Birch Creek Trading: commentary

A little introspective today from your trading blogger. I'm putting on my "philosophers" hat and taking off my trading/investors hat to talk about something that I have thought about - both publicly and privately, for many years.

My thoughts on Australia's future have evolved over time, starting from a very nationalistic bent as a youngster, to acquiring an understanding of our economic structure and place in the world and then to discover first hand via experience and travel what futures (plural) may actually lie ahead.

My progression reminds me of Francois Guizot's oft-stolen quote:

"Not to be a republican at twenty is proof of want at heart; to be one at thirty is proof of want of head."

I contend that Australia has three future paths to choose from:

Continue with the current system, evolving into a quasi-Southern European economic model
Adopt an Asian-based economic growth/highly capitalistic (i.e privatised) model
Adopt a Scandinavian (i.e Norwegian) socialist style economic model

Let's get something out of the way first - I'm an idealist - intellectually and morally, I am a libertarian. I think AND believe it is the only moral system that society can adopt and sustain for freedom, prosperity and peace. For a quick primer (if you have 10 minutes to spare), please watch the "The Philosophy of Liberty".

But, I'm also a realist. In the real world, a libertarian "State" (a contradiction in terms) would not work, neither would an anarcho-capitalist variation. It either devolves into crony capitalism - i.e exactly what the USA has become, turns into a bureaucratic charade - ala the European Union, is defeated by other nations through economic or military power, or most likely - the people don't want the responsibility and would reject most of its moral notions and requirements for living in a free society.

So what does work and why?

When you examine the world and note different countries approaches, two regions stand out because of their success: Scandinavia and Asia. The former (including Denmark, Sweden, Norway and Finland) have extremely high standards of living, 100% literacy rates, very democratic government, high GDP per capita and prosperity, but low GDP growth and mild to non-existent inflation. The latter (including China, Taiwan, Hong Kong, Japan, Malaysia, Singapore, Korea etc) have rapidly growing standards of living, huge GDP growth rates, expanding populations, modest to high inflation, autocratic styles of government (which seems to work) and a vigor and vitality for hard work unmatched around the world.

The main differences are obviously cultural and, how they approach social welfare: namely, education, retirement pensions and health.

The Scandinavians adopt the maternal approach and subsidise everything - its completely "free". Services are supplied and organised by government, not the private sector, and are paid by very high taxes, both corporate and income. It is sustainable due to the tax base (with very few loopholes - IKEA aside!), the innovation of the population and in particular with Norway, the ability to save and invest the proceeds of its lucky mineral deposits in sovereign wealth funds, for future generations to enjoy.

The Asians adopt a laissez faire approach, and mainly let the private market supply (or not supply) such services, and this relatively free market has created a diverse range that cater to almost all levels of society, but of course many fall through the gaps. Some Asian nations are more proactive in this regard, some are still growing a middle class that can afford to pay for this out of their own income. The long term projection is the majority of Asians in the 21st century will pay for their own education, health and retirement. As long as disposable income growth exceeds inflation, this capitalistic model will continue to flourish.

What has this got to do with Australia, a land of fantastic mineral wealth, boundless plains, a secure and strong economy that weathered The Great Crash of 2008?

Our current Path

We have a hybrid version of (or bastard depending on your ideological slant) the Asian/Scandinavian model.

High corporate and personal taxes, but high transfers of revenue for social welfare purposes, and widespread loopholes and gaming of the system (a very Asian way of approaching taxation!)
Private superannuation (ala Singapore) but large ingrained support, including medical, dental, pharmalogical and optometric for pensioned Seniors and low-income citizens
Capitalist economic system, with a hands-off approach to market regulation, but deep interference in politically sensitive sectors and marginal issues.
A reliance on mineral wealth exports to increase disposable income and government revenue, but no savings or investment thereof, with extremely high levels of private debt.

Because of this hybrid: a quasi market-socialism based culture and economy, I think the future, assuming no bumps in the road, will more likely resemble Southern Europe than Asia or Scandinavia.

Not necessarily a bad thing if you've spent a summer or two in Greece, Italy or Spain, but in reality, our young nation does not have the psychological wherewithal to "endure" such economic malaise.

But all of our economic commentators, pundits and spruikers maintain that Australia's future is as bright as ever, that the sun shall never set on our wondrous economic boom - so how can we end up like some PIIG basket case, the "white trash of Asia"?

Many problems - not issues - and a drastic leadership deficit
Here are the problems I foresee:

over reliance on mineral wealth
hugely complicated taxation and welfare system
structurally unsound economy, based on private debt and consumption
ever expanding dependency ratio (i.e more retirees/welfare recipients per worker)
lack of investment in education, infrastructure and regional development
too many layers of government and bureaucracy

First of all, we are truly "The Lucky Country". Imagine for a moment, an Australian economy completely devoid of either an agricultural or mining sector. Yeah. Where would our current prosperity come from? Why would the dollar ever be over 50 US cents? How would the property bubble have formed if a generation of carpenters, bricklayers and truck drivers weren't getting paid $140,000 a year for semi-skilled labor?

