Last week, I wrote an article on the issue of Australia’s government debt which the Labor Party distributed via its email distribution list**. The article is here http://campaigniq.communityengine.com/em/mail/view.php?id=1792973170&a=26848&k=8c5f3b1#facebook
I am eager for the discussion and debate concerning government debt to be elevated as there is a general misunderstanding of the issue in political circles, much of the media and the general public. This confusion threatens to unnecessarily undermine domestic confidence and global investor risk assessment when they decide whether or not to have investment funds in the Australian bond market. If the email sent by Labor has elevated the facts surrounding the issue of government debt, it has been worth it.
There was a rush of feedback on the topic and some sensible questions were raised, in particular the discussion of what the optimal level of net government debt is.
The answer to that question must be answered in some medium term context. There can be no hard and fast target for net debt that should be met each and every year. Rather, the optimal level for net government debt is dependent on the business cycle.
It is not unlike asking a company what its optimal level of debt is. If economic conditions are slow, a company would want lower debt. If there are opportunities for expansion, takeovers or if sales are strong, ramping up debt is entirely prudent as the firm aims to take advantage of favourable news. In other words, the optimal level of debt for a firm or government depends on economic conditions.
For the government, in a climate of a sustained and strong economic growth, net debt should be falling and low. The longer a strong expansion is sustained, the greater the move should be towards negative net debt (and the accumulation of financial assets) as was the case during the late 1980s and early 1990s under Hawke and Keating and during the period up to 2007-08 under the Howard government.
If in the current cycle, the economy sustains nominal GDP growth around 5.5 to 6 per cent over the next four or five years, net government debt should be eliminated by about 2017, give or take a year.
If on the other hand, the economy is less strong, or worse is subjected to a huge negative shock such as a global banking and financial crisis or a negative terms of trade shock, there are grounds for net debt to rise or at least for the path to debt reduction to be long and slow. This was certainly the approach with the Fraser government in the late 1970s/early 1980s, the Keating government as it tackled the early 1990s global recession and of course the Rudd/Gillard government as it fought to hold back the tide from the GFC.
Most of these examples show counter-cyclical fiscal policy in play and the governments undertaking such an approach did well.
Whatever the current argument, the level of net government debt has not exceeded 20 per cent of GDP in the last 45 years, a remarkable achievement given the levels of debt around the industrialised world right now.
The day after the article was published, Fitch ratings agency confirmed Australia’s triple-A rating and it cited low public debt as one of the reasons for the confirmation of this rolled gold assessment of the Australian economy.
It is an important side note that the US government has not had net debt below Australia’s current level of 10 per cent of GDP since 1915. Yet its economy over those 100 years have been remarkably strong, delivering massive riches to the bulk of its population, notwithstanding the government debt explosion unleashed a decade ago.
There is an even greater misunderstanding in terms of gross government debt, which is effectively the amount of government bonds on issue.
I have written on this in the past – here http://www.businessspectator.com.au/article/2012/11/2/interest-rates/why-government-debt-must-grow-forever .
Clearly, for the purposes of market liquidity, a benchmark bond from which corporate and other bonds are priced and an underpinning of the futures market, gross debt is and will be an inevitable market factor for decades to come. Indeed, Australia has had gross debt year in, year out ever since Federation in 1901 and the level of that debt has never posed management problems.
If Australia’s government debt level is a top tier economic problem for Australia, it confirms just how well the economy is going. To focus on it is like highlighting Don Bradman’s duck in his last innings and ignoring the rest of his career. Context is important.
Let’s hope than in the remaining five months before the 14 September election that the economic policy debate steps up well above the issue of government debt.
If the Greens, Nationals, Liberals or Independents want to talk to me about sending economic material to their email lists, under my name, I would consider it. If it is an issue I feel strongly about and on which I have knowledge, I would be delighted to help.
The economic debate not just in the next five months but for years to come needs to focus on productivity, education, the ever shrinking tax base, getting the unemployment rate towards 4 or even 3 per cent on a sustained basis, training, skills development, workforce participation and the like. I hope we see these issues elevated in the months ahead.
** Disclosure. I am not a member of the Labor Party or any other political party for that matter. I did not receive any payment for the article sent out by the Labor Party and since I established my consultancy business, Market Economics in late 2011, I have received exactly the same fees for work from the Liberal Party as I have from the Labor Party.