Tuesday, November 30, 2010

GDP only positive because of rain drenched agriculture

Today’s National Accounts figures were not a huge surprise - except, of course, to many of the mainstream economic commentators, some of whom continue to demonstrate their undying faith by stating that the decline is nothing to worry about.

Neither are the downward revisions to the June quarter figures worth a second look.  The June quarter growth trend down was revised down from 0.9% to 0.7%, and seasonally adjusted down from 1.2% to 1.1%.

And possibly my favourite lines from the ABS release
In seasonally adjusted terms, Agriculture (up 21.5%) contributed 0.4 percentage points to GDP growth driven largely by strong forecasts for grain crops... GDP increased 0.2% in the September quarter, while non-farm GDP fell 0.2%

If it wasn’t for the surge in agriculture driven by last season’s strong rains, GDP growth for the quarter would have been negative, and for the year, just 2.3%.

Perhaps it is time to revisit some forecasts by our favourite economists back in September.

Peter Jolly, NAB - Our year ended GDP forecast has lifted to 3¼% from a little under 3%
Christopher Joye, Rismark - The economy is about to embark on a period of above-trend growth
Warren Hogan, ANZ - Hogan believes we are about to see a period of serious inflationary pressures thanks to the commodities boom's income wave
Michael Blythe, CBA - reckons the income surge will add 3 or 4 per cent to GDP over the next couple of years.

Yet the serious inflationary pressures and above trend growth seem to be a little hard to come by at the moment.

At least I can give myself a plug.  Heck, isn’t that what economists do?  My prediction from early September - Inflation and GDP will surprise on the low side in the September quarter.

Steve Kates explains much better how the data early in the year was deceptive due to the dramatic impact of fiscal stimulus, and that the private sector recovery is yet to appear. 

Mid-week links

Using the National Accounts to better estimate changes in well being (PPT link) – from the OECD Measuring Progress Agenda.  Aka - Why I don’t feel like I benefit of changes in GDP.

A better comparison of the cost of living in cities around the world?  Numbeo provides a user generated cost of living index for any city in the world, with prices updated continuously as users add price data. 

One interesting comparison - Consumer Prices in Munich are 14.65% lower than in Brisbane, and
Consumer Prices Including Rent in Munich are 5.13% lower than in Brisbane. 

Who desires a longer commute? Apparently a 7% of people desire an extra 5 minutes commuting time (from here) -

In one of their studies, Mokhtarian and Redmond examined the commute (i.e. the trip to and from work). They conducted a survey in the San Francisco Bay area which asked subjects what duration their ideal commute would be, and whether their current commute is the “right” length or not.

Counterintuitively, very few people expressed a desire for a commute of “zero.” The most frequent response put the ideal commute at 15-19 minutes, and almost a third of the sample actually said their ideal commute was over 20 minutes. Only 1.2 percent answered zero; this surprising result was largely borne out in follow-up focus groups, where subjects were prompted that zero was a permissible answer.

A comparison of respondents’ ideal commutes and their actual commutes revealed that while most (52 percent) wanted their journey to work to be shorter, 42 percent reported their commute was about the right length and seven percent (mostly those with short commutes) actually wished it would take them an additional five minutes or more longer to get to work. On average, people wanted a commute of around 16 minutes.

I suspect there may have been confusion from respondents about what the question was asking – Do you desire to live in a location where the commute is X (longer, shorter, zero etc)? Or, do you want the commute from your existing location to work to be X (longer, shorter, zero etc)? Or, what is the ideal commute time from your current location with current transport systems?

More on the Peltzman Effect - Night clubs are employing emergency medics to monitor the crowd, yet the Australian Medical association has concerns that it gives a false sense of security to revellers. I can just imagine the conversation – “If you want to experiment with new drug X, do it here because they have medical staff!”

Finally, from The Onion, a spoof economics and finance article that might just make it to the front page of an Australian daily newspaper.

WASHINGTON—Some sort of tax cut or earnings or money or something was reported in economic news this week in further evidence that a lot of financial- related things have been going on lately.

According to numerous articles and economics segments from major media outlets, experts on banks and such have become increasingly concerned over a new extension or rates or a proposal or compromise that could signal fewer investments, and dollars, and so on.

The experts confirmed that the stimulus has played a role.

"This is a clear sign of a changing cycle," some top guy at one of the big banks in New York said of purchasing power parity or possibly rate of return during a recent interview on CNN. "Which isn't to say that a sustained drop in wages couldn't still occur, even if the interest paid on reserves is lowered."

