Wednesday, October 29, 2008

The fallacy of number - financial maths, financial models and the global financial crisis

Many years ago while on an exchange program with a small merchant bank as the Manager, Corporate Finance, I handled their first leverage lease on a jumbo jet. initially, the apparently complicated spread sheets put me off. Then I realised that the critical issue was simply to understand the assumptions built into the spreadsheets.

Recently this experience has come back to me because of the global financial crisis. How did so many clever people get things wrong?

A post in Club Troppo by Peter Cebon, Peter Cebon on innovation and the financial crisis, suggested that the problem was due in part to systemic complexity. This rang true.

The central point with complex systems is that the more modules or parts, the greater the complexity of the systems, the greater the integration within systems, the more likely it is that things will go wrong. This comes about because the chances of unforeseen results rises with complexity, while close integration allows for faster spread of results through the system.

This said, I was still surprised at the failure of people to properly assess risk.  

In recent years, I have noticed the continuing rise of what I call the fallacy of number. In simple terms, if there is a number, it must be right. Present some overheads, an excel spread sheet, and people will accept what you say.

Financial models have their place. They allow complex issues to be tested and presented. However, they can also be a great danger because they are only as good as the assumptions and data on which they are based.

Like most managers or advisers, I am out of touch with the complexity of modern financial maths. I barely understand the Black-Scholes mathematical model, let alone all the things based upon it. However, I come back to this issue. If you are responsible for something and do not understand the implications, you must ask questions until you do.

This is not always easy. Working on a project recently I acquired a reputation as obsessive about detail, almost a pedant, because I would not accept things, but kept digging until I understood. Some of my professional colleagues laughed when they heard this, because I am not by nature a detail person - I like the broad picture. I did not make myself popular. However, in this case the project worked because of my obsessive approach.

Many of us are frightened of asking simple questions because we fear that we will be seen as dumb. Here I think of Bob Gregory, one of Australia's best economists, who taught me on my economics master's course. I suspect Bob would be very surprised to know how much influence he had on me. I was not one of his best students!

Bob was never afraid to ask simple questions. At seminars his line, look, there is something I do not understand, would send people running to check their assumptions and analysis. I always bear this in mind in my work.

Part of the problem in the current financial crisis is that there were simply not enough Bob Gregorys.        

Monday, October 27, 2008

Return of the economist

I worked as an economist and policy adviser for the first part of my career. Later as a senior manager and strategic consultant, economics dropped back to simply part of my intellectual and management tool kit.

In the period since I first did economics, I have watched what I saw as the discipline's decline in the face of the inexorable rise of finance and financial analysis. Now economics is back.

I think the strength of economics lies not in its mathematical and quantitative aspects, but in the way its structure of thinking teaches one to ask questions, to analyse problems. In my view, and I accept that this is a prejudice, part of the reason for economics' decline lay in the way that the mathematical and quantitative elements came to dominate what had been a more broadly based discipline.

I would no longer claim to be a professional economist. I am too out of touch with recent developments in the profession. However, I am finding my core skills as an economist back in demand as I try to explain to myself and others some of the elements in the current economic turmoil. I am using the word economic rather than financial in this case because of the way that what was a financial crisis has spread to the real economy.

Today's post on my personal blog, Puzzles about the fall of the Aussie dollar - more economics 101, discusses the implications of the fall in value of the Australian dollar. Here I saw little point in trying to explain the reasons for the fall - markets are as markets do. I was more concerned to try to understand the implications of the fall.

There is nothing especially profound in my analysis. Think of it simply as an outline of some of the variables involved.

Friday, October 24, 2008

Musings in the midst of economic downturn

I have just finished up-dating the reference posts at the end of an up-date post, Ken Henry, Malcolm Turnbull and the Australian Government's bank deposit guarantee - issues arising, that I did yesterday on my personal blog on the evolving crisis in Australia's non-bank financial sector. Yesterday afternoon the total of frozen funds had reached $A5 billion. This morning the total appears around $A8.4 billion.

