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Friday, June 11, 2010

Replies to common misconceptions about RRT

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This blog post is intended to respond to some of the misconceptions I have seen with respect to the proposed Resource Rent Tax.
"Mining creates the two speed economy, heating up the Queensland and Western Australian economies while leaving New South Wales, South Australia, and Tasmania out in the cold. This presents an impossible choice to the RBA of either tightening monetary policy and depressing NSW or loosening it and allowing QLD and WA to boom, along with the inflation and bubble problems that booms entail. This is exacerbated by the inherently volatile nature of the resources industry, where prices can soar during times of high global growth and plummet during slumps, leading to structural unemployment. But how do we prevent these mining booms from making a bubble in WA without exacerbating the unemployment in rough times? This is where the beauty of a super-profits tax comes in. The tax only kicks in during the booms, and leaves the industry alone when it’s down. This is fondly referred to by economists as an “automatic stabilizer”.
This is flawed reasoning….a blatant rationalisation. Higher prices for plant, labour and equipment to service the mining sector reflects excess demand, as opposed to inflation, which reflects a relative increase in money supply. Higher prices are needed to justify new capacity since China, India, Brazil and Russia among others were growing so quickly.
The challenges of Australia's East Coast are in fact a blow-over from the property market traumas, which has more to do with the VERY easy monetary policy by Liberals & Labor, plus the distortive First Home Buyers Grant and artificial escalation of land prices through zoning restrictions.
The best regulation of the Australian economy comes by way of the currency. If imports exceed exports the AUD falls. Commodity prices are denominated in USD, so there is a ‘natural balance’. The implication is that a super-tax is not needed for balancing the economy. In addition, its not the role of governments to regulate mine supply since they are not market participants. This tax proposal highlights their lack of understanding.
So the choice is being an extortionist or parasite on or over mining…I’d sooner advocates eat their own carcass.

"The mining sector also has a negative impact on other export industries. Mining has a significant effect on the AUD exchange rate, making it harder for our agricultural and manufacturing sectors to compete internationally. As these other sectors shrink, we risk becoming dependent on mining, an inherently temporary industry, as our only export industry".
This is nonsense. Food prices are just as volatile as minerals. The implication of this argument is that we should all retire, allow our currency to collapse so farmers can have an easy time. Mineral prices are volatile because of historically poor price discovery. Markets are getting better at forecasting future prices & responding to demand. We need to remember that high prices are needed to foster new capacity...in fact over-capacity is good because it results in development of stand-by mining projects ready to match future demand.
The mining boom’s effect on our exchange rate has made it much harder for our agricultural and manufacturing sectors to compete internationally. Manufacturing benefits from being able to import cheap raw & semi-finished products, which offsets the impact of lower prices for finished product. It also benefits from strong local sales, and the ability to buy/develop manufacturing capacity offshore.
Furthermore, our exchange rate is excessively volatile because we are a small country...one of the smallest with a free-floating currency and good sovereign risk rating, up until it was undermined by Rudd's new tax scheme. We are also a speculators delight for that reason. i.e. Carry trade with yen.
What will replace mining if we sabotage the industry. Look at the high unemployment in NZ for a sense of why NZ'ers migrate to Australia, and what the impact will be if we do the same. Mining creates few direct jobs, but look at the indirect impact.
"There seem to be hardly any credible economic arguments against this tax. The only cries I’ve heard from Abbott on this are that it will decrease the value of super investments and that it will force mining companies overseas".
The most pertinent argument is the fact that the tax proposal and possible execution have caused great loss of wealth to investors without any warning. Mining sector investments embody assets valued on the basis of future earnings. The upside has been trimmed, and thus their net present value (NPV) cut accordingly. The types of governments that perform such actions ought to be recognised as fascists.

"The share prices of mining companies may take a small hit, but because they’re only hit with the tax when they are making large profits, they should still maintain relatively high share prices. If anything, the tax will help stabilize their share prices at a stable and consistent level of growth".
Investors buy mining stocks despite the VERY High risks...those risks are offset by commensurate attractive gains, which are often already moderated by govt taxes, existing resource taxes, infrastructure demands, exploration costs, pre-mining, high costs. Take away the upside and investors will buy government bonds, which do not create wealth. Shareholders don't buy shares for stability, they buy risk-free bonds for that. Rudd and his supporters lack a basic understanding of finance. I might add that Rudd has increased the risk and cost, so now we need a higher return, so he should reduce the tax rate now.

"The offshore outsourcing argument doesnt make any sense at all when talking about the mining industry. Labour intesive jobs, like telemarketing and computer programming can be moved overseas, but our soil cannot be moved. So long as Australia holds such a large share of the world’s minerals, mining companies are going to continue to mine on Australian soil".
Yes, for some commodities the Australian government has the power to use extortion to tax miners because they can't move their mining projects (i.e. tax). Should they be allowed to tax you higher because your company cannot post you overseas. Should Google pay just 0.1% tax and miners 53% because they have no choice. Sounds awfully like slavery.

"The finite nature of resources means the price is going to keep on going up and up in the long term, until eventually we run out of it all".
Actually the long term trend in metal prices is down. This is mostly due to competition and productivity gains from ever-more efficient mining practices. It will rise for a few years because of the insatiable demand of China, India and others, but supply will respond. Metal prices will be higher if the government applies the proposed imposts, and that will flow through to higher finished product prices. But it will not be an efficient allocation. Metal prices were down for 12 years before they rose. Mining is not always profitable...so it may well be a protracted drain on the economy. More importantly, no one is served by governments making commercial decisions. Remember when the NSW state government locked itself into expensive power contracts.
Resources are not really finite since resources are conditional or contextual. It depends on price. If there is a demand, they will be found, whether in lower intensity consumption, recycling or lower grade deposits, or even substitutes.

"The tax is to pay for the stimulus package, and consider this a perfect example of counter-cyclical fiscal policy. It is wholly appropriate for our government to spend in the slumps to hold up the economy and save in the booms to reign it in".
This is of course the wonderous Keynesian economics which is failing us because politicians have no self-restraint. i.e. The governments of most Western countries are indebted at the end of the current 20-year protracted cycle (1988-2008). Australia is slightly better (just 60% public sector debt of GDP) paradoxically because of mining. Thank you miners. We love you so much, we thought we'd kick you in the teeth for the risks you take.

"I am worried that this tax is being used to fund other government expenditure and it might make Australia’s budget particularly vulnerable to fluctuations in global demand. Do you think this tax will make any future GFC-style loss of revenue (causing a budget deficit) more likely or more severe?"
Good point. The govt wants to opportunistically lock in some of the gains from China & India demand expansion. The problem is that no market expands as you want, so the Aust govt is taking an investment gamble. More importantly, it is adopting the policy relatively late...the boom started 10 years ago. Once again miners & shareholders will pay if he gets it wrong because he will AGAIN chop & change his arbitrary tax.. Investors will just ignore the sector. Australian mining depends on foreign capital. If we don't use foreign capital, projects don't get funded, as Australian fund managers would otherwise be over-exposed to the resources sector.

Source of these posts comes from http://thebrisbanite.com. Amended for brevity.
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Author
Andrew Sheldon
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