Bang Crash Again

Some much needed thoughts on Ken Henry's address re the "next wave"..

Are due for another wave of fiscal terror and financial woes???
Apparently Treasury secretary Dr. Ken Henry is.

How does the bush-walking top bureaucrat plan for such an eventuality? He dons his rose-tinted glasses.

Despite this, all the commentary in the mainstream press has been on Dr. Henry's use of the word "shockwave." However, it was this comment that was perhaps the most important:

"My thinking is simply that, in a world that pays more attention to fundamentals than herd-driven investor psychology, the Australian economy will be seen as possessing the best of the qualities - of governance and flexibility - of the developed world while also offering an abundance of real investment opportunities usually found only in the developing world. That is to say, the Australian economy may be seen as offering the best of both worlds."

Dr. Henry's argument is Australia may outperform other Western economies.

He used a slide to highlight that retail sales had collapsed in all other Western economies towards the end of last year, but actually grew in Australia.

This was of course due to the stimulus package. And looking ahead he seems to think it is Australia's governance that will see investors pour many into our local economy.

Here's a surprise for you. We agree with Dr. Henry that Australia may outperform other Western economies.

However, he's 3,318 kilometres wide of the mark with his reasoning.

You see, it's not Australia's governance (funny that a civil servant should try and take the credit for growing the economy!) that will continue to attract investors, it's Australia's resources.

It's Kalgoorlie not Canberra that the Chinese and other Asian economies are interested in.

Look outside Canberra!

Sure, sovereign risk is always a factor for foreign investors when investing offshore. But to think that anyone invests anywhere purely because governance is sound is nonsense.

In fact, it's the governance that prevents investment not encourages it.

Not according to Henry. He says:

"[T]he Australian economy might attract an even greater share of global capital flows, and quite possibly even larger capital flows in aggregate."

But even if we accept Henry's argument - which we don't - it's just a shame that Australian companies will miss out on a lot of these investment opportunities due to bureaucratic red tape. The constant meddling by both political parties in workplace laws and other regulations makes it almost impossible for Australian businesses to grow.

That's why we have monopolies and duopolies in almost every industry you can think of. Only mega companies have the resources to cope with the amount of regulation forced upon businesses.

Why grow your business from a small family run operation into something bigger when you know you'll get stung by the government from every angle.

Henry's claim that 'governance' is responsible for future Australian economic growth is a warning sign to prepare for the worst.

Clearly it will embolden policy makers to become even more interventionist. Here's the slide Henry showed highlighting the fabulous Australian retail sales figures:

Government bails out retailers

"What's the problem with that?" you may ask. "It averted a recession didn't it?"

Postponed it, reader, postponed it. I'll explain this more in a moment.

We've said for some time now that Australia has a 'get-out-of-jail-free' card thanks to the resources industry and China's seemingly never-ending demand for iron ore, copper and anything else it can get its hands on.

While that is good for Australia it potentially poses a problem too.

The problem is the resources industry is perfect cover for meddling bureaucrats. The 'guaranteed' demand from China and the flow-on effect this has on the Australian economy enables bureaucrats to constantly raid the cupboards whether it's through taxes or royalties.

These taxes and royalties are then used on pet projects - roads, hospitals, schools, bribes, etc...

This necessitates more spending to create bigger and better projects.

Then the government figures if it can improve everyone's quality of life it will make them more likely to vote for them. So, what do they do?

They increase rules and regulations.

They manipulate asset prices. They manipulate interest rates. They impose arbitrary rules on businesses. They impose minimum wage legislation. They set targets to get more people into university.

The more rules the better. The outcome is a short-term hallucination that living standards have improved. Everyone can become a home owner. Everyone can own a car. And no-one has to work in a factory again.

In fact, no-one has to work again because we can all invest in property.

This inevitably leads to the destruction of the economy. Companies are forced to send their manufacturing offshore - the lucky ones that is. The unlucky ones just go out of business.

Unemployment becomes institutionalized as minimum wage legislation makes it illegal for an employer to pay someone 1-cent below the minimum wage. Even though that lower wage may have given someone a job.

Instead of banks lending money to businesses to invest in machinery or new technology, the banks lend more and more money to the housing industry. We published a table last week by the Commonwealth Bank that showed 56% of their loan book is residential mortgages.

That's a lot of money being spent on consumption. And it's exactly the same path the US took. They stopped producing and instead consumed. The fact that Australia's retail sales increased is not a positive sign. It is a sign that the economy is well and truly a net consumer than a net producer.

Think about that figure from the Commonwealth Bank again. Not one dollar of that money is being spent on something that will benefit the Australian economy relative to our international trading partners. After all, you can't export a house!

The claim that 'governance' has saved Australia is false. It has done no such thing. Governance has merely postponed the effects.

It's a governance snowball. It's getting bigger and bigger.

