Saul reveals all

Following is a guest post from Saul Eslake on last week’s Budget. Also find below a considered set of charts that offer a very clear view of last week’s Budget revenue assumptions. If you want to understand the punt we’re taking on China, not to mention growth in capital gains, this document is a must read. Saul will also be available throughout the day to answer questions if would like to post them in comments…Enjoy.


Interest rates will start rising again quite soon, the Reserve Bank indicated – about as clearly as central banks ever do signal their intentions – in its most recent quarterly Statement on Monetary Policy (issued on 6th May), despite the fact that, as Treasurer Wayne Swan said in his Budget Speech just four days later, ‘for some, talk of an investment boom seems divorced from reality’.

According to the Reserve Bank’s latest forecasts, ‘underlying’ inflation will rise from its present level of about 2¼% to 3% by the end of this year, and remain at that level for another 18 months, before accelerating further to 3¼% by the end of 2013, reflecting a gradual upward drift in labour cost inflation ‘as capacity utilization and the labour market tighten’, continued significant increases in utility prices and rents, and higher global prices for both commodities and manufactured goods (now that inflation is rising in China and other countries which have become major exporters of manufactured goods), the moderating influence on which of the recent appreciation of the Australian dollar is expected to fade.

These forecasts are also explicitly premised on what the Reserve Bank calls the ‘technical assumption’ that interest rates rise by one-quarter of a percentage point in early 2012 and again by a similar amount by mid 2013 (in line with what financial markets were pricing when those forecasts were assembled for the Bank’s May Board meeting).

But such an inflation outcome is not acceptable to the Reserve Bank, which is required by its agreement with the Government to keep inflation at ‘between 2 and 3% per annum, on average, over the course of the business cycle’.

Hence, when the Reserve Bank says, as it did in its Monetary Policy Statement, that it will ‘set policy to ensure a continuation of … low and stable inflation’, you can be pretty sure that it’s planning to increase interest rates by more, and almost certainly sooner, than that ‘technical assumption’. That’s about as close as the Reserve Bank ever gets to signalling that it is contemplating putting rates up again sooner than the financial markets have been

The background to all of this is, of course, that Australia is experiencing the largest (by a wide margin) commodities boom in our post-European settlement history, driven by the rapid industrialization and urbanization of the two most populous nations on the planet, China and India, a process which both the Reserve Bank and the Treasury believe has at least 15 years (and in all likelihood longer) to run. And Australia’s previous experience of commodities booms – the gold rushes of the 1850s and 1860s, the Korean War wool boom of the early 1950s, the mining and subsequently rural commodities boom of the late 1960s and early 1970s, and the rather more fleeting energy price boom of the early 1980s – tells us unequivocally that one of the biggest risks
associated with such events is that they can generate substantial inflationary pressures. The last three of these episodes were each associated with bursts of double-digit inflation, followed (as such bursts inevitably are) by recessions.

To be sure, there have been some important changes in the Australian economy, and the way it is managed, since the last, brief, resources boom of the early 1980s. We have a floating exchange rate, which, by appreciating as it has done since the current resources boom began nearly a decade ago, has helped to dampen inflationary pressures and (by ‘squeezing’ the profit margins of many non-resources, trade-exposed sectors of the economy) helped to ‘make room’ for the resources sector to expand. Politicians aren’t able, as they were (and did) in the 1950s, 1960s and 1970s), to succumb to pressure from manufacturing and farming interests to keep the exchange rate artificially low (in ways that ultimately lead to even greater inflation, as they did in Australia in the early 1970s and as they are now doing in China).

We have a much more flexible labour market and decentralized wage-setting system, so that the large wage rises obtained by workers in the mining and engineering construction sectors (which can afford to pay them) aren’t semi-automatically passed on by arbitration tribunals to workers in other sectors of the economy (which can’t), as happened in the 1970s and again in the early 1980s.

Australian producers aren’t sheltered behind high tariff walls, and thus aren’t able freely to raise prices (or run off to Canberra to plead for even higher tariffs) in the face of rising costs, but instead face the discipline of competition from imports, and have more of an incentive to resist pressures for higher wages. And we have an independent central bank, which can’t be leaned on by the Government of the day to abstain from doing what needs to be done to keep inflationary pressures under control (as it was during previous commodities booms).

