The crisis. No place for stunts.

EUROPE is sliding into recession, and the world is sliding with it. That's not all Europe's fault, but its slump will permeate every part of the world economy in some ways, adding to Australia's problems, in other ways, reducing them.

None of us can see through the fog ahead to know how bad it will be. But some things are clear. Each government is focused on its own political needs. No one seems to be in charge of the world economy. We have many politicians, but no statesmen. And we have no consensus on a solution that might work.

The critics were right to warn that Europe's past "solutions" were inadequate to resolve its problems. Instead, the problems have grown. Any solution to them now would be at the cost of the successful countries, and their voters feel they have no responsibility to bail out those in trouble. The path to a resolution is blocked by political deadlock.

The crisis in Europe is the one that could bring down the global economy. But growth is slowing around the world, and the common factor is a loss of confidence.

Last week's job figures confirm that the US recovery has lost its strength. China's housing market is in recession, driving down its manufacturing and steel production, which in turn is driving down prices for Australian coal and iron ore. India, swimming in debt and politically gridlocked, has seen its growth rate slump to a nine-year low.

Australia has its own problems. Each new data set confirms its growth is mostly in mining and related sectors, which are just a sixth of the economy, mostly in Queensland and Western Australia. The mainstream economy in the south-eastern states is at best growing sluggishly, at worst going backwards.

This week brings an avalanche of data, including new figures for GDP, unemployment and the current account deficit. Yesterday we learnt corporate profits have fallen 10 per cent in six months: mostly in mining, from a high level. But in the past two years, manufacturing profits slumped 34 per cent, while manufacturers' unsold stocks rose to an 11-year high. That spells job cuts ahead.

The Bureau of Statistics does not have the data to measure states' output; it just takes an informed guess once a year. But take all the data we do have, and it suggests Victoria, South Australia and Tasmania are all going backwards. Their industries have borne the pain of the higher dollar without the gain of mining investment and boom prices. And at federal level, no one cares.

Interest rates remain far too high. Even after last month's cut, rates for home buyers, small business and depositors are at 2004 levels, when the economy was in a broad-based boom, with growth of 3.75 per cent and adding 265,000 jobs. That is very different to what we are experiencing now, or what lies ahead.

The dollar remains far too high, still 35 to 40 per cent above its 20-year average from 1985 to 2005. Yet for business, the silver lining in Europe's storm clouds has been a fall in the dollar. Since February, it has slid 10 per cent against the US dollar, and 7.5 per cent against all currencies. Unless you are travelling overseas or buying imports, that is good news, because it reduces pressure on businesses that face global competition. If it is sustained, it will save jobs and incomes, and reduce the risks facing the economy.

One of the most important and vulnerable of these is home prices. Many of us might like to see home prices fall, but you would not want to see them collapse. The RP Data-Rismark index reports that the fall in home prices is accelerating at a worrying rate: down in the year to May by 8.4 per cent in Melbourne, and 5.3 per cent nationally. When house prices collapse, they take wealth and consumer confidence with them. Collapsing house prices played a key part in the intensity of the recession in the US, Spain and Ireland. It's another good reason for the Reserve Bank to cut rates today.

We don't know how serious this will become, but it is no time for political stunts. Treasury secretary Martin Parkinson was right when he said on Thursday that in a global recession, Australia has the ability to fight back with both interest rate cuts and budget measures to defend the economy. "Our fiscal position is so incredibly healthy vis-a-vis the rest of the world that we can actually provide stimulus", he said. "We could, if necessary, actually go back into deficit to support activity."

Tony Abbott endorsed this on Friday morning, then backflipped a few hours later to declare that the promise of a budget surplus should have "no ifs and buts". Is he telling us an Abbott government would rather see Australia go into recession than run a deficit? Seriously?

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Abbott is a Keynesian, after all

WITHIN weeks of a projected surplus being announced, the political argument has quickly turned back to the possibility of the budget falling back into deficit.

The government leapt onto Tony Abbott's comment on Nine's Today that he accepted "that in a crisis the so-called automatic stabilisers will operate to change the overall fiscal position".

Mr Abbott was commenting on Treasury secretary Martin Parkinson's evidence to a Senate committee this week when he indicated Treasury had been planning what it would do if European events generated a new crisis. Dr Parkinson said that while Australia's budget position was "incredibly healthy" by global standards, if the collapse of the euro leads to panic on financial markets, as in 2008, then "it's a different world all bets are off".

"We could if necessary go back into deficit to support activity," he said.

A spokesman for Treasurer Wayne Swan said that despite all his "bluster" about deficits, "Mr Abbott is talking about being in deficit himself. Of course it's no surprise to hear Mr Abbott talking about the Liberals going into deficit given the shadow treasurer has announced a $70 billion crater in the Liberals' budget that he needs to fill to achieve a surplus."

But Mr Abbott rejected the government's interpretation of his comment. "The Coalition's commitment is to have a budget surplus in year one and subsequently," his spokesman said, claiming that Mr Swan had refused to commit to delivering a surplus this financial year.

Asked by journalists whether it would be acceptable if the government, needing to adjust to international conditions, did not deliver a surplus, Mr Abbott said later: "It's never acceptable for governments to break solemn pledges.

"This government has been pledging for months now that no ifs, no buts, it will bring the budget back to surplus. Now, they shouldn't break that commitment.

"My fear is that they are preparing the ground to abandon that commitment and, let's face it, Wayne Swan has been much better at predicting a surplus than delivering one."

Mr Abbott would allow Mr Swan no leeway if there was another global economic crisis, or another natural disaster.

"There was no fine print to Wayne Swan's commitment," he said. "There was no escape clause. He made a solemn pledge again and again to Australians that the government would deliver a surplus . . . Now for him to break that commitment would be yet another sign that you just can't trust this government to manage our economy."

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Global crisis as shares crash

GLOBAL financial markets have slid into a crisis of confidence, with depositors reportedly pulling their money out of banks in Greece and Spain, and Australia's share prices crashing yesterday in their biggest fall of the year.

More than $110 billion has been wiped off the value of Australian stocks in May, with $35 billion stripped from share values yesterday alone. The ASX/S&P 200 index fell 2.7 per cent or 131 points to close at 4026.5, its lowest level for six months.

The Australian dollar fell briefly below US98? before closing local trade at US98.18?, also a six-month low. It has fallen 9.25 per cent since the start of March, amid growing concerns about recession in Europe and a slowdown in China.

Gloomy data from China sent markets down further yesterday afternoon. Official figures showed home prices falling in 46 out of 70 cities surveyed and stockpiles of unsold cars rising sharply. Goldman Sachs lowered its June quarter growth forecast from 8.6 to 8.1 per cent, while economists from the China's State Information Centre forecast growth to fall to 7.5 per cent.

