Flat Earth theory returns – budget aftermath

Imagine the time when it was the mainstream view that the Earth was flat, representing an infinite plane. The view largely died at around 3 BC but there are still some characters out there who worry about falling off the South Pole. After all the Nile River runs for thousands of kilometres and drops barely a few feet over that distance which doesn’t fit well with convexity does it?

The current budget period seems to have revitalised the theory – albeit in a different form but just as ingenious. Flat Earth Theory (FET) … say it out aloud! … has morphed into DET. This new branch of FET is now dominating the media. Overnight Generation Y are Generation DET. Young children are now viewing their parents differently – wondering why their greedy, selfish and profligate elders are going to destroy their futures. Experts are coming and going on our national TV and radio warning that we are about to fall over the edge! Well I am staying grounded! Here is the reason why.

sphere_of_the_world

I suggest they all take a look at this picture which was reproduced from the 1550 edition of On the Sphere of the World, which was a dominant astronomy textbook in Europe in the C13th and argued that the world was spherical.

Even with this, so-called “scientists” still kept standing in rivers with telescopes and followed the path of boats to prove they didn’t disappear before their eyes.

Clearly, a thorough understanding of the way planets form and the physics that govern their relationships and the empirical evidence that emerges from that understanding negates Flat Earth theory categorically.

Equally a thorough understanding of the way modern monetary systems operate and the dynamics that govern the relationships between government and non-government and the overwhelming empirical evidence that emerges from that understanding tells us that: (a) public debt is not issued to finance government spending; and (b) the debt burden will be never be so large that our future generations will have to endure high taxes to meet the necessity to “pay the debt back”.

But there are plenty of Flat Earthers (DETs) out there still fighting against this knowledge drawn from understanding how the system actually works.

For example, ABC Finance Editor Alan Kohler today says there is a Ridiculous plan at heart of pension rise. In what he purports is “Analysis” we read:

The increase in the old age pension of $2.7 billion in 2009-10 is all borrowed. The proposition that it will be paid for by an increase in the retiring age phased in up to 2023 is ridiculous.

I note that Analysis is defined as “an investigation of the component parts of a whole and their relations in making up the whole” and something is analysed if it has been “examined carefully and methodically; broken down for consideration of constituent parts” (Source).

But semantics aside, the last time I examined the monetary system methodically and broke it down into it constituent parts I concluded that the “increase in the old age pension” will be actioned by the Federal Government crediting bank accounts (adding reserves to the bank system) and using their capacity as the monopoly issuer of the currency to do so. There are no funds borrowed for this purpose because the Government is not revenue-constrained – which means …. it does not have to borrow or tax to spend.

I would also understand that the “proposition that it will be paid for by an increase in the retiring age … is ridiculous” is correct. The pension increase is being paid for week by week by Government spending using its currency sovereignty and crediting bank accounts. Very simple proposition really. The tinkering with the retirement age merely shuffles those who are eligible for the pension. It has no implications for the ability of the Government to pay the pension now or in the future.

Another Flat Earth adherent – an ABC AM Current Affairs reporter – hassled some twenty-somethings about the budget and came up with these profound insights:

Overwhelmingly, what they are most worried about is the $58 billion deficit and how long it will take to balance the nation’s budget.

“When are you going to do another surplus to pay back the debt?” Tom said.

The housemates fear they could go from being Generation Y to Generation Debt.

“[I] guess it is a little bit intimidating, particularly as we’re going to be working for a lot more years,” Anna said.

“If that’s the debt we’re going to be responsible, kind of, for paying off, it is a little bit scary.”

Scared? I am. Fancy the ABC, our national broadcaster, allowing this drivel to enter the radio waves.

A thorough understanding of the way modern monetary systems operate would tell this Reporter that a more sensible question to the twenty-somethings would have been:

Aren’t you happy that the Government is finally running deficits which will help sustain output and employment and build national infrastructure which will bolster our educational institutions and stimulate capacity building in our regions … which will increase your future wealth far beyond what would have been the case?

To which Tom and Anna would reply: Sounds cool to me!

But instead, the fear of DET was launched without any comprehension of how the system operates at all. A thorough understanding of the way modern monetary systems operate would inform Tom that budget surpluses are not required to repay the debt anyway. The Government will repay the debt when it matures in just the same way it spends – it will credit the bank account of the debt holder and throw the bit of paper (the IOU) in the bin after recording the transaction.

And Tom should sleep easy at nights because he will never be “kind of” responsible for these transactions unless he is employed sometime in the future somewhere in the Government as a computer operator in charge of making these electronic entries. If he is not so engaged, then he will never know from one day to the next when the billions of dollars are being repaid.

Moving to the print media, Sydney Morning Herald Flat Earther, Phillip Coorey headlined with A decade of debt until we’re free. I thought the article was going to be about someone getting sentenced to prison for 10 years or whatever! But then you really see the FET, sorry DET logic. He said that Australia:

… will remain mired in debt for at least 10 years, with net debt projected to reach about $188 billion within four years, and a gross debt of $300 billion. Net debt will fall to about $40 billion by the end of the decade.

