14/05/2013 - 09:57

No substitute for the ‘real world’

14/05/2013 - 09:57

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No substitute for the ‘real world’

Whatever else is revealed in tonight’s federal budget there is one thing I hope for – an end to the nonsense of ‘modelling’, because it is painfully obvious that modelling is nothing more than modern-day crystal ball gazing, and is invariably wrong.

A start would be to rename modelling for what it really is – guessing.

The fact that the budget will contain a big deficit rather than a once-promised surplus is a direct result of politicians believing the economic models produced by back-room economists and other stargazers in Treasury.

What the modellers did was commit the classic sin of all users of computer spreadsheets; they put garbage in and got garbage out.

The mining tax is the classic example, but the carbon tax isn’t far behind because both involved making assumptions (guesses) that were obviously wrong to anyone working in business.

With mining, an industry well understood in Western Australia, there was widespread recognition last year, and perhaps as long as two years ago, that the commodity price cycle was turning down – as it always does.

The so-called ‘super boom’ was nothing more than a somewhat longer boom than has routinely rolled through the commodity focused WA economy every five-to-seven years.

The one that has just passed was the seventh I have been through; and the experience was identical to the previous six. Euphoria on the way up as demand for commodities rises, gloom on the way down thanks to supply rising to meet demand, and prices falling, precisely as predicted more than 230 years ago by Scottish economist Adam Smith.

Unfortunately for Australia, the people who know nothing about commodity cycles, because they proudly live in non-mining states, are also the people who control the government.

What happened about five years ago is that boffins in Sydney, Melbourne and Canberra fell in love with investment bank research that predicted a ‘stronger for longer’ commodity boom, the so-called super cycle.

It was that discovery which triggered a government-spending boom before the cash rolled in from the commodity boom; another classic mistake called ‘spending it before you’ve got it’.

An interesting test of how government saw future tax revenue from the mining boom, and how the mining sector saw the future, can be found in the price of copper.

Sometimes referred to as ‘Dr Copper’ because demand for the metal can be a simple but accurate measure of global economic health (thanks to its widespread use in industries from plumbing to electronics), copper started signalling a rough ride several years ago.

After the 2008 GFC, Dr Copper crashed to about $US1.30 a pound, rebounded to $US4.50/lb and then started a long slide lower as the disruptive effects of the crash wore off and the real economy was revealed.

By last year, as the federal government was gaily forecasting a budget surplus, Dr Copper had sagged to $US3.50, on his way to a fraction above $US3/lb.

Swap copper for just about any other commodity, including iron ore and oil, and you get a similar result. Prices down as global growth sputtered and excess supply from the boom years overwhelmed demand.

With so much evidence available to people in Perth and other mining centres, it beggars belief why no-one in Canberra could see the downturn months, if not years, before it hit.

If nothing else, an understanding of the commodity cycle that is so important to Australia would have saved the farce of the mining tax (which has raised virtually no tax) and the carbon tax (which will be an equally big flop).

You can’t blame the computer models produced in Canberra for the dangerous financial position in which the Australian government now finds itself, continuing to spend on social welfare programs that the country can barely afford and unable to say where it will raise the money to pay for them.

But you can blame the economists in Treasury for not understanding the country they are supposed to understand, and you can blame the politicians for not questioning the data used by the computer modellers.

Nor is it good enough to say that Sydney, Melbourne and Canberra are too far from the coalface to understand how mining (and farming) are controlled by the global commodity price cycle.

Both guilty parties – the bureaucrats who do not understand their own country and the politicians who lack the courage to question the bureaucrats – are equally guilty of damaging Australia, largely because they did not visit the real world often enough, preferring to believe computer models.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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