Ecinya

CONCLUSIONS

Optimal outcomes demand that that ‘somewhere’ is at, or close to, where you want to go. Success hardly ever requires absolute precision and 95% of the time near enough is good enough. But keep in mind Peter Ustinov’s statement – ‘I love the guy who aims low and misses’.

• Europe can’t YET go forward.
• China can’t go back.
• America needs to work out where it wants to go.
• Australia needs a federal election as soon as possible.

 

ALL ROADS LEAD TO SOMEWHERE

From Lewis Caroll’s "Alice in Wonderland" –

• If you don’t know where you are going, any road will get you there. (think about America and Europe)
• Alice came to a fork in the road. ‘Which road do I take?’ she asked. ‘Where do you want to go?’ responded the Cheshire cat. ‘I don’t know.’ Alice answered. ‘Then,’ said the cat, ‘It doesn’t matter.’ (think about America, China and Europe)
• ‘I can’t go back to yesterday because I was a different person then.’ (think about China)

………….the timing of eventual outcomes is somewhat uncertain. Be careful to avoid undue pessimism, as explained succinctly in the movie "The Best Exotic Marigold Hotel" –

• ‘It will all work out in the end, and if it doesn’t…..then the end hasn’t been reached’. (the enduring view of the rational optimist requiring a significant belief in the power of fiat money and human psychology knowing that things will change because they have to, but forever alert to the possibility that it may get worse before it gets better)

 

GOVERNMENTS and ECONOMICS

In general terms Centre-Left governments around the developed world have taken the government share of GDP from circa 20% to around 30%, and the private sector and workers have been marginalised, especially small business and the middle class. Many governments claim statistics to deny this, but their statistics are generally self-serving and somewhat shonky. This mainly arises out of the fact that government budgets are cash flow statements, states are not consolidated to give a national picture, and off-budget ventures are ignored (national broadband is an example). Additionally, governments do not have sovereign debt levels front and centre probably because it will one day be a problem for another elected government. Government inhabits a world of careless accounting. Prosperity often persuades parliamentary rulers that all problems are solvable if you have a surplus available. Often opportunities are squandered as the social canvas is too broad and fragmented, and ultimately unmanageable. Good government often requires the ability and judgement not to act or intervene.

Paul Krugman said:

• ‘To talk about economics requires more and more, that one write about politics’.

After our editor’s China study tour of 2005 he wrote:

• ‘As our Ecinya editor walked back down the steps of The Hall of Central Harmony in The Forbidden City, he noticed an immaculately dressed and handsome African American reading the information board that he himself had read some minutes before. Editor addressed the man and said: "Do you think George Bush would understand that ?" He replied in a wonderfully resonant voice – "No way man. That boy wouldn’t even come close." We both chuckled and moved on to the next palace. The board read ‘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.’ (This was a proclamation of Emperor Qianlong of the Qing Dynasty made in 1645)

There was NO global financial crisis, just a European and American financial crisis. The only response needed from an Australian perspective was to guarantee bank debts to preserve liquidity and ensure solvency. Instead Messrs Rudd, Swan, Gillard and Tanner set in motion plans that destroyed the budget surplus and these actions have led to growing public debt loads at both state and federal levels. Mr Tanner, we believe, can be exonerated from this folly and probably Ken Henry as well. However, just when we might need a surplus to insulate ourselves from the unfolding stage 2 of the European/ USA financial crisis there are no biscuits left in the tin.

At schoolboy level we are told that economics is the contest between scarce resources and unlimited wants and needs. The Austrian Von Mises school teaches that disequilibrium, imbalances, chaos etc comes from the misallocation of resources. Governments, business and householders have to operate in the context of setting priorities, not always in a formal sense, but essentially functioning within the limits of their resources and their abilities and the natural resources accidently bestowed upon them by history and fate.

THERE IS TOO MUCH GOVERNMENT IN THE DEVELOPED WORLD AND A LOT OF IT IS ILL-DIRECTED AND UNBALANCED

Barbara Tuchman in "The March of Folly: from Troy to Vietnam" (1984) said:

• ‘Social systems can survive a good deal of folly when circumstances are historically favorable, or when bungling is cushioned by large resources or absorbed by sheer size as in the United States during its period of expansion. Today, when there are no more cushions, folly is less affordable.’

 

EUROPE

It is close to a certainty that Europe will record negative growth for the 2012 calendar year, and be in and out of recession for most of the year. Westpac Economics are forecasting GDP growth of negative 1% for 2012 and an anaemic recovery of +0.3% for 2013. These numbers compare with 3.0% in 2007 and 1.7% over 2010 and 2011. The major bright spot that we see is that Ms Legarde has replaced Mr Strauss-Kahn as head of the IMF and David Cameron has replaced the economic illiterates Tony Blair and Gordon Brown. Italy is under new political management along with Great Britain and recovery shoots are emerging. These are all welcome developments.

Greece still has major difficulties, Spain looks to be the next catastrophe, Ireland is probably OK, and Portugal is probably not OK. The common currency seems to be an impediment to recovery except that it tends to benefit Germany, an efficient and hard-working populace producing desired products. The years of social engineering throughout Europe has led to unsustainable sovereign debt loads and domestic deficits. Unemployment is at dangerous levels across Europe. Currency and cultural impediments seem to be a cocktail of difficulties, and gab-fests, summits, and high-level meetings cannot replace action on the ground and the development of attitudes that facilitate progress and economic well-being. A lot of the populace seem to think that street riots will force change, but that does not make common or economic sense. Resources are too scarce to replace facilities that should not have been looted or burned in the first place.

 

CHINA

China has enjoyed robust growth since the early 1980’s and has been the stand-out economy over the past two decades in particular. However, when you take into account the size of the population at circa 1.3 billion people it is clear that growth needs to continue at an elevated pace. Chinese statistics are impressive, but not so outstanding when reduced to per capita terms. A China slowdown is feared by many commentators inclusive of the following –

• Government instability currently reflected in the unfolding drama between Bo Xilia and his factional supporters and Wen Jiabao and his factional supporters.
• Export growth slippage as the global economic slowdown takes hold.
• Demand for loans has slowed significantly and credit growth has driven economic growth.
• Concerns about a property bubble.
• The divergence between the less bullish HSBC Purchasing Managers’ Index and the more bullish Official PMI. We are inclined to believe the former.
• The peak in the stockmarket in July 2009 and the subsequent volatility and general downward trend since.

On 15 March 2007 Premier Wen Jiabao described the Chines economy as "unstable, unbalanced, uncoordinated, and unsustainable".

In our editor’s 2005 tour a senior Chinese business figure said:

• ‘George, you must understand that in China we have no small problems, only big ones’. Our editor then asked: ‘What is the biggest problem?’ He replied…. ‘corruption’.

Fissures, fractures, and cracks only appear when the dam wall of economic growth is exposed to pressures. The global economy is currently providing that pressure. For how long? Our current view is not as long as some are predicting. The end has not yet been reached in China’s long economic march.

What is certain is that China cannot go back to its Maoist past. That will not work for China itself, nor for the rest of the world.

One of the notable features of China is the ENERGY and aspirational ENTHUSIASMS of the under 30’s demographic. The emerging middle class in China are setting the economic and social agenda and will provide the necessary momentum to lift living standards and achieve sustainable economic outcomes.

 

THE UNITED STATES OF AMERICA

Colin Powell’s life lessons are often apt. Lesson number 3 of 18 says –

• ‘Don’t be buffaloed by experts and elites. Experts often possess more data than judgement. Elites become so inbred that they produce haemophiliacs who bleed to death as soon as they are nicked by the real world."

Ecinya had hoped that President Obama would not be captured by the Democratic elite just as President George W Bush was captive to the Republican elite. The elites are a combination of ‘the base’, ‘party faithfuls’, doyens of longevity and doubtful abilities, headquarter’s personnel operating as sporting coaches dedicated to winning government, but not always dedicated to good governing. On 13 January 2006 Ecinya said:

• ‘In America common-sense conservatism has been replaced by a religious dogma that god somehow is more disposed towards American goodness and superiority than most other nation states. The creators of hope, freedom, and progress for such a long time, appear to be prisoners of their own worship of American capitalism rather than balanced free enterprise. They prefer to promote fear over hope; war over peace; manufactured myth over debated fact; spin over substance; force over persuasion; the might of the law over the rule of law; the replacement of politicians of good sense, judgement and integrity by charlatans and fools. In short the ends, as defined by an elitist minority of church and state, justifies the means – winning is not the most important thing, it is the only thing. But a world without a good America is a deprived and deficient, and less efficient, world. The next president of the United States is a most important, perhaps, even a critical appointment. A man with an iron fist, a velvet glove, and the communication skills to blend wisdom and attitude. Ecinya cannot see it happening easily without major electoral reform, but America does not yet appear to have a pervasive belief that the system is broken.’

