Today, we step down from the heights of the modern money-debt deflation debate and consider macroeconomic developments which demonstrate the deficit-debt hysteria is ramping up here. I may come back to the debate in later blogs but I think the issues have been well considered. While the debate has uncovered some useful issues that I often get asked about (particularly in relation to the accounting and definitional matters) it also demonstrated that very simple and unthreatening concepts get conflated into horror stories if we let the dominant neo-liberal ideology control the way we think and the language we use. Also, I know I promised a G-20-IMF blog and that will emerge but some things emerged today that need commentary.
First, the Economists’ Conference is currently being staged in Adelaide. I stopped going to these conferences when they started to go up-market and hold them at Casinos instead of at Universities. The registration fees sky-rocketed and the accommodation became very expensive against the cheap student accommodation that was available given the conference is staged during the holiday period this time of year.
Anyway, it is also the home of neo-classicana going-nowhere economics and papers are churned out that try their hardest to resemble something out of the American Economic Review. It seems that the more banal the topic and the more mathematically challenging the paper, the better it is received.
The keynote speakers are typically conservatives who demonstrate no affinity with any economics ground in reality. This was certainly the case yesterday when the former chairman of the George W. Bush’s Council of Economic Advisers, Edward Lazear pontificated on the future of economic growth.
The Australian newspaper is the home of neo-liberal news in this country and is our only national newspaper. Thankfully, the Internet has broken down that dominance down a bit because we can read all the capital city dailies easily on-line now (until they start charging). This is a minor respite, given how conservative the media is here, in general.
Anyway, today The Australian reported that:
Big government a plague to growth … A TOP US economist has questioned whether economic stimulus packages work, saying they struggle to achieve in the short term and tend to cause damage in the long run.
As an aside, Lazear’s often-cited paper Rank-Order Tournaments as Optimum Labor Contracts uses some opaque and totally spurious reasoning to justify why executives get such generous high pay packages which are far in excess of any skill variations between those in the pecking order below. It is always helpful to have mates in academia who write these sorts of inpenetrable articles (to those not versed in the area) which you can then draw on as providing the authority for the unconscionable.
As another aside, the whole edifice of mainstream marginal analysis including wage and distribution theory was developed in the second-half of C19th to offset the growing popularity of Marxism which provided a threatening view of how production was split betweeen those who did the work and those who merely owned the capital. Industrialists funded academics to develop a theory that said everything if fair and square – one gets back exactly what they put in.
Then when the system didn’t remotely produce outcomes that were in line with this theory modern developments like those provided by Lazear provided some more ad hoc adjustments to bring the theory in line with what was observed. Nonsense morphing into nonsense.
Anyway, back to macroeconomics.
Lazear is quoted in The Australian as saying:
What you have to be worried about is setting up an environment where you have a huge increase in the size of government, and in particular in the government deficit, that plagues the economy as you go forward, either in the form of higher taxes, which is not good for growth, or in the form of higher inflation, which is not good for growth.
So what do we say about all that? Not much at all except to ask some questions.
1. Where in any economic theory does it say anything about the optimal size of government? There is no economic theory (of any kind) that says anything about the optimal size of government. Any statements made – that large is bad and small is good – are ideological and cannot be derived from any known body of economic theory – mainstream or otherwise.
2. There has been a significant increase in budget deficits around the world’s economies – in line with the increase in the spending gaps and the increasing desire to save. Does Lazear have information and analysis that the net spending increases have gone beyond the spending gaps that have opened? I have information to the contrary – the rising labour underutilisation around the world and stark increases in poverty rates as a consequence
In one of the richest countries – his own – The US Census Bureau recently released a new report Income, Poverty, and Health Insurance Coverage in the United States: 2008 which shows how poverty has sky-rocketed in the US. The World Bank reveals an increasing food crisis. We could go on.
So all the evidence available tells me that the deficits are too small at present to sustain economic activity of sufficient strength to sustain adequate employment levels.
3. Why will taxes rise? Perhaps they will if the government feels growth is too strong and that they consider the private sector should have less spending power. By then the deficits will be lower via the automatic stablisers anyway. But if taxes rise it will not be to “pay back the deficits”. The deficits today are gone – they are flows. Each day the flows are embedded in the spending and revenue programs so if you want to reduce the net result each day you have to reduce spending and/or increases taxes. That will automatically happen anyway as welfare payments subside and tax revenue increases as activity returns. After that, what is left of the spending gap (non-government saving desire) tells you what the discretionary deficit has to be.
For Australia, given our external position, there will have to be an on-going government deficit if the economy is to resume strong growth and the household sector continue to increaes their saving ratio.
4. Why will inflation rise? With capacity utilisation rates so low around the world and spare labour capacity what will generate a widespread inflation? Perhaps oil prices? But that will be due to an olipolistic cartel (OPEC) and nothing to do with the deficits.
