Wednesday, December 24, 2008

Happy Christmas to all

As I write, my last post was Economic implications of the Australian Government's Nation Building package on 14 December. I have in fact several part completed posts, so don't be surprised if several posts suddenly appear dated prior to this post! Here I am going to take advantage of the Christmas break to complete some writing.

This blog began simply as a way of recording some of the writing that I and other Ndarala colleagues had been doing on management issues. More recently, I have been using it more as a place for discussion on economics related issues.

I have really enjoyed this, although I do not want to lose total sight of the management content. The change in focus has also led to a sharp increase in the number of visitors. This obviously pleases me.

To all my readers of all faiths and none, I wish you a happy and peaceful Christmas.

Sunday, December 14, 2008

Economic implications of the Australian Government's Nation Building package

Hunter Valley Coal Trains - Maitland

This photo shows coal trains passing in the Hunter Valley.

For the benefit of international readers, the Hunter Valley lies north of Sydney and is one of Australia's major coal provinces. If my memory serves me correctly, it is now the largest coal producing area in the world.


On Friday 12 December 2008, the Australian Government announced the latest economic stimulus measure, a $A4.7 billion national building package. I will discuss this in a moment. However, first I wanted to summarise the key steps that the Australian Government has taken so far. I don't know about you, but I am starting to lose track.

To do this, and despite my complaints about dreaded text tables, the following table summarises some of the measures.

Date Measure Comment
12 October Government guarantees all bank deposits plus new international borrowings by Australian banks to preserve liquidity, overcome loss of confidence, protect the bank's international competitive position Achieved its objective at one level, but also triggered a run on mortgage funds
14 October $10.4 billion Economic Security Strategy with two key elements, one-off payments to certain social security recipients from 8 December to boost demand plus increased first home buyers' grants for a defined period intended to increase home building over 08-09 and especially 09-10. With the cheques just going out now, too early to judge impact.
10 November Green car plan - $6.2 billion plan to make the automotive industry more economically and environmentally sustainable by 2020. While the Government is now including this in its list of stimulus measures, it actually reflects different policy drivers. 
18 November $300 million to fund immediate new capital spending by local Government, with funds to be committed by end June 2009. A broad based measure designed to have impact in the second half of 08-09 and 09-10.
29 November

COAG package - $15.1 billion to stimulate the economy and drive significant reform in health, education, housing, business deregulation, and closing the indigenous life expectancy gap. Claimed to create 133,000 jobs.

This measure replaces existing measures and is not all new spend. The economic stimulus component lies in a weighting of spend towards the front end to achieve a stimulus affect.   
12 December $4.7 billion nation building package to fund capital projects and encourage business investment. This fund includes  a mix of new spend plus planned spend brought forward in time. 

Despite the problems I outlined in Australia's economic stimulus packages - the practical difficulties in cranking up spend, and despite too the inevitable degree of double counting and spin in some of the wording, there can be no doubt that the Government is trying to boost economic activity especially in 08-09 and 09-10.

The new measures

Those interested in the detail of the latest measures can find them here. Ministerial statements can be found here and here.

I noted, first, that the Government is including specific job creation estimates for this and previous measures:

  • 75,000 jobs through the Economic Security Strategy
  • 133,000 jobs through the COAG Package
  • plus 32,000 jobs through the latest nation building package.

The Australian workforce is about 11.2 million, so we are looking at projected job creation of a bit over 2 per cent of the current workforce. In theory, this should more or less off-set the economic down turn, if with a lag.

The second thing I noted about the latest measures is that the projected $4.7 billion spend is made up of:

  • $2.5 billion in new planned spend plus $2.2 billion in planned spend brought forward. The significance of the second is that the money is already allocated; spend will go up now, down later on.
  • $1.5 billion to be spent in the current financial year, $2.7 billion in 09-10, $500 million in 10-11. Again, we have the biggest impact in 09-10. The Government projects that this measure will add between 1/4 and 1/2 per cent to GDP in that year.

  The proposed spend incorporates a number of very different things

Rail: $1.2 billion to fund 17 railway infrastructure projects. Of this, $580 million will be spent on Hunter Valley rail upgrades, increasing coal export capacity from 97 to 200 million tonnes per annum.

I blinked at this, because the big infrastructure bottleneck at the moment is the port itself, with coal ships often lined up waiting. In April 2007, for example, there were no less than 72 coal ships waiting to enter the port. Presumably, this will be sorted out in future spend.

Other rail spend is designed to remove bottlenecks on the major rail trunk routes between capital cities.

