Monthly Archives: June 2012

Mr Abbott – How much is this going to cost?

Has Tony Abbott just kicked an own goal?  Mr Abbott has indicated that should he win the next election, his first act would be to repeat the carbon tax.  Indeed, even before he might be Prime Minister, Mr Abbott has said:

• “As soon as an election is called, the Coalition will take immediate and concrete steps to repeal the carbon tax.”

Fair enough.  It is a big issue for Mr Abbott and the Coalition has every right to take that issue to the election.

Mr Abbott also indicated that:

• “On the day the election is called, I will write to the Secretary of the Department of Prime Minister and Cabinet to make it clear that, if elected, the first priority of a Coalition Government will be the repeal of the carbon tax.

• “I will also formally request the Clean Energy Finance Corporation to desist from making any further determinations in relation to grants, funds or financing. “

He goes on:

• “On day one, the Finance Minister will notify the Clean Energy Finance Corporation that it should suspend its operations and instruct the Department of Finance to prepare legislation to permanently shut-down the Corporation.”

• “On day one, the Environment Minister will instruct the Department to commence the implementation of the Coalition’s Direct Action Plan on climate change and carbon emissions.”

• “As soon as the carbon tax is repealed, the Environment Minister will introduce legislation to enact the Coalition’s Direct Action Plan on climate change and carbon emissions.”

That promise of Mr Abbott is wonderfully transparent and as is about as direct as one could ever wish to see.  For that, Mr Abbott should be applauded.

But there is a flaw in what Mr Abbott is doing.  It is the absence of costing for this quite dramatic policy change.  It looks to be very expensive not just in terms of revenue lost from repealing the price on carbon, but also from the fact that he will retaining the income tax cuts and pension increases that are being paid for by the carbon price.  If that is not the case that these costs to the budget will be retained by the Coalition in government, Mr Abbott needs to make that clear.  If it is the case, the impact on the Budget needs to be assessed independently.  Add to that the cost of implementing the Coalition’s policy of direct action and it is easy to see how Mr Abbott might be about to punch a massive hole in the budget bottom line.

To have credibility, Mr Abbott must also, on the day the election is called, contact either the Secretary of the Department of Finance and / or the Head of the Parliamentary Budget Office and ask them to cost the policies outlined above and have the results revealed before the election.  This way, the voters can decide whether Mr Abbott’s policy proposals to repeal the price on carbon and implement Direct Action are worth it.

Indeed, if Mr Abbott does not cost his policy proposal on carbon and has those costs available for public consideration before the election, the promises above are vacuous.

Note that at the moment, the Budget surplus projections are:

2013-14:        $2.044 billion.

2014-15:        $5.318 billion.

2015-16:        $7.469 billion.

These surpluses are not huge.  It is only fair that the electorate fully understand whether the Budget surpluses will be blown out of the water with the proposal of Mr Abbott to change the way the problem of global warming is tackled in Australia.

Not a Media Release from the RBA

Not a Media Release from the RBA

Not a Statement by Glenn Stevens, Governor: Monetary Policy Decision

At its meeting today, the Board decided to leave the cash rate unchanged at 3.50 per cent.

Growth in the world economy picked up in the early months of 2012, but more recent indicators suggest further weakening in Europe and some further moderation in growth in the United States and China. Conditions in other parts of Asia point to an ongoing trend of moderate expansion, with constraints coming from slower Chinese growth. Commodity prices have declined lately, though they are mostly still high. Australia’s terms of trade similarly peaked in the September quarter 2011 but have recently fallen.

Financial market sentiment has deteriorated over the past two months. The Board has noted previously that Europe would remain a potential source of adverse shocks. Europe’s economic and financial prospects have again been clouded by weakening growth and concerns about fiscal sustainability and the strength of some banks. Capital markets remain open to corporations and well-rated banks, but spreads have increased. Long-term interest rates faced by highly rated sovereigns, including Australia, have fallen to exceptionally low levels. Share markets remain volatile and generally weak.