On 4 September 2008 SOT, an Ecinya confidant, in a typically earnest market-related conversation said –

• I have observed nothing with Mr Obama that would yet convince me that he is any better than Mr Rudd; an ability to articulate a problem, but without the experience, attitudinal balance, or resolve, to solve it.

Mr Obama has been a significant disappointment, pretty much for the reasons enunciated by SOT.

When having the job is more important than doing the job, then it’s time to go. Confidence is an essential ingedient in progress and Mr Obama has either ignored or misunderstood the fact that small business and the aspirational middle class set the economic agenda.

America needs to do a lot of work. They need less of a Messiah and more of a Manager. Mr Romney needs a running mate of substance to complement his apparent managerial skills honed in business, managing the Salt lake Olympics and as a state governor. Paul Ryan seems to be a qualified candidate at this point in time with some expertise in relation to America’s massive public debts and budget deficit.

 

AUSTRALIA NEEDS A FEDERAL ELECTION ASAP

First a disclaimer: Ecinya consists of 2 personnel and about 12 confidants who provide valuable inputs and considerable argument. We suspect that one of the Ecinya gang of 14 is a member of the Liberal Party. We are interested in good government from all parliamentarians, and good governance at the corporate level. In relation to both of these matters there is profound disequilibrium as quantity has replaced quality. We are hopeful that green and red tape will soon start to reduce.

Bad policy well implemented leads to bad outcomes. Bad policy badly implemented leads to even worse outcomes. The Rudd-Gillard-Greens government has been an unfortunate disaster and getting exponentially worse. Though there are considerable deficiencies in the Liberal front bench they can be remedied if the Liberals win the next election. If Mr Turnbull can keep his leadership aspirational baton in his knapsack and become a team player then he should assume the Treasury portfolio after the election. In terms of risk management it would be a good idea if he were to assume it now, subject to the aforementioned caveats, as Mr Hockey is needed and well suited to the industrial relations portfolio which is a monumental policy mess as we appear to have even abandoned the Hawke-Keating reforms.

The Australian economy is failing at many levels…. growth, debt, interest rates, consumer confidence, leading indicators, medium and long term planning, tax policy and social policy, border protection, foreign policy, industrial relations, institutionalised corruption…. you take your pick and add your own dilemmas.

On 8 August 2008 Ecinya said –

• ‘Prime Minister Rudd is behaving badly. He needs to take a leaf out of the first two terms of the Hawke-Keating-Walsh government and realise that outcomes are more important than rhetoric and symbols. The Prime Ministership is not a presidential-celebrity role, it is a function, a job, a real job. At a time of diminishing world growth and failing confidence the PM needs to focus on the fact that prosperity within a balanced free enterprise system carries us all to realisation of our material and social aspirations. The PM is coming closer each day to damaging our national psyche and cohesion.’

Ms Gillard seems to have accelerated the economic failings of her predecessor.

When having the job is more important than doing the job, then it’s time to go. Confidence is an essential ingedient in progress and Ms Gillard has either ignored or misunderstood the fact that small business and the aspirational middle class set the economic agenda.

Just recently Mr Swan and Ms Gillard have started to link fiscal policy and responsibility to interest rates. This is a profound recognition and admission because in days gone by Mr Swan denied such a link. Mr Swan is Australia’s second worst Treasurer in the post-war period in our estimation and opinion. Ms Gillard is, in our opinions, the worst post war Prime Minister we have had even surpassing the regressively negative years under Mr Whitlam and Mr Fraser.

 

 

 

‘Uncomfortable’: Feeling or causing discomfort or unease; disquieting.

‘Paranoid’: Delusion of persecution; intense fear or suspicion especially when unfounded.

Collins dictionary.

FOMO: Fear of missing out.

A well-known stock market-acronym.

FOSI: Fear of staying in.

A less well-known stock-market acronym

 

PREAMBLE

At Ecinya we are currently concerned about many things at home and abroad. We are well aware that Roosevelt in 1933 said "We have nothing to fear except fear itself’, but 7 years later the world was at war and America joined in about 2 years after that at great cost in terms of men and machinery. Additionally, the statement was made towards the end of the great depression when things probably couldn’t get any worse than they already were.

Hence context is important in looking at any problem or opportunity including economies and markets. We do not like the current context. Also our methodologies, founded in the natural optimism that comes from being interested in stock-markets at all, are signalling the type of caution that comes before a market retracement, or significant fall.

Generally, as endemic optimists, we are bullish when the market is subdued and we can see signs of emerging strength or reduced weakness in the economy. We are bearish when markets are elevated and we can see signs of emerging weakness or strength not supported by underlying economic evidence. This might be formal evidence from sources like Westpac Economics, observable things like mortgagee sales, vacant shops, staff lay-offs etc.

Our 2 March 2012 Snapshot said: Danger is lurking. Central bankers as the monetary authority cannot easily overcome the cascading effects of bad fiscal policies pursued by inept and short-sighted governments fixated on political survival. There are two economies, the real economy of production of goods and services and the symbol economy of money and credit. Bernanke has led the charge to stifle the former and is creating a monster in the latter. Be extra careful!

This remains our position. We suggest that this market not be chased.

John P Hussman of Hussman Funds expressed a similar view in far more eloquent terms on 5 March 2012 in his Weekly Market Comment –

Last week, the estimated return/risk profile of the S&P 500 fell to the worst 2.5% of all observations in history on our measures. This is not a runaway bull market. Rather, it is a market that again stands near the highs of an extended but volatile trading range. I am convinced that the breakdown of the market from this range has been deferred only through repeated and extraordinary central bank actions.

 

LOCALISED CONCERNS

• Our market quant model and technical analysis generally
• Corporate earnings as reflected in our valuation models
• The opinions of respected Ecinya confidants or sources of long standing
• The Australian economic debate
• The $A dollar
• Politics
• Tax and the tax system
• The coming May budget presentation
• The mining tax
• The carbon tax
• Emissions trading schemes
• The proposed media council
• Property prices
• The small business sector
• The NBN
• The East coast floods

 

EXTERNAL FACTORS

• US GDP for the first two quarters of 2012
• US employment statistics
• The Greek resolution
• Other members of the PIIGS
• US interest rates
• The US election process
• Global growth generally
• Chairman Bernanke
• The Middle East

 

PREAMBLE HEAD-NOTE QUOTE

 

You can’t handle the truth! Son, we live in a world that has walls, and those walls have to be guarded by men with guns. Who’s gonna do it? You? You, Lt. Weinburg? I have a greater responsibility than you could possibly fathom. You weep for Santiago, and you curse the marines. You have that luxury. You have the luxury of not knowing what I know. That Santiago’s death, while tragic, probably saved lives. And my existence, while grotesque and incomprehensible to you, saves lives. You don’t want the truth because deep down in places you don’t talk about at parties, you want me on that wall, you need me on that wall. We use words like honor, code, loyalty. We use these words as the backbone of a life spent defending something. You use them as a punchline. I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very freedom that I provide, and then questions the manner in which I provide it. I would rather you just said thank you, and went on your way, Otherwise, I suggest you pick up a weapon, and stand a post. Either way, I don’t give a damn what you think you are entitled to.

Jack Nicholson as Colonel Jessep in "A FEW Good MEN".

We are sceptical of our political masters and most of the world’s central bankers working on the basis of what we do not know cannot hurt us. Truth and perspective seems to be in short supply. The Greek solution looks more like a gaggle of lawyers and economists at work without much in the way of business smarts. It looks a bit worse than TARP.

