PROFESSOR ROSS GARNAUTS' VIEW OF POOR PUBLIC POLICY

For my readers who are the remotest bit sceptical of these blogs, please have a read of the speech given yesterday at the University of Melbourne by Professor Ross Garnaut and reported extensively today in the Australian Financial Review and Australian newspapers.

Garnaut is one of Australia's leading economists and can be credited in part for Australia's 20 + years without a recession for his advices and guidance provided to Australian Federal Governments. He is worth listening to.

His message is quite simple: Australia wake up from your slumbers or face destruction (rather like Smaug the Magnificent in Tolkiens' Hobbit). Destruction in this sense means a slide into European style recession and unemployment.

One firm I should have included in my list of nine prospective industries we could have is one which is long established and manufactures and exports very specialist electronics based products - Codan, based in Adelaide. Codan fits nicely with a sustainable competitive advantage in astrophysics and the management of space. It is part of the defence related cluster in Adelaide and could become a key participant in such an industry.

Codan, like Cochlear, Resmed, CSL and others I mentioned yesterday demonstrates that you can successfully manufacture and export from Australia, at todays labour and exchange rate regimes, without tariff protection and without constant subsidy.

David Millhouse is an international entrepreneur with over 30 years in venture capital and private equity internationally. Based in Brisbane, Australia he is a specialist in venture financing and capitalisation, as well as the management of high growth companies, many of which proceed to IPO. He has conducted business in the UK, Germany, Switzerland, USA, Canada, Singapore, Hong Kong, Australia and New Zealand. A scientist by original profession, with an MBA and LLM from Bond University in Australia. He is a trustee of Bond University, Australia’s premier private University, and was formerly a trustee of the Queensland Art Gallery/Gallery of Modern Art. There are 30 years of publications and media on his professional activities and he has had a stellar career at CEO level since 1983.

For personalised solutions to the issues raised in the blog, please contact Corpbuilders TM at www.corpbuilders.com.au

THE OPPORTUNITY COSTS OF POOR PUBLIC POLICY

Reports suggest that the Australian taxpayer has provided some A$19 billion in financial support to the Australian automotive industry this last 10 years according to the Australian Productivity Commission and reported by Henry Ergas (Australian May 25th 2013).

This is government venture capital that should earn a return based upon its opportunity cost. If you were a venture capital or private equity fund manager investing over a period of ten years, you would expect to generate a portfolio of assets which have a return of several times the initial investment amount. Normally this is measured as an internal rate of return and/or a multiple of the original investment.

What did Australian taxpayers get in return for this investment? A truly independent economic analysis may not exist. Perhaps a Ph.D or Post Doctoral Fellow might give this a thought.
I last published in 1988 on such a topic when applying venture capital rates of return to publicly funded University research. Stirred up a hornets nest actually.

What could have Australia achieved with this quantum of venture capital? Probably 19 industries, all based on sectors where Australia and Australians do have some comparative advantages which could become sustainable, not from mineral wealth, but from human capital.

Australians do not generally understand the present economic arguments about "productivity". Most think it will mean working harder for less. Indeed, many people are experiencing declining standards of living as GDP and GSP per capita decline. That's what they feel and no one is providing leadership to demonstrate otherwise.

Productivity can mean working less, but a lot smarter. If there is going to be a replacement for economic activity from quarrying of resources, in what is a hollowed out economy, then some serious strategic thinking about the future needs to occur.

This will need to include the elimination of the present Federal government vilification of entrepreneurs and wealth creation and a return to the previous and productive environment where wealth creation based on innovation and entrepreneurship was encouraged by both mainstream political parties. Peter Beattie, the former Queensland Premier writes regularly on this topic. If there is no wealth creation, then there is less to distribute, and the whole population becomes poorer. This is happening in Australia today.

So what are these industries where there is the opportunity to create sustainable competitive advantage? What could we have had? All of these industries are labour intensive, not easily commoditised or replicated, and are high value adding, high reward industries. A$19 billion invested in accordance with venture capital criteria would go a long way to advance the economic and social wellbeing of Australians.

