Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
I went for a walk at lunchtime through a main shopping area where I am working today. In the past you saw Sale signs twice around twice a year – post Xmas and mid-year. The advertised discounts at this time were modest except for some enticement items that might have been discounted by 30 per cent or so. You rarely saw Closing Down/All Stock must go signs. You rarely saw massive discounts – such as 80 per cent off and the like. Times have changed and there seems to be a permanency to these sales and the discounts are huge. Previously well-to-do shopping strips are now slowly being punctuated with empty shops so the Sale/Closing Down signs are now interspersed with For Lease signs. And Australia is meant to be going through a one-in-a-hundred years mining boom and the Government tells us we are doing so well that they have to undermine aggregate demand by running a surplus to give the economy room to grow even more. The problem is that our political leaders are in denial and continually bombard us with lies to perpetuate their ideological stances which work against the well-being of the majority of citizens. It is clear that the system is failing and that means we have a choice. The problem is that we first have to identify that we have that choice.
This week is a data feast in Australia – it is both an RBA interest rate decision week and also the week that both the National Accounts with supporting data (investment, profits, government finance, current account) and the Labour Force data is published by the Australian Bureau of Statistics.
Today it was government finance and current account data. Tomorrow the National Accounts for the March quarter come out and on Thursday the May Labour Force data is released.
At 14:30 today, the RBA cut interest rates again. I tweeted in response to that decision:
Australia falling into austerity trap – RBA drops rates again as our destructive govt runs economy into ground with its surplus obsession
It is becoming patently obvious that the policy settings in the country are wrong. Well it was obvious a long time ago but, increasingly, other commentators, who normally buy into the neo-liberal lie, are agreeing with that assessment.
In announcing its decision to lower “the cash rate by 25 basis points to 3.50 per cent”, the – Statement by Glenn Stevens, Governor: Monetary Policy Decision – the RBA said:
… more recent indicators suggest further weakening in Europe and some further moderation in growth in China … The United States continues to grow at a moderate pace. Commodity prices have declined lately …Financial market sentiment has deteriorated over the past month … Europe’s economic and financial prospects have again been clouded by weakening growth, heightened political uncertainty and concerns about fiscal sustainability and the strength of some banks … In Australia, available indicators suggest modest growth continued in the first part of 2012 … both households and businesses continue to exhibit a degree of precautionary behaviour, which may continue in the near term … inflation … is likely to be in the lower part of … [its target] … range … with modest domestic growth and a weaker and more uncertain international environment, the outlook for inflation afforded scope for a more accommodative stance of monetary policy.
Regular readers of these monthly statements will note that the wording from the RBA has now shifted from “around trend growth” to “modest growth”, an acknowledgement finally that Australia’s alleged miracle economy is slowing under the yoke of fiscal austerity and the RBA is the only policy arm that cares about arresting that trend.
The Balance of Payments and International Investment Position – data release for the March quarter 2012, revealed that (in seasonally adjusted terms):
- The current account deficit rose by $A5,253 million (or 55 per cent) in the March quarter 2012. While the primary income deficit fell $A72 million, the shift into deficit on balance of goods and services was of the order of $A5,316 million.
- This means that the external sector will “detract 0.5 percentage points” from real GDP growth in the March quarter 2012.
So the much-vaunted mining boom is not delivering an external surplus capable of driving real GDP growth.
The Government Finance Statistics, Australia – data release for the March quarter 2012, revealed that:
- Tax revenue fell by 5.4 per cent since the December quarter. Tax revenue tends to fall in the March quarter for various reasons but the March-quarter 2012 decline is the worst since the March-quarter 2009 when the crisis really started to impact on aggregate activity. It is also a large fall relative to the experience of the last decade.
- Total spending for general government fell by 0.6 per cent, while spending for Public Non-Financial corporations rose by 2.3 per cent.
- This List – defines the range of government organisations. The principle “Public Non-financial Corporations” are Australia Post, NBN Co Ltd (the National Broadband infrastructure body), Airservices Australia, and the Australian Rail Track Corporation Ltd. So the major source of government spending is the NBN infrastructure development.
- In seasonally adjusted terms, real total general government final consumption expenditure rose by 0.6% compared with December quarter 2011. Total real general government gross fixed capital formation fell by 0.3 per cent.
- Taken together, in real terms the contribution of government spending will contribute the barest 0.1 percentage points to the real GDP growth, which will be announced tomorrow.
Some people might then ask – why am I concluding that the government is pushing the nation into an austerity trap and being destructive when it is still contributing to growth.
