Sunday, November 08, 2009

Another doomster who got it expensively wrong

University of Western Sydney academic Steve Keen made a name for himself with forecasts of economic doom, predicting a 40% decline in Australian house prices. Keen put his money where his mouth is, selling his unit in Surry Hills in October last year for $526,000.

In November last year, Macquarie Bank’s Rory Robertson raised the stakes, proposing the following wager: "On the maybe 1% chance that he is right, and capital-city home prices do indeed fall by 40% within the next five years—starting from Q2 2008, and as measured by the ABS—I will walk from Canberra to the to the top of Mt Kosciusko. If Dr Keen turns out to be less than half right, as I expect, and home prices drop by (much) less than 20%, he will take that long walk. Moreover, the loser must wear a tee-shirt saying: ‘I was hopelessly wrong on home prices! Ask me how."

Following this week’s release of ABS data showing capital city house prices up 6.2% for the year-ended in September, Keen conceded defeat and will be putting on his hiking boots and tee-shirt.

What does Keen say when we ask him how? ‘I didn’t know the government was going to be stupid enough to bring in the first home buyer’s boost.’ The increased first homeowner’s grant has certainly inflated house prices, transferring wealth from taxpayers to incumbent property owners, but it would be a gross exaggeration to say this prevented a decline in house prices of 40%.

So where did Keen go wrong? For a start, he neglected the supply-side of the housing market and the growing shortage of dwelling units that is putting upward pressure on prices. More seriously, Keen made the mistake of assuming that he knew something that everyone else didn’t. The efficient market hypothesis tells us that this is unlikely and we cannot reliably predict future movement in asset prices. Keen inadvertently demonstrated the veracity of the idea that asset prices are informationally efficient. Rory Robertson made the more reasonable assumption that house prices reflect fundamentals and was vindicated.

According to RP Data-Rismark, the median Sydney unit price rose 8.3% in the year-ended September. With a little help from Treasurer Swan, Keen’s bet against the market has so far cost him nearly $44,000 in forgone capital gains on his former unit.

The above is part of a press release from the Centre for Independent Studies, dated November 6. Enquiries to Snail mail: PO Box 92, St Leonards, NSW, Australia 1590. Telephone ph: +61 2 9438 4377 or fax: +61 2 9439 7310

Rudd just lucky so far; real challenge ahead

Spending taxpayers' money is easy. Saving is hard. The Rudd Government was exceptionally lucky to inherit government with no net debt and with a $19.7 billion surplus in the federal budget. It was lucky, first, because it meant that Australia was almost unique among the rich countries of the world in being so strongly financed. It was lucky, second, because it was not any national inevitability but a whim of personalities that allowed it to happen.

The Howard government was strongly tempted not to stockpile any surpluses at all. John Howard wanted to spend as much of the national revenue as possible. Peter Costello told me in an interview last year that "I had big fights with Howard, all the time" over budget policy. "Politically, [Howard] always wanted to err on the side of further expenditures." And Howard confirmed this: "Part of the job of treasurer is to resist any additional expenditure, and it's part of the job of the prime minister to insist on it,'' he told me.

Costello managed to put some money aside, unspent, as surpluses. If there had been a less assertive treasurer, or a less prudent one, Australia would have had a very different national fate.

Why was there pressure within the Howard government against the concept of surpluses? "Our worst nightmare," explained Howard's longtime chief of staff, Arthur Sinodinos, "was you might sit on these surpluses, get lambasted by the public [for not spending them], and then have Labor or someone else come in and spend them anyway." That nightmare came true. It was Australia's good fortune that it did.

This was the third way in which Australia was exceptionally lucky. Because when the global recession hit, we were one of the very few countries in the world with enough cash in the bank for the Government to be able to use it decisively as a recession-buster. Almost uniquely among the advanced economies, Australia was not constrained by debt worries. Proportionately, the Rudd Government spent more to fend off recession than any of the rich countries in the Group of 20.

