At one stage during the election campaign, either Scott Morrison or Josh Frydenberg hinted at their intention to begin paying down the national debt if they were re-elected.
It is a sad reflection on our media that no one thought to ask how this might happen. If they had, it’s likely they would have exposed a simple, albeit inconvenient truth, firstly about how that debt is created and secondly, how it is retired.
Currency-issuing governments don’t need to acquire debt, but given that the funding of deficit spending is a fact of life in Australia, we should all know just what the procedure is, and how it works.
To fund deficit spending, the government issues bonds in its own currency. Various entities, both here and overseas, buy these bonds because they have money they want to invest and bonds are considered safe investments.
The bonds are issued for a specific length of time (3, 5, 10 or 20 years), the money received for them is held in an account at the Reserve Bank, interest is paid twice yearly and when the term expires, it is returned to the bondholder.
Under current arrangements, when the Australian Office of Financial Management (AOFM), anticipates that the consolidated revenue account is running low, it will issue a bond sale tender to meet the expected shortfall.
There are other considerations such as yields and so on and the bondholders can, if they choose, sell their bonds on the secondary bond market and even make a profit from it. But that’s another story.
So when and how can this process reflect a reduction in government debt accumulation? Well, it can’t. As long as governments spend more than they collect in taxation, this is the process that plays out. It doesn’t have to, but governments choose to do it this way. It’s a political choice.
In some cases, when a bond issue matures, the government will issue a new tender just to cover the amount being repaid to bond holders. New tenders can be issued to cover maturing issues. It sounds stupid, but what can one do.
From this we can see that debt is accumulated to offset deficit spending and old debt is being retired and replaced with new debt. But what happens when government produces surpluses? Does the AOFM stop issuing tenders for bonds? That would seem to be the logical thing to do, wouldn’t it?
The last time this occurred was in the early 2000s when John Howard famously and incorrectly claimed that his government had paid down all debt.
They had, in fact, reach a point where net debt was thought to be zero, but some gross debt (bonds still on issue), was still owing. Gross debt is what interest is paid on. Howard and Costello wanted to shut down future bond sales but, as it happened, they continued to issue bonds even when the government was producing surpluses. Why?
The answer to that question is best explained by Philip Baker’s article written for the Evatt Foundation in November 2002 where he writes:
“Commonwealth bonds, which the government issues when it borrows money, are the safest of all securities. For many individuals who are labouring to pay off credit cards and mortgages, zero government debt may sound like a good thing. But it could also create a dilemma for big and small investors because it would result in a real shortage of risk-free, safe-haven assets for superannuation savings. The remaining government bonds on issue would be scarcer and more expensive for investors. Fund managers would be forced to invest in riskier corporate bonds or send the money offshore – at the very time the government has increased to 9 per cent the amount of an individual’s salary that must be invested in superannuation.”
So the Howard government continued to issue bonds because the bond traders needed them as leverage against a shrinking and less-safe market. This implies that bond sales have nothing to do with government debt.
So where does this leave Scott Morrison and Josh Frydenberg who desperately want to be seen to be paying down debt, a debt which in reality, does not exist? If the government were to cease issuing bonds it would make no difference to the nation’s fiscal balance. But it would incur the wrath of the bond traders and we couldn’t have that, could we?
Of course, none of this needs to be thought about while we continue to have a negative fiscal balance, i.e. deficit spending, and with the economy currently in a downward spiral, that situation will continue for some time yet. Despite Morrison and Frydenberg claiming we are back in the black, we are not. Not this year, or the next, or likely even the one after that.
And, just for the record, here is where the gross debt position stood back when the adults took over*** and where it is today:
May. 2019. $541 billion
September. 2016. $420 billion
September 2013. $257 billion ***
August . 2007. $58 billion
So much for a debt and deficit disaster. And where are those fearless journalists who could take on the Prime Minister and Treasurer when they make deceptive statements about paying down debt?
Perhaps an intimidatory raid on the ABC might keep them quiet for a while.
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