Federal Treasurer Wayne Swan last night issued a reassurance that prospects for Australia and the region remained healthy. But Mr Swan spent much of the afternoon and night on the phone with other finance ministers, debating what steps could be taken to restore confidence.

Australia is seen by global markets as a fair-weather investment. Money piles in here when times are good, and moves out when times are bad.

The plunge so far bears no comparison to the panic of September 2008, but with no light showing in Europe's tunnel, the future is uncertain.

Financial markets believe the Reserve Bank board will deliver another interest rate cut to restore confidence when it meets on June 5. It remains to be seen whether the banks will pass on all the cut to customers.

ANZ bank chief Mike Smith said Australian banks were still able to raise finance on global markets. ''European funding markets are essentially closed at the moment because of the uncertainty in Europe, however Asian and US markets remain open'', he said. ''Australian banks are well placed right now''.

Mr Swan said Australia's fundamentals remained solid.

''We have rock-solid public finances, one of the strongest financial systems in the world, low unemployment, solid growth, a massive pipeline of investment over long-term horizons, a reaffirmed AAA credit rating from all three global ratings agencies, world-class regulators, and a proven track record of dealing with global instability,'' he said.

Yesterday's market plunge was part of a global slump, after a report that nervous investors in Spain withdrew more than ?1 billion on Thursday from the troubled Bankia group.

The Spanish government, which has taken over the bank, denied the report, but shares in Bankia slumped 30 per cent.

Earlier, the head of Greece's central bank said depositors had taken ?700 million (about $A900 million) out of Greek banks after the May 6 election left the country without an elected government.

A run on the banks would create a serious risk that the European crisis could spiral out of control. The Greek crisis has left no one in charge, just a caretaker government that has no ability to borrow the funds its banks might need to survive.

Overnight in Europe, Moody's cut the ratings of 16 Spanish banks, citing the country's deepening recession and increasing losses on real estate loans. Fitch Ratings dumped Greek government bonds into a C-class rating, saying the Greek election results showed a lack of public and political support for the austerity pact the previous Greek government had negotiated with European authorities.

Investors are retreating from sharemarkets to park their money in safe places, such as government bonds, where their capital will remain intact even if the yield is low.

On Wednesday, the Australian government sold a new tranche of 10-year bonds at a record low yield of just 3.36 per cent, compared with 5.48 per cent a year ago. But yesterday the demand for bond futures was so intense that the implied yield sank to 3.035 per cent.

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Treasury chief denounces subsidies, sweeping cuts

TREASURY secretary Martin Parkinson has hit out at subsidies for industry, calls for further sweeping budget cuts, and pessimism about Australia's economic future which he says is "incredibly promising".

Appearing before the Senate economics committee, Dr Parkinson implicitly poured fuel on calls to cut government support for the car industry. But he also warned that more deep spending cuts as the Coalition proposes would hurt growth for no gain.

Dr Parkinson pointed to the recession now engulfing Europe, where governments have given deep spending cuts priority over economic growth. He warned that Europe's recession would last for years and be a source of global instability.

"If you want to be really hairy-chested about this, you run the risk of getting into quite dangerous territory," he told Liberal senator Arthur Sinodinos.

Treasury, he said, estimates the combined effect of federal and state budget cuts already will cut Australia's GDP by 4.25 per cent over two years.

Dr Parkinson said there were times when fiscal consolidation could enhance growth, when budget deficits were hurting business confidence. "But that's not the issue we're confronting here." He said the dangers of deep spending cuts were magnified when trading partners all cut spending together, as in Europe now.

"When the Greeks started, the expectation was that their GDP would shrink by 2 per cent, and they would do a fiscal consolidation of 8 per cent over three years," he said.

"Now their GDP has already fallen 8 per cent in 12 months, and the fiscal consolidation is about 25 per cent of GDP. How you can consolidate back into a sensible fiscal position when your economy is shrinking so rapidly is beyond me.

"We're taking the view that Europe is going to be both in recession and probably a source of global instability for a number of years to come."

Dr Parkinson, who had earlier attacked government intervention to support industries, repeated the attack to the committee, telling Labor senator Doug Cameron that the car industry has been receiving taxpayer support for 105 years.

In a speech on Thursday night, Dr Parkinson warned that industry assistance would fail in its goal of creating competitive advantage unless it was focused, defined and limited in its term.

"If you replace quotas and tariffs with other interventions, no matter whether to create 'national champions' or to support so-called strategic industries, you are placing producer interests ahead of those of consumers," he said. "It is still akin to protection."

Dr Parkinson told Senator Cameron, the former head of the Australian Manufacturing Workers Union, that the task was to transform the car industry and the rest of Australian manufacturing into "something sustainable" with a high Australian dollar.

"The exchange rate will threaten the viability of a whole lot of industries," he said. "If you think it's going to last for 12 or 24 years, we can't pretend that things can stay the same.

"The challenge for us is, how do we help manufacturing and other sectors transform themselves so they can cope in a world where we have a high exchange rate . . . We will end up with a very successful manufacturing industry." Dr Parkinson said the best way to do this was by improving the education system, workplace skills, management skills, infrastructure and industrial relations.

His third theme was to denounce pessimism, declaring Australia was "in the grip of unjustified economic gloom".

"It's almost as if most Australians think we live in Greece. We don't," he said. "We actually have an incredibly bright future ahead of us. Yes, there are challenges, but the opportunities ahead of us are the sort we've never seen before."

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Shaky sharemarket fails to stir economy

THE Australian sharemarket is being thrown down, then up, as fear and hope fight it out on the global stage. But what does this mean for our economy?

Most likely, not much. Markets plunge and soar, but the economy is doing neither. All this year it's been muddling along, stuck in second gear. And it will probably keep on muddling along in second gear.

You wouldn't guess that from the sharemarket. At one point yesterday, a fortnight of fear and panic had wiped about $240 billion off the value of Australian stocks and knocked trillions of dollars off global wealth. That's a big hit.

But then, sharemarket money is not real, unless you're selling. The benchmark S&P/ASX 200 index hit 6829 in late 2007, sank to barely half that in early 2009, rebounded to just under 5000 last April, then started leaking slowly, until fears over the parlous fiscal state of US and European governments turned leak into flood.

The S&P/ASX 200 index closed at 4603 on July 22, then started sinking. By Monday it dropped to 3986, then yesterday to 3766 before abruptly flying back up to close at 4035. Traders attributed the rebound to heavy buying in their own markets by the Korean and Taiwanese governments.

That's probably not the strongest basis for a rebound in Australia or anywhere else. This play could have many scenes left. Confidence is fragile, and global confidence will stay down until there is firm ground to support it.

Last week's debt deal in the US was essentially a decision by the Republicans to keep the US from defaulting on its debts, but to block any long-term correction to the US government's unsustainable fiscal course while President Barack Obama is in office.

