1) Adam Smith, at least, lived to have high hopes for the new country. He thought it was normal for human beings to want to live in a prosperous society, but that it was also normal for them to live in a broadly just society. Their desire for self-improvement was in many ways mysterious, but in the end it was inherently social, rooted not only in the love of acquiring but in the love of haggling, bargaining, interacting – the whole work of building worlds out of wishes. What then moved men to make markets was ultimately their love of pleasure and happiness, and who Smith wondered, could live happily in a society where all the wealth had been confiscated and kept in a few hands? He believed not that markets make men free but that free men move towards markets. This difference is small but decisive; it is most of what we mean by humanism.
AFR 29 December 2010 – Adam Gepnik of The New Yorker writing on Nicholas Phillipson’s "Adam Smith: An Enlightened Life."
(2) The principal contribution that monetary policy can make to economic well-being is to maintain low and stable inflation. I think it is true to say that if you wished to forecast the path of the Australian economy, and you were able to have fore-knowledge of only one economic variable, the one you would choose is the path of the world economy. That is not to say that we have no influence over our own destiny – we can make the situation better or worse than it would otherwise be – but we cannot escape the influence of the world business cycle and the other factors that feed off it.
Ian Macfarlane, Governor of the Reserve Bank, 14 June 2005.
(3) 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.
Peter Walsh former Labor Party Finance Minister, Financial Review 10 December 2003.
(4) The propensity of Congress to create benefits for constituents without specifying the means by which they are to be funded has led to deficit spending in every fiscal year since 1970, with the exception of the surpluses of 1998 to 2001 generated by the stock-market boom. The shifting of real resources required to perform such functions has imparted a bias toward inflation. In the political arena, the pressure to make low-interest-rate credit available and to use fiscal measures to boost employment and avoid the unpleasantness of downward adjustment in nominal wages and prices has become nearly impossible to resist. The American people have tolerated the inflation bias as an acceptable cost of the modern welfare state.
Alan Greenspan in "The Age of Turbulence", September 2007.
(5) Treasury was at its most influential during the term of the Hawke government, but I give credit for that to our greatest ever treasurer, Paul Keating, a man with a deep understanding of how to obtain and use political power, and who needed a purpose to fight for. Treasury supplied that purpose, affecting his conversion to economic rationalism. Treasury’s highest institutional objective has long been to dominate the economic advice going to the government, and no secretary has been more successful in this than Ken Henry, thanks to the arrival of the deeply insecure Rudd government, which sought to hide behind the authority of the supposedly independent Treasury.
Ross Gittins, The Sydney Morning Herald, 27 December 2010.
(6) Labor should just stop meddling with the markets: History shows Julia Gillard and Kevin Rudd always can be trusted to do the wrong thing……..Gillard, god bless her, is less inclined to write a treatise on economics during her holidays, but it would be hard to find someone less qualified to understand markets than a union lawyer who was a member of the Socialist Forum for the best part of her adult life. With Australia’s economic growth figures for the September Quarter on a precipice at 0.2 per cent, Gillard wants to introduce a tax on mining, the one thing that kept Australia out of recession these past few years, and then get to work on a carbon price….. and legislate against exit fees in home loans, a measure that non-banks assure us will make them less competitive. The truth is that the Gillard government has the same chronic problem that crippled the Rudd government: neither incarnation seems to have the faintest clue about markets. Watching them blunder through each fresh initiative leaves you with a feeling of helplessness reminiscent of being an audience member at a kid’s puppet show.
Gavin Atkins, www,asiancorrespondents.com, The Australian 28 December 2010.
(7) Global economic recovery more superficial than real: Liquidity injections and bailouts can buy time, but are not the solution for economies in need of structural repairs….. Time is not the answer for economies desperately in need of structural or fiscal consolidation, private sector deleveraging, labour market reforms, or improved competitiveness. Nor does time cushion anaemic post crisis recoveries from the inevitable next shock.
Stephen S Roach, Non-Executive Chairman Morgan Stanley Asia, Financial Times 5 July 2011.
