A Flawed Theory on How to Manage an Economy During a Recession

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“Quick! Get more sour cream and butter for the fat guy, stat! And bring some guacamole and extra cheese too!”

Nothing broke in the world economy over night. The Aussie market is at a 12-month high. The dollar is marching on the greenback with parity (and beyond) the ultimate objective. But we’re going to put all the bullishness from the fake balance sheet recovery aside for a moment and talk about bad medicine.

Your editor spent last night in a discussion with a querulous and drunk Aussie over the stimulus. “It looks like it worked to me,” he said. “Only world economy still growing. GDP up. We’ve got China. Looks like Ruddy and Swanny know what they’re doing. You’re just a hack. You’ve never run a country. And you’re a Yank!”

“Let me put it to you this way. Say you’ve got a guy in the hospital with a bad ticker. He’s a smoker, a drinker, and a fried chicken eater. His arteries are clogged. He’s got a belly like a hippo. He eats like Nero and drinks like Caligula. And say, for the sake of argument, he’s gonna die if he doesn’t change his nutritional habits. How do you treat him?”

“You tell him to quit being a fat @%$#!”

“Talk therapy. That’s good. But let’s talk medicine. What do you prescribe? More food? Do you say what I said before? Quick! Get the fat guy more calories.”

“I suppose not.”

“Of course not. The problem isn’t that the guy is starving and needs to be fed. The problem is that his diet is garbage and he needs to change his living habits. But if the doctor diagnoses the problem incorrectly, the medicine isn’t going to help at all. And as the Dean says, ‘Fat, drunk and stupid is no way to go through life, son.”

We’ll spare you the rest of the conversation. But here is our diagnosis of the Australian body politic: Wayne Swann is a bad doctor. His Keynesian prescription for the Australian economy is based on the assumption that aggregate demand must be supported in recession. But then, the Keynesian approach to monetary policy focuses on demand, not on production.

Don’t take our word for it. Swanny said over the weekend, that “Weakness in hours worked remains a potent sign of insufficient aggregate demand in the economy.” This is why, he says, it’s too early to take away the stimulus. “To entirely remove the fiscal support from the economy at once, would reduce growth by 2 per cent in 2010. That would risk stalling growth in our economy before a self-sustaining recovery in private activity has taken hold.”

Would it be so bad to lose a few pounds? Would it be so bad to reduce the amount of debt that supports toxic levels of consumption? Would it be so bad to let people build up their savings, reduce consumption, and restore the health of the household balance sheet? Or must we keep them fat, drunk and stupid at all costs?

Australian taxpayers are going to pay for today’s deficits for years on end because the Treasurer and the Prime Minister (and apparently everyone in the opposition too) is using a flawed theory on how to manage an economy during a recession. The Treasurer would have been better off thanking China for restocking its commodity inventories and left it at that.

But there are votes to buy! Supporting “aggregate demand” or firms that are “too big to fail” is another way of saying you must reward those who contribute to your campaigns or whose votes you need to keep you in power and in your privileged position. From an investment perspective, the relevant question is which industries benefit (or lose) the most from the government siphoning off money from the private sector and direct it whichever way it chooses.

Obviously bankers and builders will do well. What about everyone else? It’s tough to say. But you could be forgiven if you think that the ultimate objective of all this is to put average Aussies deeper in debt (housing and credit cards) and more in thrall to their banking overlords.

By the way, this is how governments pick winners (banks) and force everyone else to speculate. The injection of cash into the economy distorts asset values and makes good old securities analysis (Graham and Dodd style) useless. The free money and relatively low cost of capital favour the speculators over the investors, turning the stock market from a weighing machine into a one-armed bandit.

There is only one hitch in the plan for the public sector to replace the private sector as the main source of spending, though. The banks may refuse to play their part in peddling new money. Remember, the transmission of the credit crisis from the financial sector to the real economy took place via the banks. When the banks faced credit write downs, they cut off the extension of credit to small businesses and some households (although the government continues to underwrite speculative mortgage origination through subsidising non-bank lenders).

The stimulus and the FHOG were one quick way to get money directly into the hands of Australians without directly involving the banks. That’s why it led to an increase in GDP (which measures economic busyness rather than real value creation). But if the banks are still tight with credit (excepting the housing market) how else can the government keep people spending money they don’t have?

