At election time, ‘progress’ is a lesson in economic history. The past is generally the best guide to the future.

HEAD QUOTES TO ASSIST PERSPECTIVE

 

The Republican Party, now in the grip of the Reagan forces, had abandoned the reality of the retail world in which politics had always been done; they had put emotion to work in the service of ideology. The politics of the nation had been given into the hands of the salesmen, and it was certain that the salesmen would win, for they had learned the secret of modern politics, which is that no one can refute the arguments of the heart.

Earl Shorris "A Nation of Salesmen: the tyranny of the market and the subversion of culture", 1994

This (essay dated 8/2/2009) has been written to attempt a brief articulation of a major concern, that far from saving Australia from the ‘global financial crisis’ the actions, rhetoric and policies of the current Australian government are going to totally immerse us in it, or delay our recovery from it, or both. We are just 1% of the global economy. Time is needed to see where the stimulus packages of China, America and Europe will lead the world. Current local policy prescriptions seem to be pre-emptive, excessive, and poorly targeted.

Ecinya respectfully suggests that Mr Rudd has been caught by the gentle breezes of Kirribilli House, the star filled nights, the easy harbour-side celebrations, and with aligned minds in attendance, each with a glass of chardonnay poured from the public purse, is moving to govern through the prism of his ego or his own lack of self -esteem, or some other psychological disorder. There is no air of quiet confidence that creates a sense of managerial competence. Rather, there is a sense of papal infallibility. If God had meant politicians to lie he would not have invented behaviours like obfuscation, false and misleading and deceptive conduct, innuendo or delusions of grandeur. Mr Rudd was elected to govern, not ordained. Government is principally about economic management, law and order, and future investment (education, social and commercial infrastructure). On a more global perspective Mr Rudd has not mentioned the economic leakage caused by the wars in Afghanistan and Iraq, and the major transfers of wealth caused by the oil price surge, and the out-sourcing of global production to China, India, Mexico, Brazil, Canada and elsewhere. Essentially, Mr Greenspan gave the world this recession, this ‘crisis’, by creating a false economic boom to hide a war based on falsehoods. This is a ‘made in America’ recession. Led by the local branches of the Wall Street machines like lambs to the slaughter, we all participated with gusto and glee. The music has stopped, the game of musical chairs is over, and many old maids find themselves unseated. A wolf in sheep’s clothing provides no solution.

A brief analysis of the global financial crisis with special emphasis on Australia and the role being played by the Prime Minister, Kevin Rudd, written 8/2/2009 and published in Ecinya Insights 1/9/2009 (our web-site launched on 28/7/2009).

 

Politicians, and especially Ministers, are in privileged positions in which information is readily accessible. Those who fail to get, or choose to ignore the facts, or who fail to apply whatever intellectual capacity they have to analysis and decision-making, are culpable. Most culpable of all are those who fail to consider the longer-term consequences of what they do, or knowingly make bad policy decisions because they think it is politically smart. There should be some things that politicians will not do.

Peter Walsh, "Confessions of a Failed Finance Minister" ,1995.

The overall responsibility of power is to govern as reasonably as possible in the interests of the state and its citizens. A duty in that process is to keep well informed, to heed information, to keep mind and judgement open and to resist the insidious spell of wooden-headedness. If the mind is open enough to perceive that a given policy is harming rather than serving self-interest, and self confident enough to acknowledge it, and wise enough to reverse it, that is a summit in the art of self government.

Barbara Tuchmann, "The March of Folly: From Troy to Vietnam", 1984.

This model, not good luck, is the reason Australia has enjoyed a fifteen year expansion…. It is defined by a floating exchange rate that operates as a shock absorber, a credible medium-term inflation target that governs interest rate policy at the discretion of an independent central bank, a shift towards a more decentralised wage-fixing system, and a permanent budget surplus strategy set at about 1 to 1.5 per cent of GDP.

Paul Kelly, The Australian, May 2006.

A rich and generally unloved father dies after a long illness lasting nearly 12 years. After the funeral and a brief period of false mourning his 4 surviving children begin to criticise their father’s personal legacy that gave rise to his fortune, his cars, drivers, premises, status and his abundant cash. His children inherit the estate after intensive discussions with his executor and subsequently go on a spending spree with not a lot to show for it. Pretty soon they are out of money and have to mortgage assets and future cash-flows to maintain their profligate lifestyle. In their defence a few of their good mates benefited enormously from their good fortune and bountiful generosity. The children are, of course, the gaggle of four – Kevin, Wayne, Julia and Lindsay. They were, with just one exception, decent people that having not earned the fortune themselves, and having not liked their father benefactor, just got too excited at first, then careless. The executor was, of course, Ken Henry, who replaced his old and wise boss, Ted Evans, and Ken was pleased to be able to keep the children happy and fulfilled.

Ecinya Insights article 1/7/2010.

