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Charles (Chip) Krakoff is publisher and principal author of the Emerging Markets Outlook blog, as well as founder and Managing Partner of Koios Associates LLC, a firm specialized in investment and trade, in emerging and frontier markets. He has over 25 years of corporate, financial, consulting,... More
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  • Aussie Rules 5 comments
    Jun 18, 2010 1:33 PM | about stocks: RIO, XSRAF, XSRAY

    I’ve just returned from a few days in Sydney, Australia, where it is more or less the dead of winter, which means sunshine, highs in the upper 60s, and lows in the 50s. Not a snowplow in sight. Leaving aside the World Cup and Aussie Rules football and the odd murder and sex scandal, the main news story is the precipitous loss of confidence in Kevin Rudd, the Labor Party leader who became Prime Minister in 2007, soundly defeating John Howard and his center-right Liberal Party, who had been in power for the previous eleven years.  Rudd, a former civil servant in the Foreign Office known mainly for his fluency in Mandarin Chinese and his geekish, technocratic look, was meant to be the antidote to Howard’s proud pro-Americanism and belligerent attitude towards darker-skinned folks seeking political asylum in the Land of Oz. Rudd was the new internationalist, prepared to identify Australia as an Asian country and to place Australia in the vanguard on such cutting global issues as climate change. Barely three years later, and with the next election no more than 10 months away, Rudd appears to be hanging on by his fingernails, facing his lowest poll ratings ever as well as grumblings within his own party that he might have to be replaced by another politician – Deputy Prime Minister Julia Gillard, for example – if Labor is to have any chance of staying in power. What went wrong?

    Quite a few things. The Rudd Government, without consulting other countries, made a commitment in advance of last December’s Copenhagen climate conference to bind Australia to a 15% to 20% reduction in carbon emissions by 2020, and to introduce a stringent cap and trade emissions control scheme. What had at first looked like bold leadership came to look amateurish and poorly considered as soon as it became apparent that none of the other big players at the conference had any intention to follow Australia’s example. Rudd, speaking to a group of politicians and journalists after a particularly intense negotiating session with the Chinese, was recorded saying, “Those Chinese f***ers are trying to rat-f*** us.” In the normal rough and tumble of Australia’s political discourse this is fairly anodyne – Rudd’s effort to inject some passion and machismo into his bland and technocratic persona and the rough equivalent of Barack Obama’s statement that he is “looking for someone’s ass to kick” in connection with the BP oil spill – but the Chinese and most other countries no doubt interpret it differently. The Australians took it as a sign that Rudd had become rudderless and unhinged. In April of this year, the Rudd government announced deferral of its climate change program – including an emissions-trading scheme – from 2011 to at least 2013, causing the Green Party and many in his own party to brand him a traitor. Labor’s approval ratings dropped from 52% to 35% in the month that followed.

    The Prime Minister’s biggest misstep, however, is his attack on the mining industry, one of the mainstays of the Australian economy, which is credited with helping Australia avoid the worst effects of the global financial crisis and recession.

    In what may have been an attempt to shore up his left flank, Mr. Rudd in early May introduced what he called a “super-profits” tax on mining companies, which would impose a 40% tax on all income in excess of a “normal” rate of return of six percent, the rate paid on long-term Australian Government bonds. The government justified the move partly on the basis of a study carried out by the Treasury, which claimed that mining companies paid an effective income tax rate of only 17%, far less than the “headline” corporate income tax rate of 30%. This claim may have been true in a very narrow sense, but what the report failed to mention was that the 17% figure represented only the federal corporate income tax paid by mining companies, ignoring the substantial mineral royalties, surface rents, and other charges paid by mining companies to the federal and state governments, which jack up the average effective tax to 40% of earnings. The new tax would increase that average effective rate to 60%.

    Now some people, Mr. Rudd and his Treasurer (Finance Minister) Wayne Swan among them, seem to think that 60% is not only not excessive, but may not be enough. They are in a minority. Though there is some support from the measure from the unions, the Green Party, and others on the Left, popular sentiment runs against it, and some 2,000 mining workers recently turned out in protest, chanting the slogan, “Super Tax, Super Stupid.”

    Australian mining giant Rio Tinto has announced it is reviewing all investment decisions in light of the proposed tax, including a big uranium project in Western Australia. Xstrata, a huge Anglo-Swiss mining company, has placed two major investments, worth A$6.6 billion, on hold, putting more than 3,000 new jobs at risk. As much as $20 billion in other investments may be at risk, including a $2.5 billion Chinese aluminum project. Rio Tinto Chief Executive Tom Albanese last week told reporters that Australia is now his “number one sovereign risk issue globally,” strong words in view of Rio Tinto’s operations in more than 50 other countries, including Guinea, Cameroon, Madagascar, and Zimbabwe, none of which has anything close to Australia’s AAA sovereign risk rating from Standard & Poor’s.