(8) I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket, and trying to lift himself up by the handle.
Winston Churchill
(9)The Way of Heaven is profound and mysterious and the way of mankind is difficult. Only if we make a profound and unified plan to follow the doctrines of the centre, can we rule the country well.
Emperor Qianlong of the Qing dynasty, 1645, outside of the The Hall of Central Harmony in the Forbidden City on signage sponsored by American Express:
OUR QUOTES EXPLAINED (90% of the message is in the head-notes).
(1) Adam Smith is most famous as author of "Wealth of Nations" and created the thesis that the ‘invisible hand’ of enlightened self-interest pursued by men of integrity would promote pervasive prosperity.
(2) Australia needs to regularly remind itself that it is about 1% of the global economy and act accordingly. Though we participate above our weight there is a recurring tendency for our political leaders to exaggerate our place in the world and pursue policies that are against the national interest and to squander the proceeds of our recurring cycle of resources booms.
(3) The Hawke-Keating-Walsh Labor trio got the balance about right and in their first term, and a bit of the second, the Hawke government advanced Australian prosperity enormously, overcoming much of the malaise and regression under the Whitlam and Fraser administrations. Mr Walsh from retirement has branded Mr Rudd an ‘economic illiterate’ and there is currently no reason to suppose that Ms Gillard is significantly different than her predecessor. Our current Treasurer Wayne Swan’s mantra is: ‘Because everybody disagrees with me that is proof positive that I’ve got the balance about right".
(4) Alan Greenspan’s memoirs are something of a mea culpa as he was a terrible central banker who failed to realise that bubbles were being created in the American banking system and too often pursued monetary policies to favour the White House President who had appointed him, sometimes out of fear that sacking him would cause stock-market, and re-election donor disruption. He has come to realise that America had become indulgent and profligate under his monetary stewardship, borrowing and printing money to pay for recurring expenditures including defence, war and welfare. It is the essential role of central banking to privately hold the government to account, and if that cannot be done, to do it publicly via interest rates and direct market mechanisms.
(5) Ecinya cannot entirely endorse Mr Gittins’ remarks on Ken Henry but we were interested to reflect on his use of the phrase "deeply insecure Rudd government", an observation which we wholeheartedly agree with. Mr Rudd seems destined to live and travel with his insecurities. However, at this point in time we can also find elements of ‘insecurity’ in both the Liberal alternative (a crazy paid parental leave scheme that missed shadow cabinet scrutiny, Mr Hockey remaining in the Treasury portfolio), and the incumbent Gillard-Rudd-Greens coalition where insecurity is evident in excessive debt loads, waste and extravagance. The Hawke-Keating-Walsh- Howard-Costello budget bonanza has gone. Mr Henry should have refused to undertake his Tax Policy Review without inclusion of the GST and to have protested the government response to the bulk of his recommendations. The obvious candidates for the Shadow Treasury portfolio are Scott Morrison and Malcolm Turnbull, but the latter often appears incapable of separating his ego from the national interest. Sometimes even worthy ambitions have to be put into life’s knapsack.
(6) Ms Gillard, Mr Swan et al are no students of Adam Smith nor, closer to home, of the past success of the Hawke-Keating-Walsh-Howard-Costello years. Government in Australia on a consolidated basis (Federal & States) is now running at close to 30% of the national economy, instead of a more manageable and balanced 20-22%, forcing the Reserve Bank into tightening when it should be able to think about reducing interest rates. Fiscal policy waste could have been channelled into sustainable tax reform, and structural initiatives. ‘Poor-girl-of- Welsh-origin-done-good’ is not a basis to run the nation; the job is bigger than that.
(7) Wishful thinking is the enemy of hard work, and Stephen Roach’s opinions are always worth a visit, though he is often prematurely prescient.
(8) and (9) need no explanation. The current Greek solution will fail and if it forms a template for other distressed nations then chaos will prevail.
