The Future of the Federation : Lessons from the pandemic

There’s been a wealth of lessons to be learned as economies try to recover from the pandemic.

Most are being ignored.

A return to pre-pandemic days is what most policy makers appear to want.

Back to the days which have produced the mess we are now in.

The pandemic has brought all our problems into sharp focus.

We have a lopsided economy.

Capital and profits have increased their share of the national pie at the expense of wages. The trickle down effects haven’t eventuated. Asset prices have risen instead.  Owners want a return on their capital and to that end the financial sector  has been tasked with extracting more and more from the real economy leading to a more unbalanced economy. Government spending has been unable to keep up with the needs of the economy.

Are we going to rely on tax reform to help rebalance the economy?

We might be waiting a long time.

This note is intended to review the state of play and look for other ways to relieve the pressure on services delivery, particularly for State governments, the engine rooms for so many services that are crucial to our well-being.

Post pandemic policies have shown how government spending, borrowing and the role of the Reserve Bank interact.

As a rule most focus is either on the role of the General Government or the RBA. They are rarely considered as a consolidated Group.

Only when they are treated as one, does a realistic picture emerge of what is happening. Peer at the economy through an accountant’s lens and the view looks awfully like what Modern Monetary Theory (MMT) adherents see when they view the economy.

Government spending creates private assets. Budget repair will reduce private assets. Do those promoting budget repair understand this simple iron law of accounting?

Banks are intermediaries in the settlement process, interposed between the government (RBA) and the people. If instead of having a/cs at various banks for settlement purposes, everyone had an a/c at the RBA, then government spending would be directly credited to peoples’ a/cs. The balance of peoples’ a/c at the RBA would appear as a liability of the RBA just as notes and coins do. 

But they’re not debts that the government need to repay. This is one of the fundamental points most commentators and scaremongers fail to grasp.

With banks as intermediaries, reserves are created each time the government spends. Convention dictates that some of the reserves need to be swapped for government bonds should the government wish to spend and finds itself without any money.

It’s a convention not a necessity.

A recent development that eventually made it to Australian shores, has seen the central bank, the RBA, purchasing some of the government’s issued bonds.

A close look at effect of spending on the consolidated government (which includes the RBA) shows it makes no difference if the government spends what’s in its RBA a/c, or whether it runs an overdraft at the RBA or whether it raises funds by issuing bonds which are bought by the RBA and subsequently written off.

A government borrowing from itself doesn’t impose a burden. The reverse is more likely. Private assets are boosted when spending occurs.

Looking at the consolidated government, gives a more realistic view than focusing on just one of the members of the consolidated group, the General Government.

It is instructive to look at the Australian government’s financials, which aren’t included with the Annual Budget, but do appear 5 months after year’s end usually in November.

When RBA Governor Lowe tells us RBA bond buying is not supposed to indicate a new way to finance government spending is he saying net government borrowings of $684 billion at June 2021 compared to gross borrowings of $888 billion, the difference being those bonds bought by the RBA, is a figure without meaning. 

What does it mean then?

Surely it must mean the government only owes $684 billion to third parties.

Then why does everyone parrot on about a trillion dollars of debt?

Is it a rounding problem or a lack of understanding of what consolidated accounts mean?

As to where RBA got the money to purchase bonds, and how it was recorded in its accounts, this can be answered by having a look at RBA’s cash flow statement. It reveals how money is created in a modern economy.

The means to create money isn’t confined to the RBA. Most is created by private banks.  Outsourcing money creation to banks is an enormous privilege.

 ‘Creation’ is the operative word here. As the Bank of England reminded us in 2014, loans are not made from existing deposits. Loans create deposits. The Commonwealth Bank’s cash flow statement reveals this reality, with operating activities divided between income and expenses on one hand, and new loans and deposits on the other. It is a tell tale snapshot of how banking in a modern economy works as opposed to how most people imagine it to work.

The pandemic and the subsequent response have emphasised the crucial role State governments play in service delivery in a wide variety of important areas. Compared to the measures enacted to help banks by the RBA, much more could have been done.