This may not be as big a problem here in Australia since there is now a minor disagreement between the Government and the Reserve Bank. But here’s a prediction: look for national governments to becoming increasingly creative (and brazen) in given direct handouts to people in order to “support aggregate demand.” The government will become a direct lender (through tax credits or the outright nationalisation of things like housing and auto finance).

Figuring out your investment strategy in this climate is tricky. But it’s not anything new. The late Harry Browne used to say that markets go in cycles from Propserity to Inflation to Deflation to Recession. Harry recommended a basic asset allocation strategy that matched the right asset class with the right cycle. You changed your weightings between stocks, bonds, real estate, and gold depending on which cycle you were in.

In “The Fourth Turning,” authors William Strauss and Neil Howe tell us that history is worth studying. “The reward of the historian is to locate patterns that recur over time and to discover the natural rhythms of social experience. In fact, the core of modern history lies in this remarkable pattern: Over the past five centuries, Anglo-American society has entered a new era – a new turning every two decades or so.”

“At the start of each turning, people change how they feel about themselves, the culture, the nation, and the future. Turnings come in cycles of four. Each cycle spans the length of a long human life, roughly eighty to one hundred years, a unit of time the ancients called the saeculum. Together, the four turnings of the saeculum comprise history’s seasonal rhythm of growth, maturation, entropy, and destruction.”

We’ll have more on the turnings tomorrow and how Australia might be in a different season than America. Actually, that’s already true. Its spring here and late fall there. But the historical question is whether Australia’s economy and its future are now correlated to Asia and not “Anglo-American society.” This has massive implications for the economy, but also how Australians feel about themselves, “the culture, the nation, and the future.”

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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100 Comments on "A Flawed Theory on How to Manage an Economy During a Recession"

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Justin
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The Reserve Bank and the Government are one and the same thing.

Pete
Guest

Interesting how banks increased the cost of credit for mortgages and businesses. The Gov chose to prop up the mortgages, but the businesses are left high and dry.

What can pull a country out of recession, encourages GDP growth and boosts employment levels?

The answer is not mortgages.

(but at the moment you could say the answer was ‘The Government’ ha!)

Ross
Guest
Physical commodity prices and copious offshore sourced funny money have been the substance behind the Australian government’s ability to keep our consumption and asset inflation economy afloat and which subsequently allowed them to clip the turnover ticket. There is no doubt that in the recent past the funny money has been back as reflected by the AUD and local banking equity prices even if the lower valued commodities remain way off their peaks for now. So what future for on physical commodity prices? Martin Hutchinson has a view … http://www.prudentbear.com/index.php/thebearslairview?art_id=10296 Even though I believe in his bust scenario I think… Read more »
Mike
Guest

Some country is going to be brilliant and tell the 5% of US taxpayers who are paying 70% of the taxes to “Come to Australia” or “Come to New Zealand” or “Come to Tasmania” and only pay a 15% flat tax.

Without the top 5% of Americans, the US is going to fail – hard. Some other country could take advantage of these high producers!

Biker Pete, Vancouver Island, Canada
Guest
Biker Pete, Vancouver Island, Canada

Wondering about that myself, Mike. :) Many of our tenants have already made that move to WA. After four years getting their 457s, they’ll buy, of course; and this influx of money and skill is worth watching… .

prozak
Guest

Mike,
you’re in an australian fantasy land if you think that place is australia.

Not many well educated and wealthy people want to come to australia.

Most (non australian) people see it as a cultural and intellectual void.

Well, most of Europe/USA do anyway.

Michael
Guest

Mike – where does one pay a flat tax of 15%? In the Cayman Islands? Not here that’s for sure.

Ned S
Guest

15% tax in Oz – I’d expect that could be achievable if one is debt free on their home and various toys and takes advantage of negative gearing on their investments, salary sacrifices into super, uses a family trust … Any others?

Oz cultcha – Yep we’re working on raising our kids to be footy hooligans and crack addicts so in a few more years Brit and Yank immigrants should feel right at home.

Dan
Guest

Well I like our backwater isle devoid of intellectualism, business mindedness and culture. Pity it won’t last.

Ned S
Guest

I’ll have to concede the point about Oz being an intellectual void – Unlike others we weren’t clever enough to dream up lots of fancy financial products to base our economy.

Biker Pete, Vancouver Island, Canada
Guest
Biker Pete, Vancouver Island, Canada

Ned, 15% is not only achievable, it’s quite enough to pay. I’ve outlined the steps in previous blogs. The first is to list everything you _don’t_ know… . Many Aussies simply don’t know they don’t know… . ;)

Dan
Guest

You’re right, Biker Pete. And the money making world’s biggest aim in life is to prevent anyone else from thinking.