Road: $771 million will be invested in road projects, almost completely made up of accelerated spend on existing projects.

Kimberley development: $195 million has been set aside to fund irrigation and social infrastructure around Kununurra in the Kimberleys in WA.

Education infrastructure: $1.6 billion has been set aside for education. Of this, $581 million will go to fund eleven projects put forward by metro universities, with a further $1 billion to fund teaching and learning capital in TAFEs and universities.

In addition to this planned infrastructure spend, there are two further business stimulation measures.

Pay as You Go payments by small businesses for the 08-09 year will be deferred, with a 20 per cent deferral in the payment due for the December quarter. This is essentially a cosmetic measure providing a short term benefit of $440 million.

More importantly, there will a short term investment allowance of 10 per cent on capital investment over $10,000 in tangible depreciating assets by business in the period up to end June 2009. This measure directly targets business investment at an estimated cost to revenue of $1.6 billion. 


In announcing the new measures, the Government stated that it expected the budget to remain in surplus. We must be getting quite close to the line here, given previous announcements.

The infrastructure announcements strike me as generally sensible because they should yield a direct economic pay-back over and beyond the immediate stimulus effect.

While the part deferral of PAYG payments will yield a short term cash flow benefit, I do not think that this is of any real economic significance. However, the new investment allowance is of more importance.

The problem with this type of measure is that it yields a wind-fall gain to businesses that would have invested anyway. This has to be offset against the gains in investment flowing from the stimulus. That said, the measure does directly target one of the main economic drivers, business investment.

I do not have access to Treasury's econometric model. I would be fascinated to see projections as to how the various bits fit together in economic terms. Without this, it is hard to make sensible judgements as to collective impacts.

In all this, I come back to two key points.

The first is that we remain in a strong position simply because the budget position has been so sound. So long as any Government measures do not create a structural deficit, there remains considerable scope to expand Government spending.

There is no exact science in economic policy in circumstances such as this. To a degree, it comes back to trying things to see what might work.

The second is the continuing importance of the balance of payments. If the stimulatory measures create a serious deficit here, then stimulatory policy will be constrained. Fortunately, and as I argued in Australia's improving trade performance - October 2008 statistics, our position here is quite good.      

Wednesday, December 10, 2008

Australia's economic stimulus packages - the practical difficulties in cranking up spend

One of the interesting side-effects of the various Rudd Government measures intended to stimulate the economy is the delivery pressures created.

In recent years, Australia's public sector has been under constant pressure to do more with less. Now the funding taps have been turned on, with pressure to spend in the 08-09 and especially 09-10 financial years for counter cyclical purposes.

This pressure flows from Canberra down through the COAG (Council of Australian Governments) process to individual state agencies. Throughout Australia, thousands of public servants are working on spend proposals, negotiating supporting arrangements with the Commonwealth, developing implementation plans.

From a public service perspective, there is a great feeling of liberation to know that you can now do some of those things that were clearly necessary but were simply out of court because of lack of funding. However, there is a very real problem here.

There is absolutely no point in developing plans when you know that those plans cannot be implemented. Here one side-effect of the past budget constraints, the need to do more with less, is that the development pipeline has thinned over time. Now when we want to spend, we are actually starting from scratch in many cases.

Inevitably, there will be some waste. By this I do not mean that project spend itself will be inefficient in a financial sense, although this may occur. Rather, that our lack of forward planning means that we will not get the best results from the spend in a longer term economic sense.       

Friday, December 05, 2008

Australia's improving trade performance - October 2008 statistics

In the midst of all the economic turmoil around us, I have been watching the trade numbers especially closely.

In recent years, the balance on goods and services (what Australia sells internationally less what the country buys) has been negative. This has been funded by private overseas borrowings, creating a channel down which the effects of the US sub-prime crisis flowed.

The most recent trade statistics from the Australian Bureau of Statistics show a very important turn-around in this position. In simple trade terms, the country moved from a net consumer to net saver at just the right time, thus cushioning the effects of the global financial crisis.

We can see this in the table below which shows exports, imports and the balance on goods and services, using seasonally adjusted data. All figures are in $AM.

Like all statistics, care must be exercised in drawing detailed conclusions without discussing the underlying basis of the statistics themselves. However, we draw some general conclusions without getting too bogged down.