 

Quotes above: The Core Messages (note old journalistic adage – ‘90% of the message is in the head-note’)

  1. Ronald Reagan mastered the art of spin, even when he was in early stage dementia in his second term. Many politicians have come to emulate him, and his poor economic record is mostly overlooked.
  2. We long-ago believed that the Rudd government would be a mistake. Clearly the Labor party hierarchy came to the same conclusion in replacing Mr Rudd with Ms Gillard.
  3. In the post-Menzies era Labor’s Peter Walsh was, in our view, the most outstanding Finance Minister. Mr Walsh entered the Australian Senate in 1974, was Minister for Resources and Energy 1983-84, then Minister for Finance 1984-1990, before retiring in 1994.
  4. Ms Tuchmann, an American, is a pre-emminent political historian, and her book is a political masterpiece.
  5. Paul Kelly has authored several major books on Australia’s political history. He writes for The Australian as Editor-at-Large.
  6. The rich and unloved father was the John Howard-Peter Costello nexus. Their legacy came from the best years of the Hawke-Keating nexus, but Howard-Costello did not squander it, as the structural changes remained intact, enabling them to repay the Keating debts relatively quickly, aided by more than a little help from China and Asia generally

 

PROGRESS IS ALWAYS A LESSON IN ECONOMIC HISTORY

Prosperity is the tide that carries each and all of us towards realisation of our social and material goals and aspirations. Australia is richly endowed in terms of natural and human resources. Thanks to Robert Gordon Menzies the post WWII years gave us a real ‘eduction revolution’ and the means-tested Commonwealth scholarship expanded universities beyond the province of the established rich and gave the sons and daughters of the returning soldiers, aviators and naval personnel the opportunity to attend university. Doctors, engineers, architects, merchant bankers, economists, teachers, and scientists all flourished under the benign dictatorship of the Menzies era which lasted from December 1949 to January 1966. It was a period of relative stability. Menzies gave Australia its base, Hawke-Keating and Howard-Costello consolidated the legacy and prepared Australia for the challenges of the 21st century. There was a brief disruption under Emperor Gough Whitlam and Headmaster Malcolm Fraser, but the renaissance that came under Hawke-Keating was consolidated under Howard-Costello. Our latest set-back has come under Rudd-Gillard- Swan-Tanner, but we will recover over time. Ecinya favours a Liberal government because they have the better track record, but whomever wins the election we hope will overcome the debacle that the Rudd government became.

BUT Ecinya did give itself,and its readers, a warning dated February 2009, published September, 2009.

 

THE ELECTION OF 21 AUGUST, 2010

In broad terms the Australian economy comprises 40% small business, 30% government (both State and Federal), and 30% ‘big’ business. We have always believed that elections are important and that the economy works better when the government share of gross domestic product (the value of all goods and services produced) moves closer to 20-25%. At circa 30% government becomes a drag on the national economy. We also believe that monetary policy cannot overcome the cascading effects of bad fiscal policy. Despite what some economists might say there is a decisive and irrefutable link between monetary and fiscal policy. Misallocation of (scarce) resources relative to unlimited wants and needs, pushes interest rates and taxes up, and economic growth down.

 

ELECTIONS GENERALLY

Governments seeking re-election generally run on their record. Oppositions seeking to be elected generally run on policy and principle. This election is ‘somewhat’ unique in that the Labor party changed leaders (Gillard replaced Rudd) just prior to the election being called, and the Liberal party changed leaders earlier this year (Abbott replaced Turnbull). Other parallels are when Malcolm Fraser became caretaker Prime Minister after the Governor General sacked Gough Whitlam in November 1975, Bob Hawke replaced Bill Hayden in March 1983, and Kevin Rudd replaced Kim Beazley in December 2006. Mr Rudd then defeated Australia’s second-longest serving Prime Minister, John Howard, in the November 2007 election.

ECINYA does not know which party will win the election. We just hope that they return to the centre, and give balanced free enterprise a fair go. Big government generally results in big deficits, on both the current and domestic front, higher interest rates, and slower growth.

PROGRESS comes from incremental change. There are no silver bullets or ‘revolutions’. Slogans only make sense when they are consonant with constructive actions.The GST was a ‘revolution’ that was debated over almost three parliamentary terms … Keating, then Hewson, then Howard. It was an idea whose time had come!

Whitlam was fiscally inept, Fraser lacked a progressive agenda, and Rudd was awful in the extreme. Hawke-Keating-Walsh were excellent as was Howard-Costello. Both Hawke and Howard lost the plot in their final terms and tried to buy yet another election. The result was Keating got rid of Hawke, Rudd got rid of Beazley, and then Rudd defeated a tired Howard. It is interesting that the illegitimate Fraser government rising on the ashes of axed Whitlam fell short of expectations and was in turn easily beheaded by Hawke. We have a real feeling that the illegitimate Gillard government, should it be elected, will share a similar fate. Mr Rudd should have been given the opportunity to go the people. Ms Gillard looks vacuous. In today’s Australian Greg Sheridan says: "In her short tenure, she has so far emerged as a worse prime minister than Kevin Rudd on substance, process and coherence, all the ostensible reasons for her replacing him."

 

BACK TO THE FUTURE

On 2 November, 2007, just prior to the last election, Ecinya set out its policy prescriptions. Not much has changed since then. We now review our policy prescriptions of 2007 edited with our UPDATE comments..