The markets, and ratings agency Standard & Poor's, saw this as a road to ruin. The Republicans set down markers (such as preserving tax loopholes) which would equally prevent a Republican White House from getting the US back on track. The markets were falling fast even before S&P stripped away Uncle Sam's triple-A credit rating.

About time, we Victorians might say. Remember how in the '90s, the ratings agencies demoted Victoria two notches  when even under the financial foot-binding of the old Loan Council rules there was no risk of Victorian governments defaulting on debt payments?

Yet last week, the US House of Representatives went to the brink of voting for such a default.

S&P has started to apply the same rules to the US as it applies in rating other governments. It knew this would lead to turmoil on financial markets, but judged it better to pull the plug now than to keep up the pretence that buying US securities is risk-free.

Bill Gross, who runs the world's biggest bond fund, PIMCO, applauded. "S&P demonstrated some spine," he said."They spoke to a dysfunctional political system . . . they finally got it right."

Fiscally, Australia is a sharp contrast to the US. Its net debt is only 6 per cent of GDP and projected to be back in the black next year. That might prove optimistic; growth is unlikely to be as strong as Treasury projects. But as former Reserve Bank board member Warwick McKibbin puts it, "surpluses are not the be-all and end-all of policy". If things do go wrong, Australia has one of the few Western governments in a position to respond a second time.

Whether things go wrong for us will depend more on what happens in China than in the US or Europe.

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Good news for bad reason: rates tipped to fall

THE Reserve Bank will cut interest rates four times over the next year or so, as Australia slumps into a marked slowdown, with unemployment rising and consumers saving instead of spending, Westpac has forecast.

Breaking ranks with other economists who forecast rate rises and a boom year ahead, Westpac's chief economist, Bill Evans, said growth would remain stuck in second gear in 2011 and 2012 - forcing the Reserve to take back its last four rate rises.

''Interest rates are too high in Australia, given the state of the non-mining sectors of the domestic economy,'' Mr Evans said. ''A downward adjustment is required to avert a damaging round of contraction.''

His forecast comes as ratings agency Standard and Poor's warned there is now ''at least'' a 50 per cent chance that it will downgrade $14 trillion of US government debt unless Republicans and Democrats agree on a $4 trillion deficit reduction package.

If the stalemate over the deficit is not resolved by August 2, the US will run out of money and default on debt repayments. Analysts say this would trigger a second global financial crisis.

US President Barack Obama wants to cut $US4 trillion from forecast deficits over the next 10 years by cutting spending and closing off more than 150 tax loopholes. Republicans are insisting that the loopholes remain.

Mr Evans predicts that global growth will be below average in 2012, with Europe possibly in recession. Slow global growth will slash Australia's export prices and send the Australian dollar back below the US dollar.

He forecast that the Reserve would take time to concede that it had overdone the monetary tightening. But Westpac expects the first rate cut in December, to be followed by cuts every three months or so in 2012. If it is right, that would cut $250 a month off the cost of servicing a typical $300,000 mortgage, saving home buyers $3000 a year.

But what would be welcome relief for home buyers would also see widespread job losses, particularly in retailing, wholesale trade, manufacturing, non-mining construction and finance.

Westpac predicts unemployment will rise from 4.9 per cent now to 5.7 per cent within a year. That implies 100,000 more people unemployed.

''The Reserve Bank has made it clear that it welcomes softer activity in the household/housing sector to create [spare] capacity for the mining boom,'' Mr Evans said.

''We assert that it will see it is over-achieving, given that consumer spending and housing investment represent 60 per cent of economic activity, while mining investment is around 4 per cent.''

He said concerns over the carbon tax have contributed to a slide in consumer confidence, now at its lowest level since the global financial crisis.

Mr Evans said a similar slump before the GST came in lasted until some months after it had taken effect. ''With the carbon price not due to be introduced until July next year, it is likely to remain a drag on confidence for some time yet,'' he said.

The sharpest fall is in households' perception of their own financial situation. Mr Evans said households' forecasts of where they will be in 12 months' time is ''at extremely weak levels, only recorded on three previous occasions - during the recessions of the early 1980s and early 1990s, and in mid-2008''.

His grim forecast sent the Australian dollar plunging half a cent in half an hour on financial markets yesterday. Futures markets are predicting one or two rate cuts in coming months, but a Bloomberg survey found most market economists still predicting a rate rise by November.

David Jones chief Paul Zahra this week blamed the carbon tax debate for causing the worst conditions for retailers in 20 years.

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Mining boom failing to spark national economy

THE Australian economy has ended the financial year with the brakes biting hard. New data released yesterday reports lending and activity slowing, house prices falling, and job opportunities shrinking.

Separate snapshots released by the Australian Bureau of Statistics (ABS), the Reserve Bank and private research bodies throw doubt on official forecasts that the new financial year beginning today will see a boom in economic activity.

The Reserve has forecast growth of 4.5 per cent over the coming year, and recent speeches by governor Glenn Stevens and assistant governor Phillip Lowe flagged more interest rate rises ahead. Treasury is forecasting growth of 4 per cent, and more than 200,000 new jobs.

But yesterday's figures reported that:

. Net lending by the banks rose just 0.3 per cent in May, after recording no growth in April, as Reserve Bank figures show business and households remain averse to taking on new debt.

. Job vacancies in the private sector, as measured by the ABS, fell by 12,000 or 7 per cent in the six months to May, with Victoria and South Australia recording the biggest falls.

. House and unit prices nationally have fallen in every month this year, according to the RP Data-Rismark index, dropping by 0.3 per cent in May and by 2.7 per cent since December. In Melbourne, the median price fell by 1.8 per cent over the May quarter to $500,000.

. Hotels, motels and serviced apartments recorded a 0.8 per cent fall in takings in the March quarter, ABS figures show, as Australians profited from the strong dollar to holiday overseas while overseas tourist arrivals remained flat.

While the Reserve Bank would not be concerned to see little growth in debt, or house prices edging down, yesterday's figures come after broader-based measures show employment growth has slowed to a virtual standstill in recent months.

They come amid rising fears for the future of the global economy. The US government is now only a month away from running out of money, with Republicans and Democrats locked in a bitter stalemate on how to reduce the deficit.

Global ratings agency Standard & Poor's warned on Wednesday that US bonds would be downgraded to a D, or junk bond status, if it defaults on debt payments. US Treasury Secretary Timothy Geithner warns this is inevitable unless Congress raises the country's debt limit by August 2.

In Greece, Parliament on Wednesday approved an austerity package to cut its deficit but the fear is this will do little more than postpone an inevitable default, with the Greek government's debt now 150 per cent of GDP.

The domestic economy seems to have entered 2011-12 with mining construction booming but the rest of the economy sluggish. That might not stop the Reserve Bank raising interest rates again in coming months, since it believes the weakness is temporary, and next year it will need to rein in growth to stop the mining boom setting off inflation.

