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Why the budget will fail

Joe Hockey is sitting on a knife edge, just like our economy. His 2015-16 fiscal statement (the budget) is predicated on the expectation that the Australian business community will awaken from their slumber. He thinks they will kick-start our economy back to a growth rate that will absorb a sizeable chunk of the unemployed. The Age’s Michael Pascoe explains here why this won’t happen.

Hockey’s flawed plan for revenue exposes his naïveté. One can only conclude that he is listening to the wrong people, i.e. those who have a vested interest in leaving things as they are, or his advisors, who appear as much in the dark as he is.

Either way, his fiscal statement is destined for failure, and with it, the present living standards of most Australians.

One of the reasons for this is the price of iron ore. Australia supplies 59% of the world’s exports of iron ore and our two largest suppliers, BHP and Rio dominate the world market.

From a high of $180 a tonne in 2011, the price had slumped to a low of $43 earlier this year, and is currently sitting around $60 a tonne. The Australian government gets a slice of that selling price.

There are two theories as to why the price has slumped. One is that China’s anticipated steel production through to 2025 prompted mining companies worldwide to expand production. It now appears that China’s needs have been seriously over estimated resulting in that increased production now flooding world markets.

The other theory is that Australia’s two major producers have deliberately flooded the market to force prices down in the short term and put smaller producers like Atlas and Fortescue here, and other producers overseas, out of business. If successful they could then enjoy higher profits in the long term.

Whichever of these theories is true and it could be a combination of both, the price of iron ore is likely to fall further with the Brazilian company, Vale, due to add at least 70 million tonnes production to world markets next year. Goldman Sachs have suggested the price could go as low as $40 US a tonne.

This would be a calamity for the Australian government’s revenue stream from iron ore which is what prompted independent senator, Nick Xenophon to call for an enquiry into the industry.

jones Last week, in an interview with Alan Jones, Prime Minister Tony Abbott agreed that there was a need for such an inquiry. So did Joe Hockey and Mathias Cormann. Would such an inquiry uncover what is really happening?

“What we don’t want to see is predator behaviour by any companies. We don’t want to see irrational behaviour by any businesses, particularly when predator behaviour, when irrational behaviour, may well have a dramatic impact on the economy,” Abbott said to Jones.

But within a week of Tony Abbott agreeing with Alan Jones that an inquiry was a good idea, the government had a change of heart and said no, it won’t be happening. Why? It was an embarrassing about-turn with no believable explanation offered even though Abbott had already acknowledged the threat to the government’s budget estimates.

While you are absorbing that, try this.

Last week, Philip Lowe, deputy governor of the Reserve Bank gave a speech at the Corporate Finance Forum in Sydney, stating that he does not expect investment in the non-mining sector to pick up anytime soon.

Lowe’s reasoning is that businesses won’t invest in projects that do not offer a minimum return, i.e. above their ‘hurdle’ rate. Their ‘hurdle rate, is the minimum rate they accept as sufficient to justify the investment.

This cannot be achieved in a record low interest rate climate where rate returns are prompting savers to avoid spending in favour of seeking higher returns on the share market to protect their income.

If households persist in trying to save more and consumption continues to lag, then soon enough the economy starts to contract – output, employment and income all fall.

But in the budget papers, Joe Hockey has estimated business investment to triple in a few years’ time from its current 2.75% to 7.5%. Where is the evidence for that? Is it the offer of an accelerated depreciation rate to small business? Not likely.

small We can certainly expect small business, that is, those who actually pay tax, to take up the offer of a $20,000 deduction per item, but how that will necessarily translate to sustained investment sufficient to lower unemployment, is far from clear.

It will, however, further exacerbate tax expenditures with massive deductions claimed by small business for this and the next two years and no plan to curb superannuation concessions which will soon be as expensive as the aged pension.

On the iron ore front, Joe Hockey’s fiscal statement has pitched the price at $48 per tonne. For that to be realised, world growth, i.e. China, will have to do much better than even they are forecasting at the moment.

Additionally, small business will have to find additional markets for their products before employing more staff. With savers unwilling to spend in what they view as uncertain times, that too, seems unlikely.

pear In other words, Joe Hockey’s fiscal statement will go pear-shaped. It is overly optimistic on the revenue side and foolish in the extreme on the tax expenditure side. There is no plan to attack unemployment which would have a compensating effect on wages growth and tax receipts.

It will fail. The deficit will be greater than the $35 billion suggested and while that might be a good thing, it isn’t $35 billion that will relieve unemployment or contribute to an improved GDP.

