Reflections on issues for the gnomes of Martin Place.

Exactly a month ago we started our regular article on the issues for the RBA board as follows:

'The RBA meets tomorrow facing three objectives. Its single instrument of 'vary cash rate' will not be able to help fix the three economic problems except by accident for short periods.

'The RBA has said it is watching the hot property market and some (killjoys) say higher interest rates would help to prevent a boom turning into the next bubble.

'The RBA has also shed some crocodile tears about the exchange rate, and sort of let it be known that it welcomed the fall in rates that followed its rate cuts. Lately, however, the currency has rebounded with better global economic news and the lack of the US Fed's foreshadowed 'taper'.

'In its real job of containing inflation and maintaining economic activity many advisors (owners of shopping centres, real estate agents) wrongly say more rate cuts may be helpful, even necessary'.

Read on here.

Today, exactly one month later, the AFR eight column front page headline screams: 'RBA caught between high dollar and rising house prices.

Similar messages were conveyed, although less prominantly, by other news outlets.

All this excitement was generated by the latest example of the RBA's 'open mouth' policy, which can be accessed here.

Orthodoxy is a virtue for central banking gnomes, but we are all going to pay for their failure to see that current problems require unorthodox solutions.

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