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Flaw found in joint plans to cut deficits

IN A finding with dismal implications for the world economy, the International Monetary Fund has found that the new wave of simultaneous deficit reductions in key Western economies is likely to be far more painful than their governments assume.

A major new IMF study tackles the hottest topic in global economics whether it is more important for the United States, Britain and other countries with high unemployment and high deficits to spend up to stimulate jobs, or cut spending to bring their budgets back under control.

The IMF research, published as an early chapter from next week's World Economic Outlook, concludes that cutting spending is the right path in the long term. But it warns that the costs will be far higher and longer lasting than some have estimated.

It tears apart two influential studies by American-Italian economists Alberto Alesina and Silvia Ardagna, which found that fiscal consolidation rarely does much short-term damage to the economy, and can even bring immediate gains. The Cameron government in Britain, and others, have cited this research to justify heavy spending cuts.

But the IMF study apart from accusing Alesina and Ardagna of choosing their examples selectively found this was true only when isolated countries carried out fiscal consolidation, when interest rates were free to fall, and a slump in domestic demand was offset by rising exports.

None of those conditions was true now, the IMF warned. It endorsed arguments by columnists Paul Krugman of The New York Times and Martin Wolf of the Financial Times that Western countries cannot collectively export their way out of a domestic slump, since most of their exports go to each other.

When isolated countries cut spending sharply, as Australia did in the late 1980s, the study found, a budget cut of 1 percentage point of GDP created a similar cut in domestic demand. But an expansion of net exports halved the GDP cost, while interest rate cuts cushioned demand.

By contrast, the costs to GDP are doubled when the rest of the world is also cutting spending, and doubled again when interest rates are already too low to allow further cuts.

Over the long term, however, the study found that fiscal consolidation more than pays for itself, by increasing investor confidence, allowing lower interest rates, and allowing governments room to cut income tax.

It found that spending cuts deliver more long-term gain than tax rises, mostly because central banks are more likely to cut interest rates to offset the impact.

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Make banks pay for risk: IMF

BIG banks with a serious mismatch between their asset and liability maturities could be forced to pay a surcharge or take out insurance against the risks they pose to the financial system, the International Monetary Fund has suggested.

In a review of the October 2008 liquidity crisis that forced governments to guarantee trillions of dollars of bank debts not least in Australia the IMF calls for wide-ranging reforms to reduce systemic liquidity risks in future.

The proposals were revealed overnight in a chapter released early from its Global Financial Stability report, to be published next week at the annual meetings of the IMF and the World Bank in Washington.

The IMF singles out the Australian banks as examples of financial institutions that lent long term but borrowed heavily short term and then were stranded in October 2008 when lenders would not roll over their debts.

At the onset of the crisis, it says, 32.2 per cent of Australian banks' funding came from short-term borrowings, on domestic and global markets. While the banks used the period of the government guarantee to diversify their funding sources and lengthen their maturity structure, at the end of 2009, 25.6 per cent of their funding was still short term.

"Any robust systemic liquidity framework would need to encourage appropriate pricing of liquidity risk in good times to limit its negative impact in times of market stress, and minimise the moral hazard problems", the IMF argues.

"Market participants should be paying the full price of their idiosyncratic liquidity risk".

It urges consideration of an insurance fee or surcharge where the mismatch between asset and liability maturities exceeds a set safety limit.

The IMF also proposes bigger buffers against risk, tighter matches between maturities on each side of balance sheets, more rigorous valuation of collateral and due diligence into the credit risks posed by counterparties, and more use of central counterparties for clearing.

In a second chapter from the report, the IMF also takes on the three global credit ratings agencies Fitch, Moody's and Standard & Poor's calling on them to issue estimates of the probability of default and expected losses by borrowers.

Amid widespread concern, particularly in Europe, over the ratings agencies' failure to warn of the crisis, and of the contagion effects of their downgrades of one country on others, the IMF finds the agencies have done better than their enemies suggest but worse than their own guidelines suggest.

On one hand, it reports, all sovereigns that have defaulted since 1975 were rated below investment grade a year earlier.

On the other hand, the record shows almost one in 1000 corporate bonds given AAA ratings by Moody's has defaulted, roughly 30 times its own estimate of default probabilities.

The IMF urges government investment agencies and central banks to eliminate regulations that "hard-wire" their investment portfolios to ratings changes, warning that these tend to amplify the "cliff effects" of a change on the borrower's access to credit.

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IMF to stress test 25 nations

THE world's 25 biggest financial systems, including Australia's, will be stress-tested by the International Monetary Fund every five years, in a key reform to try to head off another global financial crisis.

In a compromise announced on Monday, the US and other big economies finally agreed to a five-yearly exam after blocking the IMF's plan to conduct stress tests every three years.

The refusal of the Bush administration to allow the IMF to independently stress test the US financial system was a key reason why its collapse caused vast losses worldwide.

The Howard government, by contrast, invited the IMF to join the Australian Prudential Regulation Authority to stress test its banks in 2005-06. The financial system came through the financial crisis intact.

A spokesman for Treasurer Wayne Swan yesterday welcomed the deal, which could see the IMF back in Australia next year. "Our banks are well capitalised and well managed after years of strong supervision by our world-class regulators," he said.

APRA ran its own stress test on the banks last year. Chairman John Laker says that even with a 25 per cent fall in housing prices and a recession worse than 1990-91, all institutions would survive.

The IMF's stress testing to be conducted with the World Bank in developing countries will also test the regulators' own policy framework, and their capacity to manage and resolve a crisis.

An IMF report yesterday urged Britain to accelerate reform of its financial sector while praising the stringent spending cuts imposed by the new Cameron government. In its annual report on Britain, the IMF board said its economy was on the mend. And it said the benefits of bringing the deficit under control outweighed the costs.

The Asian Development Bank has lifted its growth estimate for developing Asia to 8.2 per cent this year, but forecasts it will slow to 7.3 per cent next year as stimulus measures are withdrawn.

Growth next year is forecast to be 9.1 per cent in China, 8.7 per cent in India, 6.3 per cent in Indonesia and between 4 and 5 per cent in South Korea, Taiwan, Hong Kong and Singapore.

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It's about the skills, stupid

TODAY the three rural independents are expected to end the political uncertainty hanging over Australia since the August 21 election, and decide who, if anyone, will govern us for the next three years. But last week, amid the fog of uncertainty engulfing federal politics, the Bureau of Statistics sent out a burst of light to illuminate the economy. It issued new figures on GDP growth, surprisingly strong figures that dispelled some of the uncertainty that the new government will have to deal with.

In so doing, they made it obvious that the biggest economic issue confronting the government is not going to be deficits and debt, the subject of obsessive focus of both parties during the campaign. It's not even going to be interest rates, or infrastructure.

No, the key economic issue of the next three years will be skills training. The test of how well we handle the years of economic recovery will not be how fast we get the budget back into surplus, but how many Australians acquire the new skills employers will need as the recovery rolls on.