Month Exports Imports Balance
August 18,599 -20,488 -1,873
September 17,711 -19,920 -2,209
October 17,248 -20,207 -2,960
November 18,340 -20,563 -2,224
December 18,807 -20,644 -1,838
January 19,476 -21,747 -2,271
February 18,741 -21,766 -3,029
March 19,641 -22,136 -2,495
April 21,628 -21,909 -381
May 22,243 -23,215 -981
June 23,262 -23,039 222
July 23,475 -23,969 -494
August 24,773 -23,447 1,327
September 26,378 -25,123 1,254
October 28,141 -25,189 2,952

Source. Australian Bureau of Statistics International Trade in Goods and Services Australia, October 2008, Catalogue 5368.0 

Looking at the table, you can see the pattern of significant negative balances in the early period. Had we been in this position when the global financial crisis struck, we would have been in a great deal more trouble. Instead, the balance went into surplus at just the time we needed it to do so.

Expressed in Australian dollar terms, we continued to increase imports. However, this was more than offset by increased exports in Australian dollar terms. This meant that in the critical months August through October Australia generated a cumulative surplus of just over $A5.5 billion.

These are Australian dollar figures.

If you look at the September and October figures, you can see a sharp jump in both imports and exports. The Australian dollar depreciated sharply during this period against the US dollar, increasing both export and import prices in local currency terms. This was especially pronounced on the export side since 80% of Australian exports are sold in US dollars.

In effect, the global currency traders who dumped the Australian dollar delivered a net benefit to the country in trade terms. This could have been disastrous had it destroyed the Australian dollar market. As it was, the Australian Reserve Bank was forced to intervene several times, buying Australian dollars to maintain liquidity.

Again, the Bank's ability to do this was enhanced by the improvements in the balance of trade on good and services.           

Sunday, November 30, 2008

Shanghai's Bund

End of another month.

The following photo taken while we were in China in September shows the view across the river to Shanghai's Bund. I thought the photo was a good way to end the month because of the importance of China to the global economic outlook.  

The Bund

Friday, November 28, 2008

Operations of Australia's bank guarantee scheme

I had been wondering how the various elements of the Australian Government's bank guarantee scheme were working in practice after the initial negative fall out in the mortgage funds market. A story by Mathew Drummond in today's Australian Financial Review provides some hints. I cannot give you the full link - the story is behind the FR's pay wall.

As an aside, I have been meaning to do an update on the media and the internet. Just a reminder to myself to do so.

From today, Australian banks will be able to use the Government's guarantee to raise funds off-shore, creating triple A borrowings. In Parliament, Australian Corporate Law Minister Nick Sherry said that sixteen institutions had already advised that they would make use of the new facility. However, Mr Sherry did not know at this point just what sums might be involved.

Mathew Drummond notes that the similar British scheme that has now been in operation for a month has lowered funding costs with quite fine margins because of investor demand.

Also from today, domestic depositors with deposits of more than one million dollars will have to decide whether or not they are prepared to pay the insurance premium required to gain the Government guarantee on their deposits. Apparently only Macquarie Bank is planning to absorb this.

My feeling is that a good number won't bother. It all comes back to a risk assessment.

More broadly, I find it interesting that the heat and worry generated by the global financial crisis itself has, at least so far as Australia is concerned, largely vanished.

The topic is no longer a BBQ stopper, although withdrawals from many mortgage funds remain frozen. People are far more worried about changes to the real economy.

In an earlier post, What is the difference between recession and depression? Saul Eslake's View, I referred to Saul Eslake's discussion on the differences between recession and depression. Australia may avoid technical recession, but to most Australians it certainly feels as though the country is in recession.  

Wednesday, November 26, 2008

Winton Bates, Jim and the problem of deficits

I had to laugh. One of my old colleagues (old I hasten to add just because I have known him for a long time), Winton Bates, ran a post Can budget deficits cure the debt problem? reporting on a conversation he had had.

Now that conversation captured pretty well some of the things that I have been talking about. I leave it to you to make your own judgements.

Monday, November 24, 2008

Government budget deficits - cyclical versus structural: lessons from the 1970s

There is considerable discussion in Australia at the present time about the Australian Government's apparent reluctance to run a budget deficit. There is also criticism of the Government's apparent desire to still cut costs at a time of downturn. To a degree, the discussion confuses different issues.

The first key thing to note is the difference between cyclical and structural deficits.

In simple terms, a cyclical deficit comes about because revenue rises and falls with changes in economic activity. With given spend, the budget is in surplus at one point, then goes into deficit, then comes back into surplus. This provides a cushioning effect. Counter cyclical spend fits within this definition because it is specifically time limited.

A structural deficit is different. Here changes to the pattern of revenue and expenditure occur such that a deficit appears independent of the level of economic activity, continuing even at times of higher activity.