    In spite of a rumored compromise with the mining industry, which might raise the “normal” rate of return to 11%, the Labor Government insists it will not budge. “We are not going to be diverted from our core objective, to get a good deal for the Australian people for the extraction of resources that can only be extracted and used once,” said Lindsay Tanner, Australia’s Finance Minister (a post junior to that of Treasurer). Given that the Green Party strenuously opposes any such compromise and could scupper Labor’s chance of winning the next election, Rudd has painted himself into a corner from which he will emerge with difficulty, if at all.

    It all seems to be equal parts ineptitude and misbegotten ideology. Mr. Tanner’s remarks, and other, similar statements from other members of the Rudd Cabinet, betray an instinctive mistrust, not to say hostility, towards business. In government’s view, mining companies may have to be tolerated, but toleration is as far as it goes. The mining companies (and, by extension, many other businesses) can produce some goods and services governments cannot, so they must be allowed to operate – though on a very short leash. Rudd, a career bureaucrat, sees the mining companies as despoilers, raping the environment, mistreating their workers, evading taxes, and stealing riches that rightfully belong to the nation. Never mind that mining companies everywhere are required to pay hefty amounts into rehabilitation funds to cover the cost of repairing any environmental damage once the mine reaches the end of its useful life. Never mind that miners everywhere are the highly-paid aristocrats of manual workers and that mine accidents are called accidents because they are, well, accidental, occurring in spite of most mining companies’ strenuous efforts to assure worker safety. Never mind that gold or iron or copper or any other mineral under the ground is worth nothing at all until someone digs ups and processes the ore, a hugely expensive and risky undertaking for which investors require a higher return than the yield on a risk-free Treasury bond. And never mind that in Australia miners pay royalties ranging from 2.7% to 18% of the value of the minerals they extract, which are among the highest rates in the world and pretty generous compensation to the Australian people for use of its resources. To the extent that you believe business is, at best, a necessary evil, you subscribe to the Rudd-Labor worldview, which holds that it’s fine to seek government revenue and political mileage from bashing business, which deserves far worse than it gets..

    It’s to the credit of the Australian people that they see through this warped view and are prepared to vote against it at the polls. Unfortunately, this view seems to be gaining traction around the world. The Economist of June 10 says that President Obama has “all too often given the impression that capitalism is something unpleasant he found on the sole of his sneaker.” Governments around the world, ranging from the loony (Venezuela, Iran) to the merely confused (Bolivia, Brazil, China, Mongolia, and scores of others) echo these views, reserving huge swathes of their economies for the state, providing barely-disguised preferences and subsidies for state-owned enterprises, and subjecting private businesses to punitive taxes or worse.

    General Motors CEO Charles Wilson’s statement in 1953 that “what is good for the country is good for General Motors and vice versa” may be a touch hubristic, but it would not be inappropriate for governments explicitly to recognize that business, not government, creates the jobs, income, and prosperity on which all else depends.

    Some degree of tension between business and government is a good thing. I am suspicious when the interests of government and business appear perfectly aligned: it usually means that the business in question has bought the policy and regulatory decisions that best suit it. When a country announces that it is “open for business” it usually means that its politicians and policies are for sale to the highest bidder. Nevertheless, when a government acts with such overt hostility to business as the Australian government has done, it is usually attributable to a toxic combination of ideology, ignorance, and self-interest.

    It is hard to know to what extent Labor’s anti-business stance is a cynical and populist political gambit that has backfired badly, or a reflection of deeply held beliefs. In either case it is a sure sign – and one that voters will be quick to act on – that 11 years in the political wilderness were not enough to transform Labor into a party capable of governing responsibly. In Britain it took Labour 18 years in opposition to turn itself into a credible governing party and it took the Conservatives 13 years in opposition to New Labour to do the same. Not ready for prime time, Australia’s Labor Party needs to go back to the woodshed for more practice. I don’t  even want to think what this implies for the Republicans in the United States.

    Disclosure: No positions
    Stocks: RIO, XSRAF, XSRAY
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  • Paul Hanly
    , contributor
    Comments (840) | Send Message
    There is a complexity underlying the issue of countries with substantial minerals exports that are not considered in the above article.


