Month: October 2009

Inflation is always and everywhere a monetary phenomenon.

Milton Friedman, 1968.

‘Inflation’: A disproportionately large and relatively sudden increase in the general price level. Inflation may occur when the quantity of money or deposit currency in circulation is large compared with the quantity of goods and services offered, or when, because of a loss of confidence in the national money on the part of the public, a general and widespread attempt to convert money into commodities is precipitated. A normal increase in the price level after a period of deflation is generally not regarded as inflation.

‘Deflation’: A decrease in the general price level. Deflation may occur when the quantity of money or deposit currency in circulation is small compared with the quantity of goods and services offered, or when the fear of failure or some other cause curtails consumer spending materially, thus reducing the velocity of circulation.

‘Reflation’: Inflation or deflation of the currency in order to restore a former price level.

‘Disinflation’: A term recently coined to indicate a planned reduction in the general price level, so administered that the economy is benefited by increased purchasing power and not harmed by drastic deflation.

Sloan and Zurcher’s Dictionary of Economics, 1961 – cost twenty-two shillings and sixpence (decimal currency arrived in 1963). We wonder what this book would sell for in today’s inflated dollars. When purchased, our editor’s weekly wage as a junior accountant and part-time university student was 17 pounds.

Outsourcing of interest rate policy is an epic experiment whose longevity remains uncertain. Politicians do not usually surrender power. This surrender was based on two ideas: A recognition that central bank management might lead to a longer growth cycle; and a calculation that letting the Bank, not governments, determine interest rates might work in the long-run favour of politicians.

Paul Kelly "The March of Patriots, the Struggle for Modern Australia", October 2009.

As long as governments control money supply there will always be booms and busts. I became almost cynical as I watched an avowed gold standard and laissez-fair advocate, Alan Greenspan, take the chairmanship of the Federal Reserve Board and turn into an expert at saying nothing with far too many words – the hallmark of every ‘good’ politician.

Victor Sperandeo’s, "Trader Vic – Methods of a Wall Street Master", 1991.

 

ECINYA OVERVIEW

One of our readers asked us to write a piece on inflation and though we have commented sporadically on this topic over the past decade, we have never devoted an entire article to it. We thank Neddie Seagoon for his interest and contribution.

A bit of inflation is a good thing as it denotes a restoration or continuation of price stability. Note here that price does not equate with value, divergences occur for all manner of reasons. One of the central premises of economics is that demand and supply determine prices. Shortages generally mean higher prices and excess supply generally means lower prices. Always the major caveat is government interference in the market place that can cause supply distortions, demand distortions, and even price distortions.

In relation to the price of labour – wages – we can have mandated minimum wages, taxes on wages such as compulsory superannuation (a good thing) and payroll tax (a bad thing), an increase in unemployment benefits leading to a greater demand to become unemployed, immigration leading to an increase in the supply of labour, education leading to an increase in the quality and vocational diversity of labour etc etc. Mr Dixon of Qantas has recently demonstrated that a timid, benign and short-sighted board of directors can mandate unreasonable remuneration. How fortunate have we been that Allco did not succeed in their takeover aspirations, so warmly recommended by the then Chief Executive and his then Chairperson.

Our conclusions:

• Some inflation is better than none.
• In an era of excess capacity it is difficult to see inflation as a problem, but trade embargoes or other impediments can qualify this conclusion.
• Deflation is awful and words and happenings like recession, slow-down, and depression appear to be sinister sisters or belligerent brothers.
• Growth, recovery, are congenial companions to measured inflation.
• Inflation needs to be managed and probably a target of 1-2% is appropriate in an at-trend-growth economy.
• Growth above 3% is near enough to trend for Australia and most developed economies.
• Inflation needs to be always looked at in context, and such matters as education, tax policy, and employment policies do matter.
• Governments cause more inflation than do most central bankers.
• Our Federal election cycle is too short, leading to misallocation of resources and poor policy formulation and execution.
• Always trust falling interest rates to begin a new bull-market.
• A lot of official figures on inflation and other macro variables are ‘rubbery’ and comparison between countries is often biased in favour of the position being argued.

 

THE THREE FACES OF INFLATION

…. are an increase in the price of goods and services, an increase in asset prices, and the trade deficit impact on the current account deficit. Goods and services inflation is mainly expressed via the consumer price index, where a basket of goods and services is used to monitor changes in the inflation rate.

Asset price inflation applies to assets such as equities and housing. The trade deficit relates to the fact that importing a good or service can be perceived, or actually be, cheaper than producing the same good or service locally. Ecinya believes that not enough attention is focused on import replacement because exports are ‘sexier’ and manufacturing would require some robust economic decisions.

