Australia’s bull trap

Financial repression is a phrase used to describe a set of policies that reduce the real interest rate to zero or below. These are enacted by governments or regulators aiming to mitigate a debt burden in either the public or the private sector. The low interest rate has the combined effect of lowering debt issuance and servicing costs, as well as increasing bank margins. The knock-on effect of currency debasement boosts competitiveness, investment and inflation. All of these assist in rendering the debt-stock in question more manageable and, ultimately, shrinking it in real terms.

Readers will recognise that these conditions already exist in most advanced economies as private sectors in the United States, Europe and Japan are at various stages of unwinding debt bubbles of the past few decades. The technicals vary but the tools are the same.

Japan remains a contained mercantilist state, fighting its demographic headwinds and formerly corporate debt bubble via endless deficit spending of its government, which borrows from its people at extraordinarily low rates guaranteed by repeated quantitative easing measures conducted through its central bank.

The United States is a more open economy and is making more swift progress than Japan did in its deleveraging, but its household and corporate debt loads are still miles above historical norms. Its government also continues to deficit spend at rates in excess of sustainability, assisted in its endeavour by fabulously low interest rates across the curve, in part held in place by quantitative easing by its central bank.

Like Japan, this has stabilised its financial system and some renewed borrowing is apparent as household formation picks up. This will continue but with each successive year get more difficult. Growth from a low base has proved hard. Growth from each higher base will be tougher still. Owing to more favourable demographics and a more dynamic economy in general, US financial repression is unlikely to last as long as that of Japan. But if it takes half the time, the period from the GFC until now is about one-third of what will be required. Meanwhile, the US will export its weakness wherever it can.

Europe is harder largely because it barely exists beyond its putative bureaucratic dream. The disparate group of states with a shared interest rate and currency, but little else, uses a combination of super-low interest rates, fiscal engineering and constraint, as well as wage deflation to resolve its various debt bubbles. It’s approach has merit in the text book and in the capitalist ledger but its refusal to support the process with shared debt burdens constantly threaten political mayhem.  Europe may win in the end but only if it can prevent civil war.

And it does not stop there. The same conditions of financial repression permeate much of the emerging market world as well. The matrix is different but the tools the same. In China, interest rates are also held at low levels relative to growth and inflation to boost bank margins in the face of mounting bad loans derived from years of overspending on uneconomic infrastructure to meet official growth targets. The underlying dynamism of the economy is real and its prospects for large productivity gains very large in the long term. But the rise to influence of companies and individuals that have a vested interest in sustaining the unsustainable means financial repression goes on. Capital controls ensure the currency is fixed and that domestic liquidity is ubiquitous. The unwind will be long and each subsequent year will face the same question as the last, more pressing each time. How much will the communists renew spending on bridges to nowhere?

Which brings us to Australia. So far, it has been different Downunder. Despite a huge household debt load, Australians have not faced a deleveraging cycle. We have to date disleveraged, reducing our borrowing growth rates not reversing them. This is has been made possible by a once in a century mining boom which boosted incomes, jobs and the simple velocity of money in the economy, easing the generational shift away from debt-accumulation which is part and parcel with financial repressions.

But the shift is nonetheless real. The mining boom and disleveraging have prevented a rout but despite epic dimensions could still not disguise lacklustre growth in most of the economy. 2011/12 were the years of official forecasting misfortune. Thus the central bank and the Treasury both missed the mark in expecting China and the mining boom to outweigh the malaise in the debt-fueled service sectors, though thankfully their integrity prevailed and action contradicted predictions. 175 basis points of interest rate cuts over 15 months and the endlessly deferred fiscal surpluses tell us that.

But the Australian interest rate structure is still high; too high for the rough beast that is approaching the economy. Around mid-year the peak in mining investment growth will arrive. As we’ve been told very often, this peak will be high, very high, though not nearly as giddy as assumed by our optimistic authorities. Nonetheless, the height of the peak is about to become a problem. A steep peak means an equally steep descent.

What this means, of course, is that our special moment is passing. As the mining boom fades, so too is the support for disleveraging. Something else will have to take its place.

In my view, the first half of the year will be decent. We may see another interest rate cut in the next few months in an effort to bridge the approaching growth gap. However, the timing of further rate cuts has been complicated by the China and iron ore price rebound which will boost national income and nominal growth in the first half. Of course this is good but comes with an attached risk. China is NOT embarking on a new cycle of renewed investment vigour. Rather, it is staving off its own inevitable descent from unsustainable investment highs.

The communists have decreed that the decline will be a managed slope but it will still happen. The second half of 2013 is not going to bring acceleration in a new Chinese cycle. It is going to look more or less like the second half of 2012, with Chinese growth and bulk commodity prices under pressure. Iron ore will fall on subdued Chinese demand and awesome new supply. Coking coal is better placed long term but also has awesome new supply. Thermal coal will fall on declining demand and awesome new supply. LNG does not kick in earnest until 2014/15.

Expect the China-will-save-us bulls to upgrade forecasts in the next six months but they are straddling a bull trap which looms at the feet of Australian authorities. In my view, this last hoorah for iron iron ore will slightly ease precipitous investment decline ahead but that’s is all. Higher prices at this stage will translate mainly to boosted mining profits (80% of which go offshore) and higher government revenues. Neither increase private sector economic activity beyond perhaps some small wealth effect from a decent stock market run.

The danger is that this combination of variables delays further stimulus. There is bugger all momentum in the housing economy (excepting apartments and Perth); there is bugger all momentum in the services economy more broadly, there is bugger all momentum in non-mining tradabale goods, manufacturing, construction, government, you name it. If the RBA delays more easing then the dollar will rally, as its current ascending triangle pattern is clearly threatening:

Allowing this to happen as we approach our own investment cliff would not be a good idea. The dollar must fall and it most certainly will, but the longer it is left to do so alone, the weaker the rebound will be afterwards. I am talking about being hollowed out.

There is one more feature of the year ahead that we must consider. The Federal election approaches in October/November. Polls look fairly even at this stage with Tony Abbott by a nose.  With Labor having abandoned its surplus pledge (but perhaps being gifted a long shot second chance by iron ore) government spending can and will support the economy. At least there will be less cuts. Across the aisle, however, looms another danger. The Coalition appears totally locked into its surplus mindset. I don’t know if this is some Halcyon days view of the Howard years, pure Austrian ideology or just Opposition politics. Hopefully the latter. 2014 already looms as a real recession possibility. If the Coalition comes to power and immediately cuts spending, difficult will become bad.