So what have we done with this wondrous wealth? Have we saved it like Norway (approx. US$512 billion in October 2010, annual income exceeding US$70 billion as of 2008/9):

Or did we p%ss it up against a wall?

Given the brouhaha over the proposed Mineral Resources Rent Tax, any attempt at establishing a sovereign wealth fund by funneling surpluses from a mining boom, or even partial nationalisation of natural resources (e.g offshore gas fields that will produce enormous wealth in the generations ahead) will be met with indignation by both sides of politics. The "Stupid" Party will want to use the revenue to expand welfare and feel-good environmental solutions, whilst the "Evil" Parties will want to lower the tax base in a continued attempt to sustain the unsustainable debt binge imposed on Australian households.

Our tax and welfare transfer system is now beyond a joke. Its not the fact that over 42% of households receive transfer payments (i.e net pay no tax at all), a bill that makes up more than a third of the current Federal budget. Its the ridiculous nature, permutations and useless inefficiencies built into the ever-expanding tax code. Further, the tax base has shifted to the upper middle class (the upper class pay barely any tax on a relative percentage basis, due to numerous loopholes and an entrenched taxation industry), whilst the transfer base has expanded from the deserving lower class to almost all the middle class and anyone defined as a "working family".

This ties in with the ever increasing dependency ratio - more and more so-called "working Australians" now shoulder the financial burden of looking after an ageing population and a subsidised middle-class Australia. As The Unconventional Economist has pointed out, as the Baby Boomers retire and earn significantly less, the burden of high income - from which almost all taxation revenue, including property tax, spending and income taxes - falls to Gen X and Gen Y who struggle with record high mortgage repayments, whilst their Baby Boomer parents spend less (reduced GST revenue) and save more (no tax revenue, as almost all pensions and savings accounts for seniors are tax-free).

Note how the real growth in population in the coming years are the Baby Boomers - note the huge gap filled by the 35-50 year old Gen X. A quick reminder: without our extremely generous migration rate, (which fell 30% year on year recently) the natural growth rate in Australia is below replacement (currently 1.9 and falling. 2.1 births per woman is required to maintain a steady population)

Who is going to continue to fund the ever expanding middle-class welfare? Given the ideological entrenchment of "no deficit spending" by both sides of politics, the fund gap will not be borrowed. That leaves taxation as the answer, which will crush any GDP growth or creation.

Further, contrary to popular opinion our "strong and sound economy" is based on an illusion. I've touched on this above - we have record high levels of private debt, with record low levels of government debt. All "investment" in Australia is purchasing existing houses off each other at higher and higher prices. To do so, we have borrowed over a trillion dollars, almost half of which had to come from overseas because of the lack of domestic savings (due to structurally low interest rates, which had to be lowered by the RBA because how else could First Home Buyers afford to borrow enough to buy a house of the Second Home Buyer, who then buys a house....).

Lest I remind you what a problem this has caused overseas: Australia is not different. I firmly stand in the camp that house prices are artificially high by at least 40%, and that they will not go up, in nominal terms for the next 10 or so years - either because of an outright property crash, or more likely, a generation long Japan-style deflation.

Whatever the outcome, the stark fact remains that the economy is based on exponential expansion of debt, created by banks as loans against existing dwellings, and then deposited into the economy as freshly printed money, thus creating inflation and thus the illusion of economic growth. This system has endured due to our record terms of trade via mineral exports. But it has an end point. I contend we reached it in 2010, although further artificial stimulus may prolong its drug-addicted life for another year or so at best, until it succumbs to its deserved death in 2012.

The final problem is the lack of government debt, a serious lack of investment in education, infrastructure and regional development and a widening "leadership" deficit has hampered the entire nation as we try to compete on the unlevel playing field that is unbridled Asian capitalism. Federal government debt is far, far too low - contrary to the ranting and ravings of the neoconservatives.

Our education system is broken, with a huge fiscal reliance on foreign students, and the unintended consequence of reducing our higher places of learning, research and development into "degree factories". The lack of harmonisation and any substantial investment in education - e.g there is no Federal Minister for Education - save some token gestures (free laptops. Whoop-de-frickin-do.) is holding back our children's potential, particularly in areas where we need to succeed AFTER the mining boom: science, technology and high-end manufacturing. There is no way - none at all - that Australia can compete in any low or semi-skilled arena due to our population base and distance from economic centers of activity. This country needs an education revolution - stat!

The NBN is a revelation however. A serious chance at developing some game-changing infrastructure, but I doubt the current economic managers have a clue how to roll it out effectively. Unfortunately their opponents - who are likely to be very successful at its oversight, want to scrap the whole project.

