Austerity Awaits Australia

I hate to spoil the Christmas fun, but it needs to be said in the wake of the Moody’s report released yesterday that reaffirm Australia’s AAA rating:

Australia’s Aaa ratings are based on the country’s very high economic resiliency, very high government financial strength, and very low susceptibility to event risk. Economic resiliency is demonstrated by the country’s very high per capita income, large size, and economic diversity. As one of the world’s most advanced economies, the country has not only a significant natural resource sector–including minerals, hydrocarbons, and agriculture–but also well developed manufacturing and service sectors. It also demonstrates strong governance indicators. In particular, the framework for fiscal policy is transparent and has, until now, consistently kept government debt at low levels.

The government’s debt rating of Aaa takes into account the aim of maintaining a balanced budget, on average, over the business cycle. It is supported by the very low level of public debt and the country’s strong financial system. In comparison to most other Aaa-rated countries, Australia’s government financial strength is very high, with very low gross debt that is easily affordable and provides a high degree of fiscal flexibility.

All very laudable and comparatively excellent positions for the nation’s economy to be in, particularly “government financial strength”, where the total stock of debt is at $A223 billion, or about 15% of GDP. This is in distinct comparison to every other developed economy (where the average is closer to 100% of annual economic income) and is regularly touted as a strength.

The above has been noted, cheered and lauded by all elements of the media and the politico/housing complex. And up to this point in the report, they are correct.

The battle to return the budget to surplus and limit the size of government debt has been leveraged (sic) on both sides of politics, but this morning, Opposition Treasurer Joe Hockey went even further, if somewhat hysterically, warning about the level of debt:

THE Gillard government is maxing out Australia’s credit card much more quickly than it would have us believe and it’s what it is not telling us that makes the situation even more serious.

This has resulted in the Opposition objecting to raising the debt ceiling, currently at $250 billion, some $27 billion above current levels, a gap larger than the current budget deficit of $37.1 billion, although a tight $1.5 billion surplus is planned for 2012-13, as announced in the MYEFO recently.

The Coalition is putting pressure on the government to ensure the surplus requirement is met, including canceling the mining and carbon taxes, but have not ruled out blocking the raising of the ceiling to force these political measures.

Hockey is also putting additional pressure on the government paying down the stock of existing debt (which will grow to a “massive” $A275 billion by 2015):

Without further detail, the government’s projection to reduce net debt to zero by 2020-21 is hardly believable, coming from a Treasurer who this year will chalk up his fourth huge deficit out of four budgets. It would require six consecutive annual reductions in net debt of $22bn.

That is six consecutive surpluses larger in dollar terms than has been achieved previously (the largest underlying surplus was the $19.7bn achieved by the Coalition in 2007-08) or very solid growth in financial assets, which seems problematic given the likely continued financial and market volatility across the medium term.

Beyond the problem of an absence of a deep and liquid government debt market, thus assisting corporate Australia and superannuation savers in having a non-speculative market in which to place and match investment monies, and the lack of mathematical rigour applied to his analysis, the Opposition Treasurer is broadly correct.

Let’s get back to the final half of the Moody’s Report that is the most important:

The stable ratings outlook is premised on the expectations that the government will maintain its low debt levels and macroeconomic conditions will continue to support fiscal consolidation.

Any trend or event that caused a long-term shift in budget balances to significant deficits and an increasing public debt burden might put downward pressure on the rating.

In other words – austerity. The rating’s agencies and both sides of politics have reinforced, paradoxically, the underlying weakness and imbalances of the Australian economy.

A concentration of risk through:

  • the ever increasing “wealth” of the housing market which requires full support of the banking sector through continued access to cheap funding (a sizeable amount from overseas wholesale debt markets) and continually lower interest rates for mortgagors, and
  • the reliance on a record terms of trade (based on record high commodity prices) to boost national income.

To lose the AAA rating exposes the government and financial system to higher costs of funding any deficit, which will be required during any future financial crisis, or increasing costs for the banking system, thus restricting credit in the broader economy.

Either the government returns to surplus and maintains the fiscal austerity, hence keeping the net level of public debt low, or the rating’s agencies will reassess the “stable” outlook with all the implications that has for our banking sector and of course, the housing market, unemployment and the broader economy.

The economy could grow its way out this dilemma (through higher tax revenue), but as I showed in my post yesterday, even with enormous stimuli (including from China) and the record terms of trade, since 2008 the rate of growth is well below the long term trend, as the one speed economy continues to groan under the weight of record high private debt over 150% of GDP.

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  1. If I understand your analysis correctly, the problem faced by most developed economies is that, from a Keynesian macro-economic point of view: you’re damned if you do and damned if you don’t.

    Fiscal austerity programs (at least the major ones) have a long history of turning countries into economic basket cases. However, maintain financial stimulus for too long and your credit rating will be hampered and ability to fund this will be severely hampered.

