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It is getting ridiculous

I imagine it goes like this. Your driving along listening to the radio and the Australia Treasurer comes on and is saying that we need a budget surplus because we have a once-in-a-hundred years mining boom and are near full capacity but given the government tax take is seriously below the forward estimates because growth is slowing, the government has to have even more drastic cuts in spending in the upcoming May budget than first thought. Why? To achieve the budget surplus! Then the Opposition spokesperson for matters economic says we are running out of money. And us ordinary citizens take it all in because it is headline news this lunchtime and we become entrapped by the logic of the situation as set out by the journalist who fuels the discussion along these lines. The only problem is that I am not an ordinary citizen in this context. The problem lies in the starting premise – the blind pursuit of the budget surplus. All the rest of the nonsense follows from that ill-conceived goal. It is getting ridiculous though.

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The story I am about to tell actually happened. The characters in the story have had their identities deliberately revealed (by me) so that normal people will point at them in the street and giggle about them every time they appear in public.

The story also crosses national borders and while set in sleepy Australia is of relevance to the US and the UK and almost everywhere else that I can think of.

This morning the headline in the Sydney Morning Herald (April 20, 2011) was – Mine boom a budget buster, says Treasurer.

The ABC reported (April 20, 2011) – Swan rules out mining revenue windfall.

This was followed up by an extensive news coverage all morning and a feature on the lunchtime ABC radio current affairs program – The World Today – Swan’s resources gloom questioned. You can hear the audio HERE, although I warn you the discussion and contributions from our nation’s leaders is deeply disturbing given that they are not currently employed as comedians.

The background: Australia is meant to be having a one-in-a-century-mining export boom which is, as the story goes, pushing our economy beyond the inflation barrier as we approach full capacity. Little details like 12 per cent labour underutilisation rates and negative contributions from net exports to the most recent National Accounts are seemingly skipped in this story.

Australian Labor governments have been typically lambasted by the conservatives as being a free-spending and economically irresponsible. This has led recent Labor governments to be more neo-liberal than the neo-liberals to dispel the conservative fears that they are poor fiscal managers.

So at the height of the downturn, the Government pledged it would return the budget to surplus in record time after two stimulus injections helped save the economy from a recession of the type plaguing the US and other nations. There was no immediate economy arguments used to justify this policy goal – it was just a political statement by people who don’t understand what they are saying but know full well that almost everyone else is in the same boat and will be beguiled into thinking this is good economic management.

People like me say that the Government is mad to be locking itself into these rigid fiscal policy targets especially when there is so much productive labour lying idle and the signs are that the economy is slowing rather than booming. We argue that by trying to pursue a budget surplus when there is an external deficit means that either the economy will slow down sharply (if private domestic firms and households continue to adopt a subdued spending outlook or that the private domestic economy will grow on the back of increased indebtedness – an unsustainable strategy.

More recently, the Government has been justifying the surplus goal and the need for harsh cuts in the May Budget on the grounds that the mining boom is so strong that the public sector has to clear some “room” for the private expansion lest it invoke an inflationary spiral. All the talk is “up” – growth, mining boom, soaring wealth, growth.

The Prime Minister gave a speech last week to outline the Government’s position on how to handle this “growth”. Please see this blog – Australian Labor Government abandons its roots for my discussion of that speech.

She said:

If government doesn’t step back when the private sector employs more people, spends more money and builds more projects, we will be chasing the same scarce resources, driving up prices and adding to the inflationary pressures arising from the investment boom.

It is true that if the economy was at full employment (that is “chasing the same scarce resources”) and private spending growth quickened and the public-private mix of resource usage was advancing public purpose then yes – the government would have to allow its budget deficit to fall (either cyclically and if that is not enough to ease back behind the demand-pull inflation barrier then discretionary cuts (in the structural component) have to be made.

Then the news comes out last week and into this week that the economy is slowing and tax revenue is falling. The Treasurer’s reaction – we need harsher spending cuts in the May Budget than previously thought necessary.

Why? Answer: because the slowdown in economic activity is causing a collapse in tax revenue which will prejudice our surplus target.

Why are you pursuing a surplus? Answer: because the economy is at full capacity and we are in the midst of a one-in-a-century mining boom.

What?

Please read my blog – Distorting history to appear progressive – for more discussion on this point.

Anyway, today’s stories became even more unfathomable.

The SMH article (cited above) led with:

THE new mining boom will not deliver the “rivers of gold” in revenue that the previous boom produced, meaning the nation faces a mean budget and possibly more, the Treasurer, Wayne Swan, will warn today.

