Merry Christmas from the McKenna Family

 

 

Gregory McKenna

Lighthouse Securities

www.lighthousesecurities.com.au

 

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Blog Moving

Pharos has decided to move back to his first love currencies amd is now blogging at http://www.macrobusiness.com.au/  as Deus Forex Machina.

He is also covering a broader range of topics at his Lighthouse Securities Blog http://lighthousesecurities.wordpress.com/

Gold Standard - you must kidding

We are increasingly reading and hearing about the need for the global economy to return to a gold standard. What a load of codswallop!

A decade ago as a fulltime currency strategist I started to think the free float of the major currencies wouldn't last much longer than a decade or more given that would be around 30 years since Nixon closed the Gold window. Basically my hypothesis was that markets would push too far on one or more of the big currencies and after the massive swings in value the political class would say enough is enough and either impose a transaction, tobin style, tax or re-institute controls.

Not for a second though did we think market based players would call for it to protect from the political class and central banks. But such is the case now that even Jim Grant in the attached link to a NY-Times op-ed thinks its a good idea. How to Make the Dollar Sound Again - NYTimes.com

As an Australian we knowthe value a almost free float can bring to an economy. Certainly the RBA has intervened from time to time to help smooth out the markets more aggressive moves but for the most part the RBA leaves well enough alone.

This call for a gold standard must be resited at all costs for the same reason that Gold standards have failed in the past and the EUR is under pressure from the periphery at the moment. because of cross country differences and the need for transfers of goods, services and capital the pressure ultimately is for the peg, which a gold standard or the EUR is must break. It's no different with bilateral arrangement such as the USD-CNY rate at the moment.

The price when set doesn't always hold true through time. As it was so it is.

US players such as Grant and other should use their considerable talents to help fix the malaise that is the US and global economy not throw populist solutions from the sidelines.

Ralph's right-defiant CBA boss Ralph Norris takes swing at populism | The Australian

We aren't here to defend the Majors but we are dedicated to seeking to battle conventional wisdom and thin slicing and the debate on Australian banking is now taking on a hysterical tone which threatens to deliver a negative result for Australia and all Australians.

Earlier in the week we talked about a solution that we don't believe anyone else has floated. That is rather than simply underwriting the smaller ADI's via securitisation via AOFM the Government should "wrap" qualifying smaller institutions to the rating of Major. This is effectively what Westpac did in the 1990's while it was rebilding after its unfortunate foray with property which brought it to its knees and caused a credit downgrade. Ironically if we remember correctly its was an American Bank that provided the "wrap" so Westpac could continue to borrow and transact in professional markets like swaps and foreign exchange.

We'd argue that the tiered nature of the cost of the Australian Governments "deposit guarantee" was in its construction anti-competitive in that it relied on foreign rating agency assesment of Australian ADI strength based on international prejudices about size, systemic importance and geographic diversification rather than capitalisation, funding profile and asset strength. Indeed these last 3 criteria are downwaited in favour of the aforementioned drivers. Thus in using ratings the Government itself reinforced the competitive advantage of the Majors.

As Ralph Norris says in the attached article and we mentioned we were worried about earlier this week foreign investors will or are becoming worried about the politically charged atmosphere surrounding Australian banking now. with a huge maturity profile in 2011 the debate runs the risk of simply driving up funding costs or worse driving away investors.

These costs will have to flow back into the Australian economy to all our net detriment. Surely we can find a solution which builds up the smaller guys rather than drags down the big guys this is a win win. The alternative is a lose lose for Australia and consumers and whatever the thin slicing rhetoric that doesn't help anyone.

Rates-defiant CBA boss Ralph Norris takes swing at populism The Australian

Time to debate mining's benefits - RBA happy to drive non mining sector into a hole

We mentioned the other day after Building Approvals that the RBA was driving the other sectors of the economy down to make way for mining. Yesterday's retail sales were just another example of their apparent disregard for these non-mining sectors of the economy. The data undershoot the punditry's guesstimates by a mile whether on the monthly number or the quartely inflation adjusted outcome. More bad news for the retail sector on top of the miss-timed hike this week.

Indeed the RBA's targetting of the consumer sector and retail to make way for the mining boom suggests that the question of why Australia seems a natural oligopoly may rest at their feet. That is, Central Bank action - by driving small business to the wall - entrenches the power of the big players over the longer term as they have the critical mass and equity buffer to wear a quarter, a year or more of downturn wheras small business often does not.  Sure we may not lose too many businesses in a "net" sense but they can never compete with the big guys.

One of our favourite Economists, Bill Mitchell of Newcastle Uni, has taken them to task quite brilliantly in what we believe is a must read for any interested party.( http://bilbo.economicoutlook.net/blog/?p=12184#more-12184 ). Here is just a little of Bill's take on monetary policy:

For monetary policy to be “effective” it has to really damage the real economy in a significant way because it is such a non-targetted tool – it impacts broadly across the spending stream. It is far better to address specific sector price movements using fiscal policy which can zero in on the basics driving the bubble without damaging the rest of the economy.

The probable best conclusion is that monetary policy is mostly a very ineffective means of managing aggregate demand. It is subject to complex distributional impacts (for example, creditors and those on fixed incomes gain while debtors lose) which no-one is really sure about. It cannot be regionally targeted. It cannot be enriched with offsets to suit equity goals.

The RBA is driving the rest of the economy into a hole that mining has dug on the expectation that if they dont then mining will ignite an inflationary pulse. So why not deal with the cause not the effect?