Lachlan Scanlan
Guest

Hmmm 15% achievable. Well BP for PM then.
But just think the disgusting proliferation of self reliance, happiness and prosperity…oh and much smaller government…Biker your making me sick.

Ned S
Guest
Yes, I just did my sums – If I pay about $13,000 into super this year out of my estimated $48,000 income I’ll have a bit over $30,000 to live on after tax – With a tad over $11,000 actually getting into my super account after the 15% contribution tax. Which will work for me. And mean that my flat rate of tax on the $48,000 is 13.13% (Plus the Medicare Levy which will push it up to about 15% at a rough guess perhaps.) No grizzles here at that – My retired parents (there being two of them of… Read more »
prozak
Guest

Ned,

“I’ll have to concede the point about Oz being an intellectual void – Unlike others we weren’t clever enough to dream up lots of fancy financial products to base our economy.”

First of all what does “base our economy” mean?

Now, assuming you are referring to the CDOs etc. Then yes Australia has the same products but australians are incapable of believing that property prices could go down – and that property doubles every 7 years.

Australia is going to be in a world of hurt at some stage when the bubble bursts. Most likely when everyone else is recovering.

Ned S
Guest
Sorry Prozak – I hit “Submit Comment” button before I added the “on” on to the end to make it “base our economy on”. CDOs etc .. More a matter of referring to Greenspan dropping the 1930’s regs that kept Yank banks from getting too heavily leveraged. And then keeping his interest rates really low. And a general lack of feeling comfortable with economies that do financial tricks for a living (Iceland maybe?) Although, Yes the US has a HUGE amount going for it – Not least of which is it’s VERY big guns. Yep, a bursting of the Oz… Read more »
Ned S
Guest

Ive got hurt feelings (sniffle, cry :)) I revealed the depths of my very modest personal finances above and crunched some numbers on same and got marked with a “1” – I’m relying on you here Pete – Remember the day I voted you up over something quite inane???:

Cheers to all – Early start tomorrow – My parent’s house has sold and I’m making like a furniture removalist – The first two sales to long term Aussies crashed because the banks didn’t like their finances – But the sale to the recent migrants has been approved :)

prozak
Guest
Ned, I think you are insane if you put that much into super on your wages. I have a very different view on Super. When I work in Aus i pay the minimum. Overseas it is not compulsory so I always used to opt out of company pension plans. I work for myself now so it is much better… and I have a very complex structure set up that costs me 5% of my revenue – the good news is that I then only pay 5% tax – yep 90% take home! (DEAR SNOOPY ATO PEOPLE – I AM NOT… Read more »
Ned S
Guest
It’s a tough call Prozak – Because government figures they have given a bloke a tax break on his super so retain an interest in it – And everything that should be done in relation to it – I’d just like to see government “drop dead” – But as that isn’t going to happen then we’ve got to play the game. Yes, I wouldn’t worry with a SMSF for less than $200k – But mine is a bit over $400k, so carries it’s own weight now I suspect? And being in a SMSF, I’ve done the best I can to… Read more »
prozak
Guest

Ned,
I guess a slight disconnect between your wages and age. You must be an old fart! /joke.

As for your SMSF. Good job. At least you are in control.

Biker Pete, Vancouver Island, Canada
Guest
Biker Pete, Vancouver Island, Canada

HaHa, Lachlan. You have _no idea_ how much that 15% is, son! :) Pays an awful lot of welfare…. ! Well, at least we now know how much Prozak thinks is a large amount of super… . ;)

prozak
Guest
hahahaha… “biker” Pete. do you? Or did I just assume that because of neds wage that his super would be lower? At least we again confirmed that Biker Pete is an obnoxious moron. small time “biker” pete…. poor little man…. must try and continuously compare his penis size to others… and continuously found wanting…. poor poor “biker” pete. Perhaps since you are so “rich” you can buy an extension? Or is there little point since it doesn’t work anymore anyway? I guess it is hard struggling with two inadequacies at the same time. The wife must be terribly disappointed. Don’t… Read more »
Ned S
Guest
I turn 51 this month Prozak – So I’m a somewhat senior chap without quite yet being elderly perhaps? :) I don’t have a wage (or salary) – I live off income from a rental property and bank interest plus a bit of contract work sometimes. I did two months (at $8k per month) at the start of this financial year which was enough to kick my income estimate for the year up to $48k – Which is enough (for me). If some more work should come my way I’d probably take it – Depending on other circumstances – I… Read more »
Biker Pete, Vancouver Island, Canada
Guest
Biker Pete, Vancouver Island, Canada

yes so right. I must apologise. I am sorry for thinking anyone would be impressed with my terrible bragging about how rich I am. Hold on. My mum is knocking on the door asking me what I want for tea. Bless her. 95 and still looking after me.

