Everyone talks his own book. But when it comes to choosing between entrepreneurs and politicians, you can guess which ones we put more stock in. Still, what to think of Fortescue’s Andrew “Twiggy” Forrest calling the bottom in the first quarter of this year?
Forrest told the Melbourne Mining Club that, “2009 and certainly this quarter, I believe, will be the bottom of the market.” For everyone’s sake, we hope he’s right. But hope aside, stocks can bottom and still trade in a range for a very long time. It will be the pick-up in Asian demand for key Australian export commodities that drives an earnings recovery for the miners.
Forrest also pointed out that even a big fall in the contract price for iron ore in April would put it back to 2005 levels, which is not a disaster for everyone. But the key is renewed demand. And no one knows precisely when Asian demand for Aussie exports will recover.
It could be a good long while, especially if the demand for Aussie raw materials was driven by American consumption. But then, this is really a conversation about the whole structure of global production and consumption. The old structure has broken down.
Some day this crisis is going to end and the world will look different. The growth of domestic demand in Asian economies will fire up new demand for Aussie exports. But between now and then, a whole army of policymakers, bankers, and bureaucrats will try and preserve the current system.
Speaking of which, how about that $42 billion recovery/stimulus package, or whatever you want to call it? Kevin Rudd and Wayne Swann opened the nation’s check book and dipped into its future earnings with an ambitious plan to…do something.
Moving heaven and earth is beyond the ability of mere mortals. But moving around money, that’s a lot easier, especially when it’s not your own! The plan calls for $12.5 billion in cash and various grants for households. The rest will go into various ‘infrastructure’ programs, although that term-infrastructure-is being used rather liberally these days.
So will it work?
Well, it depends on what you mean by ‘work’? In a purely political sense, giving people more of their own money always makes them feel better. And in principle, we’ve never met a tax cut we didn’t like.
Giving people who don’t pay a lot in taxes even more money is even more popular. So in that sense, the arrival of thousands of dollars in government cash to various Aussie households will ‘work’ in the sense that it distracts people from the ongoing disaster that is the world financial crisis.
“Look honey! Free bread. Let’s go to the circus!”
Please note that shuffling a bit of cash around will not lessen a national debt-to-GDP ratio of around 140%. Nor does it do much to create long-term jobs. But hey, who isn’t impressed by a little walking around money?
What about the rest of the plan? That is more complicated. There is a stupid belief that spending money on ‘shovel ready’ infrastructure projects is a great way to get the economy going right now. That’s probably not true. That’s not to say the infrastructure projects aren’t necessary, or good long-term investments. But they may not be the sort of thing that gets money sloshing around in the economy post haste. Why?
The money multiplier. How quickly does each new dollar of spending turn into even more lending and spending in the economy? If you put cash in household hands through grants or tax cuts, household spending makes it into the economy pretty quickly.
You buy an air conditioner. You buy a lawn mower. You buy a steak dinner. You buy a bottle of Bombay Sapphire Gin. You go to the pokies. No matter what you do, the cash is in the hands of the people in the trenches and on the front lines of the economy. These bullets are probably going to get fired.
Each dollar that changes hands starts “stimulating” other spending. Don’t get us wrong. In the long term, stimulating consumption with hand-outs does nothing to build capital assets for a nation. It gives the illusion of activity. But the activity is for its own sake. It doesn’t build wealth, it just stirs it around.
The question with infrastructure spending is whether the multiplier works at all in the short-term. Does each new dollar of government spending on infrastructure correspond to three, four, or five dollars of new consumption in the economy? Or is the ratio much more modest?
We don’t know. Different people say different things. Economists Susan Woodward and Robert Hall studied the effects of government military spending on GDP growth in World War Two. They concluded that each new dollar of government spending led to a $1 in GDP growth, or a ratio of 1:1. That’s not exactly a big multiplier.
On the other hand, Christina Romer suggests that each new dollar in tax cuts raises GDP by about three dollars. Why that is exactly isn’t clear. And it’s by no means a settled point among economists that tax cuts have a bigger multiplier than government spending.
For example, Paul Krugman thinks that equating military spending with infrastructure spending and then measuring its effect on an increase in GDP is theoretically flawed because rationing limited consumption in World War Two America anyway.
It’s all a bit of a red herring anyway. Spending money for the sake of spending money doesn’t make anyone richer. It’s an artificial boost to demand that belies a host of other underlying economic conditions which are, frankly, awful.
It would be an interesting debate if you conceded that infrastructure spending provides no immediate boost to consumption or GDP, but that we should do it anyway because the projects are necessary to the long-run health of the economy. This is the “Nation Building” argument.