If the Tasmanian experience is any guide, reporting income on a profit and loss basis by State governments, has helped disguise the cash flow losses that are likely to persist for quite a while, with the supply of services likely to fall further behind what’s needed.

Tasmania’s looming fiscal sustainability problems have been well documented but largely ignored by politicians. Admitting to problems always prompts questions about what the proposed solutions are and why has it taken so long to confess.

At this stage there are no firm solutions. The progress of tax reform is glacial, and like glaciers in the era of climate change are just as likely to melt before much progress is made.

The prospect of Stage 3 tax cuts and possible budget repair which will reduce Australian Government coffers even more, suggests States aren’t a priority for the Australian government/RBA.

We need a backup plan to assist them.

The RBA needs to be given an enhanced role in the Federation, not just as banker to the private banks but helping States and Territories as the pre-eminent deliverers of services to the people.

When the Federation is viewed as a consolidated whole, government financing and spending by the States can be carried out in the same way as the activities of the Australian government since March 2020.

All government spending increases private assets.

But the key to the future is grasping the fact that government liabilities created by spending aren’t necessarily debts which must be repaid.

They only become debts if we so choose.

We need to run the show for the benefit of the people not the banks.

Debt deficits and the new Federation

What happened to the spring of hope we hoped would follow the Covid winter of despair?

The shortcomings of the existing system have become glaringly obvious. There was much talk about life on the other side of the pandemic, a place where we could build a better and fairer future on more secure foundations.  

However, two weeks of electioneering has confirmed that a move to a better place is too bigger task for our bickering political class. We are back to the same old ways of policy free mudslinging scaremongering and pork barrelling. We have learnt nothing.

There is a conspiracy of bipartisanship not to delve too deeply into important issues.

For instance, consider government debt and deficits and the all-important question of where money comes from. There has been so much to learn from how we managed the Covid crisis that should be front and centre of any election campaign. But discussion is conspicuously absent.

Most Federal government debt is not repaid. It is rolled over at maturity, replaced by new debt. As any Accounting 101 student knows debt may appear on the liability side of a balance sheet but so does owner’s equity. Debt that doesn’t have to be paid represents additional equity in the nation. Government debt is mostly owned by banks and large funds and are analogous to redeemable preference shares in Australia Inc. Interest gives the holder a regular return. The holdings can be sold at any time or redeemable at the end of the term, usually replaced with new borrowings. Debt may be owned by foreigners. But the interest on those borrowings is still paid into Australian bank accounts. If the owner wishes to repatriate the funds the Australian dollars are swapped for whatever currency is needed, so the interest always remains in Australia. Government borrowings should not be used an excuse for austerity by constantly raising the spectre of burdening our heirs and successors.

The Covid response required massive new borrowings. However, most of the new debt is owned by the Reserve Bank (RBA), our bank. We owe the debt to ourselves. The RBA now owns $288 billion of government debt. One third of government debt which is approaching $900 billion is now owned by ourselves. How is this a burden? Interest is paid to us. If bonds are ever redeemed the proceeds are returned to the government as dividends by the RBA.  This is the new reality. Central banks around the world are doing the same.

Federal government borrowings are the nation's equity

 

BUDGETS are a concoction of economics and politics with the mix depending on the electoral cycle.

The latest federal budget appears to have a heavy dose of politics given an election is on the horizon. But what of the economic aspects? What does this budget reveal?

The most welcoming change is the ready acceptance by the government of the need to continue with deficits. The reason there will be public deficits is because the private sector will continue to run surpluses. That’s the iron law of macro-accounting.

Pollies and the commentariat talk about the need for budget repair, implying the public sector needs fixing when the private sector’s predisposition to run surpluses is the flip side of the same problem.

It is normal for households and businesses to strive to be net savers over time, for a rainy day, say. This implies the normal position for a government is to run deficits, especially if the economy is growing. Bob Menzies ran 16 deficits in 17 years in the 1950s and 1960s.