The choice of words is what gives this journo away. The definition of “mired” – entangled or hindered as if for example in a mire! (Source).

We would have been hindered without the deficit that is for sure. The fact that the Government chooses to match the deficit spending with the offer of an IOU to the private sector is just a sideshow. The interesting question is why the Government willingly does that when it knows it is not revenue-constrained. I never hear the press asking the Government that question. Why? Because they are drowning in DET and like FETs need to go back to school to gain an understanding of how the system they are pontificating about actually works.

But read on and I will provide some of the reasons for the issuing of these IOUs (bonds). But the connotation that we are being imprisoned by it just is flat earth stuff … and very crude flat earth stuff at that.

The Melbourne Age columnist Peter Hartcher, another Flat Earther said in his column Rudd has lost his boldness and roar that

The bad news is that the Government has not worked out how to pay for this without recourse to what is, for all practical purposes, indefinite indebtedness … Last night’s budget projects that in a decade from now, the Federal Government will still have net debt of 3.7 per cent of gross domestic product as a result of the money it is spending today … In today’s terms, that is about $40 billion, the size of the entire economy of Lebanon. This is extraordinary. It marks this as a frightened government.

Can you believe this stuff? Generally speaking if the national government adopts a voluntary rule that every $ that it net spends (runs a deficit) that it will match it $-for-$ by issuing IOUs (bonds) to the private market which will pay for the IOUs using the funds injected into the economy by the deficit anyway, then the higher the net spend the higher will be the value of the IOUs issued. So what?

That means that the Government is voluntarily running an arrangement that provides an interest-bearing asset with some future maturity (the IOU) to the private sector to allow them to situate some of their bank reserves in that form. It just provides the private sector with portfolio options and the interest paid on that debt provides the private sector with an income return on their savings. That sounds terrifying.

It has nothing much to do with Lebanon at all, except that some people will use the return on their savings (the debt interest) to buy tickets to travel to Lebanon to visit relatives. And probably feel good about it if they manage to avoid being shot!

In turn, the IOUs “drain” the excess bank reserves that would otherwise earn below market returns. In doing so, the Government eliminates the interbank competition that would drive the overnight interest rate below the desired target of the Reserve Bank of Australia. The bond issues are a monetary operation to maintain desired short-term interest rate targets and have nothing at all to do with “financing” the net spending.

I am also leaving the News Limited journalists alone today because I am too scared to read what they have to say about all this. I might fall off my bike tonight if I read any of it … sort of like falling off the edge of the Earth!

And just a little word from the Opposition leader to finish. He said today that the Treasurer “ignored the elephant in the room, during his budget speech on Tuesday night”. I know that we are using the word “temporary” a lot lately and when I hear that word I immediately relate it to the tenure of the Opposition Leader rather than anything else. Anyway, according to the (temporary) Opposition leader:

The deficit was so horrible that the treasurer couldn’t even bring himself to mention it in his speech … This is the first time in history a treasurer has given a budget night speech and has not mentioned, has not had the guts to say, what the result of the budget is … He wasn’t prepared to say that it was $58 billion in deficit, he wasn’t prepared to say that the debt by 2012 would be $188 billion.

While I am sure the Treasurer would fail the Saturday Quizzes, he was right not to mention the size of the deficit or the debt buildup. They are largely irrelevant. The deficit is the accounting statement of the net add to private savings coming from the government and the size of the debt merely tells you how private agents have expressed those savings in the form of government paper (bonds).

When it all comes down to it, a thorough understanding of how modern monetary systems operate will tell you that the debt is private wealth and the funds to pay for that debt came from the deficit spending – not the other way around. The Government could have easily not issued the debt and then we would not have had a risk free interest-bearing asset to park the excess reserves that the deficit creates each day in the banking system. Both the deficit and the rise in debt are good things for private wealth creation.

The temporary OL and his shadow Treasurer were also at odds over how big the deficit would be if they had have been in charge. Clearly both were lost in the woods and focusing on the irrelevant. But the temporary OL said:

If we had been elected in November 2007, the deficit would be dramatically lower and the debt forecast for 2012 would be dramatically lower …

Well if they had have introduced a Job Guarantee which might have required an investment of $8-10 billion per year to generate around 560,000 jobs they would have achieved better employment outcomes for less net spending. No doubt about that fact and that underlines my major criticism of the actual Government’s position.

But given they would not have been up for that we would conclude that the recession would be deeper and longer under their management and the recovery period would be flatter and the long-term unemployment would be higher and drawn out for longer.

The Budget deficit has to fill the spending gap … what size the latter is … is how large the former has to be. The consequences of not filling the gap are rising unemployment. The fact that the Federal Government is willingly allowing the unemployment rate to rise towards 9 per cent (presuming their forecasts are sound) tells me that the 4.9 per cent of GDP deficit is far too small.