A note on our quotes
One of our esteemed confidants, Compass, often complains that our head-notes take up so much of his (precious) reading time that he is exhausted by the time he gets to the Ecinya text and the underlying message. We beg to differ and believe the head-notes enhance the message, especially in context of our fulsome explanations. But there is "nothing more beneficial than an argument between persons of goodwill" and Compass remains a favoured and esteemed colleague. We do not seek his endorsement of our every remark, but thrive upon his perceptions and his oft well directed disagreements. Our text follows.
GDP BEING DRIVEN BY TOO MUCH ‘G‘
The thesis for this paper is that Gross Domestic Product (GDP) is being driven by too much "G"…… an excess of Government which is ‘crowding out’ the private sector. Small business resides in the middle class where most of the employment is created so that when you crowd out the private sector you crowd out the aspirational middle class. The result is simple – less velocity in the economy, less income growth, less economic growth, less employment growth.
The simple equation for GDP is
- GDP= C+I+G+Net Exports
GDP is the total market value of all final goods and services produced in a country in a given year, equal to total consumer (C), total investment (I) and government spending (G), plus the value of exports less the value of imports (Net Exports). GDP is adjusted for inflation using one of several inflation measures. In America it is the Implicit Price Deflator.
Over short periods the GDP numbers can be a bit rubbery, but in the longer-term they are reliable enough and when supported by other anecdotal and hard evidence, we can generally say the GDP is rising or falling at a specified rate. GDP growth is important because it is the source of company profits and company profits play a part in stock-market advances. Healthy growth in GDP usually means healthy profit growth, but if GDP is expected to fall then expectations take over and the forward estimates for profits and GDP influence share market outcomes. Perceptions of sustainable periods of economic growth lead to higher share prices. Such perceptions are called ‘confidence’.
Looking at world economic growth numbers from the IMF we see that world economic growth in the period 1992 to 2001 averaged 3.2%, and in the 8 years from 2002 averaged 3.6% but inclusive of a global recession of 0.6% in 2009. The peak years for growth over the last decade were 2006 and 2007 when GDP growth averaged 5.25%. In broad terms a 1% fall in GDP is akin to taking out of world growth about US$700 billion, about 75% of the entire Australian economy in purchasing power parity terms.
Another way of looking at it is, if the world economy grows at 3% per annum then it doubles about every 24 years, and at 4% per annum it doubles about every 18 years, a sizable difference.
Australia is a Federation of States and numbers are not available to us on a basis that consolidates the states and the Commonwealth, but numbers were given in a Ken Henry speech of 30 November 2009 that indicate that Government has become too large in Australia relative to the sum total of GDP. Because Government is funded by taxation, it is not being over-simplistic to state the following –
- more taxation = more government
- more government = less consumption
- less consumption = less production
- less production/ consumption = lower GDP growth
WHAT DOES THIS MEAN?
One of the great difficulties in the standard GDP formulation is that governments can increase their expenditures not only via increased taxation, but by increasing their debt. However, a couple of things result from this approach. Firstly, you have to pay interest on the debt and secondly at some future time you have to repay the debt. Ultimately, borrowings means that you have to have more income to repay debt and principal.
For government the only source of income is taxation as all of their other services generally lose money. Higher taxation causes big businesses to want to pay less tax or to reduce their costs of production. The easiest way for BIG companies to reduce their costs of production is to produce in lower cost countries. This means lower growth at home and over time can impact on the ability of a country to repay its debts in a timely manner. Then a debt downgrade results and a vicious circle begins. These processes take a long time to evolve and sometimes having evolved, take a long time to become a recognisable problem such as in Greece, Spain, Iceland, Italy, Portugal, Ireland, England, America etc.
A few weeks ago we had this to say in our Weekly Strategy Review –
The ‘approach’ from SAB Miller for Fosters could be a precursor to a number of foreign bids. Australia always has the ‘FOR SALE" sign up when we have bad governments. In today’s press (front page The Australian) David Murray ( ex boss of CBA Bank and now Chairman of The Future Fund) has aggregated federal and state debts to reveal that Australia’s government debts are growing at 7% compound per annum and will reach $550 billion by 2014. This will be the equivalent of about 42% of GDP. Murray’s view seems to be saying that we are on the Greek tragedy treadmill. Debt seems to be growing at about double a real rate of GDP growth of circa 3%, AND even that is built on a mining boom. Australia has a relatively narrow export base and an extremely broad import base.
