The Energy Report: Your firm has been in the investment business for over 120 years. Can you give us an overview of the energy markets and the challenges and opportunities that energy companies in Australia face?

Ivor Ries: Australia has historically been the quarry and energy source to emerging Asian economies. As a result, our economy is inextricably linked with the progress of China, Korea, Japan, India and the other Southeast Asian economies. Initially, we were mostly a supplier of minerals, but in recent years, the liquefied natural gas (LNG) markets have become a very large part of our economy. We have two very large LNG projects in production and a third smaller one in Darwin. Another five LNG projects are now under construction, which will more than triple Australia’s LNG output over the next five or six years.

The LNG boom has its pros and cons. The investment spending is a huge boost to our economy, but it also has caused a huge shortage of contractors and manpower. The price of labor has gone through the roof in any business related to oil and gas. An unskilled laborer working on an LNG project in Australia is probably paid somewhere between two and four times as much as he or she would be elsewhere. Australia has very tight restrictions on labor coming in. At the moment, the industry is forcing the government to change that. The government recently announced it is going to reduce the visa requirements for American and Canadian oil and gas workers, so they can help plug that gap. That would be a huge relief for the industry. We have a very heavy-handed set of regulations here, and there has been a lot of media hysteria surrounding fracking, particularly in the coal-seam gas areas and a very strong campaign to have fracking stopped. Anyone running coal-seam gas or unconventional gas here has to run through a very stringent and time-consuming environmental approvals process, which probably adds two to three years to getting a project off the ground. When it comes to the cost of getting things done, everything takes longer and is more expensive than expected. That’s frustrating.

TER: What’s the breakdown of Australia’s energy production versus its consumption of oil, gas, coal and other energy sources?

IR: The domestic market in Australia is overwhelmingly coal driven. Australia is the world’s largest seaborne coal exporter, and our domestic power industry runs about 80–85% off coal and to a smaller extent off hydroelectric power and gas. Cheap coal gives us very low-cost baseload power across the entire economy. A population of only 23 million (M) people is just not enough to create a significant market for gas, and that has resulted in a terrible oversupply. Until we started shipping LNG, gas prices were incredibly low. We’re just now starting to see the connection between the domestic gas price and export prices. Typically, for the last five years, the price for gas on the east coast of Australia was about $3.50 per million British thermal units (MMBtu). Now we’re starting to see some longer contracts being signed at about $7–8/MMBtu.

TER: Do LNG exports offer a big potential opportunity?

IR: Yes. In Australia, unlike the U.S., the mineral resources belong to the government. So the people who own the land do not own the minerals underneath. In the States you have the overriding royalty system where the landowner typically gets a percentage of the production. Here in Australia, the state government gets a royalty that is typically about 10%. The net cost of producing coal-seam and conventional gas is very low. There is a good network of pipelines on the east coast for moving the gas around where cash production costs, particularly from the better coal-seam gas fields, are typically less than $1/MMBtu. That’s very cheap. With an LNG plant, the price is now around $12–13/MMBtu. Even after the pipeline charges and the LNG plant operating costs, that is quite a big margin. In the recent years, we’ve had quite a lot of consolidation with global names buying up the smaller coal-seam gas players to increase their reserves and have a bigger stake in LNG.

TER: Are most Australian energy companies geographically diversified with operations in other countries?

IR: Our bigger companies here tend to be multinationals, like BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Rio Tinto (RIO:NYSE; RIO:ASX) and Woodside Petroleum Ltd. (WPL:ASX). The Australian market is so small that to grow beyond a certain size, you have to become multinational in some way. The next tier down is a huge drop in terms of size. Our biggest pure domestic gas play is probably Origin Energy Ltd. (ORG:ASX). It has about a $16 billion (B) market cap.

TER: About how many energy-related public companies are there in Australia?

IR: There are a lot. Our market is a bit like Calgary in that we have a lot of really small exploration companies here. There are probably more than 250 listed energy companies on the Australian Stock Exchange (ASX).

TER: You have a fairly broad range of companies in your coverage list in terms of stage of development, type of business and the price of the stock. How do you decide what companies you want to cover?

