Australian Economy, Meet Austerity

Is there really no other way for people to maintain a democratic government than by handing over unlimited power to a group of elected representatives whose decisions must be guided by the exigencies of a bargaining process in which they bribe a sufficient number of voters to support an organised group of themselves numerous enough to outvote the rest?

We don’t know, Mr Hayek, but we very much doubt it.

Australia finds itself in a very precarious economic environment largely because of weak politicians and weak public service institutions. Yesterday’s poor budget news simply confirms what anyone with an ounce of common sense should’ve known was coming for a long time. That is, the Australian economy is in a spot of bother.

So we’re looking at government budget deficits as far as the eye can see? Is that really a surprise?

Let’s point the finger first and start looking at solutions later…

Number one on the blame list is politicians. The Howard government bribed plenty of voters, expanding middle class welfare and pandering to the boomers by making superannuation a very attractive low tax savings vehicle. If not for these bribes the surpluses in the good years would have been larger.

Many argue that cuts to income tax rates were too generous during this time. We don’t buy that argument. Allowing people to retain more of the income that they rightfully earn, and allowing them to spend it in ways that they see fit, is the cornerstone of a properly functioning economy.

If income tax cuts lead to a consumption boom, then it should be the job of monetary policy to control it. Raise interest rates to encourage savings over consumption. But no, the RBA under Ian Macfarlane kept interest rates too low for too long.

The real bribing got underway when Labour came to power in 2007. The 2007/08 surplus was $19.7 billion. That changed to a deficit of $27 billion in 2008/09. More deficits then followed:

2009/10: $54.5 billion
2010/11: $47.5 billion
2011/12: $43.4 billion
2012/13: $18.8 billion

These deficits came at a time when China’s economy was booming. During the first two financial years, Australia’s national income grew at a rapid clip. We should have produced budget surpluses. Instead, the government threw extra stimulus at the economy. That’s why interest rates rose over that period. Monetary policy was the only restraining factor. But rates were coming off historic lows following the GFC, so there was still a significant amount of stimulus flowing through the economy at that point.

The bottom line here is that the management of the Australian economy by politicians was a disgrace. They put themselves before the good of the country. Always looking to take and redistribute what wasn’t theirs in the first place, all to secure another term…another three years in power…another shot at shaping the country according to their ideological viewpoint. Morons.

You could argue that we’re no better. We voted the clowns in. That’s true. But the general population doesn’t take an oath to serve their country, to make decisions in the best interests of the nation. It’s their role to serve their family, or themselves, and no one else. If the government is going to hand out a bribe, you’d be stupid not to take it.

We don’t know what type of oath a politician entering parliament takes. But we’re guessing it’s got something to do with acting in the nations’ interest rather than self-interest. If that’s the case, they’ve all blown it. Liars, frauds, and crooks. And we call them ‘honourable’? Ha! The joke is on us.

Next in line for the blame game is the Treasury department. Their forecasts, which the government relied on to dole out bribes, were woefully inaccurate. It calls into question either their competence or their independence. Probably both. So don’t believe their future deficit forecasts; they are likely to still be overoptimistic.

Australia faces a sharp drop in investment in the years ahead. Our terms of trade will continue to decline, meaning national income growth will be tepid at best. If China slows more than forecast, and we think there’s a good probability of that happening next year, Australia will suffer its first recession in decades. It will be the recession we didn’t have to have.

Now here we are, facing the very real likelihood of recession, and we’ve got the current government talking about belt-tightening. This is the time when we should be looking at deficits to help the economy through a soft patch. So instead of considering tax cuts that might increase spending, people are talking about tax hikes!

The budget deficit forecast for 2013/14 is now $47.6 billion, which represents a large fiscal stimulus on the prior year. So we’ve had a large fiscal AND monetary stimulus and yet economic growth is still weak. That gives you some idea about just how bad the underlying economy is.

But all is not lost. If we realise that the next few years are going to be tough and austere, and the government finds a skerrick of backbone, important decisions can be made for the long term health of the economy. We’re not too confident of it happening, but there is hope.

Firstly, the government should get rid of a lot of middle class welfare. It’s not the role of the state to subsidise our standard of living. It also needs to restructure the tax system to incentivise productive investment instead of mortgage growth. Get rid of negative gearing and make genuine efforts to clear red tape for developers.

But making tough decisions like this involve reversing the bribes that got politicians into power in the first place. If the pollies sell such policies as genuine attempts to reform a country that has lost its way, and we voters turn around and reject it at the ballot box, then we’ll only have ourselves to blame.

If the government makes some tough choices and tackles reform, Australia has a good chance of getting back on a strong growth footing in a couple of years. Government debt-to-GDP is still very low at just over 20%. The situation is not disastrous.

It’s interesting to see the storm of commentary over the government’s debt blowout compared to the sanguine view towards household debt. Australia’s household debt-to-GDP ratio is nearly 100%. And most of that’s mortgage debt. No problem right?

That’s the consensus view. But we think it will become a problem in the years ahead, especially if we do enter a recession. Carrying such a high debt load while your economy contracts is not an easy task. What will our foreign creditors do? Probably ask for more return to compensate for the risk of lending to Australia. That means a lower currency or higher interest rates (or both).

Australia needs a few years of austerity. We need to realise that we’ve been living beyond our means for a long time. We need to pull our head in, understand that genuine economic growth and prosperity comes from investment and innovation, not speculating on house prices and relying on China to do the heavy lifting.

The next few years will show us what we’re really made of.

Regards,

Greg Canavan+
for The Markets and Money Australia

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

 


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