In Australia, available indicators suggest moderate growth continued in the first half of 2012, with significant variation across sectors. Overall labour market conditions firmed a little, notwithstanding job shedding in some industries, and the rate of unemployment remains low. Nonetheless, both households and businesses continue to exhibit a degree of precautionary behaviour, which may continue in the near term.

There have been no new data for inflation since the previous meeting. Over the coming one to two years, and abstracting from the effects of the carbon price, inflation is expected to be in the 2–3 per cent range. In the near term, it is likely to be in the lower part of that range, though maintaining low inflation over the longer term will require growth in domestic costs to slow as the effects of the earlier high exchange rate wane.

As a result of earlier changes to monetary policy, interest rates for borrowers have declined to be below their medium-term averages. Business credit has increased more strongly in recent months, though credit growth remains modest overall. Housing prices picked up in June having fallen in May and are only a little lower than at the end of 2011. Generally, the housing market remains subdued. The exchange rate has moved higher in recent weeks, but has remained broadly stable on a trade weighted basis for the past year.

At today’s meeting, the Board judged that the current accommodative stance for monetary policy was appropriate given the uncertain international environment and the outlook for inflation.  The Board will continue to monitor the economic environment and will set monetary policy in terms of the inflation and growth objectives.

RBA on hold in July – but on track for 2.5% in next 6 months

There seems little doubt that the RBA will leave official interest rates at 3.5% next week.  This is not because the economic outlook has all of a sudden turned rosy or inflation is about to move higher, but because the RBA prefers to leave rates steady and it adjusts them when there is compelling evidence to do so.  The case for a further cut right now is somewhat ambiguous.

Context is also very important.  About a year ago with the cash rate at 4.75%, the RBA was of the view that more interest rate hikes were going to be necessary as the economy moved along, wage pressures built and capacity constraints were tested.

But things changed – the world weakened, the labour market softened and there were massive downside surprises in the inflation data.   Not only did the RBA hold off its rate rises, it turned 180 degrees and starting a cutting cycle that very few people saw coming.

Despite the 125 basis points of interest rate cuts since November last year, the RBA still has a hawkish tone and its general reluctance to cut interest rates is a good thing.  Under the previous Governor, Ian Macfarlane, the RBA did a bad job as political pressures influenced its decision to postpone or even avoid interest rate hikes, even though underlying inflation was exploding to 5%.  It was a mistake that cost Australia dearly.

That was an error that the current Governor, Glenn Stevens, is desperate to avoid and so far he has done a quite brilliant job getting inflation lower in a climate of solid economic growth.  At last count, underlying inflation was at a 13 year low and there is a material risk that it could reach a multi-decade in the next few quarters.

While the global economy looks particularly weak and presents a quite substantial downside risk to Australia, the RBA already has interest rates at an accommodative level and the case for further cuts was undermined by the recent GDP, jobs and even house price data.   The RBA seldom moves interest rates 3 months in a row which suggests a pause is coming in July. There is also a lot of news between the July and August meetings of the RBA, with the June quarter CPI perhaps the highlight.

If we fast forward to the RBA meeting on 7 August, we can work on the strong probability that there will be an interest cut then, with the decision to go 25 or 50 basis points to be driven by the inflation results and any further news from the global economy and financial markets.  A low inflation result for the June quarter and further global and commodity price weakness would see the RBA go 50 which if delivered, would take the cash rate down to the same level that prevailed during the depths of the GFC.

In my view, the RBA is still on track to cut official interest rates to 2.5% by year end or sometime in the first half of 2013.  The inflation outlook will demand such monetary policy action as will the problematic weak world environment.  An on-hold decision in July from the RBA is more a tactical decision rather than suggesting this current interest rate cutting cycle is over.

More Facts Behind the Howard Government’s Debt Elimination

Australia’s net Government debt was $96 billion in June 1996.  By June 2007, Australia had net financial assets (negative debt) of $29 billion.  The Howard Government and the current Liberal Party point to this turn in the finances of the Government with pride and say it is a sign of good economic management.

To be sure, this is a significant turnaround but there are some interesting facts behind the issue of Government debt in the past 30 or so years.

