Backbone Phil wants less public and private debt

From RBA Governor Backbone Phil last night:

It is an honour to be able to address CEDA’s Annual Dinner. It became a tradition under the previous Governor, Glenn Stevens, to speak at these dinners about prosperity: what it looks like and how Australia might continue to secure it in the uncertain world in which we live. This is a tradition that I would like to continue.

I could understand why you might not have guessed that looking at the title of my remarks this evening: ‘Buffers and Options’. You might have feared that this was going to be an esoteric talk about finance. But that is not what I have in mind. Instead, I chose this title because it summarises the one element of securing prosperity that I want to focus on tonight. Glenn spoke in detail about the various things that we can do to lift our average growth rate. Rather than repeating these, I would like to focus on another element of the challenge. And that is managing risk and ensuring resilience.

To provide some context I would like to begin with two observations.

The first is that Australia’s economic success over recent decades reflects both the underlying fundamentals and our ability to ride out various shocks. The fundamentals that have helped us are well known. They include our openness to trade and investment, our generally favourable demographics, our diverse and talented people, our abundance of natural resources, our ability to undertake structural reform to boost productivity and our links with the fast-growing Asian region. But also important to our prosperity is the fact that over the past quarter of a century, our economy has not been seriously derailed by economic shocks. After all, nothing undermines prosperity like a severe recession in which large numbers of people lose their jobs and see their wealth decline.

It is not as if there has been a shortage of shocks that could have derailed us. There was the Asian crisis, the bust of the US tech boom and the global financial crisis. We also experienced a once in a century surge in our terms of trade and the subsequent decline.

The point is that we have been able to ride out these and other shocks without too much difficulty. In part this is because of the flexibility of our exchange rate, monetary policy and the labour market. We have also avoided the build-up of large financial imbalances. But this resilience is also because when the shocks hit we have had buffers to absorb them. Because of these buffers, we had options that not all other countries have had.

The second observation is that today many business people tell us they feel the heavy weight of uncertainty. The long list of factors we hear includes: uncertainty about the transition in the Chinese economy; the future direction of technology; the political environment, both abroad and at home; the impact of high debt levels on future consumer demand; and uncertainty about where the extraordinary global monetary expansion will ultimately end. Understandably, when people feel uncertain, they sometimes feel that it’s best to delay making decisions, especially if those decisions are difficult to reverse. We want to seek out more information before proceeding. We want to wait.

So, to draw these two observations together: Australians have managed pretty well over the past quarter of a century, but we feel a bit uncertain about the future.

In my view, despite the uncertainties, we should still be looking forward to the future with some optimism. Here in Australia, with our long track record of good economic growth and our demonstrated ability to adjust to a changing world, we have a set of advantages that not all countries have. Our collective challenge is to capitalise on those advantages. Ensuring a strong focus on lifting productivity is surely the key here.

As we work out how to do this, though, we obviously can’t ignore the uncertainties. But neither can we let those uncertainties force us to retreat, to withdraw from the world. If we do this, then we, and our children, will be poorer as a result. Rather, we need to deal with, and prepare for, those uncertainties. This brings me back to the title of my remarks, ‘Buffers and Options’. Part of our preparation is to ensure that we have adequate buffers in place to deal with future shocks wherever they come from. These buffers provide us with options when challenges arise.

I would like to talk about buffers in three broad areas: the financial system, the fiscal arena and household finances.

Financial System

One area where it is particularly important to have adequate buffers is in the financial sector. The financial sector can either act as a cushion for adverse shocks or it can act as an amplifier. Which one it turns out to be depends upon how well the system is prepared to deal with bad events. If the system has skimped on liquidity and is carrying too little capital, then it is likely to amplify shocks. Conversely, if the financial system has adequate buffers, it is better able to support the economy in difficult times.

The aftermath of the global financial crisis is a good example of what can happen. This chart (Graph 1) shows how bank lending has grown – or in the case of Europe, contracted – since the financial crisis in 2008. Many banks in Europe and the United States simply did not have large enough buffers for the events that unfolded. Even today, capital levels remain an issue for some European banks. Insufficient capital means that some banks are constrained in their ability to provide finance and helps explain why banks have not taken advantage of the European Central Bank’s offer to lend them money at an interest rate below zero. The European economy has suffered as a result. In the United States, the picture is more positive, partly because there were more successful efforts early on to rebuild the buffers in the system.

Graph 1
Graph 1: Total Banking Lending

In Australia, it has been a different story. The banking system did have the capacity to support the economy during the global crisis, although it is important to point out that it did this with the assistance of the Australian Government through various guarantee schemes following the freezing of global capital markets.

Around the world, the experience of recent years has rightly caused banks and their regulators to think again about how large the buffers should be. And the answer has been that they should be larger than they were before. This has been true in Australia too, despite the starting point here being better than in many other countries.

Since the beginning of 2015, the major banks have raised around $28 billion from new equity and retained earnings, significantly increasing their capital relative to their assets (Graph 2). Banks are also holding a larger share of their assets in liquid form and have changed the composition of their funding towards more stable sources (Graph 3). During 2016, liquid assets have accounted for around 20 per cent of the major Australian banks’ total assets, up from an average of around 15 per cent in the years preceding the financial crisis. Banks have also increased their use of deposits and long-term debt and reduced their use of short-term debt.

