Posted: January 19, 2005
Savings will start the slowdown!!
The Australian Bureau of Statistics released their latest credit statistics today and in November they show that personal borrowing on credit cards and overdrafts fell by around 5.3 per cent for the first time in three months. Corporate finance also fell by 1 per cent in November. Is this the first sign of the household balance sheet restructuring that I have been predicting will come given the record levels of debt being carried by households in Australia at present? If it is then the Australian economy will slow dramatically rather quickly.
The following graph comes from the sectoral flows analysis from Quarterly Valance Reports last updated in November and helps us understand this point.
The orange line is the government budget balance, the blue line is the domestic balance (domestic private saving) and the green dotted line is the current account balance (or non-domestic savings). The time period plotted is from 1990 to now. You can easily see the relationships that exist between the balances. Other things equal, when the government runs a budget surplus it forces the non-government sector to run deficits! Further, a current account deficit provides the finance (by us spending AUDs) for foreigners to accumulate AUD-denominated financial assets and satisfy their desire to net save in that currency. Both sides of the deal win.
The increased Federal defense spending in 2004 and 2005 plus the tax cuts and other benefits in mid-2004 means that the budget surplus will decline to around 0.5 per cent of GDP in 2005. As a comparison, it was 1 per cent of GDP in 2003 (a highly contractionary force necessitating the strong private debt growth to maintain overall economic growth).
Our current account has hit record levels in recent months and for 2004 will be in excess of 6.4 per cent of GDP up from 6 per cent in 2003. This is largely because the rest of the world slowed down and our exports declined as a result and higher energy prices have driven up imports. Most worrying is the fact that our private sector savings rate is now the lowest in the G10 countries as a result of the credit binge and the budget surpluses.
To maintain our economic growth rate, unless the electorally-driven fiscal stimulus is converted into a responsible fiscal stimulus aimed at achieving full employment, the already heavily debt-burdened household sector will have to take on more debt to keep domestic spending growth high. The OECD country outlook data estimates that the private balance will decline from its 2003 (binge-proportions) -7 per cent of GDP to around -5.7 per cent for 2004, and continue to decline over 2005. This is the trend that the ABS November credit figures is picking up. It means that the private domestic sector is starting to restore their fragile balance sheets. The problem is that under these circumstances domestic expenditure growth will not be sufficient to sustain economic growth at sufficiently high levels to keep reducing the unemployment rate. The Federal government has to start providing net spending stimulus through sustained budget deficits to ensure the private sector can restore some strength to their balance sheets and that the economy can maintain employment growth.
Meanwhile, the Bank of Japan, in its monthly report (released January 19) has maintained its position of "ample liquidity" keeping rates at around zero supporting the Cabinet Office's large budget deficits which are designed to keep the spending stimulus going. The BOJ was pessimistic in its previous report but now has confirmed it believes the recovery will continue, despite "somewhat weak movements mainly in production."
Have you not wondered why Japan has huge budget deficits, zero interest rates, and low core inflation (if not deflation)? Doesn't it get you thinking that the neo-liberals have sold you a dummy when it comes to relying on orthodox economic analysis of budgets to inform macroeconomic policy settings? The fact is that Japan demonstrates that budget deficits do not push up interest rates. In fact, it is quite the opposite - they push them down in the absence of central bank intervention into the cash markets. The BOJ keeps just enough excess liquidity in these markets to ensure that the interbank competition to get rid of the excess reserves (earning zero interest) will be enough to drive the cash rate down to zero. And how you ask do they do this? They issue government debt paper - bonds - to mop up just enough liquidity to keep excess reserves. Debt is issued not to 'finance' the budget deficit but to drain liquidity to manage the short-term interest rate. The BOJ could easily run a positive interest rate if they so desired. They would just sell more bonds and drain more liquidity from the reserve system. The conventional crowding out argument against government spending is a plain myth! And what about the other lie - that large deficits drive up prices? Once again this is not the case in Japan which has had nearly a decade of deflation while net public spending has been huge.
With an unemployment rate still above its full employment level, the Japanese budget deficit has to increase not decrease!
Blog entry posted by bill