This crisis was triggered by the Government's bank guarantee package leading to a flight to safety. Federal Treasurer Swan may be right when he says other factors are involved, but the package was the proximate cause. The Government's response will probably be announced some time today.

Looking back over past posts, I decided that it might be worthwhile providing a summary of some of the linked themes that I have written on over the last three years. I am not going to provide links at this point. I simply want to capture the main elements.

As a former senior Commonwealth public servant who has also dealt extensively with Government from the other side of the fence, I have written a fair bit on public policy and public administration. One reason for doing so has been a growing feeling of discomfort at what I see as an increasingly mechanistic approach to public administration and policy including the mis-application of approaches that I once supported.

To understand the nature of the changes that had taken place I looked at the evolution of public administration since the second world war, pointing to the 1970s as the tip decade that marked the end of the old, the start of new approaches. I think that this is relevant today since we are at another such point.

In writing I pointed to the way in which new attitudes to the role of the state combined with new market based ideas and new approaches to management to create a new public administration/public policy orthodoxy. In doing so, I also tried to demonstrate that many of the new ideas in public administration were sub-sets of broader trends, including the rise of quantification and standards based approaches. In turn, these linked to the rise of performance measurement, key performance indicators and performance based bay.

I remain a supporter of many of the new approaches, but in their place. The problem now is that they have become deeply entrenched, internalised, and are in fact applied back to the private sector through law, regulation and Government procurement.

Much of my writing as a management professional has been concerned with nuts and bolts stuff, trying to help managers do their job better, to help firms manage and plan better. However, my increasing dissatisfaction with modern management, with what I see as short-sighted behaviour, with the importance of fashion, has led to a growing emphasis on a return to more old-fashioned management techniques. A return to basics.

This led one of my colleagues to comment on what he saw as an increasingly old-fashioned flavour to my management comments. Perhaps that's true, although I have also been trying to develop new thinking in areas such as the resilient organisation and evidence-based management, although these too are in danger of becoming fashions. Certainly the old-fashioned tag is dangerous for some-one who is getting older!

Whatever the case may be, I find it increasingly difficult in advising, in trying to bring in new approaches, to hold my tongue when I know that things won't work. Perhaps it is time to wear the old-fashioned tag with pride?

The professional areas in which I work are themselves sub-sets of broader society. As a strategist and social commentator I am fascinated by the processes of social and cultural change. Here some of my recent writing has focused on two main, linked, themes.

The first is the growing aversion in society to risk, the belief that risk can be controlled, that adverse outcomes must be prevented by regulation or law. This is both dumb and dangerous. Risks can be managed, they cannot be controlled. To think otherwise creates a recipe for failure.

The second theme is the burden of compliance costs. In trying to avoid risk, we not only limit individual freedom to do things, we also create an economic burden that is now (to my mind) more than we can afford.

I have written about these issues in economic, management and public policy contexts. To take a public policy example, child welfare policy in NSW is a mess. In our desire to avoid things such as child molestation, we have created structures including mandatory reporting that are no longer workable. Those struggling to deliver in such systems finally give up.

More broadly, a fair bit of my writing is concerned with longer term issues.

I do not believe that one can forecast the future. There are just too many variables, the interactions are too complex. However, it is possible to identify trends, to develop frameworks, that assist understanding of the present as well as planning for the future.

This is not always easy to get across in a world dominated by activity based short term targets. To illustrate by example.

The impact of demographic change and especially the aging of populations in many western countries has been known for some time. In similar vein, the feminisation of the professions has been a feature for a number of years, as has the changing attitudes of staff to work.

For at least the last eight years I have been arguing that firms need to consider these trends in business and work force planning. Only now as these trends bite at operational level are organisations starting to take them into account. For some, the price will be high as they scrabble for workers in an increasingly competitive environment.

It may sound odd to you to be saying this at a time of economic downturn. In fact, this is just the time to be considering long term issues.