Graph 2
Graph 2: Australian Banks' Capital and Assets

Graph 3
Graph 3: Liquid Assets and Deposits

These are positive developments and they provide us with an extra degree of insurance against future shocks.

Of course, this insurance does not come for free. Higher capital, more liquidity and more expensive, stable funding all have a price. We need to keep an eye out to make sure that this price is not too high and that we don’t constrain the ability of the financial system to do its job. My view is that this has not been the case in Australia and that the changes have increased the resilience of our system.

There is, though, a legitimate discussion to be held as to who pays the price. We see this issue frequently debated in our media. One possibility is that the cost falls on the bank shareholders in the form of lower returns on equity. Another is that it falls on borrowers in the form of higher interest rates on bank loans relative to the cash rate.

Ultimately, the balance is for the market to sort out, but it would seem unlikely that the cost will fall entirely on one side or the other. Over time, shareholders and borrowers will both benefit from these larger buffers to the extent that they contribute to economic stability. The shareholders should experience less volatile returns and borrowers should be more likely to be supported during difficult times. The larger buffers provide a form of insurance to all.

Fiscal Arena

A second area where buffers are important is on the fiscal front.

Again, the events of the past decade provide a useful illustration.

In Europe, we saw examples of what can happen when public finances are not in order when difficult times strike. In some countries, when troubles arrived, governments felt that they had little choice other than to impose austerity measures to restore the fiscal accounts, despite the fact that these measures added to the immediate downturn in the economy.

Australia, again, provides a counter example. When the shockwaves of the global financial crisis hit us, the Australian Government did have the capacity to support the economy through a fiscal expansion. This support was one of a number of factors that helped us get through this period. The ability to provide the stimulus was enhanced by the sound fiscal position that had been built up over previous years (Graph 4). While the exact nature of the stimulus remains a matter of debate, regardless of where you stand on that debate the fiscal buffers that we had did provide us with options that not all other countries had.

Graph 4
Graph 4: Australian Government - Per Cent of GDP

Since the financial crisis in 2008, the budget has been in deficit and debt levels have moved higher. Under current projections, net debt is expected to peak in 2017/18 at 19.2 per cent of GDP and a balanced budget is not expected until 2020/21. This would still leave the fiscal accounts in better order than those in many other countries. Importantly, this means that fiscal policy still retains capacity to support the economy in difficult times. But this capacity is less than it once was. We have a smaller buffer than we once did and a smaller buffer means fewer options.

So from a risk-management perspective, there is merit in rebuilding our buffers on the fiscal front. This is a task that can be undertaken over time and it requires difficult choices to be made. As Secretary to the Treasury John Fraser reminded us in a recent speech, the task is made more difficult by slow growth in nominal income.[1] But it is important that we ensure our public finances are on a sustainable track. This requires a better balance to be established, over time, between recurrent spending and revenue. It is worth pointing out that this does not preclude government spending on infrastructure, where this is backed by a strong business case. Such spending can provide support for the economy and can help generate the productive assets that a prosperous economy needs. Done well, infrastructure spending is not inconsistent with establishing a better balance between recurrent spending and revenue.

Household Finances

The third set of buffers that I would like to talk about are those in household balance sheets.

These buffers too are important as they influence how households respond to difficult economic times. Ideally, in such times, people are able to draw on their savings a bit, and perhaps even access credit, so that they don’t have to cut their consumption sharply. Of course they can do this only if their balance sheets are in reasonable shape.

Again, overseas experience is relevant here. In the United States when the recession hit in 2008 some households found that they had simply borrowed too much. What followed was a period of defaults by some, less new borrowing and faster repayment of some debt. The result was a more severe downturn and a more protracted recovery than otherwise would have occurred.

Given this and other experiences, we need to pay close attention to household balance sheets here in Australia too. Debt levels, relative to income, are high in Australia and are much higher than they once were (Graph 5). Currently, household debt is equivalent to 185 per cent of annual household disposable income, a record high and up from around 70 per cent in the early 1990s. If we net off the household sector’s holdings of cash and deposits the pattern looks somewhat different. It is important, though, to recognise that the households with the debt typically are not the same ones with the large deposits.

Graph 5
Graph 5: Household Debt and Deposits

The reasons for the large increase in household debt have been well documented. The lower nominal interest rates that followed lower inflation in the 1990s allowed people to borrow more, as did the liberalisation of the financial system. As a nation, we took advantage of these new opportunities to borrow. As a result, we ended up with both higher levels of debt and higher housing prices.

Given the low level of interest rates and ongoing employment growth, most households are managing the higher levels of debt, but many feel that they are closer to their borrowing capacity than they once were and have adjusted their behaviour accordingly. Since the financial crisis, there has been a noticeable increase in the household saving rate. We are not using our houses like ATMs in the way that we were in the decade to the mid 2000s. Gone are the days when higher housing prices were a sign that we should go to the bank and borrow more to spend.

