Inflation v Tax Cuts

I want to say something about the statement 'tax cuts increases inflation' that is being thrown around a lot lately. This is being used, particularly by Cullen in New Zealand, to justify not cutting taxes (and criticising National's not yet promised tax cuts - something I will touch on below).

Inflation is caused by general demand exceeding supply. According to those using inflation as the spectre to justify not cutting taxes, demand increases as the supply of money increases and the supply of money in the economy increases when taxes are cut as the amount of money that taxpayers has increases.

Thus the statement 'tax cuts increase inflation' rests on the assumption that tax cuts will increase demand, presumably because all the tax cut money will be spent where as it would not have been if it was not cut. This is what I have an issue with... the fact that it is assumed (by Cullen, the media and those that just accept what they are told) that not only will all money returned to taxpayers be spent, but that money that is not returned in tax cuts will not be spent.

From financial year end 2006 to financial year end 2007, New Zealand government expenditure increased by 5%, from $65,422,000,000 to $69,017,000,000. Year on Year inflation in March 2007 was 2.5%. This means that government expenditure increased by 2.5% in real terms (i.e. negating the effect of inflation. The effect in real terms will be the real effect of growing government expenditure on demand and inflation) over the same period of time.

Therefore not cutting taxes is not demand nor inflation neutral, unless government expenditure grows at the same rate as inflation, inflation will be influenced. If expenditure grows slower, demand caused by the government decreases; if expenditure grows faster, demand caused by the government increases.

Growing government surpluses can reduce demand by taking money out of the economy, but such growth in surpluses has to outweigh the increase in government expenditure. Also the only place a growth in surplus in real terms can come from is by taking money out of the non government economy. The non-government economy will have to have decreased by 2.5% in real terms between 2006 and 2007 to offset the growth in government expenditure with regards to increasing inflationary pressures.

I also have issue with the assumption that all money returned through tax cuts will be spent increasing demand. Much may be said about (New Zealand's in particular) woeful savings rates, but it is unlikely that every cent will be spent. Some will be saved for those that can afford to save and some will be used to retire debt, which does not increase demand. All increases in government expenditure are spent, increasing demand.

The statement 'tax cuts increase inflation' also ignores the supply side of the inflation equation, as if supply increases relative to demand then inflation should decrease. As government expenditure is unlikely to be efficient or productive expenditure (feel free to let me know if you disagree, I have not yet examined the numbers for this) but rather redistributive, it is unlikely to influence supply. Tax cuts, and especially tax cuts for business or aimed at higher income earners, on the other hand at least have the opportunity of being put to productive use through investment in productive business, increasing supply and lowering inflationary pressure. I say tax cuts aimed at higher income earners, as it is higher income earners who can afford to, and are more likely to, invest in shares and business rather then just pay off a little bit more of the mortgage

Cullen has used the inflation spectre to criticise Key's Freudian slip that National's tax cuts will be around $50 a week. Cullen said:

"Mr Key has not yet seen up-to-date inflation forecasts, he has no idea
what Treasury is predicting by way of economic or revenue growth in the year
ahead and no idea if his $50 a week or more in tax cuts would result in higher
interest rates for New Zealanders."

Even $50 a week tax cuts will apparently cost only $5 billion, only slightly more then the increase in government expenditure from 2006 to 2007. The increases in government expenditure has had more of an influence on inflation and raising interest rates then even National's not yet promised tax cuts.

Finally, it annoys me that a rise in interest rates for those who hold mortgages becomes a burden every tax payer has to bear. But that is a blog topic for another time.

Round and round some of the (Australian) budget forecasts

The Australian budget was released Tuesday, and why in the most part I (and the commentators) thought it was a sensible budget, there were a few things that looked a bit convenient...

First the budget forecast 3.25% inflation for next year where the Reserve Bank of Australia last week forecast 3.5%. The budget based this lower forecast on its conservative growth forecasts. This is good for the government, as the government wanted this to be a 'low inflation budget' (although 3.25% is still above the target). But the budget is slightly circular, the low growth forecasts and budget itself will lead to lower inflation as forecast in the budget, which justifies an inflation fighting budget, which is based on the forecast of lower inflation. The difference in forecast is also a part of the government saying to the RBA, "look please please don't raise interest rates again, we are doing our best".

