Growing up it was ingrained that two topics are rather taboo to discuss at the dinner table; the first being politics and the second money. So, with the hope that you’re not having dinner as you read, this week we discuss the former while touching on the latter. Perhaps a subject that you may not be expecting to read about in an investment newsletter.
In particular, the subject we wish to explore is whether our esteemed or not so esteemed PM (depending on which side of the political spectrum you sit on) has been backfooted in formulating a national strategy with regards to Covid policy and in particular in relation to the McGowan government of WA and their stringent adherence to a 0-Covid policy (a policy that rhymes with that of Beijing one might add). So, we would like to address that topic and whether it is even the right question to ask of a Commonwealth Prime Minister? This may not seem like a topic of particular interest to the investor but bear with us and toward the end you may just understand why it does.
For the lawyers or historians amongst you, this may seem rather basic. Before proceeding further however, let's begin with the conclusion. It is a definitive no. Why? In order to understand that one needs to understand how institutional building occurred in this country.
A walk down history lane
Have you ever asked the question why we need different licenses when we cross state borders? After all, we live in the same country. This is the question that started a journey to understanding how Australia has been built. The nation and polity as we know it today is a young one, one that came into being in 1901 when six self-governing colonies decided to join together to form a Commonwealth (on a side note, Fiji and New Zealand were also initially part of these discussions before going their separate ways). A process that took close to five decades given the original idea (justified by efficiency) was drawn up by the 3rd Earl Grey (his father, the 2nd Earl Grey, being of Earl Grey tea fame according to some legends) in 1847.
The idea of federation received much opposition (justifiably so) during the initial stages given that many of the smaller colonies feared that a national polity would be dominated by the more populous states and their rights suppressed; each colony having evolved its own unique sense of identity and organically developed their own institutions at this point. It is within this context that Australia, unlike the UK with a unitary polity, developed its federal structure. A structure which, after much negotiation, was supposed to ensure checks and balances, whereby a Federal government would be curtailed to issues of national interest. The constitution specifically enumerates 39 areas in which the Federal Parliament may make laws, the most important of which is trade and commerce, taxation, immigration and external affairs. Those areas which are not specifically set out still reside with state legislatures by default. There was such suspicion about government overreach that when states decide to voluntarily delegate certain powers to the federal level out of necessity, sunset clauses (whereby they expire after a certain date) can be applied. Many may be familiar with the debate on funding for public hospitals which was a rather contentious topic what seems like a lifetime ago, in 2007. In particular, should the Federal or state legislatures bear responsibility for it. States are still responsible for health.
So, why then has the Commonwealth become so powerful? Simply put, control of the purse strings. Remember that it is the Commonwealth that has the first right to levy taxation. The most familiar of taxes, income tax, was first imposed by the Commonwealth during WW1 as a temporary wartime measure and, up until 1942, was imposed both by State and Commonwealth governments. Following WWII, the Commonwealth took over the raising of all income tax to the detriment of the states. In essence, while the states remained responsible for providing the majority of services, the revenue primarily remained with the Commonwealth. Ensuring an unequal partnership.
Aside from this, landmark decisions by the High Court have supported this power imbalance. The case in question here is the Tasmanian Dam Case (Commonwealth v The State of Tasmania, 1983), where the Hawke government prevented the Tasmanian government from constructing its hydroelectric dam on the Gordon river by using nebulously defined provisions under its enumerated powers (i.e. external affairs) and claiming the dam went against Australia’s obligations under the UNESCO world heritage program. It was a direct examination of the division of powers between the Australian federal government and the individual state governments. Part of a broader trend that sequentially ate away at state powers.
So, with that history, let's come back to the present. Asking whether our PM is showing a lack of backbone in dealing with state policies that seemingly go against the Commonwealth government's stance?
Our system and constitution, much like the US or many modern democracies, was designed with the intention of checks and balances. As it currently stands, this is a state issue and it is arguably not a call for Scott Morrison to be making. It is a choice for the people of WA, who have seen fit to re-elect the McGowan government with a resounding majority. Moreover, even the implication that a Commonwealth PM attempts to circumvent institutional frameworks and take a hardline against what has been explicitly stated as a state issue is, in our view, a dangerous precedent to set. That is not to say that the Federal government could perhaps have done more in taking a leadership position on the issue or been more or less forthcoming with support, we are not here to pontificate on that, but the issue is ultimately a state one as the Constitution of Australia is currently understood.