The downturn will pass. As it does, the core underlying trends will emerge with added force. Those firms that survived but who have focused on the short term may not survive the upturn.

Tuesday, October 21, 2008

Unintended Consequences - Australia's bank guarantee places pressure on the on-bank financial sector

As I write, Australia's biggest and mortgage fund, Challenger Howard Mortgage Fund, is reportedly considering placing a freeze on withdrawals following a rush by depositors to withdraw funds for transfer to the now guaranteed banking sector. Other non-bank financial institutions are facing similar pressures.

The difficulty is that a guarantee intended in part to protect the global competitive position of Australia's banks also enhanced their domestic competitive position. Those withdrawing funds are apparently not retail investors, but big funders seeking protection of the unlimited guarantee.

According to the lead story in today's Australian, the Reserve Bank warned that an unlimited guarantee could severely distort competition in Australia's financial markets. It seems to be doing just that.

Sunday, October 19, 2008

Management Perspectives - most popular posts 3

It is a bit over three weeks since I did my last post on the most popular posts among my last 100 visitors. My stats package only allows me to track the last 100 at any one time.

The three most popular posts by a considerable margin were:

So the top three this time are the same as last, if with some shifts in rankings.

The next two posts were:

Then there were five equal posts:

The chart to the right shows the countries of the most recent 100 visitors. Quite a spread. Australia has replaced the US as the most popular.

Saturday, October 18, 2008

The financial crisis - Professor N. Natarajan's view from India

Just a note.

One element in the discussion on the financial crisis has been the role of, and impact on, Asia. However, there has been very limited reporting on Asian impacts. For that reason I found Professor N. Natarajan's perspective on India interesting. See Declare Emergency In India for further details.

Thursday, October 16, 2008

Paul Frijters observations on the financial data + measures of decline in Australian personal wealth

Paul Frijters had a rather useful (and simple) piece in Club Troppo, The end of the party or the start of a new one? Observations on the financial crisis.. The discussion in comments is worth reading as well.

Jessica Irvine had a piece in The Sydney Morning Herald reporting on the latest official figures on the decline in Australian personal wealth. She does not report the source of the data, nor have I been able to find it to check.

Subject to this qualification, Jessica reports that average personal wealth has fallen by $12,000 (3.6 per cent) from its peak in September last year to just more than $237,000 at the end of June. This is the largest decline since the recession of the early 1990s. However, as at end June, personal wealth was still up 94 per cent over the decade, 29 per cent over the previous five years. but follows an increase of 94 per cent over the previous decade.

Richard Salmons in The Age quotes Saul Eslake as saying that "the stark difference between the relatively buoyant Australian economy and the serious economic problems in the United States was a result of the growth in Australians' assets in the past three years. Since March 2000, when the US share market peaked, Australian households had increased their wealth - net of debt - by 28 per cent. By contrast, the wealth of American households has fallen by 11.7 per cent, as the US market, for the first time since World War II, retreated for a third consecutive year. "

Salmon's also notes that Australian superannuation funds lost 7.2 per cent of their value last year - their worst result in 28 years.

Just for the record, there are 808,604 Australians aged 65-69, 1,064,370 Australians aged 60-64. These are the groups that will be hit double by fall in superannuation values on one side, interest rates on the other. The fact that the share boom created well above average returns in recent years is small consolation for those who did not exit on the higher returns and who have been counting on their lump sum.

The overall effect of the decline in values is beyond the scope of this post. However, it does have major implications for the million or so Australians who were planning retirement in the next few years.

I think that the key point at this stage is that the numbers show why the decline in asset values is having such impacts.

Tuesday, October 14, 2008

Australian Government's new stimulus package

This morning in Keeping a sense of perspective I suggested that the Rudd Government should take a deep breath before rushing into economic stimulus measures. This afternoon the Government announced a $10.4 billion Economic Security Strategy to strengthen the Australian economy in the face of, and I quote, the worst global financial crisis since the Great Depression.