One illustration of this change in behaviour is the large increase in balances held in mortgage offset accounts and redraw facilities. In aggregate, households now have balances in these accounts equivalent to 17 per cent of total outstanding housing loans, which is a buffer worth 2½ years of scheduled repayments at current interest rates (Graph 6). From the survey data we look at, we can see that over recent years more households in all income brackets have got ahead on their mortgages (Graph 7).

Graph 6
Graph 6: Aggregate Mortgage Buffers

Graph 7
Graph 7: Households Ahead on Home Loan Repayments

This more prudent behaviour is a positive development. Given the high and rising levels of debt, though, we need to watch things carefully. It is important that we avoid a build-up of financial imbalances in household balance sheets. We can never know with certainty exactly what level of debt is sustainable. It depends on income growth, lending standards and asset prices. But it surely must be the case that the higher is the debt, the greater is the risk. Given this, as I said recently when explaining our monetary policy decisions, it is unlikely to be in the public interest, given current projections for the economy, to encourage a noticeable rise in household indebtedness, even if doing so might encourage slightly faster consumption growth in the short term.

Conclusion

So in each of the three areas I have talked about this evening – the financial sector, the fiscal arena and household balance sheets – the story is broadly similar. Stronger buffers give us more options. And more options promote stability and prosperity. If we skimp on the buffers then we expose ourselves to more risk.

It is true that building these buffers does not come for free. In the financial sector, it might mean lower returns on equity or higher lending margins. In the fiscal arena, it means difficult trade-offs about recurrent spending and taxation. And in the household sector, it means consumption growth is slower for a time than it might otherwise be. But this is the nature of insurance. You pay a premium for protection against future uncertainties and to provide resilience. Of course, we need to make sure that this premium is not too high. But it is surely better to pay the insurance premium when the sun is shining than when the storm clouds are building or, worse still, to seek insurance when it is too late.

I am very conscious that this evening I have spoken a lot about providing resilience against future shocks. Before finishing, I want to point out that I am doing so not because we are predicting difficult times ahead. The Reserve Bank’s central scenario for the Australian economy remains a relatively positive one.

Instead, my focus tonight probably reflects the inherent cautiousness of a central banker. Just as the past 25 years have seen numerous shocks to the global economy, chances are, so too will the next 25 years. In the past, we have been served well by the economy’s flexibility and the buffers that we had. Being realistic, we will probably need these buffers again some time in the years ahead.

At the moment, though, our economy is adjusting better than many predicted to the unwinding of the mining investment boom. Over the next year, we are expecting the economy to grow at around its potential rate, before picking up a bit in the following year. We also expect some further modest progress in lowering unemployment, although spare capacity remains.

The low interest rates are helping to support the economy. And the decline in the exchange rate over recent years has assisted a number of industries. Survey measures of business conditions and consumer confidence generally remain above average. The prices for our commodity exports have also lifted since the start of 2016. As a result, for the first time in some years, Australia’s terms of trade have moved higher. This will help to boost incomes and fiscal revenues.

Inflation remains low, but the latest reading did not suggest that it was moving lower still. There remain reasonable prospects that inflation will return to around average levels over the next couple of years.

Finally, to repeat an earlier point, despite the uncertainty in the world, we should be looking forward to the future with some optimism. Australians can continue to enjoy a level of prosperity enjoyed by relatively few people around the world. We have a strong set of fundamentals and a demonstrated ability to adjust to a changing world. We should also take some comfort that our system retains buffers against future shocks. Strengthening these buffers makes sense in the uncertain world in which we live.

Thank you.

In short, we need less public and private debt. I predict that Dr Lowe will get his wish in his first term, though not in the manner he would like:

g3
David Llewellyn-Smith
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Comments

  1. I think there is a typo

    “….The fundamentals that have helped us are well known. They include ……our willingness to bet our economic future on an economic model where we close down productive enterprise with an inflated exchange rate driven up by our use of low cost off shore debt to drive down mortgage rates so that our households can drive economic activity, with ever growing levels of household debt, by driving up the price of land, a fundamental input that should be our low cost competitive advantage.

    As that alone would not be enough, so we set about funding even higher levels of consumption with the sale offshore of other IOU s and industries, infrastructure, capital assets and mountain loads of our mineral wealth.

    That is what we did and boy don’t we think we are clever….”

    Fixed.

    • A central banker states the bleeding obvious; but because he’s an AUSTRALIAN central banker where highlighting the dangers of debt makes you some kind of ‘hero’ – he has a backbone.

      We are so unused to reasonable discourse from our elite we become grateful for small mercies.

    • Exactly pfh
      How did we get this liquidity????? We saved it????? Bwahahahahahaaaaaaaaaaa!!!!!!!!!
      How can you improve liquidity and debt ratios while running a CAD?
      Answer: We sold off more of our nation to foreigners.

      2006 -“” In Australia, it has been a different story. The banking system did have the capacity to support the economy during the global crisis, although it is important to point out that it did this with the assistance of the Australian Government through various guarantee schemes following the freezing of global capital markets.””
      Phil just ‘forgot” to mention the $100 BILLION dollars in asset sales and increased foreign debt over the next 12 or so months

      For crying out bloody loud can’t just damned once can’t we have someone tell the truth about the state of our nation rather than this self-laudatory BS!
      As many have discusses from the Bible to Shakespeare to Moliere there are two ways of telling lies – the sins of commission and the sins of omission! Phil is either stupid or guilty! I’d love to hear from him which it is. I have to admit I’m surprised. I thought he might be better than this.
      This country needs an RBA Governor to speak TRUTH!