Back in October 1985 Peter Drucker had this to say –
I think, there has been an irrevocable shift in the last ten years. No matter who is in government, he would no longer believe in big government and would preach cutting expenses and would end up doing nothing about it. This is because we, the American people, are at that interesting point where we are all in favor of cutting the deficit – at somebody’s else’s expense. It’s a very typical stage in alcoholism, you know, where you know you have to stop – tomorrow.
It is now apparent that Mr Drucker was an incorrigible optimist because the rhetoric that has come from the Blair, Obama, Rudd-Gillard-Greens governments is not anything about small government at all. The universal mantra is "Markets have failed. When markets fail, governments have to "step in". This is despite that fact that it was government inefficiency, poor policy formulations, and lack of oversight, that caused the markets to fail in the first place.
The failure of governments over the past two or three decades to follow simple economic rules is the structural and systemic problem that needs to be overcome. However, the hole is so deep that only a unified plan will shift the role of government back to the centre. Qianlong is speaking from the grave.
IN AUSTRALIA THIS IS NOT JUST A GILLARD-GREENS PROBLEM
The increase in the size of government relative to the size of the economy in Australia is not just a Gillard-Greens problem. It goes back to the dark days of Whitlam and Fraser which were over-turned by the very good years of Walsh-Hawke-Keating and then all but the last 3 years of the Howard-Costello era when Mr Howard decided to try to buy an election, such a tactic having worked in the previous election to a substantial degree.
In pre-election 2007 Messrs Swan and Rudd visited their economic tailor and donned clothes of conservative economic mien but when the GFC came along they overreacted in order to appear to be on top of a problem most unlikely to have a medium term impact on Australia. But we have written enough on this in past Insight articles.
Once upon a time welfare was confined to the ‘poor’, the ‘under-privileged’ , but successive governments in Australia have increased taxation via bracket creep, hidden taxes and new taxes to fund increases in business welfare subsidies and middle class welfare. The Goods and Services tax undid a lot of this very poor practice until the 2004 and 2007 elections and the economically illiterate response of the Swan-Rudd government to the ‘Global Financial Crisis’. The latest tax incarnations are the flood levy, mineral resources tax, proposed carbon tax.
LOOKING FOR SOLUTIONS
To find a solution you need to firstly define the problem, then test, re-test, and test again.
The world is in the post-crash period and not enough has been done quickly enough, or constructively enough, to provide a solid foundation for confidence going forward. Confidence is built not upon optimism, but knowing how you will handle the worst if it should come along. Economic vandalism is always wrapped in the cloth of ‘fairness’, ‘compassion’ and ‘reform’. When governments are pretending to be economic pragmatists they add the words ‘tough decisions’ to the ‘reform’ process. We find it rather ironic that financial planners, solicitors, doctors, lawyers, chartered accountants, engineers have to complete ethics courses when politicians do not. They just take an oath of office that they frequently break to stay in power and preserve their various direct and indirect entitlements, in too many cases, but certainly not all.
The Global Financial Crisis came about due entirely to –
- Structural failure
- Systemic failure
- Cyclical factors
A quick summary of all of three points immediately above is ‘Government Failure and Chaos’ at all levels….. parliamentary, cabinet, ministerial, institutional and regulatory. The Zurich axioms say "Chaos is not dangerous, until it begins to look orderly."
In terms of structural and systemic failure we can blame the United Nations, the IMF, various central bankers, the shortcomings of the Euro-zone, Fannie Mae, Freddie Mac, Wall Street, commercial banks, ratings agencies, and history itself. But most of all we can blame GOVERNMENT in all of the developed economies and some of the developing economies.