Assuming China's economy keeps expanding fast, then our economy too will expand at a reasonable clip. The risk to it will be inflation. And the best way to minimise that risk is to find ways to attract more workers, young people, unemployed and workforce dropouts into skills training so that we do not run out of skilled workers, forcing employers to bid up wages.

It would be an even bigger challenge if the three rural independents opt today to entrust the Coalition with government. Tony Abbott's seriously silly pledge to cap net migration at 170,000 a year would limit the ability of companies to bring in skilled workers from overseas, making it even more urgent to find ways to catch and skill our own.

It's not the only big challenge we will face. We need to apply the bipartisanship of recent days on parliamentary reform to the task of putting in place an agreed system of carbon pricing, either an emissions trading scheme or a carbon tax. Without it, we will be at risk of power shortages as electricity companies delay investment until they can make long-term decisions with confidence.

The next government will need to come up with solutions to the growing crisis of young and low-income Australians being priced out of home ownership. It will have to do everything it can to offset the real danger of Australia becoming a two-speed economy, in which the mining sector crowds out everything else. And the budget outcomes matter.

Three months ago, the economic outlook for the world and Australia seemed less certain. The Greek debt crisis had exposed how serious the debt problems facing European and US governments had become. Even China's growth seemed at risk. Markets went wobbly, banks hung on to their cash and for a while there were shades of the panic of 2008.

Those global fears have now receded, notwithstanding the deteriorating outlook for the US economy. Given the Reserve Bank's success in tipping the economy's path over the past year, I see no good reason to challenge its forecasts that we are heading for above-trend growth of 3.75 per cent in 2011 and 4 per cent in 2012.

But that's not all the good news. The Reserve is forecasting and the Bureau of Statistics confirms that the record prices being paid for Australia's mineral exports will trigger the biggest mining boom we've ever seen. And that will have serious downsides and challenges.

Mining investment in the '00s trebled in size to become 3 per cent of today's economy. But, on their own estimates, mining companies plan to lift investment by a further 58 per cent over 2010-11. They won't be able to, of course, but it will trigger a bunfight as they compete furiously for scarce resources of skilled labour and equipment to invest in developing new mines, expanding old ones, and improving their transport links.

One way of dealing with this is the way the Reserve dealt with it in 2007-08: by raising interest rates as needed to ensure that if mining is running hot, then the rest of the economy must be cooled to keep the whole engine from boiling over. That could have serious implications for Victoria, and the south-east in general, as higher interest rates and a higher dollar press down on consumer spending, and investment and jobs in other industries.

A better way would be for the next government, and the mining industry, to recognise that the problem the Reserve is tackling is largely generated by a lack of skilled workers, and to work out how government and industry can change their current policies to open up more pathways for Australians to develop the skills the industry needs.

One of my concerns about the election campaign was that this issue, so central to our economic future, was essentially ignored by both sides. Rather, growth was taken as a given, and Labor and the Coalition competed on offering new entitlements to distribute the rewards of growth, rather than on how to ensure that growth is sustainable.

A classic example was pointed to by David Murray, chairman of the Future Fund, in the way Labor has designed its mining tax package. Yes, tax the miners on their excess profits, he said, but lock that money away for future needs, rather than using it to finance tax cuts, superannuation benefits and other entitlements which will have to be paid whether the miners are making super profits or not.

I'm not nostalgic about the '80s. But it is simply a fact that both sides of politics in those days were far more aware of our economic vulnerability, and knew that leaders had to make tough decisions to deny benefits today so they could invest in ensuring prosperity tomorrow.

Whoever forms government today, they need to govern for the long term.

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Same same but different: Essay on Australia

SINCE Labor took office in 2007, economic debate has been dominated by the global financial crisis. Labor's proudest boast is that Australia has emerged from it in better shape than almost any other developed country. The Coalition accuses it of reckless spending, and running up tens of billions of dollars in deficits and debt.

Labor's boasts are inflated, but basically true. Australia's national income per head is now back in the top 10 of the developed world for the first time in decades. In a world awash with economic and financial failure, it is seen globally as a beacon of success.

Australia had a mild, brief recession: Europe and the United States a deep, lasting one. There, unemployment is around 10 per cent, growth is feeble, governments in massive deficit, and there is a growing risk of double-dip recession as fiscal austerity replaces stimulus.

Australia suffered scars, but they're healing. Growth is only 2.7 per cent growth per head is just 0.7 per cent but it's secure. There are 300,000 more people unemployed or underemployed than in 2008, but unemployment is only 5.1 per cent. The banks are cautious, but they're lending.

Was our success due to the government's handling of the crisis and if so, how much? Or is it proof that, as the Coalition says, the stimulus was unnecessary, over the top, and will leave us burdened with debt?

The Rudd government's handling of the crisis is the economic issue of the election. The government thinks it deserves re-election for steering us out of trouble by its quick, bold spending and bank guarantees. The Coalition urges us to dump Labor for wasting our money on excessive, badly-targeted, mismanaged programs.

NO ROADS TO REFORM

Both are looking backwards. Apart from the National Broadband Network and emissions trading (if it happens), neither has any real reform agenda to take us forward. Labor's aim under Julia Gillard is to camp in the middle of the middle ground, and feel its way forward only where that seems safe.

Tony Abbott, by nature, is more ideologically-driven. Yet now even he has thrice denied any plans for workplace reform an issue that in the Howard government, he held so dear. The Coalition, too, has no reform agenda. Its energy has gone into campaigning against Labor, not generating policies of its own.

The one forward-looking debate is on how fast the stimulus should be unwound. And the difference between them is more in rhetoric than reality.

On monetary policy, there is no difference. Rhetoric aside, both leave it to the Reserve Bank board to decide our interest rates. What might change is the composition of that board, all of whom come up for reappointment in the next three years including Governor Glenn Stevens.

Stevens and Treasury secretary Ken Henry were both chosen by Peter Costello. Yet in opposition, the Coalition seems to view our two top economic officials as part of Labor's team. If Labor is re-elected, Stevens and Henry can expect reappointment. If the Coalition wins, that is far from certain.

There was once a big difference between the parties on industrial relations, but now it's vanished. That, like Labor's decision to postpone indefinitely its core promise to introduce emissions trading, tells you how difficult it is to carry out hard reforms in a political system as polarised as ours. It is now a roadblock to reform.

But there are differences that matter. On emissions trading, the difference between the Coalition's "never" and Labor's "one day" is not insignificant. There is a sharp divide between the parties on the mining tax, and on the tax cuts for business it would finance.

Labor would make employers pay to lift superannuation contributions to 12 per cent by 2020. The Coalition would make them pay for workers to take six months of maternity leave, topping up Labor's 18 weeks.