However, over time, rising household indebtedness has increased the amounts required to repay loans. From a national income perspective, income is either consumed or saved or used to pay taxes.

Increased loan payments mean increased savings and therefore less consumption. Increasing house prices and associated mortgages suppresses consumption in the real economy.

Student indebtedness has similar effects. With little or no growth in real wages, paradoxically one of the boosts to consumption comes from borrowed funds made possible by increased home equity.

We are living in a Ponzi world.

At the same time, there has been a conspicuous fall in workers’ share of national income. The amount going to capital owners has increased. Not just old-fashioned capital like machines and buildings but the new variants — licences, permits, goodwill, intellectual property, franchises — all designed to clip the ticket and benefit paper shufflers at the expense of workers. Greater returns to the new capital owners have kept a cap on wage costs, which in turn has led to wage exploitation, insecure work regimes and the influx of workers from overseas which has created as many, if not more, problems as it has solved by extra strains on housing and infrastructure.

Our economy is out of whack. The financial economy is devouring its host, the real economy. There’s little point tackling so-called budget repair if the foundations need fixing.

Why doesn’t the private sector spend more rather than requiring the government to run deficits? There’s not enough demand for their goods and services partly due to the erosion of the workers’ share of the national pie and the system’s incentives to speculate in second-hand assets such as houses and shares rather than investment in the real economy.

Capital gains from shuffling paper are taxed at lower rates than personal exertion income. Share owners wallow in the illusion they are business owners rather than speculators and thus entitled to a refund of company tax via franking credits.

The common good is becoming an outdated concept.

The spectre of increasing government debt that has resulted from deficits has been used to scare the populace into believing that we can’t afford to employ our idle resources to perform much needed and demanded public tasks, and also as an excuse to offload public assets and outsource public services to the private sector, all in the cause of freeing our grandchildren from the burden of excessive debt.

The latest government spin has toned down the rhetoric without a full explanation. It’s easy, as the Labor Party and many commentators have done, to point to the hypocrisy of the government’s backflip, but unfortunately it strongly suggests there’s widespread belief that government debt remains a burden for future generations.

The breakthrough in understanding why government debt is not a problem has come with the move by the Reserve Bank, our bank, to buy much of the new debt. We owe money to ourselves. Accountants have a name for owner’s loans to their businesses. It’s called equity. Accounting 101 students learn about it in Week One.

Government borrowings held by the RBA represent equity in our nation. Even much of the debt held privately will be rolled over at maturity, implying this also is de facto equity in the nation.

A nation without borrowings is a nation with a pretty skinny balance sheet.

Japan’s government debt, relatively speaking, is five times the size of our debt and almost half is owned by the Bank of Japan, the government’s central bank. Nobody believes the debt will ever be paid. It will either be written off or rolled over. The same will apply here.

We are on the threshold of a better understanding of how government financing works.

However, with most other issues in our rapid changing world our political class is still at the remedial stage.

Downturn demands bigger spend

 

The penny has finally dropped that increased public debt is not a burden, but spending in this year’s Federal Budget should have been better directed.

The magic and mystery of money

 

If nothing else of enduring benefit survives post Covid, let us hope it is a better understanding of money, where it comes from and how we can better use it for public good.

 

Staving off recession

WITH the release of the Economic and Fiscal Update Report on Friday, Premier Gutwein didn’t try to sugar-coat the economic reality the state is facing. But he persisted with the myth that he had fixed the budget prior to COVID-19.

The government’s own Revised Estimates Report in February painted a very bleak picture. Cash deficits for this year, 2019-2020, and the next three years were estimated at $1.8 billion.

The latest update shows how much the situation has deteriorated in three months.

This year spending is expected to exceed revenue by $1.2 billion. Next year, 2020-2021, the cash deficit is projected to be $1.7 billion. This year we’ll spend $1.19 for every $1 in revenue. Next year the figure will be $1.29.

Don't forget the States

DON’T FORGET THE STATES

All the post Covid-19 recovery talk centres on the Commonwealth government’s fiscal position and its unprecedented deficits for the foreseeable future.  How are States going to fund their share of the required spending? Hoping the current Commonwealth government will continue to run deficits to help fund State budgets seem somewhat forlorn at this stage.