Cyclical factors result from the ultimate realisation that structures and systems evolve that create the reality of success, but when excess evolves from that success, it is only the commentariat that says ‘enough is enough’. In the long expansion from circa 2000 to 2007 critical commentators were ignored and then summarily dismissed as ‘out of touch’, ‘doomsayers’, ‘bears’, ‘hidden aganda-ists’, ‘hysterical’, ‘myopic’, or ‘merely mad’ etc etc. Now they are often many of those things. The commentariat is frequently prematurely dogmatic, but this is better than being emphatically correct with the benefit of hindsight despite conspicuous silence during the excess growth/ bubble phase.
In the words of Max Ehrmann’s "The Desiderata’….
"Listen to others, even the dull and ignorant, they too have their story. Avoid loud and aggressive persons, they are vexatious to the spirit. If you compare yourself with others you may become vain and bitter, for always there will be greater and lesser persons than yourself. Enjoy your achievements as well as your plans. Keep interested in your own career however humble, it is a real possession in in the changing fortunes of time. Exercise caution in your business affairs, for the world is full of trickery, But let this not blind you to what virtue there is, many persons strive for high ideals, and everywhere life is full of heroism" etc
Ecinya firmly believes that the world is in pretty good shape and that a full recovery is an inevitability. Our view of the timing of a ‘real’ recovery is presently elusive and at this moment in time social, political, and economic volatility abounds, and seems omnipresent.
AMERICA
America is important for two main reasons. Firstly, it is world’s largest economy and secondly the US dollar is the world’s reserve currency.
In a recent luncheon meeting with Compass our Ecinya editor mouthed the spontaneous phrase "When the US dollar begins to rise the world will begin to normalise." Compass liked this so much, being a student of currencies, and frequently quotes it. Somebody once said "If you don’t like flattery, it just means you have never been flattered."
After World War II the US began to outsource a large part of its manufacturing to Europe as part of the Marshall plan, and then it managed the economic rehabilitation of Japan which became a major (and cheap) exporter to the USA, then South Korea came into focus after the end of the Korean war, then Taiwan, and now China. America has lost a lot of its will and capacity to manufacture and foreign countries have filled the gap. In a couple of recent visits to America our editor could only find one significant Wal-Mart department that seemed to carry mainly goods made in the USA… it was the toy department.
America’s success at exiting WW II as the world’s largest debtor nation appears to have encouraged it to spend rather than save. These expenditures have principally been on welfare, health and defence. America has also fought a number of wars which have gone over time and over-budget – the Korean War, the Cold War, Vietnam, Iraq and now Afghanistan.
As of June 2011, according to The Economist, America has a domestic budget deficit of 9.1% of GDP, a current account deficit of 3.4% of GDP and an unemployment rate of 9.0% (probably higher if properly measured). Now, all number are manageable in a world of fiat money, but they have to be actually managed. They can’t be left to themselves. there is no automatic repair system! The US political system has hit a position of gridlock and so the trend in bad numbers becomes more important than the numbers themselves. American politicians appear to have governed improperly for several decades, doing deals rather than controlling incomes and expenditures in a pragmatic fashion in the national interest.
President Obama replaced an unpopular President in George Bush and inherited the poor economic trends in evidence in Mr Bush’s second term. However, when Mr Obama came to power his mandate was free public health and it was probably unaffordable at the time. Certainly it was time consuming and while Congress blustered the economy burned . It would have been better if he had focused on the economy. However, the cult or myth of ‘American exceptionalism’ was allowed to prevail and jobs and the economy have only just become a priority, but with over-arching rhetoric substituting for an announced and broadly agreeable plan of action. In Mr Obama’s White House words speak much louder than action. Instead the growing, and somewhat encouraged, chorus is that "It is all China’s fault".
No doubt, the structural and systemic problems that Mr Obama inherited were worse than he could have imagined and advisers who pointed this out appear to have been ignored, mainly Paul Volcker. It seems a long time since America had a successful economic manager at the helm . From conversations and readings it seems that Truman, Eisenhower, Nixon in his first term, and Clinton have been the pick of the post WW ll economic managers.
