Saturday, January 31, 2009

SATURDAY INSIGHT: Our problems are worse - much worse

Yes, it's the current account deficit. Remember that? It puts us at risk.

What if a weakened financial system and weaker than usual spending are the least of our problems?

What if there's more to worry about that keeping the money flowing and minimising the extent of the recession?

What if our real problems are deeper and have the potential to sink us?

What if we are only dimly aware of them or find it easier to deny them until it's too late?

What if we've been doing that for years?

It's hardly an unlikely scenario.

In the United States a problem which did have the potential to undo the economy was ignored or denied by everyone from the world's most important central banker down.

Investments that seemed too good to be true were investigated and found trouble-free right up to the day millionaire philanthropist and funds manager Bernie Madoff turned himself in.

Welcome to Australia in the first decade of the 21st century.

Welcome to where where we find ourselves at the end of The Howard years...

Back in 1997 when the Howard government was young, financial markets took a set against a a number of Asian countries including Indonesia. Its currency plunged 60 per cent. There was mass unemployment, rioting, regime change, austere medicine imposed by the International Monetary Fund which made things worse and the loss of 13 per cent of GDP.

And yet, as the winner of this year's Nobel Prize in economics Paul Krugman points out in the new edition of his book The Return of Depression Economics, Indonesia's current account deficit at the time was smaller than Australia's. Its standard of living was more sustainable than ours.

A country's current account deficit is the measure of the foreign dollars that it pays out to rest of the world each quarter over and above the foreign dollars that come in. It can only be sustained by ever-growing foreign borrowing.

Since the Asian economic crisis - the bullet that Australia missed - our current account deficit ratio has doubled. What we pay out over and above what we take in now amounts to roughly 6 per cent of our GDP. That's quite an achievement for a nation at the end of five years of an almost-unprecedented export boom. Our imports have climbed faster.

Much of the increased import spending has been on mining equipment and the like - a necessary counterpart to the resources boom.

But much of the rest has been on consumer goods: roughly 50 per cent more on consumer electrical imports such as plasma TVs, almost 70 per cent more on imported food - all within the space of five years.

The Howard government helped, announcing personal income tax cuts in each of 2003, 2004, 2005, 2006 and 2007. Tax breaks - either outright exemptions or concessions - soared from $50 billion to $73 billion. Government spending jumped by one third. At a time when employment generally climbed 15 per cent, the Commonwealth public service (excluding Defence) swelled 25 per cent.

Almost as the fast as each wave of mining-generated cash came in, the government pushed it out where it would be spent. In its dying days it formally adopted as a campaign slogan what by then had long been its unofficial guiding principle - go for growth.

The party that in opposition had hired a "debt truck" to drive around Melbourne streets bemoaning Labor's $200 billion foreign debt, left office with a foreign debt exceeding $600 billion. During its final year we were expanding that borrowing at the rate of $200 million per day.

Much of it was spent on the not-particularly-useful exercise of bidding up the price of Australian houses. After the government halved the headline rate of Capital Gains Tax at the turn of the century Australian house prices doubled. Investors who used to account for only 20 per cent of the loans to purchase housing took out 40 per cent as they swept owner-buyers aside and pushed up prices. It used to take three to four years of a typical household income to buy a Melbourne house. It now takes seven. The US website Demographia lists Melbourne, Sydney, Adelaide, Bundaberg, and Queensland's Gold Coast as among the world's 12 least affordable markets. It identifies Melbourne as being less affordable than New York.

This makes no obvious sense from an international point of view and bears all the signs of a bubble waiting to be pricked. It has also put housing beyond the reach of Melbournians who could have once afforded it, perhaps unsustainably. But it has kept the a larger number of constituents happy. One of John Howard's parliamentary secretaries is reported to have once quipped, “rising prices make for happy voters”.

That happiness fed into a feeling of wealth, and a feeling that (perhaps aided by dipping into housing equity) it was okay for Australians to spend more than they earned each year.

Extraordinarily in 2003 Australia's household saving ratio turned negative after being in positive territory ever since records had been collected. For the first time Australians households in aggregate were spending more than they earned each pay period. We began to literally live beyond our means as our mining boom was taking hold. (Our savings ratio has since returned to positive territory and is now climbing sharply as we shut their wallets ahead of a recession.)

We could have done things differently.

Norway stands alone in the rest of the world in having had as much wealth showered on it as has Australia in the last half decade. No other nation comes close. (Canada, which has experienced the third biggest boost to its terms of trade is a distant third.)

Instead of running up a growing current account deficit, Norway built a rapidly growing current account surplus and is perhaps the most protected nation in the world from attacks by financial markets.

Whereas Australia was blessed with natural gas, coal and iron one, Norway was blessed with North Sea oil. But it knew it wouldn't last. So it moved the windfall tax revenue to an untouchable Norwegian Petroleum Fund, later renamed the Norwegian Pension Fund. Not only could the massive inflow not be paid out in tax cuts or used to expand government programs beyond all reason, most of it couldn't even be brought onshore. (It also has to invest ethically.)

Because the Petroleum Fund invests its money in foreign currencies offshore it neither bids up the Norwegian currency, Norwegian real estate, Norwegian prices nor Norwegian imports.