The Commonwealth provides 40 per cent of State government revenues with approximately half of that coming from GST. Local governments receive 10 per cent of their revenue from the Commonwealth, not directly, most comes via the States.

The Commonwealth government being in control of the currency, with a central bank (RBA) to assist, and with fiscal policy that raises over 80 per cent of the nation’s taxes, can easily attend to its own needs. If it wasn’t for the States that is.

State government do not have the same flexibility as the Commonwealth and are more inclined to austerity. Erring on the side of austerity is likely to make any recovery slower and more painful for all those affected, potentially scarring a whole generation.

Where the money will come from in the case of State governments needs to be addressed at the same time as for the Commonwealth.

We need a plan for the Federation.

The starting point for a discussion about any entity’s future must include an understanding of existing balance sheets. If that entity is a country then it must include an understanding of the nation’s balance sheet, its assets and liabilities.

The only balance sheet item that gets mentioned is the debt figure for the Commonwealth. In other words, the level of borrowings of the general government sector. So, we’ll start by having a look at the balance sheet for the Commonwealth General Government. This will lead to a look at the consolidated balance sheet for the Commonwealth, which includes government businesses, particularly its wholly owned bank, the RBA. It is crucial to include the RBA in any discussion about Commonwealth finances.

The consolidated balance sheet leads to a closer look at the Commonwealth’s debt and borrowing, how spending, money creation, debt and QE (quantitative easing) impacts the Commonwealth’s balance sheet. Understanding the mechanics of the system must be a prerequisite for policy making.

A more nuanced view of debt will lead to a look at the consolidated balance sheet for the nation’s public sector. It is only with a more realistic view of debt that the Federation’s problems can be properly addressed.  The Commonwealth/RBA needs to allow States greater access to the RBA to organise debt and spending in the same way as is possible for the Commonwealth. If the government via the RBA can provide liquidity to private banks by acquiring their assets, if the RBA can led $90 billion to banks at 0.25 per cent to onlend to SMEs because the banking system is not up to the task, it can provide liquidity to States by acquiring their bonds. QE for States with RBA holding State government bonds will mean the overall total public sector debt need not produce insomnia for policy makers or burden our grandchildren.

Where's the money coming from?

Where’s the money coming from for the government’s $130 billion wage subsidy? How can it ever be repaid?

If the government borrows from its own bank, the Reserve Bank (RBA), when the money is repaid, it is repaid to itself. It is simply an institutional arrangement transferring funds from one pocket to another.

A new approach to fiscal policy

It’s been twelve years since the global financial crisis brought the world’s economy to its knees. However, after the greatest setback since the Great Depression of the 1930s, there’s little evidence remedies are working.

At the Federal level the government is determined to produce cash surpluses, a supposed indicator of responsible economic management. Yet cash surpluses mean draining more out of the economy by taxation than is returned by spending. When an economy is weak, wages flat, unemployment and under-employment a growing problem, and State governments all struggling to fund services, taking more out of the economy is unlikely to resuscitate the patient.

At the State level the government pretends it is running a surplus when it clearly spends more than it receives.  The government uses the word ‘surplus’ to describe its Net Operating Balance figure. But as its name suggests, this only includes recurrent operating spending, and omits capital spending and equity contributions into government businesses. It’s a misleading measure of the government’s fiscal position.

Shadow Treasurer David O’Byrne ridiculed the government claims of being able to achieve a surplus but in so doing gave tacit approval of the government’s version of a surplus as a desirable goal. It’s not. The unassailable reality is that Tasmania will be running cash deficits for the foreseeable future. There is no alternative. To do otherwise would be grossly remiss. To pretend it’s not is misleading. To continue to conduct an adversarial political exchange on a false premise is derelict. The public discussion should focus on how to fund the inevitable cash deficits of the State government. It’s not a problem unique to Tasmania. It will affect all States.