      • +1 flawse
        Everyone seems very comfortable with all this debt.
        Sure 17% have offset accounts… so what? You only need 5% of the rest to fail.
        Let’s hope Trump remembers to revalue gold.

    • and ‘ The banking system did have the capacity to support the economy during the global crisis, although it is important to point out that it did this with the assistance of the Australian Government AND BAILOUT BY THE FED RESERVE, 64BN to RBA, 4.5 to CBA etc through various guarantee schemes following the freezing of global capital markets”

      FIXED

  2. Subpar growth, overpriced currency, defunct industrial base, scarce and overpriced skilled workforce (no, barista certificate doesn’t count). Squaring the circle methinks, but I encourage you to rein in debt Phil (now where the devil is my crash helmet?)

    • Jason…Jason…Relax man! You worry too much and you are not paying attention! Phil concluded…
      “”Australians can continue to enjoy a level of prosperity enjoyed by relatively few people around the world.””
      We’re going to do what we have always done and reduce that debt by selling more assets to foreigners. There will be no saving/reducing consumption to reduce debt. That you can bet on! So take Reusa’s advice. Get on the property ladder. It is going to be the only game in Aus. As a matter of fact don’t just get on it – take four or five rungs at a time!!!!!

      • Yes, Reusa the Sage´s soothing words is what I need now to steel my resolve! Where art thou Reusa, fairest of investors.

  3. How can anyone talk about public and private debt without once…ONCE…mentioning the CAD, Foreign Debt and Asset sales to foreigners??????

  4. Forgive me but doesn’t reducing both private and public debt simultaneously result in a shrinking monetary system and hence economy?

    • Jonathon
      As per my posts above – not if you sell lots of assets to foreigners. This provides you with the funds to have less debt – well it would except we are selling assets AND increasing debt at the same time.
      To reduce debt without selling assets to foreigners would indeed involve fiscal restraint on a major scale and increased interest rates on a major scale. The problem there is that as a result of the stupidity of modern economic theory on totally open capital markets increased interest rates would result in a tsunami of excess printed money from the EU and U.S. and the whole strategy gets blown to hell.
      So without a major rethink of modern economic theory, and with the Donald pretty well promising to print the world Reserve currency to hell and gone to do his infrastructure, what you’ve got is almost a certainty that we will continue on our present path. So what are the chances that Aus will suddenly reassess the economic BS of the last 30 odd years and go back and revisit the warnings of John Stone and others. – ZIP!
      MB is calling lower interest rates next year and in this environment that may be right (despite it being the worst possible choice this country could make). So the MB call for the great housing crash is more likely itself to crash than is the housing market.
      Real Estate – Always…always remember…
      If you’re not in Real Estate you are a failure to yourself and a disappointment to your family.

      • @flawse we might see lower RBA interest rates next year triggered by a ToT crisis but I think more importantly we will see external funding costs rise (as they are now) and being passed onto household mortgage rates.
        This, combined with rising unemployment (full time jobs in particular), a declining exchange rate, an increasing budget deficit and crash of confidence WILL pop the housing bubble. I’m locked in for Nov 2017 – fingers crossed!

      • Yes stomper that’s possible. The knife edge where we fall off one side or the other gets finer and finer! Nov 2017? Hmmmm
        My guess the notion that the Donald really is going to spend will catch on. Now current idea is that the Fed is going to raise rates. My GUESS is at the moment that they will – then they’ll go ‘Holy s..t look at that! Lower the rates …quick!’ You’re right – it depends on the external funding. Current economic theory makes us a cork in the Feds ocean.

    • Jonathan,

      That is correct – which is why our current crop of economists are suffering paralysis.

      The only way to reduce the amount of debt in a monetary system that treats debt (especially banking system credit) as money is to start switching to money that is not debt based.

      Now I say that with some caution because there are a lot of bank apologists out there who insist that public money created by the public sector is also debt. They do this because they want people to think there is NOOOOOO difference between debt as money created by private banks and money created by the public sector.

      Regardless of whether you insist on calling public money created by the public a form of debt it is COMPLETELY different in nature to debt as public money created in the form of banking system credit.

      So the solution to the deleveraging problem is relatively straightforward.

      When the government wishes to run a deficit that deficit is directly monetised – you can call it printing if you like but for practical political reasons I recommend that the government issue a 0% bond to the RBA who then credits the Treasury ES account. Nice and simple the RBA just bought a risk free asset and paid with it the way it always pays for the bonds it buys in open market operations – with new money in the form of accounting entries to the banking system ES accounts at the RBA.

      All existing deposits in the banking system will be converted and treated as if they had been created this way.

      However if the banking system wishes to extend new loans it must do so purely as an intermediary – which means it must acquire deposits on terms consistent with the loans it wishes to make.

      In other words banks will only be able to make loans using funds raised in the form of term deposits. That is not too much to ask of depositors – If you want to earn interest you need to trade that for the option of having your money at call.

      The government can easily supply more than enough new public money by running an appropriately sized deficit. The gap between what they spend and what they tax back.