Norwegians mightn't feel as wealthy as they might have had they gone down the Australian road. But in reality they are much wealthier, with a buffer of continuing earnings that will protect them whatever happens to China and the worldwide demand for resources.

Australia has no such buffer. Australia is in the same situation as a lottery winner who splurges the booty as it comes in spending even more than the winnings in the excitement. Norway is like a lottery winner who keeps the windfall away from the family and won't even let it in the house, banking if offshore as insurance against the day things turn nasty.

And Norway is not alone. Timor has also set up a petroleum fund.

As the globe enters its first co-ordinated recession in half a century, and as the providers of finance become more jittery than they've been in generations Australia finds itself absolutely dependent on the rest of the world to maintain its standard of living, more so than Indonesia was before its currency came under attack during the Asian economic crisis.

China's surge in economic growth - the one thing that bought Australia temporary immunity from attack by financial markets - has stalled, or perhaps stopped.

Marvin Goodfriend from Carnegie Mellon University describes China's boom as “a one-off in the history of the planet earth.”

“We have never had it before in thousands of years of planet earth and we are not going to have it again in a few thousand years,” he said during a visit to Australia.

What if China's boom doesn't restart? What if instead of being a blessing Australia's abundance of resources remains as irrelevant as it is now becoming.

In its recent economic update Access Economics reminded clients that it it has long said that, "if China's surge stumbles then Australia's trading balance will be buggered". It added, "buggered it will soon be."

Access sees Australia's current account deficit jumping to a "Godzilla-like" 9 per cent of GDP next financial year, in part because it believes our recession will be milder than those overseas and we'll continue to expand our imports without the export income to pay for them.

The result might be an orderly collapse in the Australian dollar (Access sees a collapse from US 65 cents to US 56 cents) or it might be an attack on the dollar.

Its easy to understand why foreign funds managers might feel we are good candidate for such an attack. Our current account deficit would be many times the level of the Asian countries caught up in last decade's economic crisis. Our developed legal and banking system need not save us. In 1992 funds manager George Soros successuflly took on the Bank of England, making his reputation and US$ 1.1 billion in the process. Our Reserve Bank carries only small reserves of foreign exchange. It couldn't last as long as did the Bank of England.

On the face of it the United States would be as vulnerable to a capital strike or currency attack as would Australia or Britain. But the US is different. It manufactures the world's currency. It could literally print money to buy itself time.

Earlier this week The Age spoke to seven of Australia's more thoughtful economic observers. They were asked for their thoughts on the best way to stimulate things. But some said that was the wrong question. Melbourne University's John Freebairn said instead we had to get prices, spending and saving back into balance. "I for one am not worried if Australians save any tax cuts," he said. "We've been spending too much."

"Some corrections are necessary. Our housing prices have to fall. These recessions - almost as Paul Keating said, sometimes we need them to get over our bad behaviour."

Cutting interest rates toward zero as the US has done would be a bad idea, Freebairn says. The US did a similar thing at the start of this century in order to escape its 2001 recession. It helped create the sub-prime mortgage boom whose unwinding led to the crisis that is now threatening the globe.

Freebairn wants our leaders to use the present crisis to set up things up for sustainable recovery in the decades that follow. Otherwise, he says, "it's a wasted opportunity".

The former head of the Competition Commission Allan Fels wants the government to do nothing that will make Australia less competitive for the recovery which is to follow. It's already approved the gobbling up of two middle size banks by the majors and is showing signs of handing out money to whatever interest group asks for it first. "The should plan as if the recession will last for three years," he says. "And keep their eye on the sort of Australia that will emerge from it."

Gerry Harvey of the retailer Harvey Norman says he's not that fussed about getting people back into his stores in the short-term. He'd rather the government concentrated on making Australia productive.

With surprisingly little to protect us from what the future has in store after a half decade of riches we will need to work our way out of our problems carefully.


Friday, January 30, 2009

You died "vomiting money to anyone registered to vote"

Bernard Keane's open letter to Malcolm Turnbull and Julie Bishop:

From Crikey

Dear guys,

I know it's hell being in Opposition generally and particularly hellish during periods of crisis when people only really care about what the bloke in charge is doing. But you're also both intelligent, reasonable people -- particularly Malcolm, who's got a brain the size of a planet. So I know you'll take my comments in good part.

As you know, the budget is in deficit. Not officially, but we all know it is, even before the stimulus package that will come out very shortly. But every time the word "deficit" is mentioned, you get a glint in your eyes, and suggest, ever so subtly -- and sometimes not so subtly -- that this is the Government's fault. Now, however unreasonable this is, no one can blame you for this, because in Opposition you live off scraps. Half-truths, deliberate misinterpretation and wilful obscurity are every bit the staples of communication that they are in government...

For a couple of months last year, around about the time Kevin Rudd and Wayne Swan were refusing to talk about deficits, you were saying we shouldn't be going into deficit. When they suddenly started talking about deficits -- not so much acknowledging the elephant in the room as recognising that it had deposited an enormous pile of dung right in the middle of it -- you changed tack and started saying deficits should be a last resort and that it was the "quality of the spending" that was important.

