Gail Kelly and a story about luck | Putin and perception | Should you trust your intuition? / by Adam Howard

Well, after our brief foray into the property market I thought it would be good to get back to the ol’ faithful; the Australian economy.

But before I do, I want to pose a question.  Can you place the following sovereign states in order from lowest to highest credit risk?  So, country least likely to default on the top and go down from there:







Back to this later.

Now, I want to briefly discuss the announcement during the week that Westpac’s CEO Gail Kelly will set down in February 2015 after nearly 8 years in the top job.  With average CEO tenure at 5 years the last 2 years has seen a lot of conjecture about Westpac’s succession plan with Kelly always playing a straight bat and responding in that artfully empty management speak of which I am such a fan.

You know, “Going forward my main focus is creating shareholder value.”  Love it….

Now, there is no question Kelly is intelligent and well spoken, and has shown it is possible for women to succeed and perform far better than her male counterparts in the male dominated and sometimes misogynistic world of banking.  In fact, this may be her greatest achievement.

But in my opinion what Kelly should be famous for is her ridiculous run of luck.  Just like our baby boomer property purchaser from last week’s Update, let’s take a look at how lucky Ms Kelly has been.

Kelly moved to Australia in 1997 landed a senior role at CommBank in retail banking (branches, home loans and credit cards) as that was her background in her native South Africa.   

Lucky at a really basic level, as retail banking, while not being particularly glamorous, is where commercial banks make most of their money.

Within 5 years Kelly was CEO of St George, then still effectively a building society, but one that was about to cash in on the boom in Australian home loan borrowing and the boom in the property market.  Luck loves good timing.

St George was small and didn't have a lot of cash to lend out, so in order to meet demand Kelly cashed in on the new found source of funding in the world of finance, the wholesale debt market. St George became a securitisation factory (taking bundles of home loans and selling them for cash and then using the cash to lend out to other borrowers.  These were called Mortgage Backed Securities or MBSs and yes, subprime MBSs blew up the world in 2008). 

This worked beautifully and St George grew very quickly and even began to pose some problems for the Big Four.  Lucky again.

Kelly then jumped to the top job at Westpac.  Check out the timing.  Westpac’s then boss had been in the gig for almost 10 years, so the timing was right for him to move on.  St George had grown substantially on the back of the worldwide securitisation bonanza making it possible for the boss of a smaller regional to move to be boss of one of the Big Four.   And the music was about to stop for the global finance industry as subprime bonds began defaulting and the GFC began.

Perfect.  What luck.

This allowed Kelly to pay $18 billion for St George, have the sale “sail” pass the regulators and be lauded in the process (hardly a fire sale price given St George was unable to raise cash due to global finance markets being totally frozen).  Lucky, lucky, lucky….

The next 7 years saw an unprecedented golden age for the Big Four as their cash reserves were guaranteed by the Federal Government, dropping the cost of their capital. 

And their net profit margins have soared since as bad debt provisioning has dropped away.  Lucky timing, that.

Now, there’s no question Gail Kelly possesses an above average IQ, work ethic and emotional intelligence.  But luck plays an amazing part in everyone’s lives.

It’s only in retrospect that we then tell ourselves an easily understood and pleasing story about foresight and genius, which is what’s happening now.  If I see another online link titled “Gail Kelly; seven lessons on life and business" my iPad is going out the window.

Back to economics.

The Audiophile remarked to me during the G20 that he thought it was funny all the talk about economics and politics while Russian warships floated just off the continental shelf.  That made me think about Russia and realize our mate Vladimir is under the pump a little at the moment; he is not waging a war in Ukraine, is an international pariah for not shooting down MH17… and his economy is on the ropes.

That last part might be something some readers didn’t know about.  Russia, one of the growing BRIC nations (Brazil, Russia, Indonesia and China), is enduring some very tough economic times right now.  The rouble has dropped 23% against the USD in the past 4 months, their equivalent of the cash rate is already at 9.5% (lifted in an attempt to protect the rouble’s value) and Russian firms are holding large, large piles of debt.

There appear to be a few things that are contributing to this; the substantial drop in the price of oil, one of Russia’s largest exports, the sanctions imposed by the West that are limiting the sale of Russia’s gas reserves to Europe, with gas also one of Russia’s main exports.

Normally that would indicate Russia should have a current account deficit, where the value of imports exceeds exports.  A brief aside here on how imports are paid for, and on the flip side, how exports are paid for.

Imports are paid for in foreign currency, while exports are paid for in domestic currency.  Follow me?

So, if imports exceed exports, flow of foreign currency outwards exceeds flow of domestic currency inwards, which should make the domestic currency drop in value further.  As the domestic currency drops in value it becomes more expensive for citizens to buy goods; food at the supermarket, petrol at the supermarket, a new fridge….

That’s inflation.