Here are 9 examples:

1. A world class venture capital industry, well funded, with the capital and skill sets to finance the next generation of Cochlear, Resmed, CSL, Vaccine and drug development start ups.

2. A world class arts sector, building on the magnificent success of the Queensland Art Gallery/Gallery of Modern Art in cultural tourism. This would include full sized orchestras, ballet, opera and theatre companies in each major city attracting higher paying international tourists from around the globe. Competitors to Berlin, London, Paris, St Petersburg and New York; Bayreuth and Glyndebourne. If we want to get away from the economic and social tyranny of low end volume based tourism, this is a strategy.

3. Astrophysics and the management of space, a scientific sector where geography and intellect combine to generate a national sustainable competitive advantage.

4. Clean energy from nuclear power for domestic consumption and for the servicing of nuclear fuelled ships. Baseload power to complement irregular power from solar infrastructure. Stability in energy input costs is fundamental to all manufacturing.

5. Research universities equivalent to Stanford or MIT, with the spin offs from them generating our own Silicon Valleys instead of exporting scientific and entrepreneurial talent to the US, Singapore, and other countries.

6. The built environment. With limited exceptions, people do not come to Australia for its built environment. The value of design and architecture is not a quality generally recognised in this country.

7. Embrace online merchandising of products and services. The quality of the internet today and the devices that allow access to it is such that the whole world is now the market place. Printing books was the precursor to the Renaissance and the Enlightenment in Europe. Similarly today, the internet enabled the "Arab Spring". This global shift in the sourcing and distribution of value added products can change the demand profile of most industries.

8. Medical and dental services and the provision of telemedicine internationally, and especially into growing and modernising middle classes in Asia.

9. The recent Federal Governments' "Asian Century" White Paper is "laudable", but "disappointing that it fails to discuss how Australians can engage more meaningfully with Asia"..." it needs to develop its comparative advantages - and an understanding and respect of Asian culture" says Mr Trevor Rowe one of Australia's leading business men with close links to Asia and to academia. (The complete article is found at Asia Today International authored by Florence Chong).

My own experiences in Europe & Asia demonstrate just how right Trevor is.

There is a whole new industry to be had, not only in language training but in the development of much deeper cultural and historical understandings. It is the combination of these which make for successful business engagement.

What Australia has at present is nostalgia masquerading as sound policy. Please send this blog to your Federal and State members of parliament. Ask them to explain the opportunity cost of their policies.

David Millhouse is an international entrepreneur with over 30 years in venture capital and private equity internationally. Based in Brisbane Australia he is a specialist in venture financing and capitalisation, as well as the management of high growth companies, many of which proceed to IPO. He has conducted business in the UK, Germany, Switzerland, USA, Canada, Singapore, Hong Kong, Australia and New Zealand. A scientist by original profession, with an MBA and LLM from Bond University in Australia. He is a trustee of Bond University, Australia’s premier private University, and was formerly a trustee of the Queensland Art Gallery/Gallery of Modern Art. There are 30 years of publications and media on his professional activities and he has had a stellar career at CEO level since 1983.

For personalised solutions to the issues raised in the blog, please contact Corpbuilders TM at www.corpbuilders.com.au

 

FINALLY THE TRUTH IS OUT 2

On the 6th December 2012 I wrote:

"Finally the truth is out about the Australian economy: it is in recession. The real world has been telling us this for a year, but the Australian Government and much of the media has been hiding behind mining activity skewed aggregate GDP data. Could be good for some borrowers, but those that are worried about security of employment will not want to become even more indebted. Add to this the fiscal contraction from governments at all levels, and 2013 will be horrible for many people".

I copped considerable criticism for this view actually.

Interesting then that in the Australian Financial Review of the 22nd May 2013, the Secretary to the Australian Treasury Dr Martin Parkinson finally states "conditions in the non-resources sector have been not much better than the recessionary days of the early 1990's".