I’m not sure what "last resort" actually means. Does that mean the Government should boost taxes before a deficit? Slash spending before seeing red ink? Wait until unemployment is over 10%? Anyway, we won't dwell on that.

But in case you haven't noticed, just about every economist on the planet is calling for massive government spending to replace at least a small part of the huge gap in private demand left by the financial crisis. This spending will, at least for some Australians, mean the difference between having a job and not having a job. If we learned anything from the last recession it's that unemployment is a bastard of a problem to fix and pernicious in its effect on our social fabric.

Playing political games with the deficit is grotesquely irresponsible. Other conservatives are being rather more sensible. Barry O'Farrell this week proposed cutting payroll taxes and sending the NSW Budget further into deficit to help employers. And the Canadian Government -- that'd be the one led by Stephen Harper, who wants to be John Howard so much he plagiarises his speeches -- has just announced a stimulus package that will take Canada US$30b into deficit.

But you seem determined to maintain the fiscal hairy-chestedness. As part of that, you like to maintain that when you were in Government, you were the height of fiscal responsibility.

That's complete bollocks and I'm sick of hearing it. The first two Howard Budgets were excellent. They cleaned up the profligacy of the last Keating budgets and began seriously implementing a small-government agenda of the sort a lot of us had been looking for for years. But after that, you dropped the ball. Subsequent budgets got slacker and slacker, especially once the mining boom kicked in. After 2001, your budgets got downright bad as you shelled out money to buy votes. After 2004, you were shovelling money out the door so fast slow-moving people were getting buried under it.

If you'd had just a little regard for the longer term you could have used the boom years to hand out tax cuts and built the surplus up further, or make a serious start on fixing our infrastructure, or get an ETS up and running so we had it built into our economy before the crisis hit.

But no, you died vomiting money to anyone registered to vote.

You also completely abandoned the small government agenda. This was a profound betrayal, one that has left Australian with a legacy of middle class welfare and a handout mentality that will take years to undo -- if any politician has the guts to try to undo it. You could have used the boom years of full employment to wean voters and businesses off government handouts. You’re the conservatives. You're the ones who are supposed to keep government in check, to reduce the burden of government on a free society. But instead your reached hitherto undreamt-of heights of profligacy.

So don't give us this "keeper of the fiscal flame" act, because it's rubbish. Julie, you've just come back from America, and declared that the Americans had "moved on from focusing on the malaise to what they do when the economy turns -- how to get the government out of the market".

Not sure what America you actually went to, but that description of the United States couldn't be more wrong. Moreover, I simply don't believe you when you talk about reducing the role of Government anyway. You and your colleagues had 12 years to show what you were made of on that issue and you did exactly the opposite of what your party philosophy says you believe in. I will never believe the Liberals again when they talk about smaller government, not until they spell out what programs and expenditure and welfare and pork barrelling and handouts you’re going to nix when you get into government -- and then do it.

Having wasted vast amounts of money when times were good, it seems you're determined to criticise the Government for taking us into deficit when things are at about their worst since men wore hats, the world was in black and white, and FDR had a permanent lease on the White House. I'm starting to worry that if I turn on the radio, Roy Rene will be on.

Instead of pursuing this deficit-is-evil rubbish, why don't you get creative like other conservatives, and start arguing for clever ways of generating a lasting stimulus to demand rather than demanding tax cuts we'll all stick on the mortgage, retooling the economy for greater efficiency and competitiveness when growth returns to the world economy, and ensuring unemployment doesn’t become a poverty trap tearing our social fabric and damaging our economy? It'd challenge the Government, and you'd be more credible on that stuff than trying to tell us what great fiscal managers you were. Beause, quite bluntly, you weren't.


Why not halve the rate of GST?

It'd cost, say $24 billion

One of the most senior members of the Reserve Bank board has declared the government's $8.7 billion December stimulus package ineffective and proposed instead halving the rate of GST.

Professor Warwick McKibbin of the Australian National University, a leading economic modeler and a member of the Reserve Bank board since 2001 has told The Age he would recommend slashing the Goods and Services Tax from 10 per cent to 5 per cent and holding it there for a year.

"The December stimulus payments didn't have much impact, the spending wasn't directed at the right things," he said. "The next package needs to be much more clearly focused."

"We know that when the GST was introduced people increased their spending ahead of time and then cut it afterwards."

"The trick would be to get people to bring their spending forward again but to get income tax cuts coming in the future so that they don't cut their spending too much when the GST goes up"...

Professor McKibben has also endorsed big increases in infrastructure spending, as well as the personal income tax cuts that would help maintain spending as the GST rate returned to 10 per cent.

He said that as a member of the Reserve Bank board he was unable to talk about monetary policy.

The Reserve Bank of New Zealand yesterday slashed its official cash rate by a further 1.50 percentage points to a new record low of 3.50 per cent.

The ANZ said it expected Australia's Reserve Bank to roughly halve its cash rate from 4.25 per cent to an all-time low of 2.50 per cent this year, beginning with a cut of 0.75 points at its meeting next Tuesday.

