The only nautical analogy that I have carried through my days as a professional economist is the one that apparentely John F. Kennedy coined – A rising tide lifts all boats. It was used by famous American progressive economist Arthur Okun in the 1960s to motivate his research on upgrading benefits of what he called the high pressure economy. It was an aspirational term used to goad national governments into fiscal action to ensure that the economy was always as close to full employment (high pressure) as possible. Accordingly, when the economy is at high pressure, both the strong and the weak prosper. Labour participation is strong, unemployment is at the irreducible minimum, labour productivity is high, wages are high and a number of upgrading effects across social classes and generations occur. Children from disadvantaged families get a chance to transcend poverty and workers who are displaced by global economic changes are able to be re-absorbed into productive work. Direct public sector job creation is a significant part of the national government’s responsibilities in this regard. If the private sector is incapable of providing enough jobs then there is only one sector left, ladies and gentlemen. Today I read of a new nautical analogy and my how times have changed! Its time to debrief again!
The new nautical analogy is morose, defeatist and underpins a view of government that is neither credible from an economic theory perspective or aspirational from the perspective of what we should expect from our national government in terms of full employment. This new analogy “A tight ship can emerge safe from storm” was the title of an article by The Australian economics editor Michael Stutchbury in today’s newspaper. I don’t think this maritime analogy will stand the test of time however – and thanks be for that.
The thesis of the opinion piece is that if Australia resists the need for any further fiscal stimulus packages then we will keep our AAA credit rating intact. The claim is that we will be pulled up by China and avoid a “balance of payments blowout” (whatever that means in a flexible exchange rate system) if we just bunker down and cripple the power our national government has to invoke those upgrading effects that arise from high growth.
Further, the claim is if we continue to stimulate the economy to defend jobs and the livelihoods of the most disadvantaged workers – which is chacterised by the journalist as (can you believe it) panicking then:
Australia could become a bigger risk for the foreign investors that fund our chronic external deficit. If we lost our AAA credit rating, the federal Government would find it harder to raise offshore funds. So would the states and the banks, which rely on the feds’ AAA-rated balance sheet. The credit crunch would intensify, undercutting any recovery.
The journalist then recommends that the Australian government resist the OECD’s advice to further expand fiscal policy and that the central bank should only slowly ease interest rates.
There is so much wrong with this conception that it is hard to know where to start. First, foreign investors do not fund our trade deficit. Our desire to buy more off them in real terms than we sell them (that is, more imports of goods and services than exports) finances the foreign desire to accumulate financial assets in our currency. We finance them! And given exports are a cost (they represent real things that we do not use ourselves) then it is good that we can get the rest of the world to ship more real stuff to us than they want from us. This is possible because they want to have AUD financial assets in their portfolio. Sure enough, if they suddenly changed their mind about that then we would have to reduce our net exports. But while it lasts we should be happy to have more real things than we ship away. After all, standards of living will never be reflected in nominal (financial) wealth. It is the command over real goods and services that determines how well off a nation and a person is (in the narrow terms that economists think within!).
Second, I intend to write a blog on ratings (several people have asked me about them) so I will keep it short here. The ratings agencies are essentially corrupt (they admitted this to the US Congress hearings in 2008 – taking payments in return for ratings that they knew were incorrect); error-ridden (they admitted this to a UK enquiry) and use models that bear no resemblance to the way the modern monetary economy works. They rated Enron continuously at investment grade even though they knew long before that Enron would collapse.
To illustrate how stupid the ratings are, the ratings agencies reduced the rating on Japanese government sovereign debt to the same level of Botswana earlier in this decade. They considered the Japanese government was in danger of becoming insolvent! No sovereign government can be insolvent in terms of the debt they issue in their own currency. It is simply a nonsense of the highest order. Any sovereign government can simply credit a bank account to relinquish the bond and interest on maturity. There is no financial constraint and no possibility of default.
The ratings agencies, are just money-making enterprises that are similar to “mail-order degree shops” – you pay the shop, you get the paper you want. Pay them more you will get a higher degree. Even more – you can call yourself Dr with your new PhD.
