“The Australian market is in full correction mode,” writes our colleague Greg Canavan at Sound Money. Sound Investments. “This is not surprising considering we have European debt worries, tax grabbing government policy, rising interest rates and the first signs of a slowdown in China going on all at once. At the open today [yesterday] the market was down nearly 100 points. This was the first real panic day I have seen for some time. My guess is that we saw some major international selling this morning as risk trades unwind.”
That sounds about right. Greg also effectively nailed his analysis of what it is an acceptable rate of return for mining companies and their shareholders. The heart of the issue is who gets to judge what an adequate return on capital is, the government or the risk-taking enterprise. Greg writes that:
Capital will only finance projects if the risk reward equation is attractive. The government seems to think a reward of 6% is enough…and that anything above should be taxed at a rate of 40%.
If mining companies went out in search of capital to fund a project and they were projecting a return of 6%, they would be no takers. Nothing would get built.
If a mature mining operation cannot earn 6% return on capital then it shouldn’t be in business, so we can assume that most mature mines will be paying some sort of super profits tax.
What this government imposition does is increase the pre-tax required rate of return that investors will now demand from these companies. Investors will not accept a lower after tax return and passively accept the government’s judgement.
The result for mining companies is lower valuations. The result for Australia is a loss of wealth
That loss is about $16 billion in shareholder value and counting. And that does not include the loss of Australia’s reputation as stable place to do business and make long-term plans. “If it is what appears to be, a significant tax increase, that’s another competitive advantage for Canada,” said Canadian Finance Minister Jim Flaherty. He implied that the tax change would favour more capital investment (and formation) in Canada and less in Australia.
But let’s not be dogmatic. The heart of the government’s proposed power-sharing agreement is that Australia’s resources belong to Australians and should be shared by all “stakeholders” not just all “shareholders.” Treasurer Wayne Swan told the Australian Financial Review that the wealth generated by the last boom, “failed to capture for the taxpayer a fair share of the wealth generated from the community’s mineral resources.”
Fair enough. That’s pretty clear as an argument. Resources belong to everyone and the bounty of them should be spread around equally, or at least more “fairly” (whatever that precisely means). But let us offer a less dogmatic and heated definition of what constitutes a community’s wealth.
Australia’s mineral resources don’t make it rich. Its transparent legal system, fair tax system, competitive capital market, skilled workforce, and a general environment that creates the conditions for the private sector to thrive make it rich. When you start taking a sledgehammer to this institutional framework, you destroy a nation’s wealth.
If having stuff in the ground made a country rich, African nations would be the richest places on the planet. But for commodity rich countries, it’s only when private capital and energy identify mineral deposits to develop economically that value is unlocked in exchange with buyers. A nation’s real wealth is in being a good place for people to be free and create wealth and value and jobs. Easy-to-understand laws that don’t change in mid-project attract capital, human and financial. And capital leads to more net national wealth.
But maybe all that’s too abstract. Stealing from the rich to give to the poor is always an easier sell in the court of the public opinion, especially since the rich are generally not likable. The miners counterattacked in Canberra yesterday by threatening to shelve or cancel billions of dollars in domestic projects. Maybe they’re bluffing. Maybe not.
Meanwhile, outside Australia, all the negative sentiment in the market stems from concerns about the “grave contagion effects” that the Greek crisis may spread to Portugal and Spain and lead to a general bankrupting of Europe. That would probably not be good news for the euro.
It’s okay news for the dollar, though. The greenback is benefitting from it’s “I-may-be-bad-but -at-least-I’m-not-the-euro” status. Risk bets are unwinding globally and money is finding its way into, of all things, U.S. Treasury bonds. We move from the perverse to the absurd.
This fits with our thesis that each stage of the GFC wipes out the most peripheral leveraged players while concentrating ever larger amounts of risk in a small number of asset classes, currencies, and institutions. It’s like concentric rounds of failure are making their way inward toward the core of a financial system based on debt and fiat money.
Bernanke better hope there is a lot of gold in the castle keep.
As you’re seeing in Greece, the big risk in markets where fiscal reality is forcing austerity measures or sharply higher interest rates is not really financial. If the castle keep is filled with nothing but unfulfillable promises to pay, the big risk in any given country is the temporary loss of social cohesion.
People lose money. They lose pensions. They lose jobs. But most of all they lose confidence in markets AND governments. That is, historically, part of the end-game of a financial crisis. Bad debts from the previous credit boom are liquidated. But there is massive real fallout in the real economy, where real people have real bills they can no longer pay and institutions fail.
How much of what’s happening in Greece spreads to Australia depends on how much more stable global capital markets are now than they were a few years ago. And as we mentioned last weekend, the biggest threat to Australian prosperity by far is the pricking of the real estate bubble and its knock-on effects for commodity prices (which are falling).
Gee. That is a lot of bad news. The upside is that some things (like gold we hope) are going to go up the worse the sovereign debt crisis gets. And in Australia, if the Rudd resource tax gets canned, you could have a chance to buy a lot of beaten down resource stocks on the cheap. You’d still have to deal with the China issue, though, and execute your financial escape plan. More on that tomorrow. Until then…
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