All of these structural changes will help to lessen the chance that the sorry history of previous commodities booms will be repeated in the current one. Nonetheless, the experience of what this year’s Budget Papers call ‘Mining Boom Mark I’ – the phase of the current boom which began around 2003-04 and was terminated by the global financial crisis – suggests that these changes aren’t enough, on their own, to guarantee that history won’t repeat itself. Inflation was showing signs of getting ‘out of control’ during the latter stages of ‘Mining Boom Mark I’. ‘Underlying inflation’, which had only been above the top end of the Reserve Bank’s 2-3% target range in three quarters since the early 1990s when the Bank first adopted an inflation target, broke out of the target range in the second half of 2007, peaked at 4.7% in the year ended the September quarter 2008, and (in annual terms) didn’t come back within the target range until the June quarter of 2010.

The main reason for this surge in inflation during the latter stages of ‘Mining Boom Mark I’ was that the Australian economy ‘over-heated’. Unemployment fell well below the 5% level conventionally regarded as representing ‘full employment’; and economic activity began bumping up against a wide range of other ‘capacity constraints’. And one of the reasons why this happened was that the Howard Government (in its last term), and the Rudd Government (in its first year in office) found themselves experiencing substantially larger flows of tax revenue than they had anticipated: but rather than using that to run bigger budget surpluses, they ‘gave it away’ in the form of repeated rounds of personal income tax cuts and increases in welfare payments, which those who received them in turn spent, putting further upward pressure on aggregate demand in an already over-fully employed economy. Those pressures were in some ways compounded by the surge in immigration that occurred at the same time.

The key economic policy challenge which this year’s Budget needed to address is that of ensuring that the same thing doesn’t happen again, as ‘Mining Boom Mark II’ moves into full swing. That’s why Wayne Swan is right to insist that the Budget should move decisively into surplus (although precisely which year a surplus is attained is of greater political than economic importance).

Unfortunately, this year’s Budget did very little to advance that objective. That’s not to say that it didn’t contain some very good initiatives. Among its 541 different ‘policy decisions’, there were many which (by themselves) make lasting improvements to the Government’s ‘bottom line’, or which sensibly target specific problems (such as those which boost investment in vocational education and training, which seek to induce greater participation in work among those who have been on unemployment benefits or disability support pensions for extended periods of time, and which provide more resources for mental health).

But from a macro-economic perspective, all of the myriad reductions in spending were outweighed by new spending in other areas, leaving $6.2 billion in net tax increases including (the temporary ‘flood levy’, changes to the motor vehicle fringe benefit tax rules, the abolition of the dependent spouse tax offset for younger spouses and other measures) to increase the surpluses otherwise in prospect by amounts equivalent to just 0.1 percentage point of GDP in 2012-13 and 2013-14. That’s less than the amount by which projections of the budget balance are typically in error, that far in advance. Indeed, if lower-than-assumed ‘terms of trade’ (the ratio of export to import prices) were to take 1 percentage point off nominal GDP growth in 2011-12, the $3.7 billion surplus forecast for 2012-13 would turn into a $2.6 billion deficit.

So the 2011-12 Budget did nothing that will persuade the Reserve Bank to delay whatever plans it now has to lift interest rates in coming months.

Nor did it do anything to reduce the risk that, assuming ‘Mining Boom Mark II’ lasts into the second half of the current decade, we won’t repeat the policy mistakes made during the last state of ‘Mining Boom Mark I’. The Government’s fiscal strategy says that the ‘disciplines’ by which it has bound itself since the global financial crisis – that any unexpected increases in revenues will be directed towards improving the ‘bottom line’, and that real growth in government spending will be restrained to less than 2% per annum – only apply until the budget surplus reaches 1 per cent of GDP.

On the medium-term projections contained in this year’s Budget, that will be in 2016-17. After then, presumably, the present Government (if it’s still in office after the two elections between now and then), or whoever else might be in government, will feel free to ‘splash the cash’ around in the same way that successive governments did between 2005 and 2008. The best way to prevent that happening is to establish some kind of ‘sovereign wealth fund’, governed by tight rules to prevent future governments from dipping into it for as long as Australia’s ‘terms of trade’ remain above their historical average. But for now, at least, that seems to be a ‘bridge too far’ for all but a tiny handful of Australia’s current crop of politicians.