    If this holds true then it seems to me that modern Capitalism is going to look ever more unstable.

  2. “since 2008 the rate of growth is well below the long term trend, as the one speed economy continues to groan under the weight of record high private debt over 150% of GDP. ”

    The difference in Australia is the people are able to pay on the record high debt. Now when unemployement goes up and the mining boom becomes bust then it will probably shift to the Aussie govt. This is what has happened to the rest of the Western countries. The public is able to service the record debt but for how long?

    • Let’s hope that the private sector debt doesn’t migrate to the public balance sheet in Australia, and that the shareholders of any failing insutitution take the hits, first.

      • I hope so too, Janet.
        I wish I am completely stupid in my world view on this particular subject. But all signs point to us lot doing it even more extreme than Ireland.

        We will happily offer the bond market (our keepers)
        what ever it takes for them to view AUS debt favorably.

        It is the time to reap the wealth of the middle class. This is done by making populations assume the debts from the Finance Sector. But not the profits. Those have been allocated already.

  3. We might have a good rating now. But we are but 2% of the world economy and a large part of it is going to hell in a handbasket.

    The US, UK, Euroland and Japan are all insolvent – way insolvent – and these entities will define the landscape of the coming years.

    The only interesting (or maybe, undefined characteristic) of the coming austerity for AUS is whether it will be administered by Labor or Liberal.
    Labor will try a little to avoid maximum pain on those who did not benefit from the 30 years of credit. Or at least appear to be trying. The Liberals will try to reduce the commitment by those who are doing well and stuff the rest – they don’t count. Or they don’t vote for us anyway. Same effect in my mind, just different spin.

  4. Prince, the thing is the Australian economy has been growing while also adapting to a far more debt-constrained and unstable global environment.

    We have seen the public sector achieve a very substantial tightening while a) households have been able to increase their savings and b) economic growth has not only continued, but has moved away from the borrow-and-build, property-driven model that sustained expansion from 1984 to 2007.

    This is remarkable.

    Things can go wrong. Of course, anything is possible.

    But if things do not go wrong, then the outlook in Australia should be comparatively benign. We do undeniably have the benefit of strong external demand for our resource exports. We are seeing the household sector de-lever and save more. The public accounts are indeed strong. Inflation is mild, meaning interest rates can be set at levels that will favour a resumption in jobs growth.

    Surely the basic point is not that the Australian economy had to change course and adjust, but that it has managed to do so without a recession and is positioned to react to any one of the global pathways that are possible/probable over the coming couple of years.

    • Briefly this is because Australia hasnt been hit with high employment yet. If employement goes into a tailspin then it is going to get ugly plus if china slows down and the mining boom goes to bust. Then the real issues will begin.

      • We have avoided a rise in unemployment in spite of some RBA zealotry. The thing is, there will be no domestically-induced recession and therefore there is no reason to suppose unemployment in Australia will take off unless there is a serious external shock.

        So we have to watch the international economy. The signs are that 2012 will be tough, but even this does not mean the Australian economy will necessarily import contraction. Interest rates are coming down and if export income starts to sag, the exchange rate will certainly adjust and absorb a lot of the impact.

        I suppose I am giving the various monetary authorities some benefit of the doubt – that is, they will not allow the global financial system to enter a Lehman-like paralysis – that even if banks have to be nationalized and currency-panics erupt, they will maintain all the vital signs of the payments and credit system.

        Of course, if they cannot do that, then no matter how good our current standing is, we will be in trouble along with everyone else.

        • “We have avoided a rise in unemployment in spite of some RBA zealotry. The thing is, there will be no domestically-induced recession and therefore there is no reason to suppose unemployment in Australia will take off unless there is a serious external shock”

          All you have to do is look at Retail, Manufacturing, Tourism and Services industry to see whats coming. I suspect massive layoffs coming after the holidays. This is a big chunk of the Oz economy. Then if people cant pay their high debts, such as mortgages, and the property market goes then the construction industry will get hammered big time.

          ” The signs are that 2012 will be tough, but even this does not mean the Australian economy will necessarily import contraction.”

          If China goes bust then I will bet Australia will contract. I think its gonig to be alot tougher than what you are stating but I could be wrong.

  5. Though there is serious justification to question, on past performance, whethert either Jo Hockey or Tony Abbott can count, much less frame a budget, I do support the line that Australia should now be in the countercyclical mode, in fiscal policy, to reduce debt more quickly.

    There is plenty of middle class welfare- (no, I am not advocating any attack on the basic safety net for those without income)- industry welfare and efficiencies in defence materiel purchasing to be scrutnized more closely. I am talking the whole gamut here- program and administrative expenditures, subsidies and tax concessions.

    I suspect if Lindsay Tanner were still around, he would be urging Swan and co. to be a bit braver with their positional power, whilst at the same time maintaining their principles on equity.

