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Canberra to seize Port of Darwin?

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Darwin is now the epicentre of our spat with China.

I’ve got a bold prediction for you.

Canberra is going to seize the Port of Darwin.

Possibly by the end of this year.

Now I don’t know if you know the back story to this, but I don’t know if anything else points to how quickly things have gone south between Australia and China.

So back in 2015, a Chinese company, Landbridge, was given a 99-year lease on the Port of Darwin.

It was negotiated by Andrew Robb, the coalition Trade Minister who worked on the China FTA and the lease deal, and then three months (not years, months) after resigning from parliament, went to work for Landbridge as a consultant.

Totally not dodgy.

At the time, the deal raised a few eyebrows. The Americans weren’t happy. They were like, you know we have a Marine base in Darwin right?

But $500m is $500m, and in 2015, Australia’s future was looking very Chinese. We were best buddies.

Fast-forward to 2021 and things are looking very different. As Andrew Robb said last week, the trade relationship with China has “gone to custard”.

And the Cabinet national security committee has ordered the Defence Department to review the lease.

As trade tensions escalated last year, China imposed aggressive sanctions against Australia, applying punitive tariffs on products such as wine, beef, lamb, timber and barley.

Cabinet’s national security committee ordered the Defence Department last month to provide updated advice on whether Landbridge should be forced to relinquish the lease on national security grounds, amid souring relations between Canberra and Beijing.

Defence and ASIO raised no objections when the Northern Territory government under former chief minister Adam Giles signed a $500 million deal to lease the port to Landbridge for 99 years in 2015.

However, the deal provoked anxiety in the Obama administration given the large US Marine deployment in Darwin and national security hawks have repeatedly called for it to be unwound.

Of course it should.

China runs with “capitalism with Chinese characteristics.” One of those characteristics is that the state can get involved in pretty much any company it likes. The line between businesses and the Communist Party is pretty blurry.

And if we’re on an irreversible path towards strategic rivalry – which it seems like we are – in what universe does it make sense for the Chinese government to control a major piece of Australian infrastructure?

And the tone in Canberra has changed so much that the lease has very few allies. Even Andrew Robb says, “Canberra had every right to reassess the port lease in light of changing strategic circumstances.”

Landbridge is, of course, saying it will create “sovereign risk” – it will make Australia look like risky place to invest and do business.

But hardly. The logic is pretty obvious. The fact that the lease has survived so long given the deteriorating trade relationship is evidence of how pro-business Australia is.

I don’t think any of our allies or investment partners are going to care.

So I reckon it’s probably going to happen. Canberra will seize back the lease on the Port of Darwin.

And if anyone is still dreaming that thing can ‘go back to normal’ for Australia and China (looking at you, Labor Party), tell ‘em they’re dreaming.

JG

China guns for cotton. Whatever.

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Still more people freaking out about China. When will they get it?

So it seems that China is gunning for Australia’s cotton industry now.

Australia’s cotton industry is bracing for what could be a devastating blow as it becomes the latest casualty in the escalating trade tensions with China.

Mills in China are being told to stop buying Australian cotton as speculation grows that a hefty tariff is about to be slapped on the trade.

Government sources have told the ABC the cotton industry could face tariffs as high as 40 per cent, a sanction that could make the trade with China unviable.

Under China’s current trade rules the Chinese Government determines how much cotton each mill can import through a quota system.

But the ABC understands spinning mills have been warned not to use Australian product, or risk their quotas being slashed.

Without the government endorsement, these mills could be forced to pay 40 per cent more to buy Australian cotton.

The Australian industry has become increasingly nervous about the $800 million market, which typically accounts for 65 per cent of the cotton grown nationwide.

“Devastating blow.” Get over it. Cotton should just do what coal’s doing, in light of similar attacks.

That is, shrugging it off and saying “whatever.”

BHP’s Chinese customers have asked the miner for relief from coal purchase contracts in the wake of Beijing’s move to crack down on foreign coal imports.

The requests for deferral come amid uncertainty over whether China is seeking to limit purchases of foreign coal of all origins, or whether Australian miners are being specifically targeted under an extension of geopolitical trade tensions.

BHP chairman Ken MacKenzie said he would be concerned if Australian coal was being discriminated against.

But Mr MacKenzie said he was generally “not overly concerned” about the impact that trade tensions would have on demand for BHP's products, but he was concerned about the impact on ”the economic cycle”.