1. The March quarter real GDP growth which will be announced tomorrow will come in well below the rate necessary to reduce unemployment and underemployment in any significant way. It will also be well below our recent trend growth. Somewhere around 2 per cent will be recorded if we are lucky.
2. Labour underutilisation rates remain around 12.5 per cent with teenage rates around 38 per cent.
3. The external sector is a negative growth influence.
4. The private domestic sector, particularly households are still holding record levels of debt as the housing market continues to contract and negative equity proportions rise. While there has been some attempt to reduce debt levels the process of private sector consolidation has a long way to go.
Taken togeher, the government sector should be contributing much more than 0.1 percentage points in real terms to GDP growth. The only real reason why it is still making a positive though declining contribution to growth is because the massive broadband infrastructure project is continuing which will not only deliver massive long-term benefits but is still providing solid support for aggregate demand now.
Imagine what will happen when the conservative opposition take office next year as they surely will given the state of the opinion polls. They are sworn to abandoning the NBN project as well as a swathe of other government spending initiatives. We will then be chasing the UK down the drain of nations that issue our own currencies but insist on behaving like countries that use foreign currencies (like the EMU member states).
Last week, the ABS published its March-quarter 2012 – Private New Capital Expenditure and Expected Expenditure – data, which showed that investment was strong but expected investment is now much lower than previously suggested in past data releases.
The Government’s entire strategy is based on the “pipeline” of investment it keeps telling us about. The fact is that the flow from the pipeline is not nearly as great as previously thought.
Yesterday, the ABS released its – Business Indicators – for March 2012 which confirmed what has been obvious for some time.
Manufacturing sales have fallen by 0.6 per cent in real terms over the 12 months to March 2012 and unsold inventories have risen by 3. 4 per cent. This has impacted on company gross operating profits – falling by 0.5 per cent over the same period. Over the last two years, manufacturing profits have fallen a staggering 34 per cent.
It looks like a renewed inventory cycle is emerging. Output and employment are functions of aggregate spending. Firms form expectations of future aggregate demand and produce accordingly. They are uncertain about the actual demand that will be realised as the output emerges from the production process.
The first signal firms get that spending growth is below their expecations is in the unintended build-up of inventories. That signals to firms that they were overly optimistic about the level of demand in that particular period.
Once this realisation becomes consolidated, that is, firms generally realise they have over-produced, output starts to fall. Firms layoff workers and the loss of income starts to multiply as those workers reduce their spending elsewhere.
At that point, the economy is heading for a recession. Typically, the only way to avoid these spiralling employment losses would be for an exogenous intervention to occur – in the form of an expanding public deficit or a burgeoning external sector contribution emerging.
The latter will not be forthcoming and the government is obsessed with pursuing its surplus ambitions.
While characters like me study all this data and wait for it on a daily basis, the average citizen sees the manifestation of the damaging policy settings in a much clearer way each day as they go about their normal daily lives – those Sale and Closing Down signs and For Lease signs – tell them clearly what is happening.
Melbourne Age economics writer Tim Colebatch wrote today (June 5, 2012) in his column – No place for political stunts in tackling economic crisis that:
We are lumbered with a surplus of politicians and a deficit of statesmen
This was in reference to the fact that “(e)ach 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”.
It is actually worse than that. There is a consensus – among all the major political parties in most nations. That consensus will definitely not work! That is the problem.
On May 15, 2012, the Secretary of the Treasury Martin Parkinson gave a speech in Sydney – Macroeconomic Policy for Changing Circumstances – and noted that:
In addition to the monetary policy response, fiscal policy was also used to support the economy. The Government used its balance sheet to support the effective operation of financial markets … while also undertaking significant discretionary fiscal stimulus.
Which is code for increased the budget deficit to support aggregate demand (while giving guarantees to the banks).
The use of terminology such as the “Government balance sheet” is very unfortunate. In an accounting sense it is fine. But it gives the impression that the private and public sector are similar in some way and can ramp up liabilities to permit expansion.
The point is that the Government’s “balance sheet” carries zero risk whereas the capital side of a private balance sheet can easily become negative (and hence insolvency).
Further, there are no financial limitations on a currency-issuing government unlike the currency-users in the non-government sector which have to fund all their spending in one way or another (from income, borrowing, selling assets, past saving).
As I have said many times the analogy between a currency-using entity (such as a household) and the currency-issuing government is inapplicable at its most elemental level.
