Author: ColinTwiggs

RBA governor Philip Lowe told the Turnbull government to get moving on infrastructure last Thursday. From Ross Gittins:

Another point worth noting is Lowe’s implication that the budget needs to achieve balance in spite of the huge cost of cutting company tax.
….Note, too, Lowe’s reference to “achieving a balance between recurrent spending and fiscal revenue” (my emphasis).

This isn’t the first time he’s quietly taken issue with Treasury’s longstanding practice of exaggerating the size of budget deficits by lumping spending on capital works in with recurrent spending – unlike the state governments.

Borrowing part of the cost of building infrastructure that will deliver economic and social benefits for 30 or 50 years is in no way “living beyond our means”.

And, indeed, one place higher on Lowe’s to-do list than achieving budget surplus in spite of company tax cuts is the task of “providing adequate high-quality infrastructure to help our citizens be as productive as they can be and enjoy a high quality of life”.

He notes we’ve got a strongly growing population which, if we fail to invest in sufficient infrastructure, including transport infrastructure, can “impair our ability to compete and be as productive as we can be”.

It’s surprising how many people are great advocates of high immigration levels, but won’t countenance the increased spending and borrowing needed to provide the additional infrastructure – roads, public transport, hospitals, schools – used by all the extra people.

Then they wonder why our productivity performance is weak.

Productivity improvements require more than just infrastructure, but it’s a start. A modern infrastructure lowers input costs and makes industry more competitive.

Other structural adjustment, in addition to infrastructure spending, is needed to make Australia competitive in global markets instead of simply digging holes in the ground. Some day the ore and coal may run out, or demand shrink, leaving a hole in exports.

Electricity costs are one of my favorite examples, where the average retail price of electricity is almost 3 times that of the US, Canada and Mexico….and more than 4 times that of India and China. Basic input costs like this help to make economies competitive. Some may argue that Japan and Germany are successful despite similar high electricity costs, but consider how much more competitive they would be if they could match their trading partners.

Source: Reserve Bank chief Dr Philip Lowe gently reproves Turnbull’s failings

Andrew Ross Sorkin discusses a private letter to investors written by Seth A. Klarman, the 59-year-old value investor who runs Baupost Group, a hedge fund which manages about $US30 billion:

While Mr Klarman has long kept a low public profile, he is considered a giant within investment circles. He is often compared to Warren Buffett, and The Economist magazine once described him as “The Oracle of Boston”, where Baupost is based. For good measure, he is one of the very few hedge managers Mr Buffett has publicly praised.

In his letter, Mr Klarman sets forth a countervailing view to the euphoria that has buoyed the sharemarket since Mr Trump took office, describing “perilously high valuations”.

“Exuberant investors have focused on the potential benefits of stimulative tax cuts, while mostly ignoring the risks from America-first protectionism and the erection of new trade barriers,” he wrote.

“President Trump may be able to temporarily hold off the sweep of automation and globalisation by cajoling companies to keep jobs at home, but bolstering inefficient and uncompetitive enterprises is likely to only temporarily stave off market forces,” he continued. “While they might be popular, the reason the US long ago abandoned protectionist trade policies is because they not only don’t work, they actually leave society worse off.”

Investors are hypnotised

In particular, Mr Klarman appears to believe that investors have become hypnotised by all the talk of pro-growth policies, without considering the full ramifications. He worries, for example, that Mr Trump’s stimulus efforts “could prove quite inflationary, which would likely shock investors”.

Much of Seth Klarman’s anxiety seems to emanate from the leadership style of US President Donald Trump.

And he appears deeply concerned about a swelling national debt that he suggests can undermine the economy’s growth over the long term.

“The Trump tax cuts could drive government deficits considerably higher,” Mr Klarman wrote. “The large 2001 Bush tax cuts, for example, fueled income inequality while triggering huge federal budget deficits. Rising interest rates alone would balloon the federal deficit, because interest payments on the massive outstanding government debt would skyrocket from today’s artificially low levels.”

