Michael Aitken

The Australian Securities & Investments Commission has extended its crackdown on the security of confidential information held by advisory firms. ASIC has also issued a consultation paper (CP145) examining Australian equity markets

Following the transfer of market supervision from the Australian Securities Exchange to ASIC, the watchdog says ‘insider’ lists obtained from advisers during investigations have revealed hundreds of people with access to confidential, market-sensitive information. A report on its market supervision function has revealed there were 35 referrals to the regulator’s deterrence team, up from 17 in the five months to December last year.

While the point is that the process is clearly more effective with the regulator operating both the surveillance technology and the investigations, the hard part in the sense of the number of false positive technology alerts that has to be investigated is doing ASIC no favours.

ASIC is working with one hand behind its back, and quite possibly two.

One hand is tied up – because there is no disclosure of client information in the trade records. This would make it much easier to profile clients and therefore spot unusual activity, and by comparison with the current means of operating would be like shooting fish in a barrel.

Secondly, another matter of prime concern is front running. This is another form of insider trading where the inside information is client trading activity. Besides insider trading (on corporate information) and market manipulation, broker-client conflict (of which front-running is the prime example) is one of three key prohibited trading behaviours.

ASIC is again working with one hand behind their back.

If brokers are not required to say if the are acting as principle or agent on the trading records, there is no prima facie way that a piece of technology can identify possible breaches which places ASIC in a worse position than with insider trading. There at least they can use the technology to give them a clue.

This all means Front Running – one of the three key prohibited trading behaviours – is not being monitored.

It would be good if Treasury took this into account when they make changes to the way the market operates such as are being contemplated under CP145.

Michael Aitken is the Chair of Capital Market Technologies at the Australian School of Business.

Senior Lecturer Laurel Hixon

In its boldest recommendation, the Productivity Commission explicitly considers the different parts of aged care, namely care (including personal and health care), everyday living expenses and accommodation differently.  This acknowledges the varying roles of the private market and of public risk-sharing.

With regard to both health care and retirement income, the Australian government has taken the approach of moving greater responsibility “off budget” and on to the individual and private sectors through private health insurance subsidies and mandatory superannuation schemes.

As aged care services interface with the health care system and aged care financing is closely linked to aged care pensions, it follows then that policymakers are likely to consider the same strategy—i.e. greater reliance on individuals and the private insurance sector—for addressing the future growth associated with the services needed to care for an ageing population.

On the financing side, one of the most hotly debated topics was whether or not a proposal should be put forward for insuring the risk of aged care and, if so, should it fall in the private or public domain, and should it be mandatory or optional.  In medical care, it has been well demonstrated that if a person does not know when or whether they will need care, and the cost of that care is expensive, then insurance is needed to spread the risk over people.

Yet, aged care is different from medical care in a number of important ways. What the Productivity Commission acknowledges is that certain aspects of aged care are similar to medical care and the risk of that care should be spread over the largest population and the rest should remain a private responsibility.

There are, however, two issues at play in insuring risks. One is spreading the cost of care over the widest population, the other is spreading the cost of care over time. The Productivity Commission supports retaining the pay-as-you-go tax financed scheme which spreads the risk over people, but not time. Then, with the accommodation and every living expenses which are predictable, the Productivity Commission supports these costs be covered privately within certain limits.

Moreover, the Productivity Commission acknowledges that a variety of non-traditional funding schedules be put forward. Specifically, they recommend government-sponsored equity release schemes under which money could be drawn down from the equity in a person’s home to pay the predictable living and accommodation costs.

Senior Lecturer Laurel Hixon is a Research Associate from the Australian Institute for Population Ageing Research at the Australian School of Business.

Jerry Parwada

There has been a mass of negative information over the past few days, and investors can’t just ignore it.

Even though Australian shares have staged a strong rally, it follows Wall Street’s sixth biggest points drop on record. Investors have dumped riskier assets on fears the US is headed back into recession and after the US was stripped of its triple-A credit rating.

