For the best browsing experience on this site, we recommend you upgrade your browser
AboutSubscribe Your Editors Contact Us RSS

Beware the Big Government Debt Switcheroo

Oh what a tangled web we weave when we begin to spend money we don’t have. We spend it because we think we’ll be able to pay it back later. Or, in the case of government debt, because it can make someone pay it back later through tax hikes. But the world is still full of bills that may never be paid. And if those bills (or bonds) represent assets on someone’s balance sheet, a lot of portfolios are going to take a hiding.

Stock markets are somewhere between Dr Jekyll and Mr Hyde this morning. The economic data emanating from the US and Europe isn’t good enough for anyone to get excited. And central bankers are expressing the view, for now, that there will be no more vodka in the punch bowl. This presents a problem for fund managers whose job it is to buy stocks. We’ll get back to them in a moment.

You are probably as tired of reading about other people’s debts as we are writing about them. But the issue won’t go away. Until debts are liquidated, it’s going to be impossible for the global economy to get back to anything resembling normal growth. Don’t hold your breath.

For example, Portuguese banks borrowed over €100 billion from the European Central Bank (ECB) in February and March, according to The Guardian. National banking systems in Europe are having a hard time borrowing money from private investors. The ECB is the lender of last resort.

The trouble is, it appears the money borrowed by Portuguese banks isn’t money used for loans to businesses and households. The money borrowed either props up the balance sheets of the banks (as a counterweight to enormous debts). Or, even worse, the money is used to buy yet more government bonds.

That was probably always the plan, of course. The ECB can’t directly buy government bonds. But it can lend money to banks through its Long Term Refinancing Operations (LTROs). And the banks can then buy government bonds. And then the governments have money to contribute to the bank bailout funds. And everyone is happy…but no one is any further to putting the crisis behind us.

It’s absurd, but it’s persistent. And for Australian investors, you just need to be aware that this kind of pedestrian pace to the debt crisis doesn’t mean it isn’t serious. It is. And it’s ticking.

What About Australian Government Debt?

In the meantime, Australia has its own mini-crisis ticking away. The debt ceiling on Commonwealth debt was raised last year to $250 billion. The government complained that revenues were lower than it planned for and expenses were higher. But it assured everyone things would turn around this year.

They haven’t. Commonwealth government debt is now over $240 billion, according to the Australian Office of Financial Management. At the rate the government is borrowing money, the debt ceiling will have to be lifted in about 20 weeks. And what rate are we talking about? Take a look at the spreadsheet below.

$11 billion in new government debt in 2012

$11 billion in new government debt in 2012
Click here to enlarge

Source: Australian Office of Financial Management


And you thought “debt ceiling” was a term that only applied to America. The Australian government lifted the debt ceiling from $75 billion to $200 billion two years ago. Then, in the middle of last year it lifted the ceiling again to $250 billion. With $11 billion in borrowing this year alone, the government is on pace to hit the ceiling soon, at which point they will obviously raise it again.

It is hard to get emotional about debt figures. They are just figures. Besides, when the government spends that money now, it contributes to GDP and goes into someone’s pocket. Who cares about paying it back? That will happen in the future.

But you can see how this attitude becomes permanent. Regular deficits and regular borrowing become…well…regular. You get used to living beyond your means. And when interest rates are relatively low, and there are plenty of people lining up to buy your bonds at auction, you get all the benefit of the borrowing and none of the pain. Someone else gets the pain (your kids, but they are too young and carefree and stupid to know what’s being done to them).

In any event, our interest in the culture of debt is not moral. Our interest is what will happen when Australia’s growing culture of government debt crosses paths with its declining culture of equity. If you’ve been paying any attention to the papers in the last few months, you’d have seen one “expert” after another talk about how poorly informed superannuation investors are and how the super industry is too exposed to stocks as an asset class.

We wouldn’t disagree with that statement. But the people voicing it – Ken Henry, Lindsay Tanner, Jeremy Cooper and David Murray – may not necessarily be speaking out of the goodness of their hearts. If you make the argument that Australian investors are over-exposed to one asset class, then you are implicitly making the argument they should have more money in another asset class.

In other words, the people who are arguing that Australians have too much money in stocks may also be arguing that Australians have too little money in bonds. And since the corporate bond market is relatively immature, you’d need a bigger, more liquid, and nominally “safer” bond market to park super money in.

Presto. Change-o. You now have an argument for why larger government debt is a GOOD thing. It gives super funds another, “safer” asset class in which to park your retirement savings. And while we’re at it, let’s just lift your compulsory super contribution from 9% to 12%, with a certain percentage mandatorily going into fixed interest assets (government bonds, hush).

You don’t have to be too imaginative, or too paranoid, to see how all this is trending. But you don’t have to be passive either. Now more than ever is a good time for you to meet with your spouse and financial advisor to decide how you want your assets allocated. And decide where your money is going to work best for you in the coming years. More on that question tomorrow.