Hallelujah! Although he is wrong. They are worse. I was there and founded my previous business in 1991. That became very successful over its 19 year lifespan.

It is a tragedy that the leaders of the country are not being open and honest with the people, and when they are, then they are very late in admitting it. Probably the real truth will come out after the September election in Australia. The damage is already being done.

Dr Parkinson used to run the Australian Department of Climate Change.

PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS, WASHINGTON DC

I would refer my readers to the Peterson Institute for International Economics in Washington DC. In recent reports, there are some salient insights from that institution for my Australian readers and some very different insights for my thousands of international readers.

To summarise:

• Countries that have reined in public spending are now growing faster whilst the profligate founder;
• Small countries with illiquid bond markets can lose access to international financing at minimal levels of indebtedness;
• Many countries hit their borrowing ceilings suddenly and unexpectedly because of the inherent volatility of credit markets;
• Northern Europe has minimised fiscal stimulus and grown reasonably well;
• Southern Europe, France and the United Kingdom have pursued fiscal stimulus and all suffered from recession;
• The earlier sufficient fiscal adjustment is undertaken, the earlier confidence can be restored amongst citizens, businesses and investors.

In the Australian context, I have pointed out before that Australia is a smallish (albeit worlds' 12th largest) economy but not as developed as other larger economies with which it is often benchmarked. It also has a small and illiquid domestic bond market and is very exposed to the vagaries of international capital and internationally traded commodities.

Hence the recent warnings about Australia from some very eminent opinion makers including Prof. Ross Garnaut and the deflationary warning signals now being commented upon in the mainstream Australian press.

In the European and German context, Northern countries are likely to continue to do reasonably well, especially as the US economy starts to grow again. Had the European institutions imposed their own regulatory standards earlier, then it is likely that the profligate fiscal and tax policies at the national level in the Southern countries would not have been able to inflict such damage on their own citizenry.

Australians take note. Think about getting your assets denominated in USD and Euros, your liabilities in AUD.

THE PRICE OF POOR PUBLIC POLICY 2

An insight into Australia's possible future lies on studying events in Europe and the United Kingdom. Policy pursued to date by the present Australian government will lead inexorably to a Southern European economic outcome. It has happened in some states of Australia previously and can happen again, nationally.

What is not often recognised is that sovereign debt in Australia is not just at the Federal level. As I remarked last week, it is also at the State level. Add in the unfunded liabilities which are not reported as part of government debt. If you do, as reported by Christopher Joye (Australian Financial Review 18th May), then you will see Australian governments debt at around 45% of GDP, not the 11% net debt widely reported internationally.

Australian governments debt has to double only once more, and the country ends up with an aggregate debt position similar to that of the problematic European countries. If you think it can't happen, then please think again. It already is, and the track to economic serfdom was layed in 2007.

Parts of Australia's non-resources economy are already in recession, and the plateauing now occurring in the resources sector will accelerate that slowdown. So would loss of the present AAA credit rating on Australian government debt. If you think that Australia could not possibly have a European style unemployment crisis, then think again. Some districts of the Australian cities already have it, and especially amongst young people and males above 50.

I have spent a lot of time studying German political and economic history. One of the insights I can share is the commonality of objective of various German governments in recent years including those those of the left wing. Not so long ago, the German Greens were part of a mainstream German government. Interestingly, not the hysterical shrieking wraiths that seem to populate the environmental movement in this part of the world, but serious and pragmatic thinkers like Joschka Fischer who led the German Greens for two decades. He became Foreign Minister and Vice Chancellor in the Federal Government.

It was that government that set the German economy on the path of flexibility (including in the labour market) that underpins economic stability and comparative prosperity in that country today.