Market players are looking for any signs as to the conditions they are going to face in the markets in the short term, and maybe the medium term as well. Uncertainty is stalking the market, even though there isn’t a logical reason for the markets to melt down, as the US debt downgrade had been widely anticipated. However there is a lot of uncertainty about what is going to happen in Europe, and although there are reports that the European Central Bank bought Italian and Spanish government bonds yesterday to try and stem the crisis, there is real fear. While Italy is too big to fail, it is also too big to bail out, and unless there is more belt tightening in Europe, we could see defaults there.

Overnight the Moody’s ratings agency has presented a more hopeful perspective than S&P on last week’s debt-reduction deal, which will cut more than US$2 trillion (S$2.44 trillion) from US government spending over the next decade. Moody’s says that the United States remains on a fiscal footing that is as solid as other AAA-rated countries.

The US debt downgrade will have little practical impact as the US remains the world’s biggest economy and Europe provides no alternative to US bonds as a safe haven. A rating is a measure of probability of a lender getting their money back. In this case it is an estimate that a government is going to ignore its borrowings, but there is little question of that with the US. People will still lend to the US. China will continue to buy US debts. The markets have tanked, but it is just a knee-jerk reaction to the need for information. And all the information is negative, so it has a negative effect on market sentiment.

The Australian dollar has dipped below parity, losing nearly 10 per cent against the US greenback in just two weeks. Meanwhile Chinese data shows consumer prices rose at the fastest pace in more than three years, stoking concern China will not be able to respond to weak global growth by dropping interest rates.

With all this going on, it might mean that a country such as Australia will not be immune to this unfolding crisis after all, particularly in markets for liquid assets such as equities.

Associate Professor Jerry Parwada is Head of the School of Banking & Finance at the Australian School of Business.

Jonathan Reeves

As it tries to find a way out of its debt ceiling crisis and the economic doldrums, a consequence of US policy is that inflation is being exported to the world, and that includes Australia.

Unlike the European Union, or indeed any other enterprise in the world, the US Federal Reserve has the unique ability to print more US dollars if it – and the US Treasury – deems that this is in the US economic interest.

We have had QE1, we have had QE2, and as a result of the debt ceiling compromise we may well also have QE3. The US debt deal includes major fiscal cut-backs, increasing the likelihood that the US will continue to rely on heavy monetary stimulus in its post GFC recovery phase.

It is a policy which is keeping the value of the greenback down and contributing to the record high values for the Australian dollar, a factor which is not necessarily good for our economy. Just ask the Australian education, tourism and manufacturing sectors how they are faring right now.

Inflation is a global issue and the Americans are only one, albeit large, factor in fuelling its momentum. Energy costs are rising, as is the cost of food around the world.

The reality is that US policy has intentionally devalued the $US through the mass printing of money, putting substantial pressure on the AUD$ exchange rate and the Reserve Bank’s inflation and interest rate policy.

Currently, the RBA has an inflation target of between 2 and 3 percent. Referring to this target has been a major reason why the RBA’s official cash rate have progressively risen to 4.75 percent. With a widening interest rate differential it is no surprise that the $AUD has climbed so high against the greenback, as speculators pile into a currency which – like the Brazilian real – is one of the hottest in the world right now.

All this calls into question the wisdom of the RBA’s target inflation numbers. The 2 to 3 percent per annum target is far too low in the current economic climate, and adhering to it can only exacerbate the developing exchange rate, interest rate and export issues we are currently experiencing.

Instead, the RBA should raise its inflation target to 4 percent, a move which would help us avoid some of the economic problems we have seen internationally. Raising the target would certainly take some of the pressure off the RBA to raise interest rates, and it would also take some momentum out of the $AUD’s strength.

Mining magnates may be sitting on unprecedented wealth, but a look at the rest of the economy shows that personal debt levels are at record levels – comparable to struggling economies such as Ireland. Raising rates to fight inflation would create significant financial distress and prompt sharp falls in property values, further dampening already fragile consumer and business sentiment.

Inflation at 4 percent would assist in reducing debt levels, as it did in World War II following the Great Depression.

It seems that the RBA may be mindful of this, despite maintaining its current inflation targets. Earlier this month RBA Governor Glenn Stevens said the board believed “it was prudent to maintain the current setting of monetary policy” in view of the “acute sense of uncertainty in global financial markets over recent weeks.”

