The aliens have landed

An alien has landed in Australia and is confusing the hell out of everyone. That alien’s name is lack of system growth.

In the old system, as the pie got bigger, there were no losers, only degrees of winners. Corporations in Australia’s dominant finance, realty and retail sectors could swap 2 per cent market share per annum and it didn’t matter even to those that lost it, so long as the system grew at 5%.

The game of pretend competition was played by a boys club of executives that traded assets like footy cards. Regulators occasionally got in the way but knew that their real job was to deregulate. To let the “free market” rule.

Punters didn’t care either. The superannuation guarantee ensured a river of cash poured into the share market, ensuring steady returns on pension savings that easily matched the higher prices that had to be paid to the cartels that delivered the profits that drove the share market. Mergers only made it all the sweeter.

In Canberra, policy-makers were enamoured of the Pitchford Thesis, that debt didn’t matter so long as it was held in the private sector. Occasionally, they banged on about the savings rate. The GST, a tax on consumption, was supposed to boost it, but as soon as it threatened to, by making things like housing more expensive, policy-makers ran screaming for stimulus.

And so, asset markets and consumption clattered along, competition died and vested interests were sown.

It was a perfect little system. Except for one thing. The whole box and dice relied on an ever increasing amount of credit coming from offshore. The GFC was the Waterloo for the system.

Of course, rather than admit this, it is much easier to find a scape goat, like that offered by David Uren today:

Weak retail sales and the rise in the household savings rate are the result of the government’s spending on stimulus measures, according to Griffith University’s Tony Makin.

Writing in today’s The Australian, Professor Makin said that for every dollar of government deficit, the private sector could be expected to save between 50c and 70c.

Professor Makin’s comments follow claims by the outgoing Reserve Bank board member, Don McGauchie, that the government’s deficit spending and industrial relations policy were making the Reserve Bank’s task of controlling inflation more difficult.

Professor Makin said national accounts figures going back to the 1980s showed that household and government savings moved in opposite directions.

When governments ran surpluses, households spend more on consumption believing tax cuts are in store. When governments are in deficit, households cut back, fearing tax rises will be required to pay for them.

Maybe in the Platonic universe of tax accountants – where Professor Makin is the philosopher king, H&R Block governs and Paul Hogan is Satan – such a line of reasoning make sense. But in this universe, punters do not plan budgets around possible tax increases (happy to be corrected if you think I’ve misjudged my fellow Australian).

In my view, savings are climbing because punters know, or at least sense, that the above system has passed its use-by date. Punters are not as stupid as the government thinks and despite all of the mollifying balderdash poured forth by “the system” since the GFC, they feel in their bones that something has changed.

For starters, the vast majority know that Australian housing is a debt-fuelled rocket in a world that is suddenly calling debt to account, and that’s an uncomfortable position to inhabit.

Moreover, we have a population bubble that is massively over-leveraged and over-exposed to said discomfort as they approach retirement.

Finally, for anyone that missed the Waterloo moment of Australia’s old system, the RBA has made it very clear that it will not let debt grow as it used to. Canberra knows the old system has passed, even if it keeps shreds alive in the endless China boom thesis.

So the system has lost its lynch pin. And the fallout is amazing to watch as Australia’s cartels writhe, trying to find ways of competing that doesn’t overly-expose their market dominance. It’s a dance of mock competition and high moral ground. The milk and beer wars are a prime example. From Adele Ferguson today:

The highly emotive and controversial Senate inquiry into supermarkets begins today with Coles supermarket boss Ian McLeod and a couple of Woolworths executives preparing for a shellacking over the recent milk and beer wars.

The issue for the supermarket chains is that some senators are from the Nationals, including former pig farmer John Williams, who know first hand the impact the chains can have on rural Australia.

As flagged in this column yesterday, Coles will argue it is the people’s supermarket, creating price deflation, and that competition has been reborn despite Coles being part of a duopoly.

It will even try to argue that the farmers are not being adversely affected because Coles has fully absorbed the retail price cut in a lower milk profit margin.

In relation to the milk processors, Coles will argue that it paid processors more for their milk in mid-January, before the retail price cut, which was more than enough to offset any switch between branded and private labels.