Professor McKibbin said he believed it would be possible to cut the GST rate even though by law such a change had to be approved by each of the states.

"The state governments are set to get a pay off in Commonwealth infrastructure spending, right? So on the one hand you would be taking away a fair chunk of their revenue, but on the other hand you would be handing them money."

"It would be a trade-off. There's no reason why you couldn't get around the politics of it, although it is certainbly not what the state premiers are thinking of."

Tax breaks cost what???

The Commonwealth Treasury has warned that spending on tax breaks is set to explode to $80 billion over the next 3 years unless reigned in.

The latest Treasury estimate of tax expenditures puts the cost this financial year at $67.4 billion, down from $73.7 billion last year at the height of the economic boom. It expects the cost to climb again quickly from next year reaching just short of $80 billion in 2011-12.

Roughly one third of the tax expenditures relate to superannuation, the most expensive being the one that taxes contributions to funds and the earnings of funds at just 15 per cent instead of the marginal rate. The fastest growing cost is the move to make all superannuation payouts tax free to Australians aged 60 and over from July 2007.

For the first time in a tax expenditures statement the Treasury has quantified the cost of exemptions from the Goods and Services Tax which it puts at $13.5 billion...

The biggest cost is 50 per cent tax exemption for income from capital gains, estimated at $10 billion.

The Treasury says in the statement that while direct government expenditures are annually “scrutinised by parliament, the media and the general public” in the Budget, tax expenditures are “generally not obvious” and are often closely examined only once, when they are introduced.

The estimates come as the tax review chaired by the head of the Treasury Ken Henry gets down to the detailed work of drawing up its draft proposals, due for release mid-year. Its final report is due in December.

Other large tax expenditures identified by Treasury include the Fringe Benefits Tax concessions for cars valued at $1.8 billion, exempting Family Tax Benefits from income tax valued at $2.5 billion, and exempting the 30 per cent Private Health Insurance Rebate from income tax, valued at $1 billion.

Thursday, January 29, 2009



What's happening to trade

Latest OECD data

Value Growth in OECD Trade in Goods and Services Percentage change on the previous quarter and on the same quarter of the previous year


"World Growth Grinds to Virtual Halt" - IMF

It's actually worse that that. Their numbers have it going backwards, but there's a limit as to how bad an IMF headline should look

The International Monetary Fund has forecast the worst year for the world economy since the great depression as Westpac has pushed its forecasts for Australia sharply into negative territory.

The IMF's latest World Economic Outlook puts global growth at just 0.5 per cent in the year ahead, down from a forecast of 2.2 per cent just two months ago.

But the forecast is calculated using a special non-market exchange rate created by the IMF known as "purchasing power parity". When market exchange rates are used the forecasts put global growth into negative territory for the first time since World War 2.

The Fund says the US economy will shrink 1.6 per cent while the UK contracts 2.8 per cent, Japan 2.6 per cent, mainland Europe 1.6 per cent, and a group known as "other advanced economies" which includes Australia 2.4 per cent.

Treasurer Wayne Swan greeted the news declaring it was "inevitable that Australian jobs and growth will be affected".

Separately Westpac downgraded its forecast for Australia from zero economic growth to growth of minus 0.7 per cent - Australia's worst result since the early 1990's recession. Westpac said it expected that to be followed by "positive but anaemic" Australian growth throughout 2010.

The IMF is also predicting a recovery next year although it warns that it it is not highly confident of that forecast...

"Unless stronger financial strains and uncertainties are forcefully addressed, the pernicious feedback loop between real activity and financial markets will intensify, leading to even more toxic effects on global growth," the report says.

The Fund is particularly concerned about the risk of deflation which is says is increasing in a number of developed economies. Australian figures released yesterday showed that local prices fell in the three months to December - the first quarterly incident of deflation since 2006 in which recorded prices slipped 0.1 per cent due to the "banana effect" of a return to fruit production after Cyclone Larry.

The Bureau of Statistics says Australian prices dived 0.4 per cent in the December quarter, led down by an 18 per cent slide in the price of petrol along with a 2.4 per cent fall the price of cars.

Footwear prices were down 0.4 per cent, household appliance prices down 0.6 per cent and computing equipment prices down 2.9 per cent notwithstanding the lower dollar, implying heavy discounting in the lead up to Christmas.

The home entertainment retailer Strathfield was yesterday placed in voluntary administration citing falling consumer demand and worsening economic conditions. It has 18 outlets in Victoria.

By contrast Woolworths which operates the Safeway chain of supermarkets reported a 7.1 per cent annual jump in like-for-like sales, giving some of the credit to the government's $8.67 billion economic stimulus package.

"This suggests that consumption of many basic items was strong in the December quarter," said the Treasurer. But we will await the overall data".

"I’d just like to make this point: the Government stands ready to take whatever action is required, in a responsible way, to respond to these rapidly changing global conditions," he said.

Japan unveiled a massive additional stimulus plan Wednesday valued at $80 billion including a minimum cash handout of $200 to every man, woman and child in the country. Germany unveiled a package worth $100 billion.

The IMF called on countries such as Australia with "policy room" to commit to doing more should things deteriorate.