Our democracy may seem flawed at times, it may be that times have changed and people no longer think in terms of state identities, but the question of checks and balances should be one that is always front of mind. We’re not making a judgement but let's put forth the hypothetical that what was supposedly said by Cabinet members in recent text messages is true and we do have a so-called “psycho” or “liar” running the country. The very framework that seems so blatantly inefficient at times is also one that protects us. This isn’t an issue unique to Australia, we don’t need to go into the issues around the US political system and how their checks, balances and inefficiencies in dividing state and federal power are probably in need of review. None of these systems of government are perfect.
So, why should we care about this as investors?
In our view, we see the rhetoric and the positively vitriolic debate, as well as a blatant mistrust of institutions, as a potentially dangerous move for the investor. And one which the investor must always be cognizant of. Larger global institutions like the UN, EU and WTO may be flawed, our Federal structure may be flawed but one must remember why they were created in the first place. The first two institutions, over-simplifying things a touch, so that we don’t kill off each other at an egregious pace. How often were all out wars fought in Europe pre-EU and how often after? The drop off is remarkable. The WTO may also seem flawed but, again, how many trade wars and nations undertaking beggar-thy-neighbour mercantilist policies did we have preceding its creation and how many after.
For every failure of the rules based democratic institutional framework, there are countless other success stories. For every China that didn’t follow the path, there is a South Korea, a Taiwan, a Japan etc. The spectrum is broad.
So coming back to the local context, next time you get frustrated perhaps ask your Premier or your local representative? Too much has been lost and countless sacrifices made for our democracy, whatever its flaws may be.
As for the protests and the countless ethical and social questions, this particular author would be more concerned if there were no protests at all. Whatever your view may be on the validity of the opinions of the participants. If one truly believes that there is government overreach (whether in reality or not) and does not do anything about it, that is arguably more dangerous for democracy than anything else in a given democracy. It would be fantastic if we could vote on every issue and live in a true “democracy” (not a guarantee that anything would be or have been different) but this simply isn't feasible or efficient. It was even less feasible when many of these systems/democracies were formulated (think about how technology and communication has advanced). Hence functions like three, four, five year election cycles. Modern democracies are a compromise of efficiency and democracy and the checks and balances that surround this.
So no, whatever Mr Morrisons faults may be, an unwillingness to bully states as a Commonwealth PM in a Federal structure is not one of them. If you expected him to do so because you don’t necessarily agree with what your state governments are doing, then ask the question (at the risk of making a slippery slope argument), if the Commonwealth steps in on this issue, where will it stop? Were income taxes not meant to be a temporary measure? We all know how that went. If you think they were, do reach out, it would save us a lot of helpless despair and tears during tax season.
Coming back to investment markets, we feel that this is one of the biggest risks you should be aware of. The gradual decline of institutional trust and the frameworks that helped us all as investors see phenomenal returns were made possible precisely because of this context. Have you ever wondered why, despite a 0.1% cash rate or laughable interest rates across most of the developed world, investors still pay a premia to park their funds there? It is a trust in the institutions. Consider even a mining company with operations in say Guinea with the same economic metrics as one in Australia, the differential in valuations are astounding.
It may seem that we are drifting away from the original question of the Morrison government and its stance, but we see this as a broader tendency (and a global one at that) which questions the very foundations of our so called neo-liberal world order. Every little instance, such as a Twitter feed, matters. This, in our view, is one of the greatest long term risks for the investor. One that much be watched carefully.
We may feel frustrated, we may rant, the alternative for the investor is the differential in valuation between an Alibaba and an Amazon. It is precisely the reason why Gazprom, despite arguably better metrics, does not have the same value as an Exxon Mobil. The protection of the rules based global order is the single and most important aspect of the global economy.
Still can’t accept this notion? Consider Ukraine at the moment. What most people consider when looking at this story is the fact that a significant amount of the EU’s gas and energy supply comes from Russia and thus any imbalance will have a significant impact on global growth. But look further, there is another story, it is a contest between a rules based, liberal democratic outcome and one expounded by Russia, of ruthless pragmatism. For the investor, consider also something that most people don’t look at. Something as simple as sunflower oil, for example. Ukraine accounts for around US $4bn in that particular export to India, stop that and you will have a significant impact upon CPI data with flow on impacts on monetary policy. Flow on effects on monetary policy means asset valuations and growth. Say India’s growth slows as a result, what is the effect for you as an Australian investor? Ask the question what is the eventual impact for commodities such as iron ore?
This is not to say that the current institutions aren't flawed, all compromises require give and take, or that we don’t need to examine and evolve our institutions over time. But perhaps the greatest advantage of institutions is that they curtail action (it may seem inefficient and frustrating but thank god/s for that).
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