It will be interesting to see whether the RBA agrees with this lower forecast in its next monetary statement. Assuming that nothing else fundamental changes, then this will be a major independent test of the budget... and not everyone thinks that the budget was enough for the RBA to lower interest rates.

The budget also forecasts unemployment to grow from 4.25% to 4.75%, a growth of .5%. Once again this growth is based on the very conservative growth forecasts that the budget has adopted, as lower growth leads to lower employment growth, leads to growing unemployment (leads to lower growth). Once again this benefits the government as it leads to lower inflation forecasts, wage moderation and justifies family welfare increases.

Swan probably is the 'luckiest incoming treasurer in Australian history', given he could afford to spend big and tax less. However sometimes the rhetoric around the budget has made me think of the Disraeli quote 'lies, damn lies and statistics' (or is that 'politics'), for all the anti-inflation / slashing government spending talk its very similar to what Costello would have done.

Australia v NZ: Swan's budget

The Australian budget has been released today. As expected Australia is cutting taxes. I myself am receiving $1,100 extra in the year from July 1 (although hopefully my salary will go up too) through threshold movements, plus the 1.5% medicare surcharge will disappear.

However, lots and lots of money is going to 'working families', as if they didn't get enough extra
compared to us productive childless earners anyway. Read here and here for a nice criticism of family friendly tax regimes; they really don't make any economic sense.

A note on the tax cuts and inflation, inflation (currently at 4%) will erode about $3000 from my purchasing power overt the next year, the threshold movements will redeem a bit of that, but (like the problem in NZ) bracket creep is robbing more than the threshold movements. Therefore the tax paid as a proportion of total income grows each year. At least Australia has been increasing these thresholds over the last few years unlike NZ, but the movements have not been enough to prevent bracket creep completely. It will be interesting to see what Cullen does on the 22nd, I think he will probably raise the thresholds (at least the low ones).

P.s. I am watching Malcom Turnbull trying to rip apart the budget, unfortunately he is not very convincing.

Quick news: NZ$, Distribution network sale, Immigration and ANZ bailouts

Tuesday, April 29 2008:

New Zealand exchange rate to keep plunging

It looks like the NZ dollar is to keep falling. And the current falls are only caused by the omission of the word 'significant' in Bollard's speech. What is going to happen when he actually stops tightening and releases his interest rate grip? The NZ dollar will plunge. This is a result of the NZ dollar being over valued as a result of the carry trade (borrowing in low interest rate currencies, such as the Yen, and lending in high interest rate currencies, of which the NZ dollar is the first world's highest); the Japanese housewives and Belgian dentists don't have a large risk appetite and they will lose a lot if the currency falls, so they get out of their NZ dollar investments which in turn precipitates further declines of the NZ dollar.

Not that a lower exchange rate is of itself a bad thing, it will help exporters. But inflation will skyrocket (caused by more expensive imported goods), and I am picking the speed at which it falls will cause a mini crises of confidence.

Vector sale of Wellington electricity distribution network

Apparently the sale of the Wellington electricity distribution network will go ahead:

"Dr Cullen's office said yesterday that his advice was that the network was not on sensitive land, so it did not have to pass many of the hurdles facing the Auckland Airport sale."

Why is it not on sensitive land? What makes the parcel of land that Auckland Airport is on more 'sensitive' then every piece of land the various parts of the Wellington network are on? The new regulations would be infinitely better, although still not good, if investors knew in advance what was going to be affected (i.e. stopped) by the new regulations. The article continues:

"The Hong Kong buyers of the network will instead be judged on whether they have experience and acumen relevant to the asset, whether they are of good character and have a financial commitment to the asset."