It expected the average budget deficit among developed countries to deteriorate to a near-record 7 per cent of GDP.

Australia's annual rate of inflation slid from 5.0 to 3.7 per cent in the December quarter, freeing the Reserve Bank board to consider cutting interest rates aggressively when it meets for the first time this year next Tuesday.

JP Morgan, Citibank and Westpac are among the forecasters expecting a cut of a further 1.00 per cent, with TD Securities saying there is a chance the cut could be as big as 1.50 per cent. Both Westpac and TD Securities expect the Reserve Bank's cash rate to slide to a record low of 2.00 per cent from its present 4.25 per cent.

Going Down

Global growth in 2009

United States -1.6%

United Kingdom -2.8%

Germany -2.5%

France -1.9%

China +6.7%

"Other advanced" including Australia -2.4%

IMF: January World Economic Outlook update (Click to enlarge.)

Wednesday, January 28, 2009

Not so fast with the stimulus

That's the prevailing wisdom among the public policy economists surveyed by The Age

The government has been urged not to panic as close to 80,000 workers lose their jobs worldwide in one of the darkest days since the start of the credit crisis.

In the United States more than 10 leading companies began the week announcing job cuts exceeding 75,000, among them Sprint Nextel, Home Depot, and the world's largest mining machinery maker Caterpillar. In Europe the electronics giant Philips cut 6,000 jobs and Britain's largest steelmaker Corus 2,500 jobs.

In Australia the NAB business survey pointed to further job losses with the employment index stuck at its lowest point since the 1990's recession. The bank expects the job losses to be concentrated in finance, mining, manufacturing and construction and expects an unemployment rate of 7 per cent next year, implying a jump in unemployment of more than 250,000.

Business confidence improved in the December survey, rebounding 10 points from a level below that in the last recession to one close to it.

Wholesale and retail sales rebounded somewhat in December, possibly in response to the government's stimulus payments.

Speaking from Papua New Guinea which he visited with the Prime Minister in order to discuss the economy Treasurer Wayne Swan said that while he would not get carried away with one set of data, it was "heartening" to see that the payments seemed to have helped...

Inflation figures due out this morning and International Monetary Fund forecasts out tonight will pull put further pressure on the government to announce an additional stimulus package. Inflation is expected to have turned negative during the three months to December, raising the spectre of deflation. The annual inflation rate is expected to collapse from 5 per cent to less than 4 per cent. The IMF is expected to slash its forecast for world growth to between 1 and 1.5 per cent and its forecast for Australian growth to close to zero.

As the Prime Minister and Treasurer consider their options, many of the experts surveyed by the Age have cautioned against another big spending package, with one, Melbourne University's Professor John Freebairn, saying that a recession was needed in order to fix Australia's problems.

"Our houses are too expensive, our balance sheets are in poor shape, and over 15 years we accumulated some pretty sloppy business practices. Almost as Paul Keating said, sometimes we need recessions to get over our bad behaviour," he said.

Professor Allan Fels of the Australia and New Zealand School of Government said it made sense to plan as if the recession would last for three years. "Don't use up all your ammunition at once," he counseled. "Keep some shots in the locker".

"If I was designing a stimulus package" Advice to government

Gerry Harvey, Harvey Norman

"First, find out what happened to the last $10.4 billion. We look back on it now and wonder where it went"

. Don't boost unemployment benefits, it won't create jobs

. Cut taxes to help workers

. Cut compulsory super contributions to help employers

. Consider giving money to entrepreneurs who'll create something

Allan Fels, Australia NZ School of Government

"Plan as if the recession will last 3 years. Don't use up all your ammunition at once."

. Don't hand out money on the basis of who asks first

. Give priority to the disadvantaged

. Plan to get your money back, for example through equity investments

. Don't do anything that harms competition

Nicholas Gruen, Lateral Economics

"Instead of being Captain Fix-it they should come out with a provisional plan, invite comments and lay it on the table for two weeks."

. Never offer a guarantee without charging for it

. Ask banks to automatically cut mortgage repayments as soon as they cut rates

. Consider cutting taxes for firms that expand investment or jobs by more than a certain amount

. Fast track approvals for firms that expand

Guay Lim, Melbourne Institute

"I am not convinced that the government should be rush in with
short-term assistance to industries that are likely to cut jobs. It creates a climate of dependence."

. Long-term measures, not quick fixes

. Bring forward infrastructure spending

. Cut employers super contributions to improve their financial health and help them keep workers

Stephen King, Monash University

"Don't be afraid to spend but don't drop money from a helicopter. Target spending to those sectors that will have a future when the good times return."

. Boost spending on ports to be ready when China's demand returns

. Fix Australia's water problems

. Invest in sustainable long-term transport projects

. Remove welfare traps that stop low-income Australians working

Saul Eslake, ANZ Bank

"First, be honest about the state of the budget. There's nothing wrong with going into deficit so long so long as there's a plan to get back into surplus"

. No across the board tax cuts - they will be saved

. Investment allowances for firms that undertake capital expenditure before June 2010

. Tax credits for making homes more energy efficient

. Worthwhile infrastructure spending including the repair of existing infrastructure

John Freebairn, Melbourne University

"We got into this trouble by spending more than was coming in. Part of the solution is to get those balances under control even if it means accepting a recession."