The first point to note is that the $96 billion of debt inherited by the Howard Government from the Labor Party in 1996 comprised around $39.9 billion of debt accumulated by the Fraser Government under the Treasury-ship of Mr Howard and left to the Hawke Government in 1983!  See Table 3 of Budget Paper 10 for more details.

As I discussed a while back, http://alturl.com/4o973 , when the Coalition talks of the $96 billion of Labor debt that it inherited, recall that just under half of it was in fact Liberal Party debt that was a hangover from the Fraser era.

That slightly embarrassing issue aside, let’s look at how else the Howard Government “got rid” of that debt.

Asset sales loom large in that discussion.  The list of government assets sold by the Howard government is here: http://alturl.com/bjhqk . This table shows the asset, the time of sale and the price.

To get an accurate indication of the true dollar impact on debt of those asset sales, I have converted them into June 2007 dollar terms.  Take the sale of DASFLEET, for example, which was sold for $408 million in July 1997.  In June 2007 terms, this was worth $536.8 million.  Or perhaps the first tranche of Telstra is interesting.  Sold for $17.2 billion in November 1997, that converts to  $22.6 billion in June 2007 terms.

The value of all asset sales under the Howard Government totalled  a very hefty $71.8 billion in June 2007 dollar terms.  This means that around three-quarters of the pay-down of the $96 billion of government debt was simply from selling assets to the private sector.  Nothing more, nothing less.

To summarise the above facts:

The $96 billion “Labor debt” inherited by the Howard Government in 1996 comprised $39.9 billion of Fraser Government debt that carried through the Hawke/Keating period meaning that the true level of Labor debt in 1996 was $56 billion.  To pay that $56 billion off, the Howard Government sold almost $72 billion of Government assets meaning the move to negative net debt was not really due to any miraculous and bold fiscal settings, but owed everything to a series of asset sales.

Footnote:   The spreadsheet where is move the asset sales to constant June 2007 dollars is available on request.

Australia’s Terms of Trade are free-falling…. But how far will they go?

Australia’s terms of trade, the relative price we pay for our imports versus the price we receive for our exports, are falling and in the process are threatening to undermine a critical element of Australia’s spectacularly successful economic performance of the past decade.

Much of the strength in the economy has been driven by the mining boom which in turn has been underpinned by high prices and growing exports volumes for our mining output.  The business investment performance, demand for skilled labour, company and soon to be mining tax payments, the share price for mining companies and the spin-off to the rest of the country from the mining boom has been huge.

Let’s have a look at the terms of trade in some context.

In the September quarter 2011, the terms of trade peaked hitting a level some 105% above those prevailing around 2001-02.  This boom in the terms of trade was largely the result of the staggeringly high prices that foreign buyers were willing to pay for things like coal, iron ore and gas.  Of note, import prices were also held down by the record high Australian dollar which also boosted the terms of trade.

In the December 2011 and March 2012 quarters, there was a 9.8% decline in the terms of trade.  In the context of the 100% plus rise over the prior decade, this is small beer.  The available data for the June quarter on commodity prices and the Australian dollar suggests that the terms of trade dropped another 7% or so in the June quarter which if correct, would bring the total terms of trade decline in 3 quarters to around 16%.  This is starting to get serious.

The absolute level of the terms of trade is still high on any long run assessment but at this stage, there is nothing to suggest that we are at the low point for this cycle.  Indeed, the terms of trade are at risk of a further large fall.

Importantly, there is a quite spectacular supply side response going on in the resources sector globally and not just in Australia.  The investment boom by definition sparking a sharp increase in production.  If this new supply comes on stream at a time when growth in demand for these materials is less robust than the growth in new supply, prices will keep falling.  Given the severe weakness in most commodity price indices in the last 3 or 4 months, this looks to be happening.

The fall in the terms of trade presents a big downside risk to the Australian economy.  Thankfully, the RBA is smart and pragmatic enough to make up for its past tardiness in cutting interest rates with the 75 bps of interest rate cuts in May and June.  If anything, the RBA is now  looking to get ahead of the curve as the economy is increasingly subjected to negative offshore influences.

