It's all about economics

There have been a few comments on me taking the likes of Joe Hockey, Andrew Robb, Peter Costello and Josh Frydenberg to task on their analysis of fiscal policy, the budget, gross debt, the government bond market and broad economic concepts.

Some suggest I am taking a clear partisan approach to the criticism of these people – admittedly they are all from the Liberal Party – but my wish is for an honest and factually sound debate on economic policy and economic management.

Recent contributions from these people has been dishonest and does nothing to add to the economic debate – a debate that is so important when Australians are among the richest people on the world, where the mining boom requires sensible economic management and where there is a list a kilometer long on economic policy proposals and alternatives.

I am not a member of any political party – but am a fan of getting facts right when discussing policy issues, be they the size of government, the tax impost confronting taxpayers, the future of the bond market, the importance of gross debt, among many others. In recent times, there has been a run of big bloopers from Hockey, Costello and Frydenberg in which they then twist and contort unsourced data to make some cheap political point.

In simple terms, the Liberal Party is not a party of low tax; Australia does not have a debt problem; Labor is not addicted to tax or spending and the Gillard government is not a a big spender. The facts show a mix of news on taxing and spending and debt over the last 40 years, but none of these statements is correct.

From the Liberal Party’s perspective, there are many, many economic issues where they can take the Gillard Government to task and where they can offer up a viable alternative to current economic policy settings, where they can force the Gillard Government to take some tough economic decisions to make sure Australia’s economic prosperity is enhanced over the long run.

I think it would be terrific to see Joe Hockey and Liberal Party to come out with an alternative economic agenda or set the foundations for a debate on a range of issues. A few off the top of my head might be:

• The level of the GST;
• The first home owners grant;
• Public service levels/cuts/costs;
• Drive the debate on bank funding costs;
• Streamline middle-class welfare payments;
• Recast the tax treatment of superannuation;
• Specifics on Commonwealth/State overlap and cutting red tape;
• Affordable housing;
• Targets and support for the bond market;
• Free trade;
• Bilateral or multilateral free trade agreements;
• A sovereign wealth fund;
• Labour market reform/flexibility;
• Infrastructure spending priorities.

There are many more economic issues that demand attention and a fulsome debate from the Liberals and indeed the Government – the above was a small sample.

So come on Mr Hockey – you can do. Set up a strong economic agenda on these and other issues. I would be the first to sing your praises if you and your team set out a credible and viable alternative approach which builds greater efficiency and productivity on these and a myriad of other items on the economic agenda.

Oh – and I should say that no one, including the authors, have confirmed the “mis-facts” in the articles that I have dissected and critiqued. I know there is nothing wrong with my analysis and those sniping from the sidelines are the ones being partisan.

Josh Frydenberg hopelessly wrong on some key budget and economic facts

Oh no – the Liberal Party is showing that the lack of understanding of the budget, the bond market and economics is broadly based, even among the new blood in its ranks. This time it is Josh Frydenberg, the Member for Kooyong who shows he cannot read the budget papers, nor understand economics and the bond market, with his Op Ed article in today’s The Australian.

The link to the article is here:

http://www.theaustralian.com.au/national-affairs/opinion/coalition-picks-its-path-from-menzies-road-map/story-e6frgd0x-1226233538249 .

From that article, Frydenberg suggests:

• “But as a party we will not and must not compromise on those fundamental issues that go to the heart of what the Liberal Party stands for: lower taxes, smaller and more efficient government, freedom in the workplace and an individual's freedom to choose.”

As I have written before, the current facts show:

Total government receipts (tax, dividends, fees and the like) was 21.6% of GDP in 2010-11, the lowest level since 1973-74. Josh – that is lower than for EVERY year of the Howard and Fraser governments.

The tax to GDP ratio fell to 20.0% in 2010-11, the lowest since 1978-79 and is a whopping 4.2% of GDP below the record tax to GDP ratio raked in by the Howard government in 2004-05 and 2005-06. That's a lesser tax take of around $60 billion for one year that was taken from tax payers during the peak period of the Howard government. As mentioned elsewhere, it is easy to register a budget surplus when you tax the living daylights out of the population.

These facts should embarrass Freydenberg who then suggests:

• “Menzies said of the Liberals, "we are a tax reduction party", understanding that "real tax reductions would be the best of all incentives to increase effort, earnings and production".”

Funny that when the Howard Government was elected, the tax to GDP ratio was 21.8% (1995-96). At the end of his term, the ratio was 23.7%. When Fraser was elected, the tax to GDP ratio was 20.3% and at the end of his term the ratio was 21.7%.