IR: Many companies are working on a lot of small things. Our chief criteria is the company has to be involved in pursuing one or more core projects where the central resource is at least 100 million barrels oil equivalent (Mboe). Otherwise, there’s no point. Companies chasing smaller projects tend to burn through shareholders’ capital and then ask for more. We figure if you chase a 100MMbbl target and you derisk it, you may not actually produce it, but someone will come and pay you some real money for it. So that’s the first criterion. The other criterion is the quality of the management. Once we feel comfortable in that area as well, the company goes onto our coverage list. But as you can see, there are not many.

TER: What are your favorite companies right now?

IR: The ones that stand out to me at the moment are companies like Karoon Gas Australia Ltd. (KAR:ASX), which is a midsize explorer/developer with an LNG project in Australia and a huge exploration project ahead in Brazil. Molopo Energy Ltd. (MPO:ASX) and Red Fork Enegry Ltd. (RFE:ASX) are essentially American companies that happen to be listed on the ASX. Molopo has acreage in the Bakken in Saskatchewan, Canada and a project in the Wolfcamp play in the Permian Basin in Texas. It has about 25,000 net acres in Texas. We’re very excited about that. Red Fork has about 75,000 net acres in the Mississippi limestone play in Oklahoma. It has been getting some good results from its early wells there. We think these stocks are all very undervalued relative to the size and quality of the land positions they have. The next 12–18 months for all three will be exciting because they have a lot of wells going in and production will be ramping up. If they get a reasonable run of drilling success, their share prices will be significantly higher than they are now.

Molopo’s Wolfcamp drilling areas are surrounded by a lot of very big players getting some really good results. These include EOG Resources Inc. (EOG:NYSE), El Paso Pipeline Partners L.P. (EPB:NYSE), Approach Resources Inc. (AREX:NASDAQ), ConocoPhillips (COP:NYSE), Pioneer Southwest Energy Partners L.P. (PSE:NYSE) and Devon Energy Corp. (DVN:NYSE). On some of their better wells, those guys are getting over 1.8 Mbpd from long laterals. Molopo has drilled three short lateral wells so far, and all have flowed oil. It is about to crank up production and put in somewhere between 8 and 10 wells there by year-end. Long, lateral wells will target much higher flow rates than achieved to date. As the company derisks the project, the market will really appreciate that asset.

TER: What about Red Fork?

IR: Red Fork is up in the Mississippi limestone area in Oklahoma. That’s a real hotspot, and the last time I looked, there were 240 drill rigs running in the area. Red Fork is run by some very experienced oil guys out of Tulsa. It’s had a couple wells on pump so far and has been getting some nice oil flows, and is about to crank that up. Red Fork has a very big land position. It will be getting a big following from the States as its production cranks up, going to somewhere between 10–12 wells this year. Toward the end of the year, I wouldn’t be surprised if its production was getting close to 2 Mbpd.

TER: Does that hold up or does it taper off relatively quickly?

IR: Because it has so much acreage, it will just keep drilling. I think it will eventually have more than 300 well locations that it can drill there. It will certainly be able to grow its production by just steadily increasing the footprint there. Its neighbors are getting 30-day initial production rates around 350–550 bpd on pretty low-risk wells. If it can string together a whole bunch of those, we think it will then be seen as a serious company. At the moment, Australians see Red Fork as purely speculative and they haven’t really bought the story yet.

I should talk about Karoon Gas Australia Ltd. for American investors. Over the years, it has looked long and hard at whether it should actually be listed in America simply because the Australian market is probably struggling to value it. It has three projects, including a huge gas condensate field discovery in a joint venture with ConocoPhillips in the Browse basin off the northern coast of West Australia. That’s the Poseidon fields, which have estimates ranging anywhere between 3 trillion cubic feet (Tcf) and 15 Tcf gas, with a P50 estimate of around 7 Tcf gas, and a reasonably high condensate cut in that. It’s drilling another five wells there with Conoco this year to get it to the point where it can have bankable reserves and then start going out and looking for customers. It’s not really an exploration project anymore, but more of an appraisal development-type thing. It will require very big capital and a contract offtake for at least 4 million tons (Mt) LNG before that project will stand up. We’re talking an $18–20B capex to get that project up and going. Karoon is the junior partner in that. It originally scoped it, found it and then took it to the market, and Conoco farmed into it. Since then, it’s just working it up to the point where it can start signing up customers. That’s its number-one project.