      The central bank will still have a role as an interbank clearing house and as purchaser (and seller) of the 0% bonds from treasury. It would make recommendations on the size of the deficit or surplus that the government should target to avoid inflation and deflation.

      Naturally, it would still be critical to restrict and block unproductive capital inflows that inflate the exchange rate and drive excess consumption of imports.

      None of this will make it an easier for debtors to pay back their debts – in fact some will find it harder if their source of income was derived from the unproductive industries that infest our economy but they can re-train and get a REAL job in the productive areas of the economy that will now be expanding rather than contracting.

      After all that is the advice they have been handing out to everyone else for the last 30 years.

      All in all pretty simple – nothing radical at all.

      Not that the squealing banks will go quietly into their new limited role as intermediaries.

      • “When the government wishes to run a deficit that deficit is directly monetised – you can call it printing if you like but for practical political reasons I recommend that the government issue a 0% bond to the RBA who then credits the Treasury ”

        That is very similar to what I have been thinking. No need to sell off national assets as well to raise funds. Taxpayers paying interest on money created out of nothing is a scam. But why do we need the RBA at all. Issue to the Treasury, release funds on Senate approval. At federal level only. And only for tangible nation building projects / infrastructure. Not to bail out banks, FIRE sector and bankrupt states, councils, pension funds etc. That needs to be set in concrete legislation – govt cannot borrow to bailout.

      • “But why do we need the RBA at all..”

        I agree certainly not for most of what they are doing now. The idea of trying to manage an economy by having the RBA goose the demand for interest accruing private bank credit is nuts.

        Even worse is the facade where the AOFM sell ‘bonds’ on behalf of the government to the banks who then ‘sell’ them to the RBA (who pays for them by creating money) so that the purchase of the bonds by the banks does not upset the bloody target rate on interbank overnight loans. That is just madness on wheels – the AOFM should just sell them direct to the RBA for 0%.

        About the only thing the RBA would be good for is advising the government as to the deficit / surplus that is appropriate and choosing fluffy animals for the banks notes and coins.

        Having an independent party say that they estimate a surplus or deficit of X is required to avoid deflation or inflation might be useful. But probably only need a small staff for that – wearing cardigans.

        As a filing cabinet for 0% non-transferrable bonds from Treasury it might serve a purpose and perhaps counting things and helping the ABS it might be useful.

    • Rod
      You are dealing with a dynamic. If we saved money would not be lent into existence. So if interest rates were higher at some level you’d just be lending savings. Similarly if we were a really productive economy and ran a CAS, which also involves saving, then money supply could expand without debt.
      Saying ‘money is lent into existence’ misses the complexity and reality of the problems.

      • “If we saved money would not be lent into existence” And here lies the problem, if money is saved that means a reduction in bank assets and contraction in money supply all else being equal which means debt deflation !.

        Take point on the CAS/CAD, but that is something that has never happened in Aust.

        Maybe when crisis gets real bad the Feds here will have to educate the public that ‘money’ is a totally man made construct and can be simply printed up with no increase in debt. I think Lawrence Summers is preparing the ground with his idea for a $1T Zero Coupon perpetual Bond issue to the Fed which is basically what I am describing.

      • “If we saved money would not be lent into existence. So if interest rates were higher at some level you’d just be lending savings.”

        Money can only be created by private banks creating loans, or by government spending

        Both are debt

      • Coming
        Your view is a static one. That’s not how the world is now.
        Further if you follow it back past the surface money is not created by our private banks. The money is created by the RBA when it tips money into the overnight money market to lower rates OR the banks borrow from overseas to fund their lending. Now again this is a circular dynamic. Let’s take as a given that the RBA has adjusted IR’s and their effect on the market is zero.. Now if the banks want to lend MORE they can. They CAN create a loan but what happens is that this new money ends up in one of three places.
        1. The government gets its share which if it does not re-spend its increased take means that money, in essence, disappears. It does not go back to the banks so without some other source of funds the banks would have to bid for more deposits.
        2. Much of it ends up in the external account as increased CAD. In the case of this economy I suspect that proportion is quite high and marginally probably some 40% odd. Again if that is not rep[laced the banks have to bid for deposits. What happens at the moment is that the banks borrow offshore to replace the funds or we sell assets which again funds this deficit for the banks.
        3. What remains ends up as deposits which, as per our start point, have already been lent.

        So increased money cannot be lent without the Banks borrowing from somewhere.

        “”Money can only be created by private banks creating loans, or by government spending”” We can agree to simplify the process here by treating money and credit as the same thing for the moment.

        Take the model above and change it to a productive economy, running a CAS, and where new lending goes to more import replacement or exports. In this case, assuming your government doesn’t take it and runs a balanced budget, your lending results in Banks ending up with USD which they can get converted to A$. Effectively you end up with more A$ deposits than they have lent out. NO net increased debt. Sure A$ have to be ‘printed’ but in this case these are not debt.