The Treasury boss then fell prey to the failure to portray that flaw:
With substantial risks remaining in the global economic environment, it is critical that we move now to recharge the fiscal batteries while circumstances remain favourable. By doing this, we will ensure that we retain the fiscal capacity to respond to future adverse shocks where needed as well as long-term trends such as those highlighted in the intergenerational reports.
The statement “recharging the fiscal batteries” which is sometimes expressed in terms of “building a war cheset, or in negative terms as “running out of bullets” etc is commonplace in the public debate.
I hear expressions such as these used every day by politicians, commentators, academics, and citizens.
It is a demonstration of how ill-informed the public debate really is and why when it comes to exercising our obvious choices those choices do not seem to be so obvious to most of us.
It is a total fallacy to suggest that the government has some stockpile of “spending capacity” that it has to recharge and buildup just in case it needs to “turn the lights on” in the future.
The fundamental principles that arise in a fiat monetary system are as follows:
- The central bank sets the short-term interest rate based on its policy aspirations.
- Government spending capacity is independent of taxation revenue. The non-government sector cannot pay taxes until the government has spent.
- Government spending capacity is independent of borrowing which the latter best thought of as coming after spending.
- Government spending provides the net financial assets (bank reserves) which ultimately represent the funds used by the non-government agents to purchase the debt.
- Budget deficits put downward pressure on interest rates contrary to the myths that appear in macroeconomic textbooks about “crowding out”.
- The “penalty for not borrowing” is that the interest rate will fall to the bottom of the “corridor” prevailing in the country which may be zero if the central bank does not offer a return on reserves.
- Government debt-issuance is a “monetary policy” operation rather than being intrinsic to fiscal policy, although in a modern monetary paradigm the distinctions between monetary and fiscal policy as traditionally defined are moot.
The mistake lies in thinking that such a government is revenue-constrained and that a surplus will give the government more spending capacity. Nothing could be further from the truth irrespective of the rhetoric that politicians use to relate their fiscal decisions to us and/or the institutional arrangements that they have put in place which make it look as if they are raising money to re-spend it! These things are veils to disguise the true capacity of a sovereign government in a fiat monetary system.
The claim that create the fiscal room to fund the so-called future liabilities is nonsense. A sovereign government’s ability to make timely payment of its own currency is never numerically constrained. So it would always be able to fund the pension liabilities, for example, when they arose without compromising its other spending ambitions.
The creation of sovereign funds basically involve the government becoming a financial asset speculator. So national governments start
A sovereign government’s ability to make timely payment of its own currency is never numerically constrained by revenues from taxing and/or borrowing. Therefore the creation of a sovereign fund in no way enhances the government’s ability to meet future obligations. In fact, the entire concept of government pre-funding an unfunded liability in its currency of issue has no application whatsoever in the context of a flexible exchange rate and the modern monetary system.
The misconception that “public saving” is required to fund future public expenditure is often rehearsed in the financial media.
First, running budget surpluses does not create national savings. There is no meaning that can be applied to a sovereign government “saving its own currency”. It is one of those erroneus mainstream macroeconomics ideas that appear to be intuitive but have no application to a fiat currency system.
In rejecting the notion that public surpluses create a cache of money that can be spent later we note that governments spend by crediting bank accounts. There is no revenue constraint. Government cheques don’t bounce! Additionally, taxation consists of debiting an account at an RBA member bank. The funds debited are “accounted for” but don’t actually “go anywhere” and “accumulate”.
The concept of pre-funding future liabilities does apply to fixed exchange rate regimes, as sufficient reserves must be held to facilitate guaranteed conversion features of the currency. It also applies to non-government users of a currency. Their ability to spend is a function of their revenues and reserves of that currency.
So at the heart of all this nonsense is the false analogy neo-liberals draw between private household budgets and the government budget. Households, the users of the currency, must finance their spending prior to the fact. However, government, as the issuer of the currency, must spend first (credit private bank accounts) before it can subsequently tax (debit private accounts). Government spending is the source of the funds the private sector requires to pay its taxes and to net save and is not inherently revenue constrained.
The problem is that when politicians make these statements it is obvious that they are misleading the public. They know that the nuances explained above will not be well understood.
When the Treasury boss talks about “recharging the batteries” the only reasonable interpretation an normal person will have of that statement is exactly wrong. They will intuitively think that the Government is just like them – and needs to save (make hay) to expand their consumption opportunities later.
That is dead wrong and if we all understood that we might have a different view about the policy choices that are being foisted onto us via the smokescreen of ignorance.
Please read my blog – When common sense fails – for more discussion on this point.
