>Josh Frydenberg hopelessly wrong on some key budget and economic facts


Oh no – the Liberal Party is showing that the lack of understanding of the budget, the bond market and economics is broadly based, even among the new blood in its ranks. This time it is Josh Frydenberg, the Member for Kooyong who shows he cannot read the budget papers, nor understand economics and the bond market, with his Op Ed article in today’s The Australian.

The link to the article is here:

http://www.theaustralian.com.au/national-affairs/opinion/coalition-picks-its-path-from-menzies-road-map/story-e6frgd0x-1226233538249 .

From that article, Frydenberg suggests:

  • “But as a party we will not and must not compromise on those fundamental issues that go to the heart of what the Liberal Party stands for: lower taxes, smaller and more efficient government, freedom in the workplace and an individual’s freedom to choose.”

As I have written before, the current facts show:

Total government receipts (tax, dividends, fees and the like) was 21.6% of GDP in 2010-11, the lowest level since 1973-74. Josh – that is lower than for EVERY year of the Howard and Fraser governments.

The tax to GDP ratio fell to 20.0% in 2010-11, the lowest since 1978-79 and is a whopping 4.2% of GDP below the record tax to GDP ratio raked in by the Howard government in 2004-05 and 2005-06. That’s a lesser tax take of around $60 billion for one year that was taken from tax payers during the peak period of the Howard government. As mentioned elsewhere, it is easy to register a budget surplus when you tax the living daylights out of the population.

These facts should embarrass Freydenberg who then suggests:

  • “Menzies said of the Liberals, “we are a tax reduction party”, understanding that “real tax reductions would be the best of all incentives to increase effort, earnings and production”.”

Funny that when the Howard Government was elected, the tax to GDP ratio was 21.8% (1995-96). At the end of his term, the ratio was 23.7%. When Fraser was elected, the tax to GDP ratio was 20.3% and at the end of his term the ratio was 21.7%.

Freydeberg goes on:

  • “Tragically, the Rudd-Gillard governments have become addicted to spending, squandering the strong fiscal position bequeathed to them in 2007. In just four years they have taken government spending from 22.9 per cent of gross domestic product to 26.2 per cent. “

That 26.2% is wrong – the MYEFO Table D1 shows that spending to GDP was 26.0% of GDP in 2009-10. Whatever. Freydenberg for some reason then ignores the outcome for 2010-11 spending to GDP ratio was 24.7% and further “forgets” to mention that the government spending will be 23.6% of GDP in 2012-13 – around 1.5% of GDP below the average of the last 30 years. In the 12 Howard Government Budgets, spending to GDP averaged 24.2% of GDP: and only in 3 years out of 12 of the Howard Government was the spending to GDP ratio lower than the Gillard Government is projecting for 2012-13.

Freydenberg then suggests:

  • “In addition to expanding government debt, increasing taxes and bloating the bureaucracy with more than 20,000 new public-sector employees.”

This is wrong. According to the ABS, between June 2008 and June 2011, the number of Commonwealth public servants rose by 6.0% – from 237,100 to 251,400, a rise of 14,300.

There was some hope that the new blood in the Liberal Party would have some understanding of economics and markets. This dreadful Op Ed article is dashing that hope.

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>Exaggerating the house price rise


It’s fascinating to see the reporting of the 0.1% rise in house prices in November, especially in the context of the 10 consecutive monthly falls that pre-dated this wafer thin increase.
The SMH and The Australian on line suggest, via an AAP feed:
“Homeowners have received a bout of good news at year’s end, with a private survey showing the first rise in capital city home values in 11 months.”
I don’t have complete access to the house price data but note that the median national house price was $448,500 in October, down 0.5% from the level in September. The 0.1% rise in November therefore equals a “cash” gain of $400, after a “cash” fall of around $2,200 in October. And it must be noted that in the 10 months to October, the median house price fell around $18,000.
If house prices keep rising at the same pace as they did in November (i.e., 0.1% per month), it will take around 3 and a half years to regain the nominal losses of the first 10 months of 2011! In real terms, even with 3 and half years of 0.1% monthly rises, house prices will be down a further 10% or so over that time.
Not the stuff in my mind that suggests “a bout of good news”.
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>More troublesome data – credit and house prices weak


RBA credit rose 0.3% in November for an annual rise of just 3.5%. Within that, annual growth in housing credit remained at a record (34 year) low of 5.7%. Consumers and business are not borrowing much – or the banks aren’t willing to lend much – a sure sign that growth muddled through to the end of 2011 at a below trend pace.