The other two projects are in Brazil and Peru. In Brazil, it won five blocks in a government tender two years ago. It has spent a huge amount of money and time on 3D seismic and developed a large number of 200–300 MMbbl targets there, which it will start drilling in the second half of this year. This is a very high-impact exploration program. Before it does that, Karoon is almost certainly going to farm it out to a larger player because it lacks the people and manpower to carry out a project of that size alone. Degolyer & McNaughton have done some work on this and estimate around about 900 MMbbl potential in those five Karoon blocks. So we’re expecting a strong interest in it.

TER: So that amounts to about $90B in the ground, correct?

IR: Yes. These are huge targets in not terribly deep, but not shallow water, either. These are $80–100M wells, and Karoon will be looking for someone to make a commitment to at least three wells and fund its back costs. Anyone coming through probably has to have a check in their pocket for $500M. That farm-out process is now almost complete with the partner announcement expected around mid-May, and drilling starting in the second half of the year. It already has a drill ship contracted so whoever buys into it is getting a fully worked-up project and it’s going to get instant excitement as soon as it buys.

In Peru, Karoon has some onshore and offshore leases with potential for up to 700 Mboe. Again, it’s looking for farm-in partners for that. The approval will probably come out toward the end of the year. This is a company that is chasing really big, high-impact projects. The stock is generally not held by Australian institutions. Most of the non-aligned shareholders are American pension and hedge funds and high net worth individuals.

TER: So it is definitely working in elephant country.

IR: That’s right. With these sorts of companies, the only way you can value them is by applying a probability or a risk factor to the chance of success. Poseidon is definitely a project. We just don’t know how big or how valuable it is. You have to apply some probability to the rest of the stuff. We end up with a valuation range of between $7.04 and $17.35/share. It is about $6 at the moment. Our midpoint value is $12.20. These are risked valuations with pretty heavy risk factors so if one of these things in Brazil, in particular, turns into a discovery, then obviously that valuation would increase very dramatically. It’s a high-risk, high-reward kind of stock, not for the faint-hearted.

TER: Are there any other companies you’d like to talk about or mention?

IR: In big-cap land, Origin Energy has been a great performer over the years. Its share price is really suffering at the moment because the market is so concerned about cost blowouts on LNG projects. It’s building a $20B LNG project with Conoco up in Queensland. Because other project costs are blowing out, the market is very wary, and its stock has really been sold off over the last 12 months. We think it’s really an excellent company, with about $2.5B/year cash flow from its domestic operations. It’s a really great business that’s been one of the best performers in the Australian market for as long as it’s been listed. If anyone wanted to play the big and liquid way, certainly Origin would be the standout.

TER: How would you summarize the big picture on energy investment opportunities in Australia?

IR: We think there is certainly a lot of value in Australia. Our market is somewhat thin and illiquid, so we don’t have the depth of analysis. We have a lot of companies often holding U.S. assets, which actually trade at a huge discount to what they would do in their home market. If you’re selective, you can find some real bargains here.

TER: Thanks again for joining us today

IR: Thank you.

Ivor Ries is a senior analyst and director of industrial research at E.L. & C. Baillieu Ltd., a long established stockbroking firm with offices in Melbourne, Sydney, Perth, Bendigo and Newcastle. Ries joined the world of stockbroking in 2001 after a 22-year career in media, included reporting and commentary roles with The Age, Business Review Weekly and The Australian Financial Review. Ries joined E.L. & C. Baillieu in July 2001. The firm specializes in research and corporate advice for medium-sized industrial and resource companies and counts many of the country’s major institutional investors as clients. Ries’ areas of specialization are utilities, oil and gas and online media and e-commerce. A native of Queensland, Australia, Ries lives in Melbourne with his wife and daughters. He is a Brisbane Lions supporter.

The Gold Report: Richard, at the Gold Symposium in Sydney, Australia, last November, one of your charts tracked the erosion of U.S. dollar purchasing power. Can you give us a summary?

Richard Karn: It’s interesting that if you go back to the late 18th century, the dollar has been on the gold standard roughly the same amount of time it has been on the Federal Reserve System, which presents us with a wonderful opportunity to compare the dollar’s purchasing power over time.

