Tuesday, September 29

Economics in Australia compared to the US

Economists invariably cop the tag of belonging to the pessimistic science since jokingly it is oft said by way of an introductory welcome to the podium …….Please welcome .......... who has successfully predicted 14 of the last two recessions.

Economic reputations suffered a further blow since most failed to predict the global financial crisis or identify sufficiently the consequences of the prior rising bubble.

There are notable exceptions but invariably their prior records are patchy enough to reasonably conclude this was the one prediction they just happened to get right at the right time. This patchiness is not surprising since bubbles don’t figure in economic or monetary theory nor are they included in the sophisticated economic models. Economics was never a science but is the art in dealing with the erratic human behaviors which can routinely make miserable fools of economic forecasters based upon rational outcomes. You spend most of your time looking in the rear vision mirror for any reflections indicative of the way forward.

I remember early student days full of debate on contemporary issues such as tariffs, subsidies, basic wage increases, international trade and regulatory issues for a banking system and so on. Today there is far more complexity and global interaction to consider, but I remember then many appalling decisions made in Australasia when life was simpler. Neverthless there are always lessons you can learn from studying past trade cycles, even to go far back to the great depression.

One aspect worth noting about the great depression is the assumed degree of speculation attributed by governments of the day and subsequent commentators. But if you undergo a thorough analysis of the prior trading conditions you find speculation was not nearly as rife as is commonly assumed. By way of example if you take the various PE ratios ( earnings to stock price ratios) for companies in the various industry sectors just before the massive fall in stock values you find a degree of normality that today would not cause undue concern. Lurking behind the bland facade however was the leveraged investment companies with their investments in overly valued utility companies which caused all of the havoc. Once values and profits fell in that one industry sector alone highly leveraged investments companies had to sell their shares to pay the margin lender. The same pattern happened with the individual investors in the Management Investments whose worthless investments meant they had to sell their remaining stock holdings in other sectors to cover their margin lending. Then the government talked simplistically about all of the greedy speculators as the only cause for an overvalued market which helped perpetuate the next downward spiral famously known (and still fearded )double dip. Most of the self perpetuating downward spirals were driven by leverage and subsequant sentiment but not substance that culminated in a collective fall of 89% with all of its accompanying misery.

After my studies and during my subsequent career I have almost always been responsible for forecasting economic indices and have endeavored as far as possible to follow economics which I have found both to be very interesting but equally frustrating.

When I first studied Keynes and Samuelson dominated our textbooks.
Keynes was one of the first philosophical economists who insisted economic theories must lead to fairer more ethical outcome for everyone. Keynes’ views were no doubt forged from his desire to avoid a repeat of the great depression where he held onto his shares and subsequently lost his fortune along with many others. Throughout his life he remained a colourful witty character devoted to the arts, nature and conservation to the extent he was miles ahead of his time. His highly developed mathematics gave way to theories suggesting the need for the creation of a strong regulatory regime to prudently effectively use both monetary (supply of money and interest rates) and fiscal policy (government spending and taxation) to help iron out inevitable economic imbalances were adopted in Australia.

In the USA Economics was to eventually turn away from Keynes to a different route with the rise in power of the economic monetarists who suggested you only need to vary the volume of money in circulation (money, bank deposits in demand and related interbank deposits with overnight liquidity)and interest rates to effectively control imbalances between supply and demand.This suited successive governments and business since it involved less regulatory resources and ensuing compliance as was proposed by Keynes and others. These ideas inevitably filtered through to Australia as the economy in the USA seemed to be traveling well.Subsequently the USA rode out the Savings and Loan fiasco and the Dotcom bubble but only at the expense of a burgeoning debt burden.

However fortuitously our economy in Austrtalia was to benefit enormously from increased taxation revenue derived from a mining boom wisely squirreled away in reserves for a rainy day,( some since released for a number of stimulatory measures) our close ties to the expanding Asian region and because we invested in a more effective regulatory regime following our largest corporate collapse in Australia - the demise of HIH.

At that time officials at APRA – The Australian Prudential Regulatory Authority correctly concluded that any large bank, financial, insurance or related entity could fail and with sufficient negative sentiment bring down the entire economy with them. They set about regularity changes to improve and more closely monitor solvency ratios and risk management practices with quarterly reporting requirements for all of our major institutions which caused a considerable amount of angst within the business community. These factors, inclusive of the tyranny of distance aspect which separated us from the sharper end of the pencil where all of the sub prime action was taking place ensured our lucky escape so far to date.