The trouble is, you then get into argument over what kind of nation you want to build. Are you talking bridges, roads, ports, and rails-real physical infrastructure that greases the wheels of commerce and transport and improves quality life over time? Or are you talking education, broadband networks, healthcare and other programs? How do you measure the return on investment for those sorts of things?
In one case, you have an argument that there are certain projects-because of their long-term nature, capital cost, and low investment returns (but high social returns) that ONLY the government can do. This is purely an economic argument. In the other case, you get an argument that there are certain things, in a civilised compassionate society, that the government OUGHT to do. This is purely an argument about what the proper role of government is in building a fair and just society.
Kevin Rudd’s job will be to blur the distinction between the two and spend as much as possible while everyone remains confused and scared. To do this, Australia’s government is going into deficit. It will be around $22.5 billion to begin with. That’s just above 3% of GDP.
In Japan, decades after asset deflation besieged the economy, public sector debt is well over 100% of GDP. But don’t worry. All in due time-if there is enough money in capital market to provide for that much government borrowing, while still meeting the borrowing needs of the private sector.
More reader mail?
I do enjoy your interesting and informative articles, and generally give them a lot of credit for being informed and substantial.
Today I was shocked to see – being an Austrian, living in Australia, that you gave Ludwig von Mises a different nationality. Ludwig von Mises, one of the major theoreticians on economics last century lived and worked in Europe, he was Austrian by birth and not Australian. Australia is only just now waking up to the vagaries of economic theory, having slumbered for most of its existence in the relative safety of a society buoyed by agriculture and mining. Lucky are those who manage to live here!
Please correct this!
Consider it corrected and accept our humblest apologies. We make mistakes from day to day in our frantic pace to get the DR out on time, and yesterday was one of them. For the record, von Mises was Austrian, not Australian. And he stands with Friederich Hayek, Joseph Schumpeter, Henry Hazlitt, Frederic Bastiat, and Murray Rothbard in our pantheon of economic heroes.
In your newsletter dated Feb 2 “A $4 Trillion ‘Big Bang’ – you cite Marc Faber saying “”I’m not optimistic about the global economy,” says our old friend, Marc Faber. “The next Madoff case – the next Ponzi scheme – is the U.S. government. It will go bust. It is only a question of time.”
I was discussing this comment with a couple of friends – can you please share your view on how the US Government can go broke. After all, the US Government is not a bank by definition. I understand how a Central Bank can fail (and has done in the past) – but how can the US Government technically go broke?
As long as the U.S. government enjoys the privilege of borrowing money in the currency it also prints, it can never, technically, go bankrupt. The Treasury can issue new bonds and the Fed can buy them with new dollars. This would naturally have a negative effect on the value of all the other dollar-denominated claims outstanding. But in theory, the U.S. never has to default on its bonds.
Insolvency implies that your liabilities exceed your assets, and that is certainly true for the U.S. government. Its liabilities increase by leaps and bounds each day. Its assets? Well those are tax revenues. But as long as it can pay off its liabilities with new money, it can technically forestall insolvency.
In practice, the day is coming when the foreign capital markets are unlikely to gobble up U.S. Treasury bonds. You’re going to see a Treasury auction fail before this all over. It will fail because the U.S. is about to spend $1 trillion on a grab bag of various projects selected to please political allies and local constituencies, while doing nothing effective to clear up bank balance sheets of non-performing assets that are eating away at equity capital.
Once the world gets a look at how the U.S. Congress spends borrowed money, we reckon it will be curtains for the days of limitless U.S. borrowing on global capital markets. In this sense, the U.S. cannot continue to spend more than it takes in through revenue and make up the difference with borrowed money. Its borrowing costs will go up and it will be forced by its creditors (China and Japan) to live within its means.
And one more note on collapsing Asian trade. This is the real obstacle any Aussie recover plan must overcome. And honestly, how is $42 billion of spending and household insulation going to insulate us from the kind of economic downturn this reader describes bleow?
Hi DR, I am an avid fan and daily reader of your publication.
I am an Australian living Singapore and can assure you, your pictures don’t do justice to the floating parking lot off the coast of Singapore. In recent months the number of cargo ships parked in the straits has exploded. It has been an economic indicator I have kept an eye on. The best angle to get a photograph from would be from the East Coast Park just before and after dusk. The ships leave there lights on and it looks like a floating city just off the coast. I recently went to the east coast to watch the Volvo Ocean Race which put on an ‘in harbour’ race as they passed Singapore. They almost didn’t have enough room left in the harbour to hold the race.
I would happily get you a picture or two, but am travelling in Hong Kong & Taiwan for the next few weeks. Keep up the great work, a little less ‘banging on’ about the future of gold prices would be nice. We heard you the first dozen times!!
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