  1. Do you believe any forecast from the recalcitrant Government departments that did not see the financial panic form, explode and arrive?

    Is’nt this just another government glass eating competition? Are not these the same people who when totally wrong, totally out of their depth, can only come up with a lame excuse for incompetence by saying we are in uncharted territory/waters? Or is that economic modelling failure?

    The Government forecast should be renamed a Santa wish list.

    So we’ve mentioned Government holes, mining material holes but what about the virtual holes from the $15Trillion in derivatives? Notional value becomes full value when either counterparty fails as per contract performance?

    • The Australian Treasury was hardly the only institution of its type not to see the GFC coming. But to its credit, once it did – and Australia had more warning of it since it began elsewhere – they proffered advice to the Government which resulted in a substantially more effective policy response to it than we got during the recession of the early 1990s (which is not to defend the precise nature of some of the programs, such as ‘pink batts’, or their execution).

      I’m not sure how ‘Seanm’ thinks the Treasury should incorporate the extent of outstanding derivatives into its forecast.

      More generally, while I agree that Governments (and others) should think about possible ‘worst case’ scenarios and how best to respond should they eventuate, I think it is a mistake to base a Budget (or any other policy) on such scenarios unless one seriously believes there is a high probability attaching to them. This kind of ‘worst case thinking’, irrespective of any kind of probability assessment, is one of the reasons for the absolutely over-the-top explosion of ‘security’ regulation and spending over the past decade, for which we (and other countries) are continuing to pay a high price not only in billions of dollars spent for tiny gains, but also in time wasted and productivity lost.

  2. Thanks for the post Saul. What sort of conditions should the wealth fund have and do you trust Aistralian politicians to stick to them, especially during election campaigns?

    • The Future Fund established by Peter Costello has some pretty strict rules around it preventing governments from dipping into the capital or indeed extracting the income generated by it until (I think) such time as the Public Service superannuation liability is fully funded. (The Howard Government didn’t put similar rules around the other Funds it established in its last Budget). It should be possible to write similarly strong rules around any Australian sovereign wealth fund – for example, that the capital can’t be touched unless and until Australia’s terms of trade (as published by the ABS) fall below their average of the decade ended 2004-05. And such a fund could be administered by the same Board of Guardians responsible for the oversight of the Future Fund.

      I’d also argue that such a fund should be subdivided into a number of accounts such as pre-funding costs associated with population ageing; education, health and transport infrastructure; (to the extent possible) drought- and disaster-proofing the nation; assisting the transition to a low-carbon economy; ‘closing the gap’ between Indigenous and ‘mainstream’ Australian life expectancy and living standards; and supporting economic activity after the mining boom has ended. While there might be other purposes which could be specified for the eventual use of monies deposited in such a fund, I’d like to see fairly tight rules preventing the movement of those monies from one purpose to another, except with the express authorization of Parliament.

  3. Alan Kohler when questioning the Treasurer yesterday was pretty adamant that we have a budget structural deficit. This of course was denied with an explanation I could not fathom. Do we have a structural deficit?

    How can we even contemplate s sovereign wealth fund when we cant even earn enough in the largest commodity boom ever to pay the interest on our offshore debt?

    I did enjoy your analysis though.

    • I saw that interview with Alan Kohler yesterday morning as well.

      According to estimates published by four Treasury officers in their department’s quarterly ‘Round-up’ in October last year (using information available at the time of the 2010-11 Mid-Year Economic & Fiscal Outlook) the budget was projected to be in structural deficit by about 4.5% of GDP in 2010-11, 2.5% of GDP in 2011-12, and 1.7%% of GDP in 2012-13 (the year in which the budget returns to overall surplus) and would remain in structural deficit until 2019-20.

      There were no updates of these estimates contained in last week’s Budget Papers. However given that the net impact of all the myriad measures announced or funded in last week’s Budget was to improve the overall balance in 2012-13 and 2013-14 by the equivalent of about 0.1% of GDP, I would strongly suspect that the Budget will still be in structural deficit in 2012-13, and probably remain in structural deficit at least through to 2017-18, on the other assumptions underlying the medium-term projections contained in last week’s Budget Papers.