Any further falls in the terms of trade would not only undermine the growth momentum of the domestic economy, but it would place considerable downward pressure on inflation from an already low starting point (underlying inflation at 2.1% is the lowest in 13 years).  This is why the RBA will almost certainly be cutting interest rates quite a bit more between now and late 2012/ early 2013.

But the terms of trade decline also spells a risk to the Budget.  Nominal growth in the economy is the driver of tax payments and any under-achievement in nominal GDP growth relative to the Budget-tinme estimates would risk the surplus target.  Interestingly, the very strong real GDP result for the March quarter did little to help the Government’s Budget position.  Why?  Because nominal GDP growth was probably lower that expected and the recent fall in the terms of trade is signalling  a form of deflation for the aggregate economy.

From the perspective of trying to pick the big economic and market trends, the global economy, broad commodity price measures and local inflation – in other words the terms of trade – will be the main game for the next 6 to 12 months.

Wake up Australia: Things are pretty bloody good

Let’s go back to November 2007.  You are in a household where one person earns $75,000 a year, another $50,000 a year.  This household has a $300,000 mortgage and are paying the standard variable mortgage interest rate which is 8.55%.   From their post tax income, this household spends $60,000  a year on items as per the basket of goods and services in the Consumer Price Index and any left over money is put into savings.

This is sounds pretty average.

Fast forward to today.

Assuming the wage levels of people in this household have increased at the pace of growth of average earnings, which up to the March quarter 2012 is 20.0%, the high income earner has moved to an income of $90,000 a year, while the other earner is now on $60,000 a year.

This means that before income tax and the Medicare levy, the gross income of this household has risen by $25,000 per annum.

Since November 2007, there have been a series of income tax cuts, some large, some small and all set across different income brackets.  Suffice to say that for the high income earner in the above example, they will be paying around $1,850 less income tax than had the tax scales prevailing in November 2007 been left in place.  The lower income earner in this household is paying around $2,050 less in income tax, meaning an ongoing saving of around $3,900 a year.

The combined effect of the wage increases and lower income tax rate translates to a rise in take-home income in this household is around $16,500 a year.

On their $300,000 mortgage, this month’s cut in official interest rates has seen their variable mortgage rate drop to 6.80%.  This means that on their mortgage, the annual repayment is around $4,100 a year lower than it was four and a half years ago.

Before expenses, there is more than $20,000 extra a year in cold, hard after tax cash flowing into the bank accounts of this household.

Let’s look at expenses.

Since November 2007, the CPI has risen by 12.1% meaning that this household’s $60,000 a year expenditure on the basket of goods and services covered by the CPI has increased in price by close to $7,000 a year.  This takes account of higher electricity prices, higher lamb prices, the rise in the cost of holidays, beer and takeaway food.  All of it.  It also includes the price falls evidence when the buy their computer, mobile phone charges, TV, car, childcare and clothes.

So there you have it.

This household is in clover – taking home $16,000 a year more in income than in late 2007, paying $4,100 a year less in mortgage repayments and having their cost of living rise by just $7,000.  Set out this way, this is a quite massive rise in real income and living standards in under 5 years.

It is little wonder the household saving ratio is booming with these sorts of windfall gains for the Australian consumers.

Reporting the G20: Australia’s Giggling Media

This morning’s media coverage on the G20 meeting in Mexico is concentrating on an “attack” from the leaders of some of the major industrialised countries on Prime Minister Gillard for “lecturing” them on economic policy management.

My quick survey and observation of the media coverage shows a pathetic, yet staggering coverage of the issue in the local media that highlights the reaction of the leaders of the Zombie economies rather than covering the facts, context and structure of what PM Gillard was delivering to her fellow leaders at the G20 meeting.

A couple of issues are important.  The Zombie economies are still in recession, with horrendous double digit unemployment, little to no prospect of getting their budgets to surplus, social unrest, falling living standards and general malaise.

They need all the help they can get in learning how to manage an economy and Australia and Prime Minister Gillard are brilliantly placed to deliver one of those lessons whether they like it or not.

