Friday, October 24, 2008

Only The Uncertainty Is Certain

I think it’s safe to say that the Global Financial Crisis has been in the headlines for so long now that rather than a crisis it is starting to look like the normal state of affairs. It’s been more than a year since the share market started wobbling, and the sequence of crash, rally, crash again, has been repeated so often now that it’s hardly news. Warnings of economic doom are now so commonplace that they have become more like a weather report than a news flash. Unfortunately, for the thousands of Australians whose savings have just been frozen in a host of investment funds, the crisis is still a crisis.

It is clear now that the Government made a mistake by not including a cap on the bank deposit guarantee, but despite the recriminations it would have been an even bigger mistake not to have the guarantee at all. Nevertheless, it is vitally important that stability is also restored now to the investment houses which provide annuities for self funded retirees, as well as the foreign banks who provide finance to business. Wayne Swan’s advice to retirees to visit Centrelink is really not very helpful, and if that’s the best the Government can do then they deserve the criticism currently being heaped upon them by the opposition.

At the same time, the Government cannot afford another mistake, and rushing to provide another blanket guarantee would be exactly that. Instead, a way needs to be found to guarantee the holdings of Mum and Dad investors, the annuities of retirees, and at the same time the viability of the financial institutions which deliver those services. This might involve introducing a cap after all, grandfathering existing investments, imposing a premium for any guarantee above a certain level, or a combination of these measures.

Those are matters for the Government to resolve, and quickly, rather than wasting time engaging in a debate with the opposition over what is already old news. Given the importance of private superannuation and other investments in Australia’s retirement incomes policy, it is vital that these vehicles are given some stability. The Global Financial Crisis might be old news now, but it continues to unfold with new challenges confronting the Government daily.

The only thing that is certain, is that the uncertainty will continue for a while yet.

Thursday, October 23, 2008

Bank Guarantee Needs “Fine Tuning”

One of the biggest shortcomings of politics is the absolute inability of any politician to back away from a blunder and simply admit an error. That would involve an unacceptable loss of face, the willingness to appear fallible, the admission that sometimes they make mistakes. Instead, every effort is expended to maintain the perception that everything is under control, all is going according to plan, and that no mistake could possibly have been made. The circumstances are put through the spin machine so that any alterations to previously announced measures are presented as “fine tuning”. At all costs, politicians must avoid the need to perform an embarrassing backflip.

When Prime Minister Kevin Rudd announced on October 12 that all bank deposits would be guaranteed without limit, the move was immediately welcomed as a bold step towards preserving the stability of Australia’s banking system. Now, serious doubt is being cast upon that, with the suggestion that capital is being shifted out of non-guaranteed investments into guaranteed bank deposits at a massive rate, actually undermining stability, rather than promoting it.

Foreign banks which have limited deposit taking functions here in Australia are excluded from the guarantee. As a result, it is reported that funds are pouring out of those institutions, undermining their ability to continue to provide an important source of corporate finance. Others are also calling for some sort of protection for cash management trusts, mortgage trust funds, and superannuation funds, none of which are included in the guarantee. Imagine the chaos if people were suddenly able to pull out their superannuation money and move it into bank deposits!

The Government’s solution to this problem is to introduce a levy on deposits over $1 million as a form of insurance premium. The opposition is claiming that this amounts to a new tax, and is only adding to the mess rather than fixing it. But the Government is trapped by its own spin. It simply cannot admit now that the uncapped guarantee was a mistake. In retrospect, a cap at $1 million would have been more than enough to erase the concerns of most bank account customers. In fact, given the restriction preventing foreign banks from accepting deposits below $250 000, perhaps that figure would have been a reasonable place to draw a line in the sand.

Now, the debate has descended into farce as the focus has now shifted to the finger pointing game of who gave what advice to the Government and when. Rather than getting on with the real business of shoring up the Australian economy and softening the potential impact on ordinary Australians, the Government and the Opposition are firing salvos of blame at each other and at senior public servants such as Dr. Ken Henry at Treasury, and Glenn Stevens at the Reserve Bank. Perhaps the Government acted hastily in giving an uncapped guarantee, but the matter was urgent, and it still is.

In the meantime, all of the indications from the economy are pointing to worse to come, with credible forecasts of unemployment reaching 9%, and a million Australians expected to encounter mortgage stress while the value of their homes can be expected to continue falling. At the same time an O.E.C.D. report identifies Australian retirees as the fourth poorest in the developed world, and unemployed Australians as the poorest.

Failing to cap the bank guarantee may have been a mistake, but the political point scoring occupying debate now is an unwelcome distraction from the larger challenge of limiting the economic fallout for ordinary Australians.

Wednesday, October 22, 2008

What Inflation?

Today’s Consumer Price Index figures show that inflation has now hit 5%. This is what Treasurer Wayne Swan was warning us all about earlier this year when he was talking about the inflation genie getting out of the bottle. At that time it meant interest rates had to go up. Now it’s a different story. Even with inflation rising, all of the talk remains focused on the likelihood of a November interest rate cut of another 0.5% in the battle to head off a recession. So, what’s the story? Isn’t inflation still a problem?