There was an interesting article in the UK Guardian yesterday (June 4, 2012) – Austerity has never worked – by Ha-Joon Chang, who teaches economics at Cambridge University.
His article (and insight) should serve as compulsory antidotes for the rubbish that the likes of Rogoff and Reinhardt pump out – claiming that history vindicates the need for fiscal austerity.
Ha-Joon Chang says that:
It’s not just about the current economic environment. History shows that slashing budgets always leads to recession …
He notes that the bad economic news is everywhere.
1. “Greece and Spain fall apart and the core eurozone economies contract”.
2. “Britain watches on as its economy is heading for the third consecutive quarter of contraction”.
3. “… India and Brazil … [and] … even China – are slowing …”
4. “Four years after the financial crisis began, many rich capitalist economies have not recovered their pre-crisis output levels”.
5. The ILO “estimates there are 60 million fewer people employed worldwide than if the pre-crisis trend had continued”.
We already know that neo-liberalism has failed to deliver on its claims. Poverty rates in the richest nation – the US have been rising for some years now and have accelerated in the crisis.
The important point that Ha-Joon Chang makes is that the failure of neo-liberal policies is not just a new revelation:
… there is also plenty of historical evidence showing that they have never worked.
He documents the “1982 developing world debt crisis, the 1994 Mexican crisis, the 1997 Asian crisis, the Brazilian and the Russian crises in 1998, and the Argentinian crisis of 2002” where all “the crisis-stricken countries were forced (usually by the IMF) to cut spending and run budget surpluses, only to see their economies sink deeper into recession”.
We can also go back to the 1930s when the same medicine was applied and the initial recession became a Depression.
He also documents how the claims that small government generate stronger real growth is deeply flawed;
From 1945 to 1990, per capita income in Europe grew considerably faster than in the US, despite its countries having welfare states on average a third larger than that of the US. Even after 1990, when European growth slowed down, countries like Sweden and Finland, with much larger welfare spending, grew faster than the US.
Trickle-down tax cuts to give the so-called “wealth creators” (the higher income earners) more incentive to work harder do not work:
Compared to the previous three decades of higher taxes and stronger regulation, investment (as a proportion of GDP) and economic growth fell in those countries …[where this ideology has dominated] … Also, the world economy in the 19th century grew much more slowly than in the high-tax, high-regulation era of 1945-80, despite the fact that taxes were much lower (most countries didn’t even have income tax) and regulation thinner on the ground.
Further, labour market deregulation does not work either;
Unemployment rates in the major capitalist economies were between 0% (some years in Switzerland) and 4% from 1945-80, despite increasing labour market regulation. There were more jobless people during the 19th century, when there was effectively no regulation on hiring and firing.
His message is simple – the overwhelming percentage of citizens have a choice. It is obvious that the policies our political leaders are espousing are failing.
The only conclusion we can reach is that the entrenched policy positions biased towards austerity are “against all evidence” and that tells us that the “our leaders … want to preserve – or even intensify, in areas like welfare policy – the economic system that has served them so well in the past three decades”.
That is our choice.
The relevant questions that need to be asked are:
1. “Do we want a society where 50% of young people are kept out of work in order to bring the deficit down from 9% of GDP to 3% in three years?”
2. Doe we want a “society in which the rich have to be made richer to work harder (at their supposed jobs of investing and creating wealth) while the poor have to be made poorer in order to work harder?”
3. Do we want “a tiny minority … [to] … control a disproportionate, and increasing, share of everything – not just income and wealth but also political power and influence (through control of the media, thinktanks, and even academia)?”
There are transition eras in history where the accepted power structures and dominant ideologies undergo stress and in some cases – after a considerable period of dislocation – give way to a new period where social and power relationships are redefined and progress resumes.
I think we are living through an extraordinary time and we are in one of those transition eras where the dominant power structure can be pushed aside. While for a few decades the neo-liberals were able to persuade us that there deregulation of labour and financial markets was delivering massive wealth to us all, it is difficult to mount that case now.
The evidence is compelling – the neo-liberal model is fatally flawed. So we have a choice.
The problem is that the choices we have are clouded by the snowstorm of lies that the elites bombard us with every day. The Irish yes vote is an extraordinary example of that.
It defies belief that a fully informed electorate would vote yes in the circumstances that the Irish find themselves in.
I see my role – tiny as it is – to keep pumping out an alternative narrative – ground in the evidence as well as the logical understandings of how things actually work – to try to educate an increasing number of citizens so that social networks and the like spread the education more widely.
That is enough for today!