Britain and Germany spent the equivalent of 1.6 per cent of their total economic output, or GDP, on stimulus this year, a comparison of stimulus spending published this week by the International Monetary Fund shows, while Canada spent 1.9 per cent, the US spent 2 per cent and Japan 2.4 per cent. Australia? We outspent them all, outlaying 2.9 per cent of GDP for 2009. Canberra's spending is fully half as much again as the average for the rich countries in the G20.

Rudd and Wayne Swan get credit for taking "early and decisive" action, as they like to remind us. Australia avoided recession and is recovering strongly, partly as a result.

For the Rudd Government, that was the easy part. The hard part is upon it: to rebuild the budget, to rebuild a surplus, and not to piss away the national future on populist spending to get re-elected. But which lesson will they learn? Will Rudd and Swan learn the narrow political lesson of the Howard "nightmare" and try to spend as much as they can get away with? Or will they learn the bigger lesson, the lesson of the national interest, and put rigour into the national budget?

We have to hope that they care more about Australia than they do about Labor, because Australia is going to be put to the test, and rather severely. Not by the downturn but by the upturn. In recent days, in a pair of speeches Australia's two most important economic technocrats have set out troubling visions of Australia's national future. While Swan and Rudd still like to theatrically wring their hands and furrow their brows about the short-term economic recovery, the Reserve Bank governor, Glenn Stevens, said plainly on Thursday: "The issue before us now is not, in fact, how to get onto the road to recovery: we are already on it. The question, rather, is how to make sure that the road to recovery will connect to the road to prosperity."

In his speech, Stevens foresaw the same big looming problem that the Secretary to the Treasury, Ken Henry, sketched in a speech two weeks earlier. It's this: as China and India continue their historical return to the front ranks of the world's rich nations, their demand for Australian minerals will create a mining boom without parallel in Australian history, longer and stronger than anything we have imagined, a boom powerful enough to transform the country. The commodities boom that Australia experienced from 2003 to last year is already resuming.

How can this be troubling? As Ken Henry put it, "this has conferred on Australia a large boost to its real wealth but, at the same time, set up a set of structural adjustments that will challenge policy makers for decades". The term "structural adjustments" is an economist's euphemism for wrenching change. In this case, he's talking about the advent of the so-called Dutch disease.

As Australian commodities exports boom, this drives up the value of the Australian dollar. And this is OK for the mining sector because China and India will pay almost any price for the essential ingredients to their economic modernisation. But what about manufacturing? What about tourism? What about every other Australian export industry? A booming Australian dollar, now at about US90c but conceivably rising to $US1.90 over the years ahead, could easily price them out of existence. In stark layman's terms, Australia faces the prospect of returning to our industrial structure of a century ago - as a quarry and a farm.

Glenn Stevens's euphemism was that our "trade patterns could end up being less diversified". He went on: "Such concentration would not be unprecedented and may well be worth accepting if the returns from doing so were high enough, as it appears they might be. "But we might also think about how to manage the risks associated with any concentration. The emergence of China and India is a benefit to Australia, but we stand to have a heightened exposure to anything going seriously wrong in those countries. How then to manage an income flow that is higher on average, over a long period, but potentially more volatile?"

Other countries have faced this challenge and met it. When Norway discovered oil, it set up a fund in the 1960s to save the windfall revenues against the day when the oil would run out. The fund today has some $US400 billion. When Chile ran into the commodities boom of this decade, as Australia did, it set up two reserve funds in 2006 to accumulate the windfall revenues from a soaring copper price. Those funds today hold about $US17 billion.

Australia needs to do the same, urges Professor Warwick McKibbin, a leading economist and a member of the Reserve Bank board. David Hale, the prominent US economist and adviser to the Commonwealth Bank, concurs: "Chile is a good example for Australia to follow. Chile's finance minister had to fight off others who wanted to spend the money immediately, as there always are, and he prevailed. It's given Chile the autonomy to deal with the downturn."

The closest in Australian experience was Costello's successful struggle against Howard to pay down debt and stockpile surpluses. Now the Reserve's governor and the Treasury Secretary have clearly spelled out the huge challenge looming for Australia, Rudd and Swan have no excuse. They have to stop pretending to be worried about the economic recovery as a pretext for continuing excessive levels of spending. And they need to start worrying about the next phase - a resurgent mining boom strong enough to blow the national economy apart unless it is prudently managed. Rudd and Swan need to demonstrate rigorous credentials in saving, not just spending. When they do, even their own staff might take them seriously.


