Monday, 21 April 2014

Privatisation: Broader issues

Privatising public assets is back on the agenda with Treasurer Hockey reigniting the discussion with his offer to State governments of a bonus if they sell remaining public assets and spend proceeds on new much needed infrastructure.

The Mercury ran an opinion piece on April 7th from one of its resident op ed writers Hodgman has to sell off assets  urging Will Hodgman to sell assets and  ditch the leftist, big government view of the world as a necessary precondition to reviving Tasmania.

The privatisation debate has been around for a while but nothing new was presented on this occasion.

The economic blogosphere is full of bloggers trying to come to grips with the causes of the GFC. At the heart of this discussion are the matters of money, debt, and the role of government and hence is of particular relevance to the issue of privatisation.

(For the remainder of this note the term government will refer to the Australian government, the currency issuer).

The spectre of crippling government debt is forever used as the ex-ante rationale for selling public assets and spending the proceeds on even worse performing assets.

The major supporter of privatisation is the funds management industry. The superannuation industry alone in Australia has $1.5 trillion in funds under management growing each day with superannuation guarantee contributions.

But where to invest the funds?

How to stop the leakage to the self managed superannuation sector currently accounting for roughly one third of superannuation monies or $500 billion? The latest attraction in the latter sector is the ability of self managed funds to purchase existing residences via non-recourse borrowings ( i.e. only secured by the residence being purchased) for investment purposes (a super fund is prohibited from letting to associates) in a structure where concessional or even nil rates of tax apply to income and capital gains, making it even harder for first home buyers to compete on the less than level playing field.

There’s no doubting the rigging of the system by baby boomers.

We often pride ourselves on our sophisticated superannuation industry.

Whilst it has provided incentives for mainly higher income earners to set aside monies for retirement at great cost to the budget, once inside superannuation there is nothing for fund managers to invest in, except existing assets.
A pool of funds growing  faster than the economy chasing a return .

An estimated $30 billion in fees is earned each year by the superannuation funds’ management industry, mostly from paper shuffling rather than as a reward for skill.
Rent seeking arrangements assist fee gouging as evidenced by Arthur Sinodinos’ attempt to torpedo the Future of Financial Advice (FOFA) reforms on behalf of his previous clients, the banks.

There is no incentive to invest in new riskier ventures. Much easier and more lucrative to stay with the herd.

Hence speculating in existing assets is the name of the game. Public assets with regulated if not guaranteed returns are always a welcome addition.

But that is never the argument presented. Instead privatising public assets, as argued by Joe Hockey, is necessary to provide the necessary funds for more infrastructure.

This is where the political debate relies on conventional wisdom rather than sound arguments.

The post GFC analysis is increasingly casting doubt on accepted wisdom. Strange as it may seem to non-economists, much of what has been accepted as gospel truth on matters of money and debt is no longer tenable.

There is growing acceptance that:

  • Loans don’t require deposits.

  • Savings aren’t a necessary prerequisite for investment.

  • Assuming banks are merely intermediaries between lenders and borrowers is romantic nonsense.

  • Banks make loans  based on ability to repay and collateral offered and simultaneously create deposits used by borrowers for the purpose of the loans.

  • When government do this it's called money printing and labelled reckless behaviour.

  • Bankers create money out of thin air. It has been estimated that 95% of money created in the US in the lead up to the fall of Lehman Brothers in 2008 was created by private banks.

When the US Federal Reserve started a policy of quantitative easing (QE) in 2009  to help bail out the banks and revive the economy  there was:
  • An outcry saying the Fed was risking inflation. Printing money it was called.

  • Visions of the Weimar Republic and Zimbabwe were invoked. But the elapse of time has proved that QE hasn’t been inflationary.

  • It’s simply swapping certain assets held by banks (eg bonds) for cash, simply swapping one IOU for another.

  • It provided liquidity to banks hoping they might lend it to get the economy moving.

  • But this hasn’t occurred, one because as noted above deposits aren’t required to make loans, and second, banks have instead used the cash to speculate in assets and currencies, reverting to the behaviour that caused the GFC in the first place.

Which finally gets us to the point..... why are governments constrained from creating money?

After all private banks do it remorselessly and it’s considered entrepreneurial.

What happens when the government spends money?

Quite simple. It ends up in someone’s bank account. From a macro accounting viewpoint the government’s account at the Reserve Bank (RBA) is reduced and the reserve account (the exchange settlement account) of the receiving private bank at the RBA is credited.

How does the government get funds into its RBA account?

From taxes and bond sales or debt raising.

Usually the government tries to keep between $10 billion and $20 billion in its RBA account, but what if there weren’t enough funds in the government’s RBA account?

The RBA could simply add the required funds to the government’s RBA account with the click of a mouse. Give the government an overdraft in other words.
When the government spends the funds the exchange settlement accounts of the private banks will increase.

At this point the government usually issues bonds, an IOU, and drains the exchange settlement account of the private banks and increases the government’s RBA account.

But the government doesn’t have to issue bonds. That way it wouldn’t be increasing its debt due to bond holders. It could simply pay interest on the balances in the banks’ reserve accounts, their exchange settlement accounts.