      • Hi Flawse

        “The money is created by the RBA when it tips money into the overnight money market to lower rates”
        The money I guess is created by the RBA when it pays interest on reserves? Is that what you mean? I thought that is how the RBA controls the overnight rate

        “the banks borrow from overseas to fund their lending.”
        I think that is mistated right? They don’t borrow to fund their lending. They lend first. They borrow to meet capital requirements which are arbitrarily imposed by AHPRA

        “your lending results in Banks ending up with USD which they can get converted to A$”
        There have to be $A created in the first place to exchange for

      • Rod
        This is NOT the U.S.
        The US$ is the world reserve currency – can everyone once and for all agree on that. Can we also agree that we are NOT the world reserve currency? The result is that everyone thinks the FED can print willy nilly with no debt – but that is actually BS as well. In fact the UDS runs a massive CAD of about $600B a year, which ‘magically’when you net out the feds balance sheet and treasuries, happens to be the increased net liabilities year. The only way this doesn’t happen is if you don’t treat the sale of Treasuries to foreigners as debt but as equivalent to exports. The rest of the Fedds QE is just a merry-go-round where the Bankers get merry skimming a bit off in teh circl;e so that they are nicely profitable.

        OTH, actually we have run CAS – just a damned long time ago. Once in 1971 and prior to that go back to 1959. I make the point that despite this it does alter the essence of the theory of money and how it comes into being. Howevewr it just goes to reinforce the explanation i have given above.
        If you ”create” money, in this economy as it is now structured and with effectively no incentive for saving, you do get debt. If the government doesn’t save it by running fiscal surpluses, or in the current case decreased fiscal deficits, and the private sector doesn’t save as deposits because there is no incentive vial IR’s then the whole lot eventually ends up in the external account as increased foreign debt.
        There is no such thing as free money that comes down magically from heaven. You either earn it by being productive or you have increased debt.

      • Coming
        Yes and no – I was going to get to that interpretation and its valid to an extent. Again you have a continuous spinning dynamic so where does the circle start or end?
        From my viewpoint what happens is
        1. Bank lends
        2. Money gets spent – some of it on stuff i import and sell
        3. I have top pay for it in USD so I deposit eh A$ from my sales, Bank borrows USD, gives it to me and I pay for the goods.
        Note the net effect is USD debt. However the bank only has to borrow the USD after it circulates through the economy creating imports. Note however in a dynamic this is all sort of instant and ongoing. We really are dealing with the rate at which things happen – important in building the model!

        Go the other way
        1. Bank borrows USD
        2. It lends the equivalent in A$
        3. In the absence of saving by private sector or government this A$ all ends up in the external account – save a few percent which results in increased M3 somewhere. So effectively I end up with teh A$ with which i purchase the USD the bank is holding from its initial lending. Same/same

        I believe the former interpretation gives more clarity and reality in determining policy.

        Re how the RBA operates overnight. Yes you’re correct. However in order for there to be no pressure on rates the RBA has to withdraw or add extra. Otherwise banks have to bid for overnight money and rates go up (or down if thee is a surplus) So I was just being brief and conflating a few processes.

      • Coming
        There have to be $A created in the first place to exchange for””
        Yes you do create A$ but it is for deposits not debt. That is the whole point of what we are discussing. Money going into circulation does NOT have to be debt.

      • Sorry – in the case of a CAS, which was the status I was assuming at that point, the money is created for deposits!

      • Flawse you are, and always do, ignore the floating currency

        From my point of view

        1. Bank lends, a deposit is created and so is a corresponding loan
        2. This loan is tied to an asset
        3. The function of creating new loans to allow people to bid against each other causes asset prices to rise
        Hence it is an endless circle

        Yes, the bank will have to raise funds to meet criteria imposed on them, and this will have some effect on reducing their scope for money creation and hence reduce increase in money supply and also downward pressure on AUD on foreign exchange markets.

        Your point re: external account etc is fully accounted for by the floating currency

        ” However in order for there to be no pressure on rates the RBA has to withdraw or add extra. Otherwise banks have to bid for overnight money and rates go up (or down if thee is a surplus) So I was just being brief and conflating a few processes.”

        What do you mean by “no pressure”?
        Pressure raising rates? or pressure dropping them?
        Or banks can “borrow” from the RBA, rather than other banks, for 0.25% more? Is that what you are saying?
        Its not really tipping money in though is it? Because theoretically loans = deposits, so there will always be one bank with excess looking to get a return on and one with not enough needing to borrow that
        So its really only the interest

        The initial statement/question that was raised was: if both the government and the private sector reduce debt, then the only possible outcome is reduction of the money supply and “economic” contraction (when measured in AUD).
        I thought this was fact

        Sure the RBA is creating AUD when it is paying interest on reserves. That’s an interesting point. I guess that is offset by the fact that interest has to be paid on the debt that has already been issued (and not yet destroyed by fiscal surpluses), and the magnitude of that effect is greater.

        I’m confused though

      • There have to be $A created in the first place to exchange for””
        Yes you do create A$ but it is for deposits not debt. That is the whole point of what we are discussing. Money going into circulation does NOT have to be debt.

        This is nonsense I think

        Deposits can’t be created without a loan, except by government spending (which in our financial system, is also debt)

        Please explain the mechanism by which AUD is created that is not debt?

        If I did up a rock of iron ore and sell it to china in exchange for $USD50
        This has no effect on the amount of AUD in circulation
        No new AUD is created

        The CAS/CAD has no effect on the amount of AUD in circulation, only its value relative to other currencies.