”Our concern around some of these geopolitical tensions and trade wars that are going on is the impact it could have on global growth, and in a post-Covid world that probably has even more concern,” he said.

Are you catching that? BHP doesn’t care if China doesn’t buy its coal. All it cares about if total global demand for coal goes down.

Why?

Senator Matt Canavan gets it:

National Party Senator Matt Canavan said Australian exported about 20 per cent of its coal to China.

“It’s a sizeable market but it’s not our biggest market,” he told Sky News, adding the largest market for thermal coal was Japan.

“We only actually produce about 5 per cent of the world’s coal, so if China decides to buy its coal from different countries, well, those other countries will be exporting less coal and we’ll fill a market gap in those places.

If China buys Brazilian coal, we’ll just sell to whoever Brazil was selling to.

That’s the thing about commodities. It doesn’t really matter where they end up. And that’s why BHP is so relaxed.

The real madness is here is that we allowed a single market to buy up 65% of our cotton output.

That’s nuts. That’s a strategic vulnerability.

But thankfully, we’re on the slow (and noisy) road back.

So chill, everyone.

JG

The disaster that Trump can’t defend against

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Could Corona hand the Presidency to Biden on a platter? What happens then?

Yesterday I showed you this chart here, which worryingly seems to show new Corona Cases getting out of control in the US.

As I said, it’s a misnomer to call this a second wave. It’s actually just the spread of the first wave into the southern states. Call it The Southern Wave.

But whatever the case, it seems to be getting out of control, and that has some big political implications, and I wanted to think through some of those today.

First, Trump’s approval rating is falling quickly, and that seems fair enough. Protecting the American population is the number one job of the American President. If you can’t do that, it’s not surprising people are getting angry.

Trump’s approval rating has been lower, but the runway between now and election in November is pretty short. Trump really needs to be able to put Corona Virus behind him.

If it’s a big issue come November – if it’s still an issue – it’s hard to imagine the American people are going to be forgiving.

And even though Joe Biden has all the charisma of a freshly unearthed corpse, his polling numbers are on a break-away:

And betting odds have clearly turned in his favour:

Now, we should take this with a grain of salt. The polling numbers were hopelessly wrong in 2016. But still, Trump was untainted fresh-blood back then.

There’s a good chance he’ll be going into the election with the blood of the Corona Virus on his hands.

That’s going to be hard to get off.

And so what would a Biden presidency mean?

There’s a lot of unknowns there, but Biden has set up tax policy as a clear policy difference.

Wall Street’s not happy:

Boston-based Christine Todd, who is head of US fixed income for Amundi, Europe’s largest investment manager… put out a special bulletin showing that while Biden might be better for markets than Sanders he would still dramatically reduce US share values, particularly when combined with the higher COVID-19 infection rates.

…Todd and Amundi calculate that Biden’s tax increase agenda would reduce the S&P 500 earnings estimate for 2021 by roughly $US20 per share, from $US170 to $US150. As a rule of thumb, every percentage point change in the effective corporate tax rate should change S&P 500 earnings by 1.2 per cent, or $US2 per share.

Todd and Amundi concentrated on corporate taxation but the Biden agenda also has a range of increased taxes for higher income individual Americans…

The money raised by the higher corporate and individual taxes will be directed towards increased access to healthcare and support minority communities through a new affordable housing program. There will also be substantial investment in infrastructure.

We are looking at a different America under Biden and one that will not be anywhere near as favourable to the share market.

Cry me a river, Wall Street.

It’s not the President’s job to juice share markets.

And long term, a more stable tax base and increased infrastructure investment are good news for the American economy.

But still, if we do get a V-shaped recovery in time for November’s elections, there’s every chance that a Biden victory will send stock market’s south again.

In my mind, property is the clear winner there. Funds will pivot out of equities and into property, across the world.

And depending on how much of a mandate Biden gets, it could be substantial.

But four months is a lifetime in politics, and I wouldn’t underestimate the Donald.

But even still, if that case rate gets away from him, I don’t think there’ll be any saving him.

JG.

Prediction: Clive Palmer will be PM!

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The most boring election ever just got a little bit more interesting.

Clive Palmer is going to be Prime Minister of Australia. There. I said it. I’m making the call.