Recently in the US I was disappointed to see mooted bank regulatory changes are to be confined to increasinging capital requirements rather than ensuring unregulated derivatives are separated out and excluded from cover under their banking licenses.
Even Hedge fund billionaire George Soros and Berkshire Hathaway’s Charlie Manager are calling for urgent limits on credit-default swaps- one of the prior subprime culprits. These instruments are unnecessary since there already exists regulated conventional insurance products able to cover risk. The current banking structure leaves those large institutions in the same vunerable position as existed prior to the crisis. I hope there is change in heart.

Longer term my prediction is for continued weakness in the USA dollar to ultimately lead to higher inflation and inevitably higher interest rates. But in the medium term as Fed Chairman Ben Bernanke (who co incidebtally did his PHD on the trade cycle which involved studying Keynes and the great depresion effects )correctly points out U.S. interest rates will be kept low for quite some time, because of prolonged weakness.

Meanwhile if the American economy does stabilize and begin to give grounds for some genuine hope of a rebound, which I earnestly hope it will, then I also predict there will be an abundance of born-again Keynesians to poke up their heads from under a winters burrow.

12 comments:

susan said...

Unfortunately, I think that we're living in an age of unbridled greed. Although the USA harbors a great number of them their breed is not unknown in the rest of the world. I imagine the thinking goes something like this:

Socialists, charity workers, care givers, people who volunteer to help others; they're all in reality mean spirited bastards, self-deceiving bastards or - for their own filthy left-wing reasons - deliberately trying to destroy the self-esteem of normal, healthily ambitious people like them. If everybody is nakedly ambitious and selfish, everybody knows where they are and those who have clambered to the top of the pile can feel pride rather than shame.

Being extremely wealthy and powerful is rather like living on top of a very high mountain. You don't look down to see the people on the ground because clouds get in the way - clouds of toadies and synchophants who serve to flatter and weasel whatever benefits they can grab for themselves.

I'm afraid what we've got nowadays is a very nasty disease.

Seraphine said...

everything financial was modeled by factoring various risk scenarios; the theory was you could quantify risk and price debt accordingly.
the problem, it turned out, was in the improper setting of worst-case parameters. it was all quite logical from a narrow point of view, for a while.
by focusing solely on the trees, the model lost sight of the forest.
all sense of scale was lost.

the sadness and misery that followed for so many people is astonishing.

lindsaylobe said...

Hi Susan – thanks for dropping by.
As I was about to reply to your comment I receive an incoming e mail which read -
In attempting to complete your event registration we wish to advise that session Professional and Ethical Standards update" has been cancelled due to low interest. Please refer to our micro site for a description of the other available sessions Please note: Places for computer-based sessions are limited, please respond ASAP to this email to ensure your place at these sessions.

I hope that’s not a sign of the times here.

I agree that excessive desire for wealth is evident everywhere and is possibly symbolized in the executive remuneration for US employees which I think can be up to 5 times the rate of mangers in other countries who do similar work. This was also true of American executives in the 1980s, but C.E.O.’s compensation in large companies has since grown more than six fold since. You would know more about the extent of greed in the US than me but I think maybe you have painted about the gloomiest picture I have ever read about what you imagine the wealthy people you have in mind actually think.
We always had the impression – maybe erroneously – that there were equally a large number of wealthy Americans who freely gave very generously of their time and resources to support their communities and carers. My involvement is limited to working with larger corporations who always had extensive US interests and apart from being amazed at the need to pay larger salaries (or so we were told) the people themselves – wealthy or otherwise- didn’t give me grounds to share such a gloomy assessment. But no doubt working in the private health industry however you have come across some pretty vitriolic attacks from self engrossed private health providers who fear losing a good deal of wealth in the event of improved regulatory and much needed fairer community health outcomes.

From my perspective Australian companies are adopting more socially environmental responsible and ethical business practices into their operations - albeit that much more needs to be done! I agree however such action is somewhat of a misnomer and it is an indictment of our civilized state to have to emphasize now what should have always been the case.From what i know it's also occurring in some industries in the US as well.

Hi Sera
Yes –thanks for your thoughts which summarize what happened in a nutshell combined with excessive leveraging. There is also a strong case for limiting remuneration within the financial industry. A manager’s remuneration is currently dependent on the total value of money managed with added incentives to invest in highly leveraged risky assets to yield higher average returns to compete more favorably with other funds. This is a dangerous cocktail which exposes everyone to a much larger systemic risk.

We always think that the future is fresh and we need fresh ideas – that is true to a large degree – but we can also learn from past history. What went wrong with the highly leveraged management investment companies and leveraged investors in the great depression is not that much different to the subprime malaise you have just witnessed with its attendant misery.
In fact the only really big difference is there was a lot more misery back then then now and hopefully it went on for a lot longer than what will happen on this occasion.


Best wishes

susan said...