      • Coming
        Re the floating currency – you state a floating currency but you assume a constant currency. The decline in your currency that results from having to sell more of it to get your USD is part of the COST of printing. All the floating currency does, when you print into this economy, is to fend off some of the costs to the people coming after you. A depreciating currency is not just some free kick. that’s why we sell teh whole damned natioon off to foreigners so we avoid a decline in the currency. if we just let the currency adjust to a level, as I and a few others have here have advocated since time immemorial, then the thing would go straight down resulting in a lower standard of living for everyone – less imported material goodies.

      • Yes sure but that’s not the question that was asked

        Money is debt

        Reduce the amount of debt, you reduce the amount of money

        There is no way around it

      • Coming
        “”Please explain the mechanism by which AUD is created that is not debt?”” I thought I had and that was the point of everything I’ve written.

        If I’m an exporter I sell my beef for USD. I deposit that USD in a Bank and they credit me with A$ – there are more A$ on deposit – no debt. These A$, in a CAS country, would be available to lend with no increase in debt when the whole series of transactions is accounted for.
        So on a macro scale you can lend (increase lending) without net debt if you run a CAS

      • mate, where did that AUD come from? The 0s and 1s in your bank account?
        When the bank credits your account with it (presumably because you exchanged your USD), they had to get it from somewhere.
        It doesnt just magically appear

        Someone had to create a loan

        Where did the very first australian dollar come from? Probably government spending/debt

        You are looking at it as an individual, not an overall currency system/nation

      • Coming

        Note on a macro scale if we are running a chronic CAD then yes extra lending will be more debt. Again that’s the whole point and probably why it is assumed in pretty well all western economies. However that is not a law – it depends – in particular it depends on the structure of your economy. The structure of your economy and its productiviy determines whether you have a CAD or CAS and THAT is why taking note of a CAD is important – it tells you stuff about the structure of your economy upon which you should act before you end up in a mountain of debt or live in a country owned by foreigners renting houses you can’t afford to buy.

      • Extra lending will be more debt? I don’t understand what this means

        Regardless of whether you are running a CAS or a CAD, the only way you can expand the money supply is to create more debt.
        The CAS/CAD will determine how inflationary that is, and the relative value of currency, but is otherwise irrelevant to the discussion at hand

        Reducing government and private debt will reduce the amount of AUD in circulation, will cause deflation and/or a rise in the value of the currency (depending on the CAD/CAS status)

        Recession either way

        Note this is not a value judgement on anything

      • Coming
        I have just illustrated EXACTLY how how the money becomes a deposit not a debt Where’s the problem?
        If you want to start limiting the conversation to notes in circulation then the discussion alters a bit but not much. And its pretty pointless talking about notes in circulation.

      • Extra lending will be more debt?
        What happens to the lending? Follow it around the circle. See where it all goes and how that is influenced by interst rates and government fiscal policy.
        In this economy you print money, have no savings, and run fiscal deficits, there is only one place it all goes – the CAD. Note again we are leaving out possible inflation. If it doesn’t all go into teh CADS and you don’t increase domestic production you get an inflationary impact which is again a cost to your population.

      • Reducing government and private debt will reduce the amount of AUD in circulation, will cause deflation and/or a rise in the value of the currency (depending on the CAD/CAS status)
        Yes! The point is if you run a CAS you CAN run both a private and public surplus. without reducing the A$ in circulation.

      • NO you cant!

        The only people who can increase the amount of AUD, who can bring AUD into being are
        -Australian banks
        -Australian governments

        If government and households/business run a private surplus, AUD will be destroyed
        There will be fewer AUD in circulation (notes and deposists)

        now the VALUE of the AUD (relative to other currencies) may be increased, but that is a separate point

        “I have just illustrated EXACTLY how how the money becomes a deposit not a debt Where’s the problem?”

        Where? You still haven’t told me how your Australian farmer came by the AUD he exchanged his USD for?
        Where did that come from?

      • Coming
        Because theoretically loans = deposits,””

        As explained in detail in my opening post here loans do NOT equal deposits – nowhere near it!!!!

      • For heavens sake you are going over and over the same thing. Every ti
        A private sector surplus means the private sector is saving right?
        A fiscal surplus means the public serctor is saving Right?
        Now if you run a CAS it can service both those surpluses. If the exporter makes money he can buy stuff and pay his tax and still have money left over as a deposit. It is exactly the same expanded to a macro scale. If we export a lot we can save in both the government and private sectors.DRaw a simple diagram and look at the exchanges between the THREE sectors. I know your MMY stuff, as it is preached, only considers two sectors – perhaps that is as large as their brain can account for – I don’t know. However there are in fact three major sectors. The private and public sector both interact with the third sector – the external sector.

      • Flawse you are avoiding my questions

        AUD cannot leave the australian banking system (RBA)

        AUD can only be created by the government (who choose to do so by issuing corresponding debt), or by Australian banks.

        When AUD is created by private banks, it is done so by creating a loan, which creates a corresponding deposit.
        This deposit can’t leave the Australian banking system
        Sure if the government takes a slice, but if the government budget is balanced (not in surplus or deficit), that money gets put back in somewhere in the australian banking system in the form of government spending.