Ok, it’s not going to be this election. And realistically, he’s got such a long way to go it’s probably not going to happen.

But I think we need to start taking The Clive seriously.

Ok, at this point I reckon three quarters of you are thinking, “Look out. Jon’s on the kambo again. He’s really lost it this time.”

“There’s no way that buffoon is going to achieve anything.”

But right now, with arguably the most charismatic buffoon ever in charge of the White House, I don’t actually think it’s my case to make. This is the age of the buffoon. Clive Palmer fits the bill perfectly.

But being a buffoon, just as it was for Trump, is actually a strength, not a weakness.

I mean take this bit of graffiti some frustrated inner-city graphic designers got up to over the weekend, defacing one of Clive’s Billboards.

Ok, I’ll be honest. I laughed. This is pretty funny, but mostly because it’s such a ridiculous thing to do to a political poster. If there’s a subtle point about Palmer’s political philosophy, it’s lost on me.

Two things I’d say about this. One, vandalising political posters isn’t cool, and it’s kind of typical of the thought-police censorship that “progressives” are becoming notorious for.

I mean, imagine the uproar if it was a Greens poster. Like, what if I did this:

Ok, wait. I didn’t do anything to that poster. It’s real (from NZ).

But the point is, you don’t like Clive. Sure. He’s an idiot. Fine. But does that give you the right shut-him down?

The second point is, does this hurt Clive? Does it make him look foolish? Does it make him seem less electable to the people who were possibly going to vote for him.

No. Not at all.

This doesn’t touch Clive. When you are so over-the-top that you are practically a caricature already, this kind of stuff doesn’t touch you. It didn’t hurt the Donald and it won’t hurt the Clive.

(It’s kind of like a magic power.)

The other criticism I’m hearing is that he’s importing Trump-style politics, and it won’t work in Australia.

But this isn’t an accidental tactic. This is a deliberate strategy, and I reckon it’s strong.

And really, you’ve got to think about this from a business perspective. Businesses import successful business models from other countries all the time. For some venture capitalists, that is literally all they do. Clive is just doing the exact same thing.

He’s taking the Trump political/business model, and repackaging it for Australia. It’s the same pitch to the same marginalised and forgotten voters, from a similar personality, with literally the exact same slogan.

That’s not an accident and it’s not laziness. He’s doing it because it’s a proven model.

And I’ve watched a handful of his campaign videos. They’re good. Not good as in “I’m sold and I’m going to vote for him” but good in the sense that they’re tight, well-pitched and professional.

I mean take the one from Palmer’s candidate for Abbott’s seat of Warringah. She’s impressive and genuine.

Or take the one from a candidate they call “Dave the Builder”. He’s put on a nice shirt, but then for some reason thrown a high-vis vest over the top. It’s like a casting agency was given a brief for “most two-dimensional Aussie stereotype possible”, but when he says, “Let’s give these mugs a thong-slap,” I’m there screaming “Good-on ya Dave.”

To some people this is just going to seem like a farce. And they’re the same people who just couldn’t understand how Donald Trump got elected.

Palmer has picked his mark, targeted his base, pitched it perfectly and has a business model with runs on the board.

To me, that means he’s a force to be reckoned with.

Australia, are you ready for The Clive?

Is America in Rapid Decline?

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Just checked in with America. I was surprised how many ideas I had that were out-dated.

I’ve got a bunch of interesting charts on the US for you today.

And for all the talk of China, or Russia, or Whateverstan, the US still remains the most important economy in the world – and definitely from Australia’s perspective. So it’s still worth taking an interest in.

The thing that piqued my interest in all this was learning that the US and Australian bond spreads had inverted.

That is, normally Australian government bonds have to pay investors more than US government bonds because Australia is seen as a riskier prospect.

But in recent years, that’s reversed and the gap is now the widest its ever been in Australia’s favour:

So are the prospects for the Australian economy really that much better than the US?

I mean, whatever happened to all that talk of a property market Armegeddon and all that?

It may be the case that investors just think that America is “due”. America is now approaching the longest business cycle expansion in history. If they make it to 2020, it will be the longest expansion ever.

So maybe investors are thinking, ‘what goes up, must come down’. The good times can’t last forever.

But then that’s the thing about this expansion. It sounds a bit tinny. Sure, the economy is expanding, and the US labour market is definitely looking peppier.