Or it could choose not to pay interest or pay a very small rate. It all depends on the government’s monetary policy at the time, what level of interest rates it is trying to achieve.

Subsequent lending by private banks may cause a reduction in one bank’s exchange settlement account but a simultaneous increase in that of another bank. Overall the balance of the exchange settlement accounts at the RBA would remain unchanged.

Bank reserves will remain unchanged.

Bank reserves never leave the banking system. Reserves are not lent out as we were once taught.
Only the RBA can alter the level of reserves.

Sometimes when the government issues bonds (to drain reserves) it is probably no more than a form of corporate welfare for the private banks.

Other times it is part of the government monetary policy.

The point is however that the government does not need to issue debt or raise taxes before spending.

The corollary is that State governments need not sell existing public assets to fund infrastructure. The Australian government could provide funds via the COAG process and an RBA overdraft.

An overdraft provided by the RBA to the government is an internal government loan. The sky would not fall in if it wasn’t repaid. Reductions may occur with subsequent tax receipts flowing into government coffers, or maybe from subsequent bond sales, but if there was still a balance so what? That's been the US experience with QE.

None of the above should be construed as implying governments can run large spending deficits without raising debt (or taxes for that matter) and remain oblivious to any consequences.
Rather currency issuing governments like the Australian government can do so when necessary.

This means funds for new infrastructure can be given by the Australian government to States without the latter selling existing assets.

Tasmania’s existing government businesses comprise one half of the total State government sector, so for the Mercury writer to idly assert that they should be sold to fund as yet unidentified new infrastructure without comparing the before and after cash flow effects on the State’s budget with a reduction of 50% in the size of the State sector, just to qualify for a $100 million bonus from Joe Hockey, is a policy position based on ideology rather than logic.

Ideology also clutters the road to economic salvation as long as there are refusals to take a revised look at the role of governments, debt and money. Commentators and politicians are yet to realise the full implications of the changing world over the past five years.

The road forward is easier than it looks if one is prepared to open one's eyes.


  1. It's not ideology that clutters Joe Hockey's thoughts, John. It is the quid pro quo he needs to square with the very generous people who funded his parties election campaign.
    It is all about the rich getting richer, and the best way to do that is buy up the rights to monopolistic businesses that were created to serve the common good.

    First you monetise, then you corporatise, then you privatise. It is worn into history like the bloody wallaby runs beside every road in the state.

    1. .......Which is of course is an ideology - the neo-liberal, late capitalist individualist ideology that is actually so prevalent that it is no longer seen - instead has become the default standard for measuring human experience - homo economicus

  2. Hi John,
    Thanks for this article. The problem is I simply can't get my head around the second half of it. This is extremely frustrating as I'm genuinely and extremely interested in what you are saying. Are you able to direct me to some resource that I can sit and read very slowly until the basics sink in; thus allowing me to return and fully appreciate the point you are making.
    This whole business of Governments, banks and currency is something I'd dearly love to understand. Unfortunately, I've a nasty suspicion that if I ever achieve my ambition, I'll be superior to 99% of our highly paid decision makers!

    1. There’s plenty of stuff out there depending on where you’re at. Some may be overly academic.

      Warren Mosler’s book Seven Deadly Innocent Frauds of Economic Policy was one of the first books to challenge money orthodoxy. It’s pretty accessible. Just skip the autobiographical section. It can be read online:

      A similar book, even better perhaps written by Frank Newman a banker and former US Treasury official is Freedom from National Debt. It’s only $5 from Amazon:

      Ann Pettifor has just released a book, only about 100 pages, Just Money: How Society Can Break the Despotic Power of Finance. Again only $5 from Amazon.

      Another recent short book, about 40 pages, titled Diagrams and Dollars: Modern Money Illustrated is worth a glance. It may only be an eBook but it only cost $1.50.

      The Bank of England recently put out a working paper revealing its current thinking. Titled Money Creation in the Modern Economy it can be found at:

      If Utube video explanation are your thing perhaps try Dirk Bezemer - Debt: The Good, the Bad, and the Ugly which can be found

      If you’re after an historical view economist Brad DeLong wrote a note about Abba Lerner’s 1943 article on functional finance at

      Abba Lerner’s article can be found at

      The ‘umkc’ in the previous web address refers to the Uni of Missouri Kansas City which is probably the most prominent US uni involved with modern money theory via Randall Wray and Stephanie Kelton. Articles and video presentation are pretty easy to find on line.

      Last and certainly not least is the prolific Aussie Bill Mitchell, very rigorous and not always accessible to non economists
      Try the category Debriefing 101, perhaps the article The Role of Bank Deposits in Modern Monetary Theory

      Happy reading.

  3. Your comments about Australia's huge and growing superannuation money and it's corrupting influence on the market are interesting. I had never thought of the superannuation money in that way, but you are right. All that money and no where to park it. As is already happening, it also attracts the market vultures, who will guarantee that many of us will never see our superannuation at all. It will be quietly skimmed away from it's owners.