Fischer's contributions from then are echoed today. He helped to create a European polity based on mutual trust, solidarity, the rule of law and compromise. He does not believe that austere economic policies and structural economic reform alone will solve the economic problems being experienced in the eurozone. These problems stem from profligate social expenditures, unfunded by a consistent tax base, and restrictive regulatory practices, supported by devaluing national currencies over decades.

Fischer believes that the solution lies also in a banking, fiscal and political union: in effect what we have in the United States and Australia, and what Winston Churchill proposed in 1945 - the United States of Europe. The real crisis in the EU is not financial: it is political. Whether Angela Merkel can bring the peoples of Europe together sufficiently for what could be the Final Act of this play remains to be seen. If she can, then monetary stability of the German model could be the result.

It is a pity that given Australia does not have these impediments to conquer, it is nonetheless following the southern european path of unfunded policy profligacy. The outcome, if left unchecked, will be the same.

As I wrote last week, younger Australians will have good cause to look back in anger at the 2007-13 period and the opportunity costs to them and the nation of poor public policy.

JAPANS' BRAVE NEW WORLD: DEFLATION OR INFLATION?

There has been so much focus on China this last decade that the world has perhaps lost sight of developments in Japan. It is still the worlds' third largest economy and one of Australia's largest trading partners, especially for its commodities exports.

When I first visited Japan in the 1980's, real estate in Tokyo was the most expensive in the world. Two decades of deflation later, the present Japanese government and its central bank have embarked upon a massive program of money printing in an effort to stimulate inflation.

Change always creates opportunity for investors. Ask Kyle Bass and Richard Howard from Hayman Capital. Bass predicted the US sub-prime crisis and the European Sovereign debt explosion. They publicly predicted a "full blown bond (Japanese) bond crisis in the next few years". This arises from the threat of rising Japanese interest rates on sovereign debt consuming the "bulk of the nation's entire tax take". Hayman's view of Japan is cathartic.

That assumes the money printing instituted by Haruhiko Kuroda at the Japanese central bank does generate the required inflationary policy objective. It may not, as Ben Bernanke has found out in the United States. They can both control the supply of money, but they cannot control demand for it, or the velocity of its circulation. In the US, the velocity of circulation has been dropping - less activity for a quantum of money supply. That is one reason why the money printing to date in the US, UK, Europe has not resulted in inflation, or even inflationary expectations of consumers. Demand for money has dropped. Prices have deflated.

The same could occur in Japan. Hayman might be wrong, but keep an eye on its Japan Macro Opportunities Fund. That will give you some clues as to where Australia is going to head, both from a trade and an investment perspective.

Volatility in Japan could mean asset allocations to other countries, including Australia. That has implications for the relative value of the Australian dollar and its exports to its second largest trading partner.

Given the size of the Japanese money printing, a bet either way can have massive gains or losses at the fund and at the country level.

(You can find a full discussion at Australian Financial Review 11th May 2013 written by Jonathan Shapiro).

THE PRICE OF POOR POLICY

The policies pursued by the present Australian Federal Government are now starting to hit home. And not in a good way. The effects, already apparent if you look, are now going to be apparent to every household and business.

Having pilloried the entrepreneurial people of this country, and targeted the so-called rich, government finances are now so precarious that the reach of the taxman is now extending beyond those small groups into middle Australia. Higher marginal tax rates, additional levies, and increased costs are now going to suck the financial life out of these households.

Imagine, an outer suburb, pleasant and leafy, but not wealthy, two children and a couple of dogs. A 4WD and an old second car for shopping and school. A belief in personal and social responsibility. The backbone of the nation. These are the people who are now going to pay the price because there are not enough "rich entrepreneurs" to go after, even if this were a proper policy goal.

It is going to take many years before the full impact of policy error works its way through the community, and as Maurice Newman comments "Younger Australians are entitled to look back in anger as they realise how recklessly their future has been mortgaged".

