Today I was looking through annual reports of the Australian Future Fund, which is an example of what is known the world over as a sovereign fund. I have been keeping an eye on the performance of the Future Fund not the least because it is so exposed by its stake in Telstra, which has gone downhill ever since the previous regime persuaded Australians to buy a stake in something they already owned!. Anyway, most people have been conned by the Future Fund concept – it is shrouded in lies and deceit. In general, the idea of a sovereign fund is based on a misunderstanding (deliberate or otherwise) of the way the modern monetary economy operates. So its time to debrief and make it clear that these policy choices by governments generally undermine public goods and full employment.
The Future Fund
In the midst of the nonsensical intergenerational debate that the previous federal regime used as a political tool to justify running unjustifiable budget surpluses the notion arose that the country would not be able to honour its liabilities to public sector superannuants unless drastic action was taken. Hence the hype and spin moved into overdrive to tell us how the establishment of a sovereign fund – ironically named the Future Fund (ironic because it actually undermines our future – more later) – would save the day.
The Future Fund is a sovereign fund which have become favourites of the neo-liberals over the last 20 years.
The mythology that surrounded the creation of the Future Fund was aided and abetted by statements from the so-called markets. For example, the CEO of the Association of Superannuation Funds of Australia claimed at the time that “the Future Fund was a savings vehicle while superannuation funds were investment vehicles with strategies aimed more at growth.” Nonsense!
The financial market players lapped it up because they knew they were in for more largesse at the expense of public spending. Corporate welfare is always attractive to the top end of town while they draft reports and lobby governments to get rid of the Welfare state, by which they mean the pitiful amounts we provide to sustain at minimal levels the most disadvantaged among us.
Anyway, the previous Federal government created the Future Fund in 2006 to meet what they claimed were “unfunded public sector superannuation commitments”. The imagery was that there were all the public servants who would eventually retire and divert public spending away from essential services etc so that their superannuation payments could be made. The claim was that the Future Fund would create the fiscal room to fund the so-called liabilities. Clearly this is nonsense. The Commonwealth’s ability to make timely payment of its own currency is never numerically constrained. So it would always be able to fund the superannuation liabilities when they arose without compromising its other spending ambitions.
The Futures Fund also got them out of an embarrassing hole when the T3 sale of Telstra looked like becoming a train wreck. It meant they could avoid total privatisation and still claim otherwise. How did the Government ever get away with persuading us to buy shares in something we all already owned? And then to look us in the eyes as that wealth plunged in value! That still amazes me.
And since January 2009 :
Anyway, on February 28, 2007, the Federal Government deposited 2.1 billion Telstra shares worth $A8.96 into the Future Fund which represented the final public ownership in the telecom (equivalent to around 17 per cent ownership of the company). The $8.96 billion represented the value of these shares at their value at that time. On February 28, 2007 the Telstra share price was $4.26.
After November 20, 2008, the Future Fund was no longer required to hold the 2.1 million shares in escrow and they were free to trade them. Of-course they would not be able to divest themselves of many Telstra shares because it would drive the price down even further. Institutional investors (who buy large tranches) have hardly been lining up to get their hands on Telstra shares. Anyway, on that date the Telstra share price was $3.97. So the holding losses in the period between February 2007 and November 20, 2008 amounted to around $A610 million.
Since that time they have sold their Telstra stake down to 16 per cent which on December 31, 2008 was valued at $A7.6 billion. A rough estimate suggests they have about 1.99 billion shares left (being 16 per cent of the current total Telstra share issue) which at the current price (April 18, 2009) of $3.19 means the total value of the Telstra stake held by the Future Fund is now around $A6.3 billion.
It is clear that they have squandered more than $A2 billion since the nonsensical venture began.
It is interesting to note that in their official accounts, at least those that are publicly available, they quote everything in “excluding Telstra” terms. They have stated in the past that they “prefer not to count the Telstra stake in its overall performance because it is a disproportionately large investment it inherited.” So when you have a bad story make it a little better by fudging. Their public statements are thus somewhat misleading. In a statement to The Age at the time of the Interim Report release on January 30 the Future Fund CEO was quoted as saying “During the quarter we reduced our cash holding from 56 per cent to 46 per cent, while materially increasing exposures to debt markets to take advantage of higher returns …” That seems like the fund is improving its position. But all the asset holding proportions they quote publicly or list in their financial statement ignore the 12.8 per cent of their total assets which are held as dud Telstra shares.