While this might sound good in theory, the farmers and milk processors see the world differently, particularly when it comes to negotiating milk contracts next year.

The reality is the margins have been squeezed from the farmers and processors and the mix from branded to non-branded has shifted. (Total branded milk is down from 36.2 per cent before the milk price wars to 30.9 per cent, according to ACNielsen.)

The supermarket duopoly squeezed it’s supply chains for years in the old system. But stalled system growth has them now competing head to head, not with one another, but with their suppliers and small retailers. In effect, they trying to pass on lower system growth.

Of course, other cartels are suppliers. And those that have the power to do so, like Fosters, have pushed back. Some of the dairy farmers seem to have enjoyed a bit of protection via the processing cartel.

With the higher savings rate a structural shift, this has only just begun. According to The Australian, next in line is chicken:

An unapologetic Coles chief executive Ian McLeod will tell a Senate inquiry into milk pricing today that discounting is good for customers and not harmful to local food producers.

Mr McLeod was in no mood for compromise yesterday, amid further tit-for-tat between Coles and Woolworths over who started the price war in beer that led Foster’s to withhold supply earlier this year from both chains. The two supermarket giants control about 70 per cent of Australia’s $75 billion grocery market.

The Coles boss said fresh chicken was the latest product targeted for price cuts, with more to come in the next few weeks.

He said in a statement that Coles customers, who were facing rising utility bills and interest rates, had saved $800 million over the past 12 months due to cheaper groceries as a result of food price deflation.

“Australia may have escaped the worst of the global financial crisis, but many families are still struggling to make ends meet in the face of higher household costs,” Mr McLeod said.

If you needed any further evidence, then surely this is it. The Coles chief has done his research and is ventriloquising millions of Australian households even as he drives his supply chain towards a cliff.

I’m not siding with anyone here. I don’t know what the answer is. But last year, during this blog’s “Son of Wallis Competition”, Sam Birmingham submitted an argument in favour of “sustainable competition” for financial services.

In considering policy responses to the new normal for Australian cartels, that might be a good place to start.

Houses and Holes
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  1. You know there’s trouble in paradise when a duopoly has a price war.

    I predict this decade will be the 70’s repeated. The previous decade’s prosperity and low unemployment disappears with a whimper, the bogan masses ask “what happened?” and a decade long search for the right reforms backed by the political will to make them a reality plays out.

  2. I bet the duopoly is as bad for producers as it is for consumers. Just because it seems to be headed in the right direction for the consumers doesn’t necessarily mean producers are just a bunch of whiners.

    That said, fruit sold in Adelaidian supermarkets and produced next door in the Adelaide Hills is more expensive than fruit sold in Europe even though that’s often produced in South America. I recently spoke to someone who said he had seen New Zealand lamb in a London supermarket… cheaper than it is over here! Go figure.

    • AnonNL
      I figured! And I can tell you it is an absolute rip off here in Australia.
      Especially the “good food” vegies and fruits are extremly overprized – no wonder Australians tend to grow sideways in size – Fast food is less expensive.
      Instead of a Carbon Tax a Fat Tax should be implemented. Would probably get more revenue!

    • Dave From Pakenham

      All comes down to the factors of production and economic rents. While food retail margins here are the highest in the world 6% v 4% elsewhere, this does not explain why NZ pears or South American oranges are half the price in London than Adelaide pears or Adelaide oranges in Adelaide.

      The answer is in the high cost of land and labour. To get a return out of farm land which even matches cost of interest in this country, if comparable land is double the price elsewhere necessitates much higher food prices.

      The whole system is bloated, not just Coles and Woolworths margins…

    • Add Vegamite – cheaper in the UK to the list! However, what really galls me about Coles/Woolworths is the consistent poor quality of the food. A lasagne with wrapping that implied there was meat in it got me back to Coles to ask the manager if he could see any in the product. Peaches that never ripen. Bacon that would have a Pom running for cover etc etc. The problem is , the “bogan masses” have never tasted food. A tragedy when you consider Australia’s potential. All in the name of profit. You can still get good food in the Adelaide market, but try Brisbane..