But inflation remains anchored to the floor. And as much as the Fed wants to get the economy off the QE juice – unwind it’s massive money-printing efforts – it just hasn’t been able to.

I mean, it did make a start. It did try to wind things back, but the markets didn’t like it, and it gave it up. Now, it’s not expected to even start cutting back again til 2021.

So while yes, America is currently enjoying one of the longest expansions on record, it’s hardly been one for the ages. It’s not a picture of a stallion in full stride. It’s a picture of a war-veteran, put into a plaster cast, and put back in the field.

There’s a couple of other interesting things I dug up. The first is that the US has recently become the largest oil exporter in the world, with oil exports exploding since 2010.

Did you know that? It was news to me.

Partly this is about greater domestic production, but it’s also about a more fuel-efficient economy that is freeing up oil reserves for export.

But anyway, the picture we used to have of the US economy – as one hopelessly dependent on the whims of OPEC – is past its used-by date. This has some very interesting political ramifications.

And it’s maybe why we’re seeing a more aggressive stance on US trade.

On that front, I thought this chart was interesting too. It’s authors titled it: “US Drug Deaths before and after China joined the WTO”.

That title is deliberately provocative, but it is still a disturbing picture.  The left map shows 1999 levels. The right shows 2014 levels.

America is in the grips of a serious opioid crisis. It’s claiming millions of lives.

That can’t be entirely blamed on China, but the hollowing out of American industry, particularly as companies started ‘off-shoring’ production to China, is clearly playing a part.

Anyway, put it together, and it’s a mixed picture. The economy continues to ‘stumble through’, and large segments of the American economy are hurting.

But still, the economy is delivering, and America’s political clout seems to be actually increasing.

Interesting times indeed.

If Trump pulls the trigger, you’ll want to own this.

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MMT has given politicians the intellectual cover they need to embrace print and spend. Where do you want to be investing when it happens?

Alright, wakey, wakey hands off snakey.

It is going down right now. The whole flipping financial landscape is being flipped on its head.

Rivers of cash are coming.

This might all sound a little mad unless you’ve read what I’ve been writing about over the past couple of weeks (see here, here and here).

But governments in the developed world are going to start printing cash. They’re going to be throwing it away.

As I said, that sounds like economic heresy, but that’s what I mean. The tables are being turned on their heads. Up is down, left is right. Printing money is good for the economy.

Don’t believe where this is heading? Check out Trump’s two suggested picks for the US Fed. Stephen Moore, and former Godfather’s Pizza CEO Herman Cain. They used to be inflation hawks. Now, they’re all about the easy money. That’s what Trump wants to hear.

Why? Because that’s what sells. He knows that if he can give away free money, without consequences, he’ll be the most popular president, ever.

(He already thinks that, but we’ll be able to fact check it this time.)

And for a global population already angry that our economic bail out plans almost always start and end with pumping the financial sector full of cash, a system where cash is mainlined straight to mum and dads will be like a sweet revolution.

Both the left (e.g Bernie Sanders), and the right (Trump) are jostling to get on board.

They can’t afford not to.

So what does it mean? How are we going to make money out of this seismic shift?

Well, it does depends on how the government decides to do it.

It could print money and spend it on infrastructure projects – it’s not hard to come up with a list of stuff that needs doing.

In that case, owning stocks connected to infrastructure spending – road and transport companies, shipping, civil engineering, that sort of thing – that would be a winner.

The government could also give money straight to the people. This might be in the form of grants like the First Home Owners Grant, but would more likely come through tax cuts – probably temporary tax relief.

Given this would likely have a progressive element (lower income earners would receive more benefit) and that lower income earners have a higher propensity to consume, this could be good news for companies whose fortunes swing with the consumer – furniture, electronics, department stores etc.

Real estate is a clear winner here too. As disposable income goes up, so does serviceability. When that goes up, so do prices.

And in tight rental markets more cash-in-hand means higher rental prices. Higher rental prices means higher yields, which of course means higher property prices.

This is not likely to be a one-way street though. One of the advantages of MMT that its proponents point to is that it frees up interest rate policy to fight inflation.

So interest rates do a much better job of putting a brake on economic activity, than they do of speeding things up. “Pushing on a string” is the expression.

So we could see super-loose fiscal policy going hand in hand with tighter monetary policy (i.e higher interest rates).

Where that lands will be an interesting question, and the most likely outcome is that we see a mix of cash-handouts, government spending and interest rate tinkering.