But what about high speed rail and transport infrastructure - not just for the mining sector, but for all sectors of the economy, that could provide huge returns in terms of productivity (which continues its 5 year decline). As I touched on in my "levees" post, where are the bold plans to "Flood Mitigate" (you can't flood proof anything) Queensland, or an Australian-wide water and food security system, which although economically inefficient, has future strategic implications?

For those who say we can't afford a larger national debt - say 40-60% of government debt to GDP, I say this. Would you rather we have houses that cost $600,000 and half of all mortgages owed to foreigners, and a crumbling education and infrastructure? Or a house that costs $300,000, a 21st century education and infrastructure system and a higher tax rate, the difference being your taxes go to service Federal Government bonds, most of which will be owned by Australian superannuation funds and give Baby Boomers a real income stream in retirement.

Now you see why I say we have a leadership deficit? Where are the leaders (not managers) putting forth such ideas and notions? Or are we condemned to mire in the muck of political compromise for yet another generation of spin-doctors and god-awful speeches?

Why we won't go Asian (although we might turn Japanese? I don't think so)
Culturally, we have adapted well in becoming an advanced, capitalist society. We may have "civilized capitalism" as Philip Adams says, but have we civilized our socialism?

I contend that culturally all Australians at heart are socialists - where more than anywhere in the world have you heard the phrase "the government should do something about it"?

Has anyone really celebrated the privatisation of Telstra, the Commonwealth Bank (which partly enabled a "competitive" market for unbridled credit creation) or how we are treated by private healthcare providers?

Does anyone really think that as the largest (but not greatest) generation starts their retirement they will demand less government support - particularly health care? Particularly as their own private superannuation depends almost wholesale on grossly overvalued residential property and a share market that could plunge 20% at any time? (ah, the beauty of volatility!)

We are not American, language similarities aside. Although we had a pioneering spirit like our American cousins and our colonial past was a hard, taxing life, we continue in the tradition of the fair-go and government paternalism as a given, in fact, as a demand that the State have a large say in our life, lifestyle and economy.

Both sides of politics are equally unsatisfactory in their approach to our capitalist/socialist conundrum. Partial subsidisation of education costs, but support for private schools. Increased Medicare and support services, but mandatory private health for high income workers. Tax free pensions for retirees, but higher taxes for the late Boomers and Gen X high income earners. Higher skilled migration rates, but lower investment of skilled education. It never ends, and sometimes even the "capitalist" Coalition adopts socialist measures (e.g paid parental leave) whilst "socialist" Labor adopts capitalist reforms (e.g market solution to carbon mitigation).

I don't have any solutions, just a notion: let us forget trying to forge a "middle way" (i.e stop listening to the Gordon Browns, the Kevin Rudd's et al of this world), and make a decision: are we going to be part of Asia and adopt a hard-nosed capitalist approach to social welfare, wealth distribution and growth-based prosperity, or should we just fully socialise, recognize our cultural heritage and be the Scandinavia Down Under?

With better beaches of course.

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Well this is great news: just a few days before I leave to go to Queensland, a tropical cyclone is right on track to hit our area this weekend.
For reference, I live just above Bunbury: i.e in the middle of the forecast path.

Its not as bad as the storm in a teacup re: the Gillard Flood Levy.

Given that well over 40% of the households in this country receive more money than they pay in taxes and that over $109 billion was spent on social welfare in the 2009/10 Budget, the puny amount raised by the levy (around $1.8 billion) pales into insignificance.

I wonder though what would have been more efficient:

Borrow the money by selling Australian government bonds (a market that desperately needs more liquidity so our myopic fund managers can stop buying BHP and the banks, inflating their share prices, and actually allocate capital properly), providing a welcome home for genuine savers, OR
Take the money off the wealthy, and waste about 20-30% of it on collection and accounting/bureaucratic malaise at the ATO (and countless HR departments around the country)

Sure, the former would create an income liability stream that needs funding, and would raise the national debt (which would again focus the mainstream commentariats effort on bashing the government on its extremely minor total debt position, whilst ignoring the real debt problem: households and State governments).

But the latter will inevitably result in unintended consequences, particularly the more wealthier using many available loopholes to legally reduce this new tax (although negative gearing won't be one of them - as pointed out by The Unconventional Economist, most property "investors" (sic) are in lower tax brackets than those affected materially by this levy), and the inevitable wastage and inefficiencies that go with collecting a new, temporary tax.

Had the Gillard Government been bold and gone for Option 1, and extended this to say, $20 or $30 billion and planned a major infrastructure initiative, including a widespread flood mitigation system for the entire state of Queensland, in the long run, would that have been a bad thing?

As I've stated before, this country suffers from four deficits, one is minor but could blow out of control due to the structurally unsound property market ala Spain - the Federal budget; two will eventually come back to haunt us as we squandered a whole generation's wealth and purposely destroyed our manufacturing industry and high skill base (the trade deficit and the savings deficit - i.e record household debt), but the one most in deficit in this country is leadership.

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