Bottlenecks choking recovery

THE return of infrastructure bottlenecks is threatening to push up inflation and interest rates, and so choke off the Reserve Bank's forecasts of a quick recovery from the global crisis. Rather than being at our export ports, however, the new bottlenecks are gripping first in our big cities in the form of rising home prices and rents, as a rapidly growing population competes for a limited supply of new housing.

"A huge chasm is opening up between the demand and supply for housing," Westpac chief economist Bill Evans yesterday told the Road to Recovery conference presented by The Australian and the Melbourne Institute.

Evans said this had pushed up housing prices at an annualised rate of 20 per cent over the past six months and was one of the reasons the Reserve Bank had "decided to move as fast as they did" on starting to lift interest rates.

Urban infrastructure bottlenecks in major cities, including road congestion and housing supply, are becoming the first new capacity constraint on the economy as it shrugs off the global crisis. By pushing up inflation and interest rates, these urban chokepoints have much the same supply-side economic impact as the lengthening shipping queues off the east coast coal ports during the pre-crisis resources boom.

Failures to deal with the new housing chokepoint were highlighted by a string of speakers at the Road to Recovery conference over the past two days, led by Reserve Bank governor Glenn Stevens and Productivity Commission chairman Gary Banks.

Conference speakers blamed an increase in housing demand from the faster population growth since the 1960s; extra artificial demand generated by the Rudd government's boost to first-home buyers grants; entrenched poor urban transport planning; deep-seated failures by state and local government to release affordable land for housing development; and a lingering credit crunch hitting finance for apartment building. The Reserve Bank's upgraded forecasts that the economy's growth recovery will accelerate to 3.25 per cent by this time next year yesterday came with a warning that increased China-driven investment in mining development could spill over into the rest of the economy and lead to "capacity pressures re-emerging in the near term".

The central bank's monetary policy statement warned prices for houses and apartments had increased 6 to 8 per cent over the past year due to lower interest rates, the economy's resilience and the stimulus-related increases in first-home buyer subsidies.

And it warned of "ongoing pressures in the housing market over the next few years" because of a "general underbuild in dwellings".

"Addressing this will require further steps to improve the supply side of the housing market," the Reserve Bank said.

The signs of inflationary housing shortages jarred against Kevin Rudd's claim to a Master Builders conference on the Gold Coast yesterday that the government's fiscal stimulus was financing 49,000 "major construction projects across Australia", including 10,500 for schools.

The Prime Minister said the government was committed to the "development of strategic planning frameworks for our largest cities" to cope with a forecast 35 million population by 2049. Lower interest rates and the government increase in first-home buyer's grants had " helped thousands of Australians realise their dream of home ownership" while creating jobs for builders and tradespeople.

But Mr Banks said told The Road to Recovery conference that the increased first-home buyer subsidy "seems to have contributed to a boom in house prices at the lower end of the market; an unusual phenomenon in recessionary times which will have tended to offset the affordability gains from historically low interest rates".

Mr Stevens told the conference that, while alleviating skilled labour shortages, strong population growth was putting pressure on urban housing and infrastructure.

Though the credit crunch on apartment finance was temporary, he pointed to structural problems in "land supply, zoning and approval" that meant increased housing demand was not fully flowing through to increased housing construction.

"It's a question of how is it, in a country this big in area and this small in numbers of people, we can't manage to make the marginal price of a dwelling lower than it is," Mr Stevens said.

"It seems to me quite high."

Opposition housing spokesman Scott Morrison said housing supply bottlenecks were making Australia's cities unaffordable and was now playing out in "retail politics".

"It's the big rock in the jar for housing affordability," he said.


Kevvy is all at sea over the "boat people"

A COUPLE of days ago, I found myself shouting at the radio. "For God's sake, answer the bloody question!" I suspect there were many such cries of frustration in households around the nation. Kevin Rudd was being interviewed - one of the 14 or so radio and TV appearances in his much-publicised media blitz on the asylum seeker issue. And he had nothing to tell us. No answers. Just platitudes, slogans and spin.