In a speech to the Queensland Press Club, the Treasurer will say that “mining boom Mark II” will bring all the difficulties of its predecessor, such as labour shortages, pressures on inflation and other capacity constraints, but “without the surge in revenues”.

This will “demand an intelligent policy response” – which means budgetary restraint.

An intelligent response requires some basic intelligence!

Mining Boom Mark II is the post recession lift in commodity prices as China’s growth returns. Mining Boom Mark I in the last few years of the previous growth cycle (before the financial crisis) provided strong revenue growth to the Federal government and the economy was at trend growth (around 3.5 per cent).

But the new mining boom is predicted – if you believe the Treasurer – to be a dud from the perspective of providing tax revenue.

The Treasurer told the ABC (link cited above) today that “even though mining investment is expected to double in the next financial year, it will not be accompanied by another “rivers of gold” tax windfall for the government”

Now why is that? In his own words:

We’ve still got the hangover from the global recession, we’ve got a patchwork economy with weakness in some sectors, and of course we’ve got the high Australian dollar … So we won’t be getting the same revenue stream from mining boom mark two as we got from mining boom mark one … In the short term we’ve got the impact of the natural disasters and we’ve also got softness in some parts of the economy …

Okay, it seems straightforward – the economy is slowing down and the automatic stabilisers are reducing revenue. The budget deficit will rise as a cushion against the downturn in private spending.

The mining boom is not as boomy as they are making out and private households, overladen with record levels of debt courtesy of the credit binge pre-financial crisis, is not spending. Firms, in turn, are not spending.

The Treasurer told journalists that the government is “expecting household consumption to remain 1 per cent lower over the budget period than it was during the first mining boom” and that “while mining sector profits grew 59 per cent last year, corporate profits outside the mining sector actually fell slightly”.

Add in the demand-depressing impacts of an Australian dollar now around 1.05 USD and you do not have a particularly buoyant outlook – mining-boom or not.

This is the classic situation where the government would use fiscal policy – in a counter-cyclical manner – to ensure the non-government spending weakness does not cause the economy to tank. You might imagine that would mean a commitment to on-going deficits.

But in the logic of our Treasurer nothing could be further from the truth. He said that “severe cuts” in public spending were necessary:

… that’s why the Government is so firm that we must bring the budget back to surplus in 2012-13 and make the necessary savings as the mining boom goes right through our economy.

But Dear Treasurer – there has not been a change in the tax system between Mining Boom Mark I and Mining Boom Mark II. So if the tax take expected is seriously lower then doesn’t that tell you that the Mark II might not go “right through our economy” at least not as strongly as you might imagine.

And Dear Treasurer – net exports are still subtracting from growth overall.

Anyway, all this was rehearsed during the World Today interview as above. Here is a selection of the transcript – I decided to invade the interview to ensure the ABC (our national public broadcaster) maintains political and economic balance. Here are some highlights.

Edited version of the full Transcript:

JOURNALIST: Australia’s in the midst of another mining boom, but the Treasurer says the country won’t see the rivers of gold that flowed during the last boom.

WAYNE SWAN: We’ve still got the hangover from the global recession, we’ve got a patchwork economy with weakness in some sectors and of course we’ve got the high Australian dollar. So we won’t be getting the same revenue stream from mining boom mark two as we got from mining boom mark one.

But of course what we are getting is our economy approaching full capacity.

PROFESSOR BILL MITCHELL: Excuse me Mr Treasurer – the two statements don’t accord. The revenue stream is flagging because the economy is not growing as strongly as your forward estimates predicted. The forward estimates suggested consumers and firms would spend more and that the mining boom would be stronger than it is.

Given that the economy is growing well below trend and we have 12 per cent of our labour resources idle what is the evidence we are “approaching full capacity”. Even if we were “approaching” it, the loss of tax revenue suggests were are heading away from it again.

After outlining the Treasurer’s predictions about a slowdown in private spending, the ABC then interviewed the Opposition finance spokesperson Andrew Robb:

JOURNALIST: … While the Treasurer says some unpopular budget decisions are done in the knowledge they’re the right and responsible thing to do, the Opposition’s accused the Government of crying wolf.

ANDREW ROBB: The Treasurer has to learn to spend what he’s got and no more and that is the lesson for this Government – not excuses that they’re now dredging up about other factors that are putting pressure on their management of the economy.

PROFESSOR BILL MITCHELL: Andrew, the Australian government issues our currency and has unlimited amounts of that currency to spend. It is fully sovereign in the Australian dollar. Surely you don’t want the Treasurer to be spending “what he’s got”. That would push nominal spending well ahead of the real capacity of the economy to absorb it and we would get inflation.