"In short, it's possible but not probable that growth could outpace our initial expectations," added the banking guy, who went on to say other money things, too. "It depends on investor sentiment."

The man, who also apparently mentioned the Nasdaq, the Dow, and the Japan one at some point or another, talked for a really long time about credit or reductions or possibly all these figures, which somehow relate to China.

Greece was also involved.

Monday, November 22, 2010

Prison, parenting, selection bias, and measuring success

In both parenting and the legal system one must carefully consider the role of punishment.  Recently, the discussion surrounding imprisonment has become focussed on rehabilitation, using recidivism rates inappropriately as a statistical measuring stick of success.  This seems to be the product of confusing success in parenting with success in crime prevention.

Tuesday, November 16, 2010

The Australian Housing Fiasco

The Australian housing market has experienced a hiatus at this blog but has been the subject of intense debate elsewhere.  Time for an update on Shocking Tales, Government Intervention, Why we are different, A ridiculous publicity stunt, and Google predictions.

Shocking Tales
Some say the when he catches cold it takes a $40billion bail out to bring him back to health, and that he sneezes deflation, all we know is... that the Stig of Australian banking, insider ‘Deep Throat’, has provided spectacularly shocking insights into the world of banking and housing finance.  Consider the following comment about the use of automated valuation models to ratchet up home values on loan books.

So with roughly a revaluation of the property of 20% (ask any property spruiker, “That’s nothin’ mate!”) a bank can save itself $3.20 of capital per $100 of mortgage which can be recycled as capital to support another mortgage. Think about how that increase in both return on capital and funds allocated to another mortgagor slave is an absolute incentive for bankers to perpetuate the cycle up of house price valuations. Their reward? Huge bonuses based on what is in essence a positive reinforcement spiral where everyone pats each other on the back for what a great job they’re doing. Well at least, that is, until the money runs out

There are more shocking tales over at Delusional Economics, including a prescient story behind the latest intervention being considered by the Australian government to prop up the housing market and the banks.

Government Intervention
The proposed intervention involves extending a government guarantee to residential mortgage backed securities, ala Canada, essentially shifting risks taken by banks in the housing market to Australian tax payers in a bid to secure the ability of Australian banks to raise capital as asset values stagnate.  Welcome to the world of moral hazard that is banking.

What makes the whole fiasco so outrageous is that is has proceeded under the guise of increasing competition in banking and under the housing affordability banner more broadly.

Eager to spur competition in a banking industry dominated by National Australia Bank, Commonwealth Bank, Westpac and ANZ - now with rates higher than central bank policy - Canberra plans sweeping reforms to open up the mortgage market more widely to smaller lenders, by creating a bigger government-backstop to residential mortgage-backed securities. (here)

Regardless of whether we are following Canada into financial a black hole, the degree of continued government intervention is one reason why we are different, for now. Another is variable rate mortgages.

Why we are different
Australia’s love affair with variable interest rate mortgages has enabled monetary policy to be highly effective, unlike other countries that have suffered at the hands of the financial crisis. This gives government, via the RBA, plenty of ammunition to prop up house prices while appearing to act on affordability.  And it also makes our monetary policy far more effective than our counterparts in the US, Asia and Europe.

Of course the big dilemma is what is happening elsewhere in the economy. The dramatic drop in interest rates by the RBA in late 2008 failed to stimulate the housing market without the added assistance of the first home buyers boost.

Given this situation, and coupled with government’s obvious strong desire to see housing prices stabilise, one must be careful when entering into a bet on house prices.

A ridiculous publicity stunt
Australian property spruiker Chris Joye has challenged US fund manager Jeremy Grantham to bet on house prices. This comes as a result of Grantham’s scathing analysis of the extent of Australia’s housing bubble.

As others have remarked, it is a classic ‘heads I win, tails you lose’ bet.

This is the deal. Rismark believes it can facilitate a transaction whereby Mr Grantham will be able to invest $100 million into a short position over the RP Data-Rismark Australian capital cities dwelling price index, which is universally regarded as the most accurate and timely house price benchmark in the market.

Mr Grantham’s investment would be structured as a very simple “delta-one” transaction: for every 1 per cent fall in the index, Mr Grantham would receive $1 million. Conversely, for every 1 per cent rise in the index, Mr Grantham would pay $1 million away. The trade would be settled at the end of three years with monthly margining to manage credit risk.