Throughout the 19th century with all of the booms and busts, the wars, and the incredible territorial and industrial expansions, the dollar maintained its purchasing power very well on the gold standard. Since 1914, when the U.S. went to the Federal Reserve System and especially since it has become a purely fiat currency system since closing the gold window in 1971, the dollar’s purchasing power has collapsed. Under the Fed’s administration, the dollar has lost well over 95% of its purchasing power.

We show this chart in our presentations, pointing out that the purchasing power of the dollar on the left scale is in log format while the GDP, M2/M3 and Public Debt figures are in linear format on the right scale. Our intention here is simply to highlight the explosion of nominal GDP, M2/M3 and Public Debt corresponds with the collapse of the real purchasing power of the dollar that attended the end of any pretense to adhering to a gold standard in 1971.

However, in order to dispel any accusations of bias, here is the same data in log format on both scales: the take-away is still that the explosion of nominal GDP, M2/M3 and Public Debt corresponds with the collapse of the real purchasing power of the dollar that attended the end of any pretense to adhering to a gold standard. If anything, to mathematicians the chart is even more damning.

While public awareness of this problem has grown steadily for 40 years, grassroots objection is just now reaching a critical mass, especially among the younger followers of presidential candidate Ron Paul. That is why Federal Reserve Chairman Ben Bernanke, in reaching out to the next generation of leaders with his series of university lectures, is disingenuously making a point of damning the gold standard for its “volatility” while utterly dismissing the simple truth that at least on the gold standard the dollar retained its purchasing power over time, something the U.S. dollar under the Federal Reserve Bank’s stewardship unequivocally has failed to do.

In 1914, the U.S. moved away from the gold standard and into a financial system based on debt and ever-increasing monetary inflation; the transition was completed in August 1971 when Nixon ended dollar convertibility into gold, and John Connelly famously told concerned European bankers, “it’s our currency, but it’s your problem.”

What has emerged is a system under which people earn more nominal dollars of less real value, which disguises the loss of real purchasing power. For four decades, real wages have not kept up with the rate of inflation. Savings have been drawn down and the standard of living in the U.S. has declined. As a consequence, debt levels have soared.

The Fed is targeting inflation rates of 2% to 3% per year, which roughly equates to the inflation rate Americans experienced under the gold standard over the entirety of the ninteenth century. We have long suspected that this figure was chosen because the Fed believes that is the threshold people will tolerate being stolen from their paychecks without complaint. But 2% to 3% inflation compounded annually over the course of a 35- or 40-year working career amounts to a massive loss of purchasing power as well as fostering a false sense of security regarding one’s financial situation.

This is a very sophisticated swindle, and all of the powers of government are being brought to bear in order to hide what they have done or to deflect blame, but they are increasingly being cornered by demographics. For most of their working careers, people are too busy earning a living and raising a family to take the time to monitor what monetary policy was doing to their life savings and the retirement they envisioned that they can no longer afford.

TGR: And now the largest wave of retirees in American history is about to have a nasty suprise?

RK: Exactly. Retiring Baby Boomers are discovering they have been duped and that their golden years have been confiscated by a government they believed was serving their interests—and this largest cohort of the population, as well as an increasing number of young people facing a very bleak future determined for them before they were born by deficit spending politicians and their social welfare programs that have simply run amok—are saying “We’re mad as hell, and we’re not going to take it anymore.”

I believe that when you see the radical left in America as manifested by the Occupy Wall Street movement marching right by the radical right in America as manifested by the Tea Party movement effectively mouthing the same slogans, and seeing their ranks swell with retiring Baby Boomers, change is at hand.

The United States has a history of reform, of “throwing the bums out,” and we think it likely that time is at hand once again.

To be clear: we think this is a good thing, a cleansing thing, that will lead to better lives for the mass of Americans.

TGR: You dubbed the destructive course of fiat currencies and sovereign debt levels the “global pandemic of corruption” and suggested that if people want to grow wealth in a negative real-interest-rate environment they must speculate. But where?