. We have had a real drop in our income and we have to adjust

. We won't spend more until our balance sheets are in better shape

. Don't push interest rates to zero - it'll create the next bubble

. Government spending needs to make sense in its own terms


Tuesday, January 27, 2009

TUESDAY COLUMN:Worried about inflation? Prepare for something worse

Expect what would have once been joyous news tomorrow.

Australia's inflation rate will be low - so low that for the December quarter it will have turned negative.

That has to be good, right? Falling prices will make our money go further, and then further. Added to dramatically lower interest rates and the gift of an extra $1,000 or so that many of us received from the government in December, deflation will help push our buying power higher than its been in years.

And we know that high inflation is bad for the economy - the Treasurer Wayne Swan used to continually say so - so low inflation leading to deflation has to be good for the nation, right? Wrong. Prepare to unlearn much of what you've learned.

For decades now we've only been told half of the truth about inflation...

- that a high rate of price rises devalues money, destroys the value of savings and makes it hard to plan. Let unchecked high inflation is likely to accelerate as buyers bring forward their buying decisions to get in ahead of price rises, encouraging sellers to push prices higher still. We haven't been told the other half of the truth because, well, when was the last time that prices sustainably fell?

They did it during the great depression. And the further they fell the worse the depression became. Deflation is worse than inflation. And the Reserve Bank knows it. That's why its inflation target is clearly in positive territory. Instead of adopting a target of, say, between minus 2 per cent and plus 2 per cent, which it might have done if it believed the likely damage from deflation more or less matched the likely damage from inflation, it has picked a target well away from negative territory and even well away from zero. Its target of 2 to 3 per cent is an acknowledgment that while too much inflation can be bad, any deflation can be worse.

Much of the deflation we will learn about tomorrow will be the result of a one-off slide in petrol prices and so needn't be that concerning. It shouldn't become self-perpetuating. But there is a chance that it could.

The Melbourne Institute reported last week that an impressive 9.8 per cent of us expect inflation to be negative throughout the year ahead - the biggest proportion since it began asking the question.

If these people act on that belief they'll put off non-essential purchases. "Sure, now's a very good time to buy something," they'll tell themselves, "but in six months time it will be even cheaper".

Retailers will find themselves cutting prices upfront to bring forward those sales, inadvertently reinforcing the belief that prices will fall further if only consumers hold off, encouraging consumers to hold off longer and pushing prices down further in a self-reinforcing spiral.

There are signs that retailers are already discounting savagely. The wholesale prices that they pay for imports soared an extraordinary 10.8 per cent in the final three months of last year as the Australian dollar slid. Over the year their total import costs soared 22 per cent, the cost of their imported office equipment soared 30 per cent, and the cost of imported cars soared 8 per cent. Yet the prices they charged for those things have scarcely moved. If anything cars and computers are on sale. And most of us aren't buying, yet. Why would we?

Rather than keep cutting prices, retailer Gerry Harvey has begun shutting stores. Others will follow if deflation takes hold, and the resulting unemployment will make even the majority of us who keep our jobs still more wary about buying, pushing prices down further and pushing more of us out of work.

It's a far from unlikely scenario. Japan suffered from deflation for more than a decade from the start of the 1990's. The more prices fell the more consumers shut their wallets and the more factories wound back their operations. Deflation is now a serious concern in Britain, in the United States, and in Japan again.

If it gets a hold here it may make monetary policy as ineffective as it has been there. Lower interest rates won't encourage spending if Australians expect prices to fall and they won't do much to encourage borrowing either. Why borrow to buy something that's going to decline in value? It's logic that applies to borrowing to buy a house if real estate prices are falling and to borrowing to buy (or expand) a business if the income from that business is set to fall. In Japan even interest rates close to zero couldn't expand borrowing.

Australia may well escape sustained deflation. The occasional quarter of negative inflation is not that unusual. Our last was in December 2006, also the result of a fall in the price of petrol. We had better hope that this one doesn't turn into something more.

If it does, our leaders might find themselves powerless to turn it back. That's why its imperative to prevent deflation before it takes hold. So concerned is the Prime Minister that he has asked the Treasurer to hitch a ride with him to Papua New Guinea today so they can keep talking about what action to take right now.

Monday, January 26, 2009

An extraordinary interview with the world's least-successful central banker

Actually, he is probably also the richest.

Gideon Gono runs the Reserve Bank of Zimbabwe.

Some extracts from Newsweek's unbelievable interview:

"I've been condemned by traditional economists who said that printing money is responsible for inflation... I found myself doing extraordinary things that aren't in the textbooks. Then the IMF asked the U.S. to please print money. I began to see the whole world now in a mode of practicing what they have been saying I should not. I decided that God had been on my side and had come to vindicate me."

"The cholera is under control. I've been personally involved in ensuring that we minimize and finally eliminate the disease."

"What keeps me bright and looking forward to every day is that it can't be any worse. And those who have studied the history of economies know that we are down, but that the only thing that can happen is we will move up."