The house price data showed a very tepid 0.1% rise in November, disconcertingly soft after 10 straight months of house price falls. House prices clearly remain under pressure, a key fact to consider when analysing the economic outlook given the well-known and powerful effect house prices have on consumer wealth, confidence and spending and also importantly on bank balance sheets.

Obviously the RBA knew credit and housing were weak when deciding to cut interest rates in November and December against the ranting of a few ill-informed few commentators. The interest rate cuts will, with a lag, work to arrest the weakness in credit and house prices. They would have had almost no impact on the November data. Whether on-going consumer caution or the negative effects of the global downturn overwhelm the positive influences of lower interest rates remains to be seen. I suspect house prices will get weaker before finding a true base in the second half of 2012. There is also a matter of a substantial excess stock of houses on the market which will inevitably keep downward pressure on house prices at least in the near term.

Along with a bunch of other economic news, there will be further reading on both credit and house prices before the next RBA Board meeting. Important in this space will be the release of the ABS quarterly house price series as a guide for the RBA.

That said, the Australian data flow for 2011 ends on soft note. Credit is weak and housing prices moribund. There’s nothing at the moment to deflect the RBA from its path of cutting interest rates in February with the debate remaining whether to front load a 50 basis point cut or go the softly-softly 25 basis points.

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>Top 12 Economic & Market Issues for 2012


2012 will start and probably end with clear problems in the Eurozone economy and its markets. This will remain the major negative offshore risk to Australia. The US has had more than a few encouraging signs of growth coming through in recent times which could suggest a reasonable year in headline terms for the economy. Its structural problems run deep which will act as a handbrake on longer run optimism in the US. China is slowing with authorities there are now responding with the start of a policy easing campaign. China will keep growing it seems. There is a mixed picture throughout the rest of the world, but overall activity will be below trend.

For Australia, 2011 ends with the economy growing below trend, there is the start of a monetary policy easing cycle, a quite severe fiscal tightening is still unfolding and an over-valued Australian dollar persists.

Below is a list, in no particular order, of 12 economic, market and political issues for 2012 that I suspect will attract attention.

1. Despite the RBA cutting official interest rates aggressively in 2012, perhaps to a low of 3.5%, government bond yields will be higher by end 2012 than now. The market is pricing in a 3.0% cash rate, a move that has dragged the 3 year government bond yield down to just above 3%. The 3 year bond yield is forecast to trend higher – towards 4% or more through the course of 2012. I will be getting short the short end of the government bond market at some stage in 2012, at levels around 3.1% to 3.3%, on the view these will hit 4%.

2. Based on the growth outlook below, towards the end of 2012, the market could well be starting to price in interest rate hikes for 2013 – a strong case can be made for paying the September 2012 to June 2013 OIS strip at levels around 3.0%.

3. For the economy, GDP growth will hover below and above 3% until late 2012. The drag from fiscal policy, plus on-going caution from consumers will dampen growth. The mining boom will support growth. The falls in household wealth from falling house prices and a faltering stock market will not help. Late in 2012, under the influence of easier monetary policy, perhaps that elusive upturn in the US and with China setting its sails for growth, Australian GDP growth could well start to have a 3.5% or even 4% tone to it.

4. Inflation will fall sharply through to about the middle of 2012 – the headline CPI is likely to be as low as 1.5%; with underlying inflation likely to ease towards 2%. The pick up in growth in late 2012 will probably be too late to have a material impact on the CPI in the second half of 2012, but (aside from the one-off effect of the carbon price) inflation is likely to edge up towards 2.5% by the end of 2012.

5. The unemployment rate will get to the “high-fives” during 2012 – topping out at 6% or a few ticks lower. The current below trend growth rate is still impacting the jobs market and will do so through most of 2012. The pre-emptive rate cutting action of the RBA will ensure unemployment does not become a major problem.