 

DISCUSSION OF OUR LOCAL CONCERNS

Quant & Technical

From our quant model we ascertain that the current upwave is now 76 days old. The XAO is up about 8% and the SP500 is up 20%. The upwave started on 28 November, 2011. We believe the S&P is technically over-bought. Should it retreat, our market will follow. Since 13 March 2003 our reference market indices have been up 1091 days, in transition with an upward bias for 433 days, in downwave 249 days, and in transition with a downside bias 369 days. Simply stated the markets have been up 71% of the time and down 29% of the time. Tactically we have been prepared to ‘go with the flow, without conviction’. As the market rises we have been happy to sell, ‘going against the flow with conviction’. (refer Strategy pages for explanation)

Corporate Earnings as reflected in our Valuation Models

Earnings are generally being downgraded by analysts and companies. In our last Portfolio Recommendations we had only 18% of our stocks on buy/ accumulate, 71% on hold and 9% on spec buy. What this means is that we could not see many entry points that gave us an 10% upside over the next year, excluding dividends.

The opinions of respected Ecinya confidants or sources of long-standing

Most of our confidants are sitting on about 30-50% cash. Over our 3 published portfolios we are about 30% cash. Many of the blogs we have accessed for years are turning bearish based on economic fundamentals and technical readings.

The Australian economic debate

The local economic debate is at a low ebb. The commentariat is either too sanguine or too bullish in our view, or simply misguided. Today the front page headlines are "Greens put business tax cuts at risk" (The Australian), "Big business $2bn business tax cut faces defeat" (AFR), "Coalition blocks tax cuts for big business" (SMH). Our observations are that taxes are going up – flood levy, private health rebate, local taxes and charges, the mining tax, mining royalties, carbon tax.

Ross Gittins in the SMH today says: "The only path that’s politically feasible and economically responsible is for us to pay higher taxes". Given that ALL taxes find their way into prices and/ or lower employment or higher inflation and interest rates, and often larger (intractable or structural) deficits, why are higher taxes good for us? We also believe that Wayne Swan is an awful Treasurer despite his European award and that Joseph Hockey is most likely only marginally better. We find it difficult how a grandiose paid parental scheme under Mr Abbott and an aspirational dental scheme under any government makes good common or economic sense.

We see tax revenues decreasing in the forward estimates and the Treasurer having moved this year’s costs forward to manipulate his way to the promised surplus next year. In aggregate we have had nothing but deficits under Labor. These deficits have led to increased levels of public debt at both state and federal level. Debt levels relative to GDP are not a current problem, but the trajectory is. The economic buffers we had under the best years of Hawke-Keating-Walsh and Howard-Costello no longer exist.

The $A dollar

We have a large and narrow export base and a deep and broad import base. Overall a high $A dollar is not good for the economy.

POLITICS

The debacle of the recent Labor Party fracas about the leadership and the confirmation of Ms Gillard as Prime Minister was extraordinary and still represents unfinished business. The lack of a parliamentary majority is leading to poor policy development, rhetoric that saps consumer and business confidence, and poor policy implementation. Mr Swan is now at the epicentre of a political debate talking about misguided concepts such as ‘fairness’ which has no sound basis in economics, inflammatory rhetoric about former Prime Minister Rudd, and villainous billionaires destroying Australian democracy. Dumb policies and politics seem to be in a happy nexus with dumb economics.

Tax and the Tax System

The Henry Report comprised about 1500 pages and weighed circa 5 kilograms and its recommendations have been substantially ignored. We still have well over 100 silly taxes. And the Henry mandate excluded consideration of the GST!? Capital gains taxes are paperwork intensive, reduce asset turnovers especially in relation to rental properties.

The coming May budget presentation

The May budget presentation will be so large, as it always is, to make comprehension difficult and ‘smoke and mirrors’ will be in abundance.

The Mining Tax

The mining tax is poorly constructed and appears to assume robust mineral prices forever. It ignore ROI calculations, economic flow-through, economic cycles, and competition possibilities from other mineral-rich areas. With a bit of bad luck we might find ourselves in a no-speed economy.

The Carbon Tax

The carbon tax appears to us to have little to do with greenhouse gases and a lot to do with taxation. We cannot see the benefit of Australia going ahead and being ahead of the rest of the world. Greenhouse gases are an absolute problem, not a per capita problem. Real or false morality is OK when you can afford it.

Emissions Trading Schemes

Creating ETS securities when we have trouble controlling and policing financial securities seems to us to have manifest problems. Emitters are well known to authorities and technical solutions should exist to reduce their greenhouse gas outputs. A securities industry involvement is unlikely to help, adding complexity and bureaucracy. Imagine letting the scallywags of Wall Street loose on carbon trading.

The proposed Media Council

The proposals from the Finkelstein inquiry would appear to make no sense at all. Media is not perfect and legislation will not make it so. But freedom of the press is the last bastion of economic and democratic freedoms.

Property prices

Property prices may be improving or bottoming but there is a considerable way to go. We are still hearing about and seeing enough mortgagee sales to know that the bottom is not in yet.

The Small Business sector

The small business sector does not need tax breaks so much as an increase in their incomes and a reduction in their expenses. Interesting that small business becomes a rhetorical focus around election time. A lot of people went into home insulation and solar only to have subsidies removed pre-emptively. Wrongful dismissal laws are a major problem for small business.

The NBN

Would someone tell us how much, when, why and how. Our guess is it is now over time and over budget. Large-scale government projects are rarely successful.

The East Coast floods

Little has been done on water mitigation and no quick monetary response system appears to exist . The floods will subtract from 2012 growth.

 

EXTERNAL FACTORS

US GDP

US economic forecasts from the WSJ Economics February Panel for Quarter 1 reveal a wide disparity of views, but in the pessimistic camp 16 out of 49 economists have an average GDP number of 1.7% (stall speed) compared with the overall consensus of 2.3% (lacklustre speed) which itself is distorted by 12 economists with an average forecast of 3.1%. The latest durable goods figure interrupted the plethora of less bad economic news being defined as ‘good’ news. Additionally, the ECRI (Economic Cycle Research Institute) came out with some bad outlook data deliberations. Watching Uncle Ben Bernanke carrying the US economy on his narrow fed shoulders is close to appalling as Congress remains gridlocked and seemingly oblivious to deep-seated cyclical challenges and structural problems.

US employment statistics

The official unemployment rate has fallen from 8.5 to 8.3% recently. In November 2007 it was 4.7%. There does not seem to be a lot to cheer about here. Commentators suggest that from the government’s own data base about 9 million people without jobs have been removed from the labour force simply by the government defining them as not being in the labour force anymore. This process has the benign title of ‘the participation rate’. Many people have the real rate of US unemployment around 17%. It seems that employment is not a sign of recovery of itself without also looking at productivity numbers.

The Greek Solution

Greece has borrowed many billions of Euros which it cannot repay so we lend them more money which they also cannot repay, but we give them an extension of time in which to not repay it. Somewhere along the line about $27 billion of credit default swap gains are to be made by some people and about $30 billion of default swap losses will occur for a ‘benign’ net loss of $3 billion. An Austrian bank also goes under along the way.

Other members of the PIIGS

The handouts to Greece, which is less than 3% of the European economy, would seem to lend credence to the concept of moral hazard. If Greece can have a good deal after hard bargaining why not Italy, Portugal, Ireland and Spain.

US Interest Rates

US interest rates are abnormally low and the Fed wants to keep them low until 2014. This would appear to penalise savers, drive dollars offshore, and at the end of the day is unsustainable. Chaos is not dangerous until it begins to look orderly.

Global Growth generally

Europe in recession for 2012, Brazil slowing, China consolidating, America slowing and some calling recession.

The US Election process

Mr Santorum seems to be the religious candidate. We regard overt religion and politics as a bad mix. Mr Romney seems to be more of a manager than a messiah. We often worry that America too often seems ungovernable with cronyism out of control. Mr Gingrich we have long followed and regard him as a ‘5 star nutter’. The American system seems sometimes as reckless as it is robust exposing many fears, fissures and failures.

Chairman Bernanke

Mr Greenspan gave us two bubbles – dot-com and sub prime- and a plethora of soothing words along the way. He was trusted, but in the end was nothing more than a too-clever-by-half politician. Is Mr Bernanke cut from the same cloth? Reading his convoluted FOMC statement there are many jarring words – para 1 "suggests","moderately", "depressed", "prices of crude oil and gasoline". Para 2 "moderate", "gradually", "strains", "significant downside risks". Para 3 "highly accommodative", "subdued" Para 4: "rolling over", "reinvesting". Para 5 Jeffrey Lacker disagrees (why?). We don’t see it as an inspiring treatise sufficient to drive the US or global economies towards a sustainable recovery.