Freydeberg goes on:

• “Tragically, the Rudd-Gillard governments have become addicted to spending, squandering the strong fiscal position bequeathed to them in 2007. In just four years they have taken government spending from 22.9 per cent of gross domestic product to 26.2 per cent. “

That 26.2% is wrong – the MYEFO Table D1 shows that spending to GDP was 26.0% of GDP in 2009-10. Whatever. Freydenberg for some reason then ignores the outcome for 2010-11 spending to GDP ratio was 24.7% and further “forgets” to mention that the government spending will be 23.6% of GDP in 2012-13 - around 1.5% of GDP below the average of the last 30 years. In the 12 Howard Government Budgets, spending to GDP averaged 24.2% of GDP: and only in 3 years out of 12 of the Howard Government was the spending to GDP ratio lower than the Gillard Government is projecting for 2012-13.

Freydenberg then suggests:

• “In addition to expanding government debt, increasing taxes and bloating the bureaucracy with more than 20,000 new public-sector employees.”

This is wrong. According to the ABS, between June 2008 and June 2011, the number of Commonwealth public servants rose by 6.0% - from 237,100 to 251,400, a rise of 14,300.

There was some hope that the new blood in the Liberal Party would have some understanding of economics and markets. This dreadful Op Ed article is dashing that hope.

Exaggerating the house price rise

It's fascinating to see the reporting of the 0.1% rise in house prices in November, especially in the context of the 10 consecutive monthly falls that pre-dated this wafer thin increase.

The SMH and The Australian on line suggest, via an AAP feed:

"Homeowners have received a bout of good news at year's end, with a private survey showing the first rise in capital city home values in 11 months."

I don't have complete access to the house price data but note that the median national house price was $448,500 in October, down 0.5% from the level in September. The 0.1% rise in November therefore equals a "cash" gain of $400, after a "cash" fall of around $2,200 in October. And it must be noted that in the 10 months to October, the median house price fell around $18,000.

If house prices keep rising at the same pace as they did in November (i.e., 0.1% per month), it will take around 3 and a half years to regain the nominal losses of the first 10 months of 2011! In real terms, even with 3 and half years of 0.1% monthly rises, house prices will be down a further 10% or so over that time.

Not the stuff in my mind that suggests "a bout of good news".

More troublesome data - credit and house prices weak

RBA credit rose 0.3% in November for an annual rise of just 3.5%. Within that, annual growth in housing credit remained at a record (34 year) low of 5.7%. Consumers and business are not borrowing much – or the banks aren’t willing to lend much – a sure sign that growth muddled through to the end of 2011 at a below trend pace.

The house price data showed a very tepid 0.1% rise in November, disconcertingly soft after 10 straight months of house price falls. House prices clearly remain under pressure, a key fact to consider when analysing the economic outlook given the well-known and powerful effect house prices have on consumer wealth, confidence and spending and also importantly on bank balance sheets.

Obviously the RBA knew credit and housing were weak when deciding to cut interest rates in November and December against the ranting of a few ill-informed few commentators. The interest rate cuts will, with a lag, work to arrest the weakness in credit and house prices. They would have had almost no impact on the November data. Whether on-going consumer caution or the negative effects of the global downturn overwhelm the positive influences of lower interest rates remains to be seen. I suspect house prices will get weaker before finding a true base in the second half of 2012. There is also a matter of a substantial excess stock of houses on the market which will inevitably keep downward pressure on house prices at least in the near term.

Along with a bunch of other economic news, there will be further reading on both credit and house prices before the next RBA Board meeting. Important in this space will be the release of the ABS quarterly house price series as a guide for the RBA.

That said, the Australian data flow for 2011 ends on soft note. Credit is weak and housing prices moribund. There’s nothing at the moment to deflect the RBA from its path of cutting interest rates in February with the debate remaining whether to front load a 50 basis point cut or go the softly-softly 25 basis points.

Top 12 Economic & Market Issues for 2012

2012 will start and probably end with clear problems in the Eurozone economy and its markets. This will remain the major negative offshore risk to Australia. The US has had more than a few encouraging signs of growth coming through in recent times which could suggest a reasonable year in headline terms for the economy. Its structural problems run deep which will act as a handbrake on longer run optimism in the US. China is slowing with authorities there are now responding with the start of a policy easing campaign. China will keep growing it seems. There is a mixed picture throughout the rest of the world, but overall activity will be below trend.

