Waging a War on Growth - Vivek Kaul's Diary
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Waging a War on Growth

Dec 29, 2016


The daily market roundup is becoming boring.

The Dow is tantalisingly close to 20,000 points.

Gold is doing nothing.

The US 10-year bond rate is steady, at 2.55%.

The year-end is not how the year started.

The Dow fell more than 10% on worries over oil prices and European banks.

Gold rose 20% in the first six months (peaking with the Brexit vote) and has surrendered all these gains in the last six months.

The US 10-year bond rate started the year at 2.3% and, by the middle of the year, was compressed to a low of 1.4%. Concerns over President-elect Trump's grand infrastructure plans have bond markets factoring inflation into the 2017 equation.

Trump and Brexit were the big surprises in 2016. Initial concerns about the world coming to an end have been tempered by the reality that, when it comes to politically-driven change, things happen at glacial pace.

Speaking of glacial pace...when is Australia's budget (allegedly) returning to surplus?

The government's Mid-Year Economic and Fiscal Outlook's (MYEFO) brave/optimistic/foolish/delusional forecast tells us black ink will be all over the budget in 2020/21.

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According to ABC News (emphasis mine):

'Federal budget deficits will increase by more than $10 billion in coming years as the Government battles low wage growth and falling company profits, but it insists it will still return a surplus in 2020/21.'

ABC News reports that, at a glance, the MYEFO concludes:

  • Tax receipts are predicted to be $30.7 billion lower over four years;
  • Tax receipts are down, despite recent bounces in key commodity prices;
  • Sluggish wage growth and non-mining company profits are dragging down tax receipts.

Company and personal incomes are experiencing glacial growth. This private-sector freeze also impacts government tax receipts.

The old 'knee bone is connected to the thigh bone' syndrome.

Yet, in spite of this sombre outlook, the Treasury boffins can somehow torture the numbers to transform the budget from red to black in the space of four years.

In reality, the forecast surplus is nothing more than an accounting 'pea and thimble' trick.

According to The Australian:

  • 'The Coalition's wafer-thin projected 2020-21 surplus, the linchpin of the nation's AAA rating, is achieved entirely by a change in accounting for the Future Fund headed by Peter Costello - the man responsible for the last budget surplus in 2007-08.

    'The projected budget surplus of about $1.1 billion will be achieved only because of a reclassification of about $4bn in Future Fund earnings in that year, not because of any improvement in underlying budget performance.'

Rubbery figures don't alter the underlying income trend.

And, when it comes to a nation's finances, income is up there with oxygen.

If income didn't matter, the most populous nations would be the world's economic powerhouses by a country mile.

But they aren't...at least not yet. Why? Because the dollar output (income and debt) per person is well below that of the developed world.

Country GDP per capita in US dollars
India $1,806
China $6,417
United States $51,486
Australia $54,717

If China had the same output per person as the US, it would be a US$70-trillion behemoth.

The Western world has pretty much had a free kick on economic growth since the Second World War.

But that's all changed. The 'rest' want what the West has been enjoying and taking for granted.

There's nothing like spirited competition to keep prices (including wages) down.

Ironically, the more that wages are suppressed, the more that consumers will gravitate towards cheaper imports to make their dollar stretch further. Companies get squeezed. Costs - primarily staff - are cut. A vicious feedback loop is created.

This dynamic has been in play in the US for some time.

The following chart is from an article published in the Financial Times on 17 December, 2016, titled: 'US social mobility gap continues to widen - Data show about half of 30-year-olds in 2016 earn less than their parents at same age':

Income stagnation is a glacial trend. It's taken decades for it to materialise.

That wage freeze is hitting our shores and budget bottom line.

To keep up with the Joneses, households bridged the gap between income and desired living standard with debt...another glacial trend.

For decades, debt levels steadily increased, while, on the other side of the financial see-saw, interest rates fell.

Is there an expected thaw in the wage freeze trend?

The US Congressional Budget Office (CBO) doesn't think so.

In June 2013, the CBO released a working paper that goes by the very fancy title of: 'Modeling Individual Earnings in CBO's Long-Term Microsimulation Model'.

Here's an extract from the paper's abstract (emphasis mine):

  • 'This paper describes the methods developed to project individual earnings in the Congressional Budget Office Long-Term (CBOLT) microsimulation model. CBOLT is used to assess the fiscal situations of the Social Security system and the federal government as a whole.

    'An important feature of CBOLT is that it models each worker's annual earnings over that worker's lifetime. Those lifetime earnings patterns are the key determinants of individual payroll taxes paid and Social Security benefits received, and thus of aggregate Social Security finances.

    'In CBO's modeling, the historical pattern of rising earnings inequality continues for the next two decades, but earnings inequality generally ceases to rise by the mid-2030s.'

As Robin would say, 'Holy smokes Batman, two more decades of being squeezed.'

The CBO (like our Treasury department) has an appalling track record in forecasting.

Now, before you breathe a sigh of relief, their woeful record is due to being overly optimistic.

Let's assume the CBO's crystal ball is not as foggy this time - and, with the deflationary pressures from globalisation and automation, I tend to think they are more right than wrong - this has enormous implications for economic growth and government budgets.

If wages stagnate and today's 30-year-olds (who earn less than what their boomer parents did at the same age AND have student loans to repay) are reluctant to take on more debt, what happens to GDP per capita?

Governments could boost the GDP numbers by taking on more debt, but, with shrinking tax revenues and rising entitlement costs, how do they service the higher debt load...especially if ratings agencies downgrade their credit rating and bond rates increase?

Oh what a tangled web of debt, overpromise and underfunding we have created.

But not everyone is caught in the wages freeze.

By comparison, the fortunate 1% is enjoying the warmth of rapidly rising incomes.

Any guesses on which profession dominates the top 1%?


The bankers who run Wall Street's casinos are doing very well from the debt-funded consumption model.

The peddlers of debt, dubious advice and dynamite-packed products have been clear winners from a system made up of 90% losers.

Running in tandem with income inequality is wealth inequality. In the US (and a trend being played out in other Western countries), it's reached the (ludicrous) stage where 0.1% of the population possesses the same level of wealth as the bottom 90%.

The last time this top-heavy trend happened was in the Roaring Twenties...and we know how that imbalance was corrected.

There are powerful trends at play that have major ramifications for society.

Western-world wages are stagnating (and could even fall), and there appears to be no circuit breaker to reverse this trend. Protectionism is not the answer...it's proven to be an economic disaster.

Entitlement spending is increasing, while government tax receipts are falling. No prize for guessing what gives way in this equation...

With the wage-constrained masses suffering from a severe case of over-indebtedness, how can asset prices (that make the rich richer) continue to rise?

The debt-dependent economic growth model we've built is waging a war on itself.

Something has to give.

What will it be...either the rich get poorer, or the poor get richer?

The 1930s provide the answer to this question.

Please note: This article was first published in The Daily Reckoning Australia on December 24, 2016.

Vern Gowdie is a contributing editor to Money Morning - Australia's biggest circulation daily financial email. Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia's Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top 5 financial planning firms in Australia. Vern has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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