This seems sensible right? That is because it is. If you are going to have a restriction on foreign investors (which I disagree with), this is criteria that should be used to measure the foreign investor against; the measure should not be related to what the asset is. And where do these criteria come from? From the Overseas Investment regime that was in place before Cullen changed the rules.

A few other points:

• Helen said she had no particular view on the electricity network, but noted that it had been in foreign ownership twice before. Can I just ask how this is different to AIAL which is already 35% owned by foreigners? And why should any of it matter?
• NZ First said it was a pity that another asset was passing from local hands into foreign ownership. Once again, why does it matter? Woolerton (nor Winnie) have not given any reason why it should matter. And, to jump on the dredging up the past bandwagon, Winston sold AIAL in the first place into, among others, foreign ownership. As for the worry that the new owners will bring in competing workers from China under the recent Free Trade Agreement, I doubt it, the workers can only come in where NZ is lacking in skills.
• And as for the Greens saying prices will rise. They won't. The distribution network is highly highly regulated, particularly when it comes to prices. And do the Greens think that Vector were operating without debt? The very reason they are selling the network is to reduce debt. Prices will not rise.
• Finally, also on the Greens, saying that the NZ Super Fund should buy it, what rational economic explanation can they give for the NZ Super Fund to do this? If all of its investments were made on the basis of preventing local assets falling into foreign hands I certainly would not want to grow old in NZ. Fortunately I probably won't.

NZ Politics: Immigration scandal

National is calling for the people who authorised the preferential immigration treatment to be exposed. Now usually I would say that the people within a ministry or government department are just doing their jobs and should suffer for bad direction caused by their superiors (the ministers and department heads). But if, as stated in the independent report (produced by former Justice Secretary David Oughton; a quick Google search turned up nothing of note), the immigration head was completely blameless, then those who are to blame should be outed or lose their jobs. It is situations like this that undermine the confidence in the immigration service and half arsed solutions (like an independent report that clears the department head but doesn't reveal the culprits) do not do anything to restore it.

ANZ Bailing out failing Australian stock lenders

ANZ is suffering a reputational hammering due to its handling of the Opes Prime affair (see my previous posts here, here, here and here). It has it seems taken a different tack with the other stock lending brokers whose business models are failing (see this post for more on stock lending in Opes Prime). Tricom and now Chimaera Capital have been bailed out by ANZ injecting equity into them rather then enforcing ANZ's securities or selling the shares ANZ has been lent.

Now I obviously don't know what ANZ knows about Chimaera, but is it really worth buying into Chimaera to avoid the trouble its been having with Opes? The damage has been done and the particular business model that Opes and Chimaera have been running is flawed, ANZ should enforce its security and sell the share it has and let Chimaera sink.

Opes Prime: Singes Singapore, collapsing charges and liable for litigation

Some recent updates on the Opes Prime saga:

Opes Prime collapse hits Singapore

The Opes Prime collapse has spread overseas causing a mini scandal in the Singapore markets. Merrill Lynch repossessed (hopefully under something better then its faulty Australian charge, see below) shares that were being used to take over a Singaporean company. The shares were subject to a Opes Prime infamous stock lending arrangement and on Merrill's repossession the takeover collapsed, as did the share price from 22c to 7c.

Merrill Lynch's invalid charge

Merrill Lynch, which has relied on a charge over Opes Prime assets (these include the shares purchased by the Opes clients as Opes ran what is called a 'stocklending' arrangement with its clients, see below), failed to register its charge in time (it needs to be done in 45 days of the charge being given) as well as not registering it until after Opes went into administration (and it is therefore voidable) and the charge is therefore ineffective.

I would certainly hate to be the junior in the finance team of what ever law firm Merrill Lynch uses. It is a $600 million fuck up. A career ending move (and scarily easy to do).

ANZ is lucky and does not need to rely on its charge (which was only registered the day before Opes's administration) for it to sell most of the Opes securities it already has, as ANZ had a stock lending arrangement with Opes itself (like what Opes had with its clients). ANZ does need it for its further 90 odd million loan it made to Opes just before it collapsed, but its charge will be effective for this loan anyway.