Just today we have been informed that meat and vegetable prices are falling because of the current appreciation in the $A . SOT, an Ecinya confidant (as is Neddie), often points out that there is rich man’s inflation and poor man’s inflation. SOT is so wealthy that things like international air-fares and classy restaurants bother him. He recently took advantage of a cheap flight to the UK because he could buy one ticket and get one free. Relative frugality has enabled Sot to prosper. As an example of his frugality and patriotism, he has always driven a General Motors vehicle and spurned the imported toys of BMW, Mercedes, Rolls etc although his wife recently purchased a Mercedes sports car, but our guess is this was to allow Sot to play golf in England and Scotland on his recent overseas adventure. We mention these things because the easy way to avoid inflation is to buy cheaper, or not buy at all, or spend your holidays overseas on a relative-value basis. So that in many ways, inflation is something of a choice.

Similarly, with house purchases: Houses are more expensive often due to location such as near the sea or in a highly regarded suburb. Fashionable housing in the Southern Highlands was selling at a premium, until recently. But even affordable housing is made more expensive by taxes such as the GST, stamp duties, and delays in construction due to the council approval process. Also, governments influence the availability of housing via re-zoning changes. The cost of living away from a workplace adds another dimension to goods and services inflation with higher travel costs. As populations increase, road infrastructure has to be paid for from higher traffic fines and other forms of taxation such as road taxes on transport vehicles and even income taxes. An inflationary increase in the price/ value of housing does not automatically add to either more housing or more wealth. More often than not, it just adds to the cost of housing as mortgage rates increase or slow-down the housing price appreciation. Given that housing is generally a major asset, house prices impact markedly on consumer and voter psyche. Those with low, or no, mortgage houses feel advantaged. Those with high mortgage housing, or no house at all, feel disadvantaged.

In relation to the trade deficit the obvious examples are Japan in the 60’s and 70’s where low-quality exports were replaced by high-quality exports as their skill levels and product development skills improved and America gave up its desire to manufacture. We all know the story of Honda, Toyota, Panasonic, Sony, Seiko, Mizuno, etc. In the 90s China has replaced a lot of our local manufacturing in basic household items such as ironing boards, kettles, TV screens, clothing, stationery, books, glassware, furniture, mobile phones, computers etc. A job lost in Australia is often a job created in China, or elsewhere. In looking at the deflationary impact of cheap imports we do not seem to analyse the reduced consumption levels at home, the taxes paid by manufacturers, and the compensation paid to unemployed workers. Additionally, certain social costs often derive from a pool of unemployed workers such as drug dealing, gambling and crime. Yesterday the Japanese-owned tyre manufacturer, Bridgestone, which has received 20 years of government support, closed down in Adelaide and 600 jobs have been lost. Bridgestone produced a quality tyre, and no doubt its viability has been impacted by imports.

 

THE ECONOMY THAT WE LIVE AND WORK IN

….is not the inflation adjusted economy.

Real Gross Domestic Product (GDP) is nominal GDP reduced by the inflation rate. Nominal GDP is the world we inhabit and is the source of profits and wages, and after unavoidable costs, of disposable income. Disposable income drives our consumption and our savings. Aggregate savings are used to drive investment. Savings can be public or private. Australia over recent years has had a domestic surplus which has facilitated infrastructure spend and reduced personal tax rates and helped keep interest rates at appropriate levels.

 

CENTRAL BANKERS AND INFLATION

Saul Eslake, ex-ANZ, and now with the Grattan Institute, published a paper titled "Inappropriately low interest rates are as dangerous as inappropriately high ones" in The Age newspaper on 17 September 2009. In part, he said:

"The global financial crisis had many causes, but among the more important of them was that the US Federal Reserve under Alan Greenspan, and his counterparts at central banks in other major advanced economies, kept interest rates too low for too long in the aftermath of the mild recessions which followed the collapse of the internet bubble at the beginning of the present decade."

"The mistake was not in cutting official interest rates to what were, at the time, unprecedented lows after the ‘tech wreck’ and the terrorist attacks of 11 September 2001. Rather, the mistake was in keeping interest rates at the levels struck in response to those events until as late as November 2003 in Britain, August 2004 in the United States and December 2005 in the Euro zone, long after the requirement for unusually low interest rates (to counter the risks of recession and deflation) had passed. Keeping interest rates too low for too long had two important consequences which came together in such devastating fashion in the global financial crisis."

"First, the extended period of inappropriately low interest rates enticed many American households, whose incomes or previous credit histories would ordinarily have precluded them from becoming home owners, to take out mortgages which they were subsequently unable to service once interest rates eventually began returning to more normal levels. This consequence of abnormally low interest rates was, to be sure, compounded by the way in which sub-prime mortgages were constructed (with artificially low ‘honeymoon’ rates and capitalization of deferred interest payments), but sub-prime mortgages would never have caught on in the way that they did had the general level of interest rates not been so low for so long.
More generally, the extended period of unusually low interest rates also encouraged those who had previously been able to access mortgage finance to take on more debt than would have been possible otherwise, adding to the upward pressure on house prices from those newly enfranchised in the housing market."