Regards,

Dan Denning
for The Daily Reckoning Australia

From the Archives…

Fake Savings, Detached Investments and the Mining Boom
2012-04-06 – Nick Hubble

Catch QE-22
2012-04-05 – Greg Canavan

How to Avoid Investing Idiocy by Ignoring the Fed
2012-04-04 – Dan Denning

Warren Buffett Scorns Gold. Bad Move!
2012-04-03 – Addison Wiggin

Heralding the Unsung Benefits of Frontier Markets
2012-04-02 – Joel Bowman

Dan Denning
Dan Denning is the Editor-in-Chief of The Daily Reckoning Australia and the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 as a small-cap analyst. From 2000 to 2005 he was the managing editor of Strategic Investment, where he recommended gold and warned of the US housing bubble. Dan has covered financial markets from Baltimore, Paris, London and, beginning in 2005, Melbourne Australia, where he is the Publisher of Port Phillip Publishing. To follow Dan's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.

7 Comments

  1. TPL001 says:

    Dan,

    Not many Australians seem to be aware of AOFM.gov.au nor the rapid increase in government issued debt. I have been monitoring this baby for some time – oh how it grows! And as you have noted, at a healthy monthly clip. And what do we get for our money?

    I recall a year or two ago, when it grew from around ~AUD50BN to its present ~AUD230+BN, that Prime Minister Rudd or Treasurer Swann did not wish to mention the “B” word, but rather spoke in terms of 200 or 300!

    Further, I recall the debate early I believe in the 2000s when the fixed income community wanted the government to issue government bonds so that they would have something to trade – liquidity. Go figure.

    And here we have the Labor party, subjecting us to good old Keynesian expansionary fiscal policy which leaves a debt in its wake. It is interesting to note that a number of commentators, including mainstream economists, had thought that Keynes had died – no really, that the penchant for a fiscal rescue package, under the rubric of fixing a “problem” of insufficent aggregate demand — I’d like to see them measure that and justify it from a marginal utility/subjective value perspective — was all but forgotten. Keynes has apparently been resurrected. Oh, yes, and everyone can vaguely turn and state that it saved the economy from a worse fate. Stated numbers and justification for government debt-induced expansion that has saved the Australian economy vis-à-vis the alternative, please, for the ~AUD200+BN cost.

    Granted. There are some activities run by the state which require upkeep and investment by the state; but a pro-expansionary fiscal program has nothing to with this.

  2. shortchanged says:

    One day Dan, everyone will come to realize that banks, are nothing but Ponzie schemes, Governments are on the whole a waste of space, and taxation, theft by deception. I used to believe that financial matters should be taught at school, now i am not so sure. Notwithstanding the good it would do for some, it seems overall that the young do not care, and therefor it may be better for them to be left ignorant. Maybe i am wrong, but i have yet to see or hear of any of the young protesting about the state of affairs of the world. It seems they are more interested in the latest i thingy.

  3. Rob CA says:

    Lifting the compulsory contribution rate from 9% to 12% is evidence that the current cash flows into the industry are not keeping up with the outflows to pensions, commissions and profits. In other words the superannuation industry is one giant, government mandated ponzi scheme that is drying up.

    Next step to look forward when the SHTF will be legislation by the government for a percentage of all superannuation funds to be invested in government bonds to “protect” superannuation funds. Whitlam did it in the 70′s mandating that 30% of superannuation assets to be held in government bonds and so it will happen again because, like in the 70′s, a Labor goverment is broke again.

  4. Don says:

    This is no news to me, this was always where your super money was intended to go. What’s the expression? Never get between a politican and a bucket of money – well is half a trillion big enough for you?

    Give it another 10 years or so and lump sums will be a thing of the past – pensions (based on your “super balance”) for everyone!

  5. Don says:

    Oh – the other sweet thing about your own citzens holding government debt? Well if they are still working then you get to tax the bond returns as well – so effectively the government gets a discount on the interest it pays to its own people of 15%. Don’t think the example of Japan has gone unnoticed.

  6. Andrew says:

    Hi Dan, you make comment about a portion of an individuals superannuation being required to be in government bonds, is this intended legislation or a potential path for the government to head down?

  7. Michael says:

    To be fair, Dan, this part of the article isn’t quite correct:

    “The Australian government lifted the debt ceiling from $75 billion to $200 billion two years ago. Then, in the middle of last year it lifted the ceiling again to $250 billion.”

    I have no quarrel with the suggestion the maximum bonds issues was raised in the previous budget to $250 billion from $200. But the government has had a 200 billion effective bond limit since Howard’s time. The difference was that while 75 billion was the bond limit able to be issued by the RBA under the Inscribed Stock Act and the Loans Securities Act, the Treasurer was empowered under separate legislation to issue a further 125 billion at his own discretion. 125 + 75 = 200 billion.

    The 75 -> 200 billion was merely taking that discretionary bond issue out of the Treasurer’s hands and putting the entire bond issue squarely under the Inscribed Stock Act, i.e. no discretion for the Treasurer to issue another 125 billion off his own bat. It wasn’t an increase to the bond ceiling.

Leave a Comment