prozak
Guest

PeterM (oops.. I mean Biker Pete)

Surely a man if your age… what is it now 62?… should know better than to brag and act a prat on public forums

You’re a funny looking old duffer.

Don
Guest

“Not many well educated and wealthy people want to come to australia.
Most (non australian) people see it as a cultural and intellectual void.”

I can see what you mean Prozak, it takes a lot of intellect and culture to counter someone’s argument with:

“you have a small penis.”

Astounding mate. I am in awe of your Oscar Wilde like wit and repartee. Seriously, take it somewhere else would you?

prozak
Guest

Don,
Yes I agree. I am flattered you are in awe. No need to stand there agape.

It was not I who as usual resorted to obnoxious bragging. generally seen by those with intellect and culture as a signal of a small member.

I wasn’t countering any argument. I was countering an obnoxious braggart who attempts on frequent occassions to bully and put down other posters on this site.

And Don. I am not your mate. Either use my name or call me Sir.

Don
Guest

Prozak,

the reason I felt it necessary to comment is best illustrated from your post above which effectively boils down to:

“you have a small penis.”
“your wife is sleeping with other people because you are sexually inadequate.”

I fully appreciate that you don’t like Biker one little bit and that his posts really rub you up the wrong way. However resorting to such attacks is just not necessary or useful.

Ross
Guest
Prozak, have you ever lived & worked among the intellectual & cultured? It isn’t all it is cracked up to be. Much of the thinking & mastabatory jousting descends to simple slapstick anti-human notions that an Australian quickly writes off as quackery. So to have them here provides us a bit of fun but I’more interested in developing the local intellect & trying to rekick the cultural drive can we got going for a while in the 70’s but have let languish on the back of Gough’s bureaucrats having taken control. hey and go a bit easy once in a… Read more »
Dan
Guest

prozak, prozak. This is no way to make friends. Nobody is perfect, everybody is wrong about something (probably more often than not), and we are all here to learn from each other, coming from very different backgrounds. No need for belittling comments and taunts.

Dan
Guest

Ned S, you speak for a big proportion of readers who are in a very similar boat as yourself. Your take is always read with great interest.

Biker Pete, Vancouver Island, Canada
Guest
Biker Pete, Vancouver Island, Canada

Yes, I agree, Dan. Ned, you enjoy a great deal of respect in this forum. Over the last year I’ve learned a great deal from your input. I’ve ignored Prozac’s recent rants, after recently reading a comment in The Economist (9th October ’09): “We should let the bears rove as freely as possible.” Clearly this ex-pat, ex-broker expert misread this as ‘rave’. What else might explain his recent posts? ;)

Pete
Guest

Biker, you are not one to talk about prozak’s rants.

I don’t agree with the jargon if his response, but his underlying point is completely valid.

Good to know I am not the only one completely sick of you being an “obnoxious braggart who attempts on frequent occassions to bully and put down other posters on this site”.

As I have already suggested elsewhere: why don’t you start your own blog – you can invite all your friends.

Biker Pete, Vancouver Island, Canada
Guest
Biker Pete, Vancouver Island, Canada

Ah, the old “Can’t answer your blogs, go somewhere else” response I’ve read so many times from you before, Pete. Expected no less from his cultured, intellectual colleague!~ :)

Lachlan Scanlan
Guest

In our non-socialist 15% flat tax utopia we dont need welfare Biker. Even the old age pension gets chopped, they’ll have to mooch off the kids. Family benefits chopped they’ll have to work together instead of against each other now mother government not lactating. Think of the family togetherness ah soooo sweet. All drugs legalised too and less government regulation/wars against drugs required there…no dole bludgers or desperados to buy it anyhow. But the world wont be accepting these ideas anytime soon.

David (Brisvegas)
Guest

To all those people casting personal aspersions on others, you should remember to treat people as you would like to be treated.
I’m sure DR haven’t constructed this site for people to be rude to each other.
The world is in disarray, uncertain times ahead for many, and we should consider ourselves fortunate to be able to correspond with others so easily and safely.
All is good in my world, just had a steak and a few beers at the Breaky Creek Hotel.
Don’t know where that is – google it.

