Letter from The Cape
Episode 12
July 28, 2023

Hello, and here is another episode in the Letter from The Cape.

There are two often-used narratives that are designed to militate against government spending on welfare and infrastructure.

The first is the constant use of the term 'taxpayers money', which I have considered in previous Podcasts.

The reality is that most adults are certainly taxpayers but our taxes do not provide any extra spending capacity to the federal government.

we use the currency that the government issues.

It is the government's currency not ours and they can spend as much of it as they desire without having to raise revenue in advance.

The second source of misinformation that is used to scare us into accepting cutbacks in government spending is the 'debt bomb' narrative, which feeds into a number of related storylines about governments forcing up borrowing costs and leaving future generations drowning in debt.

The 'debt bomb' narrative is very powerful because it is linked back to our personal finances.

We are told that government is 'maxing out' its credit card - spending like a drunken sailor - all metaphors designed to present an image of government as a household on a wild spending spree and soon to end up in bankrupcty overladen with debt that our grandkids will be encumbered with.

We are also told that when governments run fiscal deficits - that is, spend more than they take back in tax revenue - then they have to borrow.

So the linkages are clear - to avoid setting off the 'debt bomb', the government needs to borrow less, which, in turn, means it should not run deficits.

The problem with this seemingly tight causal train, which seems to be as inevitable as the day turning into night is that it is a fiction.

The Australian government does not need to borrow in order to spend.

When the government spends it simply credits a bank account where the spending is destined - a digital entry.

It doesn't have to have a pile of cash available or even positive balances in some other bank account that it can draw from.

That is the our destiny because we use the currency the government issues, which means our spending is financially constrained.

But that can never be the case for the federal government unless it places voluntary restrictions on itself.

Here is a story that demonstrates what is really going on,

In 2003, the Australia government ran the 'Commonwealth Debt Management Review' which was prompted by the fact that the amount of federal debt that was outstanding had fallen significantly as a result of the government running fiscal surpluses.

The point was this.

Given the government was spending less than its tax revenue, it stopped issuing new debt to the private markets.

And, as the outstanding debt matured and was repaid in full, the stock of debt in private hands fell dramatically.

Of course, the fiscal surpluses were only possible because taxation revenue continued to grow in the face of government spending cutbacks.

How did that happen?

This period was marked by financial market deregulation and access to credit expanded dramatically.

Households borrowed heavily to fund all sorts of things - houses, boats, DIY, SUVs, and other things - such that household debt went from around 65 per cent of disposable income to nearly 200 per cent (as it is today).

The borrowing allowed households to maintain spending growth even as government spending became more constrained.

The upshot was that economic growth was maintained by the private credit binge which, in turn, maintained tax revenue growth.

Without that credit binge, the economy would have gone into recession in the late 1990s and no surpluses would have been possible.

So by the turn of the century, the stock of outstanding federal debt was very low.

A lot of political miles were made of that by the Treasurer at the time.

But soon major criticism emerged.

Who do you think was complaining about the lack of debt available?

You guessed it - major players in the financial markets - the investment banks, the speculators, the gamblers ...

They demanded that the government guarantee a certain quantity of debt be released each period irrespective of the fiscal position of the government.

The government agreed as a result of the enquiry to continue issuing debt to the private speculators even though it continued to run fiscal surpluses.

So what gives?

If the public debt was necessary to 'fund' government deficits, as in the 'debt bomb' narrative, why would they be issuing debt to the private markets when they were running surpluses?

Well, it became clear that, in fact, the debt had nothing to do with funding government and everything to do with providing the financial markets with a risk-free asset on which to base their speculative gambling activities.

When there was deep uncertainty about returns in the markets, the speculators could always move their funds into government debt as a safe haven.

So, when you see through the smokescreen, it becomes clear that the selling of debt to the private sector is not to fund government deficits but, rather, to provide the gamblers with an elaborate form of corporate welfare.

The other aspect of this episode was that the beneficiaries of that corporate welfare were among the most vocal in demanding government cut spending on welfare that helped the poorest people in our society at the time.

The typical double standard, one rule for us an another for them.

Anyway, the game was up - the debt being issued by government had nothing to do with whether they were in deficit or surplus and all to do with providing a safe asset to the speculators upon which they could make huge profits.

I will be back next time.

See ya later.