You only have to look at most of the other resource rich economies around the globe. To varying degrees they've all done the same thing. They've leached the easy money from their natural resources and blown the proceeds on supporting their pals or wasting the money on pointless government projects.

If the Australian government continues to reap the rewards from the resources industry while simultaneously handicapping every other industry, the results will be catastrophic for the Australian economy.


Thanks to Chris Sayce of Money Morning

REIV Economic Update August 2009

Feature Story: August Interest Rates
The board of the Reserve Bank of Australia decided to leave the cash rate unchanged at 3.00 per cent at its monetary policy meeting today.

The board of the RBA believes that “with considerable economic stimulus in train around the world, the global economy is stabilising after an earlier sharp contraction in demand. Downside risks to the global outlook have diminished, though they have not disappeared and most observers expect only modest growth overall. There is tentative evidence that the US economy is approaching a turning point, but conditions in Europe are still weakening. Growth in China, in contrast, has been very strong in recent months, which is having an impact on other economies in the region and on commodity markets.”

The board goes on to note that “economic conditions in Australia have been stronger than expected a few months ago, with both consumer spending and exports notable for their resilience. Measures of confidence have recovered a good deal of ground. This suggests that the risk of a severe contraction in the Australian economy has abated. The most likely outcome in the near term is a period of sluggish output, with consumer spending likely to slow somewhat and investment remaining weak. Stronger dwelling activity and public spending will start to provide more support to overall demand soon, and growth is likely to firm into 2010.”


Current Economic Conditions
Economic conditions have stabilized slightly in recent months with positive economic data improving sentiment. Some positive economic data domestically suggests the Australian economy has held up strongly in the recent months, however, unemployment is still expected to continue rising throughout 2009.

The latest ABS employment figures revealed the national unemployment rate increased to 5.8 per cent in June 2009 (a level not witnessed since October 2003), with the Victorian unemployment rate reaching 6.0 per cent for the month. Many market forecasts expect the unemployment rate to reach the 7.5 per cent mark sometime next year; however, this figure has been revised from the expected 8 per cent from earlier in the year.

The All Groups CPI rose 0.5 per cent in the June quarter 2009, compared with a rise of 0.1 per cent in the March quarter 2009 and rose 1.5 per cent through the year to June quarter 2009. The most significant price increases for the year were housing (+5.2%), Health (+5.2%), education (+5.1%), food (+4.8%), and alcohol and tobacco (+4.7%). The most significant offsetting price falls for the year were for financial and insurance services (-6.6%) and transportation (-5.9%). Melbourne's CPI rose 0.3 per cent for the quarter and 1.2 per cent for the year to the June quarter 2009.

The Australian dollar was trading at 0.8281 US dollars at close of business on the 31st of July 2009. The Australian dollar has increased by 3.7 per cent in July against the US dollar. Some currency analysts expect the dollar to continue rising in the coming months as investors see Australia as a safe haven for their assets.

There has been some poor performance in the retail sector in June 2009, with seasonally adjusted data showing total Australian turnover decreasing by 1.4%, and Victorian turnover decreasing by 1.3 per cent for the month. The decrease comes after 3 months of positive and steady retail growth and is only the second month in 2008 to post negative retail growth. Unfortunately trend data not available from the ABS at the moment, as a number of issues related to current economic conditions (including the introduction of that government stimulus package) have made the calculation of the trend data series difficult.

An increase in consumer sentiment combined with some positive economic data has boosted car sales in recent months. Sales of new cars are up 5.7 per cent in June 2009 in seasonally adjusted terms, following a 5.4 per cent increase in May 2009. Car sales have not been up for three consecutive months since November 2007. Trend data was not available for publishing at this time.

Housing Market Conditions
The REIV June quarter medians have revealed that the metropolitan median price of a house has increased 9 per cent from $405,500 to $441,875, just short of the 2008 peak of $450,000. The unit and apartment market has recorded an almost identical increase as houses with the median price increasing by 8.3 per cent over the quarter from $360,000 to $390,000. The improvement can be attributed to low interest rates, confidence in the market, continuing population increases and the financial assistance to first home buyers. These factors have contributed to the July 2009 REIV auction clearance rate reaching 85 per cent. The REIV auction clearance rate has now been at 80 per cent and above for the last four months.

The ABS House Price Index released today confirms the price movements witnessed in the REIV June Quarter median prices. The house price index for the weighted average of the eight capital cities increased by 4.2 per cent in the June quarter 2009. All capital city indexes rose over the quarter with the largest increases in Melbourne (+5.2%), Sydney (+4.9%), Canberra (+3.6%) and Adelaide (+3.4%). Over the year to the June quarter, indexes in all capital cities fell, except for Darwin (+11.0%), Adelaide (+2.7%) and Hobart (+0.1%).