The same risks await the average punter. Low interest rates should not be thought of in historic terms as either the “bottom of the cycle” or “emergency” settings, at least, not in any immediate sense. They are not even responding to an emergency any more. It’s the new normal, now just normal, in which the free flow of global capital is being sensibly crimped to stabilise global banking systems. A modicum of de-globalisation as it were. In this environment, current account deficits matter.

We’ve staved it off with government spending and guarantees to our banks, as well as a serendipitous mining boom. But the underlying fact will remain. Australian households have too much debt. The level must fall relative to the surrounding economy. Financial repression is the way it will do so. That is a structural shift, not cyclical.

What does that mean to you? It means that despite favourable tax treatment, solid immigration and an unbowed politico-housing complex, house prices will likely disappoint. The much-touted housing “recovery” is a dated term that has limited reference in today’s world of ongoing structural adjustment.  When current account deficits matter, over the longer term house prices rise or fall in response only to the broader economy, they no longer drive it because the debt is not available. At a national level, flat in real terms is my guess, with risks to the downside mitigated by property investors’ “search for yield”, the flip-side of financial repression. In the longer term, the risks remain to the downside as the mining boom and demographic dividend passes and because of Australia’s lack of competitiveness in anything else.

Shares should do better. Though valuations are already remarkably stretched, earnings growth will be decent for the miners for the first half and the hope that a soft landing can be engineered by authorities has already lifted markets. More to the point, financial repression boosts financial assets as official interest rates fall and risk premia contract. Nonetheless, those seeking to buy and hold shares on anything other than the very longest of time-frames should be aware that they are in some way buying a fiction. Folks will periodically wake up. I continue to favour dollar-exposed industrials. They are our most globally efficient firms and will grow at least in line with the wider market, if not more so. More to the point, when the dollar corrects with falling interest rates the falls will result from weakness in everything else. It’s a natural hedge.

Fixed interest investors can expect yields on term deposits to fall further but the pressure on bank funding remains and the good news is that much of the financial repression spread that will be gifted to our financial firms will be on the asset side.

There is little prospect of a reversal for interest rates as far as my eye can see: inflation is quiescent, the trend in wages growth will continue to ease as national income falls after a bump upwards in the first half. Eventually the dollar will fall substantially but not until economic weakness demands it and that will cap inflation anyway. Productivity will also continue its rebound.

On the fiscal side, as MB has argued for three years, the surplus is and should be history. Anyone voting on that basis later this year needs to update their frame of reference. Although surplus politics will no doubt define the Coalition side of the campaign, make no mistake, it does not matter who is now in power, the Australian government will either borrow or the economy will weaken.  While it might be argued that some of the weakness is welcome, cleansing past mal-investment, we’ve had years of pressure on our non-mining sectors already, coping with a real exchange rate at its current levels has been the greatest of disciplines. I hope that the Coalition, should it win office, will not have to learn the hard way that when wrestling with a debt-stock of the magnitude held by our households, economic weakness can spin out of control.

All across the world, major economies are converging on the same spot, some from the point of high private debt, some from the point of high public debt, some from the point of free markets and some from the point of central planning. All are using various configurations of financial repression to grow beyond the constraints of the national debts accumulated over of the past three decades of easy demographic dividends, Keynesianism and globalising finance. Now instead they are doing everything they can to seize the largest possible share of the globe’s limited investment capital.

In a sense, this is an era of truer capitalism to that which preceded it. You compete or you die.

107 Responses to “ “Australia’s bull trap”

  1. GSM says:

    “In a sense, this is an era of truer capitalism to that which preceded it. You compete or you die.”

    Doable, but only if Govt’s and their CB’s get out of the way. Fat chance.

    As you know HnH, I put little faith, if any, in Govt to do much of anything right. Govt is simply there to serve itself, so the smaller, cheaper and least interventionist it is the better IMO. Govt should instead concentrate on enabling the regulatory and tax conditions for unleashing the available potential in the economy, not attempt to be the economic sustainer.

    I agree that very important choices are shortly to be faced. If this country stays with the Left, then a version of Europe awaits. By the end of that term, many more Australians will have become dependent on Govt funded benefits and our Debt will have risen markedly. These are not good outcomes for the future of Australia. It really is fork in the road time approaching.

    • In a regular cycle I might agree. But in this one with balance sheet problems you have it upside down. If Australia goes with austerity then a version of Europe awaits. Poor growth and rising unemployment growing the national debt burden and weighing on the private sector…a beautiful deleveraging ala US is what we need…

      • flawse says:

        HnH
        Perhaps you should read MB :)
        http://www.macrobusiness.com.au/2013/01/we-were-wrong-imf-report-details-the-damage-of-austerity/
        Remy Davidson, is Jean Monnet Chair in Politics and Economics at Monash University.

        “More seriously, the anti-austerity advocates appear to have no real concern for the longer-term consequences of indebtedness. At a certain point, fiscal deficits and sovereign debt become structural (the deficits and debts cannot be eliminated without profound alterations to the structure of public spending, borrowing, the balance of payments and the taxation base).

        Which means governments can choose:

        (1) Austerity via fiscal spending cuts;

        (2) Tax hikes for you, the over-burdened citizen; or

        (3) Both.

        Whichever way you cut it, your children, your grandchildren – in fact everybody, except Gérard Depardieu, obviously – will be paying more tax and receiving less publicly-funded welfare as governments pursue aggressive debt-reduction strategies.”

        HnH you say
        “a beautiful deleveraging ala US is what we need…”

        The US is deleveraging with the privileged position it has as the world’s reserve currency. It is able to print print print and the world just keeps soaking up dollars. Nevertheless these dollars are a claim on US assets. As the economy picks up there CAD is starting to again grow rapidly. Yet there are signs everywhere that the ‘benefits’ (I.E. you can remain profligate for longer) will end.

        The only way Aus can imitate the US is to also run a higher CAD as is already starting to happen with the announcement of the expanding Trade deficit. In order to run a higher CAD we must sell more assets or expand our foreign debt substantially.