"Second, the extended period of unusually low interest rates encouraged investors to take on more risk in order to obtain rates of return that could no longer be provided by relatively low-risk investments. This ‘ferocious search for yield’, as Adair Turner, Chair of the UK Financial Services Authority has described it, prompted a response from the ‘supply side’ of the financial services sector in the form of an ever-growing range of increasingly risky investment products cater to the growing demand for them – products whose risk characteristics neither their creators nor regulators fully comprehended."

"In short, the choices made by central banks in the US and other major advanced economies to keep short-term interest rates too low for too long encouraged both an increased demand for risky investment products and a greater supply of them. One of the reasons (although, again, not the only one) why Australia’s experience of the financial crisis has been less severe than that of most other Western countries is that Australia’s central bank was one of the very few that didn’t make the mistake of leaving interest rates too low for too long in the early years of this decade."

We cannot say it any better than Saul. We do, however, mention that Greenspan’s interest rate policy resulting in (fraudulent) prosperity at home, psychologically mitigated concerns about wars in Iraq and Afghanistan, and the high price of imported crude oil.

 

GOVERNMENTS AND CENTRAL BANKERS

Australia is relatively blessed in that our central bankers in discharging their obligations to assist the attainment and/ or maintenance of stable prices, balanced and sustainable growth, are independent of government. However, the Head of Treasury, currently Ken Henry, sits on the RBA board and has an input to the decision-making process. It was rather remarkable that the Treasurer, Wayne Swan, has been reported as saying, in parliament, that "fiscal policy has nothing to do with monetary policy". Yet, we know that the overall stimulus package has been increased government spending and borrowings, cash injections from the RBA, and lower (even down to ’emergency’ levels) interest rates.

Ian Macfarlane, ex Governor of the RBA, wrote an excellent book "The Search for Stability", which is exceptionally readable and available in paperback.

The nation’s top two economic advisers, Glenn Stevens and Ken Henry, yesterday warned the public to prepare for a series of short and long-term sacrifices as the economy returns to normal, with interest rates to rise rapidly and tax reform to leave some people worse off.

Front page The Australian 16/10/2009 by George Megalogenis.

Business hit as dismissal claims soar: Unfair dismissal applications almost doubled in the first few months of the Rudd government’s new work-place relations regime, prompting business to warn the rise will drive up costs and create a disincentive to hiring new staff.

Treasurer Wayne Swan hit back at coalition accusations that his spending pressured the Reserve Bank to raise interest rates, declaring yesterday that interest rate rises had nothing to do with fiscal policy.

Pgs 1, 7 of The Australian Financial Review 20/10/2009.

Australia didn’t have a financial crisis. The US did. No bank failed in Australia. No bank needed capital. No bank needed to be nationalised. No bank even made a loss. You ought to assess the fiscal stimulus that’s been undertaken against the mid-year forecasts. What they will show is that the Treasury over-estimated the economic downturn. What was undertaken was low-quality spend – $900 cheques that are now all gone and what have we to show for it?

Peter Costello’s last press briefing upon his parliamentary exit, The Australian 20/10/2009.

Politics is a story of conflict. In Australia, it is the Labor-Liberal conflict. For the media, conflict is the story that counts. For history, however, national progress is measured by the opposite test – where Labor and Liberal agree. Such agreement, rarely a story, is the foundation of all national progress. Australia rose phoenix-like from the ashes of the early 1990s recession to enter a low inflation growth cycle of such robust resilience that it became the longest economic expansion in the nation’s history. In the fifteen years to 2007, real income per head rose more than 40 per cent and real wealth per head more than doubled. This shifted the nation’s political culture towards markets, aspiration and enterprise while it generated an anxiety that Australia was losing its egalitarianism and social conscience.

Paul Kelly "The March of Patriots, the struggle for modern Australia" October 2009.

Is the United States bankrupt? Many would scoff at this notion. Others would argue that financial implosion is just around the corner. This paper explores these views from both partial and general equilibrium perspectives. It concludes that countries can go broke, that the United States is going broke, that remaining open to foreign investment can help stave off bankruptcy, but that radical reform of US financial institutions is essential to securing the nation’s economic future. The paper offers three policies to eliminate the nation’s fiscal gap and avert bankruptcy: a retail sales tax, personalized social security, and a globally budgeted universal healthcare system.

Introduction to Professor Laurence J Kotlikoff’s essay in The Federal Reserve Bank of St Louis Review July/ August 2006.

 

JUMPING OFF THE BUS, BUT STILL AT THE BUS STOP WAITING FOR THE NEXT BUS TO COME ALONG

We have just moved to 25% cash across our portfolios including our published portfolio ‘Cactus’ where our cash balance stands at 32%. Good trading and investment is a peculiar balance between the conviction to follow your ideas and the flexibility to recognise when you have made a mistake. The problem with today’s markets, vis those of the nostalgic past, is that markets have many more participants, are more globalised, often driven by computer programs, entry and exit costs are cheaper than ever, there is an excess of bad behaviour including rampant spin from gifted professional pundits and the companies themselves. Additionally, the ASX once it became a public company became less robust in policing bad behaviour and ASIC is always behind the curve as it is under-funded and its personnel under-trained and lacking in experience, this all adds up to one word …..’volatility’. We have long believed that a trading mentality must accompany an investment mentality if you wish to out-perform the general indices.