 

40 comments

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  1. townsvilleblog

    Every low income family I know is holding on to money, not spending it. This is because Abbott has in this budget taken $6000 a year from families. Why or rather how would one spend money that one does not have?

  2. Ross

    If companies don’t invest and grow how can those CEO’s and boards justify their obscene salaries and perks?

    Oh sorry, silly me, they don’t have to.

  3. Mercurial

    townsvilleblog, I believe Australians are very good at “spending money that one does not have.”

  4. stephentardrew

    Good lord Abbot doesn’t want to see irrational behaviour. Coming from the loon-goon and his mathematically challenged Money un-counter the hope for rational behaviour and logical thinking is long lost to the void of ignorance and magical thinking. Now Mr Rational nutter is going to tell us what rationality is because he has vast experience with irrationality. This hide bound stupidity gives him superior vision into the nature of idiot Botonomics. Praise be the royal dark knight Sir Botonomic loon-goon.

    See how it works ladies and gentlemen. An idiot can believe anything they like regardless of facts and accountability while our astute media hide in frogs hollow thanking their lucky stars that his Highness will one day concede to an interview.

    But I am just a cynical rational person lacking the skill of double speak, inverted logic and magical, mythical, paradoxical thinking incapable of understanding the spoken lie and the core illogical precepts of irrational-rational Botonomics.

    My lack of intelligent conformity is driving me into paroxysm of blithering and blathering stupefaction as saliva dribbles down my twitching chin while the doyens of idiocy contrive to bend me to their will.

    Point is when the hell are we going to awaken from this bloody nightmare?

  5. Brad

    Thanks for your insightful article, John. In the medium to long term the lower price of iron ore can only benefit the country. Firstly, it will hasten Abbott’s demise and secondly, with a hopefully more progressive agenda, stimulate the development of industries that will lessen our reliance on the stuff we dig up.

  6. diannaart

    When Rudd introduced his Nation Building and Jobs Plan to counter the worst of the GFC, I recall thinking at least the Libs aren’t in office – they’d go for austerity instead of stimulating the economy.

    I hate being this kind of right.

  7. Royce Arriso

    Thought I knew nothing about economics, but Jammy March appears to know even less. Unless of course he knows– but didn’t say–that Australian currency hasn’t been ‘backed by gold reserves’ for decades. So clearly, you’re suggesting we buy in a currency other than Australian, are you, Jammy? Hello, Jammy? Are you there?

  8. Terry2

    Jenny Macklin asked a very specific question of Joe Hockey during Parliamentary Question Time today, concerning the adverse impact of Budget measures on a single income (two parents, two school age kids) family : Hockey chose to ignore the question entirely and mocked the National Centre for Social and Economic Modelling (NATSEM) at University of Canberra who had been commissioned by Labor to do the modelling based on the budget figures.

    The supplementary Question seeking to have to first question answered was ruled out of order as, according to the Speaker, ” the Treasurer has answered the question”.

    We have a problem in our democracy when an opposition commissions independent modelling of government numbers and then has the body providing the modelling trashed in the parliament : Hockey wasn’t saying that the modelling was wrong, only that it was commissioned by the opposition.

  9. Jexpat

    Mike Stasse:

    Wake me up when a Steve Keen prediction is actually proven correct.

  10. Royce Arriso

    Hi totaram. That’s what I thought–had ‘1971’ in mind for some reason, but wider reading has the date as right after the Poms went off it in–hold yer breath–1931!! Point is, Jammy is far from well-advised. Meanwhile, anyone out there clarify? (Totaram, enjoy your posts here and elsewhere, Cheers, RA)

  11. Kaye Lee

    I am a tad confused. Why is/was the government calling for an inquiry into “predatory behaviour” and “market flooding” when they outlined it themselves as a deliberate strategy in last December’s MYEFO? Don’t they read their own fiscal documents?

    “…. it was expected that the lower prices associated with increased Australian supply would displace high‑cost production elsewhere, providing a natural floor for the price. While some unprofitable supply did exit the market, the response has been surprisingly limited to date, with much of China’s high‑cost production (which accounts for roughly 15 per cent of global production) remaining in the market.”

    http://www.budget.gov.au/2014-15/content/myefo/html/02_part_2-02.htm

  12. Glenn

    if it fools most of the people enough of the time, it will not fail. “enough of the time” being past the next election. It is still about stripping away “entitlements” and dismantling the social state. The bullshit about growth predictions, how deficit is calculated, etc etc is all about conning the public to divert from the neo-con reality and objectives. There is no way Hockey can be THAT stupid. He is a liar, and he lying to save his job and set up for the next election so the LNP has some sort of chance. Expect an election call as the economy slides downwards into 2016. Surely, the LNP are not as stupid as this budget states. Surely the MSM and general public are not stupid either? Perhaps the excuse for the public is they are disengaged….that does not excuse the MSM.