        You argue that the Govt deficit should compensate for the private sector increasing its debt at a slower rate.
        Your formula therefore argues forever higher and higher exponentially expanding debt for all, Govt Private and Foreign. At some stage soon, in order to right this listing national ship, you must be presuming there is going to be an even greater boom than the one we have just been through. I was just wondering if you might enlighten us as to just when you reckon said boom will arrive?

      • My advice to you is vote Coalition. I suspect they live in a petri-dish too.

      • flawse says:

        Yes good response to my rational argument!

        Re the coalition, as a generally conservative voter I hope they lose. To that extent you are correct. Their policies are no different to Labor in essence.

      • drsmithy says:

        Re the coalition, as a generally conservative voter I hope they lose. To that extent you are correct. Their policies are no different to Labor in essence.

        While technically true, you have i the wrong way around. It was Labor that started emulating Liberal policies around the turn of the century.

      • flawse says:

        Re petri dish comment
        BTW while you have lived your entire life in the protected over-indulged, cocooned from reality, capital cities, working solely as an academic in various forms, I have lived in various parts of regional Australia as well as a capital city, employed and invested in various occupations and industries over a period of 50 years.
        My grip on reality is far better than yours.

      • flawse says:

        Dr Smithy

        It’s another one of those self-reinforcing loops. Labor were smart politically through time. They had the resources to do the research to see what people would vote for. Popularism gained a foot-hold. It was perfects by Howard in his later years. They all now look at Howward’s tenure and try to imitate what he did..especially the Liberals. That’s why they now have no real policies.

      • flawse says:

        Look…for heavens sake can we stop with the petty insult responses. Remy Davidson pointed out a very serious aspect of the anti-austerity propaganda. If you are continuing the anti-austerity propaganda you ought answer the issue.

      • Peter Fraser says:

        flawse they are all opting for the US solution. Japan, Britain, EUzone et al.
        They aren’t concerned about the TOT as they expect the floating currency and natural market forces to counter that.

        It remains to be seen just how it will work out, but now that we know the course the ship is on we should all do what we have to do – resistance is useless and arguments are all hypothetical, they won’t change course.

      • mjohnson says:

        +1 flawse and -1 HnH.

        HnH, you discredit yourself by fobbing off a valid criticism.

        I get that the lib’s proposal will hurt in the here and now, but I don’t see that perpetually and exponentially increasing our debt above and beyond economic growth is going to somehow make us invulnerable forever. One day the system will break. This is based on the simple mathematics of exponentials that an individual such as yourself obviously understands.

        How you come to different conclusions I don’t know but you should give reasons rather than insults.

        Do you think we’ll reach some new level of higher growth that will make our deficits shrink relative to our GDP, and if so why. Or do you think we can keep increasing debt to GDP forever without it ever coming home to roost? Can we hit debt to GDP of 200%? 1000%? 10,000%? When does it stop? I ask this in all earnestness, because your arguments don’t seem to acknowledge any limitations to what we can borrow.

      • GSM says:

        HnH,

        Austerity. What exactly really is ” austerity”? I don’t believe I advocated it. In summary I was trying to say use commonsense and avoid incurring debt.

        I have no faith whatsoever the curent Govt can get anything at all right but they can and have done enormous harm to this country’s fabric. The alternative- LNP- may not be a lot better but IMO better they will be. I hope they will live up to their promise and be smaller and cheaper.

        If that is your version of “austerity” then bring it on. If Australian Business and the economy have any future in the “new normal” it will be with LESS GOVT and not the dreaded burden of more Govt and it’s accompanying regulations and taxes. I would have thought someone who believes in free enterprise would at least accept that premise.Remember, many sizeable well meaning Euro Govt’s stepped in and tried to “help” their economies. That didn’t turn out so well.

        “A bueatiful deleveraging”? Over 1.6 Trillion in Debt and rising? That’s ugly. The US Govt is loading up on Debt while it’s CB is printing the world’s reserve curreny. You may think it’s beautiful but if you are not the US, it’s hardly possible.

        doc,
        All those countries you indicate are hitting their own constraints of debt and tax burdens with the exception of special case Norway. Debt , more Govt and mores taxes is not the answer. Hard work and individual self reliance is. There is no real money available to fund frivolous waste , taking care of the necessities and genuinely in need not withstanding. The new normal for us will be a tough gig so we need to lean out and man up for it.

      • littleguy says:

        “In summary I was trying to say use commonsense and avoid incurring debt.”

        Without any debt there isn’t any money and everyone is broke. That’s the stupid debt based money system that we currently use.

      • drsmithy says:

        All those countries you indicate are hitting their own constraints of debt and tax burdens with the exception of special case Norway.

        Please provide some evidence.

        There is no real money available to fund frivolous waste , taking care of the necessities and genuinely in need not withstanding.

        Let us know when you’re prepared to define “frivolous waste”, “necessities” and “genuinely in need”. Bearing in mind that your beloved LNP specialised in frivolous waste while largely ignoring “necessities” and the “genuinely in need”.

      • Rusty Penny says:

        You’re still of the opinion you can reason with him?

      • Explorer says:

        When you ask for smaller cheaper government, remember that Australia has a smaller cheaper government than most developed countries and is ranked as one of the top 10 places in the world to do business by the Fraser Institute (a conservative think tank) offshoot.

        “Smaller government” seems to be code for greater income and wealth share to the rich with a withering middle class and less class mobility and greater wealth disparity. I present the US as an exhibit in support.

      • GSM says:

        Fundamentally we disagree HnH. Europe is on it’s present course because it embraced ;

        1) Too much Debt.
        2) Big Govt to nanny it’s citizens ( leading to high tax burdens).
        3) Irresponsible immigration policies over time.

        We have a choice – to avoid all that. You advocate taking the course of Europe. That IMO is folly and dangerous to our future prosperity.

      • This is ludicrous. It’s you that is advocating a European path. Hard core austerity. You’ll get the same result. Recession.

        At least own it.

      • GSM says:

        The path is not a fixed place. It’s a journey. You advocate Australia embarking on the European path which down the road will end in high Debt and misery.

        I am saying avoid that path. That doesnt necessarily mean austerity. It does mean making sounder choices than simply opting for the more Debt solution.

        That’s what I own.

        Why don’t you just state what clearly you really want? Which is you want Big Govt to come in , to spend , take on yet more Debt and become more of a nanny than it already is. Leading to what actually?