      We won’t be able to establish a SWF if all we can do is achieve budget surpluses of 1% of GDP or less at the height of the largest mining boom in our history.

      My principal reason for advocating the establishment of a SWF is to provide a politically saleable rationale for running much bigger budget surpluses than the conventional political wisdom deems acceptable, especially once (having regard to the need to ensure a continued supply of government bonds for ‘benchmarking’ purposes and to meet new regulatory requirements for banks to hold lots of bonds) the need for debt reduction has passed.

  4. Hi Saul,

    Thank you very much for your analysis.

    My own reading of it was that is was a bit of a buck pass to the RBA in terms of macro level controls, as the budget basically contained some tweaking at the edges and a lot of crossed fingers in terms of the future.

    The thing I took away mostly from the budget however was that the Treasury seems to be ignoring private sector debt and the pressure it is placing on the economy.

    Firstly did you sense the same thing ?

    and secondly, if so, why do you think this is ?

    • On at least one occasion last week I said that in framing this year’s Budget the Treasurer had laboured mightily in microeconomic terms (by my count there were 541 policy decisions in the budget, a lot of them ‘good policy’) to produce something that in macroeconomic terms (that is, in terms of the change it represented in the stance of fiscal policy) looked awfully like a mouse.

      I don’t think Treasury has ignored private sector debt: indeed there’s quite some discussion about the recent more cautious attitudes on the part of Australian households towards borrowing and spending in Statement 2 (where it gets a special ‘box’) and in Statement 5 (where the implications of this more cautious behaviour for GST revenues are considered). But, asisde from reducing some of the incentives which the tax system provides for taking on debt (such as negative gearing) – which is obviously too hot for politicians of either side to touch – there’s not much they can do about it.

  5. Australia may not be succumbing “to pressure from manufacturing and farming interests to keep the exchange rate artificially low” but the main driver of the mining boom is. Surely this means we face the same risks but now we have no way to control them?

    We’ve handed control of our economic future to the Chinese Communist Party, while we wind down the non-resources, trade-exposed sectors. These are the very industries we’ll need in the event of a China slowdown.

    (sorry, too long, I know)

    • There’s no denying that Australia’s economy is more exposed to fluctuations in the Chinese economy than before Mining Boom Mark I – or indeed that this exposure is likely to increase over the next decade rather than decline. However the Chinese (whether they are run by a Communist dictatorship, as seems most likely, or some other political system) have no interest in seeing the Chinese economy slow down decisively. There will of course be cycles in the Chinese economy, and these could well be quite pronounced: but as the Chinese authorities demonstrated in 2008-09, when such cycles occur, they have both the means and the will to get growth going again.

      As Glenn Stevens (among others) has suggested, the best way of providing Australia with some form of ‘insurance’ against this increased exposure to volatility in the Chinese economy is to save more during the ‘up’ swings. Which is really no more than the advice which (according to Genesis) the prophet Joseph gave to Pharoah in ancient Egyptian times. ‘Storing up grain during the seven fat years’ that would inevitably precede seven lean years was probably the first time an economic advisor proposed the establishment of a form of Sovereign Wealth Fund.

      The concern that the non-resources, trade-exposed sectors may be permanently shrunk (or eliminated altogether) during a resources boom is known among economists as the ‘Dutch disease’ (because of similar fears held for the Netherlands after the discovery of large natural gas reserves there in the late 1970s. There is an extensive discussion of this in Statement 4 in this year’s Budget Paper No 1, which concludes that the Dutch didn’t really suffer from the ‘disease’ to which they lent their name, and neither (more recently) has Norway.

      That doesn’t prove that we won’t; but it does suggest we shouldn’t assume it’s a foregone conclusion.

      • Armand Tamzarian

        Saul, I’m just wondering how to reconcile the idea of saving during boom times that you say Glen Stevens subscribes to, when further below in answer to a question I posed, it appears that private saving relative to private investment will become sharply negative if the budget predictions are realized. In other words if a surplus is achieved.

        What is really achieved if the government squirrels away money at the expense of private saving?

        If we were to look at comparable SWFs (comparable to our aspirations) such as Norway and Singapore, have those funds accumulated wealth at the expense of private savings? I would have thought that those two countries run current account surpluses whereas we run a deficit. This is surely the defining difference.


