We are ill prepared for a shock

I have intermittently tracked the economic narrative emanating from our economic leadership in Canberra and Martin Place. Looking for sense in the transition we face from yesteryear’s credit driven model of economic growth to today’s commodities investment driven growth. At times leaders have made some sense, even if they refused to acknowledge what we were transitioning from. But now, it seems to me that our economic narrative and those that weave it are dangerously close to incoherence, even as forces gather that will prove to be a serious test of our economy and our resolve as a nation.

To make my point, let’s look back. The economic narrative of Kevin Rudd’s leadership was relatively clear. The Henry Review he commissioned laid out a very clear blueprint for tax reform to address, among other things, the pressures of the mining boom on other sectors in the economy. It was to achieve this through more heavily taxing the new mining profits and redistributing the proceeds to other sectors through tax breaks. The flaws of the document were of execution not conception. The Henry Review had a clear purpose and reform proposals to deliver on it. There are credible estimates that the resource rent tax could have redistributed as much as $100 billion over a decade. That the document was politically naive is not a criticism one can make of its intellectual sense.

The other great pillar of the Rudd government was fiscal conservatism. This too made sense when coupled with a Henry Review that aimed to shift the tax base in order to sustain broader economic growth.

Meanwhile, in Martin Place, the RBA held a steadfast line that the economy must not be allowed to boom and bust, as it had done in all previous commodities booms owing to inflation. Rather than repeat this history the RBA set a course for “structural adjustment”. That is, it sought to raise interest rates and the currency to such a level that tradable goods sectors outside of mining would be uncompetitive and forced to deflate as mining inflated. The balance, of course, was an engineered two speed economy that in sum was to grow at or above trend. The RBA was also wrestling with deflating the housing bubble that had been at the heart of economic growth for the previous decade. And if politicians could never bring themselves to mention it, the RBA at least did so obliquely.

Both the Government and RBA held strongly to the view, and enshrined it in their forecasts, that the mining “boom” was going to deliver unprecedented national prosperity. So, in total, there was a unified articulation of the challenge and benefits to Australia presented by the mining boom. Of course, it didn’t work out that way at all.

After the failure of the Henry Review, the government of Julia Gillard was left with a watered down version of the mining tax that gifted accelerated depreciation to miners and looks unlikely to collect much at all over the long term. Making matters worse, having never mentioned the housing bubble and its import, the big misses in government revenues resulting from a rise in household saving associated with fears of a credit bubble burst have never even been explained. We’ve had intermittent blandishments from the Treasurer about how households “lack confidence” and an ongoing dedication to a 2012/13 fiscal surplus despite the weakness in private sector spending, but no explanations, no sense.

These two great failures of sense, the collapse of the Henry Review and the failure to explain where our economy is transitioning from, have playing into the illegitimacy that has dogged the Gillard government for a number of reasons. To combat this, what proceeds there are from the resource rent tax have been shifted from business to households. By making this change, Labor has made a dramatic shift in its economic narrative and policy making away from the national interest and towards its own political interests, even as it accuses the mining billionaires of sectional interests. No sense has now become political nonsense.

Meanwhile, the RBA, our other cluster of economic Generals, has also lost its cache. Having made repeated, aggressive growth and inflation forecasts in 2011 to support its case for “structural adjustment”, the big misses in both have hurt its credibility. Yes, the Bank has acted better, ignoring its own forecasts and acting pragmatically on data. But in terms of the economic narrative, the RBA looks as hapless as the Government, overly wedded to a boom that never came. And, having also failed to adequately explain what the economy is transitioning from, it has left all with the impression that it is out of touch. This illegitimacy is now getting worse because there is no developed narrative to explain why the banks are unwilling or unable to pass on the interest rate cuts that are themselves an open acknowledgment that the RBA’s economic narrative of the past few years has made no sense.

And into this incredibly confused national economic narrative, we can now throw two external shocks. The first is Europe, as Greece wrestles with austerity and its future inside in the Eurozone. This has two immediate impacts. The first we’ve all seen in the big selloff in global equities. The second is more hidden but not for long. It is in the rising cost of funds for our banks that ensure that the further interest rate cuts that are coming this year will not be passed on in full.