  13. ohmy

    Jammy, your ignorance of economics is frightening. not only has the gold standard gone by the wayside many moons ago, but through fractional reserve lending, at least 90% of circulating currency is iou’s between financial institutions.

    our financial system is parasitic and is eating the economy from the inside out.

  14. John Armour

    Hi Royce,

    You’re correct about 1971 for the US, and then it took another year or two to bed down the new arrangements. We didn’t get rid of the last vestiges of the Bretton Woods agreement, a quasi-gold standard, until December 1983 (Keating).

    We were in and out of gold standards like cuckoos in a Swiss clock for most of the last century.

    The euro is underpinned by a kind of gold standard in that member countries are bound by strict fiscal rules that severely crimp the ability of their sovereign governments to stimulate their economies in downturns.

    That’s a template the Abbott government seeks to cut and paste here.

  15. Wun Farlung

    Glenn
    Unfortunately the MSM are told what to report and how they report it
    As for the general public I would say they are at best apathetic unless a particular policy directly affects them and even then it’s usually accepted with a “what can you do” attitude, without a passing thought of how they vote or engage politicians.
    The vast majority have never directly contacted their local member and have little understanding of how our political system works

  16. John Armour

    Glenn,

    Hockey is both a liar, and stupid.

    He’s a conservative.

  17. John Armour

    I think we need to get over this media-driven obsession with mining.

    At the end of the day it employs less than 2% of the workforce and at the peak of the boom, it’s contribution to the national income was less than 10%. So why does it dominate the economic news?

    We should be asking why the rest of the economy, where the other 98% work, is barely treading water and going nowhere. The answer is that there’s a deficit of confidence. And we can sheet that home to the past rhetoric of the current government.

    Confidence once destroyed is hard to restore.

    Business won’t invest and generate jobs until it thinks there’s a demand for its output. Consumers won’t spend because they’re burdened with debt and are afraid of losing their jobs.

    And to the extent this budget ignores those realities it will fail because it does nothing to boost aggregate demand.

    Gerry Harvey might flog a few more ipads and laptops to a few brave small businesses, but at the end of the day, this is just “pushing on a string”, an ideological supply-side response to what is a demand-side problem.

    Ken Henry told the Rudd government what to do in these circumstances, and Swan had the guts to do it.

    Hockey is an ignorant ideologue however and would rather trash the economy than appear to be taking a lesson from Labor. Oh, the ignominy.

  18. Jexpat

    John Armour wrote: “The euro is underpinned by a kind of gold standard in that member countries are bound by strict fiscal rules that severely crimp the ability of their sovereign governments to stimulate their economies in downturns.”

    Agreed, although arrangement. like a crack in the windscreen, would appear to require need a bit more than advertised services can provide. Whether Greek owned, or not.

  19. mikestasse

    JexpatMay :

    Wake me up when a Steve Keen prediction is actually proven correct.

    His predictions ARE correct……. he makes the mistake of predicting the timing too. ALL the wheelnuts are loose. The three that are left… The only reason the wheels haven’t fallen off altogether yet is because the banks are continually bailed out, something that cannot last for too much longer.

    Watch this space.

  20. Harquebus

    I repeat.
    Those that pursue growth as a solution will fail. The growth economy, not the real one where most of us live, has outgrown our ability to sustain it. Joe Hockey is a dangerous fool, Tony Abbot is dangerous fool, Bill Shorten is a dangerous fool and so is every other growth deadhead politician.

    “And yet it created a world in which parents and grandparents could prey on their grandchildren… for the next 44 years. And it’s still not over.
    The new credit money – which could be borrowed into existence with no need for any savings or gold backing – was just what old people needed.”
    http://www.zerohedge.com/news/2015-05-15/are-you-ready-coming-debt-revolution

    “debt on our planet has grown from 142 trillion dollars at the end of 2007 to 199 trillion dollars today. This is the largest mountain of debt in the history of the world”
    “Anyone with half a brain should be able to see that this is a giant financial bubble”
    http://theeconomiccollapseblog.com/archives/the-debt-to-gdp-ratio-for-the-entire-world-286-percent

    “Such new findings will make no difference whatsoever until the economics profession recognizes the central role of energy in the productivity of the workforce.”
    http://resourceinsights.blogspot.com.au/2015/05/is-slowdown-in-productivity-growth.html
    Make that a growing and increasingly unemployed workforce.