Information received since the Federal Open Market Committee met in January suggests that the economy has been expanding moderately. Labor market conditions have improved further; the unemployment rate has declined notably in recent months but remains elevated. Household spending and business fixed investment have continued to advance. The housing sector remains depressed. Inflation has been subdued in recent months, although prices of crude oil and gasoline have increased lately. Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects moderate economic growth over coming quarters and consequently anticipates that the unemployment rate will decline gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook. The recent increase in oil and gasoline prices will push up inflation temporarily, but the Committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Sarah Bloom Raskin; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen. Voting against the action was Jeffrey M. Lacker, who does not anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate through late 2014.

US Federal Open Market Committee 13 March 2012

 

The Middle East

Iran, Syria, Afghanistan, Israel, Palestine…. all hot spots consuming vast amounts of men and materials and creating large numbers of refugees fleeing to other countries. Any attack on Iran cannot be priced into markets.

 

 

 

 

 

 

SOMETHING NEW (a short essay from a long copy devotee)

In the markets and in the world of macro economics everything is related to everything else. Each part of the jig-saw puzzle to assist in foretelling the future in even a hazy way, is incremental, and scattered pieces of data and interpretations when presented together can add perspective to deeper and broader articles floating about in our world of information over-load.

UNCLE BEN BERNANKE

Ben Bernanke, current Chairman of the US Federal Reserve and successor to the very unsuccesful Alan ‘Bubbles’ Greenspan has expressed the view that the Fed should be more transparent. Mr Greenspan only became lucidly transparent after his retirement when he said that some of his economic premises were wrong. In relation to transparency generally, though, some have said that just like the British sausage the less you know about its ingredients, the better it will taste and the safer you will feel.

Uncle Ben has the dual mandate of stable prices (low inflation) and full employment. With the official employment number hovering just under 9% it is reasonable to expect that inflation will be subdued as less jobs gives less income and lower demand. In the US economy, indeed the world economy, there is excess capacity and an abundance of goods and services and inflation is not a dominant worry for a central banker. But growth is, and bank lending is, and bank liquidity is, and bank solvency is. The world is deleveraging and the middle classes of the world have run out of ammo to fuel demand as they engage in paying down debt.

So in this new mood of transparency Uncle Ben has said that the Federal Open Markets Committee has decided that short-term interest rates will be kept at a near-zero level for another 3 years to promote economic growth and reduce unemployment. Presumably interest rates will only rise during that time if he is succesful and the economy rebounds in a meaningful, sustainable fashion. Uncle Ben has also said that the Fed may also re-start a bond-buying program if the economy remains sluggish. In passing and in context of his 3 year view on interest rates he also said "It’s certainly possible we will be either too optimistic or too pessimistic".

There has been huge condemnation of this Fed development. Comstock Partners said: "In our view the Fed’s new policy is an act of desperation rather than something to celebrate. The FOMC has used all of its conventional weapons and a lot of unconventional ones and is essentially out of ammunition. The banking system is swimming in excess reserves that it is not using—-adding more won’t make much of a difference. This is a classic liquidity trap where further easing will not be much help. The stock market strength assumes that the economy is getting stronger and that company earnings will remain at elevated levels. We think that this will not be the case, and that the market is subject to substantial downside risk."

Doug Noland author of the blog ‘The Credit Bubble Bulletin says; "It has been labeled an intellectual exercise and ridiculed as "intelligentsia." I’ll stick defiantly to the view that it remains one of the most important issues of our time: Are the Treasury and government-related debt markets part of a historic Credit Bubble and global financial mania? There are reasons why Jean-Claude Trichet over the years repeatedly stated "the ECB would never pre-commit" on interest-rate policy. The Federal Reserve this week moved further to the opposite polar extreme, essentially pre-committing to near-zero rates through late-2014. The ECB has historically believed that market speculation based upon future policy expectations works to foment market excesses, imbalances and attendant fragilities. In contrast, the activist Federal Reserve believes that it has a fundamental obligation to intervene and manipulate to achieve market outcomes the committee believes will spur growth. Unprecedented operations back in late-2008 took the Fed’s balance sheet from about $900bn to $2.2 TN. We were assured that the Fed had an "exit strategy." I’ve always presumed "no exit," and here we are today with Fed holdings at $2.9 TN. The economy is expanding, financial markets are strong and consumer price inflation is rather undeflationary – yet Dr. Bernanke is again signaling he is prepared for additional monetization."

The bottom line for us is: Exercise caution, don’t over-commit to equity markets, be careful, be selective, be prepared to jump on and off the equity express on frequent occasions. There are a lot of false prophets about and until the European banks write-off their bad debts, an abundance of false profits. Many of the false prophets seem to have just left Davos.

 

DAVOS

The great minds that assemble each year at Davos to discuss world affairs and who seemingly were unaware of Long-term Capital Management ( a speculative, model-based hedge fund rescued by the Fed in 1998), the tech-telco bubble/ crash, The Global Financial Crisis (Lehman Bros etc and the ‘too big to fail gang’), sovereign debt fiascos (from Iceland to Italy to Greece, Spain and Portugal), the current European Banking problems, the recent Corzine MFS debacle, have just concluded their 42nd meeting.

Judith Sloan who writes for The Wall Street Journal and The Australian, and who attended the conference said today " I can’t wait to get home, to a place where there are more rational and sensible thinkers per head of population than I ever realised." Ms Sloan’s home is Australia.

Last week in an op-ed piece in The Australian she said: "The meeting (on global warming) literally drips of political correctness. Much of the language is impenetrable, it is English by the way. According to the blurb for the meeting ‘the net result will be transformational changes in social values, resource needs and technological advances as never before. The necessary conceptual models do not exist to develop a systemic understanding of the great transformations taking place now and in the future’. "

The bottom line for us is: Beware of geeks bearing gifts, those who gave us the current chaos are struggling to understand the questions and almost certainly are incapable of generating the solutions.

 

FOURTH QUARTER US GDP

Fourth Quarter US GDP came in at 2.8% which on the surface looks to be a good result when compared with Q3 at 1.8%. BUT the CPI deflator came in at 0.4% (the lower the number the higher is real GDP) when other CPI numbers were as high as 3%. However, the real sting in the tail was the fact that 1.9% of the GDP number related to a rebuild of inventories which now are an over-hang for Q1 of 2012. Given that 15 out of 54 economists from The Wall Street Journal Economics Panel (28%) are forecasting Q1 2012 GDP under 2% it seems apparent (as Uncle Ben seems to be saying) that the US economy is still subdued, sluggish, less than robust, sombre, less than sunny, or whatever soft language you might like to use.

The bottom line for us is: Expect a market correction soon and volatility to continue amidst arguable and ambiguous macro statistics and political pronouncements.

 

 

OUR FORECASTS FOR 2012

Our reference indices are the SP500 (SPX), our global proxy, and the All Ordinaries index (XAO).

Our 2011 forecasts were about 95% accurate for the SP500. and about 80% accurate for the XAO, the former being regarded as satisfactory and the latter as unsatisfactory.

We regard index forecasting as essential but relatively useless for investment performance in modern markets which have vacillated over recent years between dynamic and chaotic. Eisenhower said: "In preparing for battle I have found that plans are useless, but planning is indispensable."

Ecinya prefers to work around fundamentals related to maintainable earnings yield, company and economic themes, market context and market action itself, both in a technical and quantitative sense. We have a small number of confidants and colleagues of independent and constructive mien.

OUR 2012 FORECAST IS: The SP500 will have a range of 1120 to 1350 finishing the year close to, or above, 1350. The first half will be volatile to the downside and the second half volatile to the upside.

The XAO will have a range of 4000 to 4950, closing the year close to the high end of that range. The first half will be volatile to the downside and the second half volatile to the upside.

Our major Black Swan event, which is not priced into these forecasts, is war against Iran from the US and Israel, and possibly and preferably (should it happen) joined by other Arab countries.