        That is what is ludicrous. You prefer us to end up like Europe is today. A pathetic premise.

      • Explorer says:

        Don’t forget to add that (the Euro) nations gave up their fiscal sovereignty to become users of a currency they don’t unilaterally control.

    • drsmithy says:

      . If this country stays with the Left, then a version of Europe awaits.

      We’d need to be on the Left first, our current Government is Right of centre.

      Now, if we continue further down the path of the Right, we’re going to end up looking just like America – huge wealth gaps, low class mobility, authoritarian laws, pitiful social services, stagnant wages for the working- and middle-classes (while the upper classes sit back and reap in a bonanza), demolished workers’ rights, generational poverty and barely disguised corporate control of Government.

      It was clear from Howard’s American sycophancy this was his dream, so I’m sure it’s yours as well. Personally, I’d rather be aiming to emulate countries like Germany, Switzerland, Norway, or Finland.

    • rob barratt says:

      With you all the way GSM. France is the classic case of what happens when the credit card overflows.
      Comments about Labor having drifted to the right don’t explain our lack of economic performance. Years of working in the Netherlands and Germany have taught me a lesson that a lot of people here will have difficulty swallowing – a lesson in comparative work ethic (our farmers excepted). It shows chiefly in the difference in approach to industrial relations, ours being modeled on the pre-WW2 and just post-WW2 UK.
      Also, increasingly, it explains the growth in a non-competitive nanny state, micro-managing industry and people’s lives.
      That growth tends to accelerate because the more industry shrinks as a result of over-regulation, the more people seek work in the protected public service that breeds the disease.

      These issues explain the differences in our respective economic outlooks. It will come as no surprise to me that the people who will gradually achieve ascendency in Australia will be Asians – following our inherent cultural failings. God help the lucky country when the dirt runs out, the dollar returning to more historic value, much touted as the cause of our ills, will not cure the underlying problem.

  2. flawse says:

    Perhaps here Doug Noland’s latest piece ought be read in conjunction
    A Credit Theory and “Ro, Ro” Update

    by Doug Noland
    January 11, 2013
    http://prudentbear.com/index.php/creditbubblebulletinview?art_id=10748

  3. flawse says:

    HnH

    Please consider this is not just a Balance Sheet recession. It’s a recession caused by massive distortion of the production/consumption and resource allocation process over multi-decades. In my opinion multi-decades is over 50 years.
    This distortion has caused severe dislocation of our society at all levels including our education systems.

    The ills cannot be cured by running Govt deficits, low interest rates, and increased debt. Such policies reinforce all the distortions and make it even harder to repair what is now impossible to repair.
    The answers lie back in time.

  4. Terry McFadgen says:

    Nice note HnH. Part of the solution is to get the currency down via smart policy.The tax concept being promoted by PD Jonson(aka Henry Thornton) needs to be taken up and analysed carefully.It might be the solution.

  5. Jackson says:

    Great piece HnH, thanks.

  6. General Disarray says:

    Neo-liberalism is a complete failure and we can’t start fixing it until we put banks back on the chain.

  7. Terry McFadgen says:

    Sorry-no link-but the column was in last Weekend’s Oz(as PD Jonson).

  8. Gunnamatta says:

    Good piece HnH,

    The currency needs to be brought down without stoking another bout of credit mania.

    How the hell they do that is beyond me this morning.

    For the short term – this current year the election will be critical for two reasons.

    1. The corporate world will be even less inclined to do any serious committing to Australia while there is political uncertainty.

    2. The electoral process (in a tightish election) may throw its own Black Swan. And the heavily indebted are very very sensitive to any vive which looks like calling them to account.

  9. Pfh007 says:

    “Australian households have too much debt. The level must fall relative to the surrounding economy. Financial repression is the way it will do so.”

    Financial repression is nothing more than a variant on the zombinomics practised by Japan over the last 2 decades.

    The only difference is that the Japanese have a bunch of compliant households who willingly stuff their post office accounts with cash and receive zilch.

    That will not work downunder for the simple reason that most Australians will save only under sufferance.

    That means that when you try financial repression ( ie screw savers) they bolt back to consuming or speculating on assets using debt.

    Of course there is the saver of last resort – foreigners – but they can be a fickle bunch – here one minute gone the next or they like a chunk of our capital assets or real estate as security.

    Financial repression will be attempted (as it has been the policy that got us here in the first place) but it is not in the nation’s interests and is unlikely to work anyway.

    • Everyone is doing it in different ways. We are already doing it via APRA preventing offshore borrowing. We’ll find our own way. We’ll have no choice.

      • General Disarray says:

        Of course we have a choice. The problem is we keep making the wrong one.

      • Pfh007 says:

        If APRA holds the line and forces the banks to continue to limit or further limit their dependence/reliance on the savings habits of foreigners the result will be simple.

        The interest rates that the banks need to pay to induce locals to put money in term deposits will stay up or rise.

        Faced with the choice between rising rates to attract local savings or letting the banks increase our reliance on foreign savings – my money is on the latter as the Govt / RBA / APRA policy of choice.

        At least until the foreigners get twitchy and looking for a pound of blood.

  10. aplund says:

    “2014 already looms as a real recession possibility.”

    Not according to Treasury and the RBA. They keep putting in numbers like 3-3.25% real GDP increase for 12/13-13/14.

    I have no idea how they get to those numbers. It often looks like they just fill in a table to make it look nice.

    If they used some kind of stochastic model, then they should have an standard error, which would be an important quantity to know, like 3%±3%, which does say that there is a risk of recession.

  11. 3d1k says:

    Very good post. You point re export-led growth (which in effect we have had but I understand you mean more than dirt) whilst admirable is unfortunately at the wrong end of the cycle.

    We either remain very very lucky and our natural resource base remains in demand or we are in for a taste of what the rest of the developed world have experienced.

    (good grief, Gillard and McTernan may actually get back in, only to bankrupt the nation with NDIS/Gonski/Dentistry etc and no doubt legislation passed that prevents any criticism…)

    Cheers.

    • General Disarray says:

      They should just fix the holes in the MRRT.

      • 3d1k says:

        What holes.

      • General Disarray says:

        The holes that all the revenue is getting through. A rewrite without miners in the room might help.

      • 3d1k says:

        There are no holes. The tax is operating as designed. Over time, should commodity prices remain high, additional tax revenues will accrue to government.