RK: In a negative real-interest-rate environment, if you do nothing, you lose money because the purchasing power of your money is in perpetual decline. But where should you invest? At The Emerging Trends Report, we are students of history, and what is transpiring today is not new—in fact, it has happened hundreds of times before, just not on a global scale. History tells us there has never been a successful fiat currency—every single one has failed for exactly the reasons we are experiencing firsthand today. Over time, a fiat currency’s purchasing power is utterly destroyed by politicians. So obviously, we like gold and silver, which we will come back to in a moment.

Under a fiat currency regime, the rubber always meets the road at real assets, particularly resources, which simply cannot be conjured with the stroke of a few computer keys.

First, we like oil and gas. If there are two aspects of the U.S. economy that still represent American innovation and entrepreneurial spirit, it is technology and the oil and gas industry, the latter of which is frequently overlooked as a technology play. America does oil and gas better than anybody else. Having natural gas at $2.50 per million BTUs may be the most important competitive advantage America has been legitimately afforded since World War II. It would be foolish not to take advantage of it, and we think the market will overcome the array of bureaucracies aligned against it.

Second, we like large, job-generating, economy-enhancing infrastructure projects, in particular oil and gas pipelines, the rebuilding of the North American electrical grid, and water and wastewater treatment plants—as well as the engineering and construction firms that will make it happen.

American politicians of all political stripes have neglected the maintenance, replacement and expansion of U.S. infrastructure for the better part of 30 years, preferring to kick the infrastructure can down the road while promoting pet vote-buying projects, but we have reached a point where that is no longer possible—we’ve run out of road. We have gas lines exploding, massive sink holes or subsidence from water main leakage, and a rapidly increasing incidence of brown- and black-outs.

This infrastructure program will drive the third and most speculative theme: specialty metals, all of which are leveraged either to technological advance, or the base metals upon which a domestic infrastructure rebuild program will rely.

When the U.S. goes into the market for the materials to undertake this rebuild cycle, prices will take off because there is far less of these specialty metals available today than people realize, and they are harder and more expensive to extract, process and bring to market. The upside on these metals is truly stunning.

And of course, we like gold and silver—the ultimate anti-fiat currency.

TGR: You’ve spent a lot of time in Australia looking at precious and specialty metal projects. Tell us: the success of the Australian mining industry has helped raise the Australian dollar against the U.S. dollar. What effect is that having on the mining sector?

RK: First and foremost, it is undercutting the mining industry’s profitability. Because gold and silver are priced in U.S. dollars, the Australian dollar, in which they incur operating expenses, is going up against the U.S. dollar, despite various

hedging strategies, profitability has not matched the increase in the price of gold or silver.

People in North America do not realize how difficult it is for small Australian companies to get financing. As a result, companies fund themselves by issuing shares. North American investors see an Australian company with half a billion shares out there, selling at $0.09, and they assume this is bad management, when in reality equity dilution is often a matter of not having another course available to them.

In response to the prolonged dearth of financing, which actually predates the global financial crisis, we are starting to see more medium and large companies buying smaller companies with good deposits with equity, or company scrip—the corporate equivalent of fiat currency. I believe we will see an acceleration in this trend over the next 18 months with premiums ranging from 30% to 70%.

The problem for the acquiring medium and large companies will be how much equity dilution their shareholders will tolerate before there is a backlash.

TGR: Do you particularly like gold companies in this regard?

RK: Absolutely. This trend is especially prevalent in the Australian gold sector.

TGR: Have there been any recent discoveries in Australia that have investors and the mining sector excited?

RK: I’d say over the course of the last year Northern Star Resources Ltd. (NST:AUX) and Gold Road Resources Ltd. (GOR:ASX) have probably caused the most excitement. We plan to visit both soon. Gold Road has what may prove to be a whole new gold region called the Yamarna Belt, north of the Tropicana project in Western Australia. We also want to take a look at Silver Lake Resources Ltd. (SLR:TSX), Ramelius Resources Ltd. (RMS:ASX), which is the highest grade gold mine in Australia, Alacer Gold Corp. (ASR:TSX), and dozens of others.

In fact, we’ll be spending the majority of the next 18 months in Western Australia to do exactly that.

TGR: Your newsletter has a bias for historic gold producers. Can you give us some names?