The 1970s saw the end of the old concept of the welfare state. One reason for this was that Government spending patterns in many countries ended up with specific built in features that ensured growth in spend faster than could be supported by the longer term trends in economic activity. This could not be accommodated through increased taxation, leading to persistent structural deficits. This crowded out private sector activities and helped build in inflation.

We do not want to go there again. So the issue about deficits is not just the immediate impact, but also the nature of the deficits themselves. We need to avoid the creation of structural deficits.

This leads me to my second point.

The need to control spending, to get the best value from Government spend, continues independent of the state of the economic cycle. We need to prune fat just as much during downturns as at other times. More so in fact, because in this type of downturn financial disciplines can easily become relaxed. Further, Government has a continuing need to re-set priorities as needs change

Pruning spend has an economic impact. In times like this, every dollar we save is simply a dollar that we can then spend in another way.

What is the difference between recession and depression? Saul Eslake's View

A post by Saul Eslake, What is the difference between a recession and a depression?, on Club Troppo provides a remarkably interesting discussion on a topic of interest to many at the moment.

Sunday, November 23, 2008

Scoping the global downturn - a few numbers

It is very easy to get depressed just at present about the global economic situation, especially if you listen to the news too much. In my economics posts I have tried to educate myself and, hopefully, others about some of the economic parameters involved without getting too caught up in the short term detail.

In this post I want to continue the discussion by focusing on a few macro numbers.

The table below sets out 2007 GDP for the top twenty global economies. Between them, they amount to a bit over 81 per cent of global GDP.

First the bad news.

If you look at the relative size of the economies that are either in or likely to enter recession, you can see why the world has an economic problem. In simple back of envelope terms, with countries controlling over 55 per cent of the global economy entering recession, the remaining 45 per cent must inevitably be affected.

The numbers also show why a degree of caution needs to be exercised in talking about the role of countries such as China or India. The US economy is presently a bit over four time the size of China's, so every one per cent fall in US GDP requires a four per cent increase in China's GDP to maintain the economic status quo. 

The figures also indicate the size of the tectonic shift now underway in the global economy.

At present, India and China between them are a bit under one third the size of the US economy. If, as seems possible, the US records average zero growth over the next three years while India and China average 8 per cent over the same period, then (assuming my rough maths is correct), the combined India/China GDP will rise to around 41 per cent of the US total in just three years.    

Table: World GDP 2007

Country Rank GDP
(millions $US)
% World
World   54,347,038  
US 1 13,811,200 25.41
Japan 2 4,376,705 8.05
Germany 3 3,297,233 6.07
China 4 3,280,053 6.05
United Kingdom 5 2,727,806 5.02
France 6 2,562,288 4.71
Italy 7 2,107,481 3.88
Spain 8 1,429,226 2.63
Canada 9 1,326,376 2.44
Brazil 10 1,314,170 2.42
Russia 11 1,291,011 2.38
India 12 1,170,968 2.15
Korea, Rep 13 969,795 1.78
Mexico 14 893,364 1.64
Australia 15 821,716 1.51
Netherlands 16 754,203 1.39
Turkey 17 657,091 1.21
Belgium 18 448,560 0.83
Sweden 19 444,443 0.82
Indonesia 20 432,817 0.80
Top 20   44,116,506 81.12

Source: World Bank

Now for the good news, the reason why I remain optimistic, especially so far as Australia is concerned.

Major developed countries are going to have a nasty downturn whether we like it or not. This is already flowing onto other countries including China where unemployment appears to have risen sharply as a consequence of the downturn in manufactured exports.

In some ways the global financial system is awash with liquidity. However, and putting the financial crisis itself aside for the present, this will not translate into extra activity because people (consumers and business) are reluctant to borrow unless really forced to and then banks are reluctant to lend.

Most governments are putting old fashioned pump priming measures in place intended to stimulate consumption and investment. These will take time to come into effect. Further, the initial effects will be muted because some of the initial spend is likely to flow into savings and debt reduction. People just don't want to spend when things are so uncertain.

To my mind, the big kicker will come as increased government investment spending kicks in. This will vary from country to country, but in all cases will take time. With exceptions such as China which already has projects in the pipeline, governments will have to create project pipelines. From experience, it is likely to be eighteen months before spend accelerates in most countries.

Note that I have said nothing about confidence effects. My personal view is that there may well be more shocks and that, in any event, pessimism is likely to remain dominant until things have clearly started to improve.

Pulling all this together, my best guess is that we are going to see a deepening recession in most major industrial countries over the next twelve months. I do not see how this can be avoided, although the effects are going to vary from country to country.