Further, what empirical studies unambigously show that rising inflation is bad for growth? What level of inflation has to occur before inflation is correlated (even) with lower growth? Answers: No categorical research evidence; Very high.
But you get the picture – our main conference for professional economists
Lazear told reporters after his talk at the conference, in the fine tradition of international commentators (like the IMF) who swan into a place and produce expert opinion:
.. that while he did not consider himself an expert on Australia’s economy, he believed the effectiveness of additional stimulus money to turn economies around was “very limited at this point. I would worry more about the longer-term consequences of that, just as a general matter again, not so much specific to Australia, but I think the world in general has to worry about that.”
This goes against all the evidence that even the Treasury and the RBA has provided. Just goes to show a few days in Adelaide doesn’t the expert maketh.
The same day in Sydney, the Senate Economics Committee met for the second time and heard from the RBA governor Glenn Stevens among others.
Just to remind everyone, this enquiry was forced through Senate by The Greens, who were concerned with the size of the government’s deficit and debt build-up – as I have noted previously – displaying their impeccable neo-liberal macroeconomic credentials.
You can read the Transcript of the governor’s testimony to see what he said.
After saying that Australia was in better shape than most countries he concluded that “it is reasonable to conclude against the benchmarks of historical experience of our own and in comparison with experiences abroad that Australia has done quite well on this occasion.” He listed some factors which included: (a) “our financial system was in better shape to begin with, being relatively free of the serious problems that the British, the Americans and the Europeans experienced”; and (b) “some key trading partners for Australia have proven to be relatively resilient in this episode. The Chinese economy did slow sharply in the second half of 2008 but quickly resumed very strong growth.”
Then he said:
Finally, Australia had ample scope for macroeconomic policy action to support demand as global economic conditions rapidly deteriorated, and that scope was used. The Commonwealth budget was in surplus and there was no debt, which meant that expansionary fiscal measures could be afforded. In addition, monetary policy could be eased significantly without taking interest rates to zero or engaging in the highly unconventional policies that have been needed in a number of other countries. I have maintained throughout that Australia’s medium-term prospects remain good and that we should not lose confidence. More people seem to be taking that view now.
I remind you that this statement was made by the governor of the central bank. He knows as well as I know that the fact that the national government was in surplus provides no further scope for affording the expansionary fiscal measures. If he is meaning political scope … then he should have said that and made it clear that financially the previous fiscal position had no bearing at all on what the present government could do.
He might have also said that the fiscal surpluses over the previous 11 years (10 out of 11) actually introduced increasing fiscal drag into the economy which could then only grow by dint of the increasing indebtedness of the domestic household sector (in this case). The growth would have been cut of very quickly and the federal budget returned to deficit had not the households loaded massive debt commitments onto themselves. A portion of that debt is now causing the same households considerable grief as they lose hours of work and/or their jobs.
Anyway, this statement was picked up by The Australian today and reported as John Howard surplus helped: Glenn Stevens. So in one headline, the Australian public is led into the mythical world that budget surpluses and increasing private sector indebtedness (given our current account deficits over the same period) are good things and helped save us from the crisis.
Nothing could be further from the truth for reasons noted.
After Stevens made his opening remarks the Senators on the Committee then interrogated him. First up was The Greens leader who kept pushing the point that we would have longer deficits and why wouldn’t we now cut back and “target better”. Cut back means reduce aggregate demand. With rising unemployment and very high levels of underemployment, and growth skating along the zero line at present, that is the last thing we should be contemplating.
If all this wasn’t bad enough, the Australian Government announced today a further step into stupidity by launching its “first offer of inflation-linked securities since 2003 and market participants expect strong demand from domestic and international investors for the new bonds” (Source: The Australian).
I refer readers to a previous blog – Operational design arising from modern monetary theory – to see why the national government should not be issuing any debt on its own behalf. Someone asked the other day about state governments in our Federal system.
Well it is clear they are financially constrained like a household because they use the fiat currency uiissued on monopoly terms by the federal government but have advantages that households do not enjoy – cheaper access to financial markets as a result of their taxation capacity. I would recommend the national government borrowing on their behalf and distributuing the funds through an agreed process.
I know some will challenge the political wisdom of this but my recommendation just reflects an economically sensible solution and would not work politically under our current nonsensical division of government responsibilities and revenue capacities.
Anyway, the national government has decided that the offer of an indexed bond will provide it with a better stream of revenue and according to The Australian article, “ensure that the country’s debt agency is well ahead of its funding needs, which could result in reduced sales of nominal bonds.”
Further, the government is seeking to “maximise its investor base for the new debt” by relaxing the tax withholding on foreigners who buy the bonds. The Australian Office of Financial Management, (a division of Treasury which coordinates government debt) said today that:
You can read the Information memorandum related to this issue, which tells you that:
Treasury Indexed Bonds will be issued only as capital-indexed bonds with the capital value of the investment being adjusted by reference to the movement in the CPI. Interest will be paid quarterly, at a fixed rate, on the adjusted capital value. At maturity, investors will receive the adjusted capital value of the security – the value as adjusted for movement in the CPI over the life of the bond.