The second shock is China, which is clearly going through the early phases of a hard landing. That’s not to say that the authorities that guide our great and powerful economic friend can’t turn it around. But the decline in growth is already such that Australia’s terms of trade have been hit, mostly via the prices of the bulk commodities of iron ore and coal. A big fall in national income is already on the way and the trade surpluses of the last few years are ancient history.

So, as we enter this test, one has to ask what effect the mangy state of our fiscal and monetary economic narratives will have. First I’ll observe that the two halves of our economy are ill prepared for it. The services economy that has been served up for sacrifice by the RBA is on its knees and unlikely to suddenly rebound even with cheaper credit. On the other hand, many major mining projects are already committed and will continue. But many more now will not, as we’ve seen in a range of recent company announcements. And if the growth rate in mining investment peaks in the next year then it will start subtracting from growth.

Finally, there is a more subtle effect. I find it difficult to be confident about the nation’s prospects when so little makes sense. My animal spirits are discouraged when the world around me looks confused. I look for coherence when making strategic choices. How do you plan to invest and grow amid a nonsense world?

I’m pretty sure I’m not alone.

David Llewellyn-Smith
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Comments

  1. Just Dismal 2

    I am long convinced that our economic salvation will come via a crisis. This is in the human nature

  2. Add to that the confusing narrative about climate change/energy production.

    We reduce (internal) emissions by 5% over 10 years while our economy is still relying on doubling coal and gas production within the next 20.

    • Confusing?!

      Its the great unspoken hypocrisy of the Australian economy: We tear ourselves to shreds over domestic carbon pricing (in an effort to achieve minimal emission reductions) while vastly expanding our coal production for export.

      If anyone dares raise this outrageous hypocrisy they get shouted down. Apart from the Greens no-one, and I mean no-one, talks about it. If we’re going to prosper from exporting our black death then lets be honest about our role in global climate change. We are the world’s biggest coal exporter FFS! You don’t here the Saudis talking about the evils of oil do you?

  3. It is rare to see anyone comment on economic matters without over salting their views with self interest.

    I find this article to be one of the gems, where the self interest seems to be mainly a concern about the future well being of our country. I would go further and insist that those demanding our respect (from their positions of authority) should demonstrate results justifying their compensation and respect they receive. Or be shamed out of office/boardroom/reputation.

    Could you imagine Gina (The very rich miner) or Clive Palmer, or any from our political leadership, or those very well paid commentators from the mass media coming up with something like the above?
    Something that expresses doubts, wonders where we can find the clear thinking we need, etc?.

    Am I alone when I compare the above writing to that which is on offer from the TV/Radio/papers & think I live as an alien amongst a population of complete and utter idiots?

    • I respectfully disagree with the notion that I/we live amongst “a population of complete and utter idiots”.

      I suggest rather, that most people are simply as confused, and their “animals spirits” as discouraged, by the current circumstances of life as our estimable H&H here humbly (and admirably) concedes to.

      Viable long term solutions are more likely to arise if we begin to see our fellow citizens as folks not unlike ourselves, who need enlightenment and encouragement, rather than castigation and criticism.

      • DrBob127MEMBER

        “Viable long term solutions are more likely to arise if we begin to see our fellow citizens as folks not unlike ourselves, who need enlightenment and encouragement, rather than castigation and criticism.”

        Well said.

  4. Top post.

    It’s hard not to be cautious when the system is working against you. Unless I want to trade the volatility I’m in for a kicking. Those that say we’ll be ok fail to see how global economics work.

    The FED a week ago pulled back on the sale of AIG securities sale, eventually quoting market conditions, but ask the question, what are those assets on the FED’s balance sheet now worth? Not as much as 2008-2011 auction prices….

    As for our economy, we have a mismanaged resources boom, and that’s about it. Its falling apart around us if you just look. The government are too busy implementing new policies to even notice, and they fail to listen. More is not better.

    • I don’t read newspapers nor do I watch TV so the above is my normal.

      “I look for coherence when making strategic choices.”

      I can’t make strategic choices at this stage, it is all tactical.

        • The person who explained the difference to me used a game of chess as an example. Your strategy is your plan to achieve check-mate, it is long term. A tactic is an action used to reach a specific end. So coming up with the best plays based on how the board looks involves applying tactics. The tactics are in the service of the strategy.
          Happy to be corrected if I’m off the mark.