Beyond this point, I would expect to see progressive strengthening in global economic activity as further investment spend kicks in. This is based just on mechanical economics 101 style analysis.

I really can't see in all this just how a depression might occur in global terms, barring some total catastrophic collapse. My bigger worry is the likelihood that the combined total of Government responses will over-shoot, creating a new set of problems on the other side.

Finishing with a note on Australia.

It would be a brave person who would say categorically that Australia can avoid recession. However, whichever way I look at the numbers, I think that we can say that Australia is better positioned than most to avoid a serious downturn .

We are also better positioned than most to benefit from increased investment spend since we are a key supplier of the commodity products that will be required as inputs into new infrastructure.

To the degree my overall analysis is right, then we are likely to see strengthening export demand twelve to eighteen months out.   

Thursday, November 20, 2008

More economics 101 - capacity utilisation and inflation in Australia: a note

Yesterday I completed another one of my economics 101 posts, More economics 101 - capacity utilisation and inflation in Australia.

I had in fact intended to post it here, but in using Livewriter I still had it linked through to my personal blog rather than this one! So a cross-link post.

Monday, November 17, 2008

Recession and the importance of fixed costs

One thing that I have not seen much discussed in current discussions on the economy is the importance of fixed costs at a time of economic downturn. By fixed costs I simply mean all those things that the firm must keep paying including financing costs. This is a critical issue, especially for smaller businesses that have often entered into arrangements such as leases on cars in part for taxation reasons.

The maths are simple enough. Say that you have sales or fees of 100, a profit of 10, fixed costs of 80, variable costs of of 10. Sales drop by 20 per cent to 80. Now your costs are fixed 80, variable 8, leading to a loss of 8.

There is nothing magical in these numbers. However, they do illustrate one of the key factors explaining the severity of some downturns.

With time, fixed costs become variable. However, in severe downturns firms do not have this adjustment time and can be forced to close as cash runs out. The higher the fixed cost ratio, the sharper the downturn, the more firms are forced to close, adding to downward pressures.

Those firms with better margins or greater net assets survive because they have the time to adjust. However, their action in cutting costs create second round downwards pressures, extending the downturn.

Friday, November 14, 2008

Management Perspectives - most popular posts 4

It is a just under a month 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 top two most popular posts by a considerable margin were:

Then came two posts both previously ranked in the top three:

These were followed after another gap by 

Then after a gap came:

In all, a fairly mixed bag with a bias towards my more recent economics posts.

Wednesday, November 12, 2008

Recession and the pain of adjustment

I was greatly struck by some numbers John Taplin included in his post What Now? He quotes Jeremy Grantham.

An amateur economist could summarize and simplify the Chinese economy as 39-37-37: an astonishingly large 39% of the GDP is capital spending, 37% is internal consumption, and an amount equal to 37% of GDP is exported. (These numbers do not sum to 100 as we are not using exports net of imports because we are concerned with the vulnerability of total exports to a weak global economy.) The U.S., in comparison, is 19-70-13, disturbingly on the other side of normal; 70% consumption compared with 57% in both Germany and Japan, for example, and nearly twice that in China.

The position in Australia is not quite as bad as the US although, as amoranthus keeps reminding me in his comments, our consumption is 62 per cent of the economy.

I looked at some related issues in a post on my personal blog, Agriculture, the environment and Australia's future. There I said in part:

For a long time our mainly urban population has been buying more from overseas than we sell. The gap has been met through overseas private borrowing. This is not sustainable in the longer term.

We have to either increase our saving rate or, alternatively, find new things to sell internationally. If we lose our coal and agricultural exports, the position becomes much worse. Should Steve Truman's gloomy prognostication that Australia may become a net food importer prove correct, then we may find ourselves in diabolical trouble, as will those in other countries that we presently feed.

In Robert Shiller on bubbles the Australian economist Harry Clarke looked in part at the way increasing Australian asset prices concealed our low savings rate.

One of the things that it is easy to lose sight of in the current economic climate is that recession is, in some ways, the necessary corrective to periods of boom. This may be hard to accept by those who are hurt, but is still I think correct.  

During booms, inefficiencies creep into systems across all sectors because growth compensates. Booms allow us to spend more than we are in fact earning. They lead to asset prices that are out of kilter with real values. When contraction comes it exposes all these weaknesses. We are forced to adjust.

This leads me to a nagging worry about the current adjustment packages. To some degree their aim is to restore the status quo, to put us back to where we were before. This creates a number of risks.

To begin with, to the degree they work they may leave the structural imbalances in place. Because these still have to be worked through, the outcome is likely to be low growth.