RK: I’ll give you two with interesting stories. The first is Morning Star Gold NL (MCO:ASX), a narrow vein gold mine at Woods Point in Victoria. Western Mining ran it for 25 years, and took out 25,000 to 28,000 tons of ore each year, grading 27 grams of gold per ton (g/t). Then it stopped production, not because the grade was declining or they were running out of ore but because the fixed price of gold was undermining profitability, and management decided to go chase nickel during the Poseidon Boom in the 1960s—they simply closed all six of their eastern gold mines.

After overcoming a host of obstacles, management has been very good at communicating with shareholders on its website. Morning Star has finally concluded the majority of its capital spend and has brought the mine back into production—albeit more slowly than anticipated. It has a 900,000-ounce (oz) resource with considerable exploration upside.

It’s been a “hard slog” for the Morningstar crew, but things are finally coming together. It is building toward production on multiple fronts and drilling on a couple of new reefs. One interesting anomaly Morningstar is experiencing as it resumes production is that it is finding that the final ore grade reconciliations differ from the on-site estimations, often coming in 2–4 times higher, which is consistent with historic production and should be reassuring for shareholders.

While the Morning Star mine itself will be profitable, I think the upside for shareholders will be found in the myriad historic sites spread over its 200 square kilometers of tenements in the Woods Points region. Historically, mining operations throughout the Jamieson-Walhalla Synclinorium lacked the capital to operate below the weathered zone of the countless dykes in the region. Of the hundreds of mines that were sunk in the region, only three raised sufficient capital to go below the water table with mechanization. So Morningstar has all of these targets where gold was found and extracted, but only very superficially, which we think presents a remarkable opportunity.

TGR: What are the cash cost projections?

RK: I think the company is using $750/oz all-in cash costs.

TGR: Do you think that is on the high side?

RK: No. There is a lot of fancy footwork being employed in annual reports in the gold sector. When I say all-in costs, I mean everything, including administration and exploration. I wouldn’t be surprised if the all-in cost of gold production industry-wide right now is really in the vicinity of $1,000/oz.

TGR: And the second name?

RK: Cortona Resources Ltd. (CRC:ASX), which is developing Dargues Reef, located about 60 kilometers (km) east of Canberra, the Australian capital. The large tenement package Cortona controls encompasses the majority of the sites of the biggest gold rush in New South Wales history, during which miners recovered 1.2 million ounces (Moz) of alluvial gold.

Dargues Reef may be the source, or one of the sources, of all that alluvial gold, the literal motherlode, but because of the remoteness at the time and the processing technology of the day, old-timers were unable to mine Dargues Reef economically.

Cortona has come up with a very good, and very unusual resource, in that it has an unusual uniformity grade of 7.4 g/t. To date, Cortona has also found two other geological formations exactly like Dargues Reef, which may create tremendous upside.

This is the first new gold mine to be permited in New South Wales in more than seven years and represents no mean feat. Cortona’s management has been actively engaged with the community and environmental groups for a number of years, and I think they really should be applauded for their efforts. If Cortona finds the source of that 1.2 Moz of alluvial gold, it will be opening up a new gold field in New South Wales of all places, one of the more populated areas in Australia.

TGR: Do you expect issues with permitting a bigger operation?

RK: One of the “nice” things, from an environmental point of view, about an underground narrow vein operation is that it has a very small environmental footprint. In the case of Dargues Reef, about half of the gold will be recovered by simple, unthreatening gravity separation, and the remaining concentrate will be trucked to a carbon in leach (CIL) plant 400km away.

TGR: Do you have any parting thoughts on precious metals in Australia?

RK: Australia is a safe country. It has very good miners and very good geology. We see an absolute wall of money headed Australia’s way at some point because the worse the sovereign debt and sovereign risk issues get, the more people will pay a premium for safe countries in which to operate. That pretty much sums it up.

TGR: Richard, thank you for your time.

RK: It’s been a pleasure.

Richard Karn, managing editor of The Emerging Trends Report, has a broad, multi-disciplinary background, industry contacts, and a working knowledge of these metals as well as considerable research, analytical and writing experience pertaining to them. His firm has published nine Emerging Trends Reports, which were updated in the aftermath of the global financial crisis and published in the form of an eBook, Credit & Credibility. For more than two years The Emerging Trends Report has been conducting a boots-on-the-ground survey of Australian precious and specialty metal projects. If you would be interested in participating in the exciting venture, please contact Karn at rkarn@emergingtrendsreport.com.