Much of Mr Klarman’s anxiety seems to emanate from Mr Trump’s leadership style. He described it this way: “The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making.”

He also linked this point – which is a fair one – to what “Trump style” means for Mr Klarman’s constituency and others.

‘Shockingly unpredictable’

“The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty,” he wrote. “Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan.”

While Mr Klarman clearly is hoping for the best, he warned: “If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation, and global angst.”

From the letter, it is hard to divine exactly how Mr Klarman is investing his fund’s money. His office declined to comment on the letter. His fund has more than 30 per cent in cash. He has lost money in only three of the past 34 years.

The New York Times

Forward P/E for the S&P 500 is falling, so I do not agree that valuations are spiraling out of control. But if, at some point, earnings take a hit, either from tighter Fed monetary policy or a trade war, then we are in for a wild ride.

I do agree that protectionism is dangerous and can lead to uncompetitive industries. Trump has to be careful not to “throw the baby out with the bath water” when abandoning international trade agreements. There are unfair elements that need to be fixed* but once these are addressed the US would stand to gain more than it gives in return.

We will have to assess the impact of tax cuts when the full proposal is on the table. At present I see some good, some bad, so am not too alarmed about the effect on the national debt. Hopefully saner heads will prevail.

But I share Klarman’s concern about Trump’s unpredictability. Though this may be exaggerated by a hostile media, we have seen enough to be concerned.

It would be wise to overestimate the abilities of some of the USA’s competitors (and some allies) and to underestimate his own. Trump faces some shrewd and wily statesmen with many years of experience to whom he must seem like a kid in short pants, full of enthusiasm and naivety. That way way we are less likely to be taken by surprise.

Source: A quiet giant of investing weighs in on Donald Trump

• The primary source of unfairness, currency manipulation, could be minimized by negotiation of a new monetary order — governing monetary policy and exchange rates — to replace the Bretton Woods system abandoned by Nixon in the early 1970s.

From Ross Gittins:

The economist who’s long made a close study of Australia’s commodity booms, past and present, and the problems they’ve caused when they bust, is Dr David Gruen, now deputy secretary, economic, of the Department of Prime Minister and Cabinet.

In a speech he gave last week, Gruen reviewed the progress of our transition phase.He started by reminding us of just how big an “economic shock” to our economy the resources boom has been. The size of the improvement in our terms of trade (export prices relative to import prices) makes it easily the biggest sustained boom in our history.

Since their peak in September 2011, however, they’ve deteriorated by more than 30 per cent.The boom in mining construction saw it increase from less than 2 per cent of GDP to a peak of about 9 per cent in 2012-13.

This resulted in something like a quadrupling in the mining industry’s stock of physical capital, and a tripling in its production capacity, in the space of a decade.”The largest investment was in liquefied natural gas production capacity, with Australia on track to overtake Qatar as the world’s largest sea-based exporter of LNG,” Gruen said.

The economic activity and employment that accompanied the investment boom caused a significant re-allocation of labour across industries, but this has now been largely unwound as mining projects reach completion.

The improvement in the terms of trade caused sustained growth in real income per person (much of it coming in the form of lower prices for imports and overseas travel).

Since their peak in 2011, the terms of trade have subtracted from income growth by so much that, even with reasonable improvement in the productivity of labour, real gross national income per person has been falling.

“This is reflected in gradually falling real average earnings per hour over the past four years – for the first time in living memory,” Gruen said.

With an end to the trend deterioration in the terms of [trade] now in prospect – they’ve been improving for the past three quarters – it shouldn’t be long before real incomes start growing again, with the size of that real growth strongly influenced by the rate of improvement in labour productivity.

What surprised me about the successful adjustment — to the the dramatic fall-off in mining investment — was that the Australian Dollar has not fallen further, holding above 70 cents.

Considering that commodity prices, depicted here by the DJ UBS Commodity Index, fell further than in both 2001 and 2008.

Source: Now the economy’s transition phase is ending, wages can start rising