The Prime Minister's minders would have done better to keep him locked up in The Lodge and away from the phone. What is the point of a media blitz when you have nothing to say? All Rudd achieved was to deepen suspicion that he hasn't a clue about how to deal with the problem. He resembled a headless chook running around in circles.

Tuesday's dramatic Newspoll - Labor down seven points and an 18-point two-party preferred lead slashed to just four - shocked Rudd. And his response to the poll shocked quite a few in the Labor caucus. As one of them said: "It doesn't matter if this is a rogue poll. It doesn't matter if the swing against us is seven points or five or three. What matters is the way the PM and those around him reacted."

Under real pressure for the first time since he became Labor leader three years ago, Rudd found himself without a message and without a position. He was wrong-footed by a bad poll and a difficult issue. And now a growing group of critics in the party are pointing the finger at structures Rudd has set up around himself and the Government. It is no exaggeration to say there is a degree of panic among Labor MPs as the crisis over asylum seekers worsens.

The panic has deepened with every day that the Customs ship Oceanic Viking remains off the coast of Indonesia with its cargo of rescued Sri Lankans refusing to go ashore. The group, with its "take us to Australia or else" demand, in effect hijacked the vessel. They have made Rudd - who claims to have tough policies - look weak and indecisive.

According to caucus sources, as a result of Rudd's dominance of the party and the way his office is set up, he is isolated from the kind of advice that might help to deal with the situation. The older, more experienced hands originally on Rudd's staff have left. And, to quote one of Labor's longest-serving parliamentary operators: "We no longer have powerful people in caucus who can walk in and offer a frank view. "That's because they're all, in one way or another, clients of Kevin's."

In short, there is no way wiser heads can get a message of sense into Rudd's office, and that's a serious problem. Even Labor MPs who simply want to register their concern at the extent of anti-boat people sentiment in their electorates have to be very careful. One of them explains: "If you give Kevin or his staff a hard message, they just cut you off."

The Government has not been inactive. During the week, the PM belatedly got around to phoning the Sri Lankan President in a bid to ease the pressure on Tamils to flee that country. And Australian officials aboard the Oceanic Viking went to great lengths, with offers of rapid processing of claims, to tempt the 78 asylum seekers to leave the ship. But the perception is that it has all been ineffectual.

No one suggests there is any easy solution to the situation Rudd faces. It's as complex a political problem as an Australian leader is likely to encounter. John Howard handled a lot of difficult situations and experienced some horrific opinion poll slumps. At times - in 1998, 2001 and early 2004 - pundits were just about ready to write him off. But I can't recall Howard looking as though he didn't have a handle on a problem - except at the very end.

In tough times, a political leader needs a machine to help him fight his way through. Rudd - pretty much by choice - has no such machine. If he is now forced to order the Oceanic Viking to take the stubborn Sri Lankans to Christmas Island, it will be a humiliating backdown, and caucus criticism will become more vocal.

Rudd may be close to over-reaching himself in his cavalier disregard for party feeling. ALP anger stirred up by the appointment of Peter Costello to a cushy post on the Board of Guardians of the Future Fund - coinciding with the concern over asylum seeker policy - should be a warning to him. It provoked muttering not just among Labor MPs, but among Government staffers as well. Labor, after all, had spent years painting Costello as economically incompetent. Front benchers - including Treasurer Wayne Swan - had repeatedly accused him of dishonesty. And now the Labor Government praises his expertise and gives him a key economic job. It demonstrates the hypocrisy that causes politics to be held in great odium by the public.

When, three days later, Costello announced that he would become managing director of a new investment and corporate advisory firm, the muttering increased. In the words of a prominent MP: "Think of the credibility it gives to the CEO of a new merchant bank to also be on the board of one of the world's biggest sovereign funds." Paul Keating's bitter denunciation of the appointment was far closer to rank and file Labor thinking than Rudd's justification of jobs for the (Coalition) boys.


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