• The Squid goes long on copper and I must say that I agree with them. I think I would be able to build a strong case for a long copper position in the second half of 2011.

• Simon Ward gives us some bad news on China in so far as goes his view that inflation is likely to stay higher for longer (a whiff of India here?) and thus how it is not yet all engines go in the great East. I would have mapped in a relative acceleration in H02-2011, but I might have been too optimistic here

• Global Macro Monitor peruses yesterday’s risk bounce and asks whether it is now all over for risk-off.

• Volume of house sales leads house prices in Australia.

• The ERCI says slowdown but no recession in the US. How much more deterioration would it take for them to push the R-button?

I find the sentiments in the quoted passage objectionable for two reasons. First, preventative health care is not ‘everyone’s business’. Individual adults have primary responsibility for their own preventative health care because no-one is better able to exercise that responsibility than they are. Individuals who are persuaded that preventative health care is a collective responsibility could be expected to look increasingly to the various levels of government, non-government organisations, health professionals and practitioners, communities and families – everyone except themselves – to accept responsibility for what they eat, drink and inhale.

Second, the goal of making Australia the healthiest country by 2020 is being put forward as though it is self-evidently desirable collective good that should be pursued by any and every means available to everyone. The goal is not self-evidently desirable. Individual health is not a collective good. And the end does not justify the means that are being proposed to pursue it.

If you delve behind the spin about making Australia the healthiest country by 2020, the underlying goal seems to be to raise average life expectancy in Australia to the highest level in the world by reducing the incidence of chronic disease. What does this entail? It would be hard to object to the goal of enabling individual Australians to reduce their risk of chronic disease. The problem is that the government’s strategy is more about achieving national goals than providing better opportunities for individuals – more about behaviour modification than about ‘enabling’ individuals to reduce their health risks.

The government claims that analysis of ‘the drivers of preventable chronic disease demonstrates that a small number of modifiable risk factors are responsible for the greatest share of the burden’. The behavioural risk factors led by obesity, tobacco and alcohol apparently account for nearly one-third of Australia’s total burden of disease and injury. The chronic conditions for which some of these factors are implicated include heart disease, stroke, kidney disease, arthritis, osteoporosis, lung cancer, colorectal cancer, depression and oral health problems.

Since these risk factors stem from individual lifestyles it is obviously desirable for individuals to be aware of them. There may be a role for governments in provision of this information. Perhaps governments should also be involved in helping people in various ways to live more healthy lifestyles. It is questionable how far governments should go down this path, but it is difficult to object to modest efforts by governments to improve opportunities for people to live healthier lifestyles.

However, rather than helping people to help themselves the federal government has chosen the path of Skinnerian behaviour modification. It has chosen to drive changes in behaviour through what it describes as the ‘world’s strongest tobacco crackdown’. (This is one instance when I hope the government doesn’t actually mean what it says – some people in Bhutan have apparently been jailed recently for possession of more than small amounts of tobacco products.) The government’s strategy also involves ‘changing the culture of binge drinking’ and ‘tackling obesity’, but in this post I will focus on smoking.

Some of the tactics being used in the tobacco crackdown involve information and persuasion but there is also an element of punishment involved. The tobacco excise has been increased to over $10 for a packet of 30 cigarettes and legislation is proposed to require cigarettes to be sold in plain packaging. It seems to me that this amounts to persecution of smokers and their families. It will reduce the amount of household budgets available to be spent on other products and encourage some to avoid excise by obtaining tobacco from illegal sources.

As a former smoker, I am probably more strongly against smoking than most people who have never smoked. I encourage other people to quit smoking and discourage young people from taking up the habit. But having given up smoking several times, I know how hard this can be. Governments have no basis on which to judge that people are not in their right mind if they consider that the pleasures they might obtain from additional years of life are not worth the pain of giving up smoking.

In my view this question of whether smokers are capable of judging what is in their own best interests is at the crux of the matter. The politicians and bureaucrats who seek to modify the behaviour of smokers may see themselves as enhancing the capability of these people to have lives that they ‘have reason to value’, in accordance with well-being criteria proposed by Amartya Sen. If so, their attitudes highlight a major problem with Sen’s approach. Governments have no business deciding what kinds of lives individuals have reason to value.