  1. Extended Federal Parliamentary term: Australia is an extremely talented and lucky country with abundant human and natural resources Our potential will never be fully realised if we seek to change policy direction dramatically every three years. The economic and political cycles have become destructively disengaged at a time when economics and politics are more engaged than ever. Policies take time to work in a globalised world of shifting trade and political alliances and often need to be fine-tuned over several parliamentary terms. Good policy badly executed results in poor outcomes. Bad policy well executed or badly executed results in even poorer outcomes. We suggest that the Federal parliamentary term be extended to a four year term with a minimum period of 3.5 years allowing the incumbent government a window of 6 months in which to call the next election. UPDATE: No change of view from 2007.
  2. Australian personal taxes are far too high, extend the GST to food. UPDATE: The exclusion of food from the Henry tax review should have caused Henry to refuse to write the review. The GST is a big, elegant tax and it is relatively easy to make the food inclusion neutral at inception. The end result of excluding the GST from the review was the stupid idea of an excessive Super Profits Tax on the resources industry. The amended version of the tax, in our view, is flawed. Additionally, other stupid taxes such as payroll tax, and workers compensation taxes, remain which distort economic decision-making and reduce the desire of business to employ people and/ or to grow their businesses. ‘STUPID’… Silly Taxes Upset Proper Industrial Development.
  3. Capital gains taxes are too complex and counter-productive. The reform proposal is that all gains should be treated as ordinary income on a sliding scale: 100% gain taxable under year 1, 80% year 2, 60% year 3 etc etc. After 7 to 9 years all gains are tax free. This would bring a lot of residential property into the property markets. UPDATE: Capital gains which reduce capital mobility are unchanged.
  4. Create a minister for state liaison: UPDATE: Federal budget accounting is a shonky exercise. As an annexure the Federal budget should consolidate itself with all of the states distinguishing between capital works and operational expenditure so that we know where the money comes from, and where it goes to. With such a large share of GDP government needs to be more accountable.
  5. Education should be handed over to the Federal government with state councils, including the responsible state and federal ministers, created to monitor results and direct policy. UPDATE: This is happening, albeit slowly and without sufficient transparency and clarity.
  6. Health should be entirely federal or entirely a state responsibility. UPDATE: This is now happening in a haphazard way.
  7. Jobs: It is impossible to be pro-jobs and anti-business. We are excessively focused on exports. We should have an import replacement policy as well. UPDATE: No progress here. In fact we have gone backwards and even reversed many of the Keating work-place reforms. Small business, for purposes of the wrongful dismissal laws needs to be re-defined to something like at least 50 to 100 workers.
  8. Water resources needs an agreed national approach: UPDATE: Still not happening.
  9. Ethanol and other forms of energy saving needs a proper bi-partisan and appropriate policy response. UPDATE: With the failure (thank goodness) of Copenhagen this may now happen, but if the greens get the balance of power in the Senate there will be a monumental impasse and stuff-up.
  10. Aboriginals need dedicated colleges and broad curriculums encompassing the arts as well as the sciences. UPDATE: Aboriginal policy is still sub-optimal.
  11. The balance of Telstra should be sold as soon as possible. UPDATE: Almost there after the excess parked in the Future Fund is disposed of.
  12. Big business (market cap over say $250 million) should report annually at the end of every quarter with their statutory reporting date remaining unchanged. UPDATE: Has not happened. Also continuous disclosure is a bit of a joke in many instances and deceptive and misleading statements should result in two yellow cards, then a black card, and then an investigation or enquiry. Too many companies telling porkies.
  13. Auditors should read aloud their report to shareholders at the annual general meeting to remind shareholders, boards, and themselves, that they have a duty of care to shareholders and creditors.

Big Addendums:

(1) Political donations should be banned and an electoral bank established with distributions pre and post election to be distributed on a formula basis. Tax deductions should apply. Ecinya does not have a fully developed thesis on this , but we have written a discussion paper …… Crony capitalism: Capitalism’s cancer. Crony socialism: Socialism’s endemic malady.

(2) We live in a 24/ 7 world. So abolish penalty rates for weekend work and overtime even for priests, rabbis, and ministers who have to work on Saturdays and Sundays. People who work over 40 hours per week can enter into separate contracts in relation to overtime. Job protection does not work, and Greece is just another good example of the folly of job protection and uncontrolled welfare, albeit in a context where tax evasion is rampant. The Henry report recommendation on centralising welfare was totally ignored.

 

THE GLOBAL FINANCIAL CRISIS DID not IMPACT UPON AUSTRALIA TO ANY SIGNIFICANT DEGREE.

Simply stated, we over-reacted to make the Prime Minister, the Deputy PM, and the Treasurer look good. We absolve Mr Tanner, regarding him as probably sensible, but too easily over-ruled.

In 2006 every Australian had a sovereign-cash-in-the-bank balance of about US$1000. At the end of 2009 the sovereign debt per capita is about US$8,400. The fiscal failures of the Rudd-Gillard-Swan-Tanner gaggle of four achieved this troubling result. To look at sovereign debt as a simple proportion of GDP is an over-simplification. This explains to a significant degree why we have the only central bank in the world pursuing normal central bank interest rate policies. If China slows dramatically, and Europe and America do not recover, our vulnerabilities and our narrow income base, dependent on resources, plus the size of our import bill, will become apparent.

Other errors of the Rudd-Gillard-Swan-Tanner years:

  • Environment: Emissions trading scheme. Home insulation scheme. Blow-outs in green loans and solar school systems.
  • Education: Blow-outs in school construction programme. Shortfall in computer for each child programme.
  • Consumer: FuelWatch, GroceryWatch
  • Telecommunications: National broadband no viable case presented, but it IS ONLY about $30-$40 billion
  • Governance: Promised 30% cut to ministerial staff reversed. Backflip on Auditor General vetting of political advertisements.
  • Health: Only six of promised 36 super GP clinics are fully operational. Only 52 of 2500 new aged-care beds have been opened within 2 years.
  • Skills: Only one of 2650 trades training centres fully operational.
  • R&D: Failed to secure passage of R&D reforms before parliament rose.
  • Workplace relations: Flexibility removed and wrongful dismissal laws onerous for small business.
  • Tax reform: Did not happen. A fiasco.
  • Political donations: Legislation to cap political donations and election spending by political parties stalled.

Mid year review: Stay patient, remain alert, navigate the noise

HEAD QUOTES TO ASSIST PERSPECTIVE

In preparing for battle I have always found that plans are useless, but planning is indispensable.

Dwight D Eisenhower, circa 1942.

No one would remember the Good Samaritan if he’d only had good intentions, he had money as well.

Margaret Thatcher, 1986

I stopped believing in Santa Claus when I was six. Mother took me to see him in a department store and he asked for my autograph.

