These are rather extraordinary times indeed. I have been trawling through the Australian public debt data which is spread across the federal sphere and the various states and territories. The official data published by the ABS is always dated (lagging a year or so) and the state-level debt data is actually quite hard to put together – their various ‘debt management’ offices do not make it easy to put a time series together. My interest is in working out the impact of the rather radical shift in usual conservative Reserve Bank of Australia behaviour when the pandemic hit. They started buying government bonds (at all levels) and now own large swathes of public debt. They have also effectively been funding the rather large deficits that the governments in Australia have been running. And interest rates and bond yields remain low after nearly 18 months of this shift.
The RBA begins buying up government debt in large quantities
In March 2020, as it became clear that Australia was going to be caught up in the pandemic and the Federal and state/territory governments announced emergency measures to protect incomes during the lockdowns, the Reserve Bank of Australia deviated from its recent history and introduced a large-scale government bond-buying program.
They provided this ‘explainer’ – Unconventional Monetary Policy – to educate the population on these matters.
Their explanation under the heading “Asset purchases” is largely accurate.
Asset purchases involve the outright purchase of assets by the central bank from the private sector with the central bank paying for these assets by creating ‘central bank reserves’ (in Australia these are referred to as Exchange Settlement or ES balances). (Some people have referred to this as ‘printing money’, but the central bank does not actually print any banknotes to pay for the asset purchases.)
Go the RBA for politely pointing out that it is the height of ignorance to talk about ‘printing money’ in the context of government bond purchases.
They point out that the goal of these purchases is “to lower interest rates on risk-free assets (such as government bonds) across different terms to maturity of those assets – that is, across the yield curve.”
So instead of targetting just their short-run policy rate that the RBA Board sets each month, asset purchases can “lower a range of interest rates”.
This also puts “downward pressure on bond yields”.
They left out the other important point – for obvious reasons – that this really amounts to one arm of government buying the other arm’s debt, which, in effect, once we cut through all the blather from politicians and RBA officials, is funding the fiscal deficits run by the level of government that have issued the bonds.
In March 2020, the RBA announced a series of ‘non standard’ monetary policy measures – Supporting the Economy and Financial System in Response to COVID-19 – which included asset purchases that targetted the 3-year Australian government bond yield at 0.1 per cent.
Initially, the target yield was set at 0.25 per cent, but then it was lowered in November 2020.
The RBA accomplishes this goal by standing “ready to purchase government bonds … in the secondary market”.
The central bank can control yields easily by increasing demand for the bonds in the secondary market, which as a result of the inverse relationship between yields and prices, drives down yields to the desired target.
It can target any maturity on the yield curve (1-year, 2-year, right out to 30-years) depending on which rates it wants to control.
At the moment it is buying around $A4 billion worth of government bonds per week and is committed to this strategy until at least November 11, 2021.
Here is the impact on the Australian government yield curve of the purchases.
I have provided 4 monthly snapshots – December 2019, March 2020 (when the program began), February 2021 and the most recent data for October 2021.
You can see the dramatic effect on the short-end of the yield curve of the bond-buying program.
The longer-term yields have risen a bit in 2021 as the short-term inflationary risks rose due to supply bottlenecks arising from not only Covid disrupting international shipping etc but also because of the disastrous bushfires in late 2019, early 2020, which has caused the timber shortage.
But in recent months, those risks are abating a little and the long-end of the curve is flattening again.
Public Debt Trends in Australia
When the ECB started buying large quantities of Member State debt after they introduced the Securities Markets Program in May 2010, various Executive Board members were wheeled out to tell us that they were just providing liquidity to the payments system.
It was obviously not that but they continue to play that game.
They were funding Member State fiscal deficits because if they had have left it to the private bond investors alone, the yield on some of the national debt would have gone through the roof, and, given the scale of the crisis, some governments (probably Italy, Greece, Portugal and even Spain) would have found it hard selling any debt.
That means they would have gone broke and the ECB knew that. They knew they stood between keeping the euro system intact or seeing it dissolve in a sequence of national insolvencies.
The scale of the purchases made it obvious that they were acting as fiscal agents in the monetary union as well as the central bank, given that the architects of the common currency deliberately avoided setting up a federal (European) fiscal authority.
In doing so, the central bank became the last stop – despite all their stupid ‘no bailout’ rules.
The RBA has until now not purchased much Australian government debt (either a federal or state/territory level).
In the past, when the government ran a ‘tap system’ of bond issuance (prior to 1983), the government would fix the yield and call on the market dealers to buy up to a desired volume.
If the yield announced was not competitive, then the tender would fall short and the RBA would always step in and fund the difference by taking the Treasury debt itself.
The neoliberal era was marked by the abandonment of this system in favour of the ‘auction’ process, where the private dealers bid the yield and the ‘market’ (auction) sets the final yield.
The RBA has typically not bought much debt during this era.
The change arose because politicians believed the mainstream macroeconomists who erroneously claimed that the old tap system would cause hyperinflation – ‘money printing’ (duh).
Apparently, as we were told at the time, the ‘market knows best’.
But it was more than that.
The government fell prey to special pleading from the financial markets to allow them to exploit higher returns on the risk-free assets – and so an elaborate new dimension in the existing corporate welfare system was added which led to the shift to the auction process.
Well, now, the RBA has broken out of its past mindset and has been buying large swathes of Australian government debt at both national and state level.
They clearly realised that as the fiscal deficits had to rise somewhat substantially to deal with the pandemic, the ‘auction’ system might deliver much higher yields and raise all sorts of political problems.