Its fair to say that even those of us who have been RBA watching for a few decades are confused by their current rhetoric. We get the fact that the RBA reckons its right with their outlook on inflation but everything we look at suggests the pressure in the next 12 months will be for lower interest rates. We get the conventional wisdom that the terms of trade shock should feed through to consumer spending but with mining such a small sector of the total employment market and with Australian Households labouring under a record debt burden we think the behaviours this time won't fulfill the expectation. And we think its disengenous to simply say the RBA will just cut rates if they're wrong.

We think there should be a renewed debate about mining and the distortion it is causing in the Australian economy. The coalition and the miners did a great scare mongering campaign on the RSPT but why shouldn't the miners contribute more to the rest of the economy which has to wear higher interest rates to make way for their burgeoning waist lines.

Indeed the other 90-95% of the economy deserves more of a return than just the company tax rate for what is an exhaustable resource. And the idea that projects will go elsewhere doesn't matter. The dirt and rocks remains in the groud for exploitation, sorry exploration, at a later date, probably when prices rise and the resource is more scarce. So whether miners pay more tax or they leave the dirt and rocks in the ground Australia gets a net positive benefit either way over the long run.

With the RSPT we get a rent on the resource taken out, but we should also get a debate about how fair it is that Australian Households should pay higher interest rates so BHP can buy Potash. We should also get a debate about whether its fair that small business is ground down at the alter of mining and an apparent adherance to a theoretical NAIRU and perhaps we might end up, after all of this, with an economy that isn't exposed to Chinese policy mistakes or reversals.

Whatever the question the answer is we need a proper debate on Mining's benefits in the short and long run for the economy and citizens of Australia. To us this is a much bigger issue then Bank profits.

Competition in Australian Banking

This blog is prompted by an article we read on Steve Keen's Blog (http://www.debtdeflation.com/blogs/) and referenced another blog about Joe Hockey's comments on competition in Banking. Now we don't always agree with Steve Keen and we think Mr Hockey is as much playing populist politics as he is serious.  But the Australian competitive landscape is skewed pretty heavily because of the dominance of the big 4.

But isn't this an apparent function of the size of the Australian economy and remoteness from any decent sized contiguous economy. When you look at other large scalable industries you could argue that Australia, for some reason, is a natural oligopoly economy. Lets look at Groceries and liqour - Coles and Woolies and their subsidiaries, Airlines - Qantas and Virgin Blue even though Sydney-Melbourne is pne of the busiest routes in the aviation industry, Fuel - Caltex, BP and Shell, Mining - Increasingly the big guys BHP and Rio dominate and then Banking with the Big 4

So to this end to single out the Majors seems unfair because we should be having a debate about the strusture of our economy and the tastes of our population and their want for dealing with well known and crucially, big brands. So having allowed the banks to dominate the landscape and given this domination is less concentrated than some other industries we need to set solid ground rules for competition and for pricing rather than simply wax rhetorical.

I believe that ultimately the way to create competition is for the Government to underwrite the credit ratings of the smaller adi's who in quite a few cases carry more capital, less risk, are more conservatively and sustainably funded than a Major but have lower ratings because of supposeded "concentration" of assets in one geographic region or increasingly the fact that they are not seen as strategically important to the economy. This means the marginal cost of funds for a minnow, even BEN or BOQ, is much higher than a Major.

Australia is better off for a strong banking system but the big guys seem to be pushing too far and hard at present. Like the miners who are distorting resource allocation in the economy at the moment and can be thanked for the inflationary pulse and capacity constraints, not to mention the RBA hike this month the banks should either pay rent on their licence  to conduct business and their natural incumbency or the Gopvernment should work on a scheme to wrap qualifying smaller ADI's ratings up to the AA range of the Majors.

Surely this can be done in a way that increases the overall net benefit to the Australian economy and without threatening the Majors viability. The present debate on profits and Housing runs the risk of simply driving up the margins the Majors pay off shore for funding as investors become wary of instability in our system. This will just ensure greater funding pressure on all ADI's and further increases in interst rates over and above RBA increases.

Tht's not to the net benefit of Australians but their detrimant.

RBA makes room for mining-rest of the economy suffers

It was another terrible building approvals report released this morning with all sectors posting large declines with the public sector the only exception. Unfortunately this is what happens when the RBA makes room for the mining boom the rest of the economy suffers.

Yesterday's move to tighten rates was entirely appropriate given the RBA’s concern about inflation. Equally given conventional wisdom on the relationship between labour utilisation and inflation via the Phillips curve and the outlook and build up of inflationary pressures the RBA must act now in order that it does not allow inflation expectations, which have risen lately, to feed into actual inflation outcomes.

When you look at the breakup of global growth at the moment and you see that the world is growing at trend even though the NATO countries are essentially moribund we can see why the RBA is concerned. If the global economy, particularly the NATO countries, surprise on the upside then global growth will be well above trend over the next year or to this will further increase pressure on resource utilisation and allocation within the Australian economy.

Thus, even though I strongly believe that the pressure on the RBA from global growth 12 months hence will be to lower rates they have the luxury of doing so should their outlook on the economy globally prove to be too optimistic. Therefore they think theyhave nothing to lose by tightening rates now indeed by tightening now and again early next year they probably, with a little of the banks help, forestall any need to move substantially higher if they are correct. Equally if they're not they most probably reckon 'they"ll just drop rates.

Accordingly while I don't necessarily agree with what they've done based on my outlook based on their outlook they’re right. but the big question is is there view right and are they running the risk of driving the rest of the economy into the ground/ We think so.