Shirley Temple. 1999.

People are nervous about the long-term outlook, and they should be.

Paul Volcker, 11 July 2010.

Long range plans engender the dangerous belief that the future is under control. Try to stay flexible, open minded and sceptical. Good trading is a peculiar balance between the conviction to follow your ideas and the flexibility to recognise when you have made a mistake. In a bull market focus on price & momentum, a bear market focus on valuation.

ECINYA investment rule #8.

 

Quotes above: The Core Messages (note old journalistic adage – ‘90% of the message is in the head-note’)

  1. Call it a ‘plan’, a ‘vision’, a ‘hunch’ whatever you wish, but have some idea of where you think you are going and why, and change your mind if circumstances change.
  2. Love of money is the root of all evil, but money thoughtfully invested is the cause of all progress.
  3. Alan Greenspan still thinks he is Santa Claus. We believe him to be the worst central banker of his age, but he still appears on television as a guru.
  4. We have much confidence in Mr Volcker, Head of the Federal Reserve 1979-1987, and currently Chairman of Obama’s Economic Recovery Advisory Board. We always take his remarks seriously.
  5. Be nimble, be alert, investment accumulation will test your patience, watch the earnings season unfold. Conviction and Flexibility are opposite sides of the investment penny.

 

OVERVIEW

This is an update of the papers we published at the beginning of this year: ‘2010: Our view of the year ahead’ and ‘Revisiting the 2010 overview’.

Essentially, our views remain unchanged. We are expecting one more market rally followed by a retracement over several months of the order of 15% which will end about late September. At this time the global financial crisis will be over and markets and economies will be moving towards normalising. Then the next bull-market begins, subject always to context, determined substantially by what happens between now and then. There are always stocks to buy, and stocks to hold, there are always takeovers and other corporate happenings. Our conclusions exclude event risk. As always "Exercise Caution IN Your Affairs".

 

SUMMARY CONCLUSIONS

Our market is likely to remain difficult and hostage to world markets and perspectives on the global economic outlook. Europe is not good and America is, in our view, relatively worse, because it should be better than it is, and providing leadership after having caused so much of the recent mess. The glass is mostly half empty, not half full. On 27 May we moved all of our ‘buy’ recommendations to ‘accumulate’ and we are maintaining that position. Watch for special situations, wait for value to emerge, trade around the edges. It is all very tricky.

The world is in recovery mode. The global recession is over and we should not have a double-dip recession. But the pace of recovery is muted as the sister ships of America and Europe are turning around very slowly and most of the turnaround is already priced into markets. Asia, which includes Australia, is carrying the world economy. Australia has exaggerated its perfections under a profligate and inept Rudd Labor government and our vulnerability to a global slowing in the second half of calendar 2010 will become apparent over the short-term. Fortunately, the Reserve Bank is aware of the Government’s exaggerated claims and dismal fiscal record and has moved to tighten monetary policy to the point where we have the highest official rates in the developed world. This provides some flexibility if the projected second-half slowdown becomes severe.

Our 2010 ‘view of the year ahead’ said: "Though we regard the primary trend for 2010 to be UP, volatility will be a feature as the recovery will be complex. Most of the forecasters will have their moment(s) of directional accuracy, but will not be right for the entire year. Distrust any forecaster who just gives you a year-end index figure, which is a simplistic and lazy forecast, and relatively worthless. 2010 will be a difficult year simply because we had a complex recession with misleading and deceptive behaviour from many institutional and market related sources. Political correctness, self-interest, and convenient informal conspiracies have combined over the past decade to induce complacency and to mute criticism of behaviours that were near to fraudulent at worst and criminally careless at best, in relation to this credit crisis and the last tech/ telco crash. These institutions include bankers and brokers, government ministers, long-term fund managers, hedge funds, companies, the accounting profession, ASIC, the ASX, the IMF, and central bankers. Thus the natural tendency of market participants and informed commentators towards scepticism has been in retreat, and, to varying degrees, we have been slapped in the wallet by yet another harsh dose of reality. The commentariat has polarised into rampant bulls on one side of the debate, and negative zealots on the other. The response of the thoughtful should be to develop a strategy around viable data, consonant with an effective review and monitoring process. Only the nimble can outperform the swirling mass of ‘noise’ that hits us on a daily basis."

Assigning some probabilities to those generic conclusion we said:

  • "Recovery with market retracements, subdued economic advance ……………. ……… 60% probability
  • Double dip recession, more and/or new stimulus, secular bear overtakes…………..33% probability
  • All other possibilities, new bull, depression, something we are unaware of…………..7% probability"

 

CONVERTING THOSE CONCLUSIONS INTO INDEX LEVELS (note the S&P 500 is our global proxy)

We are currently experiencing the first retracement from the intermediate high of the SP500 of 1217 reached on 23 April to a retracement low of 1022 on 2 July, a decline of 15.4%. In All Ordinaries terms (XAO) the decline is also 15.4% from 5024 to 4250 in the same period. Each of the markets should bounce around levels above 1050 and 4300 respectively for a little while yet.

The primary uptrend to the intermediate highs of 1217 and 5024 lasted 289 days and the current retracement period is 55 days. Our expectation is that it should exhaust itself after about 115 days i.e continuing to grind lower until about 30 September. For this ‘scenario/ thesis’ to unfold the current bounce should begin to falter later this month or early August, and the SP500 should go above 1100 and the XAO above 4500. Our September target levels are circa 975 for the SP500 and 4250 for the XAO.