My point in this morning's post was the need to take time to address issues in the real economy. Mr Rudd has chosen to act now, still using the language of economic warfare, so what's in the package?

The announced approach contains contains five key measures, four of which are new:

  • $4.8 billion for an immediate down payment on long term pension reform.
  • $3.9 billion in support payments for low and middle income families.
  • $1.5 billion investment to help first home buyers purchase a home.
  • $187 million to create 56,000 new training places in 2008-09.
  • Accelerate the implementation of the Government's three nation building funds and bring forward, the commencement of investment in nation building projects to 2009.

This new spend will be entirely funded from the budget. Mr Rudd notes Treasury advice that the Budget will still be in surplus after these measures. The Government will publish a full budget update in the Mid-Year Economic and Fiscal Outlook within a month.

Pension Payments

There will be a lump sum payment of $1,400 to single pensioners and $2,100 to pensioner couples made from 8 December covering.

  • Age Pensioners;
  • Disability Support Pensioners;
  • Carer Payment recipients;
  • Wife and Widow B Pensioners; Partner, Widow and Bereavement Allowees;
  • Veterans' Affairs Service Pensioners;
  • Veterans' Income Support Supplement recipients;
  • Veterans Affairs Gold Card holders eligible for Seniors Concession Allowance;
  • Those of age pension age who receive Parenting Payment, Special Benefit, or Austudy;
  • and Eligible Self Funded Retirees holding a Commonwealth Senior Health Card (CSHC)

People who are receiving Carer Allowance will also receive $1,000 for each eligible person in their care.

The Government's Economic Security Strategy includes help for self-funded retirees who are eligible for a Commonwealth Senior Health Care Card. Those who hold a Commonwealth Seniors Health Card or are Veterans Gold Card holders eligible for Seniors Concession Allowance will receive a payment of $1,400 if they are single or $2,100 to couples.

The Rudd Government approach is presented as a first step in pension reform and follows the lump sum approach introduced by the Howard Government. The spend should flow directly into increased consumption.

Child Payments

There will be one-off payment from 8 December to certain parents of $1,000 for each eligible child in their care. Those who will receive the support include:

  • Families who receive Family Tax Benefit (A); and
  • Families with dependent children who receive Youth Allowance, Abstudy or a benefit from the Veterans' Children's Education Scheme payment.

The Family Tax Benefit is means tested, but cuts out at a reasonably high income level. The Government's costing estimates are based on payments for around 3.9 million Australian children.

Again, the focus is on people who are likely to spend.

First Home Buyers

The current First Home Buyers scheme will be amended:

  • First home buyers who purchase established homes will have the grant which they are currently entitled to doubled from $7,000 to $14,000; and
  • First home buyers who purchase a newly-constructed home will receive an extra $14,000 to take their total grant to $21,000.

First home buyers will be eligible for the First Home Owners Boost from today (14 October, 2008). All contracts entered into by 30 June, 2009 will be eligible for this new additional assistance.

This one is a very mixed blessing. The increase in the grant on existing homes will, as happened when the original scheme was introduced, flow straight through into higher house prices.

The grant for new homes should add to construction.

Jobs and Training

The Government will spend $187 million to create an additional 56,000 training places this financial year in the Productivity Places Program. Mr Rudd states that there has been a huge demand for training since the Productivity Places Program began in April, with more than 50,000 jobseekers enrolled and over 11,000 having already completed their training in areas of skill shortage.

Nation Building

The Government will accelerate the implementation of the Government's three nation building funds. Government Ministers will bring forward their interim Infrastructure Report so that work can commence in 2009 on projects in the key areas of:

  • Education and Research;
  • Health and Hospitals;
  • Transport and Communications.


I have mixed views on this package. At this stage I just wanted to get the details down. I will comment on the implications a little later.