          • My strategy when playing my sister is to take every single piece she has on the board and then chase her king around for a while.

            Tactics are the next move.

            Whatever move is most opportunistic to either take one of her pieces, prevent her taking one of mine, or will put myself into a position to take one of her pieces, is the next move I perform.

            She doesn’t much like playing me. I drag it out too much :p

  5. Great analysis and writing David. Let’s hope this story gets spread a bit wider.

    BTW I didn’t give up on linking local media pieces this morning because I ran out of time/energy, its just as you highlight – the media narrative is confused, ideologically blind or just plain ignorant of what’s really going on.

  6. thomickersMEMBER

    diversification!

    although a number of SMSFs i’ve seen through friends of friends (i’m always 1 friend away from having a bogan person) have only 1 residential property with limited recourse borrowing 60%-70% LVR and 9%SG + salary contributions to just cover the loan repayments. I think it will all end in tears.

  7. I think you can still make strategic choices in a volatile world. Over the last few years my strategy has been to not purchase a property and keep everything in cash. Savings accounts when the IR is on the up, and term deposits when on the way down.

  8. Diogenes the CynicMEMBER

    My strategy has been to concentrate very hard on our costs and try to eliminate/reduce them where-ever possible. Frugality et Austerity. It is not easy, especially when governments are looking to raise utility charges, but we have found by tightening the belt and living smarter we have a little extra cash with which to save for the hard times ahead.

    Investment wise bonds have been great, but I sense that this run is getting closer to the finish.

    • JacksonMEMBER

      Add to that investing time in the kids. It’s fun, free, and they’re still young enough to do what they’re told, at least I feel I’m in control of something.

  9. Great analysis, but why would anyone expect from our governments to be different from any other in West? At the end who drove us to all this mess with global Titanic sinking? Isn’t it because of dysfunctional politicians everywhere, uncontrollable financial sector growing like a cancer on real economy body and dependent mass media? Parasitism today is a norm, not some negligible marginal negative externality. Who would be more prepared to fight the disease – Tony Abbot? I think no one would be good enough, because as MB and BS noticed there is no capable and intelligent person thriving to become a federal MP.

  10. Alex Heyworth

    Uncertainty and lack of confidence are appropriate in uncertain times, although it does help if leaders give the impression of certainty, at least.

    Seems to me that the weaknesses of the government have been of both process and narrative. They did not learn the lessons provided by their Labor predecessors. Hawke and Keating were successful because they were consultative and because they had a coherent overall narrative, to reverse the stagflation of the late 70s/early 80s. Whitlam had the narrative (his social agenda) but not the process. The current mob started out with a narrative, but poor processes and now appear to have lost the narrative as well. They need a leader who can show how their policy agenda fits into a big picture.

    • IMO they lost it when they decided to pander to the media post-Latham.

      For mind, I still don’t get the angst. He was completely about narrative, and quite convicted i his approach.

      He is the only person I have ever in Australian politics at state or federallevel who pretty much ran government policy from the opposition benches.

      I personally don’t get the fluff about his firm handshake, but the media made a storm over it.

      Even for the month after the election when he was low key, there was no vitriol against him. It was only when he left the parliament that it soon became the ‘disasterous Latham years’, where the media tried to create a narrative. A narrative that didn’t exist during his leadership.

      The ALP has ceded to that, attempting to disown his leadership, and by circumstance they have vacated the space of narrative leadership.

      Admittedly he has been quite bitter after politics, and of course that will taint him, and even reinforce the message about him. But the point still stands, the ALP’s reaction to him hollowed out their stance on narrative politics.

      For a party that takes the mantle of social justice, its extremely harmful.

      One has to remember ben Chifley’s view in 1950, to paraphrase,

      ‘we must always pursue policies in the name of social justice because we need to. Because of this, we must understand we will find ourselves in opposition more than we will find ourselves in government, but it is uor duty nonetheless’.

      That is not the ALP of today.

  11. Great stuff David.

    Given that there’s SFA in the local media today, perhaps Fairfax will give it a run?

    As a follow up, perhaps you can write a piece on likely policy changes under the (inevitable) Abbott government? How will Big Joe manage the likely simultaneous housing and mining busts?