 

BULLISH CASE vs BEARISH CASE

The bearish case is that Europe is already in recession and about to enter a significant recession as the banking system is at a point of cataclysmic failure. The European recession will flow on to America and then to China where excesses in their banking and property markets will surface. Then global recession impacts on Australia with falling commodity prices turning our two speed economy into a no-speed economy. This case has zero belief in fiat money and apparently believes that debt levels are incapable of cyclical solution.

The bullish case is that paper money works, and targeted reflation and targeted austerity works. The nascent American recovery gathers pace and America re-invents itself and becomes again a beacon for the world. China has a soft landing. Europe muddles through and addresses some of its structural problems in work and welfare. A sound bail-out institution works in the short term. Even in a softening of world growth scenario our Reserve Bank has room to move.

The bearish case involves a substantial suspension of history in relation to economic, market and political cycles.

 

WHERE DOES ECINYA RESIDE IN THIS DEBATE?

We are in the bullish camp but hoping that our natural optimism does not blind us to any negatively evolving outcomes. We want to stay watchful and alert. Our major fears are Iran, the current Australian Federal government and the faint possibility that America is ungovernable. We believe in cycles and waves and the bearish cycle we consider will be near to ending during the second quarter of calendar 2012.

However, positive outcomes also depend upon a belief in paper (fiat) money. Debt is not the problem per se, rather it is that current debt levels resulted from extreme misallocation of resources with consumers bidding up house prices, running down savings, investors leveraging their entry into share-markets, companies paying too much for assets and expanding unwisely, and governments embarking on unaffordable welfare and warfare expenditures.

Paper money represents purchasing power and is the price that is paid for people to work in the production of goods and services. Paper money keeps people off the streets and rewards them for useful work and enterprise.

According to the December 31 issue of The Economist, champions of ‘Modern Monetary Theory’ are calling themselves neo chartalists. They believe "that because paper currency is a creature of the state, governments enjoy more financial freedom than they recognise. The fiscal authorities are free to spend whatever is required to revive their economies and restore employment. They can spend without first collecting taxes; they can borrow without fear of default. Budget makers need not cower before the bond market vigilantes. In fact they need not bother with bond markets at all."

Double entry book-keeping (developed in the 11th century) has as its basic postulate that for every debit there is a corresponding credit. The credit entry of current relevance is debt which is being spoken about incessantly, almost as if it were incest. The corresponding debit is factories, mines, and public and private infrastructure, the expenditure which is not being spoken about at all. True that public and private assets were inflated in pricing terms (electricity privatisation, the Myer float, certain acquisitions by private equity, the share market generally, housing etc) but a lot of that work-out has occurred and is occurring as discounted assets are removed from bloated bank balance sheets and re-possessions feed off the carcass of past folly.

Ecinya is far from sanguine about excessive debt. In our 2006 Overview we penned the following – "The new global and urban myth – debt does not matter: That public and private debt doesn’t matter is a very substantial un-truth. A very substantial un-truth is a fallacy, a lie. The fact that many believe a lie to be true does not change it to truth. To sustain a good lie, recognisable elements must be present to give it the aura of truth, the character of truth, so that well intentioned, honest, well regarded commentators can perpetuate the fallacy and make it grow profitably for a wide range of beneficiaries – bankers, politicians, stock-brokers, real estate agents, and other brokers and commission salesmen. When these persons are getting disproportionately richer and manufacturers of real goods and services (weapons of war excluded) are getting disproportionately poorer, an adjustment is generally not far away. A pervasive lie will not die from a single gun-shot wound to the head, but from a thousand pin-pricks."

The main dangers we see for ourselves is Iran, continuing Federal government incompetence, and the fact that America may well be ungovernable in the short to medium term.

We will be watching –

• Bill Evans (Australia) and Paul Kasriel (USA) on the economics front.
• Australian credit statistics.
• The SP500.
• The ShanghaiA index.
• The copper price.
• Developments in the American energy sector.
• China generally.
• Our market quant model.

 

EXECUTIVE SUMMARY

1. Australia needs a new Federal government. The current trends are unmistakably bad. The middle class is pressured. It is a worry that Ecinya regards Mr Swan as our second worst post WW2 Treasurer at a time when he carries the trophy for World’s Best Treasurer.
2. The opposition needs to lift its economic game and credentials. Scott Morrison or Malcolm Turnbull should become shadow treasurer. Paul Fletcher could assume a more prominent role in Communications & Media. Good policy work is being undertaken by Andrew Robb, but if populism triumphs over policy our exposure to negative external developments moves to major risk level.
3. The Henry Committee should be re-convened and its terms of reference widened to include the GST. About 80% of the Henry Report was ignored and only the expedient positions embraced as the budget surplus had been totally squandered.
4. Industrial relations has regressed and needs to be reformed. Proper reform would assist both Unions and the nation.
5. The world needs more work, less welfare, and less warfare. The modern democracies have moved too far to the left. Unemployed youth, poorly targeted and poorly administered welfare, is sapping economic opportunity. Accumulated problems from warfare (Iraq, Afghanistan) have stressed sovereign budgets. The left believe in legislation and the right have a diminished ethical base, so there is fault on both sides of the debate. Wikipedia identifies about 30 wars in every decade since 1945. Refugees are developing into an economic problem rather than just a serious social problem.
6. The current ownership of the US Federal Reserve needs to be disclosed, its role and relationship with the federal government and Wall Street needs to be examined. It should become more independent.
7. Europe and America need a large dose of tax reform.
8. America needs a President who is more of a manager and less of a messiah. The George W Bush swing to the right was an ambiguous failure and the Obama experiment has failed.
9. The jury is still out on US state and municipal insolvencies.
10. ‘Balanced free enterprise’ needs to replace ‘capitalism’ and ‘socialism’. The role of government should be examined in terms of its share of national economies. We target inflation but not the exponential growth in government expenditures.
11. ‘Beneficial trade’ should replace ‘free trade’.
12. Elections should be funded through an Electoral Bank in the democracies to mitigate crony capitalism and crony socialism.
13. America can re-invent itself and Europe should muddle through after it creates an enduring bail-out institution before addressing some of its structural problems.
14. The Euro treaty and constitution needs to be re-visited. It is interesting that the Italian technocrats seem to be receiving favourable reviews.
15. China should seek to become an adult member of the international community in word and deed. For our part changing the name of The Chinese Communist Party to ‘The China Central People’s Party’ would be a sound initial step. Removal of the word ‘communist’ would mitigate cheap shots from the radical American right. China is not yet ready for democracy.
16. America in particular and the world generally needs a large dose of eduction and infrastructure spend.
17. The world generally needs a genuine debate on taxation, population, infrastructure and the way we govern ourselves.

 

LOOKING BACK TO 2010 AND 2011

We captioned our 2011 Insight Overview paper as "A year of survival and opportunity, but little room for complacency as the march of folly continues. The year will be essentially flat, but with sufficient volatility to allow traders and active value investors to outperform market indices."

During 2011 major Insight articles issued as follows:

• 28 January: We love our sunburnt country, but we should aim for solvency over the cycle.
• 15 April: Ronald and Kevin: Two failed revolutions separated by history.
• 18 July: The real GFC – Government Facilitated Chaos.
• 12 August: Crony capitalism – capitalism’s cancer. Crony socialism – socialism’s endemic malady.
• 29 September: Tax Reform: STUPID – Silly Taxes Upset proper Industrial Development.
• October 7: Is austerity or reflation the pathway to economic recovery?

Our 2010 paper was captioned "Our view of the year ahead" . (How’s that for simplicity or lack of imagination?). Our message which carried over into our 2011 deliberations as well as aspects continuing into 2012, was –

"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."

During 2010 major Insight articles issued as follows:

• 17 April: Outperformance! Seeking the holy grail.
• 26 April: Overcoming the chaos with Kotlikoff
• 5 May: KEN"S CRUSADE – searching for TRUTH in the tax reform debate.
• 10 June: Is that opportunity knocking, or is it the debt collector calling? A look at fiat money.
• 1 October: Bull or bear? Not quite the right question.
• 22 October: Paul Volcker – reasonable, rational, largely ignored. Why?
• 3 December: David Murray – a bridge too far.