6. The Australian dollar (AUD) remains a perplexing beast. It is supported by Australia’s across-the-board triple-A credit rating; record trade surpluses; relative economic strength and for the moment high commodity prices. My hunch and it is a low conviction hunch, is that the AUD will be more inclined towards US$0.90 or lower through 2012 as market positioning, flat of falling commodity prices and perhaps some relative economic improvement elsewhere in the world sees outflows from Australia.

7. Australian stocks are likely to move higher – maybe a lot higher. As one who has never really been positive on the Australian stock market (and have benefitted from that view), I reckon we are getting close to a turning point in stocks given the change in growth momentum through the course of 2012. Also aiding the stock outlook is the unfashionable nature of stocks for investors burnt so badly in recent years meaning many will feel the need to get in once the upswing beings.

8. House prices remain a problem for early 2012. There is a clear glut of property on the market which can be cleared either by a pick up in demand – which will be helped by lower interest rates – but also by falling prices. The price falls are unlikely to be huge – perhaps down 10% from peak to trough – but there might be some negative chatter as these numbers unfold. By late 2012, with more favourable economic conditions and relatively low interest rates, prices should start to bottom out.

9. The mining boom will keep chugging along. The investment boom in that sector will continue to unfold at a rapid pace with benefits for related sectors. There is a hint of risk that a fall in commodity prices will lead some to question whether there will be an investment / capacity overhang in mining over the longer run. If this talk gets traction, the AUD could fall sharply.

10. The 2012-13 Budget in May will announce a surplus well above the MYEFO estimate of $1.5 billion as the government sticks to its commitment of having every new policy fully funded by offsets elsewhere and as the parameters turn a little more positive. By the time of the MYEFO in November, the 2012-13 surplus projection (and those in the out-years) could well approach $10 billion per annum as Treasury factors in the economic upswing into its numbers. The challenge for the Government will be to hold onto the cash until the 2013 Budget.

11. Prime Minister Julia Gillard will still be PM and Opposition Leader Tony Abbott will still be Opposition leader through 2012. There will not be an election in 2012 as the focus will move to an October 2013 poll.

12. Banks will adjust retail interest rates relatively frequently and often away from moves in RBA official rates. The RBA will be even more explicit suggesting its official rate moves are directed at retail rates.

I will try to revisit this outlook every 3 months during 2012.

Happy New Year!

NOTE: None of the above is intended as investment advice. The views above are mine only and are published for the purpose of discussion and information only.

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>"Trend Economic Growth" – Definitions and Facts


It is difficult to confidently say exactly what the trend rate of economic growth is in Australia given the forever changing patterns in productivity, swings in the terms of trade, fluctuations in wealth and leverage, among many, many things. Suffice to say, most well-informed economists including in Treasury and the RBA suggest that the trend rate of GDP growth in Australia is about 3.0% – perhaps a touch higher.

Whatever the exact number for the trend growth rate of GDP, there is a very simple way of checking whether the economy is growing above, at, or below trend. The simple check that even Economics 101 students can look at is to see what is happening to the unemployment rate and inflation.

When the economy is growing “at trend”, the unemployment rate and inflation are stable. This is by definition. Looked at another way, if the unemployment rate is falling and inflation if rising, the economy by definition is growing above trend. Similarly, when the unemployment rate is rise and inflation is falling, the economy must be growing at a below trend pace.

No one would disagree with that.

So where are we in Australia?

In early 2011, the unemployment rate was 4.9%. The latest figures for November 2011 have the unemployment rate at 5.3%. That is a rise of almost half a percentage point in a little over 6 months. Unemployment is rising, albeit at a moderate pace.

Let’s turn to inflation.

In the September quarter 2008, annual underlying inflation was 5.0%. By the September quarter 2009, it was 3.4%. By the September quarter 2010, it was 2.7%. In the latest data, for the September quarter 2011, annual underlying inflation is 2.4%.

Inflation is falling and falling sharply.

So there we have it. Unemployment going up and inflation going down. The economy is growing at a below trend pace.