Having called the March rally and jumped on the bus with a measure of gusto (though we ignored most of the banks for nearly all of the time), we now find ourselves in the position where we simply do not know what is going on. So: time to pause, reflect, get off the bus, sit on the sidelines, have a breather, wait for earnings and the economy to catch up with the market. "When too many people are doing the same thing the market will adjust. Buy when others are despondently selling. Sell when others are greedily buying". Markets do not go up forever and the current bounce, in our view, has had the potential to tire for most of the past 8 weeks. But it hasn’t as the FOMO factor came into play …. fear of missing out. So we have tired ahead of the market but with technical indicators partially, or potentially, confirming our view.

Additionally, we are not enjoying the macro. The policy failings of the current government and the opposition response of attacking the man rather than the policy means that taxpayers and consumers are ill-prepared and ill-informed. Also, the American macro is unsound and that’s still the world’s largest economy, despite rapidly retreating from its dominance.

Now we may be wrong, but we feel that we must follow our view, for good or ill. We may be premature. We may be absolutely wrong. Keynes (a kindred spirit communicating from the grave with Messrs Rudd, the US Congress, Geithner, Pelosi, and Obama) said "Markets can stay irrational longer than you can stay solvent." At this moment we are so excessively solvent that our excess of conservatism may be a problem. Time will tell. Anyway, we can always jump back on the bus as we still can afford a ticket.

 

PETER WALSH

…..was the Finance Minister in the Hawke/Keating government and wrote an excellent book "Confessions of a Failed Finance Minister" in 1995. He retired in 1993 and has only occasionally ventured into print since then. Writing in the AFR on 10/12/2003 he said: "All countries which accumulate debt and habitually run big current account deficits are vulnerable. And for many centuries societies have been susceptible to irrational booms, South Sea Bubbles, tulip bulb booms, and dot-com busts. But no central bank can offset the cascading effects of bad government policy."

Where is the bad policy – industrial relations, the stimulus package poorly targeted and badly implemented, the cash hand-outs – wasteful and extravagant, the proposed broadband network, the ETS scheme which will be a shambles and achieve little to nothing, and the rhetorical attacks on the ‘neo conservatives’, whatever that means. Sure George Bush was hopeless and John Howard got too close to Mr Bush’s view of the world, but Mr Rudd is indicating that he already is what John Howard became, without ever having been what John Howard was.

Q: What was Howard? A: A competent manager of the economy? Q: What did John Howard become? A: A reformer who lost the feel and the zeal, and instead wanted to be popular.

Mr Rudd is not showing any signs of being a competent economic manager and our debt loads are large and likely to get worse before they get better and possibly the debt reduction plan (the ‘exit’ strategy) will be conceived and implemented as badly as the ‘input’ strategy, the stimulus. An excessive government share of GDP squeezes out the private sector, particularly at the small business end – the dominant and sustaining employer group. Mr Rudd is taking wedge politics to a level of sophistication that is dangerously short-sighted and economically damaging.

Mr Swan says that fiscal policy has nothing to do with monetary policy and vice versa. He is indicating that he is an economic illiterate. A dopey Treasurer. But to show some fairness we should say that Mr Hockey is far from credible endorsement on the fiscal front and his platitudes on interest rates, jobs etc are confusing and confused.

Apart from ‘crisis’, ‘revolution’, and ‘fair’, our editor is not receptive to the word ‘tough’. Bob Hawke, Paul Keating, Peter Walsh, and John Howard steered Australia to its current position with some considerable assistance from John Stone of Treasury and Ian Macfarlane of the RBA. We have to be careful of regression under the current parliamentary team. But though the persons named provided steerage, the ship of prosperity has always been the Australian people. Subject to a properly constructed and pragmatic welfare system "No man is great enough, or wise enough, for any of us to surrender our destiny to. The only way in which anyone can lead us is to restore to us the belief in our own ability to take responsibility for our own lives." (source unknown)

 

STIMULUS, STIMULI, AND MISLEADING AND DECEPTIVE CONDUCT

We avoided a technical recession, so what? Our national debt was zero and the Liberal party and other pundits said it was going to $300 billion, encouraged by Messrs Rudd and Swan. It now looks like ‘only’ going to $200 billion. Mr Swan wants to be congratulated because he has saved us $100 billion. Jolly good. Exaggerate the recession, call it a ‘CRISIS’ ad nauseum, and then exaggerate your role. Sounds and looks more like ‘too clever by half” politics than sound economics.