The RBA has not raised rates since November 2010, and inflation has been creeping upwards and currently sits at 3.6 percent. Officially amending the inflation target would take the wind out of ongoing expectations of a rate rise and could prompt some easing in the value of the $AUD.

At 3.6 percent, Australian inflation is not high by current international comparisons and does not pose as much of a threat to our economy as record highs for the currency. Given two “evils” – inflation or an appreciating currency – it is clear that our current level of inflation is by far the lesser evil of the two.

In fact, tolerating a higher level of inflation could be the key to helping Australia navigate the turbulence of the global economy.

Dr Jonathan Reeves is a financial economist at the Australian School of Business at the University of New South Wales.

A version of this opinion piece appeared in the Australian Financial Review on the 9 August 2011.

Professor Neal Stoughton

Bad economic news over the past week has led some analysts to worry that the United States and hence the world is on the brink of a new economic downturn.

However the downgrade will have little practical impact as the US remained the world’s biggest economy and Europe provides no alternative to US bonds as a safe haven.

The downgrade of the US credit ratings on Friday by S&P is mostly cosmetic.  US bonds were already on ‘credit watch’ status, which has now actually been removed, although that has received little attention. The prospect of a real default by the US on its debt is remote.

There is still some room for manoeuvre, by engaging in yet more Quantitative Easing – or printing more money to ease an ongoing credit crunch. Unlike the European Union, or indeed any other enterprise in the world, the US Federal Reserve still has the unique ability to print more US dollars if it – and the US Treasury – deems that this is in the US economic interest.

The G7 group of major industrial powers has pledged to take whatever action is needed to stabilise the market, including a third version of Quantitative easing, or QE3.

It is far easier to simply inflate the money supply which results in a ‘soft default’ whereupon US dollars are devalued.  Given that yields on long term treasuries are still extremely low by historical standards – despite the ratings downgrade – the impact of having to borrow at slightly higher interest rates is very small.

Consider the comparison with Italy which is now having to borrow at around 6% yields which causes much more pain on its fiscal budgets. Therefore the upshot of this S&P ratings downgrade is not that significant in the scheme of things, especially when compared with the real crisis going on in Europe, which has comparatively greater issues.

Professor Neal Stoughton is the inaugural Macquarie Group Chair in Financial Services at the Australian School of Business.

– Ray Spurr

There is little doubt that the strength of the dollar is hurting the Australian tourism industry. As with other trade exposed industries, Australia’s tourism industry will face increasingly tough times in a high Australian dollar world.

The Tourism and Transport Forum has reported that the number of Australians heading overseas outstripped international visitors in the past year. This is the biggest deficit in tourism data history, with 7.4 million trips out of the country and only 5.9 million trips inbound.

A time lag between planning a trip, and arrival, means the full effect on international tourists coming to Australia still isn’t showing up in the statistics. For international tourists coming to Australia full awareness of the extent to which Down Under has become a more expensive destination is likely to filter through only gradually – and having filtered through, these perceptions will take time to dispel when eventually the dollar turns down again.

The Aussie dollar has been at a high of 110 US cents, although it has dropped a little from there. It is also at a 28 year high against Sterling. Against a broad basket of currencies the Aussie Dollar is the best-performing major currency in the past year. The strong dollar is encouraging many locals to leave the country. There is a deficit of 1.5 million people and that is the largest gap ever between the number of Aussies going overseas compared to people from overseas coming to our country.

We can expect to see a further decline in visitor numbers as the impact of the more expensive Australian dollar on our price competitiveness, relative to competing destinations, becomes more widely appreciated. In the meantime tourism incomes will suffer a further cut as those visitors who have set a limit on their holiday budget in advance of their arrival in Australia spend less on tours, wine, food, and souvenirs during their stay.

It is not just tourists from overseas who are staying away from Australia – so are home-grown tourists. Just as important as the loss of income from inbound visitors, however, is the effect of the rising dollar for those leaving the country. As Australians recognise how much further their dollars now go, more of them are choosing to take their holidays overseas. They fund that travel by reducing their spending on consumer goods within Australia or by not paying down their mortgage, and very often by switching from taking a holiday in Australia. The loss is likely to fall most heavily on longer-haul Australian destinations like Far North Queensland, the Gold Coast and the Northern Territory, which compete most directly with holidays abroad.