This development means that interest payments are maintained in real terms and are attractive to large institutions (like superannuation funds and insurance companies) who offer inflation-linked benefits to their customers.
A senior official at one of the large investment banks said (rubbing his hands no doubt):
There are a lot of investors who don’t want to speculate, they just want to line up their assets and their liabilities and inflation linked assets are a very good fit for them …
In other words, sit on their hands and get a risk-free, inflation-proofed government annuity until 2025. I wonder what the purchasers of these bonds think about welfare payments to the unemployed and single-mothers, which were not increased in the May budget and which represent real cuts in living standards for some of the most disadvantaged (see the blog – Operational design arising from modern monetary theory).
In the past, notable representatives of the investment community have been vocal about the need to cut public sector employment, cut protective labour market regulations and reduce the generosity of pensions and welfare payments – all, allegedly, in the name of advancing economic efficiency. They never include their welfare cheques via the government bond market, which just became better with this inflation-proofing announcement.
The last time the federal government issued this sort of handout was in 1993.
It is argued if superannuation and life companies were unable to invest in CGS, then they may face more difficulties matching their relatively long-dated liabilities with their financial asset holdings (this was stated in the Treasury Discussion Paper that was released as part of the 2002 Debt Review).
The Submission of the Sydney Futures Exchange to that same enquiry claimed that eliminating the public debt market would:
… deny superannuants an A$ denominated (default) risk free investment for their retirement planning at a time of an ageing population and in a mandatory superannuation environment.
What is not often understood and needs to be continually restated – national government debt instruments are, in fact, nothing more than government annuities. Do the proponents of public debt really want the private sector to have access to government annuities rather than be directing real investment via privately-issued corporate debt, as an example?
This point is also applicable to claims that public bonds facilitate portfolio diversification. Why would Australians want to provide government annuities to private profit-seeking investors? Without having to go into detail, this clearly interferes with the investment function of markets, and that direct government payments be limited to the support of private sector agents when failures in private markets jeopardise real sector output (employment) and price stability.
I have never seen a comparison of this method of retirement subsidy against more direct methods involving more generous public health and welfare provision and pension support.
You can read the full submission that me and Warren Mosler put into the Review HERE.
I remind everyone that in Australia the fact that the federal government issues debt $-for-$ for its net spending arises from voluntary regulations it imposes on itself to do so. It is a net spend a $ then borrow it back sort of regulation.
Under the Gold Standard, national governments were revenue-constrained by the structure of that system. That system collapsed in 1971 – 29 odd years ago.
So all connotations that the Australian government is revenue-constrained after that time lapsed. To make matters worse, the Australian government tightened the rules that they constrain themselves with – to satisfy the growing neo-liberal policy influence – by changing the system of debt issuance (from a tap to auction) and insisting that all the net spending be fully covered by debt issuance in the private markets.
They did this to place “further fiscal discipline” (in their own words) on government spending. They knew there was no fiscal constraint and they knew the electorate could easily be duped into the “government debt is bad and choking our kids” hysteria. These changes occurred as the neo-liberals began to dominate policy and were overseeing cut backs in government and rising unemployment.
This blog – Will we really pay higher interest rates? – provides some historical perspective on this tightening noose that the Government voluntary chokes itself (politically) with.
So all this industry surrounding public debt-issuance – the banks that get involved in the sale of the debt – the commentators who whip themselves up into a frenzy over it – the economists who swan around the world telling us that we are facing a plague – the future traders who profit from using the debt as a risk-free benchmark to price their own products – and the rest of it – is all built on an ideological obsession that government is bad and private markets are good.
Imagine if the government saw through all the smokescreens and announced they were no longer issuing debt and would just continue to credit bank accounts as necessary to support full employment? The neo-liberals would scream inflation … but would soon run out of steam with that line of attack.
Further, given how much of our wealth has been lost by private markets operating in a self-regulating environment in recent years I cannot believe we still hold onto these prejudices.
As a reflection on the current modern money-debt deflation debate, I was quite amazed at the number of “anti-government, debt is slavery, deficits are invasions on our freedom” comments that appear on Steve’s blog. I was surprised with the strength of opinion being expressed in some cases when it was clear the commentator hadn’t read nor understood the body of work I and others offer and when their use of terms and concepts demonstrated they didn’t have a good grasp on how the monetary system overall functions.
Thankfully, the main crowd that regularly offer their insights on my blog seem prepared to operate at much more elegant levels of interaction and show much more tolerance and respect for each others views.
I should add, however, that the majority of interventions on Steve’s site, were in the right spirit and I think made the debate a worthwhile exercise. I hope those who are still curious keep reading and keep asking questions. When I get time, I will go back through the comments and see what I can offer by way of clarification.