They may also leave national governments encumbered with debt, limiting future flexibility.

Finally, they risk over-shooting. I have not totaled up the value of all the global support and stimulation packages, but they must run now into trillions of dollars.

The key point to remember about recession is that it frees up resources for other things. If we simply accommodate this by restoring consumption, things remain the same even if we get an immediate stimulus to economic activity.

On the other hand, if we use the free resources for investment purposes then we have assets that can generate future income.

The US has focused in many ways on attempting to protect or restore the status quo, China on future investment. Which do you think is likely to give the best result?   

Monday, November 10, 2008

A note on real estate bubbles

Don Arthur had a good post, Lessons from California’s housing bubble, on Club Troppo that is relevant, among other things, to my discussion on the views of Reserve Bank Deputy Governor, Ric Battellino. I will leave you to read the post, but in the meantime I wanted to make a simple supply and demand observation on one point arising.

The amount people pay for a house depends in part upon how much cash they have, in part upon the value placed upon the house This may reflect personal utility, but also takes into account expected future returns on the house from capital gains and, in the case of rental properties, rentals.

Just because housing is in short supply does not mean that prices will not decline. In simple terms, if people cannot afford to or are unwilling to buy because prices have got so high, then prices will fall.

In a bubble, the demand curve shifts because of people's expectations about the future. With inelastic short term supply, this quickly drives prices up.

In a crash, the demand curve shifts back. Prices fall quickly.

A very interesting feature in Don's article lies in the role of scarcity.

Where rising prices can be accommodated by increased supply, price rises are choked off. Bubbles depend upon inelastic supply responses.

Thursday, November 06, 2008

A non-economist's crib to Australia's economic outlook - part two

In my last post, A non-economist's crib to Australia's economic outlook - part one, I focused on the views of Reserve Bank Deputy Governor, Ric Battellino on the current reasonably strong financial position of the Australian household sector.

In this post, I want to look at the latest Mid-Year Economic and Fiscal Outlook prepared by the Commonwealth Treasury. There has been much commentary on this in yesterday and today's media, looking especially at some of the headline numbers. My concern is what we might learn from the document about Australia's economic outlook. All numbers are in $A unless otherwise noted.

The Official Position

At the time of the May budget, the 2008-2009 Australian Government cash budget surplus (accrual figures are a little higher) was projected at $21.7 billion. This has now shrunk to $5.4 billion. A pretty big fall.

If we look at the reasons for the fall, we find that projected expenditure has risen by $10.6 billion, largely due to the recently announced fiscal stimulation measures.

Taxation revenue is projected to fall by $4.9 billion, largely because of falls in receipts from capital gains and company tax.

Turning now to the forward estimates. For the benefit of international readers, these are longer term budget projections taking into account approved expenditure, including the Rudd Government's election commitments.

The forward estimates show projected cash surpluses of $3.6 billion in 09-10, $2.6 billion in 10-11, rising to $6.7 billion in 11-12.

The headline $40 billion figure used by many commentators to describe the total deterioration in the Australian Governments financial position is the combined change in the surplus from budget time for the total period from 08-09 to 11-12. Expressed in this way, the change is not quite as dramatic as might appear at first sight.

In considering the projected surpluses, I was struck by the following chart (2.2), showing the projected budget position in various developed countries. Australia and Canada stand out. I will discuss some of the economic assumptions on which the projections depend in a little while. For the moment, Is imply note that the figures are indicative of Australia's comparatively strong position.

Chart 2.2: Budgetary positions for selected countries in 2008 and 2009 Budgetary position - selected countries 08 and 09 For the benefit of international readers, I should add that Australia's budget figures, while subject to a range of assumptions so that outcomes are generally a little different, are not rubbery. The Australian Treasury values its reputation.

A further point to note is that Australia's position is very different this time as compared to the previous big crashes of the 1890s and the Great Depression. In both cases Australia was heavily dependent on international borrowings. In this case, the Australian Government has no net debt, adding to fiscal flexibility.

It is important to be clear here.

One measure of international indebtedness shows Australia with high and growing debt. However, that debt is private. The Australian Government's net debt position is positive to the tune of around $47 billion, with debt more than offset by things like the Future Fund, Australia's largest sovereign fund. The Government actually gets more interest than it pays! Full marks to Mr Costello as former Treasurer.

All this leads, as shown in the chart below, to immediate growth projections far better than those in most developed countries.