The National Broadband Network is the most ambitious infrastructure project since the Snowy Mountains Scheme and one of few big political risks of recent times. Work is now under way to bring high-speed broadband to 93 per cent of Australian homes, at a cost of up to $43 billion. The Coalition would abandon the field to the private sector telcos.

But the central issue is deficits and debt. Were they needed? Are they being wound back fast enough?

The global financial crisis essentially had four causes. First, US banks and other lenders lent too much money to people who were bad credit risks, under terms so onerous that default was inevitable (the sub-prime crisis). Second, Wall Street invented, and invested heavily in financial derivatives so complex that financial firms themselves did not fully understand the risks they were taking on.

Third, US regulators, swayed by the deregulatory Zeitgeist, allowed all this to happen. And fourth, European banks awash with savings invested them in derivatives, sub-prime loans, and risky lending to eastern Europe.

CRISIS AVERTED

Australia's banks were remote from that. The crisis proved their own lending sound, with a few high-profile exceptions. This was partly because of the banks' instinctive caution, partly because the Australian Prudential Regulation Authority was an effective and intimidating watchdog, and partly because they had their own lucrative game borrowing cheaply overseas to fuel our house price boom.

Debt drove Australia's long boom in the '90s and '00s. Between 1990 and 2008, household debt soared from 45 per cent of our disposable income to 155 per cent. As the banks borrowed much of that overseas, their net foreign debt soared from 10 per cent of GDP to 40 per cent. That was clearly unsustainable, yet our leaders, officials and the banks shied away from debate on how to change it.

When the crisis came, our dependence on foreign debt made us vulnerable. If global markets failed, we would be in trouble. And fail they did.

In September 2008, crisis turned to panic after Lehman Brothers collapsed. The markets stopped lending; institutions clung to their cash. Australian banks could no longer roll over old loans for new ones. By October, Suncorp, and maybe Bankwest, were within days of default, and collapse.

The Rudd government moved quickly. It guaranteed the banks their deposits, their old loans, and their future ones. Two days later it delivered a $10 billion package of stimulus spending to shore up the economy mostly as $900 cheques to all but the well-off. The crisis was averted.

Over the next 18 months, the banks raised $160 billion, mostly on global markets, guaranteed by Australian taxpayers. The scheme was designed in haste, and seriously damaged nonbank lenders, so the government then had to rescue them too. Some lenders had to merge, but our financial system survived, in good shape.

These initial interventions won bipartisan support from the Coalition, and widespread praise around the world for the "exemplary" speed and scale of the government's actions. But the bipartisanship faded when Rudd and Wayne Swan produced a second, far bigger stimulus package in February 2009, including $15 billion for school halls, libraries, etc, a second $8 billion handout to households, $6 billion to build 20,000 units of social housing, and $4 billion to insulate the ceilings of houses.

Why did Australia survive the crisis so well? There are several reasons, and economists differ over which mattered most. The banks didn't go broke. House prices didn't collapse. Exports didn't collapse, thanks to stimulus in China. Immigration kept the population booming. And the Rudd government's spending propped up demand especially for construction, usually the biggest victim of recessions.

Few economists would argue, as Abbott has, that no stimulus was needed. Without it, Treasury estimates Australia would have sunk deeper into recession over 2009, even with China buying our iron ore.

But it was excessive. It was a mistake to spend so much on the school halls programs that it became an entitlement impossible to unwind. A lot of money was wasted on poorly run schemes. Too much money was committed to schemes drawn up in too much haste. At the time, ministers and officials, like their counterparts around the world, believed they were fighting to avert a second Great Depression. Some economists disagreed at the time; we now know they were right. Fortunately.

The deficits are now being wound back: from a $55 billion deficit in 2009-10, the budget is forecast to be in surplus by 2012-13. Net debt is now forecast to peak at $90 billion, or 6 per cent of GDP. With the US forecast to owe 86 per cent of its GDP by 2015, and Japan 154 per cent, the ratings agencies, economic officials, the IMF and the OECD all agree: Australia's debt is nowhere near problem levels.

There are many real economic problems out there. Last year 21 per cent of men and women of prime working age had no job at all. We have imported a million skilled workers because we don't train enough of our own. We have borrowed $654 billion because we don't save enough of our own. We need widespread tax reforms. We have a growing inequality of incomes, and outcomes. One could go on. But in this campaign, it's pointless. These are issues the parties are not talking about.


READ MORE

The Great Crash of 2008 by Ross Garnaut and David Llewellyn-Smith (MUP) 2009.

Shitstorm by Lenore Taylor and David Uren (MUP) 2010.

This Time is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth S.Rogoff (Princeton) 2009.

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Unlearnt lessons from the financial crisis may spell disaster

JOE Stiglitz has seen the future, and he is worried. He had hoped that the global financial crisis would force reforms to ensure that it never happened again. He had hoped that Western governments would stick to their stimulus spending as long as it was needed to offset the weakness in household spending and business investment. But neither is happening.

One of the world's most eminent economists, Stiglitz has long warned that the West risks a "double-dip" recession next year as the stimulus is removed faster than private spending comes back. He is not predicting such an outcome, but with the US economy still "anaemic" and austerity measures now sweeping Europe in the wake of the Greek sovereign debt crisis, he sees the risks mounting.

"What is almost certain is that growth will slow down markedly," he says. "Whether it will slow down to the point where growth becomes negative is not clear.

"I don't think the markets or governments have taken on board the consequences of simultaneous austerity policies in the UK, Germany and others.

"Some governments have put out rosy forecasts of how little it will hurt. It's as if they

can engage in contractionary policies without getting the contraction.

"When a number of countries take these policy actions together, the effects might be very severe."

Winner of the 2001 Nobel Prize for economics, former chief economic adviser to US president Bill Clinton and chief economist of the World Bank, Stiglitz is one of the few economists who have earned a worldwide following: among economists, for his work on the adverse consequences of market players having different levels of information, and among the broader world of people who think about issues, for his penetrating criticism of the economic shibboleths of free market fundamentalism, and his articulate advocacy of an economics that makes improving human welfare its core mission.

Stiglitz, now 67, spoke to The Age yesterday from Perth, where he has just arrived for a three-week tour that will take him all over Australia, combining holiday sightseeing with 12 lectures, two of them in Melbourne, mostly on the lessons of the global financial crisis and the prospects for recovery.

If you've read his recent bestseller on the crisis, Freefall: Free Markets and the Sinking of the Global Economy, you will know that his views are bleakly pessimistic. He puts the blame for the crisis squarely on Wall Street, and the politicians and regulators who gave it free rein partly for ideological reasons, partly because of its role in financing their campaigns.

"The big question in the 21st century global economy is: what should be the role of the state?" he writes. "Today only the deluded . . . would argue that markets are self-correcting and that society can rely on the self-interested behaviour of market participants to ensure that everything works honestly and properly let alone works in a way that benefits all.

"I believe that markets lie at the heart of every successful economy but that markets do not work well on their own.