Russia is the exception to this rule as Vlad the Horserider has also imposed sanctions on the West, curbing the importing of goods from the West in reaction to the West’s sanctions, so at the moment their Current Account is still in surplus, which appears to be protecting the rouble’s value a little.

Why talk about this?  It’s Russia, right?  Hardly a vital trade partner for Australia.  And I have also spoken about my dislike for the media’s habit of talking about large events that are abstract.  It’s something that sounds serious, but is happening on the other side of the world so what impact does it have on me?

Well, I want to use Russia’s trouble and strife as an example of what can happen to a resource driven economy when the tide turns, and why Australia is a bit different.

You see, something similar is happening in Brazil right now, with the Real down against the USD over the past few months as well as iron ore drops in value.

So, what’s the story for Australia?  Iron ore is just above $70 per tonne.  Shocking news for Gindalbie and Atlas, bad news for FMG but no real concern for BHP or Rio yet.  In fact, Rio and BHP are actively flooding the market with more and more iron ore in a bid to get rid of their competitors.

Frightening times for Gina Rinehart as she is now building her own mine at Roy Hill that’s going to be shipping 50 million tpa as well.

Although I am sure everyone knows how I feel about Gina.  Gina is like the royalty of old; convinced that her wealth is a result of some divine right and supreme intelligence, rather than blind luck that she was born into the Hancock family where she inherited an enormous annuity income stream.

Gold is around $1,100 to $1,200 per oz and falling.

Coal is at 5 year lows and is very on the nose with everyone.

The AUD is well down against the USD since last year, but it’s been more of a slide than a drop off the cliff.

So, why should we consider Australia’s position to be any different to Russia’s or Brazil’s where rampant inflation and rapidly rising unemployment appear likely?  Both of which will have a damaging impact on standards of living in both nations, particularly for those who just reached the middle class.

I am going to use a bit of history here as well as our old poker analogy as well.

Firstly, I’m of the opinion that perception is reality.  The Nobel Laureate in Economics and Professor of Psychology Daniel Kahnemann performed a number of experiments around this concept and uses the term WYSIATI (What You See Is All There Is).  Time and time again he found that people make decisions based only on what is right there in front of them, and if the questions being asked are too difficult individuals will subconsciously replace these questions with ones that are easier to answer.

Empirical context is rarely sought by those observing a phenomenon.   But intuitive context is always used, and this intuition is frequently wrong.

Russia last defaulted on its debts relatively recently in 1997, and South American nations have been defaulting on their debts about once a decade for the past 40 years.

If I told you that Argentina defaulted on its government debt earlier this year, and then led onto say that Brazil’s economy was now slowing dramatically chances are you may make an intuitive leap and decide that Brazil wasn’t too far off defaulting.

So, the concerns about the Russian and Brazilian economies have a self-fulfilling element to them.  In the context of slowing resource prices, investors remember that Russia defaulted in the late 1990s, and Southern American nations have always been financial basket cases, and soon the outward flow of capital becomes an avalanche.

Investors and their traders talk to each other, read the news, see domestic rates being lifted and just see everyone running for the doors, and the domestic government doing all they can to keep people there. 

They all decide it’s too risky to stay, and leave en masse.

No rational decision making, no assessment of the pros and cons; just a decision based on memory, intuition and an awareness of what everyone else is doing.

Results?  Current account deficit, devalued currency, rising unemployment, inflation, a further slowing of the economy, further rises in unemployment….

Sounds bad…and it is, if you happen to have an economy that spooks people.

But to my mind, this is like being a bad poker player and folding regardless of your hand every time someone goes all in.  Know the probabilities.  Know the way to play your hand.

Don’t make a decision just because everyone else is making that decision.  But, I guess that’s why they call it “herd mentality”.   

Another good example of this is the Asian Currency Crisis of 1997 and 1998.  It really had its genesis in Thailand, but it flowed onto the rest of the near east.  Indonesia ended up being the hardest hit economy, and it still hasn’t really recovered.

I recall in 1998 $1AUD ~ 4,000 Rupiah, then the crisis hit and it was $1 AUD ~ 10,000 Rupiah.  If anyone has been to Bali recently you will know that the exchange rate is still close to $1 AUD ~ 10,000 Rupiah, and that’s 16 years later!!!

The reason for this contagion from Thailand across most of Asia at least according to another Nobel Laureate Paul Krugman, is that they were all Asian countries.  That’s it.  All Asian nations were rightly or wrongly tarred with the same brush and everyone got out.

Now, recall.  Perception is reality.

Australia has never defaulted on its international debts.  We are perceived to be a first world nation culturally linked to the West.  Safe as houses.

Nothing else matters as What You See Is All There Is.

All of the above is captured and reflected in the credit ratings as bestowed by Standard & Poors, and here’s a list of the ratings in order.

Now here’s the ratings of our countries, plus a couple of extras:

I suspect most people, if asked to place the above countries in order of credit risk may not have placed Thailand third.  But then, intuition is rarely right.

Food for thought…