Working Papers

The Western Australian Future Fund: A Solution in Search of a Problem

I have an op-ed in today’s West Australian making the case against the proposed Western Australian Future Fund. As I note in the article, the WA Future Fund nonetheless improves on the federal model by avoiding the establishment of an expensive new funds management operation that duplicates existing capabilities. The federal Future Fund incurred expenses of $444m in 2010-11.

posted on 21 May 2012 by skirchner in Commodity Prices, Economics, Fiscal Policy

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Mining Booms and Government Budgets

John Freebairn makes the case against a sovereign wealth fund for Australia in the Australian Journal of Agricultural and Resource Economics (no paywall for the moment!) From the conclusion:

The applicability of arguments used in other countries, including Norway and the smaller Middle East oil producers, to quarantine the revenue windfalls of a mining boom in a sovereign wealth fund for use by future generations are questioned for Australia. Relative to these countries, in Australia mining revenues represent a smaller share of the economy and budget, and Australia has a much more diverse portfolio of different minerals and energy, and many with proven reserves exceeding 50 years at current extraction rates. There are other sources of volatility of government revenues and outlays with low correlations with mining government revenues. Future generations are expected to have higher per capita incomes than the current generation. Including mining revenues and outlays within the normal budget processes provides greater flexibility for using the mining boom revenue windfalls for a wider range of investment, tax reform and debt reduction strategies to support higher future incomes than a sovereign wealth fund.

posted on 04 May 2012 by skirchner in Commodity Prices, Economics, Fiscal Policy

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Not that 70s Show: Why This Boom is Different

Treasury’s David Gruen highlights the role of Australia’s macroeconomic policy framework in sustaining the boom:

The Federal Governments of the 1970s were in direct control of all arms of macroeconomic policy, including the value of the exchange rate. When commodity prices were rising strongly, generating boom conditions in parts of the economy, it proved extremely difficult for governments of either political persuasion to impose sufficient restraint on other parts to deliver an appropriate outcome for the economy overall.

By contrast, the current macroeconomic framework has several elements that together represent a crucial improvement on the framework of the 1970s. These elements are: a market-determined exchange rate, a medium-term inflation target implemented by the Reserve Bank, a medium-term fiscal framework implemented by the Federal Government, and largely decentralised wage-setting arrangements.

A consequence of the current framework is that when commodity prices are high, the floating exchange rate is likely to have appreciated sharply, acting as a shock absorber, and reducing the expansionary effects of the terms of trade rise on the overall economy. As a consequence, there is a smaller role for ‘activist’ macroeconomic management - simply because much of the necessary restraint is imposed by the exchange rate.

The exchange rate plays its shock-absorber role primarily by imposing significant restraint on those parts of the traded sector, including parts of the manufacturing sector, which are not experiencing strongly rising prices for their output or are not directly exposed to the booming sectors of the economy…

In the longer term, the increasing numbers of people in the Asian middle classes, with disposable incomes to match, will generate rising demand for a range of Australian goods and services - whether they be a range of foodstuffs, Australian tourist destinations, or educational, financial and other professional services in which Australia has a proven track record. Indeed, this process is well underway.

posted on 29 November 2011 by skirchner in Commodity Prices, Economics, Monetary Policy

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My Review of Paul Cleary’s ‘Too Much Luck’

My review of Paul Cleary’s book ‘Too Much Luck’ is up at The Conversation. The original review included a discussion of the role of the exchange rate which unfortunately hit the cutting room floor, but can be found below the fold. The review draws on a monograph by Robert Carling and I making the case against a sovereign wealth fund for Australia that will be published by CIS in the New Year.

Paul has been offered the opportunity to respond.

continue reading

posted on 21 November 2011 by skirchner in Commodity Prices, Economics, Foreign Investment, Media

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Ehrlich versus The Doomslayer

Stanford University misanthrope Paul Ehrlich will be giving a lecture at UNSW on Monday. You can read about Ehrlich’s humiliation at the hands of Julian Simon here and here.

posted on 29 October 2011 by skirchner in Commodity Prices, Economics

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Conservatives and Libertarians for Dumping the Gold Stock

We have previously noted the irony of those who worry about an over-supply of fiat money taking refuge in a commodity in which governments hold stocks that dwarf annual production. We also noted that the pro-free trade social democrats at the Petersen Institute had suggested liquidating the US gold stock to reduce US government debt and interest payments.

Now conservative and libertarian US think-tanks are saying it too. It is consistent with their long-standing support for the privatisation of government assets. Of course, it is a lazy approach to debt reduction, but a lazy debt reduction is better than none.

Dumping the gold stock without tanking the gold price is easier said than done, but the RBA was able to discretely offload 167 tonnes in 1997, yielding a handsome profit on the old Bretton Woods parity price and adding income producing assets to the RBA’s portfolio (contrary to Paul Cleary’s FOI beat-up).

In Australia, sales of public trading enterprises Qantas, Telstra, CBA and the airports yielded $61 billion during the 1990s and 2000s, making a large contribution to the reduction in net debt from $96 billion in 1996-97 to a negative net debt position in 2005-06 before the terms of trade boom really took off. Peter Costello knew a lazy policy option when he saw one. One of the problems facing the current government is that it has to do debt reduction the hard way. And the gold stock’s long gone.