A stock lending arrangement involves:

1. A holder of shares (for example Opes) sells shares to another party (for example ANZ) for money (or something else like different shares);
2. ANZ has an obligation to sell equivalent shares back to Opes and Opes to pay the money back (less ANZ's margin);
3. While ANZ holds the shares it is the legal and beneficial owner of the shares and can deal with them as it likes including selling them and doesn't need to return them to Opes if Opes defaults (which it did here).

Opes had stocklending arrangements with most (but not all, these ones won the injunction against ANZ preventing them from selling their shares) of its clients, which is why Opes clients suddenly found ANZ and Merrill selling their shares even though they were not facing margin calls and were not in default themselves.

Opes creditors will pay for any litigation twice

Opes clients will be lucky to get the forecast 30c in the dollar, especially if they carry through with all the litigation against ANZ and Merrill that various class action supporters (those with vested interest in seeing a class action proceed) are pushing for.

ANZ, under its security, is entitled to all costs defending any actions related to the security (which the class actions will be) and the administration will need to continue while the litigation continues, increasing administration costs. These costs will quickly eat into the 30c in the dollar that the unsecured creditors have been promised.

Even if the unsecured creditors win, they won't necessarily get any more as ANZ will then enter the pool of unsecured creditors diluting their stake (and ANZ certainly will not lose on all points that the creditors will take against it).

Australia v NZ: Abandoning NZ and Cullen's comments

Stuff led with the attention grabbing headline 'One in 10 Kiwis eyeing Australia' this morning.

The article discusses the latest Fairfax poll that puts National on 52% compared to Labour on 34%, and states National, on this poll can govern alone.

It always worries me seeing 'National can govern alone' spread across the media. While if the poll did actually translate into seats it would be a good thing and although National may be secretly hoping for it, I think given the average New Zealander's tall poppy envy, resentment may start to kick in. Non-rational voters who were leaning National for the change of face may turn away, rational voters who want a National government may, by considering the election already won, turn to compatible minor parties who policies more closely align with their interests.

Anyway, back to Australia, the article is saying that approximately 430,000 New Zealanders are considering moving over here. Even if only 10% of those considering the move carry it through, that is still 43,000 abandoning New Zealand for Australia.

With the 8,500 who return to New Zealand each year, that makes a net migration to Australia of 34,500. Therefore 6,500 more New Zealanders are moving to Australia in 2008 then did in 2007 (I note that the Stats NZ population clock is only based on a net emigration, anywhere in the world, of 12,032.5 per year).

This is a worrying trend, and how does the government respond? Cullen is apparently unsurprised by the high numbers looking at Australia as an alternative:

"given the enormous publicity that's been given to migration to
Australia".

Yes, that's right Australia is marketing itself as a destination to live so effectively that 10% of New Zealanders are considering a move over, and, last year, 36,500 New Zealanders made the move. Somehow, and correct me if I am mistaken, I do not believe it is all about marketing. Cullen goes on, he cautions against an overly optimistic view of prospects in Australia:

"Of course confidence has collapsed in Australia as well. I think people better
look fairly carefully. And inflation is higher in Australia than it is in New
Zealand. I think there's still the picture the Australian economy is booming
along, whereas they're running into some headwind as well."

Yes, business confidence in Australia is down, but not as bad as NZ. However, I do not see a lack of confidence in the average Australian person. Interest rates are up, but not at the level they are in New Zealand. Job security is not an issue, Australia does not rely on a few businesses to provide jobs that support whole industry sectors (i.e. there is no F&P about to leave and topple a town's economy); it would take a BHP to leave to have the same effect on Australia, and that cannot happen as the resources BHP depends on are located in Australia, mining is not transferable (unlike a manufacturing plant, or it seems an airport).

As for inflation, yes Australia is at 4.2% where as New Zealand is at 3.4% (both CPI measures). But both are still low by historical standards, and growth in Australia remains higher (which means that higher inflation will impact less in real terms). Plus I would like to see what happens to inflation when the overvalued NZ$ collapses (either when the Reserve Bank starts easing, which it may never do, given the inflation danger, or when those buying the NZ$ grow more wary of the risk they are taking). This will send NZ inflation through the roof, everything imported will become more expensive.