The ABC then interviewed a private sector economist who used to work in the Commonwealth Treasury (Chris Richardson). Things went from bad to worse:

JOURNALIST: Economist Chris Richardson of Deloitte Access agrees money is being wasted but not in the way the Opposition says. He says it’s time to get serious about making big savings from middle class and industry welfare, along with top end tax breaks.

CHRIS RICHARDSON: The budget is still in trouble, it was a bigger victim of the global financial crisis than the Australian economy as a whole and it hasn’t recovered from that yet. The budget figure is still looking pretty sick …

PROFESSOR BILL MITCHELL: What exactly is a budget for a sovereign (currency-issuing) government look like when it is “in trouble”? There is no meaning in that statement. The budget is whatever it is. You might consider the economy to be “in trouble” if there is high unemployment, stagnating growth (as now) or rampant inflation.

Further, the budget was not a victim of the global financial crisis – it merely reflected the collapse in private spending and as is necessary it expanded into deficit to put a floor in overall aggregate spending.

The budget position is not a problem. Concentrating on it as if it is a standalone point of interest is the problem because it distracts us from the real economy – output, jobs, etc.

And from worse to terrible:

JOURNALIST: So is the picture as gloomy as the Government is portraying at the moment?

CHRIS RICHARDSON: What the Government is saying, and I certainly agree, is in essence, it’s time to be tough on spending. The Government promised a couple of years ago that as we exited from the emergency measures that we did take and should have taken through the crisis that it would be tough on spending.

Now we’ve reached the point in time where it actually has to do that and that’s a very hard thing to do with a hung Parliament. So yes, it’s now faced with a bunch of hard choices.

PROFESSOR BILL MITCHELL: The “getting tough on spending” promise was a poorly conceived political statement and didn’t reflect the underlying economic reality. The problem the Government has now is that with the economy slowing it had to run deficits or face further job losses. But it has painted the surplus as such a paragon of fiscal virtue – totally erroneously – that it will now be crucified (sorry Christian readers – being so close to Easter and all) if it doesn’t make cuts. But the cuts will further undermine its surplus ambitions.

Lesson: the blind pursuit of the surplus is the problem. The correct response as the economy is slowing is to provide public fiscal support to employment and output growth. You cannot do that if you are cutting public spending harshly.

Conclusion

The other problem is that the journalists play along with this idiocy and don’t ask the obvious questions – Why pursue a surplus when the economy is slowing as evidenced by the collapse in tax revenue?

I have been travelling today and so have had limited time.

That is enough for today!

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    This Post Has 16 Comments
    1. I have two questions:

      1) why talk about deficit if this deficit is an accounting deficit and theorically it can be endless?
      I think that is really illogical to think about money only like a debt or a deficit, especially if this is an accounting debt that no one pays.

      2) why no one talks about the illogical (economically and philosopically) idea of interest? There is not a corresponding part in real economy,
      then you are forced to produce always more than the loan you have received.

      thanks.

    2. What do you guys think of the Richard Koo analysis (in criticizing S&P action). Seems fairly MMT-ish on the sectoral balances issue:

      “What Japanese market participants understand that Western rating agencies do not is that fiscal deficits generated during a balance sheet recession are the result of economic weakness triggered by private-sector deleveraging, and that the private savings needed to finance those deficits are by definition made available at the same time.

      In other words, such conditions lead to a substantial surplus of savings in the private sector. What makes an economy under such conditions fundamentally different from an ordinary economy (i.e., one that is not in a balance sheet recession) is that those savings are plentiful enough to finance the government’s deficits.”

      Read more: http://www.businessinsider.com/sp-downgrade-us-outlook-negative-2011-4#ixzz1K40uOHza

    3. Frank, correct on all counts as I understand it. Koo is not quite MMT but many of his comments are very MMT-ish. I’m pretty sure Bill has a post here somewhere debunking something Koo said.

    4. You have to admit it’s an Australian cultural trait to down play the negative consequences and over emphasize the positive. All part of the “no whingers” society. In the words of Elton John “it’s getting more and more absurd”

      It will soon be like the Knights sketch in the Monty Python film. Australian economy missing two arms and legs. Wayne says “Come closer Bill and I’ll bite you to death.”

    5. Speaking of the S&P downgrade, Prof(?) Thoma made the following comment: “The main worry about the debt is that, at some point in the future, interest rates will rise as the world becomes reluctant to lend more to us”
      At his blog I asked him to define “some point in the future”. I wanted him to give specifics, such as the debt/gdp ratio or any other statistic of his choice that would result in the interest rate rise. He immediately deleted my post.