For the benefit of those interested, I extended my analysis of the economic stimulation package in two posts on my personal blog:

Keeping a sense of perspective

The first stanza of Rudyard Kipling's If reads:

If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;

I was reminded of this last night listening to both the Australian Prime Minister Rudd and Opposition Leader Turnbull talking on TV.

I did not intend to post today - I try to limit my posts on this blog to three a week. But seriously, we are in danger of entering very bad policy territory.

So far as Australia is concerned, I think that the financial crisis is over. It was always an international rather than domestic issue, but we had to deal with the flow-on effects. Globally, too, I think that we will soon be able to put it behind us.

We now have the problem of the real economy. Already trending down, this has been hard it by the financial turmoil.

Managing the real economy is a matter for sensible fiscal and monetary policy. Yet here the rhetoric of at least Australia's leaders is still dominated by the financial crisis - we must avoid global melt-down.

Please, Mr Rudd, take a deep breath. Yes, we need to take action to reduce the effects of economic downturn. But we also need time to think the best ways through.

If you treat the real economy with its longer lead times as though action here was part and parcel of the financial crisis, we are going to end up with a mess. Let's avoid this if we can.

Sunday, October 12, 2008

Australia guarantees all domestic bank deposits

Note to readers: I have added a brief postscript at the end of this post on the competitive implications of the Australian move.

According to breaking news reports, Australia will guarantee all bank deposits for three years and guarantee wholesale funding to Australian banks in an attempt to combat the global credit crisis. Australian will also double the funds available for mortgage-backed securities to $8 billion to help maintain liquidity for non-bank lenders. The move is apparently being coordinated with New Zealand.

The Australian move has been driven in part by competitive pressures following guarantees by other countries. Australian Prime Minister Rudd said while Australian banks were well capitalised and well regulated, the measures were needed to help Australian banks compete with others in the international market.

Under the plan, all deposits in Australian banks, building societies and credit unions, will be guaranteed by the Australian government for the next three years. Deposits in Australia tally between $600 billion and $700 billion, Mr Rudd said.

In return for the guarantees, banks would have to pay an insurance premium levied at an appropriate rate determined between treasury and the banks to ensure, in Mr Rudd's words, that this is not simply a free gift from the government by way of a guarantee to the banks.

The government will also guarantee term wholesale funding to local banks until global financial markets stabilised. This means according to Mr Rudd that anyone lending money to an Australian bank has an assurance their money is safe.


I have been watching the media comments on the Australian move. While there has been a lot of blog commentary, the main stream international media while noting the announcement has largely focused on what they see as the main game.

The Australian move will not affect stock exchange prices, Australia is too small a player, but it does have interesting implications.

At a purely domestic level, it effectively takes Australia out of the direct effects of global financial trouble. Australia will still be affected by global downturn, but the financial crisis should no longer be relevant to domestic financial market forces. Policy can instead focus again on economic fundamentals.

At a second level, it is likely to enhance the global competitive position of Australian financial institutions, something that the Australian Government clearly had in mind. The end effect here depends upon actions by other countries, but the effect is still likely to be positive.

All this, of course, depends upon the validity of my assumption about the soundness of Australian banks.

If, as I believe, there is not a problem, then the Australian move has little risk. The Government is in fact likely to make a profit out of the whole thing. If I am wrong, then all bets are off.

Saturday, October 11, 2008

Finance 101 and the global financial crisis

A short post just to mention that I have continued my on-going discussion on the global financial crisis in a post on my personal blog, Saturday Morning Musings - finance 101 and the global financial crisis. My end point in that post was:

To my mind, we should consider putting a bullet through the entire current corporate control and reporting system. It does not and cannot work. Instead, we should focus on what we really want to achieve.

The problem we have at the moment is that we fix things by changes at the margin when we should in fact be replacing the whole system. The last sentence, focusing on what we want to achieve is, to my mind, critical.

Thursday, October 09, 2008

Australia and the global financial crisis

The graphic shows the latest IMF projections for world growth. Those interested can find full details here.