Yet our media reports the comments from the leaders of these countries with an authority and implication that they have some substantive point in issues covering economic policy management.   The media again ignores the fact that the Australian economy is growing solidly, unemployment is anchored around 5%, the Budget will return to surplus in a couple of weeks, living standards are rising and that all of this has been underpinned by the economic policy choices taken by this Government, aided and abetted by the legacy of policy settings from previous Australian Governments.

The media coverage is dreadful.  Rather than judging the leaders of the Zombie economies and calling them out for their on-going humiliation in economic management and the dreadful social probelms than come from that, our media prefers the “attack on Gillard” line.

Being attacked by a failed, moribund, hotch potch bunch of economic incompetents should be a badge of honour for Australia – not that the media coverage today will say this.

Middle class suffering? Get real!

There’s a noticeable change in the rhetoric from the government and its senior ministers, including the Prime Minister, when it comes to the economy.   No doubt emboldened by the run of quite stunning economic and policy news over the last few months, the Government is focusing on the economy from the positive.

Strong economic growth; 21 years without recession, rising real wages, low interest rates, low inflation, rising productivity, a budget surplus  – you know the list – it’s long and stunning.

One can only hope the chatter from the Government about Australians “doing it tough” is fed into the verbal shredder as this rhetoric was an own goal that appealed to people like the women on Q and A on Monday who asked the Prime Minister:

• “Why does the middle class of Australia, the back bone of the economy, always suffer under a Labor Government? Why does your Government penalise hard working middle class Australians with new carbon tax and taking away or even reducing the health care subsidies? Are big income tax increases for the middle class on the Government’s next agenda?”   

The questioner added a little later:

• “We slide into the middle class band where we don’t actually get any subsidies whatsoever. So it just feels like we’re just constantly paying out and not getting any sort of gain from any sort of breaks that you’re talking about at all.”

These two short comments encapsulate a lot of the reasons why the unprecendented prosperity in Australia is not being translated into support for the Government.

The comment relating to the “middle class always suffer[ing] under a Labor Government” is clearly either a biased perception or a misunderstanding rather than a reality.  It also smacks a little of the downward envy that occasionally influences those doing well enough not to qualify for government benefits.

Let’s start looking at this issue of the standing of the middle class under Labor Government’s with a focus on jobs.  In 4 and a half years, including through the GFC, the current Labor Government has seen 835,000 new jobs created.  Under the previous Labor Government over 13 years, 2.044 million jobs were created.  Not a bad start for the middle class.

Now turn to the money in people’s pockets.  Since the end of 2007 when the Labor Government came to power, average earnings have risen by 20.0% while the consumer price index has risen by just 12.1%.  This strong rate of real wages growth is a windfall for the middle class whose purchasing power has been boosted by around 1.75% per year, every year, for the whole term of this Government’s term.

Mortgage interest rates are undoubtedly a critical factor in middle class financial well-being.  When the Howard Coalition government lost the 2007 election, the standard variable mortgage interest rate was 8.55%.  After the cut in official interest rates in June, that interest rate has dropped to 6.80%.  The cost of servicing an average mortgage of $300,000 is $4,000 a year less now than it was under the Coalition.  A kinder person might be inclined to say “thanks Labor!”

In terms of the question from the woman on Q and A, “are big tax increases for the middle class on the Government’s next agenda”, she might be surprised to learn that the total tax take in 2010-11 under the Gillard Government was 20.1% of GDP.  This is 3.3% of GDP less than the average tax to GDP ratio under the Howard Government.

So how much is 3.3% of GDP?

In 2010-11 terms, it is around $46 billion per annum.  The amount of tax collected in 2010-11 was around $4,750 a year less per household than the average of the Howard Government.  Pretty compelling stuff for the middle class.

When it comes to income tax, the woman should be aware that during the first 3 years of the Labor government, there were substantial income tax cuts delivered.

Let’s take someone earning $150,000 a year.  This may be the upper bound of middle class, but woman appears to be from a household where the income is above this.  In 2010-11 compared with 2007-08, the income tax paid is $3,650 a year lower for each and every year.  These are income tax cuts delivered by the Labor Government that are still place.