For Australia, 2011 ends with the economy growing below trend, there is the start of a monetary policy easing cycle, a quite severe fiscal tightening is still unfolding and an over-valued Australian dollar persists.

Below is a list, in no particular order, of 12 economic, market and political issues for 2012 that I suspect will attract attention.

1. Despite the RBA cutting official interest rates aggressively in 2012, perhaps to a low of 3.5%, government bond yields will be higher by end 2012 than now. The market is pricing in a 3.0% cash rate, a move that has dragged the 3 year government bond yield down to just above 3%. The 3 year bond yield is forecast to trend higher - towards 4% or more through the course of 2012. I will be getting short the short end of the government bond market at some stage in 2012, at levels around 3.1% to 3.3%, on the view these will hit 4%.

2. Based on the growth outlook below, towards the end of 2012, the market could well be starting to price in interest rate hikes for 2013 – a strong case can be made for paying the September 2012 to June 2013 OIS strip at levels around 3.0%.

3. For the economy, GDP growth will hover below and above 3% until late 2012. The drag from fiscal policy, plus on-going caution from consumers will dampen growth. The mining boom will support growth. The falls in household wealth from falling house prices and a faltering stock market will not help. Late in 2012, under the influence of easier monetary policy, perhaps that elusive upturn in the US and with China setting its sails for growth, Australian GDP growth could well start to have a 3.5% or even 4% tone to it.

4. Inflation will fall sharply through to about the middle of 2012 – the headline CPI is likely to be as low as 1.5%; with underlying inflation likely to ease towards 2%. The pick up in growth in late 2012 will probably be too late to have a material impact on the CPI in the second half of 2012, but (aside from the one-off effect of the carbon price) inflation is likely to edge up towards 2.5% by the end of 2012.

5. The unemployment rate will get to the “high-fives” during 2012 – topping out at 6% or a few ticks lower. The current below trend growth rate is still impacting the jobs market and will do so through most of 2012. The pre-emptive rate cutting action of the RBA will ensure unemployment does not become a major problem.

6. The Australian dollar (AUD) remains a perplexing beast. It is supported by Australia’s across-the-board triple-A credit rating; record trade surpluses; relative economic strength and for the moment high commodity prices. My hunch and it is a low conviction hunch, is that the AUD will be more inclined towards US$0.90 or lower through 2012 as market positioning, flat of falling commodity prices and perhaps some relative economic improvement elsewhere in the world sees outflows from Australia.

7. Australian stocks are likely to move higher – maybe a lot higher. As one who has never really been positive on the Australian stock market (and have benefitted from that view), I reckon we are getting close to a turning point in stocks given the change in growth momentum through the course of 2012. Also aiding the stock outlook is the unfashionable nature of stocks for investors burnt so badly in recent years meaning many will feel the need to get in once the upswing beings.

8. House prices remain a problem for early 2012. There is a clear glut of property on the market which can be cleared either by a pick up in demand – which will be helped by lower interest rates – but also by falling prices. The price falls are unlikely to be huge - perhaps down 10% from peak to trough – but there might be some negative chatter as these numbers unfold. By late 2012, with more favourable economic conditions and relatively low interest rates, prices should start to bottom out.

9. The mining boom will keep chugging along. The investment boom in that sector will continue to unfold at a rapid pace with benefits for related sectors. There is a hint of risk that a fall in commodity prices will lead some to question whether there will be an investment / capacity overhang in mining over the longer run. If this talk gets traction, the AUD could fall sharply.

10. The 2012-13 Budget in May will announce a surplus well above the MYEFO estimate of $1.5 billion as the government sticks to its commitment of having every new policy fully funded by offsets elsewhere and as the parameters turn a little more positive. By the time of the MYEFO in November, the 2012-13 surplus projection (and those in the out-years) could well approach $10 billion per annum as Treasury factors in the economic upswing into its numbers. The challenge for the Government will be to hold onto the cash until the 2013 Budget.

11. Prime Minister Julia Gillard will still be PM and Opposition Leader Tony Abbott will still be Opposition leader through 2012. There will not be an election in 2012 as the focus will move to an October 2013 poll.

12. Banks will adjust retail interest rates relatively frequently and often away from moves in RBA official rates. The RBA will be even more explicit suggesting its official rate moves are directed at retail rates.

I will try to revisit this outlook every 3 months during 2012.

Happy New Year!

NOTE: None of the above is intended as investment advice. The views above are mine only and are published for the purpose of discussion and information only.