Letter from The Cape

Episode 6 - May 5, 2023

Hello, here is another Letter from The Cape.

In this Episode I want to talk about debt. Public debt - to be specific.

How many times have you heard the Federal Treasurer talk about how the Australian government is "heaving with a trillion dollars of Liberal debt".

He claims the new Labor government 'inherited a budget' from the previous government which had run up public debt to unsustainable levels.

As a consequence, he claims he has no option but to 'rein government spending in'.

A familiar tale.

He told the media soon after being elected last May that:

"We need to be honest and upfront with the Australian people about the nature, the severity, the magnitude of this inflation challenge that we confront".

The 'heaving' reference has been repeated ad nauseum over the last year.

So much so that a Canberra Times journalist wrote last September that the Treasurer was "beginning to sound a little like a koel".

A Koel is a migratory cuckoo that flies to Australia from Indonesia and New Guinea in spring and leaves again with new offspring in Autumn before it gets too cold.

The reference to the Treasurer relates to the fact that the call of the Koel is repetitive, 24/7 and very grating. Have a listen.

Pretty grating eh?

The journalist demanded that the Treasurer "Drop the 'heaving' because we're heaving from hearing it too often. Once more and we'll most likely hurl."

I imagine the hurl was in reference to a brick through the TV.

I am largely pacifist by nature but I can confess to such imagery myself.

Other government ministers have formed a 'heaving' chorus with the Treasurer.

The problem is that the constant harking about heaving is based on a fundamental lie and is being used as a smokescreen to give the government cover to cut public spending.

In the last few weeks, we have seen them use the 'debt cover' to refuse calls to lift the unemployment benefit above the poverty line.

But, tax cuts for the rich and billions on submarines and missiles are apparently more important than restoring some dignity to our most disadvantaged citizens.

Of course, the Treasurer's call for honesty and transparency about public debt would help us all.

The only problem is that the debt narrative that we get from politicians, the media commentators and the mainstream economists is the opposite of those virtues.

So let's do a little sum.

In our little pencil and paper game in the last episode, you learned that when the government spends more into the economy than it takes out in tax revenue, the citizens are able to accumulate the game tokens in the form of saving, which allows them to build up financial wealth (in tokens).

And when the government spent less than it took out in tax revenue - a surplus situation - citizens were forced to liquidate some wealth they had built up in the past in order to meet their deficit.

The government surplus meant the non-government income was below the tax liability - a government surplus equalled the non-government deficit and vice versa.

Now get your pencil and paper out again because we are going to introduce debt into the game in its most simple but stark form.

So let's start in Year 1 where the private citizens have accumulated say 20 game tokens as wealth because in Year 0 the government had run a deficit of 20 tokens.

Refer back to Episode 5 if you have forgotten why the past deficits increased 'currency' wealth in the private sector.

Now the government decides that it want to encourage saving, which they see as increasing the ability of private households to manage the risk of unforeseen events - like a sudden illness or some other calamity in life.

At present, the game tokens that the citizens have saved are just sitting there doing nothing.

So, imagine I offer a 10 per cent interest return per day for each token that is exchanged for a 'government bond' which I will make available.

That means, you could earn 2 extra tokens the first day on your saving of 20 and so on.

Now think about that.

Essentially, that financial instrument - the fancy word for the government bond, which is just a commitment to reward some saving - becomes the national debt.

If you swapped all your savings of 20 tokens for 20 tokens worth of government bonds then the Federal Treasurer would claim the game is 'heaving with 20 tokens of debt'.

But you should now immediately see through that cant.

The national debt is just that portion of your wealth portfolio that you have placed as interest-bearing government bonds.

Pretty simple - you just swap one form of wealth (game tokens) that earn a zero return for a form of wealth that is interest-bearing (the government bonds).

Now, here is a tricky question.

Where did the tokens come from that allowed you to buy those government bonds worth 20 tokens?

It becomes obvious doesn't it.

When the government ran a balanced fiscal position (spending 100 and taxing 100), the citizens could save nothing, which means they could never be in a position to purchase any bonds because they had no saving and no accumulated wealth in tokens.

It was only when the government ran a deficit - meaning that it spent more than it took back out in taxes - that saving became positive and wealth was able to be accumulated.

Then the bond purchase by the citizens was just a portfolio choice between interest-bearing and non-interest bearing assets (tokens versus government bond).

And that means that the capacity to purchase the government bonds came from past government spending that was not fully taxed away, that is, past government deficits.

So the citizens could buy the debt because the government left some of its spending in the economy and didn't tax it back.

Moreover, now you should be able to see that the sale of debt provided the government with no extra spending capacity which is contrary to the popular view that debt is essential to fund government services beyond those funded by tax revenue.

Which makes harking on about 'heaving with a trillion dollars of debt' look rather silly, doesn't it?

So far, then, we have seen that neither tax revenue nor debt sales fund government spending.

We can go deeper into this story later but that should have your head spinning enough for this episode.

Take care and we will be back.