Oh – I almost forgot. It might even pay to look at the GDP data to assess the discussion over trend growth! They show that GDP grew by 2.5% in the year to the September quarter 2011, a figure obviously distorted (pushed lower) by lost production from the weather events early in 2011. It is interesting to note that annual GDP growth in Australia has not gone above 3.0% for the last 3 and a half years and over that 3 and a half year period, annual GDP growth has averaged 2.0% - a figure fitting perfectly with Treasury and RBA assessments of trend growth and the other data showing the rising in unemployment and drop in inflation.

Let’s face it, the economy is growing below trend. It’s why the RBA has started an aggressive interest rate cutting cycle.

Buffoons blustering about the economy growing at trend, and there being no domestic case to cut interest rates, remain hopelessly ill-informed. As always, it is best to look at facts and hard data in forming views about key issues in analysing the economy and the policy pressures.

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>A food guide to English test cricketers


A change of pace – it’s holiday time and the cricket is on.

Looking through some test cricket history, the following “fantasy team” for England stood out.

In more than 130 years of test cricket, there have been 650 people who have played for England. Based on their surnames, below is a food lovers guide to a fantasy English cricket team.

Alistair Cook (2006 to present)

Fred Bakewell (1931 to1935)

Allan Lamb (1982 to 1992)

Mark Butcher (1997 to 2004)

CB Fry (1896 to 1912)

George Bean (1892)

Graham Onions (2009 to present)

Steven –SharkFinn (2010 to present )

Bob Berry (1950)

Derek Pringle (1982 to 1992)

Graeme Swann (2008 to present)

Two players missed out:

Peter Willey (1976 to 1986)

Jack Crapp (1948 to 1949)

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>A little hint of optimism out of the US economy?

>The last little while has seen some less-bad (maybe even OK) numbers coming out of the US. Jobless claims are at a 3 year low, suggesting some pick up in job creation is imminent. Housing activity and builder confidence appear to have ticked up (albeit from very depressed levels) hinting that there could be some contribution to growth from housing next year. Wouldn’t that be remarkable. Consumer sentiment and spending are off the canvas – not wildly so, but just enough to suggest some pale green shoots of recovery. In addition to all of that, business investment intentions are erring (slightly) on the optimistic side.

With the Fed having set interest rates at near zero for the last 3 years and promising to keep them there for the next 18 months (at least), with massive quantitative easing; with bond yields stunningly low and what could be described as expansionary fiscal settings, it may not be a surprise that some growth is coming through.
A big issue for the early months of 2012 will be the momentum in the US. There remains a massive debt overhang, the desire for fiscal consolidation, depressed asset prices, zombie banks and limited policy flexibility, if needed, to promote growth.
The recent data might just be noise – a temporary uptick along a long run trajectory of weakness. I think it probably is. But he’s hoping these pale green shoots of pick up turn in to a substantive recovery in 2012.
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>Joe Hockey’s Gross Incompetence


From an economic perspective, I’m actually scared about the prospect of a Coalition government after 2013 with Joe Hockey as Treasurer. The unrelenting display of ignorance on basic economic and market issues should be enough to scare away international investors and undermine decades of great economic management.

Today’s article in The Australian from Mr Hockey is reproduced in full at the end of this post.

On the topic of gross government debt, I wrote this a few weeks ago – http://stephenkoukoulas.blogspot.com/2011/11/gross-debt-gross-ignorance.html – as a primer for what will be an important plank in the longer run financial well-being of Australia – whomever is in government. Critical to the long run economic performance of Australia will be maintaining a deep and liquid market for bonds (Commonwealth Government Securities or CGS). This means that with the decision to maintain a stable level for the bond market (gross debt) as a percentage of GDP, gross debt will rise for ever in dollar terms.

This is the first obvious misunderstanding of a very basis principle from Mr Hockey.

Hockey is so perplexed by the issue that he says:

  • Gross debt continues to rise in every year of the forward estimates with no end in sight.”

Yes it will and that is a good thing. Mr Hockey, that is because the economy is getting bigger every year in the forward estimates with no end in sight.

No where does Mr Hockey mention the need for additional CGS as a global requirement from the new Basel III banking rules. Either he doen’t know about those rules or he willfully ignores them in an effort to make a cheap but illogical point. Either way, it is a sign of concern from the man who is the alternative Treasurer.