Third, even if they lowered the ratings on Australian government sovereign debt what problem would that represent? The Australian government doesn’t have to borrow abroad to finance spending. In fact, no sovereign government should ever borrow in a foreign currency. That is a recipe for disaster. But more importantly, a sovereign government does not need finance its spending. Thus, it doesn’t even have to borrow locally if it is happy for monetary policy to become dependent on competition in the interbank market. But even then, the RBA could continue to target its preferred monetary policy rate by just paying the commercial banks the target rate on excess reserves. Then no debt issuance would be required and the spending would flow to lift employment in the economy and the monetary policy stance would be preserved.
There might be implications for state governments which could easily be overcome through Federal government financing – that is, avoiding the commercial markets altogether.
The private borrowers who may have to pay more for money (say the banks) should not be seen as more important than the need to get the economy out of the spending slump. The costs of persistently high unemployment (both economic and social) will always dwarf any residual costs that might be incurred if private finance is slightly more expensive.
Fourth, the credit crunch has nothing to do with a lack of funds. Loans create deposits after all. The reason banks are not lending has been covered in earlier blogs. Repeat: they are not lending because they do not think there are credit worthy customers knocking on their doors. This is because they fear that the goods and services which would be created by the capital loaned may not sell in today’s constrained economic environment. Solution: the Government needs to further stimulate the economy to get orders moving and keep employment and wages strong to ensure workers keep buying things. The last thing you want in this environment is for the Government to hold back on putting a nominal demand floor into the economy. To adocate otherwise is sheer idiocy and … wilful neglect!
With the OECD now estimating that the global contraction will be around 4.3 per cent this year (that is, in the OECD economies), and Australia precariously close to being declared officially in recession, there is a need for more spending to fill the gap. Given labour force growth in Australia is about 1.6 per cent per annum and labour productivity growth around 1 per cent, GDP growth would have to be around 2.6 per cent at the moment to keep the unemployment rate stable. So if the Australian economy slides further and, say, records a negative annual GDP growth rate of 1 per cent, then we would expect to see the unemployment rate climb up around 2.6 percentage points. That would take it close to 8 per cent. The accompanying rise in underemployment would push total labour underutilisation towards 15 or 16 percent. If GDP growth was minus 2 per cent this year … the situation gets worse and total labour underutilisation would head close to 20 per cent. That is 1/5 of our labour resources being wasted.
It is definitely not time to worry about what some ratings agencies might do as they try to restore there tattered images from their previous failures.
It is interesting to read the Full OECD report. They are inventing new neo-liberal terms. They have now introduced “room to manoeuvre” into the nomenclature which is taken to mean that “For countries with very weak initial fiscal positions, the room for further fiscal expansion is limited.” (p.10).
This is clearly incorrect. Any sovereign government has the same capacity to expand as the next irrespective of their starting positions. The fact that they may have run deficits previously or surpluses is somewhat irrelevant. Different countries will have differing need for fiscal expansion which will be dictated by the extent to which private spending in each has fallen and left the gap that must be filled. The ability of a sovereign government to spend is not dependent on what it spent last year or over the last 10 years. It is total nonsense to propound otherwise. Of-course our “maritime journalist” buys the erroneous OECD line “hook line and sinker” (just couldn’t resist continuing the nautical flavour) when he says
Australia has had room to produce two budget packages that add up to more than $50 billion because our zero net public debt is the lowest in the OECD. And the OECD now nominates Australia among the countries with the most room for further “fiscal manoeuvre”, along with Germany, Canada, the Netherlands, Switzerland, Korea and some of the Nordic nations — but not the United States.
Sorry, all those countries have the same capacity to stimulate their economies!
The article finishes with the claim that “While the the Australian recession will get worse, we will continue to suffer less than Europe and North America. But we need to keep a tight ship to ride out this storm.”
Sorry, we need to push the tide up as quickly as the capacity of economy will permit so that all the boats, even the smallest and most fragile, can proudly float again.
Bogan list, up one!