Quick Shots - 05/May/2016

ZIRP Is Coming

I bet you've been thinking I've been crazy talking about Zero Interest Rate Policy as inevitable in Australia. Well, here's something for you to cogitate upon.

The idea that the official cash rate will eventually hit zero in this cycle is far from a consensus opinion in Australia. Economists are more likely to laugh than seriously entertain the idea. But last week's shock deflation data for the March quarter, which sparked an immediate reaction by the Reserve Bank on Tuesday, adds weight to the concept that Australia is simply coming in late to the inexorable downdraft of lower inflation and rates. 

"There is going to be a very long environment of low, near zero or negative rates, and clearly Australia is converging to that environment," Mr Gallo said from London. 

Source: Algebris 

He pointed to the "extreme overinvestment" in mining and energy sectors that would need to be unwound, weighing on growth. Over the past 25 years, Australia's exports to China had grown from 3 per cent of the total to about 30 per cent, Mr Gallo said, while in more recent years, the housing market had become increasingly dependent on foreign investors, particularly Chinese. 

"If you think about the last 20 to 30 years pre-crisis, Australia was a poster child of the credit boom and the China boom," he said.

There it is. And while that's not conclusive, it's nice to know other people can spot it coming.

There's A New Central Banker

After years of guiding the RBA through the GFC and post-GFC years, Glenn Stevens' term is up. He is being replaced by his deputy Dr. Philip Lowe.

Fifty-five year old Dr Lowe has worked at the bank since 1980 while still a student at the University of New South Wales. He has served as its head of economics, head financial stability, head of domestic markets and assistant governor responsible for the financial system. 

He also served as head of the financial institutions and infrastructure division at the Bank for International Settlements in Switzerland where he authored important research on role of central banks in low-inflation environments. 

Governor Stevens described the appointment as "superb".
"There could be no one better qualified than Phil Lowe to lead the bank through the next seven years," he said. 

"The bank will be in the best hands." 

"Dr Lowe brings a wealth of knowledge and experience to the role of governor, having served as the RBA deputy governor since early 2012, heading up many of the RBA's analytical departments, and publishing on a wide range of issues relevant to the operation of monetary policy over his three decade career with the RBA," Treasurer Scott Morrison said in a statement. 

Shadow treasurer Chris Bowen who worked with him while treasurer in the Gillard government described Dr Lowe as "one of the finest Australian economists of his generation".

I'm sure he'll be the one to take us to ZIRP and if necessary NIRP. 

More On Negative Gearing

Negative Gearing is a problem because it distorts the market. Just how much this happens is always debated with the argumentative finesse of people who regularly compare apples and oranges and some how discover theirs taste better. 

The Guardian had this article which is worth a read. 

In reality it is changes to capital gains tax in 1999 that really set the fire under the housing market by turning negative gearing from a niche activity to one which the treasurer would suggest is a favourite of nurses and teaches and police officers – the archetypal “mum and dad investors”. 

Prior to 1999 capital gains were taxed at a real rate – the nominal return less the inflation rate over the period you owned the investment. The Howard government then changed it to taxing the nominal rate, but only for half the amount. 

At the time there was actually debate over whether or not this would lead to people paying more tax.

Mark Latham – then on the opposition backbench – argued the change was “an open invitation for the tax minimisers, the tax avoiders and the capital speculators to do their worst in the Australian economy”. 

And whatever you might think about Latham’s more recent contributions to public debate, he sure as heck was on the money on this issue.

That's the thing about the old Howard Government and its mantra of small government was that is never saw a tax cut it didn't like. And so with a blind eye to how this would send the wrong incentive, they proceeded to rewrite the Capital Gains Tax.

When I reflect on it, it was around the turn of the century when one of my friends who was an IT boss started looking for an investment property. He'd been advised by his accountant that he was better off selling up his place in Glebe, buying a big house as an investment while renting a small flat. The logic wasn't obvious to me at all, but it was then explained to me that negative gearing would let this arrangement be very profitable. You could well imagine how this was going to lead to a rapid growth in people arranging their lives in a counter intuitive way so as to get this Negative Gearing to deliver profit.

But really the issue is of a tax policy that drastically changed people’s habits towards minimising tax and had the side effect of setting fire to the housing market and leading to a massive spike in the level of housing debt:

Over and above whether negative gearing or the capital gains tax benefit the wealthy (which they do) the issue is whether the tax policy has distorted Australia economy.

It clearly has and as a result at the very least, the discount to capital gains tax needs to be reduced.

And there you have it. It's going to be a big point of contention in the coming years. There are plenty of people who benefit from it and their lobby is strong. The whole finance, insurance and real estate industrial complex will fight tooth an nail to keep the gravy train running.

The truly sad thing about our government is that it's taken this long for the problem to even be a discussion point, well and truly after things have gotten well out of hand. It really doesn't bode well at all.