    • PS. The whole dependency edifice of the Howard-Costello largesse for middle and upper classes and the big end of town needs to be ripped down. It is neither fair nor sustainable for a society that needs to be productive and grow.

  6. The problem I have with the Liberals is not so much that are pig-ignorant (though they certainly are that) but that they treat the public as if we are completely gullible morons.

  7. What? And the other lot don’t? Give me a break Labour is no less condesending than the Liberals or Greens.

  8. Hio Prince…I’ll return to other issues with your post later. I guess you can predict most of it.

    I have been thinking about this concept of GDP for a long time. The whole thing is askew and over some years, particularly in discussions with my somewhat over-bright economist son, I have had the concern that the whole thing doesn’t measure foreign ‘Investment’ response and takes not enough account of the CAD. Now at a conceptualt level this is so. Essentially, in measuring GDP, we take the Foreign debt that results from a CAD as unlimited in both amount and time. Clearly this is not so.

    However my concern here is with some of the maths. When we finance the CAD with asset sales eventually we face a massive outflow of funds in the form of dividends. This will massively affect the CAD but it will also affect the GDP measure…..EVENTUALLY. Meanwhile what is happening is that the dividends from the investment are largely being re-invested within Australia. So essentially, with this foreign investment dividend re-investment what we have is a claim on future income flows in the form of increased future repatriated dividends. These dividend re=investments are being included in GDP but not offset because they are not flowing out NOW. Yet flow out they will.
    Thus our GDP is being boosted by future liabilities for dividends while those liabilities are not being accounted for in any way.

    Open to thoughts!

    • “we face a massive outflow of funds in the form of dividends”
      Australian company dividends are all paid in AU$. Apart from physical cash notes, AU$ can never leave the Australian banking system/economy. They can only be spent in Australia. Foreigners holding $AU from dividends can only spend them in Australia or swap them with someone else who will have to spend them in Australia. There is no flow of AU$ funds across national boundaries.

      • Isn’t that the point, though? ( that the companies, once sold, are no longer Australian companies). The dividends produced by a foreign owner do not have to be paid in A$. Witness the profit re-allocation of locally domiciled but foreign owned banks, who shuffle their profits about to realise the profit, and hence the dividend payments, offshore, and not in Australia.

        • Sorry, I took it that the issue was part foreign ownership of Australian companies. Even so it is not at all clear that foreign take overs have a net negative effect on the source country of the company. Some interesting thoughts are offered in the The Economist on foreign take overs of British companies.

        • Any profits generated here by a locally domiciled foreign company will be in the form of AU$. If the company wishes to pay those profits as dividends to its own shareholders, rather than re-invest them here, it will need to swap those AU$ for its own currency. The AU$ profits will become someone else’s property and will remain in the Australian banking system to be spent in Australia. AU$ change ownership but stay in Australia.

          • Look why does everyone come back with this shallow MMT tripe.

            So essentially, as a corollary, you are saying that when a foreign company invests here it makes no difference to the economy?
            It is just so typical of the shallow and straight out fraudulent analysis of MMT thinking.
            Effectively when a foreign company invests here it causes the A$ to be higher than it otherwise would be. Similarly when dividends flow out the A$ is lower than it otherwise would be.

            In any case, in the interests of trying to sprout more MMT baloney, you missed the point of the whole post. I guess it is because, in essence, Mitchell doesn’t believe that there are such things as Current Account Deficits and foreign debt.

            In future if foreign dividends are PAID then the CAD will be much higher than it otherwise would be.

          • Yes, I agree, despite AU$ neither leaving or entering OZ, foreign investment raises the AU$. Likewise, I agree if they exchange their AU$ profits made here to pay dividends then it creates downward pressure on the AU$. Isn’t that a good thing? Wouldn’t a lower dollar help? Aren’t most countries trying to lower their currency?

          • Yes, I agree, despite AU$ neither leaving or entering OZ, foreign investment raises the AU$. Likewise, I agree if they exchange their AU$ profits made here to pay dividends then it creates downward pressure on the AU$. Isn’t that a good thing? Wouldn’t a lower dollar help? Aren’t most countries trying to lower their currency?

  9. The US example suggests that Australia losing its AAA-rating might be followed by bond yields falling and lower debt service costs…

  10. Is it really “austerity” to run a balanced budget ?

    Is it really austerity to return government spending to 2007 levels ?

    I still think its pretty stimulative.

    Austerity is the ultimate dead end for those Eurocrats who ran as many budget deficits as they could get away with. Once you get to 100% debt-to-GDP, you have huge budget cuts (5% or more) forced upon you.

  11. Labour shares the wealth with new taxes; Mineral resources and Carbon Tax. Libs will gain power at the next election and they will reduce wages, education and welfare and sell off assets. Not much left from last sell off. But medicare and the ABN will go and again they will claim a wonderful surplus through asset sales. And so the cycle goes on. Trickle down effect is a myth. Accept taxes for they will eventually be returned in sales and profit.