Guest post by Mr Denmore: The debt delusion

One of life’s great mysteries is the established wisdom, reflected in opinion polls and the media, that the Coalition is superior to Labor in “economic management”. Leaving aside the fact that Treasury and the RBA largely manage the macro-economy, it’s worth reflecting on this myth.

In the current election campaign, the central argument of the conservative parties is that Labor has mismanaged the economy since coming to power in 2007, spending like a drunken sailor and running up unsustainable debt.

The standard attack line from the Coalition is that Labor is borrowing $100 million a day to service our debt and fund their reckless spending. Furthermore this unrestrained government largesse is said to be crowding out private investment and putting unnecessary pressure on interest rates.

But as with so many things that come out of the mouths of politicians, the Coalition is bending the truth to make a political point. The shame is the media, either out of laziness or ignorance, routinely lets them get away with it.

Firstly, when the Coalition talks about borrowing $100 million a day, it is talking about “gross” debt. This is like comparing people’s mortgages without making referencing to their ability to service those debts – their salaries, rents and other income-generating assets. What matters to financial markets is the “net” debt position, which is calculated after subtracting financial assets such as cash on deposit, foreign exchange and gold reserves. This is the most useful measure for international comparison.

Australia’s net public sector debt in 2010-11 is projected by Treasury to be around $78.5 billion or about 8 per cent of GDP. This compares with 58 per cent of GDP in the USA, 61 per cent in the UK, 64 per cent in Germany and 111 per cent in Japan. Australia is ranked by the CIA at 108th position in the world in terms of public indebtedness, just ahead of China. Moreover, our net debt is projected to contract to 5.5 per cent of GDP within two years.

Secondly, even if we are to insist on using gross debt as the measure, Australia’s public debt position compares extremely favourably with other major economies. According to the OECD, Australia’s gross financial liabilities this year will total just over 19 per cent of GDP. That puts Australia in second position behind Luxembourg in the ranks of of the most fiscally sound countries in the developed world.

Now, this gross debt is overwhelmingly made up of the Commonwealth Government Securities issued by Treasury. What people may not appreciate is that as Australia is a rare ‘AAA’-rated sovereign borrower, its paper is highly sought after on global bond markets. This is particularly the case when sovereign wealth funds are so shy of equity markets and when asset managers are favouring more conservative investments.

If anything, the bond markets grow nervous when the Commonwealth starts running down its gross bond issuance. That is because there isn’t enough paper of this quality to invest in. Without a government bond market, there is no reference point for borrowing.

Thirdly, the Coalition insists that increasing public debt puts up interest rates. This seems hard to fathom when the US government, one of the world’s most indebted sovereigns in absolute and proportional terms, is issuing two-year bonds with a yield of 0.55 per cent, a record low and 10-year bonds at less than 3 per cent. If debt is such an issue for financial markets, surely market interest rates should be heading higher?

Fourthly, the notion that the government is “crowding out” small business borrowers by issuing debt is ridiculous. The government, like our banks, borrows on global capital markets. Its call on those markets in proportionate terms is akin to the pimple on the nose of an undersized gnat.

To give readers an indication of the size of the bond market, data from the Bank for International Settlements shows the international debt securities by all issuers totalled $24.2 trillion in March this year. Of that, Australian issuers accounted for $561 billion. The overwhelming majority of that was from Australian banks ($518 billion). Australian corporate issues totalled $26.5 billion and the Australian government $16.9 billion.

In other words, Australia’s biggest borrowers are our banks. And those banks borrow in global capital markets to fund Australian home, consumer and business loans. Borrowing by our banks accounts for 92 per cent of Australian debt issued abroad. The government is the smallest borrower, accounting for 3 per cent of debt. There goes the “crowding out” argument.

Fifthly, claims about government debt make no sense unless one looks at the reason for that debt. Every economy in the developed world is currently running a deficit. The overwhelming cause of that is the biggest and deepest global recession since the 1930s. If Australia was to be running a surplus at this time, as the Coalition suggested, tens of thousands of Australians would now be out of work and our fiscal position arguably would be even worse as the government would be losing income taxes and paying more out in transfer payments to the unemployed.

Finally on interest rates, the election perennial, there is no credible market economist who believes interest rates are more likely to be higher or lower under one political party or another. Treasury knows this, the Reserve Bank knows this. Everyone knows it but Joe Hockey and the economic illiterates who claim to be the better economic managers.

The fact is Australian cash rates now are back to their long-term average level of around 5 per cent. They are significantly higher than the near zero interest rates of Japan, the US and Europe, but that is precisely because our economy is much stronger and theirs are basket cases. Would you rather have zero interest rates and no job??

So in this election campaign, can my former colleagues in the media do the public they purport to represent the justice of challenging politicians on the facts when it comes to economic policy?