    We have reached the limits and now, the market is having great trouble finding us another Earth.

  21. jusme

    Looks like the only budget measure that will get through is the tax cut and deductions for small businesses. That loss of revenue, plus all the over optimistic assumptions falling through will mean their 3rd budget will be worse than the first two put together. Hence the reasonable suspicion they are gunning for an early election to avoid the ramifications of their actions. Yet they can’t go now because the polls are still bad for them even after a budget with a couple of sweeteners. Quite a mess they’ve got themselves into, not to mention the whole country.

  22. Terry2

    Again Abbott is playing with words and refuses to acknowledge that the concessions given away on Superannuation contributions and earnings – estimated to be $20.15 billion and $30.4 billion respectively by 2018/19 – are concessions that diminish the government’s tax collections and at the same time concessions given to families are considered wasteful and must be reined in.

    According to Abbott, these superannuation concessions, which largely go to the top end of town and will exceed the total outlay for the aged pension, will never be touched as they are “your money” as opposed to government money : it takes a while to get your head around Abbott’s thinking doesn’t it ?

  23. John Armour

    Harquebus,

    “debt on our planet has grown from 142 trillion dollars at the end of 2007 to 199 trillion dollars today. This is the largest mountain of debt in the history of the world”

    If we owed that to the Martians we’d be in deep shit. Those pricks would want their pound of flesh.

    Who do you think “we” owe it to?

    If it’s government debt, we owe it to ourselves.

  24. Gangey1959

    What Small Business’s are they expecting to do their work for them.
    Even as a self-employed person I was in trouble. Now I just have a list of people to whom I owe money.
    If I could have bought a $20,000 “ute” to write off as a cost it would have come from OS. What is the point, that doesn’t help any of us.

  25. Harquebus

    @John Armour
    We owe the future. Don’t fret, there probably won’t be anyone there to collect it anyway. If humanity does survive the transition into the anthropocene, it will be poverty and hunger that is the price.
    Will our descendants thank us? Nope, nope, nope.

  26. jimhaz

    @ Jammy Troll

    [Two, I say you are ignorant. It’s the volatility of the system that drives it, as it is the boom bust bubble that has fostered prosperity for over three hundred years.]

    This cycle has fostered Finance industry and opportunists prosperity – but not the general public though it has flowed out to baby boomers due to the housing bubble and the stupid US government prevention of recessions. The cycle supports the wealthiest whom can have real experts manage their finances and it is a way for them to buy low and sell high. For this reason I really believe bubbles are often engineered.

    In a well run society there would be a far flatter “mini-bubble – light recession” cycle. One does need occasional recessions to clean out the deadwood and to keep a lid of wage inflation. One does not need bubbles if one can attract investment by rational economic analysis, however it is human nature for people to seek out winners, and irrational investment exuberance can result from this mob behaviour. On the other hand, much of the irrational investment exuberance I’ve seen in real life though stems from companies blatantly lying about the true nature and risks to their business.

    [Invest in ASX stocks, like the banks]

    Their PE ratios are high enough already. Further investment is just more inflation of capital, not investment that leads to increased income.

  27. Pingback: Why the budget will fail | THE VIEW FROM MY GARDEN

  28. John Armour

    Harquebus,

    I think you’ve somehow arrived at the correct conclusion, but by using a flawed argument.

    Debt doesn’t change the quantity of real resources, just the ownership.

    Meanwhile shackling ourselves to imaginary debt constraints just means our collective ingenuity cannot be applied to mitigating the daunting environmental problems we are probably both concerned about.

    This is my bitch with the Greens. So long as they continue to embrace the neo-liberal orthodoxies, like balanced budgets, their more ambitious environmental polices will be still born because they’ll have no counter to the argument “where’s the money coming from?”

  29. Harquebus

    Debt has reduced the quantity of tight oil as it is reducing the quantity of other resources.
    Without currency constraints, time and effort become pretty much worthless. Constantly inflating the currency supply erodes savings and reduces spending power which, manifests itself as price inflation. It is this price inflation that keeps the debt bubble going and is why politicians and bankers are so desperate to have it that, they are willing to provide massive amounts of easing and years of low interest rates indefinitely in order to have it.

    Meanwhile, as you say, the destruction of our environment and sterilization of our oceans not only continues unabated, it is accelerating.

  30. John Armour

    “…they are willing to provide massive amounts of easing and years of low interest rates indefinitely in order to have it”

    It doesn’t seem to be working then.

    QE has no effect on the “currency supply”.