 

GLENN STEVENS IS A GOOD CENTRAL BANKER

On 15 October he had, inter alia, this to say in an address given in Perth to the John Curtin Institute of Public Policy: "The Board is also conscious, though, that a risk-management approach requires policy to be recalibrated as circumstances change. If we were prepared to cut rates rapidly, to a very low level, in response to a threat but were then too timid to lessen that stimulus in a timely way when the threat has passed, we would have a bias in our monetary policy framework. Experience here and elsewhere counsels against that approach. "

"None of this is to say that the economy is, at this moment, ‘too strong’. It isn’t. "

"The point is, rather, that the very low interest rate settings were designed for a weaker economy than we are in fact facing. Plainly, the downside risks to which the Board was responding earlier have not materialised. This is not a problem. In fact, it is a very desirable situation. It is a welcome contrast to the experience of a number of other countries. It is simply something we need to recognise in setting monetary policy – which means not holding interest rates at very low levels when that is no longer needed."

 

MR OBAMA

… inherited an economy with a serious domestic deficit of $400 billion after Mr Bush inherited an economy with a budget surplus. In the year to 30 September 2009 that deficit is now $1,300,000,000,000 ($1.3 trillion). Now that deficit is said to be not serious because the economy is growing again. But the economy is only growing because of the stimulus package that has created the deficit. The US debate about raising taxes and interest rates has begun, and will accelerate. A bad war here and there, and a bad oil price, and a bad emissions trading scheme might just make matters more than a little difficult. We remain hopeful that Mr Obama’s swing to the left is just a necessary step in the long progress back to the centre. Debates about capitalism and socialism from the loonie left and the loonie right just means that too few of those involved have read Peter Drucker and/ or have mis-read Ayn Rand or David Stockman’s book " The Triumph of Politics, Why the Reagan revolution failed"

 

INFLATION, NOMINAL GDP, EPS and GROWTH

Earnings per share growth drives share price performance over the longer-term. Earnings come from real GDP plus inflation which is called nominal GDP. The multiple that we attach to EPS is derived from EPS growth, interest rates, and confidence. At the moment the debate on inflation also encompasses the view that deflation is more of a problem. A softer word for deflation is recession, and a harsher word is depression. We have avoided a depression through monetary policy and fiscal policy acting in an harmonic way. Inflation is a problem in Australia and deflation is more of a problem in America. We kind of like a bit (but not too much) of inflation…. house prices go up, asset prices generally go up, banks are eager to lend on enhanced values, wages are stable or growing etc. In relation to goods and services you can avoid inflation by saving or spending less. Global excess capacity should mitigate the impact of goods and services inflation but we will save an extended discourse on inflation for another day.

At the moment we think the expansion in Price Earnings Multiples exceeds the EPS growth potential for far too many companies. Refer to our Strategy section and our Stock Recommendations section. You will not see a large number of recommendations at current price levels. Either our macro settings and/ or our micro EPS settings are wrong, or too conservative, or prices are simply ahead of themselves. We believe the latter.

BUBBLE #6 – GLOBAL WARMING
Fast-Forward to today. It’s early June in Washington, D.C. Barack Obama, a popular young politician whose leading private campaign donor was an investment bank called Goldman Sachs – its employees paid some $981,000 to his campaign – sits in the White House. Having seamlessly navigated the political minefield of the bailout era, Goldman is once again back to its old business, scouting out loopholes in a new government-created market with the aid of a new set of alumni occupying key government jobs.

AS ENVISIONED BY GOLDMAN, THE FIGHT TO STOP GLOBAL WARMING WILL BECOME A "CARBON MARKET" WORTH $1 TRILLION A YEAR.

Gone are Hank Paulson and Neel Kashkari; in their place are Treasury chief of staff Mark Patterson and CFTC chief Gary Gensler, both former Goldmanites. (Gensler was the firm’s co-head of finance) And instead of credit derivatives or oil futures or mortgage-backed CDOs, the new game in town, the next bubble, is in carbon credits – a booming trillion-dollar market that barely even exists yet, but will if the Democratic Party that it gave $4,452,585 to in the last election manages to push into existence a groundbreaking new commodities bubble, disguised as an "environmental plan," called cap-and-trade.

The new carbon-credit market is a virtual repeat of the commodities-market casino that’s been kind to Goldman, except it has one delicious new wrinkle: If the plan goes forward as expected, the rise in prices will be government-mandated. Goldman won’t even have to rig the game. It will be rigged in advance.

Here’s how it works: If the bill passes; there will be limits for coal plants, utilities, natural-gas distributors and numerous other industries on the amount of carbon emissions (a.k.a. greenhouse gases) they can produce per year. If the companies go over their allotment, they will be able to buy "allocations" or credits from other companies that have managed to produce fewer emissions. President Obama conservatively estimates that about $646 billion worth of carbon credits will be auctioned in the first seven years; one of his top economic aides speculates that the real number might be twice or even three times that amount.