  12. Successive governments in this country (and elsewhere) have given themselves over to the financial system, money markets and corporate interests so completely that they have essentially abrogated any obligation to diversify the types of trade we’re involved in, to diversify our markets, production, internal-external balance, develop our internal markets so we’re not dependent on exports – in the belief that the invisible hand is going to reach out of the sky and remove the necessity of an industrial policy. This is insanity. Successful countries need a coherent industrial policy, and this needs to come from government. But of course, we are now being told, again, that the problem is government, that we need less red tape, less taxes, less public policy. But there is nothing new in this, nothing creative, it is a path to mediocrity, to further enslavement to financial markets and corporate interests. We do need bold leadership, but it is clear most would baulk at the cost of pushing back against the vested interests that pretend that this system we inhabit, which they have constructed in pursuit of their own interests, is an inevitability.

    • Ore prices back to where they were a decade ago ($12.68/t). Actually, even December 2007 prices ($36.63/t) should do the trick.

      Here’s hoping!

      • Why would you hope for that. Surely you care for the jobs of resource, engineering, geotechnical and construction workers as deeply as you profess to care for manufacturing workers – all fellow human beings. 🙂

        • I will exhibit the same amount of sympathy for resources workers that you have shown for people working in manufacturing, tourism and retail.

          I will declare that the resources bust is due to a long-term structural change in the Chinese economy from investment-driven to consumption-led, and there’s nothing we can do about it.

          I will feign sympathy for resources companies as they beg for government support to get through the downturn, but emphasise that resources is a dying sector and really shouldn’t be supported because it can be done more cheaply in Mongolia.

          And I will do all of this without getting paid!

          • Alex Heyworth

            Good bit of (I hope) tongue in cheek humor, Lorax.

            On a more serious note, I hope you were also tongue in cheek about the $12 a ton ore price. Can’t see that doing anything good for workers in manufacturing, tourism or retail myself. It would only happen in a global slump, and then where would the tourists come from?

          • Yes, I have consistently empathised with those finding themselves temporarily unemployed due to structural change. Fortunately, as ABS employment figures appear to support, we remain close to full employment. Something you are unfamiliar with!

            Resources will never be a dying sector (not in our lifetimes) – but probably always prone to strong cyclical pressures.

            And you’d do it all without getting paid – fair price – the market is never wrong.

          • Ok perhaps $12 is a bit ambitious, but I reckon $60-$90/t would result in a more balanced Australian economy. i.e. miners still profitable, and a weaker currency would allow other sectors to prosper as well.

            Oh BTW, when ore was last at $12/t (2002) we had plenty of tourists and Aussie (in-bound) tourism was booming.

          • Alex Heyworth

            Yes, somewhere in the $60-90 range is where you would expect sustainable long term prices to be.

            We only had tourism booming back then because the low ore price wasn’t caused by a global slump.

      • Thanks HnH. IMO you cannot effectively plan for genuinely catastrophic events. What unfolds being fast moving, fluid and often highly unpredictable.

        Events that result in recession are not uncommon. How you would prepare for them in Australia’s circumstance I am not sure. I still am in the run with bulls(boom) camp until the end. There is little alternative.

        It ain’t over until it’s over.

    • Well done getting Fairfax to run it.

      You’ll have Buckley’s once Gina takes control. What’s she up to now? 15%?

      • Alex Heyworth

        Interesting perspective, Lorax. Why do you think Gina would not want a piece critical of the current government published? Do you think she would baulk at having the words “tax” and “mining” mentioned in the same article?

  13. ‘How do you plan to invest and grow amid a nonsense world?’

    I plan to save more, not buy a house, dabble a little bit in charting playing medium term movements, and wait for a bottom sometime in 3-10 years. And read MB everyday of course.

    That’s my long term plan for this month, mind you.

  14. Mr SquiggleMEMBER

    Excellent stuff.

    One thing sticks in my memory

    “The other great pillar of the Rudd government was fiscal conservatism. This too made sense…..”

    It was Rudd himself who confused the picture. One year he was crowing that he was economically conservative, the next he was bagging economic rationalists.

    Just like the current class-war nonsense. Dump on Gina Rinehard one week, approve 1700 migrant workers for her project the next.