Chart 1.1: Forecast economic growth rates for G7, Euro area and Australia in
2008 and 2009

Economic Growth selected countries 2008, 2008 But are these better growth projections over-optimistic? To make a judgement here, we need to look at the economic assumptions. Australians will have noted just how careful the current Treasurer is in his comments. It's not easy making assessments in an economic firestorm.

The Assumptions

I am not going to be too detailed in the following comments. After all, this is a crib, not a full scale analysis. Further, the variables are all inter-related, so a change to one flows elsewhere through the system. Treasury uses full scale economic models to test this. I will just point to the linkages.

We all know thatTerms of Trade Australia has been through something of a resources boom and that our terms of trade (the price we receive for our exports compared to the price of imports) had improved. I was struck by the chart (3.3) showing movements in the terms of trade since 1940.

The huge spike in 1950-1951 is the wool boom where demand for uniforms for the Korean War on top of rising consumer demand sent the prices we received for our wool through the ceiling. Wool reached a pound a pound, to the joy of our rural community.

With spikes, our terms of trade then declined until the early nineties. This meant that we had to sell more to get the same volume of imports. Then we had the huge resources boom. We sold more and at increasing prices, while the prices of our imports stayed down because of the emergence of new suppliers and especially ChinBulk commodity spot pricesa. We were indeed the lucky country.

This period has now come to an end. Chart 3.2 shows the collapse in the spot price for two key commodity exports, iron ore and coal. Now here we need to take into account price and volume effects.

We have existing contracts that will hold at least some prices up in the short term. Then prices for commodities can be expected to fall towards the spot price, so that our terms of trade will deteriorate.

To accommodate this, the Treasury projections forecast a decline in the terms of trade of 8½ per cent in 2009‑10. As a result, nominal GDP growth in 2009‑10 is forecast to grow by only 3 per cent, compared to growth of around 8 per cent over the last two years.

Export prices are usually expressed in US dollar terms, while producers receive Australian dollars. This means that with a lower dollar, domestic receipts may stay the same so long as volume of sales hold up, a cushioning effect. In this context, the projections assume that the Australian dollar will stay at a lower level, with reduced but continuing growths in volume because of lower but continued growth in certain countries and especially China.

If the terms of trade deteriorate by more than expected, if the Australian dollar increases in value by more than expected, if export volumes fall, then the projections will change. The Mid-Year paper models two effects, showing how GDP growth might drop to zero or even negative.

Turning now to investment.

High business investment has been one of the recent drivers in economic growth. The projections assume that this will continue in the short term because of projects already underway, but then flatten in 09-10.

Housing investment, another past driver, has been low and falling.This is where Mr Battelino's analysis, A non-economist's crib to Australia's economic outlook - part one, comes in. He suggests, and I think that he is right, that Australia is several years in front of the US housing cycle. We do not have surplus housing stocks, really the opposite. So the projections assume a pick-up in housing in 09-10, driven in part by the first home buyer grants in the economic stimulus package.

On the Government side, the projections show the Government sector making a positive general contribution to growth, driven in part by new infrastructure spending into the medium term.

By size, consumption demand is a key part of the economy. The projections assume that growth in consumption demand will be well down in 08-09, with the economic stimulus package making a contribution in the second part of the year.

Private consumption depends in part upon expectations, more upon consumer incomes. This is where employment conditions are critical. Here the projections suggest an increase in employment of one and a quarter per cent in 08-09, well down from the original budget estimates, just 3/4 of a per cent in 09-10, rising to one and a quarter per cent in 10-11 and 11-12.

This means some rise in unemployment in the short tem at least. The unemployment rate is forecast to rise to 5 per cent by the June quarter 2009 and 5¾ per cent by the June quarter 2010.

Again, we can see the way things inter-connect. If, as seems to be happening at the moment, consumers cut back on spending because of fears for the future, then this will feed through to lower demand and higher unemployment. In this context, the present job market has become very soft.


Troubled times. There are obviously great uncertainties built into the projections, and indeed some commentators have already suggested that the underlying assumptions are too positive.

They may be right. However, we can say two things.

First, the projections do provide an framework for looking and assessing future economic performance independent of immediate day-to-day fluctuations.

Secondly, they and Mr Battelino's analysis do suggest why Australia is in fact in a better position to ride through the current economic storms than many other countries.


Even as I was writing this post, the IMF was releasing new forecasts showing a further sharp fall in projected world economic growth. You can find full details on the IMF site. While the Australian economy is still projected to grow if lower than the Treasury estimates, developed countries as a whole are projected to drop into negative growth.

The new IMF forecasts illustrate the difficulty of making economic projections at a time like this, but do not invalidate the analysis in this post.