How do we arrive at these technical levels? The March 2009 low for the SP500 was 676 and the intermediate high was 1217 in April 2010. The mid point is 947, and so 975 is near enough. The corresponding numbers were 3111 and 5024 for the XAO giving a mid point of 4068 but we expect Asia to be in better shape than Europe and the Americas so 4250 is near enough.

We also believe that the fundamental macro economic and market conditions will exist to support moves in these directions.

Our stock-market (and the developed markets generally) is not a true investment market, it is being dominated by quantitative and technical traders. Why? Because there is considerable uncertainty about the outlook and traders thrive on uncertainty. Remember, the laws that would make many trading activities transparent do not yet exist. Our market is thus a difficult market for the genuine investor who seeks to ‘buy and hold’.

 

CONTEXT

Short term – next month or so: the Gulf oil spill is capped and the relief rally continues. Australia remains in election mode and the Rudd government failures become prominent causing the consumer to hesitate. We do not really care who wins the election provided that Wayne Swan is replaced and Ken Henry learns something about business or is sacked by the new Gillard or Abbott government. At this point we are far from impressed with Ms Gillard as she seems to be a more personable version of Kevin, but no less vacuous. However, the Liberal front bench needs significant rejuvenation on the economics front and they need to find a seat for Arthur Sinodinos. We will have a major Insights issue after the election is called and policy positions can be evaluated.

Mid term – next 4 to 5 months: Global GDP numbers begin to be revised downwards, particularly for the USA, and unemployment remains persistently high. Retail numbers and housing starts continue to disappoint. America remains politically dysfunctional. The US mid -term elections will be a media nightmare, but we hope that Obama comes out in front and then shifts to the right and veers towards fiscal restraint. Obama and Geithner inherited a mess, and seemingly are not solving many of the problems. We always take great comfort in Winston Churchill’s: "You can always rely on America to do the right thing, once they’ve exhausted all of the alternatives".

 

BACKGROUND

The global recession of calendar 2009 resulted in a negative growth rate of 0.6% according to the IMF statistics.Over the 20 years to 2009 world GDP growth averaged 3.2% (at constant prices) and if we exclude the low growth years 1991 to 1993 inclusive, and the 2009 recession, then world GDP has averaged 4.2%. Further, over the 10 years to end 2008 growth averaged 4.0%. If the world is growing at 3.0% then world output doubles in approximately 24 years and at 4.0% per annum it doubles in 18 years, considerably faster. We know that growth is good.

At the end of 2008 world GDP was US$61.2 trillion and in 2009 it fell to US$57.9 trillion. Thus the shortfall was $3.3 trillion and the 3% growth we missed out on was about $1.8 trillion, giving a growth shortfall of US$5.1 trillion. Thus in 2009 the world lost about 5 Australia’s, or 1 China,or close to the combined GDP of France and Germany. That’s a lot to lose!!

Current estimates for 2010 are for world growth to rise by 4.2%, 2011 by 4.3%, and 2012 by 4.5%. These numbers look overly optimistic, but even if they are ‘wrong’ or the timing of the return to normalised world growth is delayed, the world will be in far better shape in 2011 than it was in 2009. We should also note that 2009 has been the only year of negative growth in the past 20 years.

 

THE NEXUS BETWEEN THE MARKETS AND THE ECONOMY

The market is a leading indicator, it goes up or down before the economic numbers are broadly known. Our current view is that the market got too far ahead of the economy around the first quarter of 2009 as a V shaped recovery was the prevailing wisdom. But the 2009 recession was caused by credit and liquidity problems, not the normal inflationary pressures that cause central bankers to put on the brakes. The way out of the global financial crisis was to ease monetary policy and expand fiscal policy to incredible extremes with the US taxpayer bailing out the major investment banks and other institutions (Fannie, Freddie, AIG) whose profligate behaviours caused the problem in the first place. It has been a bizarre recession and the response has been a frenzied form of Keynesian economics.

 

FUNDAMENTAL FEAR LIST FOR 2010 from our overview document dated 12/1/2010 with update notes in brackets

  • America economic aggregates, and policy settings; negative trends in employment, current account and domestic deficits. (No change, in fact, things are a tad worse than envisaged)
  • The aftermath of American foreign policy history and its implications for global resource allocation and growth. (Iraq, Afghanistan and the Middle East are still excessively troubled)
  • The global economy and the possibility of growth rates disappointing as stimulus is withdrawn. (We consider the second half of 2010 will see this come to pass)
  • The lead into various elections around the world that might encourage profligate fiscal behaviour (Australia, and US mid-terms are on the horizon, but there is little room for further profligacy)
  • Higher global and local interest rates, particularly the latter, in context of rising inflation. (Has not happened, deflation now more of a problem, particularly in the USA)
  • The unintended consequences of additional stimulation. (America politically dysfunctional, and Fed Reserve part of the political system, Congress needs to cut spending)
  • Another major institutional failure in the USA. (Has not happened but BP certainly makes the list for other reasons)
  • A downgrade of US debt. (Still on the agenda, but who is brave enough, or silly enough, to do it)
  • China having a few problems which are currently overlooked such as slowing exports, failures in the small business sector, and non-performing bank loans. (Always hard to forecast or fully comprehend China problems, despotic governments can be more efficient in the short-term at least)
  • Rising taxation levels. In Australia this will be euphemistically called ‘tax reform’. (Has been recently attempted with the resource rental tax, but has failed dismally, and was far from ‘reform’… The GST should have been extended to food)
  • A break-out in local wages. (Will occur)
  • Unemployment staying persistently high. (Australia OK if you ignore some of the definitional problems, but USA particularly vulnerable to entrenched unemployment problems)
  • Commercial property values globally. (Still weak)
  • Municipal and state failures in the USA . The 10 most troubled states in the USA are Arizona, California, Florida, Illinois, Michigan, Nevada, New Jersey, Oregon, Rhode Island and Wisconsin. Other states, not far behind, are Colorado, Georgia, Kentucky, New York and Hawaii. (This is a big problem just bubbling beneath the surface)
  • US local bank failures -144 banks have failed since December 2008 and more are said to be at risk. (Has fallen below the radar screen, probably OK)

 

SHORT TERM FEARS AND RIDDLES – 25 May, 2010 from Strategy section of that date.