        The intent was to capture more monies from ‘super profits’. It was not an never should be simply an additional blanket tax over and above usual tax obligations on the sector, regardless of legitimate deductions, transfers and ultimately profit.

      • Rusty Penny says:

        never should be simply an additional blanket tax over and above usual tax obligations on the sector,

        Why should it ‘never be’ an additional tax blanket on a specific sector?

      • Opinion8red says:

        ” The tax is operating as designed…”

        … by BHP, RIO, and Xstrata.

      • 3d1k says:

        Why? And why one sector and not others?

        If government were to impose serious additional taxes at random across a range of sectors this would be damaging to Australia’s international reputation bringing to mind questions of sovereign risk in regard to investment.

        We are not Argentina. Or any other tinpot regime that attempts to manipulate and extract at will maximum additional revenues from legally operating businesses to finance policy on the run.

      • 3d1k says:

        C’mon Op8 – you are one of the few that know the truth…

      • Very true. But if Australia were to impose a well thought out tax on an individual sector making incredible profits from a non-renewable resource ultimately owned by the commonwealth and that tax also had a clearly defined imperative to rectify a market imbalance (Piguvian) then it would not cost Australia one ounce of sovereign risk.

      • Rusty Penny says:

        Why? And why one sector and not others?

        If government were to impose serious additional taxes at random across a range of sectors this would be damaging to Australia’s international reputation bringing to mind questions of sovereign risk in regard to investment.

        That’ that’s all very well and good if you decide to deviert its intention by bringing in a bunch of vague untruths.

        However, there was nothing random about it.

        It was specifically targetted at a sector that made money from a non-renewable resource.

        This is where your, and the mining industry’s sense of entitlement can’t help but show through. The resources are not your inventory which you harvested, such as agriculture.

        They are our resources which you should beg, and aren’t begging enough, to have permission to extract so you can take a margin.

        We are not Argentina. Or any other tinpot regime that attempts to manipulate and extract at will maximum additional revenues from legally operating businesses to finance policy on the run.

        Yes, policy is legislation.

        Legislation is law. I like the law and it hasn’t died with me.

        It will be a major policy issue for me to endorse in the future.

        Future Law… so to speak.

      • Opinion8red says:

        “..C’mon Op8 – you are one of the few that know the truth…”

        Indeed. Everyone else should too -

        The Galactic Hypocrisy of Wayne Swan

        Swan’s Anti-Australian Rant A Smokescreen For Treason

      • drsmithy says:

        The tax is operating as designed.

        Indeed.

        The problem is it isn’t operating as intended.

      • 3d1k says:

        [email protected]

        Royalties are paid on extraction of non-renewable resources to the ultimate owners of those resources, the States. The MRRT is an attempt by the Commonwealth to impose additional taxes on an individual sector the Commonwealth considers to be, on occasion, exceptionally profitable.

        Minor negative externalities are counterbalanced by the various and widespread benefits the success of the individual sector brings to the wider economy.

        The potential desire to control some perceived market imbalance via tax mechanisms should not be directed to an individual sector but perhaps applied directly to the problem – in our case – the currency.

      • Rusty Penny says:

        Royalties are paid on extraction of non-renewable resources to the ultimate owners of those resources, the States.

        Except the RSPT tax isn’t taxing the extraction of the resource, it’s taxing profit of the company associated with extraction.

        The commonwealth has the power to tax profit.

        The MRRT is an attempt by the Commonwealth to impose additional taxes on an individual sector the Commonwealth considers to be, on occasion, exceptionally profitable.

        Yep, that’s how we all see it.

        But the selection of the sector isn’t random as you proposed earlier.

        Minor negative externalities are counterbalanced by the various and widespread benefits the success of the individual sector brings to the wider economy.

        Nope.

        The ‘counter balance’ is not sufficient.

        Only when he add in the RSPT with balance be restored and see the great commonwealth of Australia unleash its full potential for unrivalled economic prospecrity for all!

        The potential desire to control some perceived market imbalance via tax mechanisms should not be directed to an individual sector

        Why not?

        I understand what strings your paymasters are directing here 3″d1k.

        You’re trying to make an appeal to fairness.

        But life isn’t fair, and not all sectors are equal.

        Yours extracts resources that you played no bearing in its creation. Their existence is a sovereign windfall, which the sovereign should maximise their benefit from, not the 80% of foreign shareholders.

        but perhaps applied directly to the problem – in our case – the currency.

        Addressing our currency though isn’t a costless exercise. it involves a cost, and that cost should be borne the extraordinary price of a select few commodities.

        When the commoidty price diminishes, there will be no super profits to tax…

        so if your lot kindly write out a cheque the the federal government, we can all be happy.

      • Opinion8red says:

        Government Resists Calls For MRRT Specifics”

        “The federal government is resisting pressure to reveal how much it is receiving from the minerals resource rent tax… she [Finance Minister Penny Wong] said the government could not be more specific about MRRT receipts because of taxpayer confidentiality, relying on Australian Tax Office advice that it would breach privacy provisions under the Taxation Administration Act 1953. “

        So.

        Not only has the government refused to release ANY details of the design of the MRRT 2.0 (by the foreign-owned multinationals, RIO, BHP, and Xstrata), citing “commercial in confidence” (ie, protect the foreigners’ interests).

        They are now even refusing to release specifics of how much they are(n’t) receiving in MRRT revenues, because of “taxpayer confidentiality”.

        Welcome to Australia … home of the unabashedly treasonous politician.

      • 3d1k says:

        Rusty, mate you’re talking in circles.

        We have the MRRT which will over time on continuation of strong commodity prices attract additional revenues to government. Enough said.

        Schemes designed to ‘rectify market imbalances’ come with know and unknown outcomes. The central issue in Oz at present is the strong AUD and the impact on some sectors. Target the problem directly, not via poorly considered measures of questionable worth. Are you aware that even the old school founders of Dutch Disease now advocate a go lightly approach.

        Like the Obstetrician that delivers the baby, the miners played no role in the cultivation of the prize. However like the Obstetrician, have devoted years to establishing resources and infrastructure necessary for successful extraction and delivery.

        A win win for all. :)

    • Ben says:

      “We either remain very very lucky and our natural resource base remains in demand or we are in for a taste of what the rest of the developed world have experienced.”