Ray Spurr is a senior research fellow at the Australian School of Business.

Professor Fariborz Moshirian

The politicised handling of the US debt ceiling cap has highlighted its implications for global financial stability, the US interest rate and the pace of economic growth. This  is contributing to the gradual emergence of a new global financial landscape in which the US dollar may no longer remain the key world reserve currency in the medium term. In addition the US dollar could decline in value, and less foreign capital move to the US. Euro zone countries and some Asian countries, particularly China, appear to be the main beneficiaries of this gradual change in the structure of the International Financial System.

Given the slower than expected US economic growth and the high level of unemployment, investors are aware that US government revenue may not increase fast enough to tackle the size of the US government debt in the medium term. Some of the current investors may well move away from US denominated assets over time. One scenario could be an increase in US bond yields, as a way of encouraging more investors to hold US treasury bonds. However, this in turn may reduce the pace of economic growth in the medium term. On the other hand, if investors shy away from US assets, another scenario could be that the US dollar should substantially decline to ensure that the US can significantly increase her exports and reduce her imports as part of repairing her budget deficit in the medium term.

China is the largest US bondholder. She has kept purchasing US bonds, partly because this will keep US interest rates lower and ensure stronger economic activity. This in turn will assist China’s exports to the US and also ensure that China’s largest debtor maintains her capacity to repay her loans.  However, China is no longer buying US treasury bonds (ie with 10 years or more maturity) but has been investing in US treasury bills and notes with short term maturity instead, as China diversifies her international portfolio and allows for greater flexibility to exit from US denominated assets.

In the short term, there is no alternative to the US dollar as the most important world reserve currency. Nevertheless, investors have already refocused their attention to short and medium term assets of emerging countries such as Brazil, China, India that appear to be secured at least in the foreseeable future. In the meantime, the debt ceiling crisis in the US has provided an incentive to both the European and Chinese leaders to create a more secured investment environment for foreign governments, companies and large private investors to redirect some of their US denominated assets into European and Chinese denominated assets. The Euro and China’s Yuan, in the medium term, may well take away a portion of the current 61 percent share of the US dollar foreign exchange reserves and also calve into the current 84 percent of foreign exchange transactions that are generally trades of national currencies for the US dollar.

BRIC (Brazil, Russia, India, China) promoted a global currency away from the US during the recent GFC. However, in the process of negotiations within the G20 for “ strong, sustained and balanced” economic growth, such an idea was not pursued. However, the recent US debt ceiling crisis has highlighted the potential for the IMF Special Drawing Rights (a basket of four major currencies) as one of the mechanisms to diversify the current world currency reserves. BRIC and South Africa have entered into a swap agreement amongst themselves so that they can settle some of their major trades without the use of the US dollar.

While China’s Yuan is not yet a major international currency, the way the debt ceiling cap in the US has been handled may encourage China to fast track the process of converting Yuan into a trading currency, an investment currency and finally a world major reserve currency. The Bank of China is active in accepting Yuan-deposit accounts in the US. Thousands of Chinese companies are using Yuan for their cross border settlements. The Yuan denominated “dim sum” in Hong Kong is used by and increasing number of foreign firms.

The recent sovereign debt crisis within the Euro-zone has been used as an opportunity for Euro-zone leaders to tackle the mismatch between a European monetary policy and  nationally based fiscal policies. Undoubtedly, a number of financial challenges still need to be resolved in Europe.  The recent support by Germany to finance the European Financial Stability Fund generously and make this fund an active source of credit for the various needs of the member countries, has provided a new impetus for the Euro as a credible currency and may well accelerate the process of the emergence of Euro bonds, supported by all Euro-zone governments, as secured and effective assets that can directly compete with US treasury bonds.

The current political debate in the US regarding the debt ceiling cap has created a new global financial landscape that will gradually lead to a more diversified world currency reserve, away from the US dollar as the dominant one. Depending on the way US economic growth and unemployment rates evolve in the medium term, foreign investors may move away from US denominated assets and pave the way for the gradual emergence of a new international financial system with a world currency that is independent from any national government’s  fiscal, monetary and political policies.