  3. Debt Saturation

    I think the price war on milk and well now chicken is a distraction from all the other higher prices (that keep rising). Its a cunning marketing ploy, designed to make the consumer think that the duopoly is competitive. Listen to the arguments at the hearing and Ill bet that the following line will be repeated – “Competition is alive and well”.
    I noticed yesterday that bananas are $12kg and that they weren’t selling and all were fully ripe. They wouldn’t last the next day.

  4. We are stuck with a system which requires exponential growth, versus the reality of a finite world.

    We know the eventual outcome.

    Yes, that’s right, we will discover new sources of infinite energy, materials and bigger housing plots, and expand forever. Yeah!

    Shame though, about the milk and chicken farmers, +(eggs, vegetables, meat, fish, etc.).

    Should send Woolies and Coles a copy of ‘Goose that laid the golden egg’.

  5. Is it just me, or is Richardian Equivalence complete and utter nonsense?

    When governments ran surpluses, households spend more on consumption believing tax cuts are in store. When governments are in deficit, households cut back, fearing tax rises will be required to pay for them.

    Seriously, if you give the average Bogan a cash handout do they give a moment’s thought to future tax increases to pay for it? Of course not! The whole idea is ludicrous, but you’d be surprised how many economics PhDs buy into this nonsense.

    An infinitely more rational explanation can be found further down in Uren’s piece:

    Australian National University’s Richard Dennis, who has spent the past 10 years at the US Federal Reserve Bank, said it was unlikely that households were boosting their savings primarily to pay off future tax liabilities.

    “Most households are trying to increase their savings to provide a buffer against large, adverse, unexpected events. A lot of people have learned from the global financial crisis that there is less job security out there than they might have expected.”

    • >Is it just me, or is Richardian Equivalence complete and utter nonsense?

      Yep , it is a if he didn’t even bother looking at the actual data. Just another wild stab in the dark at the national accounts to support some ideology that government spending is bad.

      No mention of falling rates of credit issuance, you know that funny little thing that keeps people spending, or the fact that credit has been slowly creeping up toward saturation levels which is causing the economy to stall.

      >“Most households are trying to increase their savings to provide a buffer against large, adverse, unexpected events. A lot of people have learned from the global financial crisis that there is less job security out there than they might have expected.”

      The other thing not mentioned here is demographic effects on savings. Boomers are now retiring, selling down their portfolios and moving to cash. In my opinion this is having all of the effects we are seeing here. A rise in deposits at the same time as a slowing in the rate of credit issuance and a stalling housing market. If I am correct then this is not some cyclic thing, it is the beginnings of a long term trend that will only end when housing has fallen enough in price to match the buying power of new entrant or the government intervenes yet again. Either way it reads like the beginnings of a very bumpy ride for the Oz economy.

    • Well I for one follow an opposite trend to Richardian Equivalence. When a government starts running surpluses or even trying to I expect asset sales, rising prices for services and poor job security. I start saving more.
      When a government starts spending big I have far more confidence that I will still have a job and can spend more.

  6. H&H, aren’t falling prices the inevitable result of a debt growth plateau, and more so if debt levels fall? And is competition an effective mechanism for deflation to pass through the economy?

    I have no idea how Coles and Woolies can have market power in the wholesale markets for milk, beer, chickens or any commodity food where an export market exists. In these markets the price is set internationally, and if local supermarkets want to pay less, no producer will supply them.

    Further, the dairy processors, brewers and many other food processors are multinational conglomerates, sometimes much larger that Coles and Woolies themselves (think Parmalat).

    The two big grocers also have serious retail competition from ALDI. Talk to people on the street and you’ll see how quickly people convert and shop there.

    Oh, and if supermarkets were exercising market power, wouldn’t they already be paying the lowest price to producers and raising prices to customers?

    • “I have no idea how Coles and Woolies can have market power in the wholesale markets for milk, beer, chickens or any commodity food where an export market exists”

      What is the quality of the products they are selling for cheaper? People might be converting to ALDI but their stuff is of dubious quality, I tried some of their ‘great value’ bacon once. I won’t make that mistake again.