Building approvals showed some promise in June. The number of total dwelling units approved in Victoria increased by 17.4 per cent in seasonally adjusted terms for the month of June 2009, following a revised decrease of 7.8 per cent in previous month. The value of total dwellings approved in Victoria increased by 59.7 per cent to $2.03 billion dollars. In trend terms, the number of total units approved in Victoria increased by 0.2 per cent for the month while the value of total dwelling units approved increased by 1.3 per cent for the month.

Housing finance statistics also exhibited a positive note. In Victoria, the number of dwellings financed by first home buyers increased by 16.2 per cent in May 2009, as uncertainty about a possible extension of the boost saw many buyers trying to get in the market before the 30 June 2009 deadline. Dwellings financed by non-first home buyers increased by 12.3 during the month. The average loan size for first home buyers decreased by 1 per cent for the month, while the average loan size for non-first home buyers increased by 2.8 per cent. The total number of loans increased by 13.5 per cent for the month, while the total value of the loans increased by 15.4 per cent.

Lending conditions have also improved slightly as the total value of owner occupied housing commitments excluding alterations and additions for May 2009 increased in both trend terms (up 3.0%) and seasonally adjusted terms (up 2.3%). The total value of commercial finance increased in trend terms (up 0.4%) and in seasonally adjusted terms (up 4.0%). The value of total personal finance commitments decreased in both trend terms (down 0.9%) and in seasonally adjusted terms (down 2.9%).

The Metropolitan Melbourne rental market eased slightly in June 2009 with a vacancy rate of 1.4 per cent. The outer and middle Melbourne vacancy rates both eased to 1.0 per cent from 1.6 per cent respectively. The inner Melbourne vacancy rate remained unchanged at 1.4 per cent.

Thanks to the REIV

Where are we going economically. One pessimists view

"I determined that it was my duty, even without precedent, to call upon the business of the country for coordinated and constructive action to resist the forces of disintegration. The business community, the bankers, labor, and the government have cooperated in wider spread measures of mitigation than have ever been attempted before... Our leading business concerns have sustained wages, have distributed employment, have expedited heavy construction. The Government has expanded public works, assisted in credit to agriculture, and has restricted immigration. These measures have maintained a higher degree of consumption than would otherwise have been the case. They have thus prevented a large measure of unemployment... Our present experience in relief should form the basis of even more amplified plans in the future."

That's a big old quote.

Does it sound familiar? Sounds exactly like something our dear leader, the Fairy Ruddfather would say.

But it isn't.

Instead it's from US president Herbert Hoover's address to the American Bankers' Association in October 1930.

You know Herbert Hoover, he's the president that's been accused of doing nothing while the US economy sank into depression in the 1930s. Maybe he's talking up his own book, but it doesn't sound like he did nothing.

It actually sounds as though he did exactly what the current bunch of hapless 'leaders' are doing now. He stuck his oar in and tried to 'fix up' the economy.

Does that mean we can expect a repeat of the Great Depression?

If we use those events as a guide for today then, yes.

But look, any attempt to compare two different periods and show a 100% correlation is fraught with danger. It's not as simple as that.

However, you can rely on history as a reasonable guide. The simple fact - that's right, fact - is that bubbles are caused when markets are manipulated. The problem is, the bubbles only become dangerous to the wider economy when attempts are made to stop the bubble from popping.

In a free market, participants (including you and I) would recognize the imbalance and prices would correct. If prices were too high we'd stop buying.

Of course it would mean some would win and some would lose. But the consequences would be relatively short lived.

Yet, when attempts are made by a government to prop up a bubble there are still winners and losers but the winners are decided upon by the government. And because it has made that decision without thought to the functioning of a free market it creates more imbalances.

It means that not only has the bubble not popped, but that it is still expanding. In the end everyone loses.

Look at the quote from Hoover again. I've picked out the key phrases and reprinted it below:

"... [A]ction to resist the forces of disintegration... business community, the bankers, labor, and the government have cooperated in wider spread measures of mitigation than have ever been attempted before... leading business concerns have sustained wages, have distributed employment, have expedited heavy construction... Government has expanded public works, assisted in credit to agriculture, and has restricted immigration... These measures have maintained a higher degree of consumption than would otherwise have been the case... prevented a large measure of unemployment... even more amplified plans in the future."

I'll state it again. Doesn't that all sound very familiar?

Compare it to this paragraph from the Fairy Ruddfather's recent essay:

"With unemployment rising, the strategy has been to reduce the unemployment impact by, on the one hand, direct stimulatory measures and, on the other hand, deploying 712,000 productivity training places to support those who have lost their jobs or cannot enter the labour market.

"The Government has done this with what it describes as a Jobs and Training Compact with Australia: a compact with young Australians so that anyone under the age of 25 must be earning or learning; a compact with retrenched Australians that provides them with training places in preparation for the recovery; and a compact with local communities, driven by a $650 million local jobs fund and priority employment coordinators in the 20 most acute unemployment regions. These measures are aimed at reducing job losses to an absolute minimum while doing everything possible to avoid the 'lost generation' of Australians who failed to re-enter the labour market after previous recessions."