How to beat the bank... Avoiding late payment / overdrawing fees

There is a general principle in law that a penalty in a contract is unenforceable. There is currently a test case in the UK as to whether the late payment and overdrawing fees that most banks apply are penalties or not. And here in Australia, VCAT (the Victorian Civil and Administrative Tribunal) has just released this decision which confirms that a $40 bank late payment fee is a penalty and unenforceable.

This does not mean that any fee your bank charges you, or the entirety of a fee charged, will be considered a penalty, but

• A fee charged by a bank must be a reasonable reflection of the loss the bank has suffered as a result of the customer’s breach;
• A fee of $40.00 for failing to pay an outstanding credit card balance (as it was in this case), as well as interest charges approaching 20%, is not a reasonable estimate of the bank's loss – rather, the fee is a profit for the bank as a result of the customer's breach of contract; and
• The relative bargaining positions of the parties is grossly uneven, with the bank able to charge any fee it likes without any course of appeal or mitigation by the customer.

Unfortunately VCAT decisions do not set a precedent, but the decision was well reasoned and based on this semi-official report, which is well reasoned and finds that bank fees are too high.

You can see the application that was made to VCAT here.

And on a related note, a colleague of mine, with four overdrawing fees, challenged the fees with the bank and two were immediately reversed. I passed him on this story, he took it to the bank, they thought about it for a day and then reversed the other two.

Australia v NZ: Foreign investment and national interest

This isn't really an 'Australia v NZ' post, but this does follow on from a post on the foreign investment issue I have made before.

This article reports that the Australian government has very politely, quietly and discreetly 'suggested' that a bunch of Chinese companies that have lodged applications to investment in Australian resource companies withdrawal their applications, which they have done.

This is not an outright rejection of Chinese foreign investment in Australia but is to give the new Rudd government more time to consider 'the issue of national interest in terms of ownership of the Australian resources industry'.

Now I do not agree that national interest should determine who can and who cannot invest in an asset, in fact I fail to see how it is even in a nations interest who does or does not invest. It arguably benefits the people within a state if all successful business within that state (I use 'state' as it is a more geographically and politically precise term then 'nation') are owned by them, but what if they cannot afford to own and grow their businesses (like New Zealand) or, shocking as it might be, do not want to (as there may be more successful business overseas)? And who invests in the poorly performing or risky domestic businesses? Are these open to foreigners? What happens if the fortunes change?

Also, does the government of the state force those within its borders to invest in local business? And if not, why not? It would be in the national interest.

Why not throw away the facade of economic liberty and nationalise all domestic productive business and force everyone to invest in those businesses by collectivising the results of personal production to put back into those businesses? There does exist a precedent... Its been done before in the USSR and Mao's China.

It really should not matter, to the business or the 'national interest', where the investment money is coming from. If there is a willing seller and a willing buyer, the transaction should benefit both parties, the business and the state. I shall explain why:

• Seller: is paid the market value for their investment in the business, they can use this payment to invest else where (either domestically or internationally, both which will benefit the seller and state);
• Buyer: gains an investment in the business, and, leading up to the transaction, did not have expend what can be very significant money (due diligence, bidding, complying with securities legislation, etc) preparing for the transaction that may be lost through an uncertain regulatory / political risk (caused by uncertain investment rules, such as 'national interest' tests);
• The Business: benefits from having a stable price for its investments not affected by market uncertainty and will likely find it easier to raise further money at a better price;
• The State: benefits from having foreign investment in that its businesses can be appropriately funded and therefore grow and it frees up domestic resources to be invested in other domestic business or internationally (which will mean foreign income comes back).