"Economies need a balance between the role of markets and the role of government. In the last 25 years, America lost the balance, and it pushed its unbalanced perspective on countries around the world.

"The problem was not so much [former US Reserve chief Alan] Greenspan as the deregulatory ideology that had taken hold."

The financial reforms passed by the US Congress this month will not stop risky lending, Stiglitz warns. While they enshrine four important principles restricting banks from investing in risky activities, forcing derivatives trading into the open, cutting bank fees on debit card transactions, and setting up a consumer product safety commission "every one has a carve-out, a big exception" that will allow the banks largely to carry on as before, he says.

To Australian readers of Freefall, it's hard to believe that two countries so similar could have taken such different approaches to market regulation. In Australia, John Laker and his team at the Australian Prudential Regulation Authority were real watchdogs, keeping the banks from risky lending strategies by warning they would have to put aside more capital to offset the risk. So our banks didn't fail, and our crisis ended up as the mildest recession since World War II.

Finding out why Australia survived the global slump so well is one of Stiglitz's goals here. "Australia is a fascinating country for me to visit, because it shows that you can actually have a capitalism that works," he quips.

Another priority here is to explain an intriguing report last year by a commission he chaired on "the measurement of economic performance and social progress". Commissioned by French President Nicolas Sarkozy, it argued that our usual measure, gross domestic product, is a poor guide to progress. Rather, we need new measures that focus on sustainability, income distribution and quality of life, as well as output.

"It's had a lot of resonance," Stiglitz says. "It's a long-term agenda, and there are a lot of issues. We're now in the process of setting up a unit within the OECD that will take it forward."

It could be one of the lasting legacies of the economist from a midwest steel town, for whom economics is about making ordinary people better off.

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The dirt on dodging the GFC

THERE was a time when the Organisation for Economic Co-operation and Development had clout in Australian politics. Its forecasts and its advice used to be treated as statements from an oracle. Not any more.

Last week, the OECD's half-yearly forecasts passed almost unnoticed here not because they were bad news, but because they were good news, and good news no longer rates.

The OECD forecasts that over the next two years, Australia and Canada will share the second-highest economic growth among its 25 rich-country members (South Korea coming first). Australia's output gap the gap between the level of economic activity and our potential level would be the lowest of all 25.

Australia's government deficit, the OECD predicts, would be the sixth lowest of the 25. Its unemployment rate would be the seventh lowest. The only negatives were that our current account deficit would be the seventh highest in the rich world and our interest rates the second highest, behind Iceland.

OK, you say, it's good news, but it's old news. We all know Australia has been among the best-performing OECD economies over the past two years. Kevin Rudd and Wayne Swan keep telling us we're leading the "major advanced economies" (a flexible term which seems to mean anything they want it to mean). What's new?

What's new is the conflict between the OECD forecasts and the Lowy Institute's 2010 poll, released yesterday, which asked Australians to give the government a mark out of 10 for its handling of the global financial crisis. On average, we gave it a mark of just six out of 10: a pass, but no credit, no distinction, let alone the high distinction Rudd and Swan think they deserve.

This is worth exploring. What we think of the government's economic management is a central issue in any election campaign. I suspect it will have more sway on this election outcome than Labor's tax on mining profits (which will hurt Labor in mining seats and in Perth, but have little effect elsewhere). If you asked the OECD and the International Monetary Fund to rate Australia's performance, I have no doubt they would give it much better marks.

Both have praised the government and the Reserve Bank for the speed and direction of their response and now, for moving early to rein in the stimulus once it is no longer needed. And I suspect most of Australia's market economists would give similar marks.

So why don't Australians in general give the government high marks for steering us out of the crisis? I can think of several reasons.

The first is that Australia's rapid population growth disguises the reality: we suffered more damage that the growth figures suggest. The bottom line is not growth in GDP, but GDP per head. It fell 2.1 per cent over the 15 months to September 2009. Real consumer spending per head has barely grown in two years.

Unemployment rose by 220,000 during the crisis, and is still 185,000 higher than in February 2008. (And remember, the dole for single workers is just $231.40 a week.)

The labour force has grown by 400,000, yet full-time employment is still 40,000 below pre-crisis levels. Parts of the economy are booming. Most are not.

The second reason is that Australians are among the world's most highly indebted people and the cost of that debt has risen sharply since the Reserve Bank and the big banks started raising interest rates last October. We owe the banks 156 per cent of our disposable income (a dramatic rise from 45 per cent two decades earlier). Our mortgage bills have risen 40 per cent in the past year. They are still lower than they were before the crisis, but many voters don't feel grateful.

Third, the Rudd government's stimulus spending has become badly tainted by all the evidence of massive waste, overcharging by contractors, poor regulation of contractors, and general incompetence, as getting value for money was ignored in the rush to roll out programs. That alone would be enough to explain the low marks we gave the government. It was our money they were spending.

But there is a fourth factor. The Coalition and its rusted-on supporters contest the idea that the stimulus spending helped Australia avoid the slumps seen in Europe, the US and even (briefly) Asia.

They've argued that we survived because Labor took over an economy in such good shape that we were never going to go into recession. Now Tony Abbott has introduced another twist, telling us it was the mining industry that saved us from recession.

Treasury secretary Ken Henry has not helped the debate by arguing that, on the contrary, the mining industry itself suffered "a deep recession", basing his claim on figures that show mining jobs falling by 15 per cent in six months.

These figures come from a survey too small to be reliable. They tell us that in 2008, mining jobs shot up by 30 per cent in nine months, then fell 15 per cent in six months, then rose 15 per cent in the next nine months! That is sheer rubbish.

The recession was concentrated in manufacturing, where output fell 11 per cent: mining output fell just 1 per cent. Mining didn't save us from recession. The impact of China's stimulus certainly helped us recover, but only after the worst had passed.

Australia dodged the worst of the global slump for two main reasons. The banks' lending was kept within sensible limits by the Australian Prudential Regulation Authority and their own management teams. And the Rudd government's stimulus measures put a floor under retail spending, housing and construction activity when it was most needed. Let's give credit where credit is due.

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Garnaut's got the goods on mining taxes

QUESTION 1 is whether the slump in global markets is a crisis or a correction. Are we seeing a second wave of the panic of late 2008, or just seeing investors retreat from positions that now seem too optimistic?

Question 2 is whether the resource rent tax will damage foreign investors' long-term confidence in Australia, and hence our future growth.

The two questions are inter-related. The mining companies and their supporters tell us the plunge in mining share prices is the result of the new tax. And as we all indirectly own shares in the mining companies through our super funds, we're all worse off.

Let's put the facts. When the markets closed on Friday, April 30, the Australian dollar bought US93 and the benchmark S&P/ASX200 index stood at 4807.4.

On the Sunday, the government released the Henry report and announced it would impose the resource rent tax.

