Surplus obsession

Death and taxes are often cited as two of life’s certainties.

There’s one other. If the Federal government runs a surplus, then the private sector must run a deficit.

“I am pleased to announce a budget surplus of $7.6 billion” Treasurer Frydenberg proclaimed on Budget night. He was of course referring to an expected figure for 2019/20.

It would have been equally valid if he had said:

“Next year we expect the private sector to run a deficit. We know the household sector is one of the most heavily indebted in the world, largely due to the string of surpluses run by my esteemed predecessor Peter Costello and the reckless greed of the banking sector as recently identified by Commissioner Kenneth Hayne, but we believe the time is right for the private sector to borrow even more”.

A surplus means the government is taking more out of the economy that it is putting back. The private domestic sector is already burdened by servicing an overseas current account deficit. Government surpluses will make this worse. Private domestic debt, needed to operate the real economy is constantly rising, due also to the rapid growth of the finance sector’s cash cow loans for residential housing which must be serviced by the real economy.

The government is selling the return to surplus as a magnificent achievement but  with a weakening economy, stagnant wages growth and a labour underemployment rate of 15 per cent, is this the right time to add to the debt burden of the private sector struggling to service the overseas current account deficit plus the rapacious demands of the finance sector?

We have a surplus fetish. Deficits are neither intrinsically good nor bad. Few people realise, but someone must run a deficit. Who does and to what extent should depend on the state of the economy, not on the timing of an election? A government surplus indicates increasing private debt. Is this a sign of a strong economy? On the other hand, a government deficit implies increased private assets. Is this the sign of a weak economy? To blithely assert a government surplus indicates a strong economy is plain dumb. Let’s not forget Prime Minister Menzies only ran one surplus in 17 years. And let’s not forget the biggest beneficiaries of that era are the same people who are now imposing a different view on the current generation.

The worship of surpluses isn’t confined to one side of politics. All do it. Bill Shorten and Chris Bowen regularly tell us ‘my surplus will be bigger than yours’. They plan to go one step further and increase the superannuation guarantee amount to 12 per cent of employees’ wages which will slow increases in take home pay  and provide  a bonus for finance sector where it will be used to further speculate in existing shares rather than invest in the real economy.

This pre-empts the broader question of whether the current approaches to restoring our economic fortunes, based around adjusting tax and government spending (fiscal policy) and interest rates (monetary policy), are working? Or are there other alternatives?

Fiscal policy has faced headwinds because of our surplus fetish. The focus is always on the cost of debt not on the benefits of deficits. What if deficits can be financed by revised monetary policy?

Adjusting interest rates is the traditional way monetary policy operates. Falling interest rates have boosted asset prices particularly house prices rather than encouraging more investment in the real economy. After the Global Financial Crisis, the Federal Reserve, the US central bank, tried a new approach by buying back government bonds, previously issued to fund government spending. It did this by simply crediting the accounts of the bondholders. Quantitative easing as it was called was just a book entry. It was hoped to revive the real economy. It didn’t work. The effect was mainly to increase asset prices rather than economic activity. Increasing assets prices favours the rich. It increases inequality.

There has been lots of chatter in the economics blogsphere about new approaches to monetary policy. Recently Ray Dalio a revered US hedge fund manager, lent his support to ideas often described as Modern Monetary Theory which are based on what happens in the real world, rather than premised on what economists would like to see happen. Governments don’t need to raise every dollar from taxes or borrowings before spending.  Even if they did, the only way the necessary reserves could exist in the first place is from government spending. Governments create bank reserves by spending. They drain reserves by taxing and borrowing. The rest of the time the reserves get shuffled around, like chips at the casino table, as part of the ordinary operations of the economy.

The experience of quantitative easing show that governments around the world can buy back their own bonds, and other investments as well, with the click of a mouse. The same approach can be used to create money and credit in a better targeted way, to fund desired projects which all States need, Tasmania as much as any, from improved infrastructure to affordable housing. This would enable the Federal government to finance deficits without the fear mongering of the deficit hawks. There wouldn’t be extra government debt. There would be extra bank reserves, but like casino chips these just get passed around the banking system. This is potentially inflationary but on current trends that is a long way off and will only occur if too much money is chasing too few goods. If that occurs, address the problem then. Right now, there is not enough money chasing what’s available. And more could be produced. That’s why there’s underemployment.

Only the Federal government can coordinate both monetary and fiscal policy. The flow on benefits via more capital grants to Tasmania  would be just the fillip the state need. Meanwhile we have both sides of politics promising the same populist blinkered preoccupation with government surpluses. The next generation deserves better.