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Saturday, June 19, 2010

Governments ought not be quasi-equity partners

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One of the more unsavory elements of Kevin Rudd's Resource Rent Tax is the idea that government will end up with an 'quasi-equity' stake in the mining industry. i.e. The government will bare a financial benefit, but also an obligation. If this fascist conception does not scare you, consider some implications and examples.
1. Government is a public trust, and it assumes money powers without responsibility. Taxpayers will ultimately pay for any mistakes. Governments are notoriously bad at picking winners. More problematic is that this is not a 'stake' or commitment that the government can honour without screwing taxpayers (i.e. slaves to a pretense of voter representation) or once again undermining the sovereign risk of Australia. Simply the proposal by the government to expropriate wealth from miners has discredited the Australian government, and reduced our credit rating. If the government takes the next step and executes it will be worse. If you protect forward 10 years when metal prices go backwards, and the government is dealing with obligations it has assumed under its new 'tax regime', then you can expect it to dishonour the tax AGAIN.
2. Governments have a notoriously bad record of picking winners. Being a mining analyst, I see a great many examples. Collectivism is always the cause. Consider the coal industry in the 1970s. Coal prices were expected to go to $100/tonne. The Colombian government nationalised the company Carbocol S.A. They built a very expensive rail system and port to export15Mtpa of coal. The project was a monumental white elephant, which played a major role in undermining the future administration of the government. Coal prices went the other way, reaching a low of $20/tonne, and they stayed low for over 10 years.
Another example comes from Eastern Europe. Vulcan Resources was doing some exploration work there in the early 2000s. A Soviet geological team developed 14kms of underground development and never produced any gold. Why because it was a state-funded enterprise. This later example is already evident in Australia because the Australian government does not do the basic things well - like regulation of companies.
Regulation in the form of justice (as opposed to market distortion) is the proper function of government. The government ought to be making sure companies are accurately reporting and that CEOs pay consequences for misleading the market. These deceptive practices ought to be punitively dealt with, but ASIC doesn't because it 'does not have the resources'. Analysts are in the best position to report companies doing the wrong thing.
Several examples come to mind:
a. Gleneagle Mining - Shareholders were mislead as to the financial viability of their mine.
b. Matrix Metals - Shareholders were mislead as to the true mining costs, and were even lead to expect a 60% increase in output.
c. Bendigo Mining - Shareholders were fed a rationalised grade prediction model in order to 'keep the dream alive'. The project received hundreds of millions to find gold that will probably not be mined for years.
The mining industry knows these mining projects are duds. They are talked about over beers in the pubs around the country. The information however is not communicated to government. If it was the government would not act, because government wants to 'keep the delusion alive'. Miners know because they closely scrutinise many projects before they take equity. The government in contrast intends to take equity in all projects.

Imagine how frequent these types of deceptive schemes will arise if government is a co-partner. It is not the government's money, so you can be sure it will happen a great deal. I can picture Kevin Rudd with one hand on the wheel of a 50-tonne truck, and the other breaking a bottle of champagne to officially open such mines. It will of course looking great. But such projects will end up as white elephants.
What we have learned from the 1960s is that Japan was able to create a lot of supply by seed funding mines in Australia, Canada and elsewhere. We can expect the same from Chinese enterprises, whether the Chinese state enterprises or steelmills. The Australian government ought not to be carrying the risk. There are factors which are not even on their radar ice ages, and other natural disasters. Natural climate variability...never mind the myth of anthropogenic climate change. Price predictability is notoriously difficult beyond a few years. Add to the fact that most price levels in the current market are exaggerated by government intervention in the market. For example, copper prices rose from 68c in the late 1990s to $4.00/lb in 2008 primarily because of government monetary stimulus in the USA. The same trend for other metal prices. Who knows what will happen when government powers are restrained (as they should be) in future years.
It will ultimately be the taxpayer who pays. I personally think Kevin Rudd developed this policy after going to China. I suggest Kevin Rudd is impressed by China. Being a career bureaucrat, he knows nothing about economics and finance. He looks at China...all the development and the 8-12% growth and he thinks this is what authoritarian government can achieve. In fact, China is growing at these rapid rates, not because of public administration, but in spite of it. The real reasons for Chinese ascension is:
1. Dual economy - Foreign enterprise is offered far better terms than local business. This is why a lot of Chinese domestic investment is channelled through HK and Taiwan, to get state concessions. Foreign direct investment is overstated.
2. Market disequilibrium - Markets are not in equilibrium. The sudden opening up of China in the 1990s allowed the mass migration of millions of Chinese farmers to the city for factory jobs. The mass over-supply of workers for factories was good for foreign investors.
3. Strategic market appeal - China is a huge market with very competitive costs. It was essentially a USA in the making, but without the values of the USA, at least not explicitly, though maybe it will ascend to a level where its respect for individualism in 50 years exceeds the USA. It will probably come only through revolution, with middle class Chinese forced to fight restless and envious rural farmers not getting the same benefits. Might this trend undermine Rudd's forecast for mining or metal prices?
4. Lack of regulation - China is the wild west. There is regulation, but its not as developed or enforced as the West, so it is thus less restrictive. This is a boon for honest and dishonest business people alike. Maybe this is why Chinese people prefer to deal with foreigners. Higher prices and more honest business practices. We have this idea that China is an authoritarian state, but effectively Rudd is more authoritarian than the Chinese premier because he has the 'force of law', whereas in China the level of compliance is far looser, and open to bribes.
Rudd presents a greater threat to liberty than Chairman Mao because he professes to be a champion of freedom. His conception is a distortion...which ought to be apparent after reading this blog and my politics blog. At least Chairman Mao was a consistent practitioner of his philosophy of self-denunciation.....Rudd is a pathetic, inconsistent, pale hypocrite who waited until he had power before he unleashed his true character...or lack of it.
Andrew Sheldon
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