There are three main reasons why this is all publicity and no substance

1.      The nature of the index
...look at the index Joye wants to use, the RP Data-Rismark Index. You may recall I mentioned above that Joye was the Managing director of Rismark International? Talk about a conflict of interest. Joye wants Grantham to take a bet, the outcome of which is directly reliant on an index which doesn't allow public examination of their methodologies and further to this one that Joye's company is directly involved with? Surely he jests! (here)

Have I mentioned the hazy area of hedonic price indexes before?

2.      Exchange rates
I’m no genius, but if I was an American investor I would want my return in US dollars.  At current exchange rates (which are already dropping from their record highs), the bet in AUD would expose about US$98million to the AUD.  He would be paid AUD$1million for any 1% decline in the index.  Unfortunately a decline in the index will be accompanied by speculation of lower interest rates leading to a decline in the Aussie dollar.

Say the price index falls by 15% and as a result of renewed uncertainty about the strength of Australia’s economy the AUD declines to $0.75USD.  Grantham would win the bet, but lose financially.  He would now have AUD$115million, which is only USD$86.25million – a loss of 12%.

Assuming his position does not entail actually having AUD$100million, but is simply a gamble on the move of the index, he would still earn just USD$11.25million for that 15% move. Remember, the greater the decline in the house price index, the greater is the likely impact on the exchange rate, so Grantham effectively faces a limit to his gains.

3.      Australian government intervention
When the counter-party to your bet has a direct line to many political power brokers (Malcolm Turnbull, the Liberal Party treasurer, had known Joye as a family friend for 15 years), and the Australian government seems hell bent on doing whatever it takes to prop up house prices, I wouldn’t be too keen to put my money on the line.

Even after offering this outlandish challenge, Joye disclaims his position by saying that Australian dwelling prices will be placed under modest downward pressure over the next 12-18months.  This makes no sense, until you look at the following scenarios.

The bet is taken, Joye wins. Now Joye can claim that his index is superior and used by international fund managers and that his analysis is so great he won a bet against Grantham (although his actual prediction was wrong).

The bet is taken Joye loses. Again, a claim of the validity of the index and that his prediction of price movements was correct (ignoring that he lost the bet).

The bet is not taken.  Publicity, and a win whichever way the price index moves.  If it increases he would have won the bet.  If it decreases it is in line with his forecast. 

Google Predictions
I have mentioned before that the frequency of Google search terms was quite a good indicator of the peak of the US housing bubble (see final graph). What is interesting is that the new more refined Google Insights for Search shows a dramatic upward trend for the term ‘housing bubble’ from Australia.

Last week’s auction results from Brisbane confirm the findings from Google – 21 auctions, 2 sales, 8% clearance rate.  

Monday, November 15, 2010

Updates and a CityCycle apology

Plastic bag banning continues to gain momentum

Well known demographer Bernard Salt had a stoush with Dick Smith in a little documentary a few months ago discussing Australia’s population growth.  Now he is back with more nonsense.

Brisbane’s CityCycle scheme, from my observations, appears to be well used.  I was pessimistic about the potential take-up rate of the scheme, but in the past six weeks of operation I have seen 27 people using these bikes – about 26 more than I expected. I do however live across the road from one station, work in a building adjacent to a station, and cycle past another half dozen twice per day.

Interestingly, I have seen one person using the scheme helmetless and smoking while talking on a mobile phone (I don’t have a problem with this if they are not riding dangerously, which they weren’t), and one bloke walk up to the bikes in work attire and promptly retrieve a helmet from his backpack before shooting off on a hire bike.  I can only hope that with more (are there more cyclist, or just people deciding to use the scheme to avoid bike theft and wear and tear?) cyclists there will be a strong push for more user-friendly bike lanes.

And just for fun, a hilarious rap battle between Keynes and Hayek to entertain the inner economics nerd.

Wednesday, November 10, 2010

Sin tax myths – why smokers reduce health costs

Smokers have been the target of Australia's latest sin tax. Meanwhile, debate continues over using sin taxes to reduce consumption of 'unhealthy' foods such as soft drinks and confectionary.

(The word unhealthy is used quite loosely due to the fact that there is sufficient uncertainty about health – Are eggs good or bad these days? Margarine? – and because it is typically not the food itself, but the quantity consumed of a single food that is unhealthy.  Almost any food item consumed in excess will be unhealthy).

The primary arguments in favour of sin taxes are that
1.      the taxes reduce ‘harmful’ or ‘unhealthy’ consumption, and
2.      the taxes raised offset likely health costs such behaviours incur on others.

