The cuts (rises) we have to have

What happens next all depends upon consumer confidence levels of the punters versus the mindset of the professional fund investors. Stay tuned…


Colin Benjamin

As the kids go back to school to learn that the only long term hedge is education, and the market prepares for another 50 point cut in the US and a 25 to 50 basis point rise in Australia, make a firm decision to remember that Peter Costello’s tsunami has hit the beach and will be pretty well washed up by April Fool’s day.


On any one day the punters that have been going short on the stock exchange have been rushing to cover their exposed portfolio bits while the seasoned hands have been quietly picking through the financial and premium stocks for longer-term bargains.


Is it any wonder that we’re all a little confused about the future? It refuses to be predictable and has a bad habit of costing us our life savings in just a few volatile minutes.


What happens next all depends upon consumer confidence levels of the punters versus the mindset of the professional fund investors, who are generally likely to be:


  • (a) Aussies who are too lazy to move quickly to follow the winds of hourly misinformation from one or two overexcited business channel “septics”.
  • (b) Ex-union types who enjoy picking the eyes out of the market to boost the reputation of private fund managers with a longer term perspective.
  • (c) Smarties who recognise that the real problem we face is the risk of inflation breaking into a gallop based upon a short-term surge in food prices, the flash of gold hedging and threats to the price of a barrel of the black stuff from some Iranian speedsters.


The RBA will be making history in the next week by raising interest rates because, according to the down-at-heel member for Wentworth, they have not been adequately intimidated by Wayne Swan and want all those tax refund cheques converted into a benign longer-term savings scheme rather than into current consumption.


It’s well worth going back to some questions the then Deputy Governor of the Reserve Bank Glenn Stevens posed and answered in an address at the 2006 Securities & Derivatives Industry Association Conference in June 2006:

“First, how does the recent period compare historically? Compensation for risk is low compared with the 1980s and 1990s, but what can we learn from a longer-run comparison?


“Second, to what extent can it be claimed that the underlying economic outcomes, which presumably have a major bearing on investors’ perceptions of risk, are less ‘risky’ or volatile than they used to be?


“Third, what are the odds that this apparently benign environment will persist? What factors might prompt a change? What is risk?”


“To begin, it is perhaps important to be clear what we mean by “risk”, and how it differs from “uncertainty” – a distinction first made by Knight way back in 1921. He wrote:

‘The practical difference between the two categories, risk and uncertainty, is that in the former the distribution of the outcome in a group of instances is known (either through calculation a-priori or from statistics of past experience), while in the case of uncertainty this is not true, the reason being in general that it is impossible to form a group of instances, because the situation dealt with is in a high degree unique.’


“Risk can be priced, on the assumption that the probabilities in the future will be those inferred from the past. In Peter Bernstein’s excellent book Against the Gods, the early development of thinking about risk is presented as arising from the study of games of pure chance – where the odds are precisely calculable.


“The classic response to the chance-like characteristics of life is insurance. Actuaries draw up tables of life expectancy for a population based on historical experience, and insurance companies, with reasonable confidence, price policies. The probability and likely cost of certain other events – fires, car accidents, etc – is sufficiently calculable that, over time, risk can be priced.


“In the case of uncertainty, we don’t or can’t know the parameters of the distribution. Events that have no known parallel in recent history, where there is no basis for determining expected frequency or impact, will not easily be amenable to pricing.


“In fact, many economic and financial processes produce outcomes that do not come from any known statistical distribution, because the human interactions which drive them are not like the turn of a roulette wheel or throw of dice. In such a world, quantification and formal management of risk can go only so far; there will always be some possibilities that simply can’t be priced.”

The gnomes of the central banks are struggling again with these questions as a combination of rising under-employment and consumer prices spiralling after speculative oil hikes is leading to pressures for rate hikes in commodity exporting countries creates unprecedented roller coaster rides with billions of dollars of stock shifting from short-term plays to long-term portfolios.

On a global scale we are seeing the transformation of the Brazilian economy with the discovery of two major giant oil fields, the Russians minting energy millionaires by becoming one of the few highly successful energy exporters, the Indians racing through both an industrial and an information revolution at the same time and the Chinese mandarins resisting pressure to raise their yuan.

This BRIC economy expansion has not been sufficient to soak up the petrodollars that have been seeking a home outside of the Middle East and continue to fuel demand for energy efficient vehicles that are supposed to offer petrol savings in the next decade.

Get out your desk calendars and mark in a few special dates. The first week of March will make the 1 April follies look tame right up until the excesses of St Valentine’s day have faded into a memory of the US Fed, having given consideration to record low bond rates and a cost of funds that reflate a measure of optimism intone the presidential race for a raft of Republican governors.


For good measure, mark in the second week of April for time to redo all of your business and marketing plans and commence strategic planning sessions with the top team members who missed out on a bonus last year.


In the next week it is likely that the union movement will break out its industrial relations banners and go after the billions of dollars that have flooded the super funds as a result of Howard’s foot on the neck of wage inflation. It is starting to come to grips with the reality that just about everyone else had a wonderful time at the public trough while they were doing it tough campaigning for workers’ rights.


Spare a thought for Lindsay Tanner and Ken Henry as they make attempts to break the Razor Gang record of Phil Lynch by carving $20 billion out of the spending (and underspending) plans of federal (feral) departments. Phil only had to find less than a billion to take a kick at the head of the out-of-control budget python (including to declare a personal historical gripe – the funding for “Life. Be in It” fight against obesity). We can all look forward to an era of justified fiscal conservatism masquerading as the cuts we had to have.



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