Fariborz Moshirian is Director of the Institute of Global Finance and Professor of Finance at the Australian School of Business, UNSW.

A version of this opinion piece first appeared in the Australian Financial Review on 3 August 2011.

Dale Boccabella

There has been a release of a discussion paper on priorities and directions for tax reform ahead of the Government’s October Tax Forum.

The tax forum discussion paper provides a useful summary of the main problems facing the tax system, including the transfer system and stamp duty. It also provides a clear direction on what the government wants discussed at the forum.

The forum, to be held on October 4th and 5th 2011 will consider unresolved elements of the wide-ranging report into tax reform produced last year by a panel led by former Treasury Secretary Ken Henry.

Very little harm can come from the government’s October tax forum, but unfortunately, the good to come from it is likely to be marginal – or at best insignificant – because it appears after all, to be just another discussion opportunity for tax experts to chew over the issues.

The government has ruled out overhauling the GST and hasn’t put it on the agenda of the October tax forum. Instead, the forum will look at state taxes such as stamp duty, payroll tax and insurance levies; however some states have now said they are not going to sacrifice their limited taxing powers without compensation.

Some glaringly obvious problems with our tax system are known to everyone attending this forum. I want to see them resolving the treatment of discretionary trusts, the continuation of negative gearing, open-ended exemption for capital gains on homes, the effectual absence of death duties, and the destructiveness of state stamp duties. Alas, it seems not much will be done about it.

The Federal Treasurer Wayne Swan has tabled a discussion paper to guide the forum today, and has made clear it will not revisit tax decisions made in the past year, including the planned mineral resources rent tax, a reduction in corporate tax rates and an increase in the superannuation guarantee from 9 per cent to 12 per cent.

There comes a time when tax experts should stand aside and let political scientists and opinion shapers hammer out the issues. There needs to be a real consensus across political parties that this must be resolved. Consensus builders must ply their skills and work out a way forward.

Associate Professor Dale Boccabella is from the Australian School of Taxation and Business, at UNSW.

– Professor James Morley

Maintaining the policy interest rate at 4.75% appears to be more appropriate than raising or lowering the rates. However, there is currently an unusual amount of uncertainty about the most appropriate level for interest rates.

The Reserve Bank of Australia is due to hold its monthly board meeting today, amid conflicting economic indicators. Business and consumer confidence have dropped while inflation accelerated last quarter to the fastest annual pace in three years.

Because there are lags between the implementation of a monetary policy and its effects on real economic activity and inflation, policy should be forward looking and consider all possible scenarios for future economic conditions. The forecasts for these conditions are currently very mixed.

Last week the ABS showed that consumer prices gained 3.2 percent in the year, however a gauge of Australian manufacturing released today dropped to a two-year low in July.

I put the highest weight on maintaining the current rate, but also place more weight on an increase than a decrease in rates.

The near-term outlook for inflation is mixed. Headline inflation is running above the target range, but should be expected to fall back into range within the next year as the large increases in food prices due to the Queensland floods ease. Also, the large increase in world oil prices has eased somewhat in recent months. At the same time, the low unemployment rate suggests limited slack in labour markets and only a small downside risk for underlying inflation.

The near-term outlook for real economic activity is dominated by the strong growth of exports to fast-growing Asian economies and the concomitant investment boom in the mining sector. The high Australian dollar somewhat mitigates the overall upside risk of an export-led boom. Also, consumer sentiment and retail sales have shown some recent weakness, which can be expected to persist over the near term. There is also a small, but non-negligible risk that debt crises in the United States and Europe will have contagious effects for the entire world economy, including for Australia. A recent rise in unit labour costs of wages relative to productivity suggests some upside risks for the impact of real-economic activity on inflation.

James Morley is a Professor of Economics at the Australian School of Business, UNSW.
He is also a member of the newly-established Shadow RBA Board. Made up of senior Australian economists, the shadow RBA board pilot project runs from August until October with each round occurring on the Thursday before the decision by Reserve Bank of Australia board. Each Shadow Board member reports percentage weights on what he or she believes to be the most appropriate interest rate.