    There is also I believe, a misstatement, ignoring that government can create jobs just as much as private enterprise. The sometimes inefficiency of government spending is no less a problem than wasteful or indulgent private consumption financed by tax cuts which prevent funding of new and improved infrastructure or basic services.


    Another misstatement is that minerals have no value in situ. The fact that the mining industry is prepared to pay for the rights to explore for and mine minerals indicate that the have value. The idea that something has no value until it is dug up and sold is ludicrous.


    There is also the issue of the difference in attitude of the mining companies to the obligations under the continuous disclosure requirements under the listing requirements for publicly traded companies and the public statements and advertisements funded by the mining lobby group.


    Some of the complexities include:
    1. Mineral exports raise the exchange rate, reducing international competitiveness of the rest of the exporting and import competing economy. As an example, one of the other industries that earns from foreign sources is tourism which is a very large employer both through construction of facilities like airports and hotels and more direct employment in the tourism industry.
    2. The main mineral exporting states are substantially funded by the taxes of other states through transfer payments by the Commonwealth government. Those states have negotiated royalty agreements which fail to capture some of the upside of price increases. The mineral exports raise the exchange rate and reduce the competitiveness of the manufacturing base of the states (NSW and Victoria) which are the "donor" states.
    3. Generational equity is assisted by the "forced saving" of leaving minerals in the ground.
    4. There are significant strategic, social and economic benefits to a diversified economy with a sound and internationally competitive manufacturing sector and no country should allow itself to be in a position where the diversified productive facilities and skills are largely lost, even if there is some other benefit obtained. (The US is seeing this problem in its international relationships, initially with Japan and now with China, Korea and other SE Asian countries).


    The mining industry has also sought to obfuscate the difference between the amounts paid for each ton of mineral mined paid to the owner (the Crown) and generally applicable state and federal taxes. They have also ignored the substantial subsidies received from governments (state and federal) either directly through provision of infrastructure or relief from taxes paid by other enterprises such as the diesel fuel excise.


    None of this is to say that the Resources Super Profits Tax is well structured or set at appropriate levels or has an appropriate treatment of existing ventures, merely that the overall intergenerational interest of Australia is not the same as the the interests of mining entrepreneurs or multinational or Australian mining companies.
    19 Jun 2010, 09:12 AM Reply Like
  • Chip Krakoff
    , contributor
    Comments (28) | Send Message
    Author’s reply » Explorer, thanks for your comment. You make some valid points, but I disagree with most of them. You seem to be saying that government can create jobs just as effectively as business. This is simply not true, if you consider the value of the services provided in each case. Some government jobs obviously do create value or are essential in some other way. Teachers, firefighters, police, emergency medical technicians, and even certain government officials and bureaucrats like central bankers, diplomats, and the like. And government expenditure can be enormously valuable - repairing and building infrastructure, for example - and can create jobs in the private sector. But far too many government jobs consist of creating and applying unnecessary, costly, and harmful regulations on individual and corporate behavior, which generally subtract value from the national economy and diminish national welfare.


    I was making something of a rhetorical point when I said that minerals in the ground have no value. Clearly they do. But the Australian government (and many others) ignore or attach little importance to the value that miners add by digging up and processing the stuff, and instead treat them as passive rentiers.


    I am baffled by your argument that the industrial states subsidize the mining states, since by your own admission a significant slug of the transfers is paid out of royalties and taxes from the miners operating in the mining states.


    You exaggerate the impact of the mining sector on the exchange rate. Mining accounted for 7.6% of Australia's GDP in 2008, a peak year for commodity prices. I don't have figures for 2009, but I suspect the percentage was lower. In any case, this is high for OECD countries (only Canada, at about 4%, comes close), though in many non-OECD countries the proportion is much higher. Yes, the Australian dollar is substantially (10% or more) overvalued against the U.S. dollar, the yen, the pound, and the euro, but this is almost certainly not attributable to Dutch disease but instead reflects the disparity between benchmark interest rates in those currency areas (U.S. 0%, Japan, near zero, Bank of England 0.50%, euro 1.00%) and the Reserve Bank of Australia's benchmark rate of 4.50%, which has risen from an historic low of 3.00% last October, most likely in an attempt to avoid a housing bubble.