Krugman on the 'debate' over whether Obama should spend up big

"The most encouraging thing I’ve heard lately is Mr. Obama’s reported response to Republican objections to a spending-oriented economic plan: “I won.” Indeed he did — and he should disregard the huffing and puffing of those who lost."

Another excellent column

Really, really good news... about coffee

Coffee Today Keeps Dementia Away

The photo is Professor Brad Delong, who puts his thoughts about economics on YouTube under the title Brad Delong's Morning Coffee

The following comes from his blog:


Coffee Today Keeps Dementia Away: A collaborative team of researchers from Sweden and Denmark enrolled 2,000 adults in the study 21 years ago. Participants self-reported their dietary habits, including their daily coffee consumption. After over two decades, more than 70% of the participants could be tracked for follow-up evaluations. That the research team could find 1,409 now-middle-aged participants out of the original 2,000 is considered an unusually high number.

During those 21 years, 61 people developed dementia. Of those 61, 48 developed Alzheimer’s disease.

After evaluating the effects of many health and socioeconomic factors, including high blood pressure and high cholesterol counts, the research team concluded the participants who drank between three and five cups of coffee a day were 65% less likely to develop dementia than those who drank less. Drinking even more than five cups a day was also associated with a reduced risk of developing dementia but the number of participants drinking this much coffee was too small to be statistically significant.

While not advocating someone start drinking coffee as a preventive measure, Dr. Miia Kivipelto...

Why not?!"

Sunday, January 25, 2009

Joshua Gans is getting serious

(I've never seen him that well dressed)

Until Monday Joshua Gans was a solo blogger

(like John Quiggin and Andrew Leigh before he took time out to work at the Treasury)

Now he's part of a team

(like Nicholas Gruen)

As he said, "not only is it change you can believe in, it is change that is here, right now and at least a day before the other change".

"Core Economics is going multi-author. There will be eight, regular and semi-regular writers. All of them are academics and most are economists. Let me introduce them to you..."

Stephen King is my long-time collaborator and has, for the past four and a half years, been a commissioner with the ACCC. Today, he takes up a new post as Dean of the Faculty of Business and Economics at Monash University and so is now free to comment publicly on all issues. Stephen is also returning today as my business partner at CoRE Research. Despite his administrative duties, I expect Stephen will be a daily contributor to the blog.

Mark Crosby is an associate professor in economics at Melbourne Business School. Mark specialises in macroeconomics and we definitely need more of that expertise right now. Mark also is a regular commentator in the media.

Kwanghui Lim is a senior lecturer in strategy at Melbourne Business School. Kwang is not an economist but it is hard to tell from the rigour of his research. Kwang specialises in technology strategy and entrepreneurship and has a vast working knowledge of technical issues related to IT. Kwang will add to the technology commentary that I dabble in on this blog.

Sam Wylie is a senior fellow at Melbourne Business School and a specialist in banking and finance. He has been a regular commentator in the Australian media during the financial crisis and I imagine will continue to provide that commentary here.

All of these authors reside in Australia. But I also figured that some Australians who were academics abroad might, from time to time, want to comment on Australian issues. Happily three of them have agreed to become authors at Core Economics:

Richard Holden is an assistant professor in economics at Chicago's Booth School of Business. Richard specialises in contract theory and applied game theory. His undergraduate education was from the University of Sydney.

Christine Neill is an assistant professor in economics at Wilfrid Laurier University (Ontario, Canada), where she spends most of her research time studying university financing, student aid policies, and individual's education decisions. Like me, she gained her undergraduate education at the University of Queensland and also, like me, she is a co-author of Andrew Leigh.

Justin Wolfers is an associate professor of economics in the Business and Public Policy Department at the Wharton School. Unlike everyone else added today, he is no stranger to blogging, holding a treasured regular slot on the New York Times Freakonomics blog. Core Economics will provide an outlet for Justin to comment on Australian issues as he has done so often in the media in the past."

Wow! It's way serious competition. Which is great.

Refuted economic doctrines


Playing the Beatles backwards

Here it is. A new, sometimes cruel, always fair, reassessment of the music that made us when we still could be made. Click on each one. Wallow.