There is a dreadful fascination in watching the global financial crisis unwind. I wish I had a spare billion or two to invest at a personal level just at present. There are some interesting investment opportunities emerging.

I must say that I find some of the continuing discussion confusing because it mixes together so many very different issues. It is quite hard to stand back and look to the longer term.

This post is intended to clarify my own thinking.

Financial vs Real Economy

In Why the US financial package should be rejected - and why Australia will ride out the storm I suggested that one problem with the US Rescue Package lay in the way it mixed together two very different things. The first was the maintenance of liquidity, I should add here the restoration of confidence, so that financial institutions could lend to each other. This was a good thing. The second appeared to be the maintenance of US property values. I thought that this was plain silly.

Economists usually make a distinction between the financial and real economies. One of our problems just at present is that the two have got out of kilter along three dimensions.

Dimension one is a shift in the relative size of the two. The sheer volume of transactions dwarfs the physical economy. One consequence has been greater instability in key markets on which the physical economy depends. The current financial crisis is but one, if the largest, in a long series. The traders have acquired a life of their own.

Dimension two is the way in which the financial markets have supported, leveraged, the growth in value of certain types of assets. During the long boom period, this supported rises in corporate and consumer debt, in turn fuelling demand. However, the process also resulted in a growing gap between the real sustainable value of assets and market prices.

Dimension three is the growth in the size of the financial sector itself within the real economy.

If you look at the attached chart from the New York Times, you can see that over the last thirty two years, the finance sector's share of total US wages and salaries rose from just over 5 per cent to 9.8 per cent. During that same period, its share of US corporate profits rose from around 17 per cent to 27.4 per cent.

What goes up is likely to come down. The problem we now have is that all three dimensions have gone into reverse at the same time. Leveraged growth has turned into leveraged decline.

I am not saying anything new in any of this. However, I am not sure that people fully realise the implications.

In past busts of this type, one outcome has been a relative decline in asset prices until a new value equilibrium is reached. This creates pain, but also lays the basis for subsequent growth. The scale of the problem this time, the way in which de-leveraging has been wiping out corporate and individual value in certain countries, creates a desire to try to maintain asset prices.

The problem here is that success is likely simply to prolong problems. We may stop collapse, but many countries may face stagnation until real equilibrium in asset values is restored.

Australia remains the lucky country in all this. We have a long history of booms and busts. We were not immune to the global financial boom. However, this time a number of things have combined to work in our favour. Here three things are of particular importance.

The first has been our improved terms of trade as a consequence of rising food and commodity prices.

Australian commentators have talked about the emergence of a dual economy, a flat economic sector especially in NSW on one side, booming resource economies on the other. What is, I think, less clear, is that this has cushioned an adjustment process that began some time ago.

As an example, Australian residential construction is close to record lows because of the end of the previous housing boom, but the economic effect has been contained. Our worry now is how to expand housing, not to preserve asset values but to meet a rental shortage.

The second thing working in our favour is that our excesses were simply less. As a consequence, we do not have the type of systemic problems that exist in some other countries. Among other things, this means that Australians are (so far at least) simply not worried about domestic bank crashes. It just won't happen.

This links to the third thing working in our favour, the way our official systems have worked.

Worried about excessive demand and potential inflation, our Reserve Bank has been tightening monetary policy for some time. Over the last few years, we have seen interest rates rise steadily as the Bank sought to contain the economy. With high interest rates by world standards, there is now scope to cut.

At fiscal level, the booming economy has allowed for budget surpluses and debt repayment. At national level, we have no net official debt. I have argued that this process has gone too far, but no-one can argue that it has not put us in a strong position to use fiscal policy to support expansion if we need too.

One interesting side-effect that I had not focused on is that Australia now has the sixth largest Sovereign Wealth Funds in the world. I have not written about this before, but should do so. Australia also has a large and growing pool of investible funds because of the impact of the superannuation guarantee levy.

All this means that we are in an unusually good position to ride through current troubles.

