Posted: April 21, 2006

Public surplus = Private deficit

Treasurer Costello announced yesterday that in net terms the Federal Government is now debt free. He went on to make some statements that do not hold up under scrutiny.

First, he claimed that budget surpluses took pressure off interest rates. Sorry, budget deficits put downward pressure on overnight rates as commercial banks scramble to rid themselves of excess reserves and in doing so find that they are unable as a group to clear away a 'system-wide excess'. That is why debt is issued in the first place under a fiat-currency system - to allow the central bank to maintain a positive target rate of interest. Just study Japan for a while to see what happens when the central bank leaves an amount of excess liquidity in the system. What happens? Zero short-term interest rates and typically, lower investment rates (long-end rates).

Second, he extolled the virtues of 'public saving'. But it makes no sense to say that the public sector saves in its own currency. A budget surplus is not saving - it is a net reduction in the liquidity held by the private sector.

Third, he said that the Federal Government had 'paid back the mortgage39; as if it was analogous to a private householder finally gaining full ownership of the housing asset they had been paying off for some years. There is no analogy between the issuer of the currency (the Government) and the users of the same currency (the private sector). The latter has a financial constraint on their spending while the former has no such constraint and can spend what it wants (subject to real goods and services being made available) without the need to arrange 'financing'. It is one of the biggest neo-liberal myths that both sides of politics propogate - that the Federal Government has a financial constraint.

Fourth, while the Government has no net debt (due to several budget surpluses and some privatisations) the household sector is now suffering record levels of indebtedness following the credit binge of the last 10 years or so. Figures show that the debt level is something like 165 per cent of total household assets which means that in a fire sale the assets would not clear the liabilities. Further, an increasing amount of debt is held in speculative assets which means that their current price is unlikely to remain should their be an economic crisis. Indeed, a portion of household assets (for which borrowings were raised) may even achieve zero value in a crash. The relationship between the public surpluses and private deficits is $ for $. They are the accounting mirror of each other.

So when the Government claims virtue in running surpluses it is equivalent to imposing liquidity constraints on the non-government sector such that to continue economic growth the latter has to become increasingly indebted.

Further, when the government claims it is reducing debt it is equivalent to them squeezing the private sector for liquidity and 'forcing' us to liquidate our wealth (in this context - the government bonds).

The storm clouds are approaching though which will sheet home the economic follow of running budget surpluses - which create fiscal drag on growth and directly cause mass unemployment. Don't forget that there are approaching 2 million Australians who either do not have enough work or have no work at all. The lack of demand in the Australian economy is directly related to the fiscal drag. But within that environment several factors are important: (1) the petrol price rises are now feeding into the inflation rate and with a pavlovian central bank in our midst interest rate hikes are coming. With the household sector at record levels of indebtedness and hence precariously poised, significant numbers of bankruptcies will follow; (2) there is evidence that the household sector is starting to restructure their balance sheets to restore some security to their financial positions. That means less consumption growth. Again bad for aggregate demand levels and employment levels; (3) the current growth engine is the minerals boom and the latest evidence would suggest that that is now finite. China is signalling that they are about to put the brakes on; (4) the pursuit of surpluses has also undermined the integrity of our public infrastructure. Hospitals are in poor shape as are roads, universities, schooling in general to note just a few crucial sources of long-term economic prosperity that have been neglected by the short-sighted macroeconomic strategies of the Federal Government.

Taken together, the growth period we have experienced (albeit not of sufficient magnitude to generate full employment or anywhere near it) is now threatened. When the economy starts to slow the descent will be rapid and deep. Then we will see the budget go into deficit. But it all could be avoided if the Federal Government was running a deficit strategy now to achieve full employment.

Blog entry posted by bill