      • I am somewhat perplexed by free-market economists’ faith in the Chinese Communist Party’s ability to manage their economy. In many ways the 2008-09 stimulus exacerbated China’s economic imbalances, and didn’t solve anything. Sure growth resumed (via fixed-asset investment) but they’ve built an awful lot of stuff since 2009 with loans that will never be repaid.

        As for the Dutch Disease (BTW, no explanation necessary for this audience) I suspect we will break new ground with the “Australian Ailment”. Am I right in thinking this is a much bigger surge in Australia’s terms-of-trade (and currency) that the Dutch experienced in the 70s?

  6. Armand Tamzarian

    Q1. According to the ABS isn’t labor underultization higher now that prior to the GFC? Isn’t that a better measure than the headline unemployment number? (slide 4)

    Q2. Given that you have conceded the post 80s floating of the currency and other post 80s structural changes, doesn’t that make slide 5 redundant? i.e. you are not comparing like to like when referring to previous booms.

    Q3. If net exports are positive and the budget is in surplus doesn’t that mean, by definition, that private saving minus investment has to be in deficit?

    • Armand Tamzarian

      please ignore Q3. if my brain hadn’t been so foggy I would have realized that the answer is “No”

    • Re Q1: in principle the answer is yes, although the ABS underutilization measure treats all people who would like to work more hours equally, irrespective of how many more hours they actually want to work (ie, one person who wants to work 1 more hour per week is given the same weight in this count as one who wants to work 15 more hours), which rather reduces its meaningfulness.

      Re Q2: I said that our floating exchange rate (and our more decentralized wage fixing system) reduce the likelihood that we will ‘blow’ the current resources boom in a bout of double-digit inflation. But I also said I didn’t think those changes were enough to eliminate the possibility entirely – and pointed to the significant rise in ‘underlying’ inflation at the fag end of Mining Boom Mark I (and for a while thereafter) as evidence of that. It will be interesting to see the extent to which the changes to the IR system made by the present Government make it more possible for wage increases obtained in the mining sector (which can afford them) flow through to other sectors (which can’t). I don’t have an ideological ‘prior conviction’ on that point: it’s a matter of drawing conclusions from the evidence, one way or the other, that I think will emerge over the next two years.

      Q3: there is a national accounting identity which says that

      X – M = (T – G) + (S – I)

      ie the balance of trade in goods, services and factor incomes (the current account balance) is equal to the sum of the budget surplus and the excess of private saving over private investment.

      In 2010-11, according to Treasury’s figures, we will have a current account deficit of 2% of GDP(our income deficit more than offsets the surpluses we are now running on trade in goods and services) and a budget deficit of about 3½% of GDP implying a net surplus of private sector saving over investment of about 1½% of GDP; while by 2012-13, according to Treasury projections, we’ll have a current account deficit of 5¼% of GDP and a budget surplus of of ¼% of GDP, implying by then a net shortfall of private saving relative to private investment of 5½% of GDP – quite a big swing.

      • Armand Tamzarian

        thanks for the answers Saul.

        Just on Q1. While I understand the criticism of the under utilization number I’d just point out that someone who works one hour per week is treated as fully employed, i.e. the number is just as, or more, limited in terms of meaningfulness. Therefore when you only take the headline unemployment number, this seems to me to be just as meaningless when used on its own as a policy determining metric. Yet it is the headline number that is only ever cited.

        And the other factor I guess would be structural. High employment is mining areas, not so elsewhere. In other words have one hand in freezing water and another hand in boiling water but on average things are ok.

        On Q3. The accounting relationship means that private savings will be smashed if the government does manage to get into surplus. Why do you think the debate about surpluses is never framed in terms of the necessary (in accounting terms) impact on net savings?


        • Thats’a fair point on Q1 – I’m aware, of course, of the way in which unemployment is defined and measured, and I’d defend it only in terms of consistency with international conventions and hence comparability among nations. The existence of this ‘under-utilized’ labour may be one reason why, thus far at least, wages growth has been so quiescent despite low measured unemployment. However there are some ominous rumblings coming out of WA on the wages front (not just in mining) so as I have noted in response to another question here today, this is something that bears close watching. And yes, you’re right about unemployment being structurally high in some regions (and among some strata of our society), which is why I support many of the measures in this budget which seek specifically to tackle this problem.