The workers' shrinking pie

The current anaemic growth in wages will have far reaching effects. Our economy is structured around large levels of consumption spending. Our State government’s precarious fiscal position is largely dependent on GST receipts which are directly impacted by slower wages growth.

Yet most of the discussion about low wage growth glosses over the fact that labour’s share of national income, as distinct from the share going to the owners of capital, has been in decline for years. Sharing the spoils was a feature of the 1950s and 1960s as labour’s share of the national pie grew. However, over the last 40 years, labour share of the pie has fallen by almost ten percentage points.

If it is a priority, we can afford it

SAYING we cannot afford something is code for saying it’s not a priority. We are a rich society. We have all the resources we need to deliver better housing, health, education and infrastructure, but we choose not to. We are constantly told we cannot afford them and we need to live within our means.

Imagine for a moment Australians were shipped to a desert island, a new paradise. All facilities were there, infrastructure, schools, hospitals, even a new K Block. Lots of people with all the required skills are ready to start working, but nobody has any money. Neither does the government nor its bank, the Reserve Bank. Nor do private banks or any residents or businesses. The government cannot raise taxes or borrow money because there’s no money to pay the taxes or lend to the government. Gridlock. What would happen?

One practical solution would be for the government to simply start spending money by crediting accounts. Hospitals would be paid enough to operate. So too schools and other government departments. Workers could then be employed and paid. Money would start circulating. Some will return to the government via taxes. Businesses and residents would start borrowing and spending. Without government spending in the first instance none of this would not be possible.

Most of us have been led to believe the opposite, that the Australian government must raise money before it can spend.

It’s not true.

Some people would regard this solution as heresy.

What do banks do? An accounting perspective

This paper was given to a U3A Group. It's a look at settlement services and borrowing/lending practices. It is not intended to be a blueprint, rather an accounting explanation of what banks do and to question whether there's another way.

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry is appropriately named. There’s been plenty of misconduct revealed. The aim of this seminar is not to trawl through all the misconduct, but to have a closer look at what banks do. Do we need them? If we were designing a new banking system would we come up with the current model?

Progressives are their own worst enemies

Misunderstanding our current problems is reaching epidemic proportions if one is to judge by Dr Michael Powell’s comments ( see here )on the new GST arrangements and the wider more crucial issue of Federal budgetary difficulties.

Just to quickly address the GST issues before moving to the broader matters of budgetary policy.

Banks: Do we need them?

People who believe the good times will soon return are harder to find these days. It’s not just the loss of trust in our institutions and the political class but a more deep-seated scepticism as to whether the suggested remedies will work.

The laws of economics are not immutable. Many are mere transient beliefs that may provide a reasonable explanation of current machinations, but when a black swan event occurs, like the Global Financial Crisis, something outside previous experiences, the old ways of thinking are of little help.

Likewise, our treasured institutions have failed us. As part of the reported proceedings of the Royal Commission into Banking, investment banker UBS estimated $500 billion out of $1.7 trillion in mortgages across Australia, that’s one third of the total mortgage debt, could be ‘liar loans’, based on dodgy documentation.

With residential mortgages growing faster than the rest of the economy, our economy is out of balance. Everyone knows it. We shuffle existing assets amongst ourselves at ever increasing prices using borrowed funds under the mistaken belief we are growing the economy when the reality is we are involved in a giant Ponzi scheme. Now we discover that up to one third of the mortgage loans may be based on suspect if not fraudulent documentation.

The bank competition myth

“Australian banks are upset. Their $30 billion per year gravy train of profits from the Australian people is finally being slowed down.

A levy on bank liabilities of 0.06% annually was announced as part of the 2017 Federal government budget, and is expected to raise about $1.5 billion per year, or 5% of bank profits.


To be clear, the banking system is a regulated cartel. Its primary function is to provide a public good in the form of the money supply of the country. As such, we would expect it to be uncompetitive, and use tight regulatory controls to ensure that the privileged position of private banks is not being abused.

In my book, Game of Mates, I explain that the result of this uncompetitiveness and lack of adequate regulation in Australia is that over half of the banks' profits can be considered economic rents, which could be taken back with better regulation and shared with the public at large.”