The most recent Interim Report from the Future Fund issued on January 30, 2009 discloses that they are continuing to lose money. Movements in financial markets since mean that the Future Fund has made further losses.
At the time the last Interim Report was issued (January 31, 2009) the Telstra share price was $3.79. It is now worth $3.28. So in 3 months the Future Fund has squandered around $1.2 billion in public spending in opportunity cost terms.
The Telstra shares generated negative returns of 8.49 per cent for the December quarter and 5.54 per cent for the 2008/09 first half. Since July 2007, when the Future Fund began trading, its Telstra shareholding has lost it 4.13 per cent per year.
But it hasn’t just been its Telstra exposure that has been the problem. Over the 2008, the Future Fund lost 8.49 per cent and in the first half of the 2008/09 financial year it return was -7.56 per cent (excluding the Telstra component).
So our Federal government continues on with its gambling ways in the World’s bourses while millions of Australians do not have enough work. If that isn’t a scandal ….!
While the Future Fund and the Finance Minister are trying to tell us that the fund is performing well in a tough climate, all the spin they like to put on it doesn’t alter the fact that the losses are equivalent to the Government putting $2 billion in a bucket and setting it alight. And they are paying the managers of the fund millions to do it! As the Annual Report 2007-08 tells us (page 84), 10 senior executives were paid a total of $4.9 million of which $1.75 million was in “performance related payments”. The top 5 executives were paid 76 per cent of the performance bonuses (totalling $1.3 million) and 64 per cent of the base pay (totalling $2 million).
Now, while this in itself doesn’t stop the Government from spending any amount that they want – given they have no financial constraint – it does pose a political issue.
What if I said that the spending they put into the Future Fund was sufficient to employ all of the current unemployed and underemployed for about the next decade at minimum wages? They would immediately say, among other disparaging remarks, that there was no fiscal room to do any more than they are doing. Yet they are spending to buy financial assets instead which are going backwards in value.
So we have a situation where our elected national government prefers to buy financial assets which then lose significant value instead of buying all the labour that is left idle by the private market. They prefer to hold bits of paper that has lost value than putting all this labour to work to develop communities and restore our natural environment.
How could we have ever become entrapped by this level of absurdity?
As a digression, with the broadband saga going on Telstra’s share price has plummeted even further as it dealt itself out of the initial tendering process (see the second graph above). However, here the conflict of interest arises and we will never really know whether it drove the abrupt change of plans by the Government. Had the Government continued with the previous plan and left Telstra out of the construction of the broadband network then Telstra’s share price would have fallen further and the Future Fund’s stake in it would have been consequently worth much less. It is clear that given the Government is still the largest single shareholder in Telstra (through the Future Fund’s 16 per cent holding) there is no way they would allow Telstra to be excluded from the “biggest infrastructure project since the Snowy mountain’s scheme”. We cannot prove anything but it is worth thinking about.
Macroeconomic theory – why this is all nonsensical
An understanding of modern monetary theory will tell you that all the hoopla over the Future Fund is basically totally unnecessary. Whether the fund gained or lost makes no fundamental difference to the underlying capacity of the Federal government to fund all of its future superannuation liabilities.
The Commonwealth’s ability to make timely payment of its own currency is never numerically constrained by revenues from taxing and/or borrowing. Therefore the purchase of a superannuation fund (in this case the Future 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. That is, it represents lunacy!
The misconception that “public saving” is required to fund future public expenditure is often rehearsed in the financial media. In rejecting the notion that public surpluses create a cache of money that can be spent later we note that Government spends by crediting an account at an RBA member bank. 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.
However, trying to squeeze the economy to generate these mythical “pools of funds” which are then allocated to the Future Fund as if they exist is very damaging. You can think of this in two stages. First, the Federal Government spends less than it taxes and this leads to ever decreasing levels of net private savings. The private deficits are manifest in the public surpluses and increasingly leverage the private sector. The deteriorating private debt to income ratios which result will eventually see the system succumb to ongoing demand-draining fiscal drag through a slow-down in real activity. Second, while that process is going on, the Federal Government is actually spending an equivalent amount that it is draining from the private sector (through tax revenues) in the financial and broader asset markets (domestic and abroad) buying up speculative assets including shares and real estate.