The bank owns a 10 percent stake in the Chicago Climate Exchange, where the carbon credits will be traded. Moreover, Goldman owns a minority stake in Blue Source LLC, a Utah-based firm that sells carbon credits of the type that will be in great demand if the bill passes. Nobel Prize winner Al Gore, who is intimately involved with the planning of cap-and-trade, started up a company called Generation Investment Management with three former bigwigs from Goldman Sachs Asset Management, David Blood, Mark Ferguson and Peter Harris. Their business? Investing in carbon offsets. There’s also a $500 million Green Growth Fund set up by a Goldmanite to invest in green-tech … the list goes on and on. Goldman is ahead of the headlines again, just waiting for someone to make it rain in the right spot. Will this market be bigger than the energy-futures market?

"If it’s going to be a tax, I would prefer that Washington set the tax and collect it," says Michael Masters, the hedge fund director who spoke out against oil-futures speculation. "But we’re saying that Wall Street can set the tax, and Wall Street can collect the tax. That’s the last thing in the world I want. It’s just asinine."

Cap-and-trade is going to happen. Or, if it doesn’t, something like it will. The moral is the same as for all the other bubbles that Goldman helped create, from 1929 to 2009. In almost every case, the very same bank that behaved recklessly for years, weighing down the system with toxic loans and predatory debt, and accomplishing nothing but massive bonuses for a few bosses, has been rewarded with mountains of virtually free money and government guarantees – while the actual victims in this mess, ordinary taxpayers, are the ones paying for it.

Matt Taibbi, Rolling Stone Magazine 2/7/2009, "The Great American Bubble Machine"

Like Jared Diamond and Stephen Jay Gould, Tim Flannery has the ability to take complex ideas and – seemingly effortlessly – make them accessible. This book captures your imagination through its extraordinary range of argument, its vivid imagery, its wealth of research, quick wit and richness of detail. You need to read it carefully, twice.

Mr Flannery provides much more urgent, specific evidence of imminent peril. He also makes sure that you will never again look at an electric-light switch in quite the same way… "The Weather Makers" is detail-packed to the point of terrible fascination.

Newspaper Reviews on Tim Flannery’s, "The Weather Makers", by The Sydney Morning Herald and The New York Times, 2005

Most ministers’ ideas can be squashed by discrediting the facts they are based on. But if they are political ideas, facts don’t come into it.

From the 1989 diary of Sir Humphrey Appleby, Secretary to the Cabinet under the British Prime Minister, James Hacker.

INTRODUCTION

For purposes of this essay let us assume that climate change is real, and that greenhouse gas (CO2) is a major contributing factor. The dimension and urgency of the problem is something that we are not able to talk about, simply because we do not know. But we do sincerely believe that Messrs Rudd and Turnbull in their respective capacities as Prime Minister and Alternative Prime Minister are NOT providing real leadership on climate change. In fact, they are confusing the issues in their desire to be seen as nascent saviours of the world. Their motives are political and essentially counter-productive, and each in his own way is as bad and mischievous as the other.

EVEN IN OUR POSITION OF RELATIVE IGNORANCE

….. or lack of expertise, we cannot understand why Copenhagen is relevant at all. Australia can begin to solve its emission problems on a constructive timetable, and the rest of the world can follow later. We do not need an Emissions Trading Scheme (ETS). It seems to us that there are probably less than 2,000 significant carbon polluters in Australia. Why not simply give them a tax break on the expenditure required for them to create and/ or buy the technology that will reduce their emissions to agreed levels, and perhaps a bonus if they exceed their targets? In relation to households something can be done via direct subsidies and/ or tax relief, and education.

CARBON CREDITS

….. might cause the next bubble and be a significant factor in the next recession. The world discovered recently that America had a hidden bubble called ‘sub-prime’. Before that they had another bubble called ‘tech/ telco’. Every time America finds a new source of income, it manages to invent new sources of manipulation, embezzlement, obfuscation, fraud, or whatever name you wish to attribute to their bad behaviour. At the same time, China is something of a closed economy and they have a vast amount of $US holdings that might give them some advantages in a carbon credits market. Data can be manipulated, and countries are not always completely open and honest in their dealings with one another. Jack Lang, a former NSW Premier, famously said: "Put your money on self-interest; it’s the best horse in the race, because you know it’s always trying".

MATT TAIBBI’S ARTICLE

….. should be read in its entirety. The arguments are cogent and hence difficult to refute. Our editor is relatively convinced that Goldman Sach’s exaggerated many aspects of the ‘tech/ telco’ era and in more recent years led the cheer squad for ‘$200 per barrel oil’, whilst running major trading operations in commodities. It does not take much imagination to see that carbon credits becomes the next ‘growth’ industry. Eventually we could see carbon derivatives, collaterised carbon credits, and sub-prime CO2 certificates. The financial engineers could have a ball, a predators’ ball, at a ‘prime’ (not sub-prime) venue. Good intentions do not always translate into beneficial policy outcomes.

