Exploring a Unique Take on the Market

Sound Money Sound Investments editor Greg Canavan went on the record last week predicting commodity markets to rebound in 2014 as global capital goes hunting for cheap assets. But they might not be as cheap as they should be thanks to the Indonesian government. Every nickel, tin and copper miner not operating in Indonesia might be handed a Christmas re-rating upwards, too. But why?

On January 12, 2014, the Indonesian government is due to ban exports of unprocessed raw mineral ore and primary concentrates out of country. The Financial Times reports ‘the ban is part of a controversial plan to encourage industrial development by pushing mining groups to build smelters.‘ The January date will make it official, but earlier this month the government reaffirmed its position. Markets are pricing it in now. Take a look at Dr Copper’s verdict in early December.

Copper Goes Boing
Source: StockCharts
Click to enlarge


The idea, as far as the Indonesian government is concerned, is to capture more value added wealth than simply shipping off Indonesia’s natural wealth (sound familiar?). The problem is that, as one of our World War D  speakers, Byron King, points out, ‘Currently, Indonesia lacks sufficient roads, railways, energy systems, processing plants, support facilities, service industries and workforce to refine all the ore that already comes to the surface. But despite these facts on the ground, the government of Indonesia now wants smelting and processing done in country — starting in January.

According to the Financial Times, there is still a chance of last minute reprieve as miners on the ground try to negotiate.

Reuters reports Freeport-McMoRan Copper & Gold, who runs the world’s second largest copper mine in Indonesia, warned the plan could cut its revenues in the country by 65%, and would mean laying off 15,000 employees. That’s just one company.

What Indonesia will get if it goes ahead is job losses and lost export revenue. That’s not exactly something Indonesia looks like it can afford right now, with a current account deficit and the rupiah down 25% against the US dollar in 2013.

Of course, you can’t say the companies didn’t have some warning. This plan has been on the table since 2009. There does seem to be a bit of ambiguity about if the politicians will follow through with the plan. That is to say, don’t pencil the law in until it’s January 13 and it’s gone through as it stands today.

Scenario one is the mining industry won’t continue to invest in Indonesia because of the onerous obligation to invest extra capital in refining capacity, and that they will go elsewhere. Or the politicians will be made to bend so mining companies can hold on to their lucrative licenses and the economic rent those licenses entail.

Who gets the economic rent is the central issue for our colleague Phil Anderson. Phil, as you many know, looks at the market, especially the real estate market, in a unique way. The economic rent is the difference between the costs of production on different acreages of land. This is based on the works of long dead and mostly forgotten economists David Ricardo and Henry George. Phil argues the work of George and Ricardo identify the key to the economy is not monetary policy, deficits, wage rates or any other standard economic indicator you care to name. It is land value.

The reason land value is the key, the ‘Georgists’ argue, is that land value is allowed to  capture the gains in wealth from society. Landowners receive unearned share of income that they don’t deserve because of the enclosure of the rents. This is part of the reason why there is a real estate cycle, according to Phil.

We’re still teasing out the implications in our own mind, dear reader, but stay with us. This is what our recent reading has brought up.

Perhaps the best example of the theory was right next to us for most of our life. Our grandfather bought two empty blocks of land years ago in the seaside suburb of Merricks Beach on the Mornington Peninsula. It was so long ago he may have paid pounds for it. We certainly weren’t around at the time and it’s too late to find out now. He built a beach shack on one block and left the other one empty. Years later, our mother moved us into the beach house and bought the empty block next to it from him.

Merricks Beach is a beautiful spot, dear reader. We called it a suburb but the word doesn’t really fit. It is minutes to walk to the beach. The roads are unpaved and rustic. Native plants discreetly shroud houses. There are birds and koalas. The population is small, peaking around summer and mostly quiet for the rest of the year. There isn’t a shop or business in sight.

That brings us back to the empty block of land next to the house we grew up in. No labourer tilled its soil. Nobody grew anything on it. No businessman put capital to work on top of it. Not one bit of productive, wealth creating activity happened on the block of land for over forty years. But its value went through the roof over time. That gain, argue the Georgists, is economic rent. It is value that is allowed to accrue to those who do nothing to generate wealth.

