It’s been a busy week in finance as markets swoon over fears of Greek default, a Chinese bubble and an Australian tax.
Overnight, European and US stocks fell as markets sold down in response to the continuing trouble in Greece, where a massive €110 billion (AU $155 billion) bailout from the European Union and the International Monetary Fund has failed to calm market jitters.
As a condition of the bailout, the Greek Government has had to commit to deep cuts to public spending, pension reform, public sector pay cuts and significant increases in many taxes. Greek citizens are not happy. Overnight, Greek unions led a general strike that included significant parts of the public sector, while massive protest marches in Athens ended in tragedy after a bank branch was firebombed, killing three bank employees.
The Greek debt crisis has been building for several months. Greece is running a massive government deficit and needs to roll over as much as €300 billion (AU $424 billion) by 19 May. The country is struggling to sell its government bonds, with investors fearing that the country will be unable to pay its long-term debts and will eventually default.
In the short-term, Greece’s problems are about making the next repayments on its huge government debt bill. In the longer term, the country will face the awkward problem of either leaving the euro currency zone (destroying the investments of those holding Greek debt denominated in euros), or accepting a crippling debt burden and perhaps a decade or more of slow growth, probably with rampant inflation to boot. The deeper causes stem from Greece’s post-war legacy of authoritarian governments and civil unrest, an anaemic private sector, and endemic tax evasion and corruption. As former IMF economist Simon Johnson has argued, the bailout will not solve the long-term problems for the Mediterranean nation, which have increasingly come to resemble those of that perennial sovereign-defaulter, Argentina.
The real problem for Europe is the spectre of contagion. Greece is not the only heavily indebted country in the EU zone; all of the so-called PIGS (Portugal, Italy, Greece and Spain) face similar fiscal pressures, with Portugal being warned of a credit rating downgrade by Moody’s overnight. Investors fear that the debt crisis could spread from Greece to Portugal, Spain and even the UK, all of which face growing debt burdens and will struggle to summon the necessary political courage to rein in yawning budget deficits. Led by Europe, global markets have slumped in the last week as the Greek crisis has accelerated.
European sovereign debt is not the only macroeconomic shock that threatens Australia’s miracle economy. Concerns are growing about the risk of a crash in the Chinese property market, which is currently experiencing bubble-like growth in asset prices. In past weeks, several prominent economic commentators have warned about an incipient Chinese property crash, including such veteran bears as the Gloom, Boom and Doom report’s Marc Faber, legendary hedge fund manager Jim Chanos, Harvard economics Professor Kenneth Rogoff and Asian equities analyst Andy Xie.
Rogoff thinks that a Chinese property crash could spark a regional slump; Bloomberg recently reported him as saying "it would cause a recession everywhere surrounding" China, and would be "horrible" for Latin American commodity exporters. You don’t need an economics degree from Harvard to work out what a Chinese downturn would mean for one of the world’s biggest commodity exporters to China: Australia.
But here in Australia, you’d be forgiven for thinking that the greatest threat to the stockmarket is a government announcement that it will increase taxes on resource company profits. Since Sunday’s release of the Henry Tax Review, the local media have been deluged with reports quoting aggrieved mining magnates forecasting the end of the Australian mining industry as we know it. Queensland’s Clive Palmer (coincidentally one of the biggest donors to Queensland’s Liberal National Party went so far as to describe the plan as "communism". Yesterday, BHP’s Marius Kloppers and Rio Tinto’s David Peever flew to Canberra to meet with the Coalition’s Tony Abbott, Joe Hockey and Andrew Robb. Abbott emerged from the meeting declaring that the Coalition would vote against the tax increase in the Senate. Kevin Rudd flew to Perth to meet with angry junior mining executives.
Meanwhile, overnight, Rio Tinto’s head of Australian iron ore operations, Sam Walsh, was reported as saying: "The concern is that people are looking at this now in boom times, not realising that sooner or later, we’re going to be in tough times and it’s going to be very, very tough for projects". Walsh foreshadowed that Rio would delay an $11 billion expansion plan of its operations in Western Australia.
But have the big resource companies overplayed their hand? As I argued on Monday, these companies are in good health and can easily afford a higher tax rate on their multi-billion dollar profits. Commodity prices are at near-record levels, reflected in a terms of trade boom for this country which is well documented by official ABS statistics. Moreover, there are sound economic justifications for the taxing of non-renewable resources, as the Henry Review explains at length.
In an insightful post, Club Troppo’s James Farrell points out that the argument that says the new tax will stifle resource investment doesn’t stack up. For a start, the tax only affects resource profits above the long-term bond rate — not ordinary profits, and certainly not exploration, labour or operations costs. As Farrell writes, "Rent taxes … appropriate surplus income that arises from ownership of a resource that’s unique or fixed in supply. Since the income doesn’t correspond to a cost of production, taxing it doesn’t affect economic decisions and distort the allocation of resources."
As Julia Gillard pointed out on ABC1’s Lateline last night, Australia already has an operation resource rent tax — for petroleum and natural gas production — and that hasn’t stifled massive investment in projects like the giant Gorgon gas development.
But that hasn’t stopped much of the Australian media from swallowing the mining companies’ talking points whole. It was refreshing to hear a Sky Business correspondent observe early this morning that if Rio Tinto really is halting $11 billion worth of iron ore expansion plans, it is legally obliged to announce this to the ASX. In fact, no ASX announcement has been disclosed. Crikey‘s Possum has made the same point. By mid-morning, Rio was forced to deny the rumour in a statement to Reuters.
Ironically, if the Chinese property market does go bust, causing a regional recession, mining companies will be begging the Rudd Government for the new tax. That’s because the Resources Super Profit Tax, as described in the Henry Review and announced by Wayne Swan on Sunday, will not tax miners who don’t make a profit — unlike the state-based minerals royalties it will replace.