Now, why having restrictions on investment (what ever the restrictions are) is bad for all these parties:

• Seller: will not get a true market price (read 'won't get as much', just look at AIAL's share price before and after the NZ government's 'strategic asset' intervention) as the price people are willing to pay is distorted by the restrictions on investment. Seller may also have a much more illiquid investment as the pool of purchaser's is reduced and others who can purchase despite the restrictions may find the investment less desirable as a result of the restrictions;
• Buyer: obviously cannot purchase if restricted and must invest in a less desirable asset;
• Business: finds it's value distorted from the true market value due to artificial restrictions on investment in it. Business may find it harder (or at least more expensive) to raise funds, as it's value is lower;
• State: who creates the restrictions, will find its citizens stuck investing in a business that they cannot transfer and more significantly the state (or at least those poor citizens who have been stuck investing in the business) is now shouldering all the risk in the business where some of that risk would have been spread overseas (the politicians should remember that investment does comes with risk and they should accept the blame and political cost when a business fails that has been subject to a foreign investment restriction). Of course the State does receive the political benefit of being seen to 'protect' a domestic asset; a benefit that flows from those citizens who do not invest.

The only time that I can see a national interest restriction on foreign investment being appropriate is where the foreign entity has a nefarious plan. That is they are only investing in order to damage the business. But why restrict such an examination to foreign entities? Such a prohibition should apply to everyone (and arguably does though the general company law (in both Australia and NZ) relating to directors duties. A nefarious shareholder is not going to be able to ruin a business, as the directors, even the directors appointed by the nefarious shareholder, would have to breach their directors duties in order to do so).

It is this that presumably the Australian government wants to consider further. Do the Chinese have a nefarious plan to drive down resource prices (damaging the businesses they are investing in) in order to benefit China? If they do not, what possible national interest consideration could mean that they should be denied investment?

Some, including BHP, will no doubt argue that the Chinese are not trying to drive down resource prices but are trying to prevent the BHP / Rio Tinto merger for fear that a combined BHP / Rio will be too powerful. But what is wrong with that? Surely it is the Chinese's prerogative to purchase a company to prevent a merger (the purchased companies directors still have a duty to act in the companies best interests), just as it is the current owner's prerogative whether or not to sell to the Chinese. To stop the merger, the Chinese will have to pay a premium to what BHP are offering (Chinalco paid more for its Rio purchase then BHP is offering, by about 16%), which will send more money to the current shareholders, increasing the money they can use to invest elsewhere.

Fortunately, and unlike the NZ government, the Rudd government is taking the time to get things correct procedurally and ensuring the rules will be consistent across the foreign investment landscape. So while I may not agree with the idea of a 'national interest' restriction on investment, at least it will not create an uncertain investment environment with regulatory / political risk.

Opes Prime: What transpired?

This article goes through the lead up to Opes Prime collapse and gives a good summary of why it fell over and what questions are still unanswered.

It is a little harsh on ANZ in my opinion, saying:

"Yet, knowing that Opes was dealing internally with highly questionable share transactions, knowing that its financial position was extremely precarious, and knowing that Opes has called in an insolvency specialist to examine its books, ANZ lent it $95 million."

To be fair to ANZ, although it probably did know all of this it most likely came to the conclusion that without further immediate assistance Opes was going to go under. ANZ had Deloitte in there and would have been closely following Opes from the time of its margin call and would have believed that with the extra loan to, and strict controls over, Opes it might trade through, this would be the best result for everyone (including ANZ).

It wasn't until after Opes collapsed that the more dodgy dealings would have become known to ANZ. At the stage it made the further loan of $95 million it was (according the public reporting) aware of margin calls not being made against some of Opes clients, but, almost perversely with the benefit of hindsight, this makes Opes position look slightly stronger. Opes was, to ANZ, in trouble but it had several clients it could make margin calls on, it would have looked like Opes was suffering a liquidity problem (i.e. not being able to pay its debts as they fall due) rather than a solvency problem (i.e. its liabilities exceeding its assets).

A far more serious issue then ANZ's last minute loan is raised in this article. This alleges that Opes was lending money to Tricom (another distressed, although not yet collapsed, finance company) in return for illiquid securities in full knowledge of ANZ and Merrill Lynch and the ASX in order to keep Tricom afloat.