Unfortunately neither argument is compelling.

Tuesday, November 9, 2010

Public and Private schools – evidence from economics?

As an Australian parent in 2010, the public versus private school debate is hard to avoid.  In a society where private schooling is becoming the norm, yet literacy and numeracy skills are stagnating, how does one objectively analyse the costs and benefits of school choice?

First, let me say that school choie is just one factor determining vocational, personal and emotional skills during adolescence.  Genetics, parenting, the home environment, peer groups, sports and other club activities, amongst many factors, all contribute to shaping young minds. 

Additionally, the composition of students at the school plays a strong role in determining academic outcomes.  Many private schools for example, offer academic scholarships.  If those students had instead attended the local public school, any difference in average academic results may be greatly reduced.

How then does one separate the impact of school choice from these other factors?

Without the opportunity to conduct controlled studies, for example, by studying twins who attend different schools while holding all else constant, the best analysis of the measureable benefits of private schooling would be a statistical test of various measures of ‘success’, controlling for external factors such as parental intelligence and education, household income and location, and child’s intelligence prior to arrival at the school.

Unfortunately, in this debate one of the most overlooked considerations is what measure of 'success' would potentially make private schools ‘better’ than public schools. Is it simply a matter of final grades and tertiary entrance scores, or do parents (and children) value a broader measure of success? Does a public school with more diverse student cultural backgrounds give a better social experience, or does a private school offer more valuable professional connections?

The results of any statistical study will necessarily be narrowly defined to reflect the impact of school choice on a single measure (such as academic test scores), ignoring social benefits and opportunities for extracurricular achievement. 

So what do economists and social scientists have to say?

Wednesday, November 3, 2010

Talking climate with Warwick McKibbin

I met RBA board member Professor Warwick McKibbin yesterday.  Alas, his reserved academic demeanour was a successful deterrent to a gruelling discussion on monetary policy and his thoughts on Australian housing.

I was, however, enlightened about his academic research and particular area of expertise – macro-economic modelling and climate change.

For such a diminutive guy he manages to raise a large public profile and promote intense debates on matters of macro-economic policy.  He was intensely critical of the government stimulus package, although many economists see it as very well implemented in hindsight.  

Some of the critics of the implementation of Australia's fiscal stimulus fail to see the broader political picture.  Professor Tony Makin, for example, argued that the fiscal stimulus was not necessary because adjustments in exchange rates and interest rates absorbed most of the impact of the crisis.  Yet he gives no credit to domestic impact of fiscal stimulus from abroad, particularly with our main trading partners.  His argument was that we should have been free riding on the stimulus of other nations.

The broader political picture reveals that there was an explicit agreement by G20 nations in November 2008 to take coordinate fiscal action to avoid this very issue.  In an international context our stimulus appears light on – maybe we still did partly free-ride.

But McKibbin is clearly most passionate about climate policy, driving hard his ideas for coordinated global action – The McKibbin-Wilcoxen Blueprint for climate policy.

Monday, November 1, 2010

Rates surprise

The RBA Board decided to raise official interest rates by 25 basis points today against my, and many other economists, expectations. One wonders if they take pleasure in proving forecasts wrong, or whether they are simply following the cardinal rule of monetary policy - defy expectations.

Unfortunately I think it is the destabilising thing to do, and maintain that we may see this decision reversed in the future.  With a housing market waiting to crumble, tourism and education exports fading, commodity prices peaking and inflation already moderating,  expect some sullen economic data this festive season.

Australia not an island away from world’s troubles – recession, bank runs, and printing cash

The continued media hype around Australia’s economic stability and security can be partly attributed to the fact that, by official figures, we avoided a ‘technical recession’ during 2008/09, and also that ‘the health and strength' of Australia's banking system played a major factor in domestic economic outcomes following the financial crisis (here for example).

Griffith University’s Professor Tony Makin, however, has a little more to say about whether Australia actually avoided recession. The answer depends on your definition, and we are unique in that respect.

In the aftermath of the GFC in September 2008, Australia's nominal GDP, real GDP measured on an income basis and on a production basis, as well as real GDP per person, all fell over two successive quarters, as did various other national income measures that account for the slump in export commodity prices (or terms of trade) at the time.

Of the many national accounts series the Australian Bureau of Statistics publish, the only one indicating there wasn't a recession was the real, or price level adjusted, national expenditure series.