HT: Marginal Revolution

185. “Revolution 9”
184. “Honey Pie”
183. “I Want You (She’s So Heavy)”
182. “Yer Blues”
181. “Good Day Sunshine”
180. “Ask Me Why”
179. “Long, Long, Long”
178. “Little Child”
177. “Old Brown Shoe”
176. “You Know My Name (Look Up My Number)”
175. “I Wanna Be Your Man”
174. “Love You To”
173. “Why Don’t We Do It In The Road?”
172. “Magical Mystery Tour”
171. “Wild Honey Pie”
170. “For You Blue”
169. “Don’t Pass Me By”
168. “Doctor Robert”
167. “And I Love Her”
166. “The Word”
165. “You Like Me Too Much”
164. “Maggie Mae”
163. “Tell Me What You See”
162. “Thank You Girl”
161. “I’ll Cry Instead”
160. “Everybody’s Got Something To Hide Except Me And My Monkey”
159. “One After 909”
158. “I Want To Tell You”
157. “Don’t Bother Me”
156. “Sun King”
155. “What Goes On”
154. “Flying”
153. “There’s A Place”
152. “Her Majesty”
151. “Do You Want To Know A Secret”
150. “Dig It”
149. “Maxwell’s Silver Hammer”
148. “Julia”
147. “Day Tripper”
146. “Blue Jay Way”
145. “Birthday”
144. “Baby You’re A Rich Man”
143. “Cry Baby Cry”
142. “Only A Northern Song”
141. “Penny Lane”
140. “Every Little Thing”
139. “When I Get Home”
138. “Run For Your Life”
137. “I’m Happy Just To Dance With You”
136. “Misery”
135. “I Call Your Name”
134. “It’s Only Love”
133. “If I Needed Someone”
132. “Another Girl”
131. “Dig A Pony”
130. “Love Me Do”
129. “The Night Before”
128. “Mean Mr. Mustard”
127. “Get Back”
126. “Michelle”
125. “The Inner Light”
124. “Baby’s In Black”
123. “Think For Yourself”
122. “I’ll Be Back”
121. “I Me Mine”
120. “All I’ve Got To Do”
119. “Polythene Pam”
118. “Hold Me Tight”
117. “Got To Get You Into My Life”
116. “Lucy In The Sky With Diamonds”
115. “Can’t Buy Me Love”
114. “I Want To Hold Your Hand”
113. “Savoy Truffle”
112. “The Continuing Story Of Bungalow Bill”
111. “With A Little Help From My Friends”
110. “Good Night”
109. “All Together Now”
108. “Paperback Writer”
107. “I’ll Get You”
106. “I’ll Follow The Sun”
105. “From Me To You”
104. “Martha My Dear”
103. “Being For The Benefit Of Mr. Kite”
102. “Revolution 1”
101. “Ballad Of John And Yoko”
100. “Girl”
99. “Sgt. Pepper’s Lonely Hearts Club Band”
98. “She Said She Said”
97. “Tell Me Why”
96. “Because”
95. “Yellow Submarine”
94. “I Should Have Known Better”
93. “I’m A Loser”
92. “All My Loving”
91. “Any Time At All”
90. “Ob-La-Di, Ob-La-Da”
89. “What You’re Doing”
88. “I Need You”
87. “You Can’t Do That”
86. “I Will”
85. “Eight Days A Week”
84. “Drive My Car”
83. “Sgt. Pepper’s Lonely Hearts Club Band (Reprise)”
82. “Wait”
81. “She’s A Woman”
80. “I’m Only Sleeping”
79. “You’re Going To Lose That Girl”
78. “Oh! Darling”
77. “She Came In Through The Bathroom Window”
76. “It’s All Too Much”
75. “P.S. I Love You”
74. “Don’t Let Me Down”
73. “Rocky Raccoon”
72. “Your Mother Should Know”
71. “Piggies”
70. “I’ve Just Seen A Face”
69. “It Won’t Be Long”
68. “I’ve Got A Feeling”
67. “When I’m Sixty-Four”
66. “The Long And Winding Road”
65. “Fixing A Hole”
64. “I’m So Tired”
63. “Let It Be”
62. “Happiness Is A Warm Gun”
61. “Lovely Rita”
60. “I’m Down”
59. “Glass Onion”
58. “Hello Goodbye”
57. “While My Guitar Gently Weeps”
56. “Norwegian Wood (This Bird Has Flown)”
55. “Come Together”
54. “Help!”
53. “Helter Skelter”
52. “I Feel Fine”
51. “Yesterday”
50. “A Hard Day’s Night”
49. “Blackbird”
48. “Revolution”
47. “Getting Better”
46. “Hey Bulldog”
45. “Good Morning Good Morning”
44. “Back In The U.S.S.R.”
43. “Mother Nature’s Son”
42. “You Never Give Me Your Money”
41. “Sexy Sadie”
40. “I’m Looking Through You”
39. “Things We Said Today”
38. “This Boy”
37. “Across The Universe”
36. “Octopus’s Garden”
35. “Not A Second Time”
34. “And Your Bird Can Sing”
33. “I Saw Her Standing There”
32. “Taxman”
31. “The Fool On The Hill”
30. “Two Of Us”
29. “Here Comes The Sun”
28. “You Won’t See Me”
27. “Within You Without You”
26. “No Reply”
25. “Ticket To Ride”
24. “She Loves You”
23. “Rain”
22. “I Don’t Want To Spoil The Party”
21. “Yes It Is”
20. “Here, There, And Everywhere”
19. “You’ve Got To Hide Your Love Away”
18. “Tomorrow Never Knows”
17. “Lady Madonna”
16. “Please Please Me”
15. “Nowhere Man”
14. “If I Fell”
13. “For No One”
12. “We Can Work It Out”
11. “Dear Prudence”
10. “Eleanor Rigby”
9. “Something”
8. “Strawberry Fields Forever”
7. “In My Life”
6. “All You Need Is Love”
5. “Hey Jude”
4. “Golden Slumbers/Carry That Weight/The End”
3. “She’s Leaving Home”
2. “I Am The Walrus”
1. “A Day in the Life”

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