Well, yes it is, because while the cost of living continues to rise people find it harder to make ends meet. But for now the fallout from the Global Financial Crisis is seen as a much bigger problem. Our’s is a consumer economy, and for it to function consumers must continue to buy the things that they need. If they stop doing that, then business revenue falls and jobs will be lost. That becomes a vicious cycle where spending dries up further, leading in turn to more job losses. That’s why it is so important for Government to ensure that the welfare safety net provides at least some spending power to the community.

The expectation is that inflation will reach a peak and then begin to decline as the economic slowdown works its way through the system. In fact, the forecast is that today’s 5% inflation figure is the peak and from here inflation will level out and then fall away. It’s a nice idea, but it’s not guaranteed to work. Perversely, the big money being spent by the Government to prop up the economy could also continue feeding inflation so that the overall effect of the assistance is dissipated. It is a delicate balancing act.

The other problem is that whatever the Government does, and however effective their actions might be, the final outcome is still very much subject to global conditions. The jury is still out on just how badly the Chinese economy might be hit, which will have a direct bearing on just how difficult things become here. Longer term it is reasonable to believe that China will continue to grow strongly, but in the short term there is a chance that a hiccough in the Chinese economy could cause a complete seizure in ours.

In that context, inflation is the least of our worries. But if the theory proves to be wrong, then it could come back to haunt us at a time when we are less well equipped to cope with it. A combination of high inflation and low economic growth is a double whammy that nobody wants, and that’s why cutting off a recession is the priority.

Tuesday, October 21, 2008

Back To The Future

The Prime Minister’s recent proclamations on the evil of greed and so called “extreme capitalism” have been met with a chorus of agreement from the ordinary everyday people who are likely to suffer most in an economic downturn. Sure, the corporate high fliers might suffer losses adding up to lots of dollars, but most of them are not going to be wondering if they can buy groceries next week. But the battlers and the pensioners have little or nothing to fall back upon so that any downturn can cause serious hardship.

It’s not true that excessive executive salaries have caused the financial crisis, but they are a symptom of the problem. The problem is that bad decisions have been rewarded in the short term with these inflated payments. I have always maintained that there is nothing wrong with anyone being well paid for a job well done. But when it comes to executive salaries, it is too often the case that the reward is out of all proportion to the effort, and not directly related to the best interests of the company, its shareholders or its customers.

While the idea that the Government could somehow regulate or cap executive salaries is attractive to many, it is contrary to the ideals of a free market. It should rightly be left to the board of directors, acting on behalf of their shareholders, to set executive remuneration at a responsible and a sustainable level. The trouble is that doesn’t seem to have worked.

It has now emerged that the Government is considering introducing a new top level tax bracket for incomes of $1 million or more, at a rate of 50%. This is nothing new. In fact this is a return to the way things used to be. A generation ago, the top tax rate was 60%, but to be in that tax bracket an individual had to be earning almost 20 times average income. Today’s average income is a little above $60 000 a year, so 20 times that is $1.2 million, around the ballpark that is now being discussed.

This proposal makes sense, in every respect. With more than 5000 Australians earning over a million dollars a year, the increased revenue is substantial. What’s more, the proposal is in keeping with the proper functioning of Government in that tax is an instrument to be used for influencing behavior. Governments should offer tax relief to activities it wishes to encourage, and increase tax on activities it wishes to discourage. It provides an incentive for companies to reduce excessive payments and redirect the money more productively.

Just as importantly, it also sends a signal to the battler that the top end of town is also expected to carry its share of the load.

Monday, October 20, 2008

Message Received

The swing against the New South Wales Government in the by-elections held at the weekend was massive: 22% in Ryde and Cabramatta, and 12% in Lakemba. Despite the magnitude of the swing, only the seat of Ryde actually changed hands with Liberal Victor Dominello taking what was former Deputy Premier John Watkins’ seat. Nevertheless, the message for the New South Wales Government is clear. By any measure, the Government is in deep trouble. But then we already know that. The real question is whether Premier Nathan Rees can perform some sort of miracle in the next two and a bit years.

Premier Rees says he has heard the message: “Lift your game or else.” Although he has been Premier for only six weeks, he has insisted that he is going to deliver where his predecessors have failed. He has promised to be decisive. He has promised to consider matters that have been left to languish in the “too hard basket”. He has warned us that he is accustomed to being underestimated, and that the criticisms don’t worry him.

On the positive side, the Premier has flagged the possible removal of developer levies which add to the cost of new homes and which have been a significant factor in the affordability crisis. He has announced that City Rail maintenance must meet new standards by March 31 next year or it will be outsourced to the private sector. He has proposed a joint State-Commonwealth plan to boost nurse training places at universities and in hospitals.

On the negative side, we have heard it all before. The people of New South Wales have had 13 years of policy promises and announcements which have either not been delivered or have led to costly debacles. The rail expansion plan, the T-card scheme, the Cross-City Tunnel have all been examples of big talk resulting in either a failure or a mess. Then, the doomed mission to privatise electricity saw the Labor Party rip itself apart so badly that it’s ability to govern evaporated.

Now, Nathan Rees is asking New South Wales to believe that he can bury the history of the past and make good on his promises for the future. Even with a little over two years up his sleeve it would take some sort of miracle to convince the voters that this time it’s for real. Even if Nathan Rees is the man he says he is, voters will still have reservations about the Party that he leads.

The Premier insists that he is listening to the people of New South Wales and that he has heard their message. The question is though, are the people of New South Wales listening to him?