Hi Lindsay,

Thanks for your kind response to my rant of last evening. You're right that I sometimes do get very distressed and angry about my day to day dealings with the medical insurance industry and every so often I surprise myself by expressing my own frustration in terms that I hope are at least lucid, if not necessarily completely true.

Just yesterday a very bright and well educated young colleague in the business office asked me if there were any countries with single payer health coverage then went on to say - oh yes, Canada, right? I think I may have actually spluttered before telling him that every first world country except the US had it.

I can very well imagine your own surprise in getting that email about the Professional and Ethical Standards update having been cancelled due to a lack of interest. I hope it's not a general sign of things changing there since we certainly need more courses being taught in ethics while there are still people who know the meaning of the word.

Next time I feel an urge to write such scathing prose I'll try to leave it in the claws of my sardonic friend, Crow (who knows better than I to keep it light).

Keeping my fingers crossed, I send you best regards.

Susan

lindsaylobe said...

Hi Susan -

You’re welcome to make a rant at any time in the future especially if it helps clear your head following a frustrating day at the office. I am sure there is elements of truth in what you say and my responses was more a matter of thoughts from afar which naturally enough will not be tinged by any day to day experiences at the coal face so to speak.

Meanwhile I notice the debate continues as to whether or not the Fed is in the best authority to oversee intended consumer protection laws to help reduce the likelihood of the previous abusive practices involving mortgages, credit cards and other financial products from reoccurring.

You cannot legislate morality but I think there is plenty of room to ensure Financial Service providers are better regulated in the future, to be required to maintain a working document – subject to audit - setting out and explaining how risk and client appropriateness is linked to the services offered and supported by product disclose statements. Such an approach usually necessities a massive additional training impost within a firm’s staff to ensure standards of accreditation are maintained. It is impossible to implement such training requirements without encountering ethical questions about ultimatedly what everyone is trying to achieve – integrity/ transparency/ understanding – in addition to profit.

I find it difficult to understand how your Fed, given its present structure, can meet that challenge unless it restructures itself into separate compliance divisions. But ultimately, of much greater importance I fear a huge underestimation of the extent of the task ahead after many decades of regulatory laxity. It’s a matter of changing a culture and changing culture is a dam side harder than most realize and invariably takes a lot longer and more resources than you think. . But that is just my perspective from afar – maybe there is more work being undertaken that I can gauge so I would like to hear about a contrary viewpoint.


Best wishes

Seraphine said...

there is one hopeful point lindsay:
if economists have forecast 14 of the last 2 recessions, perchance their prediction of a long, anemic recovery is equally overstated.

lindsaylobe said...

Excellent point Sera –as you are no doubt aware even the veritable Dr Doom himself - Noriel Roubini started talking about “light at the end of the tunnel, ” only to confirm in his next breath “The recovery is going to be extremely anemic” and talk about the dreaded graphical U bends.

In think the risks are real enough but I’m not sure it helps to keep emphasizing that point to enshrine what may become a self forfulling prophesy.

Best wishes

susan said...

Interestingly enough, just today more announcements were made about the American dollar being in imminent peril of losing the status it's held since Bretton Woods as the world reserve currency. No more Petro dollars. Will the new one be called a bric or will we be looking for yuan to buy our daily bread?

Seraphine said...

"peaks of glory with noble gasps of exertion"
i like that lindsay! thank you. brave words indeed.

lindsaylobe said...

Reference: Interestingly enough, just today more announcements were made about the American dollar being in imminent peril of losing the status it's held since Bretton Woods as the world reserve currency. No more Petro dollars. Will the new one be called a bric or will we be looking for yuan to buy our daily bread

Susan –True –maybe the US$ is safe enough just for now, but long term only a rebalance from the previous huge imbalances will save the day. The way forward is for China to place more reliance on internal infrastructure spending rather than continued overreliance on consumer type exports. The US would have been much better served to have engaged in more dialogue with China to discuss their mutual economic objectives. The latest move to jack up tariffs on imported Chinese tyres, risks further retaliatory measures.
China is currently holding $4 trillion in US denominated debt securities – e g mainly in Treasuries –and for China to avoid a devaluation requires a change in policy to readdress the current massive imbalances.
Hence I think any success in maintaining the value of the US dollar will have much more to do with the action of China and other developing nations than on the US. Meanwhile the US government just ran a record $US1.4 trillion ($A1.5 trillion) budget deficit for 2009 fiscal to surpass all previous records.

Best wishes

Seraphine said...

hey i saw australia recently RAISED interest rates! congratulations. that means things must be pretty good there.
our rates are projected to stay at nearly zero for a bit longer, in an attempt to keep the economy limping along.

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