 

A WORD ON FORECASTS, SOME NUMBERS FROM WESTPAC, AND ENDURING STATEMENTS FROM IAN MACFARLANE AND PETER WALSH

A forecast is a prediction and calculation related to future events. The future is difficult to predict both in relation to time and dimension. Therefore, the underlying hypothesis has to be set out so that as events unfold and time passes, the forecasts can be measured to provide confidence or provoke action.

An hypothesis is according to our Collins Dictionary "A suggested explanation for a group of facts or phenomena, either accepted as a basis for further verification or accepted as likely to be true".

According to Westpac Economics the world was in recession for calendar 2009 with world growth running at negative 0.7%. The 2010 recovery resulted in world growth of 5.1%, about equal to the pre-crisis growth rate of 5.4% for 2007. Westpac’s estimate for 2011 is 3.9% and their forecast for 2012 is 2.8%. (Note that global growth under 2% is generally viewed as a global recession)

The problem we have is that the 2010 recovery was largely synthetic with massive stimulus coming from America and significant stimulus from elsewhere, including Australia where the reaction to crisis was clearly political and dysfunctional (education, climate, taxpayer hand-outs). America still has not addressed its structural and systemic problems.

In relation to Australia the 2010 and 2011 calendar years will yield growth around 1.7%, well below trend of circa 3.2%. Westpac have European growth at 1.6% for 2010 and 2011 and negative 1.0% for 2012. Over both 2011 and 2012 growth for the USA is 1.7%.

Ian Macfarlane, former Governor of the Reserve Bank, in June 2005 said; "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."

Australia has a narrow export base and a broad and deep import base and it is important that domestic budget surpluses be preserved and that budget deficits be shallow. The Rudd-Gillard-Greens coalition government has departed from this wise counsel and HAS made things ‘worse for itself’.

As our sovereign debt continues to grow at an almost alarming pace (refer Insight article 3/12/2010 ‘David Murray – A bridge too far’) it seems that the governments since 2007 have also ignored sound advice from Peter Walsh, Finance Minister under Robert Hawke. He said, in 2003, criticising his own side of politics: " 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."

 

WISHFUL THINKING

Wishful thinking is the enemy of hard work. Undeterred, we set out below a fulsome list of our wishful thinking for 2012 for Australia –

• A new federal election is held as soon as possible.
• Extension of the Federal parliamentary term to a minimum of 3.5 years and a maximum of 4 years, later moving to a minimum of 4 years and a maximum of 5 years.
• Incorporate and activate Australia wide an Electoral Bank to fund both state and federal elections
• Lower the carbon tax or abolish it and move to a direct action model using viable technology.
• Modify or abolish the current Mineral Resources tax.
• Re-convene the Henry Tax Committee and include the GST in its brief. Come up with efficient solutions to abolish payroll tax, the anti-economic velocity and paperwork problems of capital gains taxes, and inefficient state taxes.
• Conduct an enquiry into retail rents and the extent of the subsidy to major supermarkets and department stores.
• Conduct an enquiry into the overall impact that the monopoly supermarkets are having on Australian agriculture.
• Develop a long-term plan for water storage and flood mitigation.
• Publish a feasibility study and progress report on the National Broadband Network. This is a sleeper that may well be a disaster.
• Disclose in a single paper the costs of our border protection/ refugee policies.
• Imposition of a $5 fine on politicians who use the word "fair" and a $10 fine on the phrase "fair and balanced" with the proceeds going to a charity nominated by Don Watson, the author of "Death Sentence – the decay of public language".

 

 

 

 

 

 

 

 

 

 

THE AUSTRALIAN SURVEY 17/12/11
If you had the ability to make one change
to improve the nation, what would it be?
MOST CONSTRUCTIVELY ACCURATE, agreeable to ecinya
Rob Murray Lion Nathan	A genuine debate on population, infrastructure, taxation
	and the model by which we govern ourselves
Patrick Snowball Suncorp Metway	Longer terms for governments
Mike Smith ANZ	Simplify and rationalise the tax system
Frank O’Halloran QBE	Greater control over (and reduced) government spending
Elmer Funke Kupper ASX	Radically reduce state and federal inefficiencies
Mark Selway Boral	Review Australia’s welfare system to put the country back
	to work
Terry Davis Coca Cola	Engage better with Asia
Doug Rathbone	A greater emphasis on Australian agriculture
Malcolm Jackman Elders	A sustainable plan for the Murray Darling basin
David Thodey Telstra	Less regulation and greater focus on productivity
	across all industries
Mike Wilkins IAG	Eliminate inefficient state taxes
Chris Lynch Transurban	Leadership
Mathew Grounds UBS	An election to produce a clear mandate
HELPFUL BUT A CONSEQUENCE OF OTHER ACTIONS
Productivity
Mike Hurst Bendigo & Adelaide Bank	Increased national productivity to allow broader
	participation in wealth
Tony Albanese Rio Tinto	To keep productivity at the front of the political agenda
Kerrie Mather MAP Airports	Improve national productivity
Mathew Quinn Stockland	Bipartisan support for planning reform
David Attenborough Tabcorp	Eliminate interstate rivalry and inconsistencies
Michael Cameron GPT	More effective infrastructure investment
James Fazzino Incitec Pivot	Develop world scale downstream industries on
	the back of the resources boom
Andrew Reitzer Metcash	Focus on industries to help after the mining boom
Nicholas Moore Macquarie	Reform of urban infrastructure
John Mullen Asciano	An economically viable dedicated rail network
Education
Kim Williams News Ltd	Have the national direction united by education renewal
Richard Freudenstein  Foxtel	Making our education system better
Tom Gorman Brambles	Increased focus on education and training
John Macfarlane Deutsche Bank	Recognise the value of education
Rob Priestely JPMorgan	Increase innovation and education investment
Other
Graham Twartz Hills Industries	A modestly lower (say 10c) lower and relatively stable
	Aussie dollar
WISHFUL THINKING BUT NAÏVE, WOOLLY,
John Borghetti Virgin	A post resources boom growth plan
Bernie Brookes Myer	Policy vision, wealth and prosperity
Grant King Origin	Business & government work together on productivity
Ian Narev CBA	Genuine bipartisanship on key debates about
	maximising the many opportunities to build a
	strong Australia for the long term
Dominic Stevens Challenger	Policy debates triumphs politics and personalities
INTERESTING WORTH THINKING ABOUT
David Dearie Treasury Wine estates	Invite more Scots in
David Livingstone Credit Suisse	Modern nuclear power
Richard Goyder Wesfarmers	Real progress in reconciliation with Aboriginal and
	Torres Strait islanders
Sue Morphett Pacific brands	Build a national program to reverse the obesity trend
Neville Power Fortesque	Show greater tolerance and understanding of the plight
	of many aboriginal Australians
Mike Young BC Iron	Make Janet Albrechtsen the PM for life
MOTHERHOOD, POSSIBLY SELF SERVING & SHALLOW, BUT?
Craig Dunn AMP	Improve national pool of savings
David Knox santos	Create better conditions for the businesses that
	provide the investment, jobs and wealth
Ahmed Fahour Australia Post	Abetter perspective on what a wonderful place Australia
	is
David Flanagan Atlas Iron	Voters and politicians take a long-term approach to policy
Gail Kelly Westpac	Ensure superannuation and insurance become higher
	priorities
James McPhee ME Bank	That key stakeholders work collectively and
	collaboratively to act in the best interests of the nation
Grant O’Brien Woolworths	Increase economic confidence of Australian consumers
Chris Ryan Perpetual	We are too quick to criticise and need to grab the
	opportunities before us
Paul Zahra	Improved consumer confidence
NOT TERRIBLY INTERESTING
Ahmed Fahour Australia Post	A better perspective on what a wonderful place Australia
	is
Alan Joyce Qantas	Make regular health checks compulsory
Paul O’Malley Bluescope	A Colorbond steel roof on every house
Paul O’Sullivan	Every school age child has a tablet
Mike Quigley NBN	For public debate to be grounded in reality rather than
	scaremongering
George Plummer Onesteel	Australia must realise it’s been lucky and needs to do
	better

RECOVERY?

Economic forecasts are being wound back fairly dramatically as practitioners have realised that they have got their 2011 forecasts wrong as Bernanke’s stimulus bounties underwrote the 2010 recovery which ran out of steam in April 2011. Take away the drip feed and the patient becomes comotosed.