      Of all the words written on this and other websites, print media etc over the past God-knows-how-long, this sentence sums us Australia’s position perfectly.

      • Rusty Penny says:

        Essnetially, it’s just another way of rephrasing Donald Horne.

      • Ben says:

        Inasmuch as both use the word ‘lucky’, yes. But that’s about it. 3d’s comment says nothing of quality of leadership (a pleasant change…).

  12. mirage says:

    The answer is so simple. It’s not left or right, austerity or keynesian, nor does it require a PHD to solve it.

    The reason why we are all stuffed is every dollar, every account balance and every cent of goverment spending is DEBT. Until we rid the economy of debt based money whereby the global elite collect their dividends from bank profits, there are no solutions.

    We must move to sound money. Ignore Liberal/Labor two party propoganda and unify. Ignore Surplus/Deficits, these are distractions from the above problem.

    Let’s talk more about the real issues.

    • littleguy says:

      “The reason why we are all stuffed is every dollar, every account balance and every cent of goverment spending is DEBT. Until we rid the economy of debt based money whereby the global elite collect their dividends from bank profits, there are no solutions. ”

      Agree. We need to change the monetary system.

    • Opinion8red says:

      Ban usury. Problem solved.

    • Explorer says:

      Yeah, like the private debt which is 7 times bigger than the public debt.

  13. Lef-tee says:

    Good article H&H, generally agree with a lot of it.

    I disagree that the mining boom has allowed us to avoid outright deleveraging, just as it was not the mining boom that drove the generalised pre-GFC economic boom – it was the rapid expansion of private credit. This occurred in countries all over the world without many of them having mining booms. Strong, generalised real growth is not a prerequisite for booming credit growth. The boom in Aussie mining and the boom in Aussie private debt simply ran coincident to one another, credit expansion was not dependent on mining.

    Perhaps we have avoided outright deleveraging due to the dominance of variable mortgage interest rates in this country? When debt servicing costs fall sharply, they fall sharply for most people here. It seems logical to me that this must surely allow many of those who lose working hours to still hang onto their homes, for people to maintain consumer spending while allowing for an increase in savings without overly impacting said consumption – in short, interest rates cuts (assuming they are passed on) might be more effective here than in other places. This contrasts with other countries such as the US where fixed rates are more the norm, meaning it is only the price of new rather than existing credit that is suddenly, dramatically cheaper – and people in shock and awe of the economic and social carnage unfolding around them usually don’t want to borrow more anyway.

    At least that’s what I have read but I’m not certain of the accuracy. Anyone know for certain if the structure of Australian mortgage rates really is different to that of many other countries?

  14. Jud says:

    “Although surplus politics will no doubt define the Coalition side of the campaign, make no mistake, it does not matter who is now in power, the Australian government will either borrow or the economy will weaken”

    possibly a silly question but I’ve always wanted an economist to explain this to me. Say you are budgeting a deficit of $X bn, what is the difference between borrowing and printing that money? I understand the theory about quantity and inflation, but even if this is so, isnt the equal amount of money ($Xbn) flowing into the economy in both cases?

    • littleguy says:

      Borrowing will make things look better in the short term but leave a bigger mess in the end.

    • Rusty Penny says:

      Printing just adds to one side of the ledger, and to even out it has to be distributed amongst all existing products (and potentially new, but with us that will be imports) brought to market in the economy, thus inflation.

      With a loan, an entry sits on the other side of the ledger, with an outgoing cash stream used to service it moving forward, and is inherantly deflationary. It can be seen as countering the inflationary injection of new cash in the first place.

      In today’s environment, its essentially welfare for the rich, giving the rentier a guaranteed yield as they’ve overpriced all remaining assets that they all seem to have small yields and decreasing in capital value.

      • Opinion8red says:

        Ban “yield”. Problem solved.

      • Rusty Penny says:

        I can’t agree with that.

        We’re in this problem because interest rates were too low.

        Insufficient yield being paid in the first place was the problem.

      • Opinion8red says:

        No. We are (all, the entire human race) in this problem because all “money” is debt carrying the burden of usury. The “money” system itself is an unsustainable Ponzi scheme, for one reason only.

        Usury.

      • Rusty Penny says:

        The burden that can be borne is limited by the yield.

        If yields are too low, then a greater capital burden can be (seemingly) borne.

        This burden can be too much, especially noticeable when you see calibrations moving from 3.5% to 3.75% eliciting angst from the bogan.

        The banker is supposed to police the correct burden, but they’ve long ago negelcted to do their job properly. The death penalty for some banking CEO’s should correct this.

      • cyrusp says:

        Rusty you’re not getting what Opinion8red is saying.

        “from 3.5% to 3.75% eliciting angst from the bogan”

        If we banned usury the bogan wouldn’t have been able to get a mega-mortgage in the first place.

        They would have had to buy their house using savings or entered into some sort of equity arrangement.

        We don’t need debt and usury – equity will suffice.

      • Rusty Penny says:

        I do get what Opinion8red is saying.

        He beats that drum as much as flawse goes on about the CAD.

        Banning ursury isn’t a problem, its yield on debt. I actually view debt as the mechanism to intergenerational transfers of wealth and assets.

        When taking on someone elses forgone consumption, you are accessing their asset.

        The same as rent is the yield on renting someone elses house.

        I either rent someone elses house, or I acquire a house with someone elses savings, use that to purchase (consume) a house of my own, and return a yield to the the owner of the asset I have acquired.. i.e. the lump sum of cash.

        A cash flow to an owner of an asset occurs no matter what.

        The element I introduced about the bogans angst of 0.25% interest rate hikes just demonstrates over-consumption.

        However, neither instance is a problem in it’s holistic structure.

        What is a problem is the (obvious) structure of a lender being a rentier, with arguably too many incentives in our economy for being a rentier, in comparison to the incentives to being an innovator or a producer.

      • dumb_non_economist says:

        RP,
        I like the death penalty comment, most fitting!

      • Jud says:

        Thanx RP

        yes, of course, a loan is a two sided entry. But no country ever repays its loans, they just replace them with other loans, usually bigger. So the added quantity of money in the economy is the same as printing, the only difference being interest. So if worried about inflation why not print the same as you would borrow less the interest you would pay. Equal quantity in both cases

        Am I missing sth??

      • Rusty Penny says:

        That’s right in that the interest payment is a differential.