  • The IMF has said global growth has returned to circa 4%. They didn’t know about the GFC until it slapped the entire world in the wallet. Thus we should treat their pronouncements and actions with some scepticism. Currently, their solution for Greece seems to be fluid in context of rubbery Greek numbers on the depth of the ‘crisis’ and the political reality of potential solutions. (No change here)
  • What has emerged with Goldman Sachs thus far looks like the the first cockroach, meaning that more are sure to exist. Michael Lewis’s book ‘The Big Short – Inside the Doomsday Machine’ throws up a lot of questions. (No change here, someone needs to be held accountable)
  • The new GDP numbers for most of the developed world have been achieved via massive fiscal and monetary stimulus so that unqualified comparisons seem misleading. Australia has moved pre-emptively on interest rates and that seems good policy in context of sub-optimal fiscal policy outcome. (New securities laws in America having a trouble passage through Congress)
  • US housing is still cum housing credit and better weather for construction.(Housing falling away as stimulus withdrawn)
  • Can the US continue to borrow abroad at current interest rate levels? Watch 10 year bond yields. (America is a ‘safe haven’, perception is that Europe is worse, but we have always thought Europe was disinterested in growth and addicted to welfare anyway)
  • The Henry Tax Review is likely to be substantial nonsense. (This has been shown to be true)
  • The All Ordinaries index looks weak vis the SP500. (Still unfolding on the weak side despite the current rally)
  • The SP500 looks stretched and vulnerable. (Still unfolding on the weak side despite the current rally)
  • The Shanghai index looks to be rolling over. (Still unfolding on the weak side)
  • The copper price looks like the Shanghai index. (Volatile to the downside, but not really falling over)
  • British politics looks to be complicated leading into the election. (Conservative-liberal coalition going very well)
  • America believes it is a capitalist country and wants to debate socialism under Obama and capitalism under anyone else. Congress seems to be fighting old wars on dogma and confusing and disappointing main-street.(America remains fragmented and dysfunctional)

 

A short trip, ‘fair’ to ‘fairy tale’. The long journey, ‘credibility’ to ‘trust’.

HEAD QUOTES TO ASSIST PERSPECTIVE

 

When the legislative changes for the GST were back in the House of Representatives on 30 June 1999, a little known Queensland Opposition backbencher, Kevin Rudd, told the Parliament: "When the history of this Parliament, this nation and this century is written, 30 June 1999 will be recorded as a day of fundamental injustice – an injustice which is real, an injustice which is not simply conjured up by the fleeting rhetoric of politicians. It will be recorded as the day when the social compact that has governed this nation for the last 100 years was torn up. It will be recorded as the day when the nation’s taxation system moved from progressivity to regressivity. It will be recorded as the day when the Parliament of the country said to the poor of the country that they could all go and take a running jump."

From "The Costello Memoirs", 2008. Hyperbole in magnificent dimension from our former PM.

This model, not good luck, is the reason Australia has enjoyed a fifteen year expansion…. It is defined by a floating exchange rate that operates as a shock absorber, a credible medium-term inflation target that governs interest rate policy at the discretion of an independent central bank, a shift towards a more decentralised wage-fixing system, and a permanent budget surplus strategy set at about 1 to 1.5 per cent of GDP.

Paul Kelly, The Australian, May 2006.

Tax reform will fail because there is no leadership on the issue.

A sub-optimal Prime Minister carrying a litany of fiscal disasters on his curriculum vitae cannot be trusted to formulate proper tax policy nor to implement his misguided efforts in a near-enough-to-viable way. At Mr Rudd’s current level of fiscal recklessness Australia will gravitate towards the parlous state of fiscal folly currently in view in parts of Europe and the United States of America. You cannot run policy through the prism of a PM’s ego. Australia has tried that before, and failed. All countries that try it fail.

Prosperity is the tide that carries us all to fulfilment of our material and social goals and aspirations. You cannot be anti-business and pro-jobs.

Mr Rudd uses weasel words like "working families" without definition, prefaces his remarks about "long-term sustainability" and "Australia’s national interest while I am Prime Minister" whilst being engaged in short-term waste and misallocation of resources. He was elected, not ordained, yet continues to give interviews outside of his church. Presumably Jesus Christ has given prior approval. He talks in platitudes of ‘stronger, fairer and simpler’ as layers of bureaucracy and complexity are added to an already stressed tax and fiscal expenditure system. In 11 years of absolute and relative prosperity John Howard ‘did not meet the challenges of government’ according to Mr Rudd. Boy oh boy, does this guy have a self-esteem problem.

In terms of primeval salesmanship, immediately upon Mr Rudd becoming Prime Minister, the neo-conservatives were responsible for our manifest fiscal and social folly. Now it is the turn of ‘the greedy miners’ where years of toil, often speculative exploration, overcoming extraction, production and transport difficulties and having to sell into often volatile and cyclical markets. But expertise and positioning over time count for nought. Mining companies re-capitalise themselves in the good times to sustain development in the bad times. Many developments do not produce a viable return for years and years.

In looking at the rhetoric coming from Mr Rudd on the tax "reform" package, the paras immediately above and Kevin’s quoted response to the GST in 1999, it seems certain that even when the PM is putting on his trousers each day it is an historic event. The nonsense never ends!