    My point was not to say that mining companies should be given carte blanche to do whatever they want - sensible regulation and taxation policies are essential - but rather that the Rudd government has displayed its ignorance of and disdain for business and seems to think that miners - greedy buggers all of them - should be squeezed dry. By taxing mining companies more heavily than almost any other country does, Australia's government ignores, or doesn't care, that mining companies will henceforth seek more friendly jurisdictions in which to invest.
    19 Jun 2010, 03:51 PM Reply Like
  • Paul Hanly
    , contributor
    Comments (840) | Send Message
    If you have worked in a large corporation you will know that generalisations about efficiency of the private sector are subject to numerous exceptions.


    NSW and Victoria have larger numbers of taxpayers and pay more taxes to the Federal government than the other states, largely because of larger populations. The federal government provides more funds to the smaller population states on a per capita basis. The more manufacturing based states subsiidse the more resource based states.


    It is not the proportion of GDP that drives exchange rates, it is the proportion of international trade and transfers.


    Your statement about the high importance of mineral export in non-oecd states seems to support my statement that development of efficient other industries is harder when the currency is kept high by mineral (or agricultural) exports. (Australia has high mineral and agricultural exports, both supporting the AUD at levels higher than it would otherwise be).


    While there may be some regulation that some might find excessive, there are many who believe that there has been too little regulation and too little enforcement over recent times. For the US, banking & finance and offshore oil are two industries that come easily to mind.


    I acknowledge the role of interest rate differentials in exchange rate determination. However Australia is widely regarded as a currency driven by commodity prices and the sensitivity of the AUD to the GFC and fall in commodity prices and volumes is some evidence of that. I don't believe that it is commonly accepted that it is interest rate differentials that drive the AUD exchange rate. According to Wikipedia:
    "For decades, Australia's balance of trade has depended primarily upon commodity exports such as minerals and agricultural products. This means the relative value of the dollar varies significantly during the business cycle, rallying during global booms as Australia exports raw materials, and falling when mineral prices slump or when domestic spending overshadows the export earnings outlook. This movement relative to the global economy is generally in the opposite direction to other major currencies, which are more popular during slumps as traders move value from falling stocks into cash. This high volatility and unorthodox movement in exchange rates has contributed to the AUD's status as one of the most traded currencies in the world."
    20 Jun 2010, 08:50 AM Reply Like
  • Chip Krakoff
    , contributor
    Comments (28) | Send Message
    Author’s reply » I don't want to get into a running debate here, but a couple of points. are worth making. The fact that Australia "is widely regarded as a currency driven by commodity prices" doesn't make it true, any more than does Wikipedia's analysis. Until some point in 2007 or so, it was "widely accepted" that mortgage-backed securities merited the triple-A ratings they were given and that AIG was not insane to sell trillions of dollars worth of credit default swaps, since the risk of default was minimal. At some point in 2008 - right around the time that Bear Stearns and Lehman collapsed and the U.S. government shoveled tens of billions of dollars into AIG - it turned out that what was widely accepted was, in fact, completely false. South Africa's exchange rate is far more exposed to commodity price swings than the Australian dollar, but even the rand is far more insulated than previously, as mining's share of GDP has declined.
    20 Jun 2010, 09:07 PM Reply Like
  • Paul Hanly
    , contributor
    Comments (840) | Send Message
    The fact that one widely accepted correlation broke down doesn't make a different widely accepted correlation untrue.


    The fact that something is a widely accepted belief or is accepted by Wikipedia as true doesn't make it untrue either, and widespread acceptance and acceptance by Wikipedia deserve better refutation than your comments above.


    If South African Rand is more correlated with movements in commodity prices than AUD it doesn't mean there is not a good or strong correlation between the AUD and commodity prices.


    A view of AUD/ZAR since Dec03 shows that there are longish periods of stable relationship punctuated by dramatic realignments of AUD and ZAR. The major realignments were:
    Mar 06 to Jan 07
    Jan 08 to Feb 08
    July 08 to Aug 08.


    From Nov 08 to June 10 the currencies appear to have remained around 6.30 to 6.90


    While accepting that you don't want to debate, nothing you have shown in the above comment refutes that the double whammy of mineral and agricultural exports leads to a currency strength that mitigates against import competing/export industries and that this is a relevant consideration for a sustainable long term economy so there are possible offsetting benefits to any reduction in new mining investment.


    The Government apparently accepted advice from Treasury as to the impact of the Resources Super Profits Tax and Treasury's advice re the GFC was good enough to keep Australia out of recession (or was it Chinese mineral purchases) but the theoretical basis of Treasury's advice on this matter has been criticised by Steven Keen, one of the few economists who predicted the the GFC with cogent reasoning and reasonable timing. (He didn't anticipate the strength of the international government responses) See Keen's criticism:
    21 Jun 2010, 02:32 AM Reply Like
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