In the US, a recession dating committee of the National Bureau of Economic Research uses a battery of macro-economic measures, not just the somewhat arbitrary two successive quarters of negative real GDP.

If the behaviour of Australia's business cycle in the aftermath of the GFC had been assessed by an independent committee of economists with reference to a broader range of macroeconomic indicators in this way, a recession, albeit mild, would most likely have been declared for 2008-09. But this would not have been of great concern because, due to greater labour market flexibility, unemployment did not rise anywhere near as much as in the recessions of the early 80s and early 90s.(here)

No doubt business people would have wondered how official figures could have been so out of touch with on the ground realities during early 2009, but a mere statistical discrepancy kept the headlines optimistic.

And as far as the ‘health and strength’ of our banking system, well, let’s just say a better phrase would be ‘government rescue’ of the banking system, with the deposit guarantee and massive fiscal and monetary stimulus.

This extract from the book Shitstorm: Inside Labor’s darkest Days, has far more detail on just how perilously close our own banks were to disaster.

All around the country, banks were facing unusual demands for cash. Small businesses in Queensland and Western Australia were switching their deposits from regional banks to accounts with the big four banks.

An elderly woman turned up in the branch of one bank in Queensland with a suitcase and asked to withdraw her term deposits of $100,000 or more. Once filled, she took the suitcase down to the other end of the counter and asked that it be kept in the bank's safe.

A story did the rounds of the regulators about a customer who wanted to withdraw his six-figure savings. The branch manager said he did not have that quantity of cash on hand, but offered a bank cheque, which the customer accepted, apparently unaware that the cheque was no safer than the bank writing it.

It was a silent run, unnoticed by the media. Across the country, at least tens and possibly hundreds of thousands of depositors were withdrawing their funds. Left unchecked, there would soon be queues in the street with police managing crowd control, as occurred in London at the Golders Green branch of Northern Rock a year earlier.
Households pulled about $5.5bn out of their banks in the 10 weeks between US financial house Lehman Brothers going broke - the onset of the global financial crisis - and the beginning of December. That is roughly 80 tonnes of cash salted away in people's homes. Mattress Bank is doing well, was the view at the Reserve. A year later, only $1.5bn had been put back.

The worst problems were in the second-tier banks, particularly Queensland's Suncorp and, in Western Australia, Bankwest. Deposits at the big four banks were surging as customers sold their shares, pulled money out of cash management trusts and put the proceeds in the bank. But at Suncorp deposits slumped by $1bn. They dropped $2bn at Bankwest.

The regulators and the government were gravely concerned for these two banks. Suncorp had total assets of $75bn and Bankwest $60bn. Bankwest was in double trouble because its British parent, HBOS, was teetering on the edge of bankruptcy.

Despite their preparation, the Lehman crash caught local banks by total surprise. NAB chairman Michael Chaney had set off on a 13-day rafting trip down the Grand Canyon on the day Lehman failed. He had taken a satellite phone but by the time he got it to work his share price had collapsed by almost 30 per cent. "I couldn't get a helicopter in there, so it was a five-hour climb out," he says.

Balance of payments figures show that in the immediate aftermath of the crash, Australian banks were called on to repay $50bn in short-term debt to international investors who refused to roll over their exposures.

Governments across the world were also being tested. Two weeks after the Lehman crash, Ireland's banking sector was facing an alarming run on larger deposits. The government stepped in and guaranteed all deposits and wholesale fundraising.

There was an immediate call for the British government to follow suit. Within a week, Germany, Denmark and Greece had offered unlimited deposit guarantees, while the British and a number of other European governments had increased the size of their insurance schemes. The Reserve Bank, APRA and Treasury were worried as were the chief executives Wayne Swan was talking to.

The long-standing concerns of the main banks about depositor protection were cast aside. The fate of small institutions could influence the stability of the system.

"One of the lessons of this whole period is you can have an abstract almost clinical discussion in the absence of a crisis about which institutions are systemically important and which are not. But when the crisis hits, is there any financial institution that is not systemically important?" Henry says. "It was my view back in September after the collapse of Lehman, I came to the view there was no financial institution in Australia that could not be regarded as systemically significant."

The issue was so delicate that most cabinet ministers knew nothing of what was going on.

"Some of this stuff is so sensitive, the bank guarantee could only be agreed between the Prime Minister and myself," says Swan. The government's unlimited guarantee of retail deposits went further than any other country, partly because Treasury was now concerned about capital flight.