The Gillard Government successfully negotiated an exemption from the strict interpretation of the Basel III rules otherwise gross debt would have had to increase to more than half a trillion dollars! As it is, the amount of gross debt is tiny on any measure.

Mr Hockey, in other places, lauds the government for supporting banking competition by having the Australian Office of Financial Management (AOFM) buy Residential Mortgage Backed Securities (RMBS). This initiative involves the Government through the AOFM buying up to $20 billion of RBMS. In broad terms, these transactions add zero to net debt (the Government holds bonds issued by the smaller banks), but boosts gross debt by up to that $20 billion as it needs to raise money to buy them.

Mr Hockey again did not mention that some of the rise in gross debt is simply the result of prudent, sensible management of the economy and the nation’s finances through participation in the RMBS market, when that market failed during the GFC.

I wont rehash the other points about gross debt, other than to suggest Mr Hockey and others re-read my piece referred to above.

There is an obligation on The Australia or indeed Bloomberg, Reuters, Dow Jones, the AFR, Business Spectator or any other group with an interest in this issue to do a survey market economists, regulators and if possible the RBA and Treasury to get their take on Mr Hockey’s and the Coalition’s threat to block the rise in the gross debt ceiling.

I can’t preempt what they would find, but I’d be shocked if the findings weren’t a humiliation for Mr Hockey and his understanding of how to manage gross debt the Australian bond market. Blocking the legislation that allows for a rise in the government’s debt ceiling risks sparking a flight of capital from Australia (as we saw in the US earlier this year when Congress threatened to block the rise in the debt ceiling there) with consequences for the stock market, interest rates and the Australian dollar.


Our gross debt keeps growing

The Australian December 23, 2011 12:00AM

THE Gillard government is maxing out Australia’s credit card much more quickly than it would have us believe and it’s what it is not telling us that makes the situation even more serious.

The government is keeping major programs “off budget” so they have no impact on the underlying budget balance. These include $50 billion for the National Broadband Network and $10bn for the Clean Energy Finance Corporation, or “Gillard Bank”.

The impact of these programs on overall government borrowing is shown in gross securities on issue. This is forecast to rise to a massive $272.4bn market value in June 2015.

Gross debt continues to rise in every year of the forward estimates with no end in sight. On top of this, the government has failed to explain how it plans to pay for several of its other commitments, such as its talk about a national dental scheme and the $6.5bn a year for a national disability insurance scheme. The Coalition fully supports doing whatever is possible to help people with a disability, but this spending has not been included in the projections of budget spending or debt. These additional commitments will substantially lift spending and debt.

There is now an increasing likelihood the government will need to again lift the legislated limit of $250bn on commonwealth securities on issue.

Although the Coalition has supported this in the past, the government should not expect a rubber stamp.

In a few years, Labor has increased its limit from $75bn to $200bn and, in May, to $250bn. Any proposal to lift the debt limit further should be assessed against five tough criteria.

First, all significant spending proposals must be subject to a cost-benefit analysis. It is shameful the $50bn government-owned monopoly NBN hasn’t had a cost-benefit study, as recommended by the Productivity Commission.

Second, new spending proposals should be funded from savings in existing programs. Cancelling the carbon and mining taxes and associated expenditure would deliver substantial savings to the budget bottom line and would be a good place to start.

Third, the government must commit to a credible strategy for paying down debt across the medium term. Without further detail, the government’s projection to reduce net debt to zero by 2020-21 is hardly believable, coming from a Treasurer who this year will chalk up his fourth huge deficit out of four budgets. It would require six consecutive annual reductions in net debt of $22bn. That is six consecutive surpluses larger in dollar terms than has been achieved previously (the largest underlying surplus was the $19.7bn achieved by the Coalition in 2007-08) or very solid growth in financial assets, which seems problematic given the likely continued financial and market volatility across the medium term.