  7. For wholesale prices it is true. I was buying Australian lamb in Moscow for much less than half price here, also New Zeland cheese was about 4.5$ Excellent cheese, much better than the one imported from Holland and Germany. Now Moscow is what some petty 13-14 000km from here and when you count transport costs it means that we are being ripped of in supermarkets. In that same Coles, Bery juices 3L were 1.3$ in September 2009 and strawberries you could buy for 50c 250g pack. Now prices are 3 – 4 times higher, and we do not have inflation here 200% a year? Or do we?

    • I did a while a ago now, I’ve been eating like a devote Buddhist Monk ever since.

      And since then if I eat out, its’ either at the Hare Krishna restaurant in Darlinghurst Sydney, or a the Green Gourmet Chinese Vegetarian restuarant on the Pacific Highway Crows Nest.

      Believe me (and Dan too), that documentary will have that kind of affect on you.

  8. H&H,

    An excellent analysis. Surely it is time that we added some new terms to describe national debt.

    1. The Pitchford thesis should become the Costello dream (ie. more expensive private debt is always better than government debt unless you need liquidity to support a bond market)

    2. The Macquarie put is when private debt (Costello dream) becomes unmanageable (ie GFC) and the government has to take it over (Ireland) or guarantee it as in Australia.

    P Costello and his mates such as Kennett, Stockdale, Brumby, etc. have created a monster that now has an unjustified life of its own (until a GFC event).

    Thanks to Macrobusiness for shining light on some dark corners.

  9. Milk is a comodity. Branded milk producers have been riding a gravy train and are now whinging about it being taken away by the supermarkets. To a large extent they have been charging more for the same product – it was never going to last.

    Farmers work bloody hard, are an important part of our economy, and are hostage to many risks outside of their control. BUT the fact remains that most farmers are wealthy land owners. Not to mention a powerful lobby group. I won’t be shedding too many tears!

  10. Not surprisingly, it’s on for young and old in the RE sector… I read in the last week or so that Ray White is responding to the house bubble popping (OK, my terminology 😉 by aggressively seeking to increase market share… (it’s quite possible that the article I read was linked from here)… If I recall correctly, they are aiming to increase market share from 17% to 22%…

    I’m concerned that it’s going to get very ugly… for all concerned…

  11. I’ve been enjoying $2.00 for 2L of full cream milk for a couple of years IIRC. Skim starts at $1.25 per litre at the local Woolies. Pauls Skim/Skinny is always marked down to $3.35 for 2L.

    There are hidden costs in all items bought from the store. These costs are driven by our “resilient” economy. Wages are higher here than elsewhere and one must presume that retail shopping spaces still fetches a huge premium compared to the rest of the western world. Since we were didn’t yet experience the recession in a big way, like say the UK, our wages and rents have remained high. We desperately need some deflation.

    What concerns me is that though prices (including wages) may fall when our economy is finally “outed” for the basket case that it is, we will also likely experience a great increase in prices of all imported goods as our AUD goes into reverse.

    If the price of petrol continues to rise, this will put a lot of pressure on households – particularly those with recent mortgages. Can’t imagine the extent of the calamity if price increases due to CO2 tax is thrown into the mix. Its my feeling that these fears are driving people to put their houses up for sale, particularly those who have only purchased over the last few years.

    • Dave From Pakenham

      If we get price deflation locally across assets as well as consumables we will be buying petrol for half the price we are today.

      Deflation here will be the direct result of carry trade unwind and China unwind, therefore vastly cheaper commodities.

  12. Aldi will improve. In the UK, ten or so years ago Aldi was like it is here. Now, most stores are slick and efficient and offer own-branded produce of great quality and value.
    Of the few thing I miss about the UK, Aldi is one. They provide excellent competition for the big boys.
    I only wish they would venture up to the FNQ!

  13. The silent elephant in the room for me is the world oil price and the unstable political theatre in the Middle East.

    If the situation in Bahrain continues to deteriorate and the extremist Shiites loyal to the Iran regime unite the moderates across the region and pursue their objective of taking control of the Saudi peninsula; we’ve got a situation where quite quickly 30% of the worlds oil production supply could become compromised with nothing but a highly dysfunctional Saudi government and an ineffective “Arab league” to stand in the way.

    Consider the proposition (fall out) of a $180 buck-per-barrel outcome if this plays out … It’s touching $104 at the moment how high will it go?

    An extreme hypothetical, maybe.