Claytonator
Guest
I’ve been in your position prozak. After implying that pushbike pete exerted similar traits to a transient internet cafe hopping paedophile in an earlier Australian property related post I apologised reluctantly a day or so later. I don’t know what it is that makes us want to hit our heads against brickwalls when property tycoon pete spruiks property and how his property was all purchased at the right time, the right price, the right locality and the right tenants and it hasn’t devalued because he is so smart etc etc etc. Biker Pete annoys me – I am not a… Read more »
Dan
Guest

Just be glad you haven’t chosen a hobby with such a high rate of serious injury – a mate of mine took his first steps this week, almost a year after his nearly fatal motorbike accident. Financially, Prozak has an even higher risk of serious injury – hats off to you for surviving. Just accept, people, that you have biases and your own priorities, and stop being like kids in a playground, calling names and taking nothing in.

Biker Pete, Vancouver Island, Canada
Guest
Biker Pete, Vancouver Island, Canada
Your ‘reluctant apology’ was immediately accepted, Claytonator. If you go back and reread past posts, you’ll find that your statement: “…his property was all purchased at the right time, the right price, the right locality and the right tenants… ” isn’t entirely correct. As others will attest, we’ve admitted paying too much for three blocks. We’ve also stated that our particular property market has plateaued. Your apology was wrung from you by a jury of our peers. You’re a suitable mate for our cultured, intellectual London bedsit friend. Your retraction is as noble a gesture as I’ve witnessed on any… Read more »
Claytonator
Guest

Got kids Pete? Got a wife? Did you inherit your fortune? You don’t strike me as the type who would answer to a boss. Sadly that’s reality for some of us underlings.

Claytonator
Guest

Sorry – Biker Pete i’m referring to here obviously

prozak
Guest

Don,
Yes you are correct. It was not useful.

Sometimes I let scum drag me into the gutter with them.

And I agree I went a little to far this time.

Apologies to everyone who felt offended by my response to Peter M (aka Biker pete)

prozak
Guest

strangely my rant is rated 5/5 at present…

so perhaps not many people that offended after all… or at least a couple agree with my sentiment toward Biker Pete aka Macca.

Either way, apology to those that were.

prozak
Guest

Pete,

Yes biker pete does have his own blogs… his own myspace, his own facebook and his own twitter.

Alas, no one is interested.

Which must be a huge blow to his ego… considering what he “tries” (very poorly i might add) to do for a living….

so he came here to ramp himself up a bit and try and put others down.

Ned S
Guest
Thanks Dan and Biker. Prozak you really do leave yourself wide open with comments like “I am not your mate. Either use my name or call me Sir.” In all of the various towns where I got dragged up you’d be doomed to be known as “Sir Prozak” for the term of your remaining natural life – Smile! But Aussie etiquette (as I understand it) says that while chatting about the size of a bloke’s middle leg might be tolerated in certain circumstances, casting aspersions on his missus’ fidelity is out and out antisocial. Anyway, not my problem with Biker… Read more »
Dan
Guest

prozak, you finally made me say it. You belong on http://failblog.org

Dan
Guest

.. but apart from that, I respect your views when it comes to your expertise and I hope you keep contributing because the more the merrier.

Ned S
Guest
Totally off blog topic but what the hell – The “call me Sir” comment reminded me of a yarn about some Aussies who were stripped to the waist and digging a trench in Tobruk in preparation for greeting Rommel – A Brit lieutenant comes striding up replete with swagger stick under arm and batman in tow – Demanded to be saluted! One dirty sweaty digger reached for his shirt, put same on, and said “Mate, you see these four pips – They mean I’m a major – And none of these blokes’ll salute me. But seeing you are so big… Read more »
prozak
Guest

Dan,
I am unlikely to click on a linked called failblog… but i am sure it wasn’t a complimentary suggestion.

No need to respect my views. But glad you find some use in them.
I am either right or wrong.
I don’t care which.
Unlike many people, If I am wrong I change my views.

“When the facts change, I change my mind. What do you do, sir” (keynes – perhaps the only useful thing he ever said)

prozak
Guest

Ned,
Nice tale.
I am sure you will not be surprised to learn that there are plenty of british army officers that have not changed a great deal in their “right to rule” attitude.

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