        The other side is that the creditor can also come in, redeem their capital and buy up all goods. In other words get an excess claim of product, ahead of the general populace.

        With outright printing and inflation, then they more or less contest the inflationary effects on a similar footing, barring who has the knowledge to hedge against inflation, by means of physical exertion or corruption.

        Again, government debt in times like now are welfare for the rentier.

  15. Ben says:

    Great piece HnH.

    My forecast for 2014 – PM Tony Abbott declares “this is the recession Australia had to have”…

    Seriously though, what odds on Aus govt balance sheet blowing out in the next few years, as per US, EU, UK etc?

  16. China-Bob says:

    For me CAD is a much greater problem than Debt because Australia’s solution to CAD is sell-em-more-dirt!

    As a country we are truly fortunate to be sitting on mountains of 62% IO that can be mined for under $20/Tonne. Unfortunately this reality affects the relative attractiveness of all other export focused activities. AS a result Australia has practically no export capability that is supported by the labor and intellect of the Australian workforce. I’ve mentioned Taiwan before because it has a similar GDP to Australia and a similar population. The BIG difference is that they have NOTHING but their skills/labor & intelligence to sell. As a result you find Taiwanese businessmen at the forefront of many emerging businesses, they are continuously reinventing themselves as the product market transitions from small unit niche’s to mass produced Chinese goods. Obviously their proximity to China helps but that is definitively not the whole answer.

    The point I’d like to make is that their Current account remains remarkably balanced because the forces which result in Import blowouts are exactly the same forces that generate Export surpluses. by contrast Australia tries to balance Chinese demand for IO and coal against Australian consumer demand for big screen TV’s and imported cars. It does not take a PhD to understand the inherent difficulty in balancing the Aussie economy when such disparate forces shape its future.

    • Rusty Penny says:

      The BIG difference is that they have NOTHING but their skills/labor & intelligence to sell. As a result you find Taiwanese businessmen at the forefront of many emerging businesses, they are continuously reinventing themselves

      Well Donald Horne did say we are lucky.

      The point I’d like to make is that their Current account remains remarkably balanced because the forces which result in Import blowouts are exactly the same forces that generate Export surpluses

      You’d maybe think that after 20+ years of giving good money over bad to the likes of Holden and Ford, a message may have been slipped in a condition to say ‘stop building cars that we can no longer afford, and learn how to build mining vehicles’.

      The rest, consumer behaviour, it can only be enabled by an overpriced dollar, which is reinforced by assets sales to foreigners, which is desired by bogan boomers seeking payola. Unfortunately, the cycle is self-reinforcing, as you said.

      Eliminate the old aged pension, and make the dollars that are going into the 3rd plasma and the 2nd mazda cx-7 move into superannuation accounts instead to force a behavioural change. Otherwise you’re going to irritate a whole bunch of creditors.

    • Jud says:

      ?
      I thought Taiwan has about 1/3 of australia’s GDP

      • China-Bob says:

        Depends on how you measure GDP, I was using PPP (purchase price parity) method. Taiwan is indeed about 1/3 Aussie GDP if you measure absolute USD GDP taking into account the current high AUD exchange rate.

  17. jerry says:

    Hello all,

    I have been enlightened by the post and the discussion. IMHO 2014 just may see “the recession we have to have” however the solution of the current problems will be “way” beyond the political class of to day be they be to the left or right.

    I refer you to the excellent article in John Mauldins Outside the Box ( January-11-2013 – The Crisis of the Middle Class and American Power and the attached article by George Friedman also entitled

    The Crisis of the Middle Class and American Power

    Parallels with Australia are in escapable.

    Jerry.

  18. China-Bob says:

    I don’t believe I’ve ever advocated additional support for the likes if Holden and Ford. Their business model is completely broken, it is not just exchange rates that are making their products unattractive, their product are fundamentally unattractive and propped up by bad policy.

    I do agree that Australia should produce a much greater share of the mining industries equipment. That is simple logic, however this will never balance the economy because very few Australian’s are even remotely involved in mining. The vast majority of Aussies live somewhere on the east coast on a narrow strip of land between Sydney and Melbourne. As far as I can tell they produce absolutely nothing of external value YET they consume. The purchasing power of this Syd/Melb demographic must be balanced if Australia is to remain a prosperous nation. Unlike 3d1k I would be in favor of Australia using this mining boom to actively fund new business development. New taxes on obscene profits are beneficial to the whole economy, frankly I don’t care about the concept of sovereign risk created by changing the rules mi-game, because the IO is owned by Australians. IO should be leveraged to benefit the next generation rather than impoverishing them with silly exchange rates and capital shortages.

    • Opinion8red says:

      “New taxes on obscene profits are beneficial to the whole economy…”

      Indeed. Strange that so few pause to consider the obscene – I would argue “evil” – profits made by banksters. For doing what, exactly?

      “Helping” folks to sign loan debt-slavery documents. Oh yes. And then, the burdensome task of typing book-keeping entries into a computer, with which said folks can go out and buy sh*t they rarely if ever actually need.

      Let’s not do anything about those obscene profits. Oh no… hell forbid!

    • Rusty Penny says:

      I don’t believe I’ve ever advocated additional support for the likes if Holden and Ford

      No you haven’t. I enjoy your views and wouldn’t even assume you would.

      But a lot of policy makers and their advisers have handed over plenty of cheques carte blanche, and i am wondering has no one though of imposing reciprocal conditions to them.

      The vast majority of Aussies live somewhere on the east coast on a narrow strip of land between Sydney and Melbourne. As far as I can tell they produce absolutely nothing of external value YET they consume.

      There is the latent capacity to design the said mining machinery just mentioned, however….

      Unlike 3d1k I would be in favor of Australia using this mining boom to actively fund new business development

      You do? Why?

      I work in finance and the level of ‘talent’ we have here saddens me. Structurally we have a very sound base in that we have a trillion dollars in super funds sloshing around, much of it with a 20+ year duration before it is claimed, that should be used to create wealth.

      Instead we have the power-suit, power-tie, 3 hours for lunch GPS old boy just buying the ASX 8 every fortnight regardless of the price.

      I do believe we have the engineers and tehcnicians to make the product, but the people in charge of the purse strings, much like our executive class, we are close to world’s worst practice.