UPDATE: Portugal is under pressure to sell its Nazi gold back to Germany.

posted on 16 May 2011 by skirchner in Commodity Prices, Economics, Financial Markets, Fiscal Policy, Gold

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The Finite Resource Assumption: Tripling or Quadrupling Down with Jeremy Grantham

Malcolm Turnbull is not the only person to be led astray by the assumption that resources are finite. According to GMO’s Jeremy Grantham:

Scavenging refuse pits will no doubt be a feature of the next century if we are lucky enough to still be in one piece.

Here is Grantham’s strategy for trading commodities:

Given my growing confidence in the idea of resource limitation over the last four years, if commodities were to keep going up, never to fall back, and I owned none of them, then I would have to throw myself under a bus.  If prices continue to run away, then my small position will be a solace and I would then try to focus on the more reasonably priced – “left behind” – commodities.  If on the other hand, more likely, they come down a lot, perhaps a lot lot, then I will grit my teeth and triple or quadruple my stake and look to own them forever. 

Sounds like a good formula for losing ‘a lot lot’. Apparently, this is what passes for macro strategy at GMO.

posted on 06 May 2011 by skirchner in Commodity Prices, Economics, Financial Markets

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‘That’s an Eternity from Now’: The Day of Reckoning for the Tierney-Simmons Wager

John Tierney collects on his ‘peak oil’ bet with the late Matthew Simmons:

Five years ago, Matthew R. Simmons and I bet $5,000. It was a wager about the future of energy supplies — a Malthusian pessimist versus a Cornucopian optimist — and now the day of reckoning is nigh: Jan. 1, 2011…

When I found a new bettor in 2005, the first person I told was Julian’s widow, Rita Simon, a public affairs professor at American University. She was so happy to see Julian’s tradition continue that she wanted to share the bet with me, so we each ended up each putting $2,500 against Mr. Simmons’s $5,000.

Just as Mr. Simmons predicted, oil prices did soar well beyond $65. With the global economy booming in the summer of 2008, the price of a barrel of oil reached $145. American foreign-policy experts called for policies to secure access to this increasingly scarce resource; environmentalists advocated crash programs to reduce dependence on fossil fuels; companies producing power from wind and other alternative energies rushed to expand capacity.

When the global recession hit in the fall of 2008, the price plummeted below $50, but at the end of that year Mr. Simmons was quoted in The Baltimore Sun sounding confident. When Jay Hancock, a Sun financial columnist, asked if he was having any second thoughts about the wager, Mr. Simmons replied: “God, no. We bet on the average price in 2010. That’s an eternity from now.”

The past year the price has rebounded, but the average for 2010 has been just under $80, which is the equivalent of about $71 in 2005 dollars — a little higher than the $65 at the time of our bet, but far below the $200 threshold set by Mr. Simmons.

What lesson do we draw from this? I’d hoped to let Mr. Simmons give his view, but I’m very sorry to report that he died in August, at the age of 67. The colleagues handling his affairs reviewed the numbers last week and declared that Mr. Simmons’s $5,000 should be awarded to me and to Rita Simon on Jan. 1…

posted on 29 December 2010 by skirchner in Commodity Prices, Economics, Oil

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Shorting Human Ingenuity

The other side of the long commodities trade:

When you buy commodities, you’re selling human ingenuity.

…Why bet against human ingenuity by buying physical commodities when you can bet on it by investing in the enterprises whose task is to remove the bottlenecks and lower commodity prices? So devote cash to the fixers, not the source: What I know is that I’d much rather buy the companies – for example the low cost integrateds, E&Ps and drillers – whose job it is to fix the world’s emerging energy problems than I would buy the energy itself.


posted on 20 December 2010 by skirchner in Commodity Prices, Economics

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The ‘Chinese Demand’ that Isn’t

Chinese demand is our demand.

posted on 12 November 2010 by skirchner in Commodity Prices, Economics

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US T-Bills Versus Tuna

James Hamilton on the implications of negative real interest rates:

You’re better off storing a can of tuna for a year than messing with T-bills at the moment. But there’s only so much tuna you can use, and many expenditures you might want to save for can’t really be stored in your closet for the next year. It’s perfectly plausible from the point of view of more realistic economic models that we could see negative real interest rates, at least for a while.

Even so, within those models, there’s an incentive to buy and hold those goods that are storable. And in terms of the historical experience, episodes of negative real interest rates have usually been associated with rapidly rising commodity prices.


posted on 27 October 2010 by skirchner in Commodity Prices, Economics, Financial Markets, Monetary Policy

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The Rare Earths that are Neither Rare nor Earths

Tim Worstall on why we shouldn’t worry about China’s interest in rare earths:

But the non-rarity of the rare earths themselves means that China’s position isn’t sustainable. That California mine, for instance, could potentially supply 20 percent of world demand, currently around 130,000 tons a year. Another facility, Lynas Corp.‘s Mount Weld in Australia, has the capacity to produce a similar amount. In fact, there are enough rare earths in the millions of tons of sands we already process for titanium dioxide (used to make white paint) to fill the gap, while we throw away 30,000 tons a year or so in the wastes of the aluminum industry. There’s that much or more in what we don’t bother to collect from the mining of phosphates for fertilizers, and no one has even bothered to measure how much there is in the waste from burning coal.