  31. Harquebus

    QE is increasing the money supply and it ain’t working because it is intrinsically worthless.
    Cheers.

  32. John Armour

    “QE is increasing the money supply and it ain’t working because it is intrinsically worthless.
    Cheers.”

    QE is functionally incapable of increasing the money supply.

    All it does it create reserves, which are not loaned other than between banks.

  33. simon oaten

    John

    QE is a mechanism to recapitalise the banking system. Given rates of return, it is little wonder these same banks are now punting markets around the world (+ve yield game, circa 5yrs old+). The reserves can indeed be put back into circulation – which is when inflation “kicks-off”.

    the job of Government is to create an environment for companies&individuals to deploy wealth, generate a rate of return, and (typically) employee people (spread the wealth). The Govt’s only revenues come from taxation of corporates / individuals (unless the appropriate it !), the decision of Govt to spend its $, is ideologically based. What should be clear – is that rev’s will fall and Australia has “wasted” the commodity boom. If we borrow during the bust, we are at the mercy of international financiers..this is how one transfers wealth from those that own to those that finance. Internal debt (Japan) just results in haircuts for locale savers, external debt means assets get transferred (eventually).

    eventually, markets will demand a higher rate of return (bond yields) ……and then its game over……don’t cry for me Greece !

  34. Kyran

    For my penny’s worth, the missing link is jobs. Between the unemployed, the underemployed, the youth and aged unemployed, those who have stopped looking, we have a problem far greater than 6%. $20k for plant and equipment is worth feck all for jobs as most of the purchases will be imported. Try before you buy employee’s has been proven demonstrably false historically, with various schemes introduced for the government to subsidise ‘trainee’s’, only to see businesses make them redundant (without penalty) when the subsidy ceased.
    As a matter of related interest, some journalists did try and pose a few questions about the budget. Malcolm in the middle took them to task (only the female one’s). An interesting article appeared this morning from one of the journalists, which is well worth a look.

    http://www.abc.net.au/news/2015-05-27/alberici-focussing-on-my-aggression-ignores-the-budget/6499896

    We need people of vision, not derision. Your article highlights the inadequacies of their policies, deficient in detail or content, that can be changed on a whim. Thank you for the read. Take care

  35. John Armour

    Simon,

    “QE is a mechanism to recapitalise the banking system”

    How does swapping bank owned assets for central bank reserves recapitalise banks?

    QE is just the central bank buying back Treasuries and other assets to depress rates at the long end of the yield curve in the hope this might stimulate lending and borrowing. More enlightened analysis likens it to “pushing on a string”.

    How exactly are reserves “put back into circulation” as you believe? It’s more likely they will be destroyed via bond issuance when and if central banks stop paying interest on reserves. Meanwhile they just sit on the central bank’s balance sheet doing nothing.

    If you know anything about central bank operations you would know they are not loaned.

    Do you think that might be the reason the predicted inflation never happened? QE’s been in full swing now for some years but many economies are staring into the abyss of deflation despite the dire predictions.

    “If we borrow during the bust, we are at the mercy of international financiers..”

    Foreigners certainly buy Australian government securities but that’s very different from borrowing in foreign currencies from foreign financiers. All our so-called debt is issued in AUDs.

    The Australian government can always meet all its financial obligations.

    The Australia/Greece comparison is not applicable. We have our own sovereign, non-convertible, freely floating currency whereas the Greeks surrendered their soverignty to the euro.

    Australia is not subject to whims of the bond vigilantes.

    We issue bonds to manage the cash rate, not to fund government spending.

  36. John Armour

    “Ben Bernanke himself admitted that QE is basically currency creation.”

    He said the Fed created the reserves to buy the assets.

    There’s a big difference, but you seem to have your own ideas.

  37. John Armour

    Comedy segment…

    We are repairing Labor’s debt and deficit disaster and have set the budget on a path to surplus. Over the next four years the deficit will reduce each and every year from $35.1 billion in 2015-16 to $6.9 billion in 2018-19. Any new spending in this budget meets the government’s commitment to redirect funding to investments that boost Australia’s productivity and participation.

    We are committed to returning the budget to surplus as soon as possible.

    If families and businesses must live within their means, then it is only right and proper that the government does the same.”

    This was the Liberal MHR for Dobell on the NSW Central Coast, Karen McNamara, in parliament a couple of days ago, talking up the budget.

    McNamara will soon learn there’s an economics version of Aesop’s parable of the North Wind and the Sun: the harder you chase a budget deficit, the further away it gets.

    If McNamara saw business and households struggling in deep water, clinging to a straw, her idea of helping would be to jump in and join them rather than throw them a rope.

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