The projections have been made on the basis of current policies and ignore the effects of further stimulatory action in various countries. I must admit to a growing concern that the combined effect of the various stimulatory measures may lead to over-shoot in the opposite direction, fueling inflation in due course, leading to another round of corrective measures.

Wednesday, November 05, 2008

A non-economist's crib to Australia's economic outlook - part one

Last week Ric Battellino, the Deputy Governor of Australia's Reserve Bank, delivered what was written up as an optimistic view of the Australian economic outlook.

Following some bad economic news, the Reserve Bank cut official interest rates yesterday (Melbourne Cup day) by 75 basis points. Commentators focused on the apparent difference between Mr Battellino's views and the decision. If things were so good, why was such a deep cut necessary?

Today the Australian Treasurer released the Treasury Mid Year Economic and Fiscal Outlook. Commentators focused on the headline numbers, the decline in the projected budget surplus.

I don't know about you, but I sometimes get confused in the flow of daily commentary and news, in part because I cannot always remember enough of past data and analysis to put it all into a context. For that reason, I thought that it might be helpful if I provided a sort of an economic crib to recent official statements.

Ric Battelinos' Speech

Those interested can find the original of Ric Battelino's speech here.

Headed An Update on Household Finances, the speech was concerned to reinforce confidence among Australian Australian households worried about recent developments.

Mr Battelino began by suggesting that the past five years had been an extraordinarily favourable period for Australian household income. This is an important starting point because it sets a context for the challenges Australia now faces.

During that period, real disposable income of the household sector grew on average by 6.1 per cent per year, resulting in a cumulative increase over the five years of more than 30 per cent.

This is quite a remarkable increase, meaning that the growth in household incomes in Australia greatly exceeded that in any other developed economy, round twice that in the US. For example, growth in real household disposable income was only about half that in Australia. Mr Battelino also noted that the growth in income in Australia was fairly evenly distributed through the household sector in that the percentage increase in real income was very similar across all the income quintiles.

This is a pretty good result, although it also means that income disparities increased because the rich have more bucks on which to get a bang than the poor.

Mr Battelino then looked at the impact of growth on household balance sheets.

This is an important issue because in Australia, as in the US, household debt has been rising. However, unlike the US, the Australian household position is quite strong. Australian household debt position

If you look at the attached graph, financial assets at 30 June averaged around $275,000 per household while liabilities averaged $150,000 per household. Since then, the Reserve Bank estimates that average assets have fallen to around $245,000 per household, leaving quite a strong average positive position.

Note that these are financial assets. They include housing debt, but do not appear to include the value of the family home.

The graph shows just how important superannuation is to average household financial assets. Much superannuation is invested in shares, making the equity component much greater than the formal equity value in the graph.

This is important, because in the short term it means that over a million Australians approaching retirement are suffering from current falls in share values. However, in the medium term it also means that a large majority of Australian households are poised to gain from future increases in share values. Here Mr Battelino iReturns on Sharesncluded a number of graphs to demonstrate the relative performance of shares.

The next graphic shows the total annual return on Australian shares over the last one hundred and something years. The return goes negative every five years or so, sometimes by significant margins, but the average return is very good.

He then compares the return on shares with the return on bonds, a safe cash equivalent, taking $100 in 1908 as a base. The hugely different returns on shares are easy to see in the graphic.

Quite simply, shares have beaten cash hands down over a very long period. This is likely to continue, providing a base for improvement in household financial positions as the share markets recover. Value $100 invested

Mr Battelino then turns to look at the value of housing, the other key household asset.

Here he makes the very interesting point that the boom in Australian housing prices, one that peaked some time ago, did not elicit the same supply side response as in the US. This means that we simply do not have the same number of surplus properties, placinon-performing loansng a floor under prices.

This, in combination with a better underlying household position than the US, helps explain why Australian banks have far fewer non-performing housing loans than in the US.

There are some hot-spots, Sydney's western suburbs for example. Further, non-performing loan figures are worse among non-bank lenders. Even here, though, the Australian position is better, with non-performing loans in Western Sydney by mortgage originators running at about 1.6 per cent as compared to over 2.5 per cent for US banks as a whole.


The main media coverage of Mr Battelino's speech focused on some of the supporting comments he made dealing with the broader economy. Here he flagged that inflation was still a problem, while pointing to some of the reasons why he thought that Australia would avoid recession.

These broader comments are best discussed in the context of the Mid Year Economic and Fiscal Outlook, the subject of the second post in the series. In the meantime, Mr Battelino's speech provides some interesting insights into the structure of aggregate household finances in Australia.

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.