But the point I would make is that consumer price inflation and asset inflation tend to go hand in hand.

When you flood the system with money – regardless of whether you’re doing it through a financial sector channel ala QE, or through the public sector and the consumer ala MMT – that money goes looking for a home.

And the home it is looking for is wherever it earns the most. So just as we saw a massive bid on financial assets during QE, we’re going to see another massive bid with MMT.

And remember, the massive property boom we’re just on the tail of now, between 2010 and 2017 – that was largely due to the flood of easy money QE unleashed on the world.

I’m not sure if that’s the received wisdom yet, but it seems pretty obvious to me.

And so another boom, exactly like the one we just saw, could easily be on the cards again. Another seven year boom, another tripling of prices.

In my mind, it could easily happen. Mark my words. It’s coming.

Is this wages boom too late to change the election?

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In six months, Morrison could have crushed it in. Shame the election is now.

So the election has been called. What’s going to be the deciding factor?

We like to think it’s about big-picture vision and value positions. It’s about the issues.

But it’s not. It’s the economy, stupid.

I don’t think Bill Clinton ever expected that that little quip would be one of the most lasting contributions of his “legacy”, but it is exactly right. People need to feel secure first and foremost. The economy has to be delivering real jobs and a decent standard of living.

If it’s not, everything else is a side-show.

And on that front, you’d have to think the economic tides are with Morrison.

And they are to a degree. The economy continues to perform reasonable well, especially on the most important metric that matters – employment.

Employment growth is easing, but it remains decent. And most importantly, the number of jobs is growing faster than out labour force population, and the unemployment rate continues to fall. 

At 5%, it’s a pretty decent outcome, all things considered. By itself, it’s certainly not a ‘turf them out’ type number.

But there are problems for Morrison that are hidden behind this headline number.

The first is that employment growth is uneven. Some sectors, especially the public sectors, are doing well. Others, particularly mining and construction, less so.

That patchiness can create ‘pockets of pain’ in the economy. It can create segments were unemployment is concentrated, and political venom starts to pool. Think the mining communities of Far North Queensland, for example. It’s not possible for a miner who’s lost his job in Townsville to just go and become and community care worker in inner-city Melbourne, for example.

The other headache for Morrison is that while people have jobs, wages growth has been… what’s the economic term? Piss poor.

Wages growth has been hobbling around 2%, which means that people probably feel they’re going backwards in real terms. Technically, it’s still outpacing inflation, but I think that’s probably only a technicality. Ask around and I don’t think people will tell you that they’re keeping pace with the cost of living – especially with energy prices becoming a real pain point.

So that’s a headache for Morrison. It’s something that can shift the electoral dial.

The real irony here though is that wages are actually starting to pick up. Take a look at the chart and you can see that yes, wages growth is relatively low by historical standards, but it has definitely ticked up in recent months.

And the NAB survey is showing that more and more firms are reporting difficulty finding suitable labour.

So wages pressures are building. We’re still six months to a year away from this feeling like things are really on the up and up for everybody, but it’s coming.

So Morrison must be spewing. If only the election could have been called six months later. He probably could have ridden a growing sense of optimism to victory.

But instead, people are still grumbly, There’s not a lot of gratitude in the community.

And if Morrison loses and Labor wins, they’ll enjoy a very sweet honey-moon period as wages continue to pick up and households enjoy the boost in confidence. Even though they’ll have done nothing to deserve it.

That’s just how the cards have landed. Tough break, ScoMo.

Revealed: taxes are actually rising

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RBA data shows that taxes are actually rising right now… that is not what this economy needs. 

There was a fair bit of chatter last week about tax cuts. Most of it focused on how big the tax cuts would be and who was going to get them. 

But today, I want to explain why we actually need tax cuts right now – at this stage in the cycle. 

I’m not talking ideology here. I’m not here to say that tax cuts are always a good thing. (I’ll save that for another day.) 

I just want to make the point that given where we are at in the cycle, and how things have evolved, we’re actually taking more tax than we intended, and we probably want to rein that in a bit. 

To make this point I’m going to draw on some interesting work RBA Deputy Governor Luci Ellis did a few weeks ago – work that was largely ignored. 

The short version is that for a few reasons, the tax burden on households has been growing faster than household income, effectively meaning that households have experience a net tax increase in recent years. 