Do the words 'control freak' come to mind. Looks as though conscription has been reintroduced for anyone under 25. You've either got to have a job or you've got to learn something. Whatever happened to freedom of choice?

Anyway, as the Ruddfather's essay shows, you can't get a single politician or mainstream economist or mainstream commentator to admit that government interference made the Great Depression of the 1930s worse.

Even worse they'll pin the entire blame on the free market. Or as the Fairy Ruddfather puts it in his egotistical and tyrannical essay:

"As I have argued elsewhere, the boom-and-bust economic cycle of the past decade has been an unavoidable consequence of a decade of neo-liberal free market fundamentalism..."

The Ruddfather's essay runs to some 6,000 words, yet it can be summed up in that single sentence.

As I stated above, booms-and-busts of the scale we have witnessed in the last ten years only occur because of government meddling. Without the government trying to manipulate the market, distortions would be quickly corrected and a dangerous bubble avoided.

But even those that favour government intervention and manipulation can't make their argument without contradicting themselves. Remember their argument, the government needs to step in to help the free market. And also remember that supposedly in the 1930s, governments everywhere just stood back and did nothing.

So how can we explain this example from Erik Eklund, professor of history at Monash University?

"Faced with the emerging crisis from the late 1920s, and overwhelmed by the scale and complexity of the problem, governments tried a range of responses. Tariff barriers were raised, levels of migration were monitored and reduced. Customs excise, the main form of taxation income, was increased. Some governments sought alternative sources of loan monies while others moved to guarantee farm income by setting a guaranteed minimum price on commodities such as wheat. Such strategies were actually grounded in the 1920s, implemented in the desperate hope that somehow the world had not changed as dramatically as it had."

After those disastrous policies by Australian governments which obviously skewed the economy in one harmful direction, what did the politicians do? Did they realize it's impossible for them to micro-manage an entire economy and back off?

Did they heck. Instead they tried to skew the economy in a different direction. As Professor Eklund explains:

"The Premiers' Plan clamped down on wages and pensions. There was a 10 per cent wage cut for some workers... On the coalfields of NSW and Victoria workers lost between 10 and 20 per cent of their wages. Award rates for single women in industrial employment, already about half of the male basic wage declined from £2 per week in 1923 to £1.17s by 1933..."

In other words they meddled again. Mainstream and Keynesian economists can't claim the governments of the 1930s did nothing when it is plain to see they do something.

They interfered. In any government distorted economy it is rarely one single act of meddling that causes a problem, it is typically a series of events.

Of course, in typical academic fashion, Professor Eklund claims that the failure of the government to spend lots of money is the reason why the Depression became great:

"The traditional government response to unemployment in times of economic downturn was to increase public works and thereby absorb many of the underemployed. Instead, the federal government, which had spent over £2 million on public works in 1930, withdrew nearly all of this funding in 1931."

We can only hope that Eklund sticks to history and doesn't venture into economics.

The naïve belief among many in the mainstream is that spending - especially government spending - drives an economy. That is clearly false. It may appear that government spending is good for an economy at face value, however it fails to acknowledge the consequences.

Even in basic terms, $1 stolen from an individual through taxation is $1 less that the individual has to spend or save for themselves. The fact that businesses and individuals stopped spending - or tried to stop spending - in the 1930s and recently should indicate to anyone that there is an imbalance or distortion in the economy.

These distortions need to be worked out. If it means that a company has to hold a 'fire-sale' to unload at below cost, or for a lower profit, excess stock then so be it. It is the falling prices that will encourage the consumer and other businesses to re-enter the market.

Merely giving people and businesses free money in an attempt to prop up prices means that money will be misallocated to where it isn't needed, and further, propping up prices ensures the consumer will have to pay more and therefore misses the opportunity to buy goods at a cheaper price.

Building a road, school, hospital or bridge does not provide an economic stimulus to the economy. It merely takes money and resources from one area of the economy and arbitrarily hands it to another.

The $43 billion the government is spending on various measures as part of its stimulus package merely means there is $43 billion being spent on housing insulation and free handouts that could otherwise have been spent or saved elsewhere.

Like any debt, it must be repaid. And it will be repaid through either inflation or higher taxation.

Therefore $5 billion spent on housing insulation by the government today, means $5 billion that can't be allocated by the economy to something individuals and businesses really want.

Of course, the Great Depression is a massive topic, and the further away in time we move from it the more argument there will be about its causes.

However, one thing is clear, at any point in time politicians have an insatiable desire to interfere with and control people's lives. They did so in the 1930s and they do so today.

Thanks to Kris Sayce
Money Morning