Ecinya Insight article "Ken’s Crusade" 5/5/2010

This has been written to attempt a brief articulation of a major concern that far from saving Australia from the ‘global financial crisis’ the actions, rhetoric and policies of the current Australian government are going to totally immerse us in it, or delay our recovery from it, or both. We are just 1% of the global economy. Time is needed to see where the stimulus packages of China, America and Europe will lead the world. Current local policy prescriptions seem to be pre-emptive, excessive, and poorly targeted.

Ecinya has suggested that payroll tax relief, personal tax cuts being brought forward, and some relaxation of capital gains taxes for long-term residential property holders upon sale would provide sufficient short-term relief. We are totally opposed to the $950 per person hand-out which apparently will cost about $11 billion and we don’t understand the pre-occupation with direct infusions for commercial property as opposed to working through the banking system. We are strongly in favour of infrastructure spending, but the schools programme is blatantly political and can unfold more slowly than currently envisaged. Some of the ‘green’ programmes seem also to be politically inspired.

Ecinya private article written February 2009, re-produced under Insights 1/9/2009: "A reflection: Australia and the global financial crisis."

 

Quotes above: The Core Messages (note old journalistic adage – ‘90% of the message is in the head-note’)

  1. The GST was a gigantic and productive taxation reform, not just a tax grab. It was both fair and balanced.
  2. Certain economic reforms under Hawke and Costello underpinned a substantial amount of economic progress. These reforms were real policy.
  3. From Ecinya’s response to the Rudd government’s response to the Henry tax ‘reform’ package.
  4. From Ecinya’s response to the Rudd government’s response to the global financial crisis.

 

A VISIT TO OUR COLLINS DICTIONARY

The dictionary is always a source of wisdom and inspiration. Politicians are as fond of the word ‘fair’ as they are of ‘working families’ , ‘ordinary Australians’ and ‘sustainable outcomes’. ‘Fair’ is defined in our dictionary as "free from discrimination, dishonesty; apparently good or valuable". Just 14 words later ‘fairy tale’ is defined as "a highly improbable account".

In the world of tax reform, that ageless and enduring pursuit of the earnest and aspirational politician, whenever the word ‘fair’ is repeated ad nauseum as if it were irrefutable logic, one invariably realises on closer examination, that it really is a ”fairy tale’…… "a highly improbable account". Such a politician invariably needs the money to pay for his fiscal misdeeds, and propensity for recklessness, wrapped in the cloak of good intentions.

Such is clearly the case with the Resources Super Profits Tax, and prior to this episode, the GFC – the global financial crisis.

 

Australian and G7 Global Statistics end 2006 and end 2009

G6 GDP

 

BUT THERE IS MUCH MORE TO THIS TAX REFORM FAIRY TALE

A rich and generally unloved father dies after a long illness lasting nearly 12 years. After the funeral and a brief period of false mourning his 4 surviving children begin to criticise their father’s personal legacy that gave rise to his fortune, his cars, drivers, premises, status and his abundant cash. His children inherit the estate after intensive discussions with his executor and subsequently go on a spending spree with not a lot to show for it. Pretty soon they are out of money and have to mortgage assets and future cash-flows to maintain their profligate lifestyle. In their defence a few of their good mates benefited enormously from their good fortune and bountiful generosity. The children are, of course, the gaggle of four – Kevin, Wayne, Julia and Lindsay. They were, with just one exception, decent people that having not earned the fortune themselves, and having not liked their father benefactor, just got too excited at first, then careless. The executor was, of course, Ken Henry, who replaced his old and wise boss, Ted Evans, and Ken was pleased to be able to keep the children happy and fulfilled.

Ecinya is of the opinion (well documented in past Insight articles) that ‘climate change’ and ‘THE global financial crisis’ were convenient episodes for Mr Rudd to demonstrate his capacity to strut the world stage and offer solutions ostensibly beyond most of the capacities and capabilities of the other 19 countries in the G20. Note that Australia bats at about number 17 out of that 20 in absolute terms and at about 8 in per capita terms. The above table demonstrates clearly in our view the need for Australia to be modest when it seeks to be persistently loud on global issues. Hyperbole can easily be counter-productive on the global stage.

A number of background points:

  • The last election was decided on 24 November, 2007. At the end of 2006 Australia was in very good shape with a domestic budget surplus, no sovereign debt, comparable growth stats and better-than-average unemployment stats.
  • Australia is but 1.2% of gross world product and G7 was 44% of gross world product in 2006, and 41% in 2009. The 3% slippage from 2006 to 2009 is equivalent to circa $2.1 trillion; nothing to really worry about, except if you’re one of the unemployed victims and/or have had your house repossessed.
  • All of the G7 countries showed negative growth in 2009 despite fiscal and monetary stimulus, as Australia’s growth was disproportionately stimulated to a positive outcome.
  • Big countries can have bigger sovereign debt loads so that an unweighted comparison is often not completely valid.

Our conclusion is clear and fits nicely with the fact that the fifteen year expansion (described by Paul Kelly in our head quotes above) and Australia’s relatively good position resulted from the very compatible policy initiatives pursued by the Hawke-Keating-Walsh- Button government, with external wisdom provided by Lindsay Fox and Bill Kelty, followed by the Howard-Costello government with sound monetary policy provided by Ian Macfarlane at the Reserve Bank plus the Liberal Party’s psychological nexus with small business. The GST which failed under Hawke and Hewson, to become law under Howard, would not have been possible without the support of the Australian small business sector. The trade-off for the GST of course was lower personal tax rates, abolition of wholesale taxes, and a number of other indirect tax offsets.