Read the full article on Cameron Murray’s blog.

Game of Mates

“This is the story of how Australia became one of the most unequal societies in the Western world while merely a generation ago it was one of the most equal. It is the story of how groups of ‘Mates’ have come to dominate our corporate and political sectors, and managed to rob us, the Australian majority, of over half our wealth.”

So begins a just released book by one of my favourite economists Cameron Murray, written with another Queenslander Paul Frijters.

Reforming banking

Economist Nicholas Gruen has posted a couple of interesting articles recently about reforming banking. Our central bank, the Reserve Bank RBA, lies at the heart of the banking system. Rethinking and adapting its role more in line with the internet age could easily put thousands of dollars into the pockets of Australian households and billions into government coffers he argues.

Budget challenges: Money debt & other myths

This is an address to a breakfast meeting of the Burnie Chamber of Commerce & Industry on 12^th April 2017.

I’d like to advance the proposition that most of what is commonly believed about money, government spending and debt is wrong. Seriously wrong....and it’s stopping us from sensibly moving forward.

You may remember the Queen in 2008 going to the London School of Economics to open a building as I recall. Referring to the GFC (global financial crisis).... Lehman Bros had just collapsed....she was famously captured on camera saying "Why did nobody notice it?" Their models were wrong that’s why. Money wasn’t in the models. Banks were assumed to be passive intermediaries lending funds from patient savers to willing borrowers. That may have been the situation pre 1971 before President Nixon abandoned the 1944 Bretton Woods agreement which incorporated the gold standard and underpinned bank lending practices. The world changed after that .....and economics didn’t keep up.

Put simply...a lot of economists don’t understand accounting.

Housing bubble now official

Great post by Matt Ellis , the Rational Radical.

“Our three economic regulators have finally revealed themselves as the three witches busy tending their poisonous brew while chanting “Bubble, bubble, toil and trouble!” to a nation of tone-deaf property speculators and commentators-come-experts. The architects of our dreaded housing and economic Frankenstein are among the last to formally recognise the monster of their own creation for what it is – a hideous creature that defies all reason, logic, decency, ethics and ultimately, any ability to survive.

Such is the well documented exceptionalism and wilful blindness of the collective Australian bubble psychology, that bubble believers and sceptics alike have come to the physics defying conclusion that Australia has invented an actual perpetual motion machine. The problem with perpetual motion machines? They don’t exist. Can’t you just feel the growing friction rubbing up against the bloated sack of housing hot air? I am amazed at how tenacious the belief is that exponentially growing imbalances can go on forever, when every fibre of the economy must be sacrificed at the altar of housing speculation in ever more dramatic interventions just to keep the damned thing afloat for another few months or years. For just one more election cycle.”

Read the full blog at HERE

Australia's new class war: A return to the Gilded Age

The betrayal of an entire generation of young Australians by the political classes by refusing to do anything about the Great Housing Bubble is a national disgrace.

Matt Ellis writing as Rational Radical sets out the arguments.

 “Even the so-called party of the youth, the Australian Greens, and the traditionally progressive Australian Labor Party are just as leveraged into landed wealth as any political force in the country.”

.        .        .        .        .

“But for the most part, the vanishing class consciousness of the newly minted home owner or property investor has created a political and media culture of looking the other way as wealth inequality and economic imbalances threaten to tear the system and community apart. It is so ingrained in the every day Australian cultural psyche, that it has become a truly rarified exceptionalism, wherein any person of influence or power who dares to question the path of the great Australian Housing Bubble is patronisingly reminded that history does not apply to Australia, and that genuine reform is for doomsayers and bankrupt European states.

Indeed, our exceptionalism has morphed into full a blown collective denial of the very same imbalances that brought half of the modern world to its knees only 8 years ago. That somehow these forces do not apply to the economic miracle that is Australia, and that income inequality is only a matter of a few mega-rich corporations evading their tax obligations.”

Spend five minutes to read Matt’s compelling blog..