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.

The RBA maintains the bond buying exercise is not aimed at financing the government. Rather it should be seen a part of monetary policy influencing interest rates and providing liquidity for the banking system. Nevertheless, it provides clear evidence of what is possible for a sovereign government in control of its own currency.

State governments are not in control of their own currency. They are currency users just like the rest of us and need to be mindful of their borrowings. Since Covid their borrowings have increased significantly. The RBA has also been buying State government debt and now owns $68 billion. Of that amount $946 million is debt issued by our state government, roughly one third of the Tasmanian government’s debt. And every year debt is projected to grow.

Just imagine for a moment the time to redeem State government bonds coincides with rising interest rates and a continuing struggle to provide adequate services despite ongoing cash deficits. It is more than likely State governments will negotiate with the Feds to write off debts owed to the RBA. Just like the Feds wrote off Tasmania’s housing debt two years ago. It can’t be construed as being inflationary because the spending that flowed from the borrowings would have occurred many moons earlier. It would be a book entry with few consequences other than to boost the equity position of State governments.

Who but the deranged believe major tax reform is possible in the current adversarial climate? We need a different approach. Tax reform is still needed to ensure a fairer society. But as for providing funds for necessary services, the pandemic recovery has clearly demonstrated we have other tools, which should be used particularly to progress to a more effective federal structure where the enormous advantage of being a federal government in control of its own currency is shared with the States.

We live in a Federation where collectively governments are facing cash deficits for at least the next 10 years. Debt that can’t be repaid won’t be. And it needn’t be. If it is repaid private assets will reduce and the nation’s balance sheet will shrink. Government debt is not a burden for future generations. It should correctly be seen as equity in our nation.