      • China-Bob says:

        “Unlike 3d1k I would be in favor of Australia using this mining boom to actively fund new business development

        You do? Why?”

        Starting something completely new in a country is a huge risk and Super managers will never take that risk. I’d rather miners had a choice: Pay the tax OR develop the new business. Mining super profits would become the venture funds for Australia.

        Australia also needs to create a more sensible tax regime that actually favors rather than punishes start-ups. Employee Stock options are an ESSENTIAL tool for every high tech start-up yet look at the ridiculous treatment they get under Aussie tax law. WHY? I cant imagine this is a significant revenue stream so why tax a valuable startup toll so punitively. There are several other silly taxes, that would never exist if Australia had an entrepreneurial culture.

        There is a huge cavern between traditional finance and venture capital. Successful VC partners are part of the startup business environment they eat, sleep and breve in sync with their investments. Traditional finance tries to divorce itself from the risks of their portfolio businesses, this funding structure will strangle the startup because it will deny the startup capital at the very moment they need it most, the tools by which you judge a continuing business are completely unsuited to the startup model, good VC understand this and develop their own performance metrics.

      • Rusty Penny says:

        Hehe, I don’t mean “WHY?” from an altruisic viewpoint. I view at it from the talent, incentives and methods of account we have in place. The realities of Australia, from how i see it.

        “Starting something completely new in a country is a huge risk and Super managers will never take that risk”

        Well risk at this level is offset by a broad enough risk management matrix. With $1 trillion, there is enough to lose on ‘losers’ before they find a winner.

        I for one find it peculiar we didn’t develop a VC culture here, considering our super scheme is the 4th largest pool of funds in the world, and they have a long duration to maturity.

        yet look at the ridiculous treatment they get under Aussie tax law. WHY?

        Probably for the same observation you gave tradies. Their more inclined to find ways to gauge customers than increase productivity.

        I’d say many executives have gamed option schemes that the government couldn’t stand by.

        Successful VC partners are part of the startup business environment they eat, sleep and breve in sync with their investments.

        Yep, and we don’t have any.

        We reward the rent seekers.

        Frank Lowy, Harry Triguboff, Gerry Harvey, Solomon Lew.

        Virtually all industries are duopolies, barring the banks who are legislatively prohibited to the big 4. We don’t know how to compete, barring a few male dominated techincal fields.

        I understand what you say from an idealistic point of view, but I don’t take heart in us being good at many things.

        So when I say ‘we’ should develop our business, I’m more inclined to not settle for second best. I’d rather outsource (as sad as it is) the development.

    • 3d1k says:

      China Bob – I have advocated numerous times my preference for something along the lines of the export focussed tax incentives offered to companies in Ireland. This would take a really radical shift in thinking by both parties – a move to a 15% tax rate for businesses with export focus. A fast-tracking of approvals, a reduction in duplicated red tape etc. A Peter Thiel/Taleb approach. It is always the entrepreneurs that may the real difference. A supportive environment for success.

      Both our governments remain intent on the path of broadening the tax base/take and recently shown propensity to target in numerous ways the business sector.

      I remain less convinced of success by committee/government in picking winners, even more of that view after reading Anti Fragile.

      • Explorer says:

        The Chinese system of export zones/regions and export only companies being taxed at lower rates seems to work.

      • 3d1k says:

        Which is not dissimilar to the Irish approach. Ireland realised decades ago that as a small nation foreign capital investment and export incomes would be the generational lifeblood and introduced various measures to attract and promote export producing businesses.

      • Rusty Penny says:

        So all nations in the world should become net exporters?

      • 3d1k says:

        Many would like to be ;)

      • Rusty Penny says:

        Many would like to be holders of the global reserve currency.

        But it isn’t prudent or wise to plan to be eternal net exporters, all you will ever do is engage in a race to the bottom.

      • China-Bob says:

        “So all nations in the world should become net exporters?”

        From my experience living in “net exporter” countries for most of my adult life, I’d say that the process of becoming a “net exporter” begins with necessity.

        Even today in countries like Germany or Taiwan, there is very little separation between the Export sector and the rest of the economy. If you look at consumer confidence reports they mirror the CAS results. This means Imports regulate themselves so the exchange rate does not get completely blown-out.

        By contrast in Australia the unions pursue their own agenda and consumer confidence depends more on capital availability than underlying business success. If consumer confidence persists than a CAD blowout quickly results and the necessary capital is gladly imported by an equally hungry / corrupt banking system.

        Personally, I’m just glad that all my Aussie friends are so rich, just ask them they’ll tell you that their houses are worth millions. Hmmm What a curious concept of wealth!

  19. China-Bob says:

    a move to a 15% tax rate for businesses with export focus

    I’d also like to see a tax structure similar to Ireland’s, but at this point in time developing / importing the raw talent is a bigger problem than corporate taxation. so focusing on changes to ESOP will give more bang for the foregone tax buck.

    Picking high-tech winners is always problematic and never a gov’t job, look no further then Obama’s stupid choices. I’m not sure what’s the correct path forward for Australia. I’d suggest politicians look closely at what worked for Singapore and South Korea back in the late 80′s and 90′s.

  20. Yorrick says:

    Interesting that HNH takes a counter position to Kyle Bass on the stability of the Japanese financial system.

  21. MJV says:

    Aggressive fiscal austerity in Australia would have allowed for lower interest rates and brought down the dollar. You have been clamouring for ZIRP to ameliorate our hamstrung manufacturers, but economic conditions have simply been too favourable. Fiscal austerity would have provided the necessary slow down to enable the RBA to erase the interest rate differential that has burdened us with a strong currency. Yet for the most part you have complained of the tragedy of Australia’s surplus fetish, or begrudgingly accepted the equally-tragic necessity of a public surplus to buttress the banking system.

    I would have thought that the government should abide by its (albeit lacklustre) commitment to reduce spending this year. Whether or not a surplus is actually met is immaterial. If your primary concern is the high dollar, then economic conditions need to deteriorate for the RBA to cut rates to levels needed to discourage the carry trade appeal of our currency. We all saw what happened after the last cut when traders became aware that no further cuts were in the offing. Now that China is undergoing an engineered rebound, interest rate cuts and currency depreciation are unlikely until the 3rd or 4th quarter, at least. Austerity will bring them forward.

  22. Jackson says:

    Just trying to close the italics.