        The CAD is irrelevant to the discussion of how much AUD is in existence.

      • you are conflating value and amount

        they aren’t the same thing

        please elaborate on your theoretical australian beef farmer

        What does he do with the USD he receives for his cattle?
        He can’t hold it in the Australian banking system

        If he wants to exchange it for AUD, he has to find a willing person to swap

        this doesn’t create any new AUD, just a demand for the AUD that already exists

      • “”Because theoretically loans = deposits,””

        Again in a CAS economy deposits would/could be greater than loans depending on government fiscal status.
        In any case in either a CAS or CAD economy loans do not equal deposits.

      • See above

        http://www.macrobusiness.com.au/2016/11/backbone-phil-wants-less-public-private-debt/#comment-2751464

        People get all wound up about whether or not money created by the government is debt.

        Even if one accepts that it is a form of debt it is quite clearly very very different to the kind of debt as money that is created when an ADI extends credit.

        For starters – the government created money (as debt) can be created without any interest trailing commission. All that Treasury would need to do is ‘sell’ the RBA an asset in the form of a 0% bond. The RBA pays for the bond by making a credit in the Treasury ES account which Treasury can then happily spend.

        At some point in the future the Treasury can buy that bond back from the RBA and the RBA will debit the Treasury ES account.

        No interest paid at any point by the Treasury and none asked for by the RBA.

        Whereas nowhere on the face of the planet will a bank create money as debt for a customer without charging interest – a trailing commission. Because the interest is not created by the loan the process is inherently deflationary and destablising as the only way to overcome the deflation is by constantly expanding the credit creation process. It is just maths.

        By all means say that all money is debt but there is simply no reason to create public money by treating interest accruing bank debt as equivalent to public money.

        That is a barbaric relic of the 19th century error whereby the public authorities attempted to solve banking fraud by allowing dodgy bank notes to be exchanged for public bank notes. The Central Bank as ‘lender of last resort’ was nothing more than creating a refuge and public guarantee for banker fraud and mismanagement.

        Just imagine how many other businesses would like their promises honoured by the public when they issue too many and cannot fulfill their promises to their customers.

        There is simply no need to continue this public policy failure – it has caused far too much damage already.

      • Coming
        Go back to the very beginning Banks are merely a transmission point of RBA monetary policy and government fiscal policy interacting with the external account.
        If the banks çreate too much A$ it ends up, in the case of an economy running a CAD, as debt in the external account. Or by your thinking the Banks borrow in th external account and then lend. Either way money creation has a consequence and that consequence is debt. If the consequence is a fall in the currency then that is just debt pushed off onto those who come after us.

      • pfh
        Please read what I have written.
        If you push money into this economy running negative RAT rates, from the government already running a deficit as it now is, you end up with foreign debt. There is nowhere else for it to go.
        Again in a CAS economy you can push money into the economy from deposits. Banks, as we’ve agreed, can earn money by servicing the transfer from deposits to loans. That money earned is still in the economy either as wages etc or as profits.

      • I’ll ask again

        please elaborate on your theoretical australian beef farmer

        What does he do with the USD he receives for his cattle?
        He can’t hold it in the Australian banking system

        If he wants to exchange it for AUD, he has to find a willing person to swap

        this doesn’t create any new AUD, just a demand for the AUD that already exists

        No one is disputing the external account is important, but it isn’t what we were discussing and you are mixing in a lot of mistruths and falsehoods in amongst some good posts

      • Flawse

        “If you push money into this economy running negative RAT rates, from the government already running a deficit as it now is, you end up with foreign debt. There is nowhere else for it to go.
        Again in a CAS economy you can push money into the economy from deposits. Banks, as we’ve agreed, can earn money by servicing the transfer from deposits to loans. That money earned is still in the economy either as wages etc or as profits.”

        Yes – but that is not what I am proposing.

        We are running negative RAT under the current system to drive credit creation because that creates money under our bank credit as money system.

        There is no need to do that if the government is creating money via a fiscal deficit.

        Instead what will happen is that interest rates will more accurately correspond to the interaction of savers and borrowers.

        That still leave the issue of unproductive capital inflows because our mercantalist trading partners will still want to drive capital into our market to push down their exchange rate and it will be more attractive to do so because interest rates on Term Deposits are likely to be higher.

        But that is what you and I keep on saying – unproductive capital inflows must be heavily restricted and that is not going to be difficult to do because they are pretty easy to spot

        1. Offshore govt bond sales

        2. Offshore borrowing by our banks for mortgage lending

        3. Sale of assets off shore

        4. Which is least of all – excessive reliance on particular exports that create single point risk etc.

        It is pretty straightforward but is made confusing because of the idiotic fusion of public money and bank created ‘money’ and the religious mantra about completely free markets.

  5. Extrawq lending will be more debt?
    What happens to the lending? Follow it arouind the circle. See where it all goes and how that is influenced by interst rates and government fiscal policy.
    In this economy you print money, have no savings, and run fiscal deficits, there is only one place it all goes – the CAD. Note again we are leaving out possible inflation. If it doesn’t all go into teh CADS and you don’t increase domestic production you get an inflationary impact which is again a cost to your population.