    6. Thoma is very good at asking others to produce models to support their assertions. “At some point in the future” – I’m surprised he didn’t reply “the infinite horizon”.

    7. PROFESSOR BILL MITCHELL: The “getting tough on spending” promise was a poorly conceived political statement and didn’t reflect the underlying economic reality. The problem the Government has now is that with the economy slowing it had to run deficits or face further job losses.

      Not necessarily true – it could just cut interest rates.

    8. Sometimes….sometimes not…..it isn’t an option for the US, for example. Locally, we have room to cut rates to be sure, though the RBA has been engaging an inflation-hawkery over the last year that would put Hoenig to shame, and despite the available and accumulating evidence to the contrary over the past couple of years.

      Further, the private sector isn’t exactly gagging for new debt (see Credit Data), and is already overleveraged (see RBA Chartpack), so it’s odd to expect a RE-leveraging under those circumstances. Targeted spending would appear to be a better option than a catch-all suck-it-and-see.

    9. possible…..but there again, yes and no….remember the dotcom boom? If a country raised rates at that time, it was seen as a hindrance to growth, which is all the markets cared about at the time. The currency had downward pressure. Cut rates and you were the friend of business and progress. Your currency would appreciate. Counterintuitive I know, because as you point out, higher rates tend to attract capital, and that is the normal course of events. I’m not convinced cutting rates 25/50/75bps would cause the AUD to come crashing down. It’s beating to another drum (terms of trade-based risk appetite, leverage). However, I can see a fairly robust downward effect as risk assets grapple with the end of the 1-way bet that is QE.

      Looking back at recent history, the AUD was rallying while rates were being eased in late08-early09, then there were periods of coorelation interpersed with very little. The most recent pause has seen the AUD actually make it’s fastest gains. Just noting there are many peices to this puzzle, and cash….the USD…. are just examples of those right now.

      Currently there is little prospect the RBA are actually going to raise rates, and it has been that way for a while, and yet the currency is going nuts (we’re in the realm of a blowoff top if you ask me, just don’t ask me from where!). Further, the government, like the economics profession has been blindsided by what appears to be a fairly predictable set of events over a long period – the mining sector is small (the target of policy…even though it is impervious to it), and not big enough to account for the lagged effects of raising rates, and a large (commodity-based) appreciation in the currency that has been gutting the domestic side of the economy…..and still is.

    10. “I’m not convinced cutting rates 25/50/75bps would cause the AUD to come crashing down.”

      Hard to say, it depends whether the market anticipates further cuts. Lowering the rate to parity with the euro would definitely have an effect.

    11. markg, thoma likes deleting posts with no good reason (like a lot of economists who don’t like being challenged). I stopped posting there because of that.

      He only seems to like things that fit his philosophy.

    12. “But Richard Koo of Nomura has written before that ratings agencies don’t understand how government debt functions in a deleveraging cycle, or a balance sheet recession.”

      I’d argue that Koo does not understand currency without a bond attached and/or assumes aggregate demand is unlimited.

      “What Japanese market participants understand that Western rating agencies do not is that fiscal deficits generated during a balance sheet recession are the result of economic weakness triggered by private-sector deleveraging, and that the private savings needed to finance those deficits are by definition made available at the same time.

      In other words, such conditions lead to a substantial surplus of savings in the private sector. What makes an economy under such conditions fundamentally different from an ordinary economy (i.e., one that is not in a balance sheet recession) is that those savings are plentiful enough to finance the government’s deficits.

      Corporate savings (and personal savings to a lesser extent) have boomed since the recession, and it’s that excess cash the U.S. government can continue to make use of while the country is deleveraging to keep the economy from shrinking.”

      I’d say it is more like savings of the rich and savings of the rich corporations = dissavings of the gov’t plus dissavings of the lower and middle class.

    13. It’s the transglobal and large national corps that are piling up cash, as in the Ernst & Young report the other day, not the SME’s, I’d say.

      Of course, E&Y recommended business spending (investing?) rather than return the gain to consumers by cutting prices and easing the short term soft commodity/energy spike’s effects.

    14. The term “surplus of savings” occurs often. In a simplified national accounts model a surplus of savings may be indistinguishable from a lack of purchasing capability, but as a general term it is misleading. Can someone point to a discussion that includes the unemployed/underemployed sector separately from a sector that opts to deleverage or save? Thanks.

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