The View: Don’t Wake The Elephants

Friday, October 11th, 2019

The volatility encountered this week in equity markets somewhat belies the intention of Central Banks, including our RBA, in keeping interest rates low.

With bond yields at all time lows and cash rates plummeting, there should be plenty of support for higher yielding equities – even if their growth outlook is subdued. However, that is not the case in Australia where the initial stockmarket euphoria (it lasted about one hour) after the RBA cut rates on Tuesday has given way to declines generated in the US markets. Australian short term investment sentiment is still substantially driven by US markets as our political leaders and bureaucrats fail to create unique policies designed to benefit Australia.

Source Capital Economics

This was again on display this week as Australia’s Treasurer announced the formation of a “trimmed down” superannuation and retirement enquiry. Concurrently he reiterated, despite a plea from the RBA, that the Australian fiscal surplus was the most important thing for this Government to achieve, even as economic growth slowed.

We will address these two issues in the following commentary.

 Fiscal Policy

Whilst the Australian economy is not falling into a recession, it is clear that economic growth is very subdued and is growing at levels below those of the GFC period of 2008 and 2009.

While we are not and have not suffered negative economic growth in any quarter since 2010 (see orange bars above), it is the make up of the growth that discloses the necessity for the Government to take positive actions at this point.

The above table discloses the current importance of Government demand (public demand), which exceeds the growth in private consumption. Indeed, private consumption is particularly weak given population growth and some income growth.

Both dwelling investment and mining investment are moving through cyclical downturns that should improve at some point. The benefits of improved trade are noted in the GDP figures and improved profitability of miners will lead to improving levels of capital investment in 2020.

However, non mining investment growth has been low for many years and continues to be at levels recorded in Australia’s last recession period (1992).

It is the household sector which is perplexing the RBA and has motivated its call-out to the Government for fiscal support. As the following chart shows, Australia’s household net worth is near historic all time highs measured against household income. It has picked up again in 2019 with residential property stabilising and a recovery in equity markets.

The ABS recently estimated net household wealth at about $10.5 trillion, with household income estimated at $1.5 trillion per annum (75% of GDP) and household debt of $2.8 trillion, the bulk of which is mortgage debt or property investment debt.

Household assets are mainly superannuation ($2.8 trillion) and direct non super investments, with housing assets (dwellings) worth about $8 trillion.

However, in spite of the high net wealth of Australians, the confidence levels of households is weak and this is affecting consumption.

The reason for this is well explained by the following chart created by Shane Oliver from AMP.

The above chart shows that while Australian GDP and therefore National Income is at record highs, the per capital income (ie GDP divided by population) has fallen over the last 2 years. We may not be in a recession, but it feels like one – creating the need for the RBA and Government to orchestrate and co-ordinate policies that stimulate economic and consumption growth.

More significant is the next chart that shows that Australia’s annual growth in per capita GDP is amongst the lowest in the developed world

The obvious solution is income tax cuts for low and middle income earners which we define as anyone earning below the average wage of about $80,000.   But tax cuts are not contemplated by a Government that is hell-bent on producing a fiscal surplus.

A trip to the US (which has a 5% fiscal deficit) did not sway the Government. Nor did a rally in Greek government ten year bond yields to an all time low of 1.3%.

Our precious AAA credit rating allows us to borrow at just 0.4% cheaper than junk Greek bonds over ten years. So the question must be asked – Do we really have an economic growth strategy, or is the economy being run on hope to see what happens?

Tax cuts are the elephant in the room. They are clearly needed and clearly necessary, but no one wants to look at it. Meanwhile pathetically low interest rates, below the level of inflation, are used to hopefully stimulate while they drive down the interest burden on a mountain of household debt.

To add to the unfairness for savers, outside pension funds, they are slugged with tax on interest income that transforms a poor return into a shocking one. The integrity and ethics of Australia’s taxation system that cruels returns with a delusion that a surplus will work for the greater good – it beggars belief!

Source:Capital Economics

In any case, how clever is the creation of a fiscal surplus, through bracket creep, unfair taxes, record commodity volumes, a weak AUD and the benefits of the lower costs from rolling government debt? 

The Superannuation Review

This week Treasurer Josh Frydenberg announced the terms of reference for a review of the current system of superannuation as recommended by the Productivity Commission. “The review will look at the three pillars of the existing retirement income system, being the Age Pension, compulsory superannuation and voluntary savings.”

Specifically, the terms of reference for the review as outlined by Frydenberg were:

  • how the retirement income system supports Australians in retirement,
  • the role of each pillar in supporting Australians through retirement,
  • distributional impacts across the population and over time, and
  • the impact of current policy settings on public finances.

The review stems from last year’s Productivity Commission call for a proper retirement incomes study before the compulsory super guarantee is lifted from 9.5% of wages to 12%.

In defining the terms of reference, the Treasurer avoided another elephant in the room by directing that the Review does not consider the means testing of the family home (in the asset test) for the Commonwealth pension.

As our wealth table above disclosed, the family home is a more significant asset than superannuation and non-superannuation investments combined. The logic of directing that non-super assets should affect a pension entitlement, whilst a family home does not, is unclear.

Indeed, the fault line in the pension entitlement directly flows from the original Keating creation of an accounts-based superannuation system, rather than a combined system that included a contributory national pension scheme. Such a contributory pension scheme would allow every aged Australian to receive a pension without a bureaucratic overlay.

In other words, how much simpler would the Commonwealth pension be if everyone contributed and everyone benefited?

Is it too late to create such a pension scheme? No, given the burgeoning growth in super assets that seem to be endlessly growing without a national investment and economic plan to harness them for economic growth.

The diversion of a portion of the funds into a national scheme would alleviate the ongoing burden for the government in funding pensions. However, such a scheme would require a major rethink by the Review panel. That would be a Review panel which is not hamstrung by directives to the ignore the elephants.

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