          I’m not sure why there is so little attention paid to overall national (ie private + public) savings, as opposed to the budget balance in isolation. Of course private sector net borrowing is not a problem provided it undertaken for purposes which will ultimately facilitate its servicing and repayment (which certainly hasn’t always been the case in the recent past, but with the more cautious attitudes now being displayed by households may well be more likely to satisfy this criterion in the years ahead). But certainly proposals which increase private saving at the expense of public saving have not been ones with which I have generally found favour.

  7. If that was a tough budget I’ll stand ……

    Swannie is our 2nd worse Treasurer after Howard.

    Julia and Wayne are too weak to do their jobs.

  8. Alex Heyworth

    Seems to me that the main reason for the current structural deficit is the collapse in Commonwealth revenues. This suggests to me that one of the most sensible things the Government could be doing is looking for revenue sources that are not so heavily influenced by the economic cycle. Did the Henry review contain anything that looked promising? Any chance of such items being revisited in the Taxation ex-Summit later this year?

    • While the downswing in revenues precipitated by the GFC played an important role in driving the budget into deficit in 2008-09 and 2009-10, the estimates presented by Treasury suggest that the deficits in 2010-11 and 2011-12 are largely structural in nature, and that structural deficits will persist until the end of this decade.

      The main causes of this structural deterioration in the budget balance are, in my view, the damage done by the Howard Government (in its last term in office) and the Rudd Government (in its first year in office) through ‘giving away’ (in tax cuts and untargetted welfare handoutds) the revenue windfalls that would otherwise have resulted in budget surpluses being forecast at more than 1% of GDP; and subsequently by increases in spending by the Rudd and Gillard Governments that have been only partially unwound in the current budget.

      That’s my main criticism of the macro thrust of this Budget: that although a lot of the decisions in it are, viewed in isolation, quite good, taken as a package it’s done almost nothing to improve the structural position of the budget, or to reduce its vulnerability to unforeseen swings in commodity prices.

  9. Thanks for posting Saul – hope to see more of your work here and hopefully draw broader attention to this site.

    Questions: At the current interest rate levels we’re already seeing increased defaults, corporate bankruptcies and now falling home loans – the lop sided side of the economy is creaking. How much more can the Australian economy take before it snaps?

    • Although two of three major banks which reported their half-yearly results last month signalled increases in mortgage delinquency rates (NAB didn’t), these are from levels that are still very low by international standards and by Australia’s own experience from the early 1990s. And according to the RBA, rising delinquencies seem to be most pronounced in South-East Queensland (where weak economic conditions and perhaps the impact of floods are a factor in addition to rising interest rates).

      I expect that mortgage delinquencies will rise further, not least among first time buyers who were enticed into the market by outsized government grants and unsustainably low interest rates in 2009-10. However I doubt that they will get close to US-style levels. Australians typically have much higher levels of equity in their houses than Americans, because of generally lower starting LVRs, a tax system that encourages early repayment of principal (by not allowing interest payments as a tax deduction), and by our system of variable rate loans which encourages borrowers to use reductions in interest rates (which most of those who took out loans before the GFC are still enjoying, on net) to accelerate the repayment of their principal.

      The RBA’s most recent Financial Stability Report, published in March, says that non-performing business loans have ‘levelled out’ as a proportion of total business lending, and that business failures ‘remain modest'(although it acknowledges this is a ‘lagging indicator’.

      I suspect there will be more corporate failures in sectors of the economy that are vulnerable to higher interest rates and/or a higher dollar. That, regrettably, is part of the process by which higher interest rates and/or a higher dollar help to ‘make room’ for the resources sector to expand without the entire economy bursting through its capacity constraints (as it did during each of our last three resources booms. But I don’t think this amounts to the economy as a whole ‘snapping’.

      • Hi Saul. Thanks for your time today. It’s much appreciated. On your point that Australia won’t see US-style default rates, I agree with your assessment. In addition to the mitigating factors that you mentioned, we also have full recourse loans, unlike some of the US states (e.g California).

