Throwing good money after bad

Prominent New York fund manager Bernard Madoff embezzled $US50 billion from his investors.  In doing so he increased public awareness of the meaning of a "Ponzi Scheme".

This involves collecting money ostensibly to invest but actually using new collections to pay existing investors.

Madoff's operations were naked fraud -- he falsified entries to fool investors into thinking he was making good returns.

When the value of a bank or investment fund's assets decline substantially it is converted into a sort of Ponzi Scheme.  Such an asset-value collapse brought down the formerly great US financial institutions like AIG and Lehman Brothers.

Australia is seeing similar plummeting asset prices -- share prices are off by 40 per cent.

Australian house prices have been stable, unlike those of the US and Britain, which have seen price falls of 15-40 per cent.

Only the most optimistic real estate agents expect to see stable Australian house prices this year.

Compounding this, prices of rural and mineral export commodities are falling.  The effects of these developments are not yet evident.

Before Christmas, Canberra's $10.4 billion gift to pensioners kept retail sales buoyant, though this did little for new-car sales which started to plunge from the middle of last year.

The fillip provided by the government hand-out is temporary and there is little further scope to repeat it.

Governments are attempting to kick-start their stuttering economies by spending money they don't have and lowering interest rates.  Current circumstances doom such approaches to failure.

A successful kick-start can clear a blockage in a basically healthy engine.  But, where the engine trouble is more serious, kick-starting, at best, means wasted energy and, at worst, aggravates the problem.

And that's the situation Australia faces right now.

The economy is seriously unbalanced.  Shares and houses comprise two-thirds of household wealth.  The decline in their values represents a correction of inflated prices.

These were caused in part by governments strangling the supply of land for housing and partly by loose credit.

In recent years the houses and shares we own have seen higher values but these largely reflect price escalation rather than genuine savings.

The upshot is that we are all a lot less affluent than we thought we were.  The value of our shares and superannuation is less than we had hoped and the equity we have in our homes is about to fall.

So any correction must involve repairing our savings rather than subsidising consumption.

While 2009 is likely to be filled with bad economic news, government measures to boost demand will only make it worse.

Governments cannot prevent the downturn by throwing money at consumers and hoping this will increase spending, generate investment and bring a sustained recovery.

Such policies bring a lengthy stagnation and mounting government debt.

Right now the government should be redoubling its efforts to reduce its own spending.

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