The next day, both the dollar and the market index fell, but slightly, by 0.5 per cent. Over the next two weeks both slid by roughly 4 per cent. That's a fall, but no cataclysm.

The real damage came in week three. By last Friday morning, the dollar had plunged 9.7 per cent in four days and a bit, and the sharemarket by 8.7 per cent. That's a market plunge. But then they kept rising.

The important thing is that this was not unique to Australia. Sharemarkets worldwide have fallen by similar amounts over the same period. Mining stocks in the US fell by similar amounts to mining stocks here.

The Aussie dollar fell more than most against the US dollar, but there are other reasons for that.

Commodity exporters such as Australia have manic-depressive currencies: they rise higher and fall lower than the rest when the outlook for global growth changes. Back in 2008, we went from US97.86 in July to US61.22 in October. Now forecasts for global growth have fallen, with Europe facing years of slow growth and China slamming on the brakes to head off inflation.

Second, the crisis in Europe has reversed the market's bets on what the Reserve Bank will do next. A month ago it was forecasting several rate rises ahead. Now it's punting on rates staying on hold until the second half of 2011. And that has halted the carry trade, in which investors borrow in Japan or the US at low interest rates to invest in Australia.

Third, Australia plans to impose a resource rent tax on miners, reducing the profitability of mining projects. All three are factors in our falling dollar and share values. Yet Australian shares have fallen at similar rates to the rest and bank shares have fallen as much as mining shares. To me, that suggests the new tax has been only a marginal influence.

What of the future? Your guess is as good as mine, but most analysts see this as more correction than crisis, at least outside Europe.

Asia's biggest markets are growing at incredible speed: China, Taiwan, Thailand, Malaysia and Singapore all grew by more than 10 per cent in the year to March, with South Korea and Hong Kong not far behind. That momentum would take some stopping. And the Federal Reserve is forecasting US growth of 3.2 to 3.7 per cent this year. Europe alone is in trouble.

What about us? With an election looming, it's no surprise that the mining companies have put projects on hold. I suspect they will stay on hold until the election is over and (if Labor wins) the new tax becomes law, with the support of the Greens, who will hold the balance of power in the new Senate.

In the short to medium term, you'd expect that it will lead to less mining investment than otherwise. Mining Australian deposits will become less profitable, and in some cases those projects will drop down the priority list of the multinational miners. But as I have argued before, that simply defers those projects until they become more profitable. Our mineral despots will not be moved. Coal aside, they will all be mined eventually. And the government is right to demand a better return for them.

But how? A consensus is starting to form around a sensible compromise, well-expressed last Thursday in a thoughtful, fair-minded speech by Professor Ross Garnaut at the University of Melbourne. Decades ago, Garnaut and Anthony Clunies-Ross invented the resource rent tax we now use for the oil and gas industry. Garnaut is also the long-time chairman of Lihir Gold, and has worked closely with both the Rudd government and Rio Tinto. No one knows the issues better.

There is no space to summarise his speech here: for those interested, it's at www.theage.com.au. Garnaut chastised his fellow miners for using emotive arguments and threats rather than logic, and upheld the government's right to impose it on existing as well as new projects.

But he also questioned Treasury's assumptions that mining companies could borrow money at the same rate as the government to finance their initial losses, and that future governments would honour the pledge to pay mining companies 40 per cent of their losses on failed projects.

A better solution, he argued, would be to use the Henry formula to tax mining exploration, and put his own long-established (and less extreme) tax on mining production. It's the logical solution. Pity they won't agree on it any time soon.

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Greek lesson in the perils of overspending

THE fatal riots in Athens reflect the vast gulf in how the Greek financial crisis is seen at home, and in the world. Greeks, by and large, are outraged by the cuts and reforms thrust on them by their government, the European Community and the International Monetary Fund. "It's not fair!" they insist. "Why are they doing this to us?"

To outsiders, it's all too clear. Greece has been living beyond its means for years, borrowing heavily from the rest of the world and, until recently, fudging its books to hide the reality. The financial markets no longer trust it, and will not lend to it or roll over debt, except at prohibitive prices. That's what happens when you push your luck too far.

The facts are simple. Last year, Greece ran a budget deficit equivalent to 13.5 per cent of its gross domestic product (compared with 4.1 per cent in Australia). Its gross public debt was 115 per cent of GDP (as against 16 per cent in Australia), and rising rapidly. And the banks would not lend more.

How did it get there? Take its pension system. Greeks can retire early on a lifetime pension equivalent to 80 per cent of their final salary, and indexed to match wage growth. They receive 14 months a year of pension payments, with bonuses at Christmas and Easter. The OECD estimates that some Greeks actually receive more on the pension than they did when they were working.

In Germany, which underwent bruising pension reforms in the mid-2000s and now finds itself unwillingly funding 30 per cent of the EU's bailout for Greece, top-selling tabloid Bild went to town. "Why do we have to pay Greece's luxury pensions?" its front-page headline demanded last week, alongside a photo of an elderly Greek pensioner it said was paid $A5000 a month.

Greece, it told readers, is "the land of bankrupts and luxury pensions, tax dodgers and rip-offs. It's a country where the authorities use satellites to search for houses with swimming pools, in order to send the owners a tax bill." It reported that Greeks on average paid almost $A2000 a year in bribes, and shops routinely refused to provide tax receipts for purchases.

And that is part of the story. Greece joined the European Union, joined the euro, but never became part of that northern European culture in which officials, taxpayers and citizens obey the law because they see the state as theirs. In Greece, tax evasion and corruption are rife. Transparency International's annual index finds investors rate it the most corrupt country in the developed world, worse even than Saudi Arabia and Ghana.

And change is not coming easy. American-born Prime Minister George Papandreou, elected last October, has taken a series of courageous decisions to admit the true state of Greece's finances, and impose cuts and reforms across the board to reduce the deficit from 13.5 per cent of GDP to 3 per cent within three years.

Pensions have been frozen, and in some cases cut. Early retirement has been abolished. The public sector will hire no new staff in 2010, except for essential positions. Some 10,000 qualified applicants have been turned away. From 2011, hiring will resume, but only at the rate of one public servant hired for every five who leave. Contract employees will be terminated, overtime payments have been cut by 30 per cent, bonus payments and salaries have been cut, and public sector wages reduced overall by 10 per cent in the government itself and by 13 per cent in its enterprises.

But Greeks have rebelled, with a poll finding 51 per cent vowing to fight the cuts. At one end of society, the Athens rioters demand that the rich should pay, not them. At the other, London real estate agents Knight Frank report that 6 per cent of all purchases of London properties for more than £2 million ($A3.2 million) in recent months have been by Greeks shipping their money out of the country.

The biggest risk is that nervous markets are now losing confidence in the other heavily indebted, high-deficit countries of western Europe. Spain, Portugal and Ireland form the new frontline of countries that could be forced to replay the Greek tragedy.

It's a great case study for fiscal prudence.

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