Add in the facts of the struggling SME sector where most of the employment presently is - (some of this is anecdotal, much is not):

• 1,000 restaurants to close;
• 62% of SME's are chasing late payments from debtors totalling over A$10.00 billion;
• 240,000 jobs lost in the SME sector;
• Reduced hours because of penalty rates, even if people wanted to work those hours at the normal rate;
• 51% fall in engineering vacancies.

The list goes on.

Two of Australia's most eminent academic economists in a recent paper argue that "commodity prices, resources investment, and resources exports would shift from being a powerful stimulus .... to a deflationary influence of similar force over the next 18 months". (Reported by David Uren, Australian 13th May).

Scary stuff.

I have long commented that political and institutional Australia has been hiding behind aggregate economic data. Now the tide is going out and we all shall see - especially middle Australia - who has clothes on.

Please review my blogs of 6th December 2012 ("Finally the truth is out") and 18th February 2013 ("Lions led by donkeys"). What you read in those blogs is now becoming daily news.

As Henry Ergas reports (Australian 4th May 2013), "Bad policy just does not happen". How right he is.

For my non-Australian readers, the Australian economy is being squeezed from several directions at once. Some of these pressures are inflicted by its own government, and some are the consequences of a globalised world and just have to be managed.

What is clear, and many Australians are starting to become very concerned about their specific situations, is that the future is not going to be like the immediate past. Why?

First: The money-tap is being tightened by falling real commodity prices and increasing supply sources. This will also apply to LNG and other commodities as the United States and Canadian suppliers change patterns and pricing in world markets. Reversion to the long term price mean results in lower prices for Australian producers.

Second:The global sea of newly created money in the United States, United Kingdom, Europe, and Japan pushes down the relative quantity of Australian dollars, and increases its relative price, especially since the Federal debt remains AAA rated, along with Norway, Switzerland, Canada, and Sweden. The ECB may reduce European interest rates to zero or below. Australia has relied heavily on foreign capital inflows, which presently upwardly support the relative value of the Australian dollar. But, because Australia is not a "developed" country in the sense that Switzerland is, and Australia will continue to require capital inflows to "develop", then the policy measures to reduce the relative strength of the Australian dollar need to be be different. Taxing those foreign inflows, as proposed by eminent economist Henry Thornton (nom de plume), may not be the solution. And reductions in Australian official interest rates are probably akin to pushing on a string.

The chances are therefore, that the relative value of the Australian dollar will remain where it is. That changes the producer economics permanently and reduces domestic profit margins hugely at a time of rising unit cost structures. Hence the lower corporate tax receipts, even though Australian corporate taxes are high by world standards.

Third:Australian public debt as a percentage of GDP is reported to be relatively low by "developed country" standards. What is not reported is that if you add in the sovereign debt of the Australian States and Territories (who can themselves borrow on world capital markets), you get a vastly higher level of sovereign debt (about twice Federal debt). This is already becoming a political issue in Australia with fiscal consolidation occurring Federally and in the States. Governments are needing to borrow for well into the foreseeable future.

Four: Price inflation for tradeable goods and services is presently benign in Australia. Price inflation for statutorily mandated services, pensions, labour, electricity, and utilities is significant,  and is causing increasing business and household distress. So are personal tax rises. Australians pay a top marginal rate of almost 50% if you include levies and other quasi income taxes. The marginal rate in Singapore is 20% and in New Zealand 33%, and both countries are competitors for Australian talent.

Five:It is inevitable that measured unemployment will rise. The real killers, as I have blogged before, are underemployment, a belief that jobs aren't available, and a decline in entrepreneurial activity. It is this loss of confidence that is deflating property prices. If people are not confident, or they know people who are not confident, they will not borrow money, no matter how low the interest rate. Go back to 1991. At some point, this will affect the banks and the bubble in bank share prices will be pricked as a result.

This all points to a deflationary domestic environment. Real spending in government, business, and households will decline. So will the velocity of circulation of money. This makes Australia and Australians vulnerable and uncertain. That is certainly the feeling you get talking to real people. Real people understand intuitively and from walking around that things are not as well as they were. Political and institutional Australia is only now waking up to that reality. Their problem is that they have lost control and do not have the necessary policy tools to regain it without significant forthcoming pain.