John Howard described many of the participants ostensibly looking after Aboriginal welfare as ‘the Aboriginal Industry’. Our editor, having visited ATSIC HQ in Canberra a few years ago, and from general observation, it seems that certain people in the ‘Aboriginal Industry’ are relatively well-off compared with vast sections of the Aboriginal population, drifting inexorably into squalor and hamstrung by significant lack of opportunity.

BARNABY JOYCE

….. is a seemingly clear-thinking and articulate spokesperson for rural Australia and, on many occasions, sounds eerily similar to Senator Peter Walsh, Finance Minister in the Hawke Government from 1984 to 1990. Prior to that Mr Walsh was Minister for Resources and Energy from 1983 to 1984. He was, and probably still is, a wheat and sheep farmer in Western Australia. Anyone who has spent time in rural Australia knows about the level of wise counsel and common sense utterances that come from this source. Labelling people ‘mavericks’ or ‘smart arses’ who disagree with the populist and alternative view is just nonsense and a denial of democratic rights. In our opinion, Senator Walsh is one of the unsung heroes of Australia’s current prosperity and global position. If Messrs Rudd and Turnbull are unsympathetic to regional concerns, then taxpayers should be concerned.

WHEN

….. are we going to see a full-page ad or government editorial that sets out the cost of the technology and the infrastructure that will reduce carbon emissions? At Ecinya we feel substantially uninformed, yet we sense that our taxes and operating costs will rise and emissions will not fall proportionately. Mr Rudd, giving a press conference on climate change and other matters as he leaves church, seems to imply that his god has ordained his view or at least confirmed the substance and tempo of his approach to economic, social, and global challenges.

IF CARBON EMISSIONS ARE SO DANGEROUS WHY NOT

….. seek a consensus with competing and supportive views represented in equal measure? Ross Garnaut is reported in today’s AFR (13 October, pg 5) as follows: "Meanwhile, Ross Garnaut, author of the federal government’s climate change review, said the rancorous political debate on an ETS was one of Australia’s worst cases of policy-making on a major issue. "It is a very difficult issue, so I suppose it was never going to be easy. But the way it has broken down is extraordinary."

We disagree with Mr Garnaut in that we find it totally unnecessary to have an ETS. Through the tax system at the corporate level and education at the household level, some electric cars, the acceleration of some alternative fuels such as ethanol, gas, solar and wind, we believe that solutions exist. We understand from recent readings that new and cheaper and more effective forms of nuclear are about 5 years away.

The bottom line is that our major polluters are in essential industries. Additionally, talking about the debate in per-capita terms distorts an absolute problem. On a per-capita basis our numbers look universally good or bad depending on the statistical point you wish to make. We have a lightly populated country (if you ignore water resource problems) with vast resources and per-capita stats always look meaningful.

HAS THE RECESSION BEEN FORGOTTEN?

A few weeks ago, a few months ago, the world was in a global recession, the worst since WWll. Governments have de-leveraged the private sector by running up huge amounts of public debt and providing stimulus packages from coast to coast, village to village. Somehow at some time, the taxpayer will have to pay extra taxes and suffer higher interest rates and perhaps just then the cost of carbon will hit with a ferocity of which we are totally unaware.

WE DON’T LIKE TO BE CRASS

but Mr Turnbull is an ex-Goldman Sach’s man. We hope that his information and insights are not being derived from this self-interested and self-indulgent source. We hope that local election coffers on both sides are not being filled by climate change industry participants.

Former US Federal Reserve chairman Paul Volcker said the rise of China and other emerging economies underscored a decline in the comparative economic and intellectual leadership of the US. "I don’t know how we accommodate ourselves to it," said Mr Volcker, who heads President Barack Obama’s Economic Recovery Advisory Board, in an interview with PBS television. "You cannot be dependent upon these countries for 3 to 4 trillion dollars of your debt and think that they’re going to be passive observers of whatever you do," he said.

The Australian Financial Review, 30 September 2009.

I believe an administration – any administration – that ignores business expectations is committing a grave error of judgement. That this is precisely what Obama and his Chicago cronies are doing is supported by rumours that they are ignoring the counsel of Rubin, Volcker and the rest of the White House economic advisers. No one should be surprised at this since left-wing ideologues have never had any real time for economics. For them, politics trumps all, including economic laws – or so they think. Nevertheless, one should NEVER allow personal feelings to cloud one’s judgement. The fact remains that this recession began before Obama was elected just as the last recession began – irrespective of what hard-core Democrats assert – before Bush won the 2000 election.

Gerard Jackson, BrookesNews.Com, 4/10/2009.

Myer is over-valued, even at the low end of the pricing range, possibly as much as $1 a share on my calculations. But valuing the business is not the same as predicting its share price: The stock could rise on the back of sentiment. In the long run however, Myer will need much stronger earnings growth to justify its valuation and I am not convinced it can achieve it. I am also concerned that the owners of Myer are selling out. Better opportunities are elsewhere.

Roger Montgomery, independent share analyst, as reported in the AFR 3/10/2009.