In the US February 2008 primaries which our editor watched in a ski resort because he was suffering a broken wrist (cost US$35,000, equivalent surgery in Australia circa $9,000, but thank god for travel insurance) the outstanding candidate on matters economic on the Democratic side appeared to be Hilary Clinton and Mitt Romney on the Republican side, but it was always clear that money and soaring rhetoric were going to carry the day for Mr Obama. The Republican nominee was a war hero, John McCain, and a very attractive running mate in Sarah Palin. There is a fridge magnet featuring Sarah Palin’s face that says "Thinking gives you wrinkles". And to boot Mitt Romney is a Mormon!
THE WEALTHY DO NOT MAKE AN ECONOMY HEALTHY
Putting definitions to one side and ignoring comparisons in, and between, countries the most economically healthy countries are where the middle class exists and is growing. The three phases of a normal life are –
- Preparation for a working life…. growing up, education, (say 20 years)
- A working life……..skills development, building a small business or earnest vocation, creating a happy family etc (say 45 years)
- Exiting a working life i.e retirement (say 20 years)
It is now clear to most of us that the State cannot provide the means whereby Stage 3 will be at a level consistent with the level of comfort and enjoyment you experienced in Stage 2, where relative youth enabled you to work hard and play hard, with holidays and leisure part of your primary pleasures. America has all but destroyed the middle class, and in many places Europe (except for the cash economy) is not far behind. With big business getting excessive subsidies and the poor getting excessive relief the burden of 20th century progress has been borne by the middle class. Show Ecinya a strong middle class, and an aspirational middle class, and it will reveal a healthy economy.
SO WHAT ARE SOME OF THE LESSONS FROM ALL OF THIS?
On the systemic side America needs a White House administration with an interest in business and economics which means the election of a President who can tell the difference between dud advice and good advice and the difference between good personnel and mediocre personnel. Most times people agree with the President because he is akin to the Pope. Papal infallibility and Presidential infallibility are close cultural, historical and psychological relatives.
Wall Street has to be brought to heel and get back to its original function of recognising and financing sound business ventures. This means less emphasis on derivatives and speculation generally. Probably a few people need to go to jail for past misdemeanours. American institutions have to be looked at from Freddie and Fannie and all the way to the Federal Reserve.
Structurally the US tax system is a shambles and this needs to change. Warren Buffett has long been an advocate of this.
America probably need to find a way to fight less wars or when it fights, win a just result with significant consensus, more quickly.
If Ecinya had to make just one big US adjustment it would be the banning of political donations and express limits would be placed on the cost and financing of elections. Refer an Ecinya paper on this subject, clik here.
EUROPE
Europe is a mess; get rid of the euro and its spawned organisations, and go back to nation states with their own sovereignty and currencies. Write off portions of the country debts in exchange for meeting austerity and recovery targets. Replace most of the left wing governments; suggest to the Greeks and the Irish that repairing damage from street riots is a misallocation of resources and costs jobs and mitigate recovery efforts.
CYCLICAL FACTORS
The main thing about a cycle that ends is to not create the conditions for the next bad cycle and to not make the recovery worse than it already was, and is. Certainly in Australia our mistakes have been significantly bad, and getting worse.
The recovery from this cyclical phase would be best handled in America by an informal committee that included the likes of Paul Volcker, Paul O’Neill, Stephen Roach, George Soros, David Rosenberg, Warren Buffett, Peter Schiff, and Bill Gross. Their European counterparts are not known to us as we have come to believe that if Asia is right and America is right and we have balanced government then Australia is OK.
JUST TO CONCLUDE WITH A FURTHER WORD FROM WINSTON CHURCHILL
"It is a good thing for an uneducated man to read books of quotations…. The quotations when engraved upon the memory, give you good thoughts. They also make you anxious to read the authors and to look for more."
AND A FINAL OBSERVATION
Politicians in many developed economies might be well advised to look at their own track record and inadequacies rather than to attempt to shift blame to Rupert Murdoch and/ or NewsCorporation or the media generally. Such diversionary tactics are inappropriate and on balance the Fourth Estate has served the cause of human freedoms and progress, in every sense, well. There is little doubt that hubris in the cavernous bowels of The News of the World have created a problem of significant and historic, and hysterical, proportions.