Shifts in the economic tectonic plates

If you look at the IMF projections, you can see that the IMF believes that while developed economies will enter recession, growth will continue in some of the developed economies including India and China.

As I see it, the current global financial crisis is like an earthquake marking a shift in the economic tectonic plates. As part of this, the share of the global economy held by the big emerging economies will increase.

Of course they will be affected by the downturn. We can see this in China already with downturns in certain sectors linked to export markets. I actually think that the impact will be greater than the IMF allows. However, it remains true (as the IMF suggests) that these economies have significant capacity to expand domestic activity to compensate.

From the viewpoint of China, the current downturn may be a blessing in disguise. China has been suffering from rising input costs. These were going to squeeze some export activities anyway. The global downturn provides China with the opportunity to expand domestic investment and consumption at a lower price than might otherwise be the case.

Australia may suffer in the short term because of lower commodity prices, but we can still make a fair bit of money.


I suppose my key point in all this at global level is that we need to keep a sense of perspective on the changes. At local level, I feel that Australia remains the lucky country.

Wednesday, October 08, 2008

The international financial crisis - return of the liquidity trap?

All those years ago when I did macro-economics for the first time, one thing that we learnt about was the Keynsian concept of the liquidity trap. This came about where no matter how much you lowered the interest rate or expanded the money supply (=liquidity), there was no impact on economic activity.

This came about because, among other things, plans to save were greater than plans to invest. In these circumstances, economic activity would contract no matter the expansion in liquidity. The only solution was fiscal policy, an expansion in real spend.

I think that this where we are now.


I had no idea when I penned this simple post this morning just how right I appear to be. Listening to the news tonight - it is now 10.50 -the continuing financial meltdown is flowing straight across into the real economy. In Australia, consumer confidence is down 11 per cent.

In all this, there are rich pickings for some such as the Commonwealth Bank's acquisition of BankWest.

Monday, October 06, 2008

We managers need to be easier on ourselves

Much of my writing on management issues deals with the way that we as managers might improve our performance. Yet recently I have had cause to question whether this constant focus on performance improvement might not be wrong.

Don't misunderstand me. All managers have a professional responsibility to improve their skills and performance. It's just that I feel that we are in danger of setting absolute benchmarks, expectations, that cannot be delivered.

Our management skills vary. Further, all of us are better managers in some circumstances than another. None of us can be perfect.

My feeling is that we should stop agonising over the question as to whether we are a good manager or not. Instead, we should just focus on improving what we do.

Yes, this is still a focus performance improvement. But the emphasis is on relative improvement, not some focus on an absolute benchmark that none of us can meet.

We cannot aim to be perfect. We can only aim to improve what we actually do now.

Friday, October 03, 2008

The remarkable fall of the Australian dollar

After many years as a professional economist and strategic consultant, I know better than to try to predict the market. Still, both my wife (she is also an economist) and I blinked at the current decline in value of the Australian dollar as, and I quote, a "risky" currency.

Australia's economic fundamentals are some of the best in the world. Yes, local interest rates will fall, but so will they elsewhere.

Still, one should not complain. While the decline in the aussie will add to local inflationary pressures, it will also provide gains to exporters while discouraging imports. That's not a bad thing just at present.

Thursday, October 02, 2008

The international curse of the ratings agencies

I know of no solution to this, but the ratings agencies have become something of an international curse.

As originally envisaged, their role was to aid transparency through the provision of information. Who could argue with this? The difficulty is that they have really become players in their own right, exercising authority without responsibility. The problem here lies in part with the agencies, more with those responding to them.

At Government level, the Australian state of NSW provides a current example. Maintenance of the state's triple A credit rating has apparently become the key policy driver. But to what purpose?

NSW faces a difficult budget position because of the current downturn in the State's economy. The state also needs a range of new infrastructure because of previous under-spending, driven in part by the perceived need to limit debt to retain the triple A rating. Further, the desire to limit debt has also driven the state into various forms of private-public partnerships, some of which have been fairly spectacular failures.