        The UK perhaps provides a better template for what to expect. Like us, they have a high proportion of floating rate mortgages as well as full recourse lending. Their NPLs have risen, but nowhere near as much as the US:

        • Yes the UK’s mortgage system is closer to ours than any other I can think of. The sharp fall in housing prices which they experienced during the GFC was largely due to an abrupt curtailment in the supply of mortgage finance after the demise of Northern Rock, and the difficulties encountered by some of their big banks – neither of which had any real parallel here. Also the UK economy is much weaker than ours (although unemployment doesn’t seem to have risen by as much there as one might have expected given how weak GDP has been).

          Another thing we share with the UK when it comes to housing is a physical shortage of it, relative to ‘underlying’ demand. I think this is one reason why UK house prices rebounded somewhat once the flow of mortgage finance was (partially) restored: whereas in the US they have (and always have had) an excess of housing supply over ‘underlying’ demand, and of course they still have a problem with the supply of mortgage finance.

      • Thanks Saul. Couple of points and I know you won’t answer – maybe for next time:

        Mortgages make up around 50% of banks balance sheets so even the smallest moves in delinquency rates can have a larger effect. So to “‘make room’ for the resources sector to expand without the entire economy bursting” would require the reallocation of capital and labour to that segment of the economy so as to keep equilibrium and prevent the rise in delinquency rates. This is internal redistribution is not happening. The non-mining sector is hurting but the resources are not being reallocated to ‘adjust’; the pool of underutilised labour and capital is increasing with the 2nd and 3rd order effects being decreasing loans, increasing mortgage stress and delinquencies.

    • That’s my pleasure: thanks to the operators of this site for putting my stuff up and giving me the opportunity to respond to a series of sensible and interesting questions. But that’s it for today.

  10. Saul, if I’m not too late:

    Hypothetical – where do you see the Australian economy if the resources boom had not occurred.

    What are the main impediments to the introduction of a SWF.

    RBA (and mortgage providers) are well aware of interest rate pressure thresholds for various brackets of mortgage holders. Do you think the (RBA would raise rates to these thresholds if it were necessary to contain capacity re the mining boom.

    If I am too late, again, thanks for these thoughtful and informative comments. Really enjoyed reading your responses.


    • Armand Tamzarian

      re: SWF

      I fired in a late question but Saul had gone. Maybe those remaining can kick this around — that the defining difference between SWF that exist (e.g. Norway, Singapore) is that the countries that have them have current account surpluses, whereas we have a deficit. Therefore squirreling away money in a SWF will only come at the expense of private savings.

      What do people think?

      • Armand, our situation is indeed different from Norway or Singapore. As a country with a relatively small population (and at least until recently a relatively low household saving rate) and a relatively capital-intensive economy (not just because of our relatively large mining sector but also our widely-dispersed population necessitating a lot of spending per capita or as a % of GDP on transport infrastructure), we have an almost chronic disposition towards a shortfall of private saving relative to private investment (the current conjuncture is unusual, and not expected to last).

        I’d argue that ‘squirrelling money away in a SWF’ is one way of preventing the current account deficit from becoming even larger, not ‘at the expense of’ private saving (if the Government saves what it takes in tax from, eg, mining companies which would otherwise be paid out to shareholders many of whom are foreigners, how does that reduce Australian private saving?), but rather by way of partially offsetting private dis-saving.

  11. Saul are yu payed from the taxpayer?

    And how much more debt can we pile on before we need a operation to get the bankers big 1 out of our bottom?

    • I work part-time (“3 days a week on average over the course of the cycle”) for the Grattan Institute which, as is a matter of public record, received $15mn by way of ‘start up capital’ from each of the Federal and Victorian Governments, as well as smaller amounts from BHP Billiton and a few other corporations.

      That said, I’m not sure what the relevance of it is to the subject matter at hand.

      I hope, ‘Ponzimania’, that you’re not like Gerard Henderson who, judging by his snide comments in this morning’s Sydney Morning Herald, appears to think that the fact that I’m ‘perfectly capable of working in the private sector’ (as indeed I did for 25 years before joining Grattan) but no longer do so somehow disqualifies me from any right to comment on whether particular people should receive government handouts. Or was Mr Henderson simply revealing some kind of frustration (or other emotion) that the Grattan Institute has received funding from governments, while his Sydney Institute hasn’t (otherwise, why mention the fact?).