As an example, world growth according to Westpac Economics latest projections is expected to average 3.5% over calendar 2011 and 2012 compared with 4.2% just 3 months ago. The circa 1% difference is about US$700 billion in real terms. Fears of double-dip recession are expressed daily from reputable sources. America is struggling on all levels – fiscal, monetary, militarily, national identity; Europe has a banking and sovereign debt crisis, Japan is recovering from a natural disaster and years of almost zero growth, the Middle East and North Africa are at various stages of civil war.

Strife abounds, which in historic terms means we are in the early stage of the opportunity cycle. We repeat ad nauseum, that bottoming is a process, not an event.

Though there won’t be much evidence of recovery in calendar 2011, if policy makers and politicians work hard on policy and communications, and politicians in particular start to behave like adults, then the world should experience a normal recovery in the last 3 quarters of 2012. The US election cycle will, of course, create some volatility.

 

OUR QUESTION

Q: Is austerity or reflation the pathway to economic recovery?

A: A strong measure of austerity is necessary, coupled with a stronger measure of reflation.

Austerity should proceed along the lines of cutting waste, reducing the size of government, or at least curbing its current rate of growth, and re-directing the moneys saved into sustainable projects such as infrastructure. All welfare should be centralised by the Commonwealth taking it over so that only one cheque or set of social benefits issues per household or person, rather than a plethora of payments and social benefits from separate government departments. At the same time reflation should occur by cutting taxes, making the tax system more efficient. Simple measures like phasing out stamp duty on house transfers, phase out payroll tax, and reduce capital gains on long-term assets held. Ecinya has written on taxation matters in various Insight articles.

Remember that all taxes ultimately reflect in all prices… goods, services, assets…… such that special-interest pleadings generally miss the holistic picture. Government has to raise a certain amount of public capital. The real danger comes when political parties use the tax system to re-distribute income and garner votes via hand-outs which are tantamount to bribes. There are shades and shadows of the Greek disease in Australia and the USA.

 

THIS WEEK

The purpose of this week’s Ecinya Insight is to have a quick look at a few numbers on the global economy to underline our macro thesis that the recovery and stock markets are currently fragile and unconvincing with insufficient evidence of viable change. Bandaids are no substitute for patient and sustainable policy. Stocks should thus be purchased on down days and not chased on up days. A few takeovers would help underpin the bullish view that our own market has reached the value stage. However, prosperity in the economy is not easily recognisable as the small business sector is struggling under the weight of a poor government, and high interest rates.

At the moment we consider the Reserve Bank to be acting appropriately in relation to interest rates as monetary policy cannot be expected to overcome or offset the cascading effects of bad fiscal policy. Mr Bernanke has recently admitted this reality and has now called upon the US Congress to do their part. It appears that Uncle Ben is threatening the recession scenario believing that Congress will only act at the point of actual or perceived crisis.

With world growth slowing, disequilibrium has morphed into a bizarre loss of historical perspective of the cycle of boom and bust. There is a universal loss of faith in fundamentals. Confidence is clearly not in abundance. In an August 12 Wall Street Journal survey of 46 economists 13% said the USA is already in recession and 29% said recession is coming.

 

THE TRIPLE MISERY INDEX (TMI)

The TMI is our simple concoction and adds together 3 aggregates – the unemployment rate, plus the domestic deficit and the current account deficit as percentages of GDP. Out of the 16 countries selected Australia is well positioned with its TMI around 10. Above 15 we have Italy, France, India and the United Kingdom. Most worrying of all we have the USA, Spain and Greece above 20. Europe will not sort out its problems quickly, nor will America. But we believe that America will sort out its problems more quickly than Europe if it elects a wise and economically and commercially literate president.

‘Leadership’ is very important to the American economic and market psyche and it has relied on celebrity presidents far too often…. Reagan, George W Bush and Obama fit decisively into this category. It is a good thing that Donald Trump, Sarah Palin and Mr Huckabee will not be running in the 2012 presidential race. Ronald Reagan sowed the seeds of fiscal recklessness into the fabric of the American dream and it has been there ever since reflected in intransigent domestic deficits, except for a brief respite under the Clinton-Newt Ginrich ‘contract with America’ period.

 

Improvements: China, Germany, Russia

Mild Improvements: USA, Brazil, Canada, France, Indonesia, Italy, Spain, UK

Worsening: Australia, Greece, India, Japan, Turkey

 

CHINESE INDUSTRIAL PRODUCTION

Although the emergence of the Chinese middle class is an amazing phenomenon, China at the margin has gained its prosperity and enormous currency reserves from becoming the major exporter to the world – Europe, Asia, America, and Australia. Australia has not been terribly disadvantaged, on balance, as China has become our major export market in natural resources. But China industrial production is slowing as world growth slows and domestic imbalances have emerged, mainly in property markets. This will impact on Australia in the short term. As Europe and America learn to reflate efficiently and non-recklessly, then the world can begin to normalise, China can resume above-trend growth and Australia will recover that much faster.

 

 

What does ‘normalise’ mean?

In our view it includes the following –

• A stronger US dollar.
• A cessation of Congressional hostilities leading to an outbreak of fiscal responsibility.
• The election of a thoughtful and economically literate US president (Mitt Romney seems to have the appropriate CV)
• Tax reform in America… probably a national GST/ sales tax.
• Institutional reform leading to institutional accountability.
• A reduction of European welfare.
• Recapitalisation of European banks.
• Cessation or extreme modification of the European Union and a return to sovereign states allowing some states to use their own currency alongside the Euro. Additionally beneficial trade treaties can be negotiated… not ‘free’ trade agreements, there is no such thing as ‘free’.
• Relative peace in the Middle East aided by a European-Arab reconstruction fund.
• In China we need to see the continued emergence of the middle class and certain safety nets for workers which will increase Chinese production costs and re-balance their trade to some extent. Safety nets.. superannuation, minimum wages, less exploitation, workers comp insurance etc.
• The Chinese Communist Party should change its name to ‘The China Central People’s Party’ to indicate a deper engagement with the west and acknowledgement that it has become a free enterprise economy. China is not yet ready for democracy.

FIAT MONEY AND REFLATION

The great thing about paper money is that it is easy to print. In a global economy where there is excess capacity increasing the money supply does not need to be inflationary IF the increased money supply is spent and invested wisely. Putting more people to work and having less people at war should be good for global prosperity.

 

SUMMARY CONCLUSIONS TO THIS INSIGHT ARTICLE

Silly Taxes Upset Proper Industrial Development.

Australia has largely ignored the tax reform proposals communicated in the 1685 pages (circa 5 kgs) of the August 2008 Treasury Paper and the December 2009 Henry Report. The Labor government is not inclined to take tax reform seriously and next week’s tax summit will cause more confusion than ever. Tax policies that promote profits and jobs create the fiscal cash-flows able to be applied to meaningful social and commercial infrastructure. Delusions built around the narrow emotional theme of ‘fairness’ are no substitute for national aspirations rooted in hard and enjoyable work-place ambitions. Synthetics, such as job protection and safety nets, means capital deployment to other places and jobs created abroad to cement ourselves as import obsessed and dependent. A Liberal Government is, of course, an unknown quantity, but their track record and ethos does appear to offer better prospects for sustainable prosperity.

There is no such things as a ‘jobless recovery’ and no government can be anti-business and pro-jobs.

 

STUPID

Acronyms, in our view, are a formula for thought.

"STUPID" was coined by Gerry Van Wyngen and our editor in March 1991 when they submitted a proposal via a full page advertisement in The Australian newspaper for the abolition, or phasing out, of payroll tax. This tax was regarded as an impediment to employment and economic growth and was no longer appropriate to the economic circumstances Australia was in at the time. The advertisement was addressed to Prime Minister Hawke, Premier Greiner, Reserve Bank Governor Fraser, and Mr Kelty, then head of the Australian Council of Trade Unions. The rationale, supported by an economic model, was that unemployment would be cut by 1%, inflation would reduce to under 2%, and the cost to consolidated revenue was less than supposed. This latter point was predicated on the fact that payroll tax is deductible so that only a net 70% of it finds it way into taxation coffers.

1991? Fundamental change does not occur quickly.