Department stores overseas have been among the biggest casualties of the global crisis and long-term performance has been weak. There are certainly easier ways to make money than department stores. Customers are increasingly fickle and willing to shop around, the stores need lots of floor space in expensive areas, have high inventory costs, high staff costs and fashion sensitive products. It has not been a great industry to invest in globally and the outlook is deteriorating.

Stephen Ogden-Barnes, Australian Centre for Retail Studies, Monash University as reported in the AFR 3/10/2009.

"Too many people believe that today is yesterday," said editor. "I like that," said Compass.

Our editor talking to Compass, an Ecinya Confidant, at 3.50 pm, 6/10/2009

Straws and camels, questions searching for answers

Sometimes analysis is simply a question searching for an answer. Sometimes we are just looking for the straw that might break the camel’s back. After a day off to celebrate Labour Day in New South Wales, the ACT and South Australia, we began the day with a high level of uncertainty and had moved to our number 5 tactical position of ‘ambivalent, uncertain, relatively clueless’. (The other four tactical positions are outlined under the Strategy tab.) What brought this on?

Anyway, to clear his head our editor went for a walk to the bank and to buy some lunch. This caused him to think about the up-coming Myer float, which he considered to be considerably over-priced. He then remembered that he had removed page 45 from the Weekend AFR with a view to reading it at some appropriate time. That appropriate time had, in his view, now arrived as he searched for some clues to what might lie ahead in the markets – the XAO and the S&P 500 in particular.

Looking at some other straws, but the same camels

The stimulus straw: A number of learned economists have asked the question "What happens when the stimulus is withdrawn, what will be the quality and quantity of economic growth post-stimulus?" David Rosenberg of Gluskin Sheff of Canada estimates that 80% of the rebound in US growth has been induced by stimulus measures.

The bull markets are driven by liquidity straw: Much of the liquidity injections provided by central bankers acting in concert around the world, has found its way into equity markets. This has prompted ‘cash on the side-lines’ to join the party. So after about 150 days from the retracement bottoms of March 2009, the All Ordinaries index has hit an intermediate peak of + 49.7% on 29 September, following the peak in the S&P 500 (our global proxy) at 53.4% on 18 September. Averaging these numbers we get a nice bounce of 52%.

The equity re-capitalisation straw(s): Many companies are talking of revised guidance, but not emphasising the earnings-per-share number. They are simply ignoring the dilution impact. David Jones is running full-page fashion look-alike ads talking about ‘growth’, their share price performance from 3 January 2003, dividends etc. But hidden away in the disclaimer are the words: "Past performance is not a reliable indicator of future performance". And no mention of EPS growth or what interest rate rises might do to retail spending between now and Christmas.

The real unemployment straw: In Australia the ‘official’ unemployment figure has stayed below 6%, but the number of people now working on a part-time basis (the under-employed) has not been factored in and the number of people that have given up looking for work is never factored in.

The US banking straw: The number of US banks that are now on the FIDC’s stressed list has almost doubled over the past year from circa 1458 banks to 2256 banks. It seems that accounting changes, government guarantees and quasi-nationalisation has delayed banks having to recognise bad and doubtful debts.

The municipalities in distress straw: Obviously the most notable of these is California, the world’s 6th largest economy, but many Australian councils and even several state governments are short of money.

The regulation solves the problem straw: As Nero fiddled while Rome burned so has the American regulators. The problem has not been lack of laws and regulations, but lack of supervision, oversight and accountability. Australia has been relatively fortunate in this regard as APRA and the commercial banks have performed reasonably well. A few notable exceptions – Babcock & Brown group, Allco, various property groups, Timbercorp, Great Southern, Opes Prime, Storm Financial etc.

The G20 ‘aren’t we marvellous’ straw: Having adopted massive Keynesian type stimulus packages that have not been seen since the end of World War ll, world leaders from developed nations recently basked in the Washington/ New York glory that they had saved the world from disaster. In fact they probably did, but much of the spend has been frivolous and reckless, and taxpayers have not been made aware of when and how they will pick up the tab.

But are we over-reacting?

And "whether or not it is clear to (us) no doubt the universe is unfolding as it should" (The Desiderata) and time will tell. But we have now written on this topic four times if you include today’s issue: ‘Time to pause’ was written on 25 August; ‘Pendulums swing, imbalances ebb and flow, and the band plays on’ was written on 15 September; and ‘On the bus on the road to recovery, transitioning slowly towards sustainability’ was written on 22 September.

Tactically, up until recent weeks, we stayed on the bus. We have just hopped off and decided to wait for the next bus. For us, the straw that has broken the camel’s back has been the pricing of the up-coming Myer float at between 14.3 and 17.3 times earnings when we think a reasonable multiple might be around 12 times. Based on median earnings per share of 27.8 cents, the vendors are targeting a share price/ value of $3.90 to $4.90. Our rough calculation puts us at about $3.35. But perhaps yesterday has arrived again today and perhaps the old Jewish proverb "Ecinya, you are my friend. I would not advise you to buy what I am selling" does not apply today.