Something more like 6-8 per cent is more like the figure that would be required. Note that in the US, the Government is still underspending on stimulus and their Deficit to GDP ratio is already around 14 per cent. It will have to go towards 16 or 17 per cent to more fully meet the challenge.

I have my eyes peeled at present for Flat Earth theorists.

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    7 Responses to Flat Earth theory returns – budget aftermath

    1. K says:

      I don’t really understand this but I am only 23, so I hope the unemployment rate dosen’t get too high and I can’t believe this is just happening as I am starting my career. It’s unfair. Did you see that documentary about the cost of Medicare in the US and how the costs are only set to increase in the future. Do you think that will happen? It also had all the reasons why Bush contributed to the recession. eg. The stupic war on Iraq and major tax cuts. The US has an unemployment rate as well.

    2. Lefty says:

      Speaking of flat-Earth adherents, check out Adele Ferguson in todays Australian, dribbling away about how vast sums of money will need to be raised by the private sector to pay for the infrastructure spending.

      http://www.theaustralian.news.com.au/story/0,25197,25476807-5014000,00.html

    3. bill says:

      Dear Lefty

      I have deliberately avoided the News Limited take on all this.

      best wishes
      bill

    4. generation X says:

      Thanks for your blog. As someone not trained in economics I share some of your readers confusion over how the money supply works, but I can understand deflationary spirals and the need to maintain spending. When I was at high school we were taught both Keynes and Friedman’s theories and there was a bias towards the latter, but I don’t remember there being this level of hysteria about the governments running deficits. What are the origins of all this mania for maintaining surpluses in booms and busts? Surely the business community must understand the governements need to make up for the shortfall in private spending? I have found the media coverage of this budget vearing into the surreal.

      I found Nicholas Barr from the LSE had a good take on how the intuitive “pub economics” can get things wrong on intergenerational arguments about pensions.

    5. 1earth says:

      Hi Bill,

      I first heard you on Radio National and am intrigued by your analysis of the deficit. One question i have is how creating money
      in people’s bank accounts impacts on inflation. I was under the impression that if you ‘print’ more money than is collected through revenue, that will cause inflation and devaluation of the currency (devaluation may be not all bad), with the extreme example being Zimbabwe.

      is it a case of:
      “During the Howard budget surplus years, money was being withdrawn from the economy by the surplus, but then created by
      the explosion of credit = no deflation, while now money must be created through the deficit so people can pay their credit debts (which withdraws money again) = no inflation.” ?

      then, (i think as you have said), the deficit must match the sudden disappearance of more credit flowing into the economy,
      but not more, otherwise there will be inflation. is this correct?

      Another question. Herman Daly expounds ‘ecological economics’: the economy is bounded by the Earth’s ecoystem, so
      it cannot grow unrestrained or it will damage the ecosystem (and already is). Does this imply that the deficit spending
      (and job creation) should be directed towards sustainability?

      cheers,
      1earth

    6. Alan Dunn says:

      Hi 1earth,

      Regardless of what many people say I would challenge that nobody has in anyway a complete or even sufficient understanding about the dynamics of inflation.

      Your questions are effectively based on the quantity theory of money which is based on fixed exchange rates, , a gold standard, and the assumpotion that says law always holds.

      With respect to surplus and defict I like to talk in terms of the non-government sector. In other words for the Howard Costello years I always talk about the massive deficits they forced upon the non-government sector (which I think you alluded to as well).

      The inflations / deflation rhetoric has been discussed before by Paul (I’m a complete Joke) Krugman with respect to Japan and the prior Asian financial crisis. I think you would find the reply to Krugman by Jan Kregal (one of the best economists alive) may answer all your questions.

      Cheers

      Alan

    7. bill says:

      Dear 1earth

      Governments do not spend by “printing money”. This terminology is used to dissuade us from supporting government deficits on the grounds that they will be inflationary. Ultimately, if the government net spends beyond the scope of the economy to absorb the nominal demand (that is, it cannot produce anything more to meet the demand) then inflation will occur. Inflation can also occur at any time if there is an asset price bubble but that is not a specific criticism of deficits. Any spending can set off a bubble.

      Your depiction of the Howard years is reasonably sound. The only reason the economy kept growing in the face of the surpluses was because of the credit binge. If that had not occurred, the budget would have quickly gone back into deficit but at high levels of unemployment.

      I think the last point is excellent. One of the problems of old-fashioned Keynesian generalised expansion (using deficits to stimulate the economy) is that it is difficult to target the impact and has no intrinsic “green” credentials. That is one of the reasons I advocate a Job Guarantee – this can absorb spending to create jobs which would have to satisfy green criteria before they were approved.

      I think the Government has a great opportunity to use this recession to build green spaces – putting people to work and repairing our degraded community and environmental spaces.

      best wishes
      bill

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