… which was never the plan. 

She makes the point that right now, taxes are growing about twice as fast as household income.  

In the past year, taxes paid by households increased by around 8 per cent, more than double the rate of growth in gross household income of 3½ per cent. 

So the ratio is more like a bit over two-to-one at the moment, rather than 1.4 to one. 

That is at the high end of the range this ratio reaches, but as this graph shows, it is not unprecedented (Graph 12). But this effect has cumulated over time, so that the share of income that is paid in tax has been rising (Graph 12, bottom panel).

The key picture in all this is that bottom panel. It shows the tax-to-income ratio is steadily increasing, and is approaching record highs. 

What that means households are getting less, and the government is getting more – a bigger slice of the pie. 

And maybe that’s ok, but it seems to have happened by accident. I don’t remember the Coalition going to the last two elections with a policy of increasing the tax take of government…

More to the point, is this what we need right now? 

Economistscould have a field day talking about that one, but given everyone is feeling a bit gloomy about the outlook, given the GDP numbers continue to come in under forecasts, given wages growth remains sluggish, and given most economists now expect the RBA will be forced to cut rates, possibly some time this year… arguably it’s not a great time to be covertly increasing taxes. 

In fact, I’d even venture so far to say that even Blind Freddy can see that now is not the time to be increasing the tax burden on households. 

Ellis puts this shift down to a few factors – lower interest rates have mean lower negative gearing deductions, and the ATO has made a good fist of increasing the tax take through enforcement and compliance. 

So it just worked out that way. It wasn’t been a deliberate decision. 

But that doesn’t mean the impact on the economy isn’t real. 

And I would argue that at the very least, we need to cut taxes just to bring this back into balance – to lower the tax-to-income ratio back to normal levels.

And this is why we need tax cuts. 

The budget is a lie!

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This economic revolution is playing out in real time. Today, they attack the budget.

The budget is built on a lie. Everything we know about the budget is wrong. Every number Josh Frydenburg laid out for us on Tuesday misses the point.

That’s the word from MMT – modern monetary theory.

Ok, so we’re picking up from last week and the week before. I’ve been explaining that the ideological dam has broken. People now realise that the tools we have for managing the economy just don’t work the way we expected them to work.

Quantitative Easing (QE aka printing crap-cans of money) should have created inflation. It didn’t.

So we need a new theory for understanding the economy, and with any new theory comes a new set of tools.

And as I said last week, Munters (my name for MMT proponents) believe that:

  • Capacity constraints, not money, create inflation;
  • Interest rates are a useless policy tool if there’s no demand (looking at you RBA); and
  • Governments are not constrained in the way we thought they were.

The second point there potentially kills off monetary policy and the RBA’s agenda completely, but point three could be a complete game changer.

And budget night will never be the same again.

The key point the Munters make is that the way we’ve been trained to think about the government budget is wrong. It’s the wrong metaphor.

The metaphor we’ve been trained to use is to think of governments as a household. Households can’t live beyond their means, so neither can governments. Households have to balance their budgets, and so do governments. If households are saving money (earning more than they spend) that’s a sign of good money management. The same is true for governments.

All of this is simplistic in the extreme, but Munters are also keen to point out that it’s actually wrong too.

It’s wrong for two reasons:

1. Governments can print money

If a nation is ‘monetarily sovereign’ (it has a flexible exchange rate and issues debts in its own currency), then are no hard constraints on how much money it can print. It might create inflation that way, or it might devalue the currency, but both of these things can be managed, and depend a lot on what else is happening in the local and global economy.

As Munters argue, inflation only comes from capacity constraints, not automatically out of money creation – as QE has proved.

A household obviously cannot print money to pay its debts. If I tried to pay my creditors in JonCoins, I’d probably end up in jail.

Munters argue that given this important difference, it makes almost no sense to compare governments to households.

2. Governments are not in the business of making money

Munters also argue that it’s not helpful to have a government that is motivated like a household (maximising its own wealth) or a business (maximising profits.)

Here the idea of ‘sectoral balances’ comes in. This is just the accounting identity that if the government sector is in surplus then it is lending money to the other sectors in the economy. That necessarily means that the other sectors must be a net borrower, and must be in debt.

So a government that forces itself into surplus, forces households and business into debt.

Is that a great outcome?

