Its official, “the economy is still on life support.”
“The economy grew 0.5 per cent in the March quarter, driven by a further 11.6 per cent rise in government construction spending, which accounted for more than all of the economic growth offsetting slides in business investment, private housing investment and exports.”
Peter Martin at The Age does quite a good job of outlining just how miserable things really are. His last line is rather out of place:
“Australia’s annual growth rate is still about 2.7 per cent.”
So it turns out stimulus spending works. Governments paying people to dig holes can make GDP jump. Who cares if the real economy is tanking?
Strangely enough, while the government was telling its employees (or contractors) to dig holes, it told the mining industry to stop digging them. More on that below. We’re sticking with the “digging holes for economic stimulus”, not the “digging holes to provide something of value to someone”.
The King of Stimulus was of course Lord John Maynard Keynes. And here is what he had to say about digging holes:
“If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is..”
The problem with all this is that it ruins the economy in the long run. Devoting capital, resources and employment to digging up a finite amount of money hidden in glass bottles can leave you suddenly empty handed and looking very stupid.
So the governments would have to bury more bottles.
Pretty soon, your economy would consist of filling glass bottles with paper (money), burying them, unburying them and paying your paper to the government in tax to be buried again.
Presto, full employment and a great GDP figure.
If the economy tries to revert back to providing something of value, it will notice that capital, resources and employment will have to be reallocated. This is not a fun process. It is called a depression. But if you don’t have the depression, you will continue to misallocate the capital into malinvestments, which turn out to be worthless to the economy in real terms.
To be fair to Keynes, he also mentioned to following:
“It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing”
So, the allocation of resources could be more sensible than digging up dollars. But the issues are the same. If houses aren’t being built by the private sector, it is because this would be a malinvestment; a misallocation of capital, resources and employment that would later be exposed as unsustainable, causing turmoil in that industry. So if the government builds houses anyway, you end up with that malinvestment and the resulting turmoil. A malinvestment remains a malinvestment.
The joyous part in all this is that Keynes advocates government stimulus just when the economy goes into a depression. In other words, just when the malinvestments from previous stimulus are being cleaned out of the system and capital, resources and employment are being allocated to a better cause.
Stimulus doesn’t save an economy. It bashes it back on track to ruin.
The Uncertainty Country
The other way to ruin an economy pretty quickly is to introduce uncertainty. It’s taken Kevin 07 several years to pick up on it, but better late than never. Strangely enough, announcing the Resources Super Profits Tax (RSPT) had a damaging effect, even before Kevin fully understood what it actually is.
So now the miners are reacting and it’s a bluffers game of Russian roulette with dice thrown in for good measure:
Monday: Top miners dig in against resource tax (The Australian)
Tuesday: KPMG predicts investment fallout over tax (ABC)
Wednesday: Miners turn down heat on resources tax (The Age)
Thursday: Rudd not intimidated by Xstrata deferring projects
So how will it end? Nobody knows – which is exactly the problem. Investment doesn’t like uncertainty and the government is giving it plenty. Mining investment is especially sensitive because of the delay in payoffs from the initial investment.
Sadly, political risk has been brought up and is likely to stay. So long, lucky country…
The steady flow of debt rating downgrades continued last Friday with Spain as the latest victim. But what changed? How come the rating was downgraded after the austerity measures were announced? Surely being thrifty is good for your balance sheet?
Dan explained on Monday that “ratings agency Fitch said [the austerity] measures would damage Spanish growth prospects.”
Harvard’s economics historian Niall Ferguson has a good grasp on certain aspects of the crisis, but on this issue he seems to side with the ratings agency. He uses the sovereign debt racked up during World War 2 in his explanation of the three ways to get out of debt. You can grow out of it, decrease government spending, or raise taxes.
Which do you think is most politically viable?
But sadly, government driven growth gives you fake growth, as explained above. It leads to more of the same problems down the road. The strange thing is that Niall Ferguson is fully aware of this. He “would not be at all surprised to see another crisis in a relatively short time” because all the solutions to the crisis have only made the problems worse. He gives moral hazard as an example. And yet he supports government action to prevent a depression.
So, having a worse depression somewhere down the track is apparently better than having one now.
Ferguson is also a fan of Keynes, but it’s unlikely that the King of Stimulus would have approved of how his theories are interpreted. It seems the mainstream is advocating ruining the long run for the sake of the government statistic known as GDP.
But there may be more important things than GDP for governments to prop up. Themselves for example. If a government can’t borrow enough to keep GDP at the levels it deems appropriate, then the economy could really be in trouble. Even the legitimate services of government would suffer.
So what does Markets and Money Editor Dan Denning think about the implications of European nations struggling to fund themselves? He explained on Tuesday that the consequences of a sovereign debt crisis in Europe would hit banks holding that debt hard. And there aren’t many safe assets to sure up your capital base, so what do you do? Hold cash? Not while Bernanke and Trichet are behind the printing presses!
Degrading the Debt Downgraders
The EU has completely misinterpreted the Latin phrase “quis custodiet ipsos custodes?” (Who guards the guards?). Their latest plan is to “create a watchdog to curb credit rating agencies”. There will also be a “review of the way banks are managed”. So after basing bank capital adequacy laws on ratings given by companies paid to give good ratings, the government sees room for more meddling. Paul McCulley from PIMCO agrees with their analysis:
“[The breakdown of our financial system] was about the invisible hand having a party, a non-regulated drinking party, with rating agencies handing out the fake IDs.”
McCulley is right at the top of our least favourite people, so we will keep this short. The party got out of hand because the Federal Reserve was handing out free drinks. Holding the interest rates that bankers borrow at below the rate of inflation is like handing out cocaine at a rehab centre. Free thrills.
Supposedly “financial gain affects the same pleasure centres of the brain that are activated by certain narcotics,” so the metaphor is quite apt.
But of course nothing is free and the hangover had to come around. It didn’t last long, as interest rates went to 0 and the drinks began to flow again. Can you guess how this will end?
One noteworthy aspect of the EU plan to regulate credit ratings agencies is the timing of the announcement. Just as the sovereign debt crisis begins to spread and countries begin to see their bonds getting downgraded, they decide to extend their power over the rating agencies…
Going for Gold … going going gone
According to Zero Hedge, the US mint is out of gold and silver American Eagles (coins). Unprecedented demand happens to be the reasoning.
People all around the world are paying significantly over the spot price of gold for their coin investments, just to get their hands on something. Speaking of which, your editor has been reliably informed by an attractive local “expert” that Argyle Diamonds just happen to be good alternative to gold as an inflation hedge.
Some analysts believe that China is avoiding purchasing gold from the IMF, as this would give the gold price an unstable boost. Instead, their purchases are more covert, but still substantial.
Quotes of the week
Warren Buffet before Congress:
“The entire American public was caught up in a belief that housing prices could not fall dramatically… Rising prices became their own rational.”
Dan Denning, reading the Australian Financial Review, murmured the following:
“There are so many ads for government jobs in here. It’s really depressing.”
Until next week,
Markets and Money Week in Review