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.