More and personalised guidance can be found at www.corpbuilders.com.au

INVESTING IN VOLATILE TIMES

For my many readers who have been following the themes in these blogs, you can gain some insight into how this is being developed into investment strategy by visiting: http://www.abnnewswire.net/press/en/75159/Article

THE DESTRUCTION OF COMPARATIVE ADVANTAGE AND THE POLITICISATION OF SCIENCE

This series of blogs reflecting disparate climate change opinion commenced on the 13th April 2013 where I related my early experiences in the politicisation of science. In particular, the predictions by one Paul Ehrlich in the 1970's that the earth will cool and food supply will be reduced. Scientific opinion and Malthusian economics rolled into one. Neither proved true.

And neither have the more recent hyperventilations on so-called anthropogenic warming which is leading to significant economic hardships in Australia and flawed energy policy in Germany and other countries. In these countries, destruction of comparative advantage is the result. My most recent post on this issue described what is likely to happen given the energy revolution underway in the United States.

Very credible scientists from the United States, Russia, and Taiwan now offer different views on climate change, and appear to be of the view that the earth is heading for a cooling period.

Abdussamatov from the Russian Academy of Sciences believes that "another cool period was due and would come about regardless of whether industrialised countries put a cap on their greenhouse gas emissions". "Mars has global warming....without the participation of Martians". He predicts a new "little Ice Age" will start this year or next"(On earth).

Hill at the US National Solar Observatory said "three different analyses of the sun's recent behaviour all indicate that a period of unusually low solar activity may be about to begin". From the Academia Sinica in Taiwan, where there are concerns about cooling as a result of Chinese emissions, Hsu states " the pause in warmingof the past decade is more likely to be explained by natural variability".

So there you have it: From the US: "the connections between solar activity and climate change are still very poorly understood"; from Taiwan: "the problem is the present state of climate models is still too simplistic for nature", and from Russia "a deep freeze that would last for the rest of the century".

(For interested readers, please refer to Graham Lloyds' column, Weekend Australian May 4-5 2013 and the original references).

From an investors' perspective, the gaming of misguided public policy could reap huge rewards. The losers are the households, small businesses, and larger company shareholders who all have to pay the costs associated with politicised public policy.

THE DESTRUCTION OF COMPARATIVE ADVANTAGE IN GERMANY

One of my German readers of this series of blogs has recommended you visit www.eike-klima-energie.eu. Herrn Sebastian Poetter is a leading Berlin and Brussels based lawyer and kindly posted me this link. It is in German but easy to translate.

The German economy (please refer my "Ping Pong Pang" Series) has been a sucess story this last 20 years. This success is based on a combination of world leading technical innovation, the availability of capital, investment into science and engineering skills, a flexible labour market, and access to relatively lower cost labour in other parts of Europe.

Germany is a high energy cost economy and was forecasted to become much more so, to the point that renewables (particularly wind) become competitive with nuclear and fossil fuels. The reality is different. That is a direct result of the energy revolution in the United States and Canada. This revolution will result in the US and Canada becoming largely self sufficient in energy and lower world prices for LNG and other fuels.

The result is that previous energy price forecasting for German industry is wrong and planned reliance on much higher priced renewables likely to cut a swathe through German manufacturing industry. Present energy price assumptions will destroy the aggregate advantages created by German industry.

I actually do not think this will come to pass. The Germans are too smart and they think long term and strategically. But it will mean changing the present assumptions and resulting policy mix. Change creates investment opportunities in a an environment of future declining world prices for energy sources.

Compared to the  policy mess in Canberra, Australia, where clearly, there appear to be few smarts and even less strategic thinking, and i know where i would put my money. Not in LNG developments in Queensland. No wonder Woodside deferred its investment into its Browse LNG project in Western Australia.