Fourth, the government must publish key financial data for the medium to long term to enable proper scrutiny of its spending and debt. These should include total government expenditure, including spending for long-term projects that are presently classified “off budget”, such as the NBN and Gillard Bank, and expected spending for proposals such as the NDIS. This additional information must also include securities on issue and gross government liabilities. This will provide for a more accurate picture of the spending undertaken by this government, particularly in those instances where much of this spending is to occur beyond the forward estimates and it will provide some assurance about the medium-term debt repayment strategy.

Finally, as I called for in my post-budget speech, the government should publish estimates of the structural budget position. A budget that is in structural balance across the cycle ensures surpluses in the good times to offset deficits in the tough times.

Unfortunately this government is running a deep structural budget deficit, with a $37bn headline deficit at a time of record high terms of trade and the labour market close to fully employed.

These are the criteria the government must address if it wishes to seek an increase in the $250bn debt limit.The lesson from Europe, Japan and the US is that countries must live within their means.

Joe Hockey is the shadow treasurer.

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>Waterboarding the employment data to make it tell you what you want


It is not clear whether the reporting or the report is to blame, but this story in today’s Daily Telegraph http://www.dailytelegraph.com.au/news/national/australia-in-the-grip-of-a-jobs-crisis/story-e6freuzr-1226227990029 is build on foundations of sand.

The claim in the article that:

  • research firm CoreData suggested the number of unemployed people in Australia will jump by nearly 106,000 next year, assuming the labour force grows at its current rate and the unemployment rate rose to 5.75 per cent, as predicted”.

Here are some facts and scenarios:

As at November 2011:

  • employment in Australia was 11,457,100;
  • the labour force 12,092,900;
  • the number of unemployed was 635,800; and
  • the unemployment rate was 5.3%.

If we assume the same growth for the labour force for the last 12 months (0.46%) out to November 2012, the labour force will rise to 12,148,500. If in those circumstances, the unemployment rate forecast of 5.75% proves to be correct, the number of unemployed will 698,500. That’s a rise in unemployment of 62,700.

By the way, based on the 0.46% rise in the labour force over the next year, if the unemployment rate happens to come in a 5.5%, the rise in unemployment would be 29,400 people. If the unemployment rate were to be 6.0%, the number of unemployed would rise by 93,100. If the unemployment rate happens to be 5.0%, the number of unemployed would fall by 28,400.

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>Moody’s Triple-A Assessment of Australia


Moody’s have just reiterated Australia’s triple-A credit rating and in doing so, have slapped down the economic drongos who keep moaning, bleating and foaming at the mouth about Australia’s temporary budget deficit, the Government’s “addition to tax” and record levels of gross debt.

May they shut up and look at the facts. In doing so, they should give some praise for Australia’s economic and fiscal strength that has been built up over the last 30 years.

In reiterating the triple-A assessment, Moody’s note (I have bolded key points):

  • “Australia’s Aaa ratings are based on the country’s very high economic resiliency, very high government financial strength, and very low susceptibility to event risk.”
  • “It also demonstrates strong governance indicators. In particular, the framework for fiscal policy is transparent and has, until now, consistently kept government debt at low levels.”

Critical in Moody’s assessment appears to be:

  • “The government’s debt rating of Aaa takes into account the aim of maintaining a balanced budget, on average, over the business cycle. It is supported by the very low level of public debt and the country’s strong financial system. In comparison to most other Aaa-rated countries, Australia’s government financial strength is very high, with very low gross debt that is easily affordable and provides a high degree of fiscal flexibility.

In terms of the outlook, Moody’s note:

  • “The stable ratings outlook is premised on the expectations that the government will maintain its low debt levels and macroeconomic conditions will continue to support fiscal consolidation.”

It’s clear from the comment on negative risks to the outlook, the Moody’s were struggling to find one. It noted:

  • “Any trend or event that caused a long-term shift in budget balances to significant deficits and an increasing public debt burden might put downward pressure on the rating. Such trends could include, for example, fiscal costs associated with an aging population. However, since the government has been proactive in addressing this issue through its superannuation policies and proposed reforms to healthcare schemes, Moody’s does not anticipate sustained fiscal deterioration over the rating horizon.”

Australians should be delighted and proud with such a glowing report card on the economy. Well done to Treasury, the RBA, Government and the regulators in locking in this World-Best report card on the Australian economy.

For the full report, go to:


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