Enrolling into a drug rehab program can be the hardest thing to do but it can save a life.

As you would expect this dampens the negative price spiral that can occur in countries where walk away is an option. However, consequence of this is that in the face of financial difficulties people will tend to restrict other spending and divert money to paying off the mortgage to avoid the stigma of bankruptcy (although this doesn’t seem to have bothered “former tennis ace” Mark Philippoussi) This contraction in discretionary spending acts like the “Paradox of Thrift” Terry mentions in his article.

I think Terry makes a good case that “house prices could simply slide down gently over a long period, with inflation doing most of the work of price adjustment” but he does identify four risks/shocks which could bust prices.

He notes that the RBA is between a rock and a very hard place in trying to de-bubble housing but having to increase interest rates too much to control inflation, or having to cut interests rates too much if housing tanks which will weaken the Aussie dollar and stocks as foreign investors pull out.

My view is that push come to shove RBA will cut rates and damn the exchange rate as an imploding housing market is not good for banks and the political pressure will be too intense. This will be an extend and pretend that will work for a few years as there is plenty of room to move with interest rates at the 6% level. A weak exchange rate is good for AUD precious metals prices, by the way, a sort of hedge against house price drop in a way.

I would also not discount politicians doing something stupid to “help” housing. With debt to GDP of 20% a populist call to “do something” could be made when other countries are at 100% ratios (”we have the capacity”). It will all be wasted of course but could drag the game on a bit longer.

However, as the US shows us, once you get to zero interest rates you’ve got nowhere to go and QE doesn’t help housing. Once we reach that point then we will really see a housing price crash as the boomer demographics, China slowdown and “income levels [don't] hold up relative to interest rates” factors all kick in together.

To sum up my view on house prices, “It Won’t Happen Overnight … But It Will Happen” (explanatory link for non-Aussies)

The insight behind the welfare pedestal is that welfare payments can provide perverse incentives by encouraging some people to remain on welfare rather than to seek paid employment. Over the last decade or so, concern about an emerging problem of inter-generational welfare dependency (in non-indigenous communities as well as indigenous communities) has led to some tightening up in the provisions attached to unemployment benefits. It is too soon to claim that the problems associated with unemployment benefits and pretend work schemes have all been resolved, but the problems are now widely recognized and some appropriate remedial action is being taken.

The example of a government program contributing to the welfare pedestal that Pearson gives in his recent lecture, ‘Pathways to Prosperity for Indigenous People’, is family benefits. He suggests:
‘Life on the welfare pedestal in a country that distributes money through a generous family tax benefit system is quite a rational choice’ (The Sir Ronald Trotter Lecture, New Zealand Business Roundtable, 2010).

I had not previously thought of the family tax benefit in that way. I have tended to view the family tax benefit as a kind of negative income tax, providing net benefits for families with low and modest incomes. I was previously aware of adverse incentives resulting from fairly high effective marginal tax rates for people on fairly modest family incomes above the point where the means test begins to cut in (about $45,000). According to the way economists usually look at these things, however, a family with four children obtaining $19,600 per annum from family benefits has no disincentive to obtaining additional income from work of more than $25,000.

In another paper Pearson acknowledges that the absence of punitive marginal tax rates is probably not an important consideration when people in Cape York Peninsula make their decisions about how many hours of the week they allocate to work or leisure. He writes:

Pearson argues that ‘conditions and incentives to make active and beneficial life choices should apply to family payments’ even though he acknowledges that problems arise because such payments ‘are not indigenous-specific schemes’.

That poses a question: If people make the choice to live on generally available family benefits rather than to earn higher incomes, why should we view this as a problem? I see no problem in individuals choosing to live on low incomes. We should respect the choices that some individuals make to live a life of poverty (and of chastity too, if that is their choice). I can’t see why anyone should have a problem with individuals making whatever income/leisure choice that they desire.

I can see a problem, however, in governments providing family benefits to people who do not have adequate regard for the well-being of their children. I think we (taxpayers/voters) should insist that family assistance should only be provided to parents when they meet conditions such as ensuring that their children attend school regularly. Perhaps it would not be too difficult for a prime minister who has a special interest in educational opportunity to find a simple way for such a condition to be applied to family tax benefits across all sections of the community.