If rare earths are so precious, why isn’t the United States working harder to collect them? The main reason is that, for these last 25 years, China has been supplying all we could eat at prices we were more than happy to pay. If Beijing wants to raise its prices and start using supplies as geopolitical bargaining chips, so what? The rest of the world will simply roll up its sleeves and ramp up production, and the monopoly will be broken.

posted on 24 October 2010 by skirchner in Commodity Prices, Economics

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China’s Underappreciated Boost to Global Resource Supply

China’s contribution to global resource demand is well known, but its important contribution to augmenting global resource supply is underappreciated, frequently misunderstood, and often feared. Concerns over Chinese intentions in relation to commodity production and pricing were readily apparent in the Australian debate over Chinalco’s failed bid for Rio Tinto last year, but have also been raised in relation to other acquisitions.

These issues are examined in a new study, China’s Strategy to Secure Natural Resources: Risks, Dangers, and Opportunities, published by the Peterson Institute and authored by Theodore Moran, a member of the US Director of National Intelligence Advisory Panel on International Business Practices. Rather than just raising abstract concerns, Moran examined the actual record of China’s 16 largest foreign resource procurement arrangements between 1996 and 2006, including several in Australia.

Moran concludes that ‘looking at the effect of Chinese procurement efforts on the structure of the global supplier base for energy and minerals, the empirical record to date suggests a predominant thrust … toward diversification of output and enhanced competition among producers.’ It is for these reasons that competition regulators in Australia, Germany and the United States did not raise significant objections to Chinalco’s proposed increased stake in Rio.

Moran argues that Chinese involvement in the development of rare earth elements (REEs) ‘may constitute a significant exception’ and warrants greater ‘circumspection.’ But even here, concerns have been exaggerated. Despite the name, these elements are not particularly rare. The least abundant REEs are still 200 times more abundant than gold. The idea that REEs are scarce is belied by the fact that low prices have often been the main obstacle to the development of more diversified sources of supply.

Australians tend to see China through the prism of growing export demand and higher commodity prices, although there are also significant benefits to Australia’s terms of trade through the import side of the trade relationship. China’s real long-term significance to the global resource sector may be as a source of the much-needed investment that will increasingly alleviate global supply constraints, putting downward pressure on global commodity prices by boosting output, employment and exports in countries like Australia.

posted on 18 July 2010 by skirchner in Commodity Prices, Economics, Foreign Investment

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Ken Henry and the Club of Rome

Terry McCrann on the resource scarcity assumptions motivating the RSPT:

It is also clearly founded on the assumption of a long-term—Club of Rome-flavoured—secular upward trend in commodity prices. Thanks to China and India, demand is ever rising, while supply is limited. There’s only so much copper, etc. We must surely run out.

This is a merging of Henry’s green tendencies with his intellectual faith in the purity and reliability of econometric modelling—a blend most dramatically on view in the ludicrous Treasury modelling of the emissions trading scheme.

Henry implicitly rejects the view that non-fuel commodity prices are necessarily on a long-term secular down-trend—as revealed in graphs of aluminium and copper prices through the 20th century.

“Observed trends are sensitive to the commodity selected and the choice of time period,” he notes. So a chart of the copper price over a shorter period, between 1930 and 1970, showed the price “trended quite sharply upward”.

What he didn’t do was reproduce the shorter time period graph for aluminium. I don’t know why. It would have shown the exact opposite of the copper graph—the aluminium price on a long and short down trend.

There is more to this than selective charting. The anti-Club-of-Rome perspective—reality—of mineral supply and demand is not compatible with the logic of the super-profits tax. There is no alternative to developing our resources, even if the government takes 40 per cent more of the profits.

More exquisite was the graph with which he started his presentation. Taken from the budget, it showed the difference between Treasury’s GDP forecasts and projections in last year’s budget, and the ones in this year’s document.

What a very big difference a year makes. Henry is completely unable to see how Treasury’s failure, and the failure of its models, to get even close to predicting the present.

posted on 22 May 2010 by skirchner in Commodity Prices, Economics, Fiscal Policy

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AUD Underperformance and the RSPT

That the Australian dollar should underperform the euro is not entirely surprising, given that AUD typically suffers from the global risk aversion trade, along with commodities and other assets that are perceived as risky. What is harder to explain is AUD’s underperformance against the New Zealand dollar, given that NZD is typically viewed as being even riskier than AUD. A CTA I spoke to earlier in the week said that the message from the broker dealers is that foreign capital is exiting Australia because of the proposed RSPT. Australian equity markets underperformed the Nikkei and Hang Seng yesterday.

posted on 20 May 2010 by skirchner in Commodity Prices, Economics, Financial Markets

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