At the state/territory level, the rising yields could have even threatened solvency, given the state and territory governments use the currency that the federal government issues.
So the bond-buying program began and 18 months later it is still in full swing.
The first graph shows the spectacular increase in non-government wealth held in government bonds since the GFC.
It shows short-term government securities issued in Australia (red) and long-term government securities issued in Australia since 1995 to July 2021 (the data is monthly and is available – HERE).
The data is for the total public sector in Australia (so Federal and State/Territory)
Clearly, there was an steady increase due to the GFC and then the very sharp increase to deal with the pandemic.
The data shows that between February 2020 and July 2021, the total public debt in Australia rose by $A351.7 billion or around 11.5 per cent of the flow of GDP produced since the March-quarter.
A relatively large increase in other words.
The next graph shows the total public sector debt since 2003 (to July 2021) and the Federal debt, which dominates.
But it still remains, that in July 2021, the non-currency issuing states/territories had around $A400 billion in outstanding debt.
Which is one of the reasons the RBA also started buying the ‘semis’, which are treasury bonds issued by the states and territories.
It knew that with the Federal government acting in a penny pinching way – forcing cost-shifts onto the states and territories, who under our constitution bear the major responsibility for health care, that the state deficits would rise quickly.
All states bar Western Australia have recorded large swings towards higher fiscal deficits as they take on major new spending obligations associated with the pandemic.
It would have been much better for the federal government to fund the whole response and save the states and territories from increasing their debt levels.
I will come back to that in closing.
The next graph shows the proportion held by non-residents, which at the end of June 2021 had fallen to 48.8 per cent.
Mainstream commentators who do not understand currencies butt in here and claim that our deficits are being funded by foreigners – the ‘China-keeping-the-US-government-afloat’ myth.
Modern Monetary Theory (MMT) demonstrates that the external deficit countries (such as Australia typically) ‘finance’ the desire of the external surplus nations to accumulate financial assets denominated in the currencies of the deficit countries. If the deficit countries stopped purchasing that desire would be unfulfilled.
Further, to pursue that desire, the surplus countries are willing to net ship resource benefits (goods and services) to the deficit country. What do they get in return? Bits of paper and electronic bank balances.
But the nationality of the holder of Australian government debt is largely irrelevant.
Per se, it doesn’t really matter who holds the debt issued by a government. Foreigners are never ‘funding’ Australian government spending, notwithstanding the fact that the Non-residents (institutions) hold large swathes of Australian Treasury-issued debt.
For a currency-issuing government such as Australia, the funds associated with the debt issuance do not provide the government government with the capacity to spend. That capacity is intrinsic to a currency-issuing government.
Non-residents do not issue the Australian currency but have to purchase debt in that currency.
There are exchange rate implications of foreign nations running external surpluses against Australia and thus accumulating financial claims in Australian dollars, some of which can manifest as Australian government bonds.
But these issues are separate from the solvency-type issues.
Please read my blog posts for a discussion of those implications:
1. Trade and external finance mysteries – Part 1 (May 8, 2018).
2. Trade and finance mysteries – Part 2 (May 9, 2018).
3. A surplus of trade discussions (May 23, 2018).
How much debt has the RBA purchased?
The following graph shows the impact of the RBA’s bond-buying program of its percentage holdings of Australian federal debt.
They now hold 26.6 per cent of all outstanding debt.
At the onset of the pandemic they held 2.2 per cent of all outstanding debt.
In terms of total outstanding public debt in Australia (federal plus states/territories), the RBA now holds 20.8 per cent (July 2021) compared to 1.9 per cent pre-pandemic (February 2021).
1. To achieve that increase in its total share of outstanding federal government debt, given the low base pre-pandemic, the RBA has bought 92.2 per cent of all the debt issued between February 2020 and August 2021.
2. In terms of overall government debt changes (Treasury bonds and semis), the RBA has purchased 68.7 per cent of the total change in debt issued.
3. The impact will be that the Federal government is effectively having its deficits funded by itself and will be paying interest to the RBA, which will then be recycled back to the Treasury in the form of dividends – right pocket/left pocket governmental transfers.
For the states and territories though, they will have to service and repay the debt when it matures with flows to the RBA. And these flows will, in turn, end up, at least partially with the Federal Treasury.
In other words, the federal government is ripping off the states and territories again and no-one is talking about this.
4. As the RBA noted in the Explainer I linked to above:
In addition, investors can use the proceeds they receive from selling their assets to the central bank to purchase other assets. These portfolio adjustments by investors can affect the price of these other assets and the exchange rate.
While, initially, the bond-buying program represents an opportunity for the sellers to alter the mix of their wealth portfolio, it remains that the liquidity the RBA provides the sellers in return for the bond instrument can be used as a speculative fund to pursue other assets – financial or real (such as real estate).
It is impossible to estimate how much has gone in to fuel the ridiculous boom in housing over the last few years, but some of it probably has.
The problems this is now causing younger and lower-paid workers is a direct result of the government maintaining the fiction that it has to issue debt to the primary market in order to spend.
It doesn’t and given that, ultimately, the government just ends up buying its own debt, they could eliminate any negative consequences of the whole charade by abandoning the practice of debt issuance and just instructing the RBA to credit various non-government bank accounts as required to facilitate its spending program.
The crediting is already happening but it would be cleaner without the debt charade.
The debt phobes who are starting to lift their heads above the slime should understand all this.
They will undoubtedly start to mount their ‘grandchildren burden’ stupidity. But with the federal government buying nearly all of its debt itself they should realise there is nothing to say.
That is enough for today!
(c) Copyright 2021 William Mitchell. All Rights Reserved.