Messrs Rudd and Swan and Tanner and Gillard and Henry DID NOT save Australia from the global financial crisis. Time will show that they over-reacted by something like $15 billion of direct expenditure and $100 billion of debt. We have plucked these figures from the air, but they will prove to be conservative when intensive analysis is undertaken and becomes available.

A big feature of the GST is that it was presented to all of the members of the Federal Liberal team in great detail prior to release and Treasury Secretary Ted Evans and his deputy Ken Henry, worked assiduously, to push the reform, from behind the scenes, rather than from the public pulpit as good staffers should do. The real job of selling the tax over the 12 months before the 1998 election was done by John Howard and Peter Costello. It was a great pity that food was excluded, but 80% of something was better than 100% of nothing. Our domestic budget surpluses and the reduction of the large sovereign debt inherited from Paul Keating’s brief interlude as PM can be fairly (there’s that word again) attributed to the GST. Ecinya was fond of Mr Keating but when he went solo his voice was never the same

The RSPT is a very bad tax policy, and the manner of its release and presentation was/is badly flawed. With the exception of China, Australia’s major trading partners are barely out of recession and still in a work-out phase in relation to the global financial crisis. With the American consumer slowing some impact can be expected to flow to China, itself grappling with the inflationary pressures, excesses, labor unrest etc evident after three decades of exceptional growth. The question of whether, or not, China is in property-bubble territory is unresolved.

 

RUBBERY NUMBERS BUT STILL A USEFUL THESIS

It is always difficult to measure the percentage relationship that government has in relation to national GDP as we have a Federal Government plus 7 state governments, partially funded by a federal ‘big brother’. It is interesting that companies have to consolidate in their annual reports and meet accounting standards of general transparency, but governments in Australia do not. In a recent speech Ken Henry gave a figure of about 26%, so adding say 7% for the states (adjusted for double-counting) would give a rubbery number of around 33%. This figure is near enough to correct we believe, and is far too high, adding to pressure on interest rates and, of course, private sector investment activity.

Far too many of our tax dollars are absorbed by government and this is partly due to the fact that food was excluded from the GST and from the circa 1450 pages of the Henry Tax Report. Investment comes from savings and we cannot, under the present tax system afford to tax savings at lower rates. Capital gains taxes also inhibit transferability of property in the residential community pushing up the price by restricting supply. Henry should be asked to write an addendum to his report inclusive of the GST.

Governments all around the world have conveniently adopted Keynesian stimulus dogma: ‘ In bad times government should spend to make up for private sector shortfalls.’ But without having spoken to John Maynard Keynes ever, but having a vague recollection of his theories from university days, Ecinya believes that Keynes would not have been an advocate of undisciplined spending, particularly in a world very different than when he developed his economic theories. The Von Mises school of economics is strongly against ‘misallocation of resources’. Peter Costello is reported as saying in yesterday’s Financial Review that "The Building Education Revolution is a scandal. It’s the insulation batts without the deaths." This seems accurate, and he did not even mention the household fires that have occurred. These programmes are blatant examples of misallocation of scarce resources.

 

Mr Rudd’s departure will benefit us all, but the Labor party lacked the courage to let him go to the electorate

Paul Krugman in "The Great Unraveling" said: "To talk abour economics, requires more and more, that one write about politics."

We hope that our remarks in this essay are more focused on policy outcomes than politics, but even ‘fair play’ and the ‘fair lady’ ( just two of the words between ‘fair’ and ‘fairy tale’) is in the eyes of the beholder. We are not critical of governments, just bad policy and bad policy outcomes.

In yesterday’s editorial in The Australian it was said: "Things got worse as Mr Rudd backed himself into a corner over the mining tax, alienating voters across the spectrum with his faux class warfare. Spin was no substitute for a lack of understanding of how the nation had changed over 30 years of economic reform. When swinging voters, such as tradies, contractors and other workers worried about the impact of the tax on the economy, began to desert the man they had backed in 2007, it was clear to the grown-ups in the party they were being led by the apprentice. It may be tempting to see in Mr Rudd’s downfall the swords of conspirators determined to destroy him. But the former leader speared himself with his unprofessional handling of politics. His dismissive approach to the "mythical" centre back in 1998 would prove fatal. There is a centre and successful prime ministers find where it is and govern from there. Unsure where his votes lay, and with little understanding of how to secure them anyway, Mr Rudd failed this key test of Australian political life."

We found it strange to reflect on the fact that the proposed resources tax is essentially a tax on coal and iron ore, our major exports, and that coal is said to be the major cause of global warming due its greenhouse gas emissions. So it can fairly be said that the more coal we export to the world, the greater is the proposed tax take. Funny hah hah (?)

Jack Lang, a former NSW Labor premier, once famously said: "Always put your money on self-interest. It’s the best horse in the race because you always know its trying." Mr Rudd was not ousted for policy imperfections, but because his fellow parliamentarians in marginal seats were feeling the heat of unemployment or lesser employments.

 

TO FINISH

‘Credibility’ is on page 229 of our Collins dictionary and ‘trust’ is far away at page 1075, a journey of some 846 pages. Fortunately we will not have to wait 845 days to consider legitimising the current Julia Gillard government, but that government will be in office for about 1075 days – if Labor wins the election – and each of those days will be important as the challenges have been magnified by errors over the last 1000 days. In the meantime we can easily anticipate that spin will be rampant and smiles and good cheer will be in the air. Ecinya hopes that the election will be sooner rather than later and that a ‘deal’ of dubious merit on the RSPT and a few deals on other matters are transparent for all of us to weigh up the policy implications and hence decide on the political options.