      There’s now a lot of evidence to suggest that households have become much more cautious about borrowing (from banks and elsewhere) than they have been for almost two decades. We’re simply not ‘piling on debt’ any more.

  12. Saul

    If you do check back on here would appreciate more detailed thoughts on the proposed VET measures – especially given Grattan will be doing some work in this area. I’m quite sceptical of the Commonwealth’s proposed shift to industry-demand and Canberra dictating to states where training should take place. I think this will just reinforce industry’s passivity in relation to training. Surely, student choice and quasi-markets are better models for the Commonwealth to be pursuing as they are doing in Higher Ed and Vic and SA are doing at State level.

    Also, my understanding is that the claimed savings for the Productivity Places Program may not be all that the Commonwealth says – would be interested to know if you have picked up on this.

    • Michael, we will be doing some work on VET and skills training more generally, but we haven’t started it yet and so I’m not really in a position either to endorse or disagree with the comments you’ve made here. Instinctively, I’d favour systems which gave more choice to students – but also, I’d add, ones which gave employers a bigger voice in what and how skills are imparted by the VET system. But I also intend to confront those instincts with such evidence as I can uncover before coming to definitive conclusions.

      • Saul

        Appreciate the reply – number of occasions I’ve witnessed you being very generous with your time.

        Looking forward to seeing what Grattan comes up with in regards to skills.

  13. Saul said
    “But certainly proposals which increase private saving at the expense of public saving have not been ones with which I have generally found favour.”

    this is a bit worrying , this is fine as long as the terms of trade is in our favour but when that stops the public sector will go into deficit whether they like it or not if the private sector is deleveraging

    • ‘Indo’, that’s true, but one of the main reasons for arguing that the public sector should be willing to run large surpluses during periods when the terms of trade are at unusually high levels (and other things are going in the right direction, which not all of them are at the moment, as Treasury Secretary Martin Parkinson reiterated today), is so that it can sustainably run deficits for a while when things move in the opposite direction, whether as a result of private sector ‘deleveraging’, a sharp fall in the terms of trade, or for some other reason.

  14. I would disagree that the Aus housing/ mortgage markets are more comparable with the UK.
    My belief is that Australia sits in the middle between he US and UK. The UK has a genuine housing shortage (massive population on a tiny island). Land is not freely available and what is, is subjected to draconian planning laws.
    Australia on the other hand has vast quantities of land (yes, even in your sparsely populated cities) which are subjected to similar planning controls.
    Subsequently I can (and do)see an over supply building up here. I think the under supply theory banded about has little basis on fact and is exactly the same kind of claims seen from Ireland/USA/Spain/etc/etc.

  15. We do indeed have vast quantities of land, but I’d argue that very little of it is available for development (or re-development) within, say, the next few years, largely as a result of State and local planning and infrastructure-charging policies. The arithmetic is set out in considerable detail in reports of the National Housing Supply Council (disclosure: of which I am a member).

    It was easily demonstrable, both at the time and subsequently, that the level of new dwelling construction in the US, Ireland and Spain was running well in excess of ‘underlying demand’ (driven by population growth), whereas that has never been the case here in Australia, at least not in the last 15 years.

    It may be that there is developing a small excess of supply (property on the market) relative to the EFFECTIVE demand for it (that is, the demand backed by a willingness to pay), which is in turn putting some mild downward pressure on prices across the country.

    But in the absence of a large volume of forced selling (either by distressed home-buyers, or mortgagees in possession), as was the case in the US, I can’t see a US-style house price crash happening here. Of course, that assertion assumes that the Reserve Bank doesn’t induce a large volume of forced selling by raising interest rates too quickly, or too far.

  16. So Saul, if the govs pile on the debt for us, then you beleive thats wise???

    So your a keynesian? Have you read any austrian economics, or are those ideas for the loonies?

    How long do you beleive we can overt a depression, and do you beleive we will be carrying around 1k notes by 2015, thanks i hope yur expertise can shed some light on these questions no matter how silly they sound.

  17. 1 more, how can the RBA raise rates when the household debt to gdp is 160% if im not mistaken? Are they going to roast the pigs on the spit with the apple in the mouth??