How did this gain come about? Georgists would argue Melbourne’s population grew, pushing the bounds of Melbourne outwards, and bringing Merricks closer. Roads from Melbourne to the Peninsula were improved, infrastructure added. Over time, more people moved to the Peninsula, attracted to its quiet streets and natural beauty. Governments built schools and hospitals in the area. Other landowners built houses and improved their properties. That is to say, the locational value increased.

Now the conventional view is our grandfather (probably unwittingly) made a shrewd property investment and is entitled to whatever gain accrues to him or his family.

The Georgists argue that the activities of the community, however, created this value, and instead of being returned to the community, it is captured privately thanks to the privatization of the land via the government title.

The Georgists argue that 100% of this gain should be taxed away and used to fund whatever the community deems desirable. In return, the current and intolerable weight of today’s crushing taxes could be taken off the back of workers and business. This would allow the general wealth of the community to flourish. Social mobility would rocket because every man could keep what he earned and not be robbed of the wealth he produced. The rentier class would be neutralised because the only way to get rich would be to produce something of value.

But that is not how our current system works. Instead, argue the Georgists, income is taken from labour and capital via taxes, and thanks to public spending, robs the common man not once, but twice. Not only is the wealth he produced taken from him via force, but infrastructure spending and other government boondoggles enrich the landed class. This is because the wealth invested will show up in higher land values wherever it is spent.

But the implications don’t end there. This is where Phil, in his analysis, draws upon the Austrian tradition of economics. Higher land prices allow the banks, via fractional reserve banking, to expand credit against this inflated land value. They enrich themselves at the expense of workers who must labour longer and longer to buy their piece of Australia, or America, or England. All for land that, the Georgists argue, is theirs in the first place because land was produced by no one and therefore common to all.

Enclosing the rent also encourages land hoarding and land speculation.  As the land price is allowed to ‘capitalise’ higher and higher thanks to the wealth generation of the community, bankers and financiers go into a frenzy of speculation, creaming off rich profits thanks to the interest on the debt they sell. This process from bust to boom, according to Phil, averages about 18 years in the United States. 4 years down and 14 years up. At the peak of the boom the land price inflates so high the productive work of labour and capital can longer afford the asking price of land. Then comes the inevitable collapse as the land value contracts. The outstanding loans made by the banking system become greater than the value of the land that provides the collateral. The banker is caught in a death vice. Here you have 2008.

But bankers are a shrewd lot. They don’t pay the price. They arrange to have the losses socialised. So the common man is robbed again as governments go into debt to bail out the banks and try to restore high land values.  The banks won’t pay the government debt, but the taxes taken from income will. Of course, central banks will inflate the money supply too if necessary. Here you have QE1, QE2 and QE3.

The Fed’s job, in the case of the US, is to reflate the system when it collapses so bankers don’t get crushed by the very debts they create. The Fed IS the bankers. Of course it’s going to save their bacon. We mention that because the Fed celebrates its 100 birthday on Monday.  Much will be made of how the Fed saved the world economy. But did it really?

We dare say Phil would argue the whole Federal Reserve experiment has been a raging success of socialising the losses on the American people from a century of financial collapses and bailouts to protect the vested interests who profit from the unearned wealth that is the economic rent.

At some point in the future, too, regulators and politicians will suggest the financial system is repaired and the appropriate regulations are in place to prevent ‘another 2008’. David Ricardo and Henry George, however, were they alive today, would perhaps suggest another 2008 is certain as long as society permits banks to create credit against inflated land value. It’s certainly something to keep that in mind when you read about a hundred years of Fed central banking next week.

Of course, Phil says you can take advantage of this ‘cycle’ knowledge by timing your real estate investments to the rhythm of the cycle. He argues the bust phase of the real estate cycle is over and to watch for continued signs of recovery in 2014. Hmm. That’s a contrarian stance in this office. And it’s certainly not conventional. But what we do know is Phil was out of the market when it went bust and in it when it went up based on his cycle theory. So it’s our vote for the most intriguing idea for the year. Let us know yours at letters@marketsandmoney.com.au

It’s one reason why 2014 is going to be a fascinating year. Stay tuned. We’ll leave you with those thoughts and, of course, wish you a very merry Christmas.


Callum Newman
for Markets and Money


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Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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