In the early 1980s, trader Ray Dalio was so broke he had to borrow money from his dad to tide him over until he could sell his car.
Mexico had defaulted on its debts and Dalio bet everything that the US would tip into a depression. Yet the US economy rode it out and stocks went on a bull run. Dalio went broke.
Three decades on, Dalio is one of the richest people on the planet and runs the world’s biggest hedge fund: the $US100 billion behemoth Bridgewater.
In his book Principles, the Wall Street Titan, who is regularly consulted by governments and policymakers around the world, explains the blow-up of the early 80’s taught him he needed to do four things if he wanted to be successful.
We’ll get back to the first three later, but the fourth and possibly most important of those from a strategy perspective was this:
Balance risks in ways that keep the big upside, while reducing the downside.
It’s solid advice not just for traders, but for life in general: manage things so that even when things aren’t going your way, the damage is minimal; and place bets such that you can lock in big gains when you get a few breaks.
It’s not dissimilar to the budget strategy under Scott Morrison as Treasurer.
Cast your mind back to the Joe Hockey days. China was slowing down, commodity prices were tanking, and the economy was still scratching around for signs of private investment. Consumer confidence was brutalised in the 2014 budget.
Hockey was staring down tens of billions of dollars in revenue write-downs over four years as the economy consistently under-performed. The plan to end the “debt and deficit disaster” that was a core pillar of the Coalition’s 2013 election win was in tatters.
Then Morrison became Treasurer in September 2015.
In his first major policy document, the mid-year economic and fiscal outlook of December that year, Morrison moved decisively to shift focus away from the urgency of returning to surplus by setting out the reality that the government’s books were in a parlous state.
At the time, he expressed exasperation with the surplus obsession, saying it was “like the family saying: ‘Are we there yet? Are we there yet?’”
“The path back to budget balance is similar to that,” he said. “We need to take a safe and careful route and one that does not put at risk our jobs and growth.”
In an interview, he said: “Next year we will hopefully continue to move away from the binary way in which our economic challenges and responses are framed and understood. For too long, the only way seen to address a spending problem in the budget is by setting fire to it. If you don’t do this, then apparently you don’t think there is a spending problem.”
There’s an acceptance in here of something often missing from the public debate around fiscal policy in Australia, especially from the extensive ranks of budget hawks: government spending has a vital role in the economy in times of fragility or a clouded outlook. Government spending accounts for a quarter of Australia’s economic activity. Pulling out the dollars too fast in times of uncertainty risks derailing everything.
The last three budgets have reversed a years-long pattern of federal revenue missing expectations by billions of dollars. This chart buried in the budget papers shows Treasury’s revenue predictions versus results going back over two decades.
This year, Scott Morrison has benefited from the kind of breaks any Treasurer needs in order to be generous.
China’s economy has continued to grow at a faster rate than most were expecting over the past couple of years.
More importantly, job creation in Australia has been far stronger than anyone expected, even Morrison himself.
Businesses busy hiring people have not only created jobs for people but delivered a pre-election gift to the Coalition.
Put the two together and you’ve the foundations for the vastly improved budget position that Morrison has at his disposal. Importantly, as so much of the extra collection comes from income taxes rather than commodity prices or company profits, it’s not flash-in-the-pan. Income tax receipts, by far the biggest source of revenue in the budget, tend to grow steadily as the economy expands and be far less volatile than those from company profits.
So yes, the Treasurer has benefited from improved activity at home and abroad. But, to Ray Dalio’s point about success relying on managing the downside and having a lot of exposure to the upside, luck isn’t always dumb.
As far back as December 2016, economists at Goldman Sachs noted conservative estimates on a range of economic parameters in the mid-year outlook left “a great deal of scope for a meaningful upgrade to forecast revenues”.
For the avoidance of doubt that there was a new approach to budget forecasting, Morrison told Kieran Gilbert on Sky News 11 months before the Goldman note on the conservative assumptions:
In the last MYEFO statement we had some major changes to our growth forecast and that did lead to a significant writing done what some of those revenues were. But the most significant part of those revenue changes in the MYEFO was actually by having a more conservative outlook on growth than had previously been put in the Budget. Now that was just about being I think upfront and having a very realistic set of numbers in that MYEFO statement and obviously they will be under constant review.
Conservative forecasts provide the upside if things go your way. Consider the impact of the iron ore price forecast, which is currently baked into the budget at $US55 a tonne. Revising this upwards by $US10 would improve the bottom line by $4.8 billion over the next two years.
Even nudging it by a few bucks would make the projected surplus of $2.2 billion in 2020-21 look vastly more impressive and very few people would quibble about it.
But Joe Hockey got burned by iron ore projections and Treasury is not ready to repeat that mistake.
There is still a remarkably upbeat outlook for wages growth, as David Scutt outlines here, and seen in this chart:
Around the world, wages growth in advanced economies has practically vanished in real terms, for reasons economists (at least the good ones) admit they don’t fully understand. Some of it is technology and casualisation; some of it, as the RBA governor has argued, may be weaker bargaining power from the perspective of workers who fear their jobs could be automated at any time.
Anyway, aside from this questionable assumption around wages growth, the numbers in the budget are solid.
But even though the numbers stack up and reflect a period of sensible fiscal management, there’s still a yawning black hole in this budget.
What, exactly, is the plan?
Tax cuts and a flatter tax system is not a blueprint for Australia’s future.
What’s entirely missing is what’s consistently absent in everything the Turnbull government does: a sense of mission, some kind of vision for where the country is going and the kind of nation it wants to be.
It’s not articulated in the budget papers but reading between the lines, the underlying message is that in the medium-term Australia of the future, 94% of people pay 32.5% tax, some more elderly people are working later in life, and the roads are pretty good.
Oh also, the borders are secure and everyone can see a doctor. Fine, but that’s the case today.
To steal the reflection in the title of Bob Geldof’s autobiography: is that it?
Everyone will have a view on what an Australia of the future should look like. Unfortunately the people who can really do anything about it are politicians.
The inevitable retort is it’s impossible to pursue any plan for nation-building without a strong economy.
Again, fine, but what follows from a strong economy? There’ll be money to spend. Where will it go? Because when you are in power in a strong economy there is a lot you can do, especially if the coffers are full.
Conservatism would posit that, aside from providing essential services, government really has no role in shaping society.
Perhaps the plan is to have no plan, setting up a sharper contrast with a more interventionist Labor party and banking that Australians just want to be left alone and things will just take care of themselves.
Perhaps they’re burnt by the innovation platform backfiring in their faces in the last election.
Either way, there are two possibilities here: either the Turnbull government is holding back its vision for an election campaign, or they simply can’t think of one.
Postcript: the other three things Ray Dalio realised he had to do to be successful were:
- Seek out the smartest people who disagreed with me so I could try to understand their reasoning.
- Know when not to have an opinion.
- Develop, test and systemise timeless and universal principles.
Morrison seems to have done well to take on the point about balancing risks to minimise the chance of everything falling apart. And look at the results. But good luck getting them to take on Dalio’s other pointers for success.
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