That is what the Future Fund is about. It amounts to the Treasury competing in the private equity market to fuel speculation in financial assets and distort allocations of capital.
However, as you can see from pulling it apart, this behaviour has been grossly misrepresented as providing “future savings” to pay for the superannuation liabilities. Say the sovereign government ran a $15 billion surplus in the last financial year. It could then purchase that amount of financial assets in the domestic and international capital markets. But from an accounting perspective the Government would no longer have run that surplus because the $15 billion would be recorded as spending and the budget would break even.
In these situations, the public debate should be focused on whether this is the best use of public funds. It would be hard to justify this sort of spending when basic infrastructure provision and employment creation has been ignored for many years by neo-liberal governments.
How can the government justify purchasing speculative financial assets which it has lost several billion on while holding when there were more than 9 per cent of willing labour resources either not employed at all or being forced to work less hours than they desired because of overall spending constraints in the economy?
If we want to provide for a better future the Government should be spending sufficient amounts to make sure everyone has a job. That is a minimum requirement for improving the future prospects. Then it might spend some of the $60 billion it put in the speculative Futures Fund on medical research to find cures for cancer and HIV and to make our public schooling system the best that money can buy. That would be a funding the future. The Future Fund does nothing for our futures and should be unwound as soon as possible and the executives made to earn a living somewhere else!
Under the control of Witchdoctors and Shamans
I was thinking today about how all the mainstream economists were egging the Government on with respect to the creation of the Future Fund. It amazes me that given how central economic matters are to our lives that we are so uneducated in economic matters. We rely, as a society, on the banal and wrongful statements by so-called “economists” … more and more, the media uses statements from bank and financial market economists who are not independent but say what is in the interests of the corporations that employ them. Unfortunately, we hold these economists out as experts who do understand even if “we” do not.
But in fact, most of the statements that go as expert economic commentary reveal an ignorance of how the modern monetary economy works and how a government with a monopoly in the currency issuance operates.
In that sense, no matter how sophisticated we aspire to be as a society, we are really in the hands of witchdoctors and shamans who circle us with mantras and spells and leave us feeling as though the ship is being run by those who know something that we do not. In that sense, we are a most primitive society.
The Future Fund is a good example of that “trust”. But just as we would deride the rantings of some “mystic” who was predicting the end of the World, so we should ignore these economic shamans.
This is the basic lesson of macroeconomics. Firms produce to meet expected spending. All output will be sold if spending equals the sum of all income. If an agent spends less than its income, output will go unsold unless another agent goes into debt and buys that output. If there is a generalised net desire to save – output will go unsold and the stock build up will lead to declining production and employment.
The reverberations of the lost incomes generate a downward spiral in output. In this situation, the economic outcome depends entirely on the policy response by government. If demand for private production falls but people still desire to work then there is no valid reason not to switch them to public goods production until private demand recovers.
Unemployment results when the policy response inhibits this switch. Surprisingly, most commentators and public officials fail to realise that the unemployed, supported by welfare measures, are already ‘in the public sector’. A sensible policy response would utilise this capacity to both attempt to produce socially beneficial outputs, and reduce socially detrimental reactions to unemployment.
In this regard, market forces should determine the level of government deficit spending. A fixed-wage Job Guarantee policy can attenuate any tendency towards financial instability and provide the switch between private and public sector employment over the business cycle, as well as provide an “anchor” effect to the price level.
It is ironic that during a time of heightened appreciation of market forces, the option to let market forces determine the size of the fiscal deficit has not been open to discussion.
So: (a) the performance of the Future Fund shows that even if we use the erroneous logic of the Government – that it is a major “waste of money”; (b) But the logic used by the Government is spurious in the extreme and therefore sovereign funds are totally unnecessary and just hand over public spending to high paid financial executives and fuel speculation on assets traded by the top-end-of-town; and (c) It shows how deceitful or ignorant our policy makers are in terms of the dialogue they engage us with.
That is enough for today!
(c) Copyright 2021 William Mitchell. All Rights Reserved.