And if point one above is true, it’s much worse for households and businesses to be in debt since they can’t print money to pay off their debts.

So while it might be nice at the individual level for governments to be running a surplus, taking the economy as a whole, it’s not clear that a wealth-maximising government is that great a thing.

Not a Free-for-all

This is not to say that Munters think it is a free-for-all and that governments can do whatever they want. It is only to say that governments are not constrained in the way we thought they were – in the way that the ridiculous governments-as-a-household metaphor would have us believe.

And that means that there is a much greater role for governments to print money and support demand than we previously believed.

This idea runs totally against the prevailing economic wisdom.

But the prevailing economic wisdom has failed.

And MMT is an idea who’s time has come.

I’m not arguing it one way or the other. I don’t have a horse in this race. But I can see the writing on the wall. Momentum is with the Munters.

And the implications are going to be huge.

More on that next week.

Negative Gearing Reckoning: who will it hurt?

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If Labor wins, negative gearing reform is go. But who is it going to hurt?

Labor has announced that their negative gearing and capital gains tax reforms will come into effect on January 1, 2020.

Like most people, I was expecting them to go for the end of the 19/20 financial year, so this means two things:

  1. there’s going to be a rip-the-bandage off approach, and I think that’s probably a good thing.
  2. Labor knows it’s onto a vote-winner and is happy to double-down.

But like all things in politics, there must be winners and losers, so who is going to be worse off under the new policy settings?

Well, literally everyone, according to the Real Estate Institute of Australia:

“The REIA has always been concerned with the impact the policy would have on housing markets, buyers, renters and economic activity,” REIA President Adrian Kelly said.

“This concern is magnified in the current market.

“There is almost truck loads of analysis and reports showing the adverse impacts of the policy on mum and dad investors, home owners, renters, the construction industry, state governments and the economy.

Investors, home-owners AND renters?

How does that even work? I actually struggle to think of a scenario where all three are made worse off under ANY policy proposal – maybe something like “All housing will be nationalised and turned into jumping castles for Swedish tourists.”

Or are we using a definition of “worse-off” that I’m not aware of?

I want to pick this apart a bit, not to be cruel to REIA, but to make a point about how the housing market actually fits together. I think it will be useful.

Anyway, if we’re saying everyone in the market is going to be worse off, then I assume we’re saying that house prices are going to fall (bad for investors and owner-occupiers) and rents are going to rise (bad for renters).

That’s the only scenario that makes sense. If rents fell, that’d be bad for investors, but you’d have to chalk that up as a win for renters.

Likewise, if houses became more expensive that would be bad for renters looking to buy, but would be a win for owner-occupiers and investors.

So we’re talking about falling house prices (though I know a café full of millenials cheering that on), and rising rents. But how would negatively gearing actually make rents go up?

They might go up if the reforms exacerbated our housing shortage, but since negative gearing will remain in place for new stock, it’s hard to see how removing it for existing homes will have any affect on construction rates…

But, just for arguments sake, let’s imagine that somehow negative gearing reform does increase rents.

What happens then?

The point to remember here is that since housing is an asset, like all financial assets, the return is linked to the price.

The link between the rental return and property prices is captured by “yield”.

Now the thing to note about property yields is that they’re affected by structural conditions in the market – interest rates, risk appetites etc. Yields are not determined by rents and prices themselves.

That may sound counter-intuitive, given that yields are a calculation of prices and rents, but the causation actually runs the other way. Yields determine prices.

If you track yields over recent years, you’ll see that they’ve been very stable.

For 15 years, they’ve barely deviated from 4%. Even though rents and prices have been all over the shop, yields have barely changed.

So if rents go up, what happens to yields?

Well, you’d think yields would go up as well. But that doesn’t happen, because prices are set by people buying property, and the people buying property are happy with yields of 4%, on average.

So if rents go up, yields stay constant, and the adjustment is forced on to prices. Prices go up and yields remain at 4%.

Statistically, that’s been true for as long as we have data for.

But if prices go up, isn’t that a win for owner-occupiers and investors?

Yes.

Personally, I think the reforms will have no impact on rents, and push prices down at the margin, but not by a huge amount. Yields will adjust a little because the ‘cost of carry’ appetite will have changed (I’ll talk more about that another time).

But all this ‘everyone is worse off’ is just BS.

But remember this. If you want to know what’s happening to prices, look to rents and yields first.