Just at present the NSW economy is in a slump. In the old days, this would have provided the opportunity to expand capital spending to catch up on the infrastructure back-log without adding to resource pressures. Not now.

Would it matter if NSW was slightly down-graded in credit terms? Not really.

Debt as a proportion of state GDP is low in historical terms. By global standards, NSW is a highly secure borrower. Given a shortage of Government debt in Australia at the present time (the Commonwealth itself has no net debt), I suspect that any NSW public loan raisings would be rushed. NSW simply does not need the rating agencies at this point.

At private level, the most significant problem is the way in which changes to ratings have become market players in their own right. Assume a sound company. A change in ratings can lead to loss of support that then affects company funding. In worst case, sound businesses may actually be forced down because of reduced capacity to fund activity.

In all, a bit of a mess!


Winton Bates, an economist with long Government experience, had an interesting post on this one - Why did the rating agencies put their reputations at risk?

Wednesday, October 01, 2008

Why the US financial package should be rejected - and why Australia will ride out the storm

This post deals with two issues, one macro, one local.

Listening to the debate on the proposed US financial rescue package, I have slowly come to the conclusion that it should (at least from a US perspective) be rejected. I say this for one core reason.

The package mixes together two very different things. The first is the maintenance of liquidity so that financial institutions can lend to each other. This is a good thing. The second appears to be the maintenance of US property values. This is plain silly.

What will happen if the package is rejected? The worst case is that the US economy will slip deeper into recession as necessary corrections for past excesses work their way through. We have seen this before. The right economic answer would be to use monetary and fiscal policy to then expand the real economy.

What will happen if the policy is accepted? At best, it may ease the immediate pain, while leaving the US economy (and Government) saddled with still over-valued assets. The outcome will be slower longer term US economic growth.

Both Australian PM Rudd and Opposition Leader Turnbull are strong supporters of the rescue package. Both have the Australian, not the US interest, at heart. Both are, to my mind, wrong. We do not want a reduction in immediate local pain if the outcome is an enfeebled US.

Australia will survive current US problems. We do have significant structural problems, but they are far less than the US.

Our banking system is sound. Liquidity is a problem because of the flow-on effects of the impact of the sub-prime crisis on international bank lending. However, we also have a very large domestic deposit base. Non-bank lenders have been hardest hit by the collapse in liquidity because they do not have this deposit base. Hence the Government's actions to improve liquidity in this area. Overall, we are not going to see bank collapses even if the banks have to take major write-downs.

Our Government financial position is sound. Even NSW, Australia's basket case economy, has very low debt relative to Gross State Domestic Product. Our Federal Government has a present budget surplus and no debt. The Australian Government system has a whole has great capacity to use fiscal policy without mortgaging the future.

Our trade position is much weaker. However, and here Mr Keating (not one of my favourite people in normal circumstances) deserves credit, we have a floating exchange rate.

We can expect an export hit. Commodity prices will fall, although base demand will continue. Food prices may fall a little, but demand will continue. Service exports will decline. Here I am especially concerned about the education sector because we have built structures that in fact depend upon full fee paying students. If on worst case scenario we get a major decline in this area, all our major universities will need some form of bail-out.

While exports may decline, a floating exchange rate means that the external trade position will tend to adjust with time. We may see a fall in the value of the currency, although this is not certain. Should this happen, there will be flow-on inflationary effects. However, these can be managed.

In all this, both Government and Opposition have been spooked into a short term focus. In my view, now is the opportunity to adopt a longer term perspective. What should we do to build the domestic economy, including especially our infrastructure? What might we do, as we did during the Asian financial crisis, to help our Asian neighbours and trading partners adjust to the crisis?

Take China as an example. Chinese car sales are dropping in part because of price hikes on raw materials. Should the Government in conjunction with our resources sector be looking to lower China's raw material prices to encourage Chinese domestic demand?

I am not saying that we should. I am simply arguing that we need to think about our strength in a more turbulent world.