 

THE HENRY REPORT

Ken Henry, as Treasury Secretary, handed down his 1319 page report on 23 December, 2009. The terms of reference were narrow and focused more on social outcomes than economic outcomes that might lead to the balanced achievement of social outcomes. Thus the terms of reference had the tax cart well ahead of the fiscal policy horse.

The report followed the 366 page report from Treasury dated 18 August, 2008 called "Australia’s future tax system – Architecture of Australia’s tax and transfer system".

Both reports have been substantially and substantively ignored.

 

ECINYA’S INTEREST IN TAXATION

Taxation is what taxpayers are willing to pay for goods and services that are provided by a Committee called the government. Unwilling taxpayers will either move offshore, evade their taxation responsibilities at home, or decide that the safety net of welfare will give then a happy and fulfilled life. It is thus incumbent upon government to tax wisely and spend wisely. Unfortunately, governments in modern democracies have a limited shelf-life and act and react to community and business demands which invariably means that good governments give a bad government a nest-egg to squander, and bad governments give various deficits – debt, domestic and current account – to be repaired.

In good times all things are possible but pervasive prosperity over economic and business cycles enables government to deliver viable social and infrastructure outcomes. Prosperity seldom occurs when taxes are too high, economic growth too low, and interest rates too high. The fountain of fiscal policy is taxation. Economic momentum, or velocity, occurs within context of an harmonic monetary policy. Australia has been generally blessed with good Reserve Banks and occasionally blessed with good governments. In the post war period, Menzies was appropriate for his time in a world that moved slowly; Keating-Hawke-Walsh were excellent fiscal managers, as was Howard-Costello. Whitlam, Fraser, and Rudd-Gillard-Greens have been conspicuous failures.

The American political historian, Barbara Tuchmann said in 1984: "Social systems can survive a good deal of folly when circumstances are historically favorable, or when bungling is cushioned by large resources or absorbed by sheer size as in the United States during its period of expansion. Today, when there are no more cushions, folly is less affordable." In this, our spring of 2011, clearly 1984 is upon our doorstep again.

THERE IS NO REASON FOR OPTIMISM THAT THE TAX SUMMIT NEXT WEEK WILL ACHIEVE ANYTHING MEANINGFUL OR WORTHWHILE………..The Labor-Greens coalition shows no depth of understanding of local or global economics that would promote meaningful tax reform.

THEREFORE, we revisit sections of our May 2010 commentary on the Henry Report with some updated commentary in context of circa 15% of the economy growing strongly – the resources sector- and 85% of the economy heading for a possible recession as the cushion of the budget surplus was squandered in 2008 and 2009 in a fiscal panic attack around the Global Financial Crisis.

 

ECINYA’S TAX REFORM PACKAGE

• Extend the Federal parliamentary term to a maximum of 4 years and a minimum of 3.5 years to give policy time to work or to be modified, abandoned, or fine-tuned.
• Abolish direct donations to political parties by pooling them into a fund with a formula for distribution to retard the growth of crony capitalism and crony socialism.
• Expand the GST to food which will be a big tax, and compensate "the losers" such as pensioners and genuine welfare recipients.
• Capital gains on the sale of residential and commercial investment properties and personal share-holdings to be treated as ordinary income on a long-term sliding scale basis, say 7-9 years. (gains 100% taxable year1, 90% year 2, 70% year 3, 60% year 4, 40% year 5, 20% year 6, 10% year 7, zero thereafter.) Too much real and personal property is tied up in dormant and indolent hands. The national balance sheet is comatosed as a result. Inert can hurt.
• Abolish payroll tax collected by the states via a compensation system and abolish many of the other taxes proposed by Henry.
• Increase the tax free threshold and change personal and company tax rates as dramatically as is sensible.
• Have a target rate of total taxes to total GDP similar to the inflation targetting system e.g. 20% in good times.
• Introduce tax breaks on certain forms of savings particularly for younger people specifically savings to acquire a home.
• Have an exceptionally modest federal royalty tax on mining, say about 5% exceeded slightly by the mining royalties currently collected by the states.

 

KEN HENRY’S TAX REFORM PACKAGE

The key recommendations are set out below and we use the same numbers in our cross-reference commentary. We have ignored the 133 (non-key at this stage) recommendations not taken up by Mr Rudd and his Treasurer.

1. Impose a 40% "resources rent tax" on the mining sector (emphatically disagree).
2. Cut the company tax rate from 30% to 25% (agree)
3. Flatten personal tax rates, increase the personal tax-free threshold from $6,000 to $25,000 (agree)
4. Replace state-based taxes such as payroll tax and stamp duty with broader consumption taxes including land tax on the family home (emphatically agree, except for land tax on family home).
5. Curb negative gearing (disagree)
6. Combine all family tax benefits into a single means-tested payment (emphatically agree).
7. Taxes on interest earned from savings be slashed by 40% (emphatically agree)
8. Remove the medicare levy (don’t know)
9. Restore fuel indexation (don’t know, but do not like indexing anything, inflation numbers too rubbery)
10. Introduce traffic congestion charges (agree).

 

Mr SWAN’S KEY CHANGES (our comments are in brackets)

1. Impose a 40%"resource super-profits" tax on the mining sector from 2012-13 (expedient rubbish).
2. Raise the compulsory superannuation rate from 9 to 12% by 2019-20 (agree)
3. Cut the company tax rate from 30% to 28% by 2014-15, two years earlier for small business (Agree, let’s hope that the definition of small business is not the same as for the wrongful dismissal laws. Lot of potential silliness here.)
4. Create a $700m infrastructure fund to help build state infrastructure from 2012-13. ( Disagree: Unwieldy, complex, hopefully the Building Education Revolution and National Broadband are not the templates.)
5. Continue to allow workers approaching retirement to top up their super by $50,000 a year. (Agree)

 

UPDATE

The Resources Tax is currently a confusion, but has been modified to something in the 20-30% bracket, down from 40%. It should be scrapped altogether. Additionally, a flood levy tax has been imposed, and this should be scrapped as well. Additionally, a carbon tax is being proposed that will achieve very little, or nothing at all, in the short or medium term, and this should be scrapped as well.

We are of the opinion that the path to recovery and trend growth in the economy will not be achieved by increased taxation in whatever form it takes. Rather we would prefer to see some incremental reductions in government spending, some incremental changes in the tax mix, and in context of fiscal responsibility being evident to both consumers and the Reserve Bank, reductions in interest rates.

 

SOME ‘RUBBERY’ NUMBERS

In fiscal 2010 total tax revenues ( Commonwealth, State and Municipal) were $333 billion equivalent to about 27% of Australia’s GDP. This $333 billion was made up as follows –

• $187 billion as taxes on income (56%)
• $89 billion as taxes on goods and services inclusive of GST (27%)
• $32 billion property taxes (10%)
• $17 billion as payroll tax (5%)
• $8 billion other taxes on goods and activities (2%).

Treasury has recently pointed out to the Gillard-Greens coalition government that the GST is a growth tax, and in an ex-growth economy the GST goes down, not up. They supplied the following numbers to increase the GST tax take at the current 10% (which Ecinya thinks should not be changed) –

• $5.9 billion for food – uncooked, not prepared, not for consumption on premises for sale, some beverages.
• Health and medical services $2.95 billion.
• Education $2.6 billion
• Financial supplies $2.2 billion.
• Imported services $1 billion
• Financial supplies, reduced input tax credits $990 million
• Water, sewerage and drainage $700 million.

If the after-tax cost of payroll tax is about $12 billion ($17b x 70%), then taxing food, medical and education would result in $11 billion of additional receipts. If the federal and State governments could then over time reduce thier expenditure by say 2% of the total tax take of $333 billion that would give another $7 billion to apply towards reducing tax on savings and some property taxes such as stamp duty on housing. We fully appreciate that payroll tax is a state tax and respectfully suggest that state governments phase out the tax in return for a quarterly Federal reimbursement of the payroll tax revenue foregone.

We are in no position to do the modelling but we do know that taxes are so diffused across the economy that the current sytem is unweildy, inefficient and counter-productive. Current complexity allows politicians and social engineers to obfuscate and confuse us as well as themselves. Changes do not require ‘tough’ decisions, they just require sensible and appropriate decisions well-explained. All taxes impact on prices. What we do not need is the hyperbole of a past back-bencher who, in 1999, said:

"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."

That back-bencher was, of course, Kevin Michael Rudd.