The run of hard facts would suggest that the Q and A woman is either ignorant, biased or has some other financial issue not related to recent government policy that she is blaming the government for.  I don’t know.  That said, the facts suggest her plight would be significantly worse were it not for the policies of the current government.

A Little Quiz on Interest Rates

It’s that time again – a market and political economy quiz.

The recent Essential Poll showed that only 35% of the population knew interest rates were lower now than when the Labor Government was elected in 2007 and a stunning 20% thought that interest rates were higher.  The others presumably had no idea or interest in the interest rate matter.

This prompted me to frame a quick quiz for those interested in the interest rate issues.

Question 1:

The standard variable mortgage interest rate was 8.55% when the Labor Government won the November 2007 election.  After the June cut in official interest rates, what is the average mortgage rate of the big banks?

 A:  6.80%

Question 2:

How much is the annual savings in repayments on a $300,000 mortgage with interest rates at 6.80% versus 8.55%?

A:  $4,100 a year.

Question 3:

The June cut from the RBA saw the official cash rate fall to 3.5%.  When was the last time a Coalition or Liberal Party controlled Government presided over a cash rate this low and who was Prime Minister at that time?

A:   1965; Robert Menzies.

Question 4:

When was the last cut in official interest rates during the Howard Government?

A:  December 2001.

Question 5:

What happened to official interest rates during the final 6 years of the Howard Government?

A:  Interest rates only rose – there were 10 straight interest rate rises from a low of 4.25% in December 2001 to 6.75% by the time of the November 2007 election.

Question 6:

If the futures market is correct, where will the official cash rate be at the start of 2013 and what does this imply for the level of mortgage rates?

A:  Around 2.25% to 2.50% for the official cash rate, which implies a standard variable mortgage rate around 5.75% to 6.00%.

Question 7:

What was the average official cash rate under the Howard Government? (April 1996 to November 2007)

A:  5.43%

Question 8:

What is the average official cash rate under the Rudd and Gillard Governments? (December 2007 to June 2012)

A:  4.71%

Economic nirvana: Long may it reign over us

The data and events of recent weeks present a picture of the Australian economy in a structurally brilliant position with a near text-book perfect implementation of macroeconomic policy.

Think about it:

• GDP growth picking up to  4.3% and is now set to be locked in around 3.25% to 3.5% to be back around trend.

• Inflation at 2% to be at the bottom of the RBA target band and looking a million miles from getting near 3% which is the top end of the band.

• Solid job creation with 85,000 new jobs created in the last 3 months: the unemployment rate is hovering around 5 to 5.25% which is low on any reasonable measure.

• The three major ratings agencies have affirmed Australia’s triple-A credit rating.

• The yield of government bonds has been tracking at record lows and as a massive vote of confidence in Australia’s economy and policy settings, around 80% of the government bonds on issue are held by foreigners.

•  In terms of policy, the budget locked in an unambiguously restrictive tightening in fiscal policy with a return to surplus and historically low levels of spending and tax to GDP ratios.

• This fiscal prudence, among other matters, has allowed the RBA to move monetary policy to an easy setting which helps the softer parts of the patchwork economy and takes some of the heat out of the strong Australian dollar.

All that is good, but here are a few lesser known facts about Australia:

• Despite being the 52^nd largest country in the world in terms of population, Australia is the 13^th largest in terms of US$ GDP.

•  Using per capita GDP in US$ terms, the average Australian is 30% better off than those in Canada, 35% higher than the US, 50% higher than in Germany and 70% higher than in the UK.

• Australia has had a decade where growth in household incomes has outpaced the rise in the consumer price index.  This rise in real wages is not being matched in many other industrialised economies.

• The current 5.1% unemployment rate is very good, but the last time Australia’s unemployment rate was above 6% was in July 2003.

•  Australia has gone 21 years without a recession.

Pretty good ay?  